CPA Exam: FAR · Select Transactions
CPA Exam: FAR: Revenue Recognition and Leases Concepts
Importance ★★★★★ · 50% (estimate)
Written by AI. Only units that passed a separate AI check (re-reading facts and numbers) are published. Tell us if you find a mistake.
Overview
This chapter covers two standards that shape most business transactions: revenue from contracts with customers and leases. Revenue follows one five-step model for all industries, and lease accounting puts nearly all leases on the lessee's balance sheet.
The five revenue steps are: identify the contract, identify the separate performance obligations, determine the transaction price, allocate the price to the obligations based on standalone selling prices, and recognize revenue when or as each obligation is satisfied. Variable consideration is included in the price only to the extent a significant reversal of revenue is not probable. Revenue is recognized over time when certain criteria are met; otherwise it is recognized at the point control passes to the customer.
A lessee records a right-of-use asset and a lease liability for both finance and operating leases, except where it elects not to for short-term leases of 12 months or less. A lease is a finance lease if any one of five criteria is met, such as ownership transfer or a lease term for the major part of the asset's remaining economic life. A finance lease shows interest expense and amortization separately, while an operating lease shows one straight-line lease cost.
Key concepts
Five-step revenue model
1) Identify the contract. 2) Identify performance obligations. 3) Determine the transaction price. 4) Allocate the price to the obligations. 5) Recognize revenue when or as each obligation is satisfied.
Memory tipRevenue follows transfer of control, not receipt of cash.
Source: FASB ASC 606 · as of 2026
Performance obligation
A promise to transfer a good or service that is distinct: the customer can benefit from it alone or with readily available resources, and it is separately identifiable from other promises in the contract.
Memory tipA standard assurance warranty is not a separate obligation; a warranty sold as extra service is.
Source: FASB ASC 606 · as of 2026
Allocation by standalone selling price
The transaction price is split among performance obligations in proportion to their standalone selling prices. If a price is not observable, it is estimated.
Memory tipAllocate any discount proportionally unless it clearly relates to specific items.
Source: FASB ASC 606 · as of 2026
Variable consideration
Amounts that can change, such as bonuses, rebates, and penalties, are estimated using expected value or most likely amount, and included only to the extent a significant revenue reversal is not probable.
Memory tipThis limit is often called the constraint.
Source: FASB ASC 606 · as of 2026
Finance lease criteria (lessee)
A lease is a finance lease if any one applies: ownership transfers; a purchase option is reasonably certain to be used; the term is a major part of the asset's remaining life; payments' present value is substantially all of fair value; or the asset is so specialized the lessor has no other use.
Memory tipIf none applies, the lessee has an operating lease.
Source: FASB ASC 842 · as of 2026
Lessee measurement
The lease liability is the present value of unpaid lease payments. The right-of-use asset is the liability plus prepaid lease payments and initial direct costs, less lease incentives received.
Memory tipA lessee uses the rate implicit in the lease if readily determinable, otherwise its incremental borrowing rate.
Source: FASB ASC 842 · as of 2026
Often tested
- Revenue: contract, obligations, price, allocation, recognition.
- Allocate price by relative standalone selling prices.
- Variable consideration is constrained to avoid a significant reversal.
- Both lessee lease types put a right-of-use asset and lease liability on the balance sheet.
- Short-term leases of 12 months or less may be kept off the balance sheet by election.
- Finance lease: interest plus amortization; operating lease: single straight-line cost.
Easy to confuse: Finance lease vs. operating lease (lessee)
| Item | Finance lease | Operating lease |
|---|---|---|
| Balance sheet | Right-of-use asset and lease liability | Right-of-use asset and lease liability |
| Income statement | Interest expense plus amortization expense | Single lease cost, generally straight-line |
| Cash flows: principal portion | Financing | Operating |
3 sample questions
Verified practice questions from this unit.
Question 1. Under ASC 606, when should a company recognize revenue for a promised good?
- ① When control of the good transfers to the customer
- ② When the company receives cash from the customer
- ③ When the contract is signed by both parties
- ④ When the company finishes making the good
▼ Show answer and explanation▲ Hide answer and explanation
Answer: ① When control of the good transfers to the customer
Key point: Revenue is recognized when control transfers
ASC 606 is a control-based model. Revenue is recognized when (or as) the company satisfies a performance obligation by transferring control of the good or service to the customer. Signing, producing, or collecting cash alone do not trigger revenue.
Wrong choices
- When cash is received: collection timing does not decide revenue; cash received early is a contract liability.
- When the contract is signed: signing creates the contract (step 1) but nothing has been delivered yet.
- When production is finished: the good is still the company's until control passes to the customer.
Question 2. A company sells equipment and a one-year service plan together for $900. The standalone selling price of the equipment is $600 and of the service plan is $400. How much of the $900 is allocated to the equipment?
- ① $600
- ② $540
- ③ $500
- ④ $360
▼ Show answer and explanation▲ Hide answer and explanation
Answer: ② $540
Key point: Allocate price by relative standalone selling prices
The transaction price is split in proportion to each item's standalone selling price.
- Total standalone selling prices = $600 + $400 = $1,000
- Equipment share = $600 / $1,000 = 60%
- Allocated to equipment = $900 x 60% = $540
Check: service plan gets $900 x 40% = $360, and $540 + $360 = $900.
Wrong choices
- $600: this is the full standalone price; the $100 discount must be shared by both items.
- $500: this splits the price equally, which ignores the relative standalone prices.
- $360: this is the amount allocated to the service plan, not the equipment.
Question 3. Under ASC 842, how does a lessee generally recognize expense for an operating lease in the income statement?
- ① As interest expense on the lease liability plus separate amortization of the right-of-use asset
- ② As rent expense equal to the cash paid each period
- ③ As one expense for the total payments at the lease start date
- ④ As a single lease cost, generally on a straight-line basis over the lease term
▼ Show answer and explanation▲ Hide answer and explanation
Answer: ④ As a single lease cost, generally on a straight-line basis over the lease term
Key point: Operating lease = single straight-line lease cost
For an operating lease, the lessee still records a right-of-use asset and a lease liability on the balance sheet. In the income statement, however, it shows a single lease cost that is generally spread evenly (straight-line) over the lease term.
Wrong choices
- Interest plus amortization: this two-part pattern is for a finance lease.
- Cash paid each period: if payments are uneven, cash paid differs from the straight-line cost.
- All at the start date: lease cost is spread over the lease term, not expensed up front.