Final answer:
The FASB's new revenue recognition update outlines a 5-step process designed to standardize revenue reporting, making financial statements more comparable and transparent. Examples of accounting profit show how earnings are calculated by subtracting explicit costs from revenues.
Step-by-step explanation:
Understanding the 5 Step Revenue Recognition Process
The Financial Accounting Standards Board (FASB) introduced a new Accounting Standards Update influencing the way companies recognize revenue. This update highlights a universal revenue recognition process applicable across various sectors, designed to improve comparability and transparency within financial statements. Below is an overview of the 5-step revenue recognition process:
Identify the contract(s) with a customer. A contract can be written, oral, or implied by customary business practices and must create enforceable rights and obligations.
Identify the performance obligations in the contract. Performance obligations are promises in a contract to transfer distinct goods or services to the customer.
Determine the transaction price. The transaction price is the amount of consideration a company expects to be entitled to in exchange for transferring goods or services to a customer.
Allocate the transaction price to the performance obligations in the contract. If a contract has multiple performance obligations, a company must allocate the transaction price to each performance obligation based on the standalone selling prices.
Recognize revenue when (or as) the entity satisfies a performance obligation. Revenue is recognized when a customer obtains control of the good or service, which could occur over time or at a point in time.
To provide an example of accounting profit calculations as seen in the provided reference material: A firm with sales revenue of $1 million and explicit costs amounting to $950,000 (labor: $600,000, capital: $150,000, and materials: $200,000) would have an accounting profit of $50,000. This calculation is derived by subtracting the explicit costs from the revenues.
Another example is a company earning $200,000 in revenue with $85,000 in explicit costs, resulting in an accounting profit of $115,000 by applying the same principle of subtraction.