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An Introduction to Contracts With Customers

Do you remember the first sale that you ever booked or made on your own? It was probably pretty exciting — that feeling of elation and top-of-the-mountain. You suddenly realize that you might understand how this whole business thing works and you might be able to do this.

But of course there are practicalities to consider when you make a sale. It can be tempting to recognize revenue right away, but there’s always a risk.

What if the sale cancels, for example? What if it costs more to create the product or service than you’ve booked? It just can be a difficult process to learn the ins and outs of recognizing revenue.

Standards to Recognize Revenue

Fortunately there are standards to use that others have figured out. These standards are a great way for companies to make sure that people understand what they are doing is on the up and up.

Non-accountants must be aware of the concept of recognizing revenue from contracts with customers. Because payments are often not a straightforward affair, accountants have to allocate revenue using specific standards set by national and international accounting boards.

While this information doesn’t seem important for non-accountants to understand, it is. Knowing when revenue can be recognized in your company’s financials affects everyone, from the salesperson’s commission to the marketing budget next quarter.

What are those standards and what are the takeaways from them? This graphic explains it.


An Introduction to Contracts With Customers

To understand and accomplish the new revenue recognition standards, businesses should complete the following five steps: 

1. Identify the contract with your customers

Clearly identify the goods or services provided and describe each party’s right to them


2. Identify your performance obligations

Specify exactly what you owe your customers and explain what defines “good performance.”


3. Determine the price of your products or services

When doing so, don’t forget to consider promotions and other discounts.


4. Allocate a transaction price to the obligations specified in the contract

Align the price of your services with your compnay’s performance obligations


5. Recognize revenue as performance obligations are satisfied


Sales people also must understand the difference between booking and revenue. A booking is when the customer makes a commitment via a contract to buy your services or product.

Revenue is when the revenue “counts” on the books – When accounting can account for the revenue as being recognized.