Revenue Recognition Under ASC 606: Examples and MCQs
By SimplyCPA · 11 October 2026
On this page (8)
- Core principle: Recognise revenue to depict the transfer of promised goods or services, at the amount the entity expects to be entitled to.
- Steps 1–2: Identify the contract, then the distinct performance obligations in it.
- Step 3: Determine the transaction price, including variable consideration — but only to the extent a significant reversal is not probable.
- Step 4: Allocate the price to each obligation based on relative standalone selling prices.
- Step 5: Recognise revenue when (or as) each obligation is satisfied — over time if one of three criteria is met, otherwise at a point in time.
The five steps
- Identify the contract — approved by the parties, with identifiable rights and payment terms, commercial substance, and collection of the consideration probable.
- Identify the performance obligations — each promise to transfer a good or service that is distinct: the customer can benefit from it on its own or with readily available resources, and it is separately identifiable from other promises in the contract.
- Determine the transaction price — fixed amounts plus variable consideration (discounts, rebates, refunds, bonuses, penalties), estimated using the expected value or most likely amount method and constrained so that a significant revenue reversal is not probable. Adjust for a significant financing component, non-cash consideration and consideration payable to the customer.
- Allocate the price to each performance obligation in proportion to its standalone selling price (SSP). If SSP isn't observable, estimate it (adjusted market assessment, expected cost plus margin, or — in limited cases — the residual approach).
- Recognise revenue when control of the good or service transfers.
Over time or at a point in time?
Revenue is recognised over time if any of these is met:
- the customer simultaneously receives and consumes the benefits as the entity performs (routine services);
- the entity's performance creates or enhances an asset the customer controls (construction on the customer's land);
- the asset has no alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.
Progress is measured with an output method (units delivered, milestones) or an input method (costs incurred to date ÷ total expected costs). Otherwise, revenue is recognised at the point in time control transfers — indicated by a present right to payment, legal title, physical possession, the significant risks and rewards of ownership, and customer acceptance.
Worked example 1: bundled sale
A company sells a machine with two years of maintenance for $110,000. SSPs are $100,000 (machine) and $20,000 (maintenance).
Allocation: machine $110,000 × 100/120 = $91,667; maintenance $110,000 × 20/120 = $18,333.
Revenue: $91,667 on delivery; $18,333 over 24 months (about $764 a month).
Worked example 2: variable consideration
A contractor will earn $1,000,000 for a building plus a $100,000 bonus if it finishes by June 30. It estimates a 70% chance of earning the bonus, but weather risk is high and the outcome is outside its control.
Using the most likely amount, the estimate would include the bonus. But the constraint asks whether including it could lead to a significant reversal. Given the high uncertainty, the contractor excludes the $100,000 until the uncertainty resolves — the transaction price is $1,000,000.
Worked example 3: cost-to-cost over time
A fixed-price contract for $5,000,000 has expected total costs of $4,000,000. Costs incurred in Year 1 are $1,200,000.
Progress = 1,200,000 ÷ 4,000,000 = 30%. Year 1 revenue = 30% × $5,000,000 = $1,500,000; gross profit = $300,000.
If expected total costs ever exceed the contract price, the entire expected loss is recognised immediately.
Other rules worth knowing
- Principal vs agent — if the entity controls the good or service before transfer, it's a principal and recognises gross revenue; if not, it's an agent and recognises only its fee or commission (net).
- Licences — a right to access intellectual property (a brand, updated software) is recognised over time; a right to use it as it exists (a film, functional software) is recognised at a point in time.
- Warranties — assurance-type warranties are cost accruals (ASC 460); service-type warranties are separate performance obligations.
- Contract costs — incremental costs of obtaining a contract (sales commissions) are capitalised if expected to be recovered; a practical expedient allows expensing if the amortisation period is one year or less.
- Contract balances — a contract asset is a conditional right to consideration; a receivable is unconditional; a contract liability is consideration received before performance.
- Bill-and-hold, consignment and repurchase agreements often mean control hasn't transferred yet.
Practice MCQs
1. A software company sells a licence to use its existing software, plus one year of technical support. The licence is functional and distinct. When is licence revenue recognised?
(A) Evenly over one year (B) When the licence is transferred and the customer can use it (C) When cash is received (D) At the end of the support period
Answer: B. A right to use functional IP is satisfied at a point in time. Support is a separate obligation recognised over the year.
2. An online marketplace arranges for third-party sellers to ship goods directly to customers. It never controls the goods and earns a 10% commission on a $200 sale. How much revenue does the marketplace recognise?
(A) $200 (B) $180 (C) $20 (D) $0
Answer: C. It's an agent, so revenue is its net commission.
3. A customer pays $12,000 in advance on January 1 for a 12-month subscription. At March 31, the balance sheet shows:
(A) Contract asset $9,000 (B) Contract liability $9,000 (C) Receivable $3,000 (D) Contract liability $3,000
Answer: B. Three months ($3,000) has been earned; $9,000 remains a contract liability (deferred revenue).
Full coverage is in our FAR revenue recognition notes.