The 5 Step Model of Revenue Recognition

Jet Blue Case Study

Will the new revenue standard provide more decision-useful information than prior U.S. GAAP?

Generally speaking, revenue recognition is the process of recording revenue in a company's accounting records. However, there are different ways to approach revenue recognition, and each perspective may slightly alter the way that revenue is recorded. For example, the cash basis approach simply records revenue when cash is received, regardless of when the product or service was actually sold. The accrual basis approach, on the other hand, records revenue when the sale is made, even if cash has not yet been received. There are also hybrid approaches that combine elements of both cash and accrual basis accounting. Ultimately, the most important thing is to be consistent in your accounting methods so that your financial statements accurately reflect the financial health of your business. With that said, there are some important points to consider in the case of Jet Blue and the new revenue standard.

As Deloitte (2021) explains, “the core principle of the revenue standard is to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods and services” (p. 1). One reason for the revenue recognition principle is to ensure that financial statements provide a true and fair view of an entity's financial position. If revenues were only recognized when cash was received, then entities could manipulate their financial statements by delaying recognition of revenue until they needed it. Thus, Deloitte (2021) adds that “significant judgments frequently need to be made when an entity evaluates the appropriate recognition of revenue from contracts with customers. These judgments are often required throughout the revenue standard’s five-step process that an entity applies to determine when, and how much, revenue should be recognized” (p. 1). To assist in making those judgments, the FASB and IASB issued in 2014 a new revenue recognition standard.

The new revenue standard would provide more decision-useful information than prior US GAAP because it uses a 5-step model:

1. Identify the contract

2. Identify the performance obligation(s)

3. Determine the transaction price

4. Allocate the transaction price

5. Recognize revenue when (or as) each performance obligation is satisfied.

This methodology provides a more granular and holistic view of an entity’s revenue streams, which is especially useful in industries with complex products or services like Jet Blue. For example, a company like Jet Blue would need to track revenue more closely and have systems in place to capture all relevant data points (KPMG, 2019). Jet Blue would be using information such as flight times, ticket prices, and passenger counts, onboard purchases, excess baggage charges, change fees, in-flight entertainment, Fly-Fi, ancillary services like EvenMore Space, its customer loyalty program, and more to fill out its pricing model under these new standards (Booth et al., 2017). By using this data as decision-useful information, Jet Blue would be applying the FASB’s 5-step model of revenue recognition, and the company would be able to provide accurate financial reports that investors and other stakeholders could rely on. The 5-step model would provide investors with more detailed and transparent information about the company’s revenue streams. This would in turn enable stakeholders to make more informed investment decisions.

In addition, the 5-step model is more principles-based than prior US GAAP, providing greater flexibility to account for transactions in a way that best reflects their underlying economic substance. Under the new model, accountants would need to exercise professional judgment in applying accounting principles to transactions, which could result in different treatments of similar transactions by different companies. However, the overall goal is to provide financial statements that better reflect the economic reality of the underlying transactions and to standardize this process across industries and sectors. In short, it means that businesses must consider a number of factors, including the timing of the delivery of goods or services, the completion of any necessary performance obligations, and the amount of risk involved. Yet, making the correct decision is essential in order to provide accurate information to investors and other stakeholders—and that is what the 5-step model is meant to help companies like Jet Blue do.