Apply the revenue model

A signed contract may state one price for several goods and services. Suppose a company signs the contract in November, receives an advance in December, performs consulting work from January through March, and sends its final invoice in April. The signature, cash receipt, work, and invoice occur on different dates. Revenue must follow the transfer of the promised service, not whichever date is easiest to observe.

The company therefore must determine what it promised, how much consideration it expects, and when the customer obtains control of each promised good or service.

Topic 606 organizes that work into five steps.

The five steps determine revenue. Billing and collection then determine whether the balance sheet reports a receivable, contract asset, contract liability, or some combination of those accounts.

One model, many settings

These principles appear in many settings, including consulting projects, software implementations, subscriptions, engineering engagements, and many construction contracts. An industry label can signal that specialized guidance applies. When ASC 606 governs the arrangement, the contract's promises and the way control transfers drive the revenue conclusions.

Some arrangements are governed partly or entirely by other accounting guidance. Those specialized rules are outside this course. Here, the goal is to understand the core revenue decisions and apply them to a new customer contract. Students should also recognize when more guidance may be needed.

Step 1: Identify the contract to account for

A company applies the revenue model to a contract with a customer only when all five of these conditions are satisfied:

1. The parties approved the arrangement and are committed to perform.
2. The company can identify each party's rights to the goods or services.
3. The company can identify the payment terms.
4. The arrangement has commercial substance, which means it is expected to change the risk, timing, or amount of the company's future cash flows.
5. Collection of substantially all the consideration to which the company expects to be entitled for the goods or services that will transfer is probable. This assessment considers the customer's ability and intention to pay when payment is due.

These conditions establish whether the company has a contract to which it can apply Topic 606. A signed document alone does not establish that conclusion. In US GAAP, probable means that an event is likely to occur. ASC 606 does not assign that term a fixed numerical percentage, so the conclusion depends on the available evidence rather than a mechanical cutoff.

The amount the company expects to be entitled to may be less than the stated price when the company expects to grant a price concession. That commercial judgment is different from credit risk. A customer who cannot or does not intend to pay an amount the company still expects to be entitled to may fail the collectibility criterion; the company cannot treat that failure as a price concession merely to qualify the arrangement for Topic 606.

Cash received before Step 1 is satisfied

If the criteria are not met, the company stops before Step 2 and continues to reassess the arrangement. Cash received is generally a liability rather than revenue. For an equipment arrangement that has not qualified as a Topic 606 contract, Customer Deposit Liability describes why the company still owes the customer performance or repayment.

Entry when Step 1 is not satisfied

The company keeps the liability until the arrangement later meets the Step 1 criteria or a limited revenue condition in ASC 606-10-25-7 occurs. Those conditions include contract termination with nonrefundable consideration. They also include circumstances in which the company has no remaining obligations and has received all, or substantially all, nonrefundable consideration.

If the arrangement later qualifies, the company begins applying ASC 606. Any advance for goods or services the company still owes becomes a Contract Liability.

That situation differs from advance payment under a valid service contract. When the contract criteria are met but the service remains unperformed, the credit is a Contract Liability. A company's ledger may use a more specific title, such as Unearned Service Revenue or Deferred Subscription Revenue. The account remains a contract liability under ASC 606.

Entry for an advance under a valid contract

Credit deterioration after a valid contract exists raises a different accounting question. An existing receivable is evaluated under the credit-loss guidance rather than reduced through revenue. A significant change in the customer's ability to pay may also require the company to reassess the Step 1 criteria for the remaining contract. Chapter 14, Receivables, explains the allowance for credit losses under Topic 326. For now, distinguish an inception collectibility failure from a later change in the credit quality of an existing receivable.

Decide whether separate agreements form one contract

Agreements entered into at or near the same time with the same customer or its related parties are combined when at least one of these conditions applies:

• the agreements were negotiated as a package with one commercial objective;
• the consideration in one agreement depends on the price or performance of the other; or
• promises in the agreements form one performance obligation.

Combining contracts changes the set of promises and consideration analyzed in the remaining steps. The fact that two agreements involve the same customer is not sufficient by itself.

Step 2: Identify the performance obligations

Begin with an inventory of the goods and services promised to the customer. Include promises stated in the contract and promises created by the company's customary practices or published policies. Exclude administrative and setup activities that do not transfer a good or service to the customer.

A performance obligation is a promise to transfer either:

• a distinct good or service, or a distinct bundle of goods or services; or
• a qualifying series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer.

Apply both parts of the distinct test

A promised good or service is distinct only when the answer to both questions is yes.

How to answer each question

The next two explanations follow the decision tree in order. Use each one to answer the matching numbered question before moving to the next question.

Question 1: Can the customer benefit from it?

Answer yes when the customer can use, consume, sell, or otherwise benefit from the good or service either on its own or together with a resource that is readily available. A resource is readily available when the customer already has it or can obtain it separately. Answer no when the customer can benefit from the promised good or service only by receiving another promised good or service that is not yet readily available to the customer.

Question 2: Is the promise separately identifiable in the contract?

Consider whether the company:

• provides a significant service that integrates the item with other promises into one combined output;
• significantly modifies or customizes another promised item; or
• provides items that are highly dependent on or highly interrelated with one another.

Answer no when these factors show that the promise is an input to a combined output rather than a separately identifiable promise. Combine it with the specific promised goods or services in the contract to which it is not separately identifiable. Reapply both questions to that combined group. The company continues only until it identifies a group that satisfies both parts of the distinct test; it does not add unrelated promises merely to create a bundle.

The Step 2 conclusion matters in later steps. Each performance obligation identified in Step 2 is a unit of account: the company allocates part of the transaction price to it in Step 4 and determines when to recognize that amount as revenue in Step 5.

Microsoft's revenue note provides a real example of this judgment. Microsoft accounts for some software licenses separately, but it combines certain desktop applications and cloud services when their integration, interdependence, and interrelationship make them one performance obligation. The business setting is different from Atlas, but the distinct-goods-and-services question is the same.

Account for a qualifying series as one performance obligation

The series rule requires a company to account for a series of distinct goods or services as one performance obligation when the goods or services are substantially the same and have the same pattern of transfer to the customer. That pattern exists only when both of these conditions are met:

1. Each distinct good or service in the series would qualify for over-time recognition if the company accounted for it separately.
2. The company would use the same method to measure progress toward complete satisfaction of each distinct good or service.

For example, each day of a qualifying daily monitoring service may be distinct, but the company accounts for the series of daily services as one performance obligation. Separate product deliveries that transfer at points in time do not qualify merely because the products are similar or have the same price.

Step 3: Determine the transaction price

The transaction price is the consideration the company expects to be entitled to for transferring the promised goods or services. Begin with fixed consideration, then evaluate amounts that can change.

Estimate variable consideration

Refunds, rebates, price concessions, bonuses, penalties, and performance payments can make consideration variable. Estimation has two parts. First, select the method that better predicts the amount of consideration to which the company will be entitled. Then apply that method to estimate the amount:

• Expected value: probability-weight the possible amounts. This method often fits a range of outcomes or many similar contracts.
• Most likely amount: use the single most likely outcome. This method often fits an uncertainty with two possible outcomes, such as receiving all or none of a bonus.

Use the chosen method consistently for that uncertainty. The resulting amount is the estimate of variable consideration; it is not automatically included in the transaction price.

The variable consideration constraint is the separate requirement that limits how much of that estimate the company may include in the transaction price. Include an amount only to the extent that it is probable that recognizing it will not cause a significant reversal of cumulative revenue when the uncertainty is resolved. Here too, probable means likely to occur, not a fixed percentage. Relevant evidence includes how much of the outcome is outside the company's control, how long the uncertainty will remain, and whether experience with similar contracts predicts the outcome.

If the company has received or has a right to consideration that it expects to refund, it reports a refund liability for the amount it does not expect to retain. The same expected refund is excluded from the transaction price. The company updates both estimates when the facts change.

Estimation and constraint answer different questions:

• Estimation: Which method better predicts the consideration, and what amount results when the company applies that method?
• Constraint: How much of that estimated amount may the company include in the transaction price without creating a probable significant reversal of cumulative revenue later?

Identify a significant financing component

A contract has a significant financing component when the timing of payment provides a significant financing benefit to the customer or the company. If the customer receives the good or service well before paying, the company may be financing the customer. If the customer pays well before receiving the good or service, the customer may be financing the company.

Why separate financing from revenue? Revenue should measure the price of the good or service when control transfers. An additional amount charged solely because the customer pays later is interest, not revenue from the good or service. Likewise, an advance payment may include financing provided by the customer. Separating the financing effect ensures that revenue reflects the amount attributable to the promised good or service, while the effect of paying early or late is recognized separately as interest over the financing period.

Use this process:

1. Compare payment with transfer. Identify when the customer pays and when control of the promised good or service transfers.
2. Identify who receives the financing benefit. Later payment may finance the customer; early payment may finance the company.
3. Decide whether the financing benefit is significant. Consider the time between payment and transfer, the difference between the promised amount and the cash selling price, and relevant market interest rates.
4. Separate the two components. Measure revenue at the cash selling price when control transfers. Recognize the financing effect as interest over the financing period.

Suppose a company sells equipment to a customer and transfers control of the equipment today. The cash selling price is $100,000, but the contract requires the customer to pay $121,000 two years from now. The two-year delay provides financing to the customer. The company recognizes $100,000 of equipment revenue when it transfers control, not $121,000. It recognizes the remaining $21,000 as interest income over the two years. The contract has not produced extra equipment revenue merely because the customer pays later.

A long interval does not automatically create a financing component. For example, payment terms may protect one party from the other party's failure to perform, or the timing of payment may depend on a future event outside either party's control. In those cases, the payment schedule may serve a purpose other than financing.

Topic 606 permits a practical expedient: a company need not adjust for a significant financing component when it expects, at contract inception, that one year or less will pass between transfer and payment. In this course, a problem requiring an adjustment will provide the cash selling price or the information needed to calculate it.

Step 4: Allocate the transaction price

The first three steps supply the inputs for Step 4. Step 1 established that the company has a contract to which Topic 606 applies. Step 2 identified the separate performance obligations in that contract. Step 3 determined one total transaction price for the contract. Step 4 now answers the next question: How much of that total transaction price belongs to each performance obligation?

The company allocates the transaction price in proportion to the performance obligations' standalone selling prices at contract inception. A standalone selling price is the price at which the company would sell a promised good or service separately to a similar customer in similar circumstances.

If an observable standalone selling price is unavailable, the company estimates it using reasonably available information. Possible approaches include an adjusted market assessment or expected cost plus an appropriate margin. Unless estimating the standalone selling price is the question, this course will provide the amount needed for allocation.

For each obligation:

The final allocations must add to the transaction price. A contract or list price is not automatically a standalone selling price.

Relative standalone selling prices provide a consistent basis for associating consideration with the goods and services transferred to the customer. Without that basis, invoice labels or management preference could move revenue among obligations—and therefore among reporting periods—even though the economics of the exchange had not changed.

Topic 606 contains exceptions for a discount or variable amount that relates to only part of a contract. Apply an exception only when the facts establish all of its conditions. For variable consideration, the payment must relate specifically to an obligation or distinct item, and assigning the amount there must remain consistent with the allocation objective for the contract as a whole.

Step 5: Recognize revenue when control transfers

Step 4 assigned part of the transaction price to each performance obligation. Step 5 determines when each allocated amount becomes revenue. Apply the timing analysis separately because the customer may obtain control of different goods or services at different times.

Begin by determining whether a performance obligation qualifies for over-time recognition. It qualifies when any one of these three conditions is satisfied:

1. The customer simultaneously receives and consumes the benefits as the company performs.

   • Service or software example: A customer receives continuous access to a SaaS application for one year. Each day of access provides benefit during that day; the customer does not wait until year-end to receive the entire benefit.

2. The company's performance creates or enhances an asset that the customer controls as the asset is created or enhanced.

   • Service or software example: A developer modifies software that the customer already controls in the customer's environment. The customer controls the enhanced software as the developer completes the work.
   • Physical-product example: A contractor constructs an addition on land and an existing building controlled by the customer. The customer controls the construction in progress as the addition is built.

3. The company's performance creates an asset with no alternative use to the company, and the company has an enforceable right to payment for performance completed to date. Both parts are required. The asset lacks alternative use when the company cannot readily redirect it to another customer. The payment right must compensate the company for work completed to date, including a reasonable profit margin, if the customer terminates for a reason other than the company's failure to perform.

   • Service or intangible example: An engineering firm develops plans for a customer's unique facility. The plans cannot be redirected to another customer, and the contract gives the firm an enforceable right to payment for work completed to date if the customer cancels for convenience.
   • Physical-product example: A manufacturer builds a turbine to a customer's unique specifications. The turbine cannot be sold to another customer without significant rework, and the contract provides an enforceable right to payment for work completed to date, including a reasonable profit margin.

The examples illustrate the conditions; the product or service label does not determine the answer. Apply the relevant contract, control, alternative-use, and payment-right facts to each performance obligation.

Over-time recognition: select a measure of progress

If at least one condition is satisfied, recognize the allocated amount as the company performs. The company must then choose a measure of progress that faithfully depicts how performance transfers to the customer. An output measure uses results delivered to the customer. An input measure uses resources consumed or efforts expended relative to the total expected inputs. Elapsed time is appropriate only when effort and benefit are transferred evenly through the period.

Accenture example: why cost can measure progress

In its 2025 Form 10-K, Part II, Item 8, Note 2, "Revenues," Accenture explains that it uses costs incurred relative to estimated total costs for certain technology-integration consulting contracts. The note gives the reason:

"Incurred cost represents work performed, which corresponds with, and thereby best depicts, the transfer of control to the client."

The important point is not that consulting companies always use a cost-to-cost measure. Accenture uses that input measure because the costs incurred for these contracts correspond to work transferred to the client. If significant costs did not reflect progress toward transferring the promised service, including them without adjustment would distort the measure of progress. The company would need to adjust the input measure or select a different measure that better depicts performance.

Point-in-time recognition: identify when control transfers

If none of the three conditions is satisfied, recognize the allocated amount at the point when the customer obtains control. To identify that point, consider indicators that control of the promised asset has transferred to the customer, including:

• the company has a present right to payment;
• legal title has transferred;
• physical possession has transferred;
• the customer has the significant risks and rewards of ownership; and
• the customer has accepted the asset.

No single indicator applies mechanically in every contract. Evaluate the indicators together against the transfer of control.

Record and report the contract

Revenue, billing, and cash collection are different events. Their order determines the customer-contract accounts.

In Chapter 1's journal-entry sequence, cash received before service created unearned revenue because the company still owed the service. Chapter 2's accruals and deferrals showed the opposite timing: performance can create revenue and a receivable before collection. ASC 606 retains those debit-and-credit patterns and adds an important distinction between a conditional contract asset and an unconditional receivable.

A receivable is an unconditional right to consideration: only the passage of time is required before payment is due. A contract asset is a right to consideration that still depends on another condition, usually further performance. A contract liability is an obligation to transfer goods or services for consideration already received or due.

The company presents unconditional receivables separately. For the remaining rights and obligations in one contract, the relationship between performance and payment produces a contract asset or a contract liability.

Adobe: why two future-revenue measures differ

Adobe's 2025 Form 10-K, Part II, Item 8, Note 2, "Revenue," includes a section titled "Deferred Revenue and Remaining Performance Obligations." It describes deferred revenue as:

"billings or payments received in advance of revenue recognition"

The same section explains that remaining performance obligations represent:

"contracted revenue that has not yet been recognized"

Adobe reported $7.03 billion of deferred revenue and $22.52 billion of remaining performance obligations as of November 28, 2025. The amounts differ because remaining performance obligations include both deferred revenue and contracted amounts that have not yet been billed. Deferred revenue answers whether billing or payment occurred before performance. Remaining performance obligations answer how much contracted revenue has not yet been recognized. Neither amount is automatically revenue for the next year because Adobe must still satisfy the related performance obligations, and some of the revenue will be recognized after the next 12 months.

Apply the five steps to Fairmont Health

The exhibit below contains the selected terms needed for the accounting analysis. It is a teaching document, not a complete legal agreement. Read the business terms first. Each step then returns to the relevant language and explains what it establishes.

1. Identify the contract

The five conditions require evidence from both the agreement and Sable's customer records.

Together, that evidence satisfies all five conditions. Sable therefore accounts for the agreement as a contract with a customer under ASC 606.

Sable signs a separate agreement with Fairmont's research affiliate two months later. It was negotiated separately, its price does not depend on the April agreement, and its promises do not combine with the April promises. Sable does not combine the two agreements.

2. Identify the performance obligations

Clauses B through D identify the promises and supply the facts needed for the distinct analysis. Fairmont can use the standard analyzer with kits from a qualified supplier. Another qualified vendor can perform the standard installation, which does not significantly integrate, modify, or customize the analyzer. The analyzer and installation are therefore distinct.

Each scheduled kit batch is usable when delivered and is not integrated with another promise. Each batch is distinct and transfers separately at a point in time. The calculations below aggregate the identical batch allocations for display; that presentation does not turn the batches into a Topic 606 series.

Fairmont receives and consumes the calibration-monitoring benefit each day. Each day would qualify for over-time recognition, and Sable uses the same elapsed-time measure for each day. The monitoring services therefore form one series performance obligation.

3. Determine the transaction price

Apply the Step 3 decisions in order:

1. Begin with fixed consideration. Clause E states a fixed contract amount of $360,000.
2. Identify the variable amount and its possible outcomes. If Fairmont processes more than 500 tests by December 15, it receives the $12,000 credit and Sable is entitled to $348,000. If Fairmont does not exceed 500 tests, there is no credit and Sable is entitled to $360,000.
3. Select and apply the estimation method. Because the credit has two possible outcomes, Sable uses the most likely amount. Fairmont processed 780 tests with its prior analyzer, the current year follows the same pattern, and little time remains before the measurement date. The more likely outcome is that Fairmont earns the $12,000 credit, producing an estimated transaction price of $348,000.
4. Apply the constraint. The $12,000 credit is the maximum reduction under the contract. If Fairmont does not earn it, consideration increases to $360,000; it does not fall below the $348,000 estimate because of this uncertainty. Using $348,000 therefore does not expose recognized revenue to a later downward reversal from the usage credit, so Sable does not constrain the estimate further.

Fairmont exceeds 500 tests on December 15, and Sable issues the credit. The uncertainty is resolved before year-end, and the final consideration remains $348,000.

Clause F ties invoices to acceptance, completion, delivery, and quarterly service. The scheduled payments occur close to the related transfers and do not provide either party with a significant financing benefit. Sable therefore does not discount the consideration or recognize a separate interest component. Its transaction price remains $348,000.

4. Allocate the transaction price

Step 3 produced one $348,000 transaction price, and Step 2 identified the obligations that must receive portions of it. Sable's pricing records show standalone selling prices of $200,000 for the analyzer, $40,000 for installation and validation, $120,000 for the kit batches, and $40,000 for monitoring. Sable first allocates the $360,000 fixed consideration in proportion to those prices. Clause E makes the credit depend specifically on kit volume, and assigning it to the kit batches is consistent with the allocation objective for the full contract. Sable therefore assigns the $12,000 variable amount to the kit batches.

The final allocation ties to the $348,000 transaction price.

5. Determine when to recognize each allocation

Apply the Step 5 timing decision to each obligation before calculating the amount recognized through December 31.

The analyzer and installation use different recognition patterns, but both are fully recognized by year-end. The analyzer transfers at one point on May 15. Installation transfers over time, and Sable has completed it by December 20.

The kit and monitoring obligations are only partially recognized by year-end. For the kits, 3 of 12 delivered batches means Sable recognizes 25% of the $96,000 allocation:

For monitoring, Fairmont receives and consumes the benefit as Sable performs. Because the service and benefit are even throughout the three years, elapsed time faithfully depicts progress. Nine of 36 months have passed by December 31:

The completed analysis produces the following obligation-by-obligation summary:

Report Fairmont's year-end balances

By December 31, Sable has invoiced Fairmont $264,000 after issuing the expected $12,000 credit. Fairmont has paid $228,000, leaving a $36,000 unconditional receivable. Sable has recognized $249,000 of revenue.

Sable presents the $36,000 receivable separately from the $15,000 contract liability. The credit to Fairmont has already settled the expected refund, so no refund liability remains at December 31.

Apply the model independently: Northline Components

Northline Components and a customer sign a written agreement for a standard controller and a custom production mold. The agreement identifies both items, requires the customer to pay $40,000 when the controller is delivered and $80,000 as specified mold milestones are reached, and can be terminated only under stated conditions. Both parties are committed to perform. Northline's credit review shows that the customer has sufficient financing and a reliable payment history. The arrangement is expected to change the timing and amount of Northline's future cash flows.

Northline earns another $10,000 if the customer approves the mold by March 31. Approval either occurs or does not occur. At December 31, all engineering tests are complete, the customer has approved every prior mold at this stage, and no remaining factor is outside Northline's control.

The controller is an off-the-shelf product that the customer can use with its existing equipment. Northline also designs and builds a mold for a new product with dimensions unique to the customer. Northline does not integrate the controller and mold, and neither item modifies the other. Their standalone selling prices are $40,000 and $80,000.

The customer pays the $10,000 bonus only if the mold passes the customer's specified approval tests. Northline regularly sells similar molds for $90,000 when they have passed the same tests. Northline delivers the controller on December 15.

The contract prohibits Northline from redirecting the unfinished mold to another customer, and its unique dimensions would make another use impractical. The customer must pay for work completed to date plus a reasonable profit if it cancels for a reason other than Northline's failure to perform. Applicable law makes that clause enforceable. Northline uses labor and machine costs to measure progress because those inputs correspond to the design and production work transferred to the customer. At December 31, qualifying costs incurred are $20,000 and total expected qualifying costs are $80,000. No abnormal waste is included.

By December 31, Northline has billed $40,000 for the controller and an unconditional $15,000 mold milestone. The customer has paid the controller invoice but has not paid the milestone invoice.

Question 1: Should Northline account for the agreement as a contract with a customer under ASC 606?

Question 2: What are the performance obligations?

Question 3: What is the transaction price?

Question 4: How is the transaction price allocated?

Question 5: How much revenue is recognized by December 31?

Question 6: What remains on the balance sheet?

Sources

• FASB Accounting Standards Update 2014-09, Revenue from Contracts with Customers
• FASB Revenue Recognition Implementation Q&As
• Microsoft 2025 Form 10-K, Note 1 revenue recognition
• Accenture 2025 Form 10-K, Note 2 revenue recognition
• Adobe 2025 Form 10-K, deferred revenue and remaining performance obligations