Question

In service companies, revenue is recognized either at a point in time, or over time. Compare and contrast the rules for recognizing revenue under these two circumstances. please answer in your own words.

Answer 1

Accounting Standards Codification (ASC) 606 states that revenue should be recognized when the seller satisfies their performance obligations. Generally, this occurs when (or as) control of goods or services is transferred to customers. Control can be defined as having autonomy over the use and benefits of an asset and preventing others from using and obtaining benefits from the asset.

Each performance obligation requires the determination of whether it is satisfied by transferring the control of goods or services over time or at a point in time.

Performance Obligations Satisfied Over Time -

Revenue is recognized over time if one of the following conditions is met :

1. The customer simultaneously receives and consumes the economic benefits of the provided asset as the entity performs;
2. The seller’s performance creates or enhances an asset controlled by the customer as the asset is created or enhanced; or
3. The seller’s performance creates an asset with no alternative use, and the seller has an enforceable right to payment for performance completed to date.

Recognizing Revenue Over Time -

If a contract meets one of the three criteria to recognize revenue over time, revenue should be based on the completed progress of the performance obligation. Applicable methods may be based on outputs (results, milestones, units produced, etc.) or based on inputs (resources consumed, labor hours, costs incurred, etc.). Judgment is needed to determine which method better reflects the transfer of promised goods or services. One method per performance obligation is used and must be applied consistently to similar performance obligations.

A seller can only recognize revenue covering costs incurred if it cannot measure its completed progress of a performance obligation.

Performance Obligations Satisfied at a Point in Time -

When the criteria to recognize revenue over time are not met, then revenue should be recognized at a point in time (the point when control is transferred). To determine when the customer obtains control of a promised asset, guidance in the ASC 606 should be considered.

Summary -

Whether control is transferred over time or at a point in time is an area that may result in changes in revenue recognition. It is important for management to assess when performance obligations are satisfied. Further, judgment is required to determine which method best measures the progress of the performance obligation.