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Why this topic matters
Financial Accounting and Reporting (FAR) covers the five-step model of Accounting Standards Codification (ASC) 606. Business Analysis and Reporting (BAR) applies it to harder arrangements: long-term contracts with losses, licenses of intellectual property, repurchase agreements, consignment and bill-and-hold, material rights, upfront fees, contract modifications, and principal-versus-agent judgments.
Long-term contracts recognized over time
Construction and similar contracts usually meet an over-time criterion (the customer controls the asset as it is built, or there is no alternative use plus an enforceable right to payment).
- Input method (cost-to-cost): percent complete = costs incurred to date ÷ total estimated costs. Revenue to date = percent complete × total transaction price; current-year revenue = revenue to date − revenue previously recognized.
- Uninstalled materials and wasted costs are excluded from the measure of progress.
- Changes in estimates are applied with a cumulative catch-up in the current period.
- Loss contracts: when total estimated costs exceed the contract price, the entire expected loss is recognized immediately, regardless of the method.
EXAMPLE: Contract price $1,000,000. Year 1 costs $300,000, estimated remaining $450,000. Year 2 costs $400,000, estimated remaining $150,000.
Year 1: 300 ÷ 750 = 40% → revenue $400,000; gross profit = 400,000 − 300,000 = $100,000.
Year 2: total cost now $850,000; 700 ÷ 850 = 82.35% → cumulative revenue $823,529; Year 2 revenue = $423,529; Year 2 gross profit = 423,529 − 400,000 = $23,529 (cumulative profit $123,529).
If instead total estimated costs rose to $1,050,000, the full $50,000 loss would be recognized in Year 2, reversing the $100,000 Year 1 profit (a Year 2 loss of $150,000).
Licenses of intellectual property
| Type | Examples | Recognition |
|---|---|---|
| Functional intellectual property — a right to use the property as it exists | Software, films, music, drug formulas | Point in time, when the customer can use and benefit from the license |
| Symbolic intellectual property — a right to access it as it changes | Brand names, logos, franchise rights, team names | Over time across the license period |
Sales- or usage-based royalty exception: royalties based on the licensee's sales or usage are recognized only when the later sale or usage occurs (or the obligation is satisfied, if later) — no estimate upfront.
Repurchase agreements
| Arrangement | Accounting by the seller |
|---|---|
| Seller has an obligation (forward) or right (call option) to repurchase | The customer does not obtain control — account for it as a lease (repurchase price below original price) or a financing (repurchase price at or above the original price) |
| Customer can require repurchase (put option) | If the customer has a significant economic incentive to exercise: lease or financing. Otherwise: a sale with a right of return. |
Other arrangements
- Consignment: the consignor keeps control (the consignee can't be required to pay until sale and can return goods) — no revenue until the consignee sells to an end customer.
- Bill-and-hold: revenue before delivery only if the arrangement has a substantive reason (customer request), the goods are identified separately as the customer's, are ready for physical transfer, and can't be used or directed to another customer.
- Customer options — material rights: an option to buy additional goods at a discount the customer wouldn't otherwise receive (a loyalty program, a renewal discount) is a separate performance obligation; allocate part of the price to it based on its standalone selling price (adjusted for likelihood of exercise).
- Nonrefundable upfront fees (activation, membership initiation) usually relate to future goods or services and are deferred over the contract period — or longer if they give a material right to renew.
- Principal versus agent: the entity is a principal if it controls the good or service before transfer. Indicators: primary responsibility for fulfillment, inventory risk, and discretion in setting prices. Principals report revenue gross; agents report the net commission.
- Franchise fees: initial franchise rights are symbolic intellectual property (over time); private companies may elect to treat certain pre-opening services as distinct.
- Software as a service: a hosting arrangement where the customer can't take possession of the software is a service recognized over time, not a license.
Contract modifications
| Modification | Accounting |
|---|---|
| Adds distinct goods or services at their standalone selling prices | Separate contract |
| Remaining goods or services are distinct from those already transferred (but not priced at standalone selling price) | Prospective — treat as terminating the old contract and creating a new one |
| Remaining goods or services are not distinct (part of a single partially completed obligation) | Cumulative catch-up adjustment |
Contract costs
- Costs to obtain a contract (incremental commissions) are capitalized if recoverable — the practical expedient allows expensing if the amortization period is one year or less.
- Costs to fulfill a contract are capitalized if they relate directly to a contract, generate resources used to satisfy it, and are recoverable (unless covered by other guidance such as inventory).
- Capitalized costs are amortized consistent with the transfer of the related goods or services and tested for impairment.
How it is tested
- Compute revenue and gross profit on long-term contracts, including loss contracts.
- Classify licenses as functional or symbolic, and apply the royalty exception.
- Account for repurchase agreements, consignment, and bill-and-hold.
- Account for contract modifications and material rights.
EXAM TIP: On a loss contract, recognize the whole expected loss now. Candidates often recognize only the loss "for the percentage complete", which understates it.