Revenue Recognition Methods Flashcards

Under ASC 606, which of the following is NOT a required criterion for recognizing revenue over time for a construction contract?

Answer: The contractor can reliably estimate both the costs to complete and the progress toward completion.

While the ability to make reliable estimates was a key determinant under older guidance (like the percentage-of-completion method), ASC 606 shifts the focus to the transfer of control. A contract must meet only one of the other three criteria listed for revenue to be recognized over time.

A contractor uses the cost-to-cost method to measure progress on a fixed-price contract. The total contract price is $5,000,000 and the total estimated cost is $4,000,000. In Year 1, the contractor incurs $1,000,000 of costs. However, this includes $200,000 for specialized, uninstalled materials delivered to the site, for which control has not yet transferred to the customer. What is the amount of revenue the contractor should recognize in Year 1?

Answer: $1,000,000

Under ASC 606, when using a cost-to-cost input method, costs that do not depict the transfer of control must be excluded from the progress measurement. The cost of the uninstalled materials ($200,000) should be excluded from the numerator. However, revenue can be recognized to the extent of the cost of those materials if control has transferred, but in this case, it has not. The progress is calculated on the other costs ($800,000 / $4,000,000 = 20%). The revenue recognized from progress is 20% of $5,000,000, which is $1,000,000. Since control of the materials has not transferred, no separate revenue is recognized for them. Therefore, total revenue is $1,000,000.

A construction contract includes a $100,000 bonus if the project is completed by June 1st and a $40,000 bonus if completed by July 1st. The contractor assesses the probabilities of completion as follows: 60% chance by June 1st, 30% chance by July 1st, and 10% chance after July 1st. Using the 'expected value' method, how much variable consideration for the bonus should be included in the transaction price?

Answer: $72,000

The expected value method calculates the sum of probability-weighted amounts in a range of possible consideration amounts. The calculation is: ($100,000 * 60%) + ($40,000 * 30%) + ($0 * 10%) = $60,000 + $12,000 + $0 = $72,000. This amount would then be subject to the constraint to ensure it's probable that a significant reversal will not occur.

Which of the following revenue recognition methods defers all revenue and costs until the project is substantially complete?

Answer: Completed Contract Method

The Completed Contract Method (CCM) recognizes revenue, expenses, and gross profit only when a contract is fully or substantially completed. The other methods are approaches to recognizing revenue over time as performance obligations are satisfied.

According to the five-step model for revenue recognition under ASC 606, what is the immediate next step after determining the transaction price?

Answer: Allocate the transaction price to the performance obligations.

The five-step model under ASC 606 is sequential: 1) Identify the contract, 2) Identify performance obligations, 3) Determine the transaction price, 4) Allocate the transaction price, and 5) Recognize revenue. Therefore, after determining the price (Step 3), the next step is to allocate that price to the identified obligations (Step 4).

A contractor signs a contract to build a specialized manufacturing facility on land owned by the customer. The contract specifies that the facility cannot be repurposed for another customer without significant modification, and the contractor has an enforceable right to payment for work completed to date plus a reasonable profit. This contract most likely requires revenue to be recognized:

Answer: Over time, because the customer controls the asset (the land and building) as it is created.

Under ASC 606, one of the criteria for recognizing revenue over time is that the contractor's performance creates or enhances an asset that the customer controls as it is created. Since the construction is happening on the customer's land, the customer controls the work-in-progress, satisfying this criterion. The other criterion mentioned (no alternative use and right to payment) also supports over-time recognition.