The Five Key Steps to Revenue Recognition Under ASC 606

The Five Key Steps to Revenue Recognition Under ASC 606

Revenue recognition is at the heart of financial reporting — it tells us when and how much revenue a company can record. Under ASC 606 (U.S. GAAP) and IFRS 15 (international standard), revenue recognition follows a principle-based model that applies across industries.

The standard outlines five key steps every organization must follow to properly recognize revenue. Let’s explore each step with simple explanations and examples.

Step 1: Identify the Contract with the Customer

Everything begins with the contract. A contract is any agreement between two or more parties that creates enforceable rights and obligations.

For a contract to qualify under ASC 606, it must:

• Have approval and commitment from both parties.
• Define each party’s rights.
• Define payment terms.
• Have commercial substance.
• Make it probable that consideration will be collected.

Example:
A software company signs a 12-month subscription agreement with a client. The contract specifies services, price, and payment terms. This is a valid contract for revenue recognition purposes.

Step 2: Identify Performance Obligations

A performance obligation is a promise to deliver goods or services to a customer.

• If a contract includes multiple goods or services, each distinct one is treated as a separate performance obligation.
• A good or service is distinct if the customer can benefit from it on its own and it can be separately identified in the contract.

Example:
A consulting firm signs a contract that includes training, software, and ongoing support. Each of these may be distinct performance obligations if they can be used separately by the client.

Step 3: Determine the Transaction Price

The transaction price is the total amount of consideration a company expects to receive for fulfilling its obligations.

• It may be a fixed amount.
• It may include variable consideration (discounts, bonuses, penalties, rebates).
• It may be in a form other than cash (e.g., barter, credits).

Key point: It’s the amount you expect to be entitled to, not just the invoice amount.

Example:
A manufacturer sells equipment for $90,000 with a potential $10,000 bonus for early delivery. If early delivery is probable, the expected transaction price is $100,000.

Step 4: Allocate the Transaction Price

If a contract has multiple performance obligations, the total transaction price must be allocated to each obligation.

• Allocation is based on the relative standalone selling prices of each good or service.
• Discounts and variable amounts are spread proportionately unless otherwise specified.

Example:
A bundle includes:

• Software license ($80,000 standalone price)
• Installation ($15,000)
• Support ($5,000)

If the transaction price is $90,000, you allocate it proportionately across these obligations.

Step 5: Recognize Revenue When Performance Obligations Are Satisfied

Finally, revenue is recognized when control of the good or service transfers to the customer.

• This can occur at a point in time (e.g., delivery of equipment).
• Or over time (e.g., monthly SaaS subscription, long-term construction project).

Example:

• A car sale → Revenue recognized at delivery.
• A streaming service → Revenue recognized evenly over the subscription term.

The amount recognized = the portion of the transaction price allocated to the satisfied obligation.

📌 Final Thoughts

The five steps — Identify Contract → Identify Performance Obligations → Determine Transaction Price → Allocate Price → Recognize Revenue — form the foundation of ASC 606 and IFRS 15.

For finance teams, ERP consultants, and auditors, these steps ensure revenue is reported in a way that reflects the economic reality of contracts. They bring consistency across industries, reduce manipulation risk, and give investors clearer insights into company performance.