Question

Provide an example of transaction that follows five-step revenue recognition principle. Please identify each revenue recognition steps.

Answer 1

Let us consider the 5 steps in brief:

STEP 1: IDENTIFY THE CONTRACT (OR) AGREEMENT WITH THE CUSTOMER/CLIENT

STEP 2: IDENTIFY THE PERFORMANCE OBLIGATIONS & DELIVERABLES

STEP 3: DETERMINE A TRANSACTION PRICE

STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS

STEP 5: RECOGNIZE REVENUE WHEN PERFORMANCE OBLIGATIONS ARE SATISFIED

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Let us Illustrate the 5 Step Revenue Recognition Principle with an example of an Entity that provides Security Manpower Services (i.e.., Supply of Security Guards and Other Security Related Services).

Basically, The Entity provides the services of hiring and appointing of security guards on behalf of their clients for various locations where their client(s) may have retail stores that may need security personnel round the clock.

STEP 1: THEY WILL FIRST ENTER INTO A CONTRACT WITH THE CLIENT DETAILING THE BELOW CRITERIA:

a) The rights of both Parties (i.e.., The client "Retailer" and the Entity "Manpower Service Provider")

b) Services to be provided (Manpower Supply & Security Consulting Services)

c) Terms of Payment & Commercial Substance

The Service Provider is to charge a fixed monthly rate of $7,200 (calculated at a hourly rate of $10 for 30 days, i.e.., $10 x 24 Hrs x 30 Days) for the Manpower Supply Services AND Security Consulting services at a variable rate $20 per hour provided on Demand only,

Remuneration of both services are payable on the 5th of every succeeding month

In case of Non-Availability of Security Personnel a Penalty of $12 per hour will be deducted from the Transaction Value.  

d) Approval By both parties (Whether written or oral)

STEP 2: IDENTIFY THE PERFORMANCE OBLIGATIONS

In this case, there are 2 Performance Obligation(s) which are:

(A) The provision of Adequate Trained Manpower on a rotation basis at various Retail Outlets on a 24/7 basis at a fixed price net of any penalty.

(B) Security Consulting Services at a Variable price (ON DEMAND ONLY)

STEP 3: IDENTIFY TRANSACTION PRICE

At the end of the month:

• Non-Availability of Security Personnel (In Hours) : 7 Hours (As such a Penalty of $12 per hour has to be deducted from the transaction value)
• 5 Hours of Consulting Services have also been recorded for the month.

HENCE, THE TRANSACTION PRICE is:

$7,200 (FIXED) (+) (5 Hrs x $20) (VARIABLE) (-) (7 Hrs x $12) (PENALTY) =   $7,216/-

STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS

Before recognizing the revenue allocate the transaction price to the performance obligations:

SECURITY MANPOWER SUPPLY: $7116

SECURITY CONSULTANCY: $100

STEP 5: RECOGNIZE REVENUE WHEN PERFORMANCE OBLIGATIONS ARE SATISFIED

Once the Service has been found satisfactory, revenue can be recognized only for the period for which the Performance obligations are duly met and completed.

Hence we can raise an Invoice for the services provided for the month of $ 7216 showing adequate break up of performance obligations and their transaction values.