21.2: Revenue Recognition

Question 1

How is revenue recognized if the sale of goods were exchanged for cash and returns not allowed?

Answer 1

Revenue would be recognized at the time of the exchange.

Question 2

How is revenue recognized if the sale of goods were made on credit?

Answer 2

Revenue can be recognized at the time of the sale, and an asset, A/R is created on the balance sheet.

Question 3

How is revenue recognized if payment of goods is received prior to the transfer of foods?

Answer 3

A liability, unearned revenue, is created when the cash is received to offset the increase in the asset “cash”. Revenue is recognized as the goods are transferred to the buyer.

Question 4

What is the IASB and FASB converged standard for revenue recognition? What is the 5-step process for recognizing revenue?

Answer 4

The standard takes a principles-based approach to revenue recognition issues. The central principle is that a firm should recognize revenue when it has transferred a good or service to a customer and should be recognized only when it is highly probable that they will not have to reverse it.

The 5-step process for recognizing revenue:

1. Identify the contract with the customer.
2. Identify the separate or distinct performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the performance obligations in the contract.
5. Recognize revenue when or as the entity satisfies a performance obligation.

Question 5

Define contract.

Answer 5

A contract is an agreement between two + parties that specifies their obligations and rights.

Question 6

What is a performance obligation?

Answer 6

A performance obligation is a promise to deliver a distinct good or service. A distinct good or service needs to meet the following criteria:

1. Customer can benefit from the good/service on its own or combined with other resources that are readily available.
2. The promise to transfer the good or service can be identified separately from any other promises.

Question 7

Define transaction price.

Answer 7

A transaction price is the amount a firm expects to receive from a customer in exchange for transferring a good or service to the customer, which is usually a fixed amount but can also be variable.

Question 8

How is revenue recognized for long-term contracts?

Answer 8

Revenue is recognized based on a firm’s progress toward completing a performance obligation. Progress toward completion can be measured from the input side or output side.

Input side: ie. using percentage of completion costs incurred as of the statement date

Output side: ie. using engineering milestones or percentage of the total output delivered to date

Costs to secure the contract are placed on the balance sheet as an asset. The effect of capitalizing these expenses is to decrease reported expenses on the income statement thereby increasing reported profitability during the contract period.

Question 9

What are the required disclosures under the converged standards for revenue recognition?

Answer 9

Required disclosures:

1. Contracts with customers by category
2. Assets and liabilities related to contracts, including balances and changes
3. Outstanding performance obligations and the transaction prices allocated to them
4. Management judgments used to determine the amount and timing of revenue recognition