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Accounting Reference03

Revenue Recognition

ASC 606, performance obligations, deferred revenue, principal versus agent.

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Reference Notes

Deferred revenue and contract liabilities

When a customer pays before the work or the service is delivered, the cash is a liability, not revenue, because the company still owes performance. Revenue is recognized as the obligation is satisfied, evenly over a subscription term or when control of a product passes to the customer, and the balance runs on a schedule per contract. Invoicing is not revenue, and collecting is not revenue; a company that recognizes on invoice overstates its early months and understates the later ones.

Source: FASB ASC 606-10-45Last revised September 2026General information, not advice

ASC 606 revenue recognition: the five-step model

Revenue is recognized in five steps: identify the contract, identify the performance obligations in it, determine the transaction price including any variable consideration and its constraint, allocate that price to the obligations on relative standalone selling prices, and recognize revenue as each obligation is satisfied, over time or at a point in time. The step most companies get wrong is the second one, bundling or splitting obligations by how they invoice rather than by what the customer can benefit from on its own.

Source: FASB ASC 606 (IFRS 15 is substantially converged)Last revised September 2026General information, not advice

Principal versus agent: gross or net revenue

A company that controls a good or service before it transfers to the customer is the principal and reports revenue gross; one that arranges for another party to provide it is the agent and reports its fee net. Indicators include which party is primarily responsible for fulfilment, which carries inventory risk, and which sets the price. Marketplaces, resellers and pass-through billings are where the question arises most.

Source: FASB ASC 606-10-55-36 to 55-40Last revised September 2026General information, not advice

Contract costs: capitalizing sales commissions and fulfilment costs

Incremental costs of obtaining a contract, typically sales commissions that would not have been paid without the contract, are capitalized when the company expects to recover them and amortized over the period the related goods or services are transferred, which can be longer than the initial term when renewals are expected. A practical expedient lets a company expense them when the amortization period would be one year or less. Costs to fulfil a contract are capitalized under this guidance only when no other standard, such as inventory or fixed assets, covers them, and only when they relate directly to the contract, generate resources used to satisfy it, and are expected to be recovered. Capitalized contract costs are tested for impairment, and under US GAAP an impairment is not reversed.

Source: FASB ASC 340-40 (340-40-25-1, 25-5, 35-3, 35-6)Last revised September 2026General information, not advice

SaaS and subscription revenue: ARR, deferred revenue, setup fees, usage

Subscription revenue is recognized evenly over the subscription term as a series of distinct services, however the customer is billed, so annual prepayments sit in deferred revenue and release monthly. A setup or onboarding fee is usually not a separate performance obligation and is recognized over the term, or over the longer period the customer is expected to renew when the fee gives it a material right to renew without paying it again (ASC 606-10-55-50 to 55-53); usage-based fees are recognized as the usage occurs. Annual recurring revenue is an operating metric, not a GAAP number, and the two should reconcile in a bridge the board can follow.

Source: FASB ASC 606 (606-10-55-50 to 55-53 for upfront fees); practiceLast revised September 2026General information, not advice

Construction and long-term contracts: over-time recognition, contract assets and liabilities

A contract whose performance creates an asset the customer controls, or that has no alternative use with an enforceable right to payment, is recognized over time, usually by the cost-to-cost input method: revenue to date equals total expected revenue times costs incurred over total expected costs. Billings ahead of revenue are a contract liability; revenue ahead of billings is a contract asset, or a receivable once only time stands before payment; and a contract expected to lose money records the whole loss as soon as it is evident. Estimates of total cost are updated every period, and revenue moves with them.

Source: FASB ASC 606-10-25-27 (over time); ASC 605-35-25-45 to 25-49 (provisions for anticipated losses, still in force)Last revised September 2026General information, not advice

Warranties: warranty reserve, warranty expense, extended warranties, product guarantees

A warranty that only assures a product works as promised is not a separate sale: the expected cost of honouring it is accrued as an expense and a liability when the product is sold, estimated from the company's claims history (ASC 460-10, ASC 450-20). A warranty the customer can buy separately, or one that provides a service beyond that assurance, such as an extended term, is a separate performance obligation, and part of the price is deferred and recognized as revenue over the coverage period (ASC 606-10-55-30 to 55-35). The warranty reserve rolls forward every close, opening balance plus accruals less claims paid plus changes in estimate, and a reserve that never moves is a number nobody is checking.

Source: FASB ASC 606-10-55-30 to 55-35; ASC 460-10; ASC 450-20Last revised September 2026General information, not advice

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