 Hello and welcome to the session in which we would look at revenue recognition. What is revenue recognition? Revenue recognition is when do we recognize revenue? When do we record revenue? Revenue is one of the most important figures for companies. Revenue drives everything else on the financial statements. It's called the top line for a reason. It is the top line and it's the most important. It drives your earnings before interest and taxes. It drives your earnings per share, which in turn will drive your stock price. A company cannot exist without revenue or they might be able to exist for a short period of time, very short period of time, if the investors kept investing money. But without revenue, you can't have a profit. Without revenues, you should not be incurring any expenses. So revenue is important. In the real world, revenue is subject to fraud. So that's why revenue recognition is important. Gap had numerous standards in the past and this is, I'm going to give you a little bit of background information. Over 100 standards for revenue recognitions and some of them were inconsistent with each other. That's in the U.S. Globally, IFRS had only one general standard and some limited guidance. So what they decided to do, they decided to combine and create one sets of revenue recognition for both U.S. and IFRS. So FASB and the AISB, that's what they agreed on and they came up with something called revenue from contract with customers. And the key word is contract. We need to talk a little bit more about contract. So the purpose of this convergence is to improve comparability across countries, companies, industries, because if investors wants to learn about Sony's revenue, it should be easy to read Sony's financial statement, or if you want to learn about a European company, Adidas, or a U.S. company, it should be all the same in how they recognize revenue. The purpose also is to simplify the preparation of financial statement and also help the users understand how revenue is recognized. Specifically, they used something called the asset liability approach and this approach state that revenue is driven by measurement of assets and liabilities arising from the contract. So basically what they said, when we need to recognize revenue, look at the contract and see how the contract is changing the assets of the company. For example, a count receivable, do you have, do you expect you have a legal expectation to receive the money or the liabilities are we having a liability because of this contract? So this is what they said, the contract will drive this asset liability, what's called asset liability approach. So revenue is driven by how the contract is changing your assets and your liabilities. Specifically, they have five steps of revenue recognition and to illustrate those five steps, I'm going to just work a simple example, but those five steps will be covered in details later on. In this session, I will cover one step of them and that's identify the contract with customers. And we're going to start with a simple example. Let's assume Tesla entered into a contract to sell the Model Y for 75,000. This is the Model Y to be delivered 60 days from the day. First thing is, do we have a contract? Well, the answer is yes, we have a contract. Maybe the customer went online to Tesla and input the information and that's the contract or maybe the customer walked into Tesla's dealership and one of the malls in the US and signed some paperwork. So somehow there is a contract. Does it have to be in writing? We'll talk about the contract later on on the next slide, but the point is there is a contract. There is an agreement between a buyer and Tesla. That's the first thing. The second thing is, the contract will have to identify the separate performance obligation in the contract. Now, for the sake of simplicity, there's only one performance obligation and that is what? Tesla has to deliver the car to the customer. That's it. So identify the separate. There's only one because we're keeping this example simple. One obligation and that's to deliver the car. Now, for example, if Tesla would want to sell a maintenance agreement on the vehicle, then that will be a separate performance obligation. But here we're assuming one obligation. Step three in the revenue recognition five-step process is determine the transaction price. That's easy. The transaction price is 75,000. We're going to have a whole session about determining the transaction price, which is because sometimes it's not as straightforward or simple. Then we're going to allocate. Once we determine the price, once we determine the price, we're going to allocate the price to the obligation, to the separate performance obligation. Once again, we have one thing here, one price, one obligation. It's easy. So the 75,000 is toward the car and Tesla would recognize revenue when each performance obligation is satisfied. They only have one and that one is to deliver the car. So revenue is recognized when Tesla perform the obligation. And when does Tesla perform the obligation? They're hoping 60 days from today they will perform the obligation. So in this session, we're going to focus specifically on identifying the contract with customers. We need to know what are the pieces, the different pieces in a contract in order to understand step one. Before we proceed any further and cover step one, I would like to remind you whether you are a student or a CPA candidate to take a look at my website farhatlectures.com. My motto is saving CPA candidate and accounting students one at a time by providing new resources. I don't replace your CPA review course. I'm a useful addition to your CPA review course. And this is a partial list of all my accounting courses, intermediate, international, governmental, audit, tax, so on and so forth. I provide you lectures and multiple choice. My CPA material is aligned with your Becker, Wiley, Gleam, Roger or Miles. I also give you access to 1500 originally released, previously originally released AI CPA questions with detailed solution. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with others, connect with me on Instagram. I'm trying to grow my Instagram, Facebook, Twitter and Reddit. So let's now dive a little bit more into step one. Identify the contract with customer. Well, what is a contract? That's the first thing we need to know. Well, it's an agreement that create enforceable rights and obligation. Two parties agree to the contract. You cannot have a contract with one party agreeing if the other party don't agree. If you want to sell me something, you send me a contract. Well, you send me the contract. You signed it. Well, if I didn't sign the contract, there is no agreement. So it has to be by both parties. And the contract doesn't have to be in writing. If it's in writing, it's helpful. It's good. It's better to have a contract in writing, but sometimes it's not feasible to have a contract in writing. Because let's assume you want to buy something from the store, you walk into the store, you pick it up from the shelves, you walk to the register and you buy it. You don't need a contract to do that. So basically, or you don't even have to talk to anyone, for example, if you pick up something in the supermarket, sometimes you have what's called the self checkout. You check it out yourself. That's also a contract. You're taking the item, you're paying for it. So the contract is implied. Sometimes the contract is oral. If the individual agree, and that could be two car dealerships or any two individuals can agree to buy and sell. And as long as they trust each other, it's an oral contract. Or sometimes it's the contract is customary. For example, when your inventory reaches a certain level, I send you the product. I don't have to talk to you. This is customary in the industry because you need the product and you are relying on me. So the contract doesn't have to be in writing. It can be implied. But the point is you have to have some sort of a contract. This is the foundation. If you don't have a contract, whether it's in writing or implied, you don't have revenue because you need something. The contract should also have five additional criteria. We're going to go over these criteria separately. One is commercial substance. Commercial substance, sometimes it's called a protective clause not to inflate revenue. Simply put, when you go into a contract with someone, that contract is for an actual business transaction. And you're not only shuffling papers to inflate your revenue. Simply put, I would say, okay, let's do this. Let's sign this contract for this period. And I will sell you the stuff. And next period, I will buy it back. Now, what you did is you inflated your revenue and you're buying back the product. Well, it has to have an actual business reason, not shuffling papers. It has to have business sense, economic substance. We are entering into a transaction because there's a benefit for you and a benefit for me in a sense that it's a business benefit. Both parties, as I told you, have to approve the contract. Otherwise, the contract is not enforceable. And we talked about this. Also, you cannot have a termination clause that you can easily exit. If we have a contract and you can easily exit, there are no consequences for breaking the contract. You really have no contract because you can at any point leave exit. There is no real a true contract. Three, you have to identify the payment. Now notice here, you don't have to be specific in terms of the payment, the consideration. We'll talk about payment later on. There's one whole section about how to determine the payment. You have to have enough information to determine the price or be able to estimate the price on the contract. If it's easy, like in our contract with Tesla, that's fine. Or for example, let me just kind of make this a little bit more interesting. For example, when you bought this Tesla, Tesla would say, look, if our stock price above $1,000, we're going to reduce 5% of your selling price. So when you signed the contract today, it's $75,000. Then, well, if the stock price of Tesla on the day that we sell it to you, we're going to give you a 5% discount. Well, it's not fixed. It's not specific. But I just made up this example. Just to tell you, it doesn't have to be specific. We'll talk about that later on. But this is just a fictitious example. Also, the contract will have to identify rights to goods and services. Exactly. What am I getting? What am I paying for it? What am I getting? Okay. I know what I'm paying for. I know how much I'm paying, but what am I getting in return? You have to identify, what am I getting? Also, collectability. If you cannot collect the money from a contract, you're basically a charity. That's not really a true contract. Now, sometimes you may enter into a contract, and collectability from that person is susceptible because they're really shaky, but you still want to make the sale because they might pay you. Under those circumstances, when collectability is susceptible, you're not really sure, but you want to take your chance, then you would use cash basis accounting. What's cash basis accounting? You wait until you get paid, and this is where you really recognize the revenue. You would use cash basis, not a cruel basis, not what we are learning here. Now, what should you do now? The best way to learn more about this is to go to my website, farhatlectures.com, and work MCQs, work through false questions, look at exercises that's going to help you reinforce the concept. In the next session, we're going to be looking at step two on the contract, and that is, after we have a contract, we have to know what are the obligations, the performance obligation in the contract, and we'll have a one session about performance obligation, and we'll have a one session for determining the price, so on and so forth. Invest in yourself, invest in your career. Don't shortchange yourself. Go to farhat, subscribe, try it for a month. You like it, you keep it. If it's helping you, if not, you let it go. Good luck, study hard, and of course, stay safe.