CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingHard
A company recognized revenue from a contract to install specialized machinery. The contract stipulated that payment was due 30 days after installation, but the customer could return the machinery within 60 days of installation for a full refund if it did not perform to specifications. The company determines that the customer has a significant economic incentive to return the machinery if it does not perform as expected, and the likelihood of return is difficult to estimate reliably. When should the company recognize revenue under ASC 606?
- AUpon signing the contract.
- BUpon installation of the machinery.
- CUpon receipt of cash payment.
- DUpon the expiration of the 60-day return period.
Show answer & explanationAnswer & explanation
Correct answer: D. Upon the expiration of the 60-day return period.
ASC 606 requires revenue to be recognized when performance obligations are satisfied. In this scenario, the company has a significant variable consideration (the right of return) that is difficult to estimate reliably. Revenue recognition is deferred until the uncertainty is resolved, which occurs upon the expiration of the return period.
Why the other options are wrong
- A. Revenue is not recognized upon signing the contract, as performance obligations (installation and successful operation) have not yet been satisfied.
- B. While installation satisfies a performance obligation, the variable consideration (right of return) makes revenue recognition uncertain until the return period expires.
- C. Revenue recognition is based on satisfying performance obligations, not necessarily on the receipt of cash payment, which is a financing activity.
Variable Consideration (ASC 606)
The portion of the transaction price that is contingent on future events or conditions, such as discounts, returns, rebates, or performance bonuses.
- Estimate variable consideration at contract inception.
- Constrain estimates to prevent overstatement of revenue.
- Update estimates at each reporting period.
Memory trick: Uncertainty's end, revenue's friend.