Revenue recognition now follows five steps, not cash timing

The record

On 28 May 2014 the Financial Accounting Standards Board, working jointly with the International Accounting Standards Board, issued Accounting Standards Update No. 2014-09, codified as Topic 606, Revenue from Contracts with Customers. FASB's own summary, FASB In Focus, describes the update as replacing numerous industry-specific GAAP revenue rules, including separate guidance for software and real estate, with a single framework built around a five-step model: identify the contract, identify the performance obligations, determine the transaction price, allocate that price across the obligations, and recognize revenue when or as each obligation is satisfied. The core principle the update states is that revenue is recognized when control of a promised good or service transfers to the customer, in an amount reflecting the consideration the entity expects to be entitled to.

What the documents establish

FASB In Focus is the standard-setter's own plain-language account of what it issued, and it is explicit that the update governs when revenue appears in financial statements, not when cash is collected. A company can satisfy a performance obligation, and so recognize revenue, before or after it receives payment. The document also sets out the effective dates FASB itself adopted: annual periods beginning after 15 December 2017 for public organizations, and originally 15 December 2018 for other organizations. A second FASB document, Accounting Standards Update No. 2015-14, issued in August 2015, is the actual amendment that deferred the original 2016 and 2017 dates by one year; a further 2020 update, described in the same In Focus summary, pushed the nonpublic date to periods beginning after 15 December 2019 for entities that had not yet issued financial statements as of 3 June 2020. Reading the two together shows a standard whose effective date moved twice before most private companies ever applied it.

The operating read

This is editorial, not FASB guidance: a founder reading a revenue recognition memo or an S-1's critical accounting note should treat any reference to performance obligations as a signal that Topic 606 governs, and should ask how management separated distinct promises in a bundled contract, such as a subscription sold with implementation services. Steps 2 and 4, identifying obligations and allocating price among them, are usually where a growth-stage company's revenue policy differs most from its bookings figures, and where cross-company comparisons break down if the underlying allocation judgments differ.

What to check before you decide

Before treating a reported revenue figure as comparable to another company's, or as a proxy for cash collected, check the following against the company's own disclosures and your accountant's reading of them:

• Does the revenue recognition note identify the performance obligations in a typical contract, and does revenue timing differ from invoicing or cash collection timing?
• Which effective date applied to this company, public or nonpublic, and was early adoption elected?
• Where a contract bundles distinct goods or services, how did management allocate the transaction price among them, and is that allocation disclosed?

Topic 606 changed how revenue is measured and reported, not how or when a customer's payment arrives; conflating the two is the most common misreading of a revenue recognition footnote.