What Method Should I Use to Recognize Revenue?
Revenue may be recognized on a progress towards completion basis as performance obligations are satisfied over a period of time, as opposed to at a specific point in time. ASC Topic 606, Revenue from Contracts with Customers requires all contracts that fall under this category to use one of two acceptable methods for measuring progress – either the input or output method. Application of one method over another can result in material differences in revenue recognition timing. For fair financial statement presentation, the chosen method must be appropriate in the contract circumstances to faithfully reflect the substantive transfer of goods or services to the customer. In addition, it must be consistently applied across similar contracts.
The output method focuses on the direct value transferred to a customer, measuring results achieved as control of easily measured and observed goods or services are transferred compared to total estimated outputs needed to complete the contract. Outputs may include achieved milestones. In some circumstances, the contractual right to invoice may be used to recognize revenue as a practical expedient. The objective is to correlate revenue recognition with actual substantive contract performance.
The input method focuses on effort or costs incurred to date as an indirect measure of performance obligation satisfaction, as actual outputs are not easily measured or observed. Total inputs required to satisfy a performance obligation must be estimated (e.g., time, materials, or other appropriate measures) and then proportionate efforts expended to date are used to determine revenue recognition. Only inputs that directly contribute towards contract completion are included in the measurement, which excludes waste, inefficiency, and similar.
If contract progress cannot be reliably measured based on either the input or output method, then revenue may only be recognized to the extent of recoverable costs incurred until measurement becomes possible.