According to the five steps for revenue recognition, what is the first step?

The first step in the five-step model for revenue recognition established by the IFRS 15 and ASC 606 frameworks is to identify the contract with the customer. This step is crucial because it sets the foundation for all subsequent steps in the revenue recognition process.

When recognizing revenue, organizations must first establish whether a valid contract exists between them and the customer. A contract is defined as an agreement between two parties that creates enforceable rights and obligations. It typically outlines the terms of the transaction, including the parties involved, the goods or services to be provided, the payment terms, and other relevant conditions.

Recognizing a contract ensures that the obligations are clearly defined and that both parties have agreed to the terms, which is essential for determining how and when to recognize revenue. This clarity helps businesses understand what is expected from them and what the customer can expect in return, making this initial step vital for accurate revenue recognition.

Following this initial stage, the other steps can be executed: determining the transaction price, identifying performance obligations within the contract, allocating the transaction price to those performance obligations, and eventually recognizing revenue as the performance obligations are satisfied. This structured approach enhances consistency and comparability in financial reporting.