Navigating Revenue Recognition under U.S. GAAP for the FAR CPA Exam

Introduction

Revenue recognition is a critical component in understanding a company's financial performance. U.S. GAAP offers specific guidelines on when and how to recognize revenue, making this a crucial topic for candidates studying for the Financial Accounting and Reporting (FAR) section of the CPA exam.

Basic Criteria for Revenue Recognition

Under U.S. GAAP, revenue is generally recognized when:

1. A contract with a customer exists.

2. Performance obligations are identified.

3. The transaction price is determined.

4. The transaction price is allocated to performance obligations.

5. Revenue is recognized when (or as) the performance obligation is satisfied.

Example 1: Sale of Goods

Suppose Company A sells 100 units of a product at $20 each.

• Debit Accounts Receivable $2,000

• Credit Revenue $2,000

Percentage of Completion Method in Construction Accounting

Construction contracts often span multiple reporting periods. The percentage of completion method is commonly used for recognizing revenue in long-term construction contracts.

The formula is:

Revenue to be Recognized=(Total Estimated Revenue)×(Percentage of Contract Completed)Revenue to be Recognized=(Total Estimated Revenue)×(Percentage of Contract Completed)

Example 2: Construction Contract

Let’s assume Company B secures a construction contract worth $500,000. The total estimated costs are $400,000. At the end of Year 1, Company B has incurred $200,000 in costs, suggesting that it is 50% complete (200,000/400,000).

Revenue to be recognized = $500,000 × 0.50 = $250,000

1. To record construction costs:

• Debit Construction in Progress $200,000

• Credit Cash or Accounts Payable $200,000

2. To record revenue recognition:

• Debit Accounts Receivable $250,000

• Credit Construction Revenue $250,000

3. To record billings (let's assume $230,000 was billed):

• Debit Accounts Receivable $230,000

• Credit Billings on Construction in Progress $230,000

Differences Between Over and Under-Billings

Sometimes, the amounts billed to customers may need to align with the revenue recognized. The difference gives rise to either over-billing or under-billing.

• Over-Billing: Billings on Construction in Progress > Construction Costs

• Under-Billing: Billings on Construction in Progress < Construction Costs

Example 3: Over and Under-Billing

From Example 2, billings were $230,000, and costs were $200,000. Since the billings exceed the costs, this is an over-billing scenario.

• Credit balance in Billings on Construction in Progress: $230,000

• Debit balance in Construction in Progress: $200,000

• Net: Over-billed by $30,000 (Presented as a liability on the balance sheet)

Disclosures

For revenue recognition, U.S. GAAP mandates various disclosures, including revenue disaggregation, contract balances, and the transaction price allocated to the remaining performance obligations.