 Hello and welcome to this session in which we would look at the revenue recognition process. Specifically, we're going to be working on step two in the revenue recognition process and the prior recording we looked at step one which is identifying the contract with customers. Now in the real world, identifying the separate performance obligations is the most challenging for companies. Well, for us, it's not as challenging. Hopefully, we will understand the concept and that's all what you need to do. And the reason is this. Once you identify the performance obligation, it means what do you need to do? What is your obligation? What are you expected to deliver? Then you're going to allocate the transaction price to those separate performance obligation or one obligation. If it's one obligation, it's pretty straightforward. If it's more than one, then you have to determine how to allocate this money. Then so point two, step two will influence step four and step two would influence step five because you would recognize the revenue when performance obligation is satisfied. So first you have to identify that performance, then give it a give it a price. Then once you complete it, you have to recognize the revenue. So that's why it's an important step in this process. Now let's identify how do we define or how do we identify the separate performance obligation in the contract? So what is a performance obligation? So let's talk about this word, performance obligation. Well, at the performance obligation, it's a promise. You made a promise to provide or to transfer a goods or service a product to a customer. That's your obligation. That's your performance obligation. When you deliver goods or product, the goods has to be what we called a distinct service, a distinct product or service. Now, what do we mean by distinct? What does this word means? Because we have to define it. Distinct means the customer can enjoy the product, can benefit from the product on its own. So you gave them something and that something is useful to them either on its own or they can use it with something else, other readily available resources. So if they cannot use it on their own, they can use it with something else. In other words, it's useful to them. It's not an incomplete. An incomplete means you give them something that they cannot use. And we'll talk about this a little bit further. Typically, those distinct product usually, they are a standalone product. It means usually the company sell them separately. Typically, this is what you would do. No one's going to buy an incomplete product from you if they cannot use it or if they cannot enjoy it. Also, a distinct product don't have to be integrated with other goods and services. It's a standalone product. Also, not interdependent. Interdependent means if it's not sold with something else, it's not useful. No, those distinct product are totally independent. They are good to go. Also, maybe your competition sells it. This is how we know it's a distinct product. This is how you determine whether it's a distinct product or not. Also, it's available in the market as a separate item. So you can go to the market and you can buy it as a separate item. Then you have a distinct product. So those are the features that you would look for to find out if you have a distinct product or not. Now, we're going to look at specific examples, but it's also important to define what is not explained, what is not considered a distinct product. Because if we understand what's not considered a distinct product, then we'll understand how a distinct product would work. Before we proceed any further, explaining the distinct product versus what's not distinct product, whether you are an accounting student or a CPA candidate, take a look at my website farhatlectures.com. I don't replace your CPA review course if you're studying for your CPA or your accounting courses. My motto is saving accounting students and CPA candidate one at a time by providing resources, lectures, multiple choice, true, false. That's going to help you in your CPA review course, which is aligned with your backer, Roger, Gleam and Wiley. And it's going to help you in your accounting course, whether you are taken intermediate, audit, tax, governmental, so on and so forth. If you're a CPA candidate, I give you access to 1,500 previously released original 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 other connect with me on Instagram, Facebook, Twitter and Reddit. So let's see what is not a distinct product. Well, I'm going to give you a simple example, but hopefully it will make the point. Goods and services that are highly interdependent or interrelated. Well, what would be a good example of this? Well, let's assume I enjoy vanilla chai tea and specifically I enjoy it from Wawa. And because I talk about Wawa and all my lectures, one of a CPA candidate that passed his exam gave me a generous gift card from Wawa. So yes, that's my favorite place in case, you know, hint, hint. So what is, what is vanilla chai is made of? Vanilla chai is made of milk and tea spices. Now it means of other things, but we're simplifying the example. Now, can you enjoy the vanilla chai without the milk or without the spices? So can you separate them? Can you separate the milk and the tea spices and say those are two independent product? Yes, they are two independent product, but I'm not buying milk or tea spices. I am buying a vanilla chai. So a vanilla chai is one distinct product. I cannot break it into a milk. Say I sold the milk, I'll account for the milk, then I'll account for the tea spices. So you can't do that. Why? Because they are highly interdependent. When, when the product is highly interdependent or interrelated, then you don't have this, this product is the distinct product, the cup of, the cup of chai tea. Now, can you enjoy, can you enjoy it separately? No. Now let's assume you want to buy a vanilla chai tea, a cup of that, and also an egg sandwich from Wawa. Are these two separate distinct product? And the answer is, yes, Wawa will, will have a price for this and they will have a separate price for this and they, they can sell them separately. Here you have two independent product, two independent product, because the customer can enjoy each item separately. Remember, we talked about how the customer can enjoy benefit from it. Well, we can, we can eat this and we can maybe buy a fry separately and, you know, enjoy it. It doesn't matter or we can eat it separately. So these are not interdependent or interrelated, although they are two distinct products. So you can, you can, you can sell them separately. So that's the first item. If the product is highly interdependent, then it's not a distinct product. So the chai tea itself is a distinct product, but we cannot say the milk or the tea spices are distinct. In this example, now you can buy milk separately from the supermarket. That's a distinct product. That's a distinct product. Two, also what's not a distinct product is when the company integrate the goods and services promise in a contract into a bundle of goods and services that represent one product or service offered to customer. Here's what's going to happen is this, we're going to take several distinct good, they could be several distinct goods or services, we're going to bundle them and we're going to sell them as one product. How do we know we're selling them as one product? It will be written in the contract. Do you guys remember in the prior recording, we emphasize the concept of contract? In the contract, it will spell out what we need to do. So here's an example of how this works. Let's just assume I entered into a contract with a construction company to build the home from A to Z. A to Z means I'm going to tell them, look, build the home. Once you're done, give me the key and I will, you know, the deal is over. So what would the construction company will have to do? The construction company that I hired, they will have to dig the foundation, pour the concrete, do the wiring, piping, electrical, of course I need the roof, so on and so forth. So notice, these are all independent steps and they can be sold separately by the construction company, but that's not how I am buying them. I told them I'll pay one price, give me the house. So as they complete this, they did not really sell me a distinct product because that's not how the contract is written. So you have to have the whole thing to get to the contract, to the final product, which is giving me the house. So under those circumstances, this is a one product. Let's look at another example that illustrates similar concept but differently. So when do we have multiple performance within a contract? We have to spell it out. So the company promised to sell the goods or services to the customer must be separately identifiable from other promises within the contract. So remember in the previous, in the last example here, we said it's a one product because that's how the contract is written. Let's assume I want to build a website for my business and I contracted with a company called Maze Inc. for the following items. One, design the website. Two, build the website. Three, provide training to update the website. Four, maintenance and support and Maze sells these services on a standalone basis and they can easily separate and identify each task. So now the way we wrote the contract is totally different. Well, I said, okay, here we go. We're gonna go into this contract and here's what's gonna happen. We're gonna have several items here. First, I'm gonna pay you for designing the website. So that's a one performance obligation. They can design the website and I can only agree to this and take this design, go to another company and ask them to build the website. Can't I do that? And the answer is yes. So designing the website by itself is a distinct product because I can enjoy it. I can use it. Remember when we said you could either enjoy it, you can either enjoy the website or what you can do is you can use it with other readily readily available resources. Maybe I have someone at my company that can build the website, just design it for me, give it to me and I will build it. Okay, so it's not good enough by itself but I have something else that I can make it useful for me. So this is what we meant by if it's not readily but you can use it then with some other resources, then building the website. I can ask them to design the website and build the website. That's it. Then I will tell them, look, I don't need any training. I can get a third party, give me training for the site. I can do that. I can also contract with the company for maintenance and support. So the way I wrote the contract, it's a four different tasks. And what's gonna happen is Mays will have to, Mays is selling me four different distinct product. So under those circumstances, the way the contract is written, it's a four distinct product. Although you may think, well, why isn't this example similar to the construction? Well, I cannot use the home because the final product was the home unless I have all those pieces. But this is how I wrote it in the contract. The contract is deliver the home. Here I can write the contract as you are performing these service obligations step by step. So maybe they do the design and I say, okay, thank you very much. I'm gonna build the website, so on and so forth. This is how it's written in the contract. And obviously, Mays will sell also those product are sold separately. So Mays might build a website for some other designer. That's something that they do. So under those circumstances, they would recognize revenue for each step fulfilled, for each step fulfilled. Again, it's all about how the contract is written. So keep that in mind. Okay, let's look at another example. MFARHAT purchased a Toyota RV RAV4. The Toyota dealer offered MFARHAT a one year free SOS button for emergency services. And basically, this is a button in case something happened, you got into an accident, you can click on it and will contact the nearest emergency service. Okay, after one year, if MFARHAT chooses to keep the service, then she needs to pay for the service separately. And she is my wife. MFARHAT is my wife. That's who bought the RAV4. Now, here we go. The SOS cost by itself. So the SOS, if you want to price it, if you want to buy an SOS system in your vehicle, there's an annual fee of $80. But here, they're given my wife one year of a free service. Then she can pay for the rest on her own if she chooses to keep the service. Well, what do we have here? Do we have one or two products sold by Toyota? And obviously, we have two. Why? Items are not interrelated. So we can enjoy the RAV4, the car, without having the SOS system. They're not interrelated. And the item is sold separately. They can sell this item separately for anyone. Here we have a two distinct product. So Toyota can sell the car without the SOS button for emergency services. Now, Toyota cannot say, well, selling the batteries inside the car and selling the tires are sold separately, those are separate distinct items. You can't do that because the car will not function without not batteries, one battery, maybe you need some smaller batteries for other things or the tires. You can't drive the car. It's not a distinct product. So you cannot separate the batteries and the tire, but you can separate this SOS system. Again, these steps in the real world are the most challenging because you have to make a judgment. What is this? What is this product? Can we account for it separately? Yes or no? No. For the CPA exam, for accounting classes, it's not as challenging. What should you do now? Go to farhatlectures.com, work MCQs, work exercises that's going to help you reinforce the concept. In the next session, we'll look at step three in this process, and this is the transaction price. And after step three, we'll look at step four and step five, and by doing so, completing the revenue recognition. Once again, go to Farhat Lectures, invest in yourself. Don't shortchange yourself. Give me a try for a month. 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