The Statement:
“The core principle behind this new revenue recognition standard is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled for those goods or services.“
Elaboration:
- “Recognizes revenue”
This means the company records revenue in its financial statements. But when and how much revenue is recognized depends on when the company has actually fulfilled its promise to the customer. - “Depict the transfer of promised goods or services”
- The company must have promised something specific to the customer (a product, a service, a bundle of both).
- Revenue is only recognized when control of that good or service passes to the customer, not necessarily when cash is received.
- Example: If you sell a software license, revenue is recognized when the customer actually obtains the right to use the software—not when the contract was signed or payment was received (unless that’s the same time).
- “In an amount that reflects the consideration”
- Consideration means the payment the company expects to receive from the customer (could be cash, or other forms of value).
- This isn’t always the same as the stated price—it could include discounts, rebates, performance bonuses, or penalties.
- The key is: recognize revenue equal to what you expect to actually be entitled to, not just the invoice price.
- “To which the entity expects to be entitled”
- Revenue is tied to rights earned through performance, not just billing.
- For example, if a contract includes potential bonuses for early delivery, you only recognize that part of revenue if it’s probable you’ll earn it.
- Likewise, if there’s a chance the customer might return goods, you must reduce the recognized revenue by expected returns.
Putting it together in simple words:
The standard wants companies to align revenue with performance. In other words:
➡️ Recognize revenue when you actually deliver what you promised to the customer, and only recognize the amount you realistically expect to earn from that delivery.
It prevents companies from recognizing revenue:
- Too early (e.g., when a contract is signed but nothing has been delivered yet).
- Too late (delaying revenue even though the performance obligation is met).
- Too much (by ignoring discounts, refunds, or variable payments).
Example:
Imagine a company sells 100 laptops to a retailer for $100,000, with the right for the retailer to return up to 10 laptops if unsold.
- Under the principle:
- The company recognizes revenue for only the 90 laptops it expects to remain sold ($90,000).
- The rest is not recognized until it’s clear the returns won’t happen.
This shows how revenue reflects the true economic substance of the deal, not just the invoice.
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