Ch 18 Flashcards
GAAP: revenue recognition principle: 2 times companies should recognize revenue
1 when realized or realizable
2 when earned
6 common sources of revenue
1 sales 2 fees 3 rent 4 interest 5 royalties 6 service revenue
Revenues are realized when a company…
Exchanges goods and services for cash or claims to cash
receivables
Revenues are realizable when…
Assets a company receives are readily convertible to known
Amounts of cash or claims to cash
Revenues are earned when a…
Company has substantially accomplished what it must do
To be entitled to benefits represented by revenues
4 revenue transactions that allow companies to recognize revenue under the revenue recognition principle?
1 selling products at date delivered to customers
2 when services provided and billable
3 permitting others to use enterprise assets (interest, rent
Royalties)
4 disposing of assets other than products at date of sale
2 common reasons for departure of sale basis?
1 recognize earlier
2 delay recognition
Wen is earlier recognition appropriate?
If there’s high degree of certainty about amount of revenue
Earned
When is delayed recognition appropriate?
If degree of uncertainty concerning amount of either revenue
Or cost is very high
Or sale does not represent substantial completion of earnings
Process
2 types of sales transactions?
Selling products
Providing services
Revenue recognition: at point of sale
Companies commonly recognize revenues from manufacturing
And selling activities at point of sale (usually delivery)
The imputed interest rate is more clearly determinable by either of 2 ways?
1 prevailing rate for similar instrument of issuer with similar
Credit rating
2 rate of interest that discounts the nominal amount of the
Instrument to current sales price of goods or services
Sales with right of return: high rate of returns
High ratio of returned merchandise to sales
Postpone sales until return privilege has substantially expired
FASB: if company sells its products but gives buyer the right to return it, the company should recognize at time of sales transaction only if the following 6 conditions are met…
1 seller’s price fixed/determinable at date of sale
2 buyer has paid or is obligated to pay seller, obligation not
Contingent on resale of product
3 buyers obligation to seller doesn’t change if theft occurs
4 buyer acquiring product for resale has economic substance
Apart from what’s provided by seller
5 seller doesn’t have significant obligations to bring about
Resale
6 seller can reasonably estimate amount of future returns
Bill and hold sales
Result when buyer is not ready to take delivery but takes
Title and accepts billing
Principal-agent relationship
Amounts collected on behalf of principal are not revenue of
Agent
Revenue for the agent is the commission they receive
(Which is usually a percentage of total revenue)
Revenue recognition: Gross method
Record revenue for the full price of the ticket and then
Charging the cost of the ticket against the revenue
Revenue recognition: net approach
Revenue received is the commission for providing travel
Services, not the full fare price
Consignments
The consignor (Manufactures or wholesalers) ships merchandise to consignee (dealer) who acts as agent for The consignor in Selling the merchandise
Consignee charges a commission
Consignment: Account sales
Shows merchandise received, sold, expenses chargeable
To the consignment and the cash remitted
Report consignor periodically receives from the consignee
Trade loading
Crazy practice where manufacturers try to show sales,
Profits and market share they don’t actually have
Induce their wholesale customers (known as the trade)
To buy more product then they can promptly resell
Example of trade loading
Cigarette industry has exaggerated a couple years’ operating
Profits by as much as $600 million by taking profits from
Future years
Computer software industry: channel stuffing
Software maker offers deep discounts to its distributors to
Overbuy and record revenue when software left the loading
Dock
Done when software maker wants to make its financial
Results look good, reduces future earnings
Multiple deliverable arrangements (MDAs)
Provide multiple products or services to customers as
Part if single arrangement
Units In a multiple deliverable arrangement are considered separate units of accounting, provided that 3 things occur…
1 delivered item has value to customer on standalone basis
2 arrangement includes general right of return relative to
Delivered item
3 delivery or performance of undelivered item is considered
Probable and substantially in control of seller
Multiple deliverable arrangements: basis for allocating separate units?
Relative fair value
Relative fair value
What vendor could sell component for on standalone basis
Accounting guidance: sales and discounts
Trade, volume and cash discounts reduce sales revenue
Accounting guidance: sales with extended payment terms
Fair value measurement of revenue is determined by using
fair value of consideration received
or by discounting Future payments using imputed interest
Rate
Accounting guidance: sales with right of return
If there is uncertainty about possibility of return, recognize
Revenue when goods are delivered and return period has
Lapsed
If company can reliably estimate future returns, recognize
Revenue at point of sale
Accounting guidance: sales with buy back
Terms of buy back agreement must be analyzed to
determine if seller transferred risks and rewards of ownership
Accounting guidance: bill and hold sales (recognition depends on 3 circumstances)
1 recognize revenue when title passes to customer and
Seller is only obligated to store item
2 customer makes fixed commitment to purchase goods,
Requests that transaction be on bill and hold basis
3 goods must be segregated, complete and ready for
Shipment
Accounting guidance: sales involving principal-agent relationship (general)
Amounts collected by agent on behalf of principal aren’t
Revenue of agent
Revenue of agent is commission from sale
Accounting guidance: sales involving principal-agent relationship (consignments)
Consignor recognizes revenues when goods are sold by
Consignee
Consignee recognizes revenue for commissions received
Accounting guidance: trade loading and channel stuffing
Unless returns can be reliably measured, revenue shouldn’t
be recognized until goods are sold by distributor to 3rd parties
Accounting guidance: multiple deliverable arrangements
Apply general revenue recognition principles to each element
of arrangement that has stand alone value
Once separate units of accounting are determined, amount
Paid for arrangement is allocated among separate units
Based on relative fair value
Revenue recognition before delivery: percentage of completion method
Companies recognize revenues and gross profit each
Period based on progress of construction (% completion)
Completed contract method
Companies recognize revenues and gross profit only
When contract is completed at point of sale
When should companies use the completed contract method (either of 3 conditions)
1 company has primarily short term contracts
2 company can’t meet conditions for using percentage of
Completion method
3 inherent hazards in contract beyond normal business risks
Companies must use the percentage of completion method when estimates of progress toward completions, revenues and costs are reasonably dependable and all of the following 3 conditions are met…
1 contract clearly specifies enforceable regarding goods or
Services by parties of contract
2 buyer can be expected to satisfy all obligations under
Contract
3 contractor can be expected to perform contractual
obligations
Measuring progress toward completion: input measures
Costs incurred, labor hours worked
Measuring progress toward completion: output measures (3)
1 Units of delivery measured as tons produced
2 floors of building completed
3 miles of highway completed
Cost to Cost basis
Company measures percentage of completion
Percent complete equation
Percent complete =
costs incurred to date/most recent estimate of total costs
Revenue (or gross profit) to be recognized to date equation
Revenue (or gross profit) to be recognized to date =
% complete) x (estimated total revenue or gross profit
Current period revenue (or gross profit) equation
Current period revenue (or gross profit) =
Revenue (or gross profit) to be recognized to date
- revenue (or gross profit) recognized in prior periods
Percentage of completion: subtracting the balance In the Billings account from construction process…
Avoids double counting the inventory
IFRS: competed contract method, percentage of completion method
IFRS doesn’t permit completed contract method
Companies must use percentage of completion method
2 types of long term contract losses
1 loss in current period on profitable contract
2 loss on unprofitable contract
loss in current period on profitable contract
Arise when during construction there’s a significant rise
In estimated total contract costs, but rise doesn’t eliminate
All profit
Loss on unprofitable contract: accounting treatment
Company must recognize in period the entire expected
contract loss
loss in current period on profitable contract, accounting treatment
Company records adjustment as loss in current period
Completion of production basis
Companies recognize revenue when metals are mined or
Crops harvested b/c the sales price is reasonably assured
The units are interchangeable and no significant costs are involved in distributing the product
Revenue recognition after delivery occurs when…
Collection of sales price is not reasonably assured
3 methods of revenue recognition after delivery?
1 installment sales method
2 cost recovery method
3 deposit method
Installment sales method
Recognizes income in periods of collection rather than in
Periods of sale
Company only defers the gross profit, not the actual sale
Accounting for repossessions
Recognizes that company isn’t likely to collect related
Installment receivable and should write it off
If installment sales are part of normal operations, companies may consider them as…
Current assets because they are collectible within the
Operating cycle of business
If a company has deferred gross profit on installment sales, it generally treats it as…
Unearned revenue and classifies it as a current liability
3 elements deferred gross profit consists of?
1 income tax liability to be paid when sales are reported
As realized revenue
2 allowance for collection expense, bad debts, repossession
Losses
3 net income (retained earnings restricted as dividend
Availability)
Cost recovery method
Company recognizes no profit until cash payments by
Buyer exceed cost of merchandise sold
Deposit method
Seller reports cash received from buyer as deposit on the
Contract and classifies it on balance sheet as liability
Revenue not recognized til sale is complete
Under the deposit method what account is the liability listed as (2 possible)
1 refundable deposit
2 customer advance
