B4-M2 Revenue recognition advanced topics

Question 1

What are the five steps approach for revenue recognition?

Answer 1

Nemonics: ISTAR

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

Question 2

How to allocate Transaction price?

Answer 2

Allocated contract $ = SSP / Total of all SSP

Question 3

What is incremental costs?

Answer 3

Costs to obtain contract

Question 4

When should an revenue/loss recognized?

Answer 4

Long-Term Construction Contracts
Recognized either:
Over time = % completion
Point-in-time = Completed contract

Completed Contract
Revenue = when COMPLETED
Losses recognized immediately!

Question 5

Construction contract - when to recognize current asset/liability? Also, How do you account for construction revenue recognized over time?

Answer 5

The excess of accumulated costs plus estimated earnings over related billings will represent a current asset. A liability only exists when progress billings exceed costs and estimated earnings.

Estimated earnings when revenue is recognized over time are calculated as follows:

1. Calculate estimate profit = Contract Price $ − (Costs incurred + Estimated cost to complete)
2. Percent (%) complete = Costs incurred / (Costs incurred + Estimated cost to complete)
3. Calculate estimated gross profit earnings to date = Estimated Profit × % complete

You can then compare Accumulated costs + Estimated earnings vs. Progress billings
= Current Asset or liability

Question 6

Provide the JEs related to the revenue recognition of a construction contract

Answer 6

If Revenue is recognized over time/Point in time (same for both methods):
To record cost:
Dr. Construction in progress (Inventory account)
Cr. Materials, cash, etc.

To record billing:
Dr. AR
Cr. Progress Billings

Record cash received:
Dr. Cash
Cr. AR

JE to record estimated GP during construction (Over time):

Dr. Cost of long term construction contracts
Dr. CIP
Cr. Revenue from LT construction contracts

JE to record estimated GP during construction (Point in time) - No revenue!! (Wait til job is done). Loss are recognized once incurred!

JE to close construction contracts (Over time)
Dr. Progress billings
Cr. Construction in progress

JE to close construction contracts (point in time)
Dr. Progress billings
Cr. Revenue

JE to close CIP to expense (point in time)
Dr. Cost of LT construction contract
Cr. CIP

Question 7

What are the criteria to determine if the revenue should be point in time or over time?

Answer 7

If any criteria below is met, revenue should be recognized over time

1. Entity’s performance creates or enhances an asset that the customer controls
2. Entity has enforceable right to payment for performance completed to date
3. Performance does not create alternative use to the entity

If any of the above is NOT met, recognize point in time

Question 8

What are the main forms of repurchase agreements?

Answer 8

Forward = Must buy back (obligation to repurchase)
Call option = Can buy back (right to repurchase)
Put option = Must buy back (obligation to repurchase) at customers request

Question 9

How to account for sales with repurchase agreement (forward/call option)?

Answer 9

Accounting for the sale will be based on whether the seller must or can repurchase the asset for either
If Buyback price < Original Price = Lease
If buy back price > original price = Financing arrangement

If financing arrangement, entity will (1) recognize asset and (2) recognize financial liability for consideration received from the customer. Difference is interest.

Once the option to repurchase lapses, derecognize Financial liability and recognize revenue

Question 10

How to account for sales with repurchase agreement (Put option)?

Answer 10

Accounting for the sale will be based on whether the seller must or can repurchase the asset for either
If Buyback price < Original Price = Lease (if with significant economic incentive) or sale with right of return (if w/o significant economic incentive ex. market value at the end of term is below the agreed buyback price so customer would most likely obliged the seller to buy back)
If buy back price > original price = Financing arrangement

If financing arrangement, entity will (1) recognize asset and (2) recognize financial liability for consideration received from the customer. Difference is interest.

Once the option to repurchase lapses, derecognize Financial liability and recognize revenue