The 5-Step Model for Revenue Recognition

Interactive Guide to Revenue Recognition

The 5-Step Model for Revenue Recognition

This guide breaks down the core U.S. GAAP principle for recognizing revenue into five manageable steps. Interact with the components to see how they work.

Step 1: Identify the Contract with the Customer

A contract is an agreement that creates enforceable rights and obligations. For revenue to be recognized, the contract must be valid. Use this checklist to see if a contract meets the criteria.

Contract Criteria Checklist

All parties have approved the contract and are committed. Each party's rights to goods/services are identified. Payment terms are identified. The contract has commercial substance. It is probable the company will collect the consideration.

Step 2: Identify Separate Performance Obligations

A performance obligation is a promise to transfer a good or service. You must identify each promise that is *distinct*—meaning the customer can benefit from it on its own and it's separately identifiable.

Example: Separate Obligations

A software company sells a license, installation, and tech support. These are separate if:

The license is functional on its own.
Other companies can perform the installation.
The software works without the tech support.

Result: Three separate performance obligations.

Example: Single Obligation

A construction company builds a custom house. The individual items (wiring, plumbing, framing) are not separate because:

They are highly integrated and interdependent.
The company's main promise is to deliver a finished, combined output (the house).

Result: One single performance obligation.

Step 3: Determine the Transaction Price

This is the amount of consideration the company expects to receive. It's not always the list price and must be adjusted for several factors.

Variable Consideration

Discounts, rebates, performance bonuses. Estimate using an expected value or most likely amount.

Significant Financing

If payment is delayed >1 year, adjust for the time value of money.

Noncash Consideration

Measure at fair value at contract inception (e.g., paying with equipment).

Consideration to Customer

Treat rebates or vouchers as a reduction in the transaction price.

Step 4: Allocate the Transaction Price

If the contract has multiple performance obligations, the total price must be allocated to each one based on its relative standalone selling price. Use the calculator below to see this in action.

Allocation Calculator

Total Transaction Price ($)

Allocation Result

Obligation	Standalone Price	Allocated Price

Step 5: Recognize Revenue

Revenue is recognized when a performance obligation is satisfied by transferring control to the customer. This can happen over time or at a single point in time.

When is revenue recognized?

Customer consumes benefit as it's provided (e.g., monthly service). Company creates/enhances an asset the customer controls (e.g., construction). Asset has no alternative use, and company can demand payment for work to date. None of the above are met.