CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsMedium
A company manufactures custom machinery. It charges customers an upfront non-refundable fee of $20,000 for design and engineering services, which are performed evenly over a 4-month period. The manufacturing of the machinery begins after the design is approved, taking another 6 months. The total contract price is $500,000. How much revenue should the company recognize from the upfront fee in the first month following the contract signing?
- A$20,000
- B$5,000
- C$50,000
- D$0
Show answer & explanationAnswer & explanation
Correct answer: B. $5,000
The upfront non-refundable fee is for design and engineering services performed evenly over 4 months. Therefore, the revenue recognized per month from this fee is $20,000 / 4 months = $5,000.
Why the other options are wrong
- A. Incorrect. This would imply the entire fee is recognized upfront, which is not appropriate if services are performed over time.
- C. Incorrect. This is a distractor based on the total contract price or other calculations.
- D. Incorrect. Revenue should be recognized as the service is performed.
Non-Refundable Upfront Fees (ASC 606)
Under ASC 606, non-refundable upfront fees that relate to activities that transfer a good or service to the customer are generally deferred and recognized as revenue as the related goods or services are provided.
- Must assess if fee relates to a distinct good/service.
- If it does, recognize as that service is delivered.
- If it's an advance payment for future goods/services, defer revenue.
- Often linked to a performance obligation over time.
Memory trick: Five Steps to Revenue: Contract, Obligations, Price, Allocate, Recognize – don't forget the upfront fee has to earn its keep!