CPA Exam: FAR Revenue Recognition and Leases Summary

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.

The transaction price is split in proportion to each item's standalone selling price.

1. Total standalone selling prices = $600 + $400 = $1,000
2. Equipment share = $600 / $1,000 = 60%
3. 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.

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.

A lessee classifies a lease as a finance lease if any one of five criteria is met: ownership transfer, a purchase option reasonably certain to be exercised, a term for the major part of the asset's remaining economic life, payments with a present value equal to substantially all of fair value, or a specialized asset with no other use to the lessor. Ownership transfer meets the first criterion.

Wrong choices

• Half of economic life: 50% is not a major part of the economic life (75% is a common threshold).
• PV is 60% of fair value: this is not substantially all of fair value (90% is a common threshold).
• Standard asset easily re-leased: this is the opposite of the specialized-asset criterion.

The lease liability is the present value of the lease payments not yet paid. Payments are at the end of each year, so the ordinary annuity factor is used.

1. Lease liability = $10,000 x 4.2124 = $42,124

Check: the liability is less than the $50,000 total payments because of discounting.

Wrong choices

• $44,651: this uses the annuity-due factor, which is for payments at the start of each period.
• $50,000: this is the undiscounted total; ASC 842 requires present value.
• $32,124: this subtracts one payment, which is only right when the first payment is made at commencement.

The five steps are, in order: (1) identify the contract, (2) identify the performance obligations, (3) determine the transaction price, (4) allocate the price to the performance obligations, and (5) recognize revenue when (or as) each obligation is satisfied. So the third step is working out how much the entity expects to receive.

Wrong choices

• Identify the performance obligations: this is the second step.
• Allocate the transaction price: this is the fourth step; you must know the price before you can split it.
• Recognize revenue: this is the fifth and last step.

A good or service is distinct only when both tests are met. First, the customer can benefit from it on its own or together with resources that are readily available. Second, the promise is separately identifiable in the contract, meaning it is not highly dependent on or integrated with other promises.

Wrong choices

• Benefit even if highly dependent: this meets only the first test; heavy integration fails the second test.
• Sold separately once a year: separate sales can show the first test is met but are not a required condition.
• Separate invoice line: how an invoice is laid out does not decide what the performance obligations are.

The marketplace does not control the product before it reaches the customer, so it is an agent. An agent recognizes only its fee or commission as revenue.

1. Fee = $200 x 15% = $30

Check: the seller (the principal) keeps $200 - $30 = $170.

Wrong choices

• $200: gross revenue is for a principal that controls the product before transfer.
• $170: this is the amount passed on to the seller, not the marketplace's revenue.
• $0: the marketplace has earned its fee once it arranges the sale, so revenue is not zero.

Under the cost-to-cost input method, progress equals costs incurred divided by total estimated costs.

1. Progress = $200,000 / $800,000 = 25%
2. Revenue = $1,000,000 x 25% = $250,000

Check: gross profit = $250,000 - $200,000 = $50,000, which is 25% of the total expected profit of $200,000.

Wrong choices

• $200,000: this is the cost incurred, not the revenue.
• $50,000: this is the Year 1 gross profit, not revenue.
• $0: that would wait until completion, which is not allowed when revenue is recognized over time.

Revenue is not recognized for goods expected to be returned; a refund liability is recorded instead.

1. Units expected to be kept = 100 - 5 = 95
2. Revenue = 95 x $50 = $4,750
3. Refund liability = 5 x $50 = $250

Check: $4,750 + $250 = $5,000 total billed.

Wrong choices

• $5,000: this ignores the expected returns.
• $4,500: this removes 10 units instead of the 5 expected.
• $2,850: this is the cost of the 95 units, not revenue.