18.01 Revenue Recognition

Question 1

What is the five step model for revenue recognition?

Answer 1

Revenues are recognized by applying a five-step process: 1. Identify the contract; 2. Identify the performance obligations; 3. Determine the transaction price; 4. Allocate the transaction price; 5. Recognize revenue

Question 2

What is the definition of a customer?

Answer 2

A customer is defined as “a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.

Question 3

What is the definition of a contract?

Answer 3

A contract is an arrangement between two or more parties that creates legally enforceable rights and obligations. If either party can terminate the arrangement without penalty prior to either party’s performance, it is not considered a contract.

Question 4

What are the four criteria of a contract?

Answer 4

A contract will conform to four criteria: The parties have approved the provisions and have committed to perform; The rights in the contract and the payment terms can be identified; The contract has commercial substance; Collection is probable (i.e. the customer has the ability and intent to pay).

Question 5

True or false: the contract is required to be in writing.

Answer 5

False. There is no requirement that the contract be in writing. IT may be formal or informal, written or oral, and may even be implicit based on the normal manner in which the entities or individuals act.

Question 6

What is a contract modification?

Answer 6

A contract modification is a change in the scope and/or price of a contract that is approved by both parties. The modification may be in the form of an amendment, a change order, or a variation. It may be written, oral, or implicit from the behavior of the parties.

Question 7

What is a performance obligation?

Answer 7

An enforceable promise to transfer goods/services to a customer.
Distinct performance obligations are those that meet two criteria: 1. the customer must be able to benefit from the good/service on its own or together using other resources that are readily available to the customer; 2. the promise to transfer the good/service is separately identified from other promises in the contract.

Question 8

What is a warranty?

Answer 8

Warranties may be purchased separately or included in the purchase price of the goods to which the warranty relates. If the warranty may be purchased separately, it is a distinct performance obligation.

Question 9

What are the two classifications of warranties?

Answer 9

Warranties are classified as either assurance-type warranties or service-type warranties.

Question 10

What is an assurance-type warranty?

Answer 10

An assurance-type warranty protects the customer from obtaining a product that is not capable of performing at the level that the seller indicated that it would. These warranties are generally only available from the seller. To the seller, an assurance-type warranty represents a contingent liability that is probable and estimable and should be accrued in the period incurred, generally the period of sale.

Question 11

What is a service-type warranty?

Answer 11

A service-type warranty generally provides a customer with repairs in the form of parts and labor in addition to making certain that the product performs as promised. Service-type warranties may be required by law, may extend beyond the reasonable amount of time it should take to evaluate the product’s performance, or may provide services that extend beyond making certain that the asset performs as expected. A service-type warranty is a separately identifiable promise in a contract. A service-type warranty is a distinct performance obligation.

Question 12

What is the transaction price?

Answer 12

The transaction price is the amount of consideration that the entity expects to be entitled to in exchange for transferring goods/services in a satisfactory manner, excluding amounts to be collected on behalf of others, such as sales taxes.

Question 13

What are factors that will affect the amount of revenue that is recognized?

Answer 13

Whether the reporting entity is a principal or an agent in the transaction; Whether variable consideration is exchanged; Whether there are significant financing benefits associated with the transaction; Whether nonmonetary consideration is exchanged; Whether the seller provides consideration to the customer; Whether the seller provides the customer with a right of return.

Question 14

What is the obligation of a principal?

Answer 14

The principal has the obligation to provide goods/services.

Question 15

What is the obligation of an agent?

Answer 15

The agent has the obligation to arrange for another party, the principal, to provide goods/services.

Question 16

When the seller is a principal, how is revenue recognized?

Answer 16

When the seller is a principal in the transaction, the entire amount of revenue will be recognized, and amounts paid to third parties will be recognized as expenses or as a component of cost of sales.

Question 17

When the seller is an agent, how is revenue recognized?

Answer 17

When the seller is an agent, only the net amount of revenue to be retained after paying the principal is recognized.

Question 18

What is the significant factor to consider to distinguish between a principal and an agent?

Answer 18

A significant factor to consider is who has control of the goods/services that are the subject of the contract before they are transferred to the customer.

Question 19

What is variable consideration?

Answer 19

Variable consideration may result from discounts or rebates provided to buyers; credits, price concessions, or incentives; performance bonuses; or penalties.

Question 20

What are deferred revenues?

Answer 20

Deferred revenues (i.e. unearned revenues) are liabilities representing cash received for goods that have not yet been delivered or services that have not yet been performed. Recognition of revenue occurs when the firm provides the good or service, at which point the deferred revenue (liability) is reduced, often by making an adjusting journal entry.

Question 21

What is a contract asset?

Answer 21

A contract asset represents the entity’s right to consideration.
If the entity performs by transferring goods or services to the customer before the customer pays consideration, then the entity may recognize a contract asset (i.e. accounts receivable).

Question 22

True or false: long-term contracts (i.e. construction industry) allow the contractor to bill the customer at intervals, as it reaches various milestones in the project.

Answer 22

True.

Question 23

How is revenue recognized using the percentage-of-completion method?

Answer 23

Over time: as construction is completed. Appropriate portion of total revenue expected from the contract is recorded at end of each period on income statement. Billings and collections are recorded in balance sheet accounts.

Question 24

How is revenue recognized using the completed-contract method?

Answer 24

At a point in time: when construction is complete. No profit/revenue entries are made until completion. Billings and collections are recorded in balance sheet accounts.

Question 25

How are costs reported using the percentage-of-completion method?

Answer 25

Charged against income in proportion to revenues recognized during period. Anticipated losses recognized immediately on the income statement.

Question 26

How are costs reported using the completed-contract method?

Answer 26

Held in CIP account on the balance sheet until completion. Anticipated losses recognized immediately on the income statement.

Question 27

What are the conditions for use of the percentage-of-completion method?

Answer 27

1. Customer consumes benefits of asset(s) as they are delivered; 2. Customer has control over the asset(s) during creation or enhancement; 3. Entity lacks alternative use for asset(s) and is entitled to payment for completion to date.

Question 28

What are the conditions for use of the completed-contract method?

Answer 28

Customer has control over asset(s).

Question 29

What are the measuring progress option for the percentage-of-completion method?

Answer 29

Output method: % complete with respect to output (i.e. milestones reached, units completed)
Input method: % complete with respect to effort put in (i.e. costs incurred, labor hours)

Question 30

What are the two types of losses on long-term contracts?

Answer 30

Single-period loss: When the total gross profit through the end of a given year is less than the gross profit recognized in previous years, a loss has occurred in the given year, although the contract still may be profitable. The completed contract method is unaffected by single-period losses.
Overall losses: When an overall loss on a contract is anticipated, the loss must be recognized in full for both methods. An overall loss occurs when the total estimated costs of the project exceed the contract price.