Ch 18 Flashcards
FASB and IASB indicated that reporting for revenue
Was unsatisfactory
IASB and FASB issued a diverged standard on revenue recognition called
Revenue from contracts with customers
Boards believe new standard will improve GAAP and IFRS BY
Providing a more robust framework for addressing revenue recognition issues
Improving comparability of revenue recognition practices across entities, industries, jurisdiction, and capital markets
Simplifying prepapartion of financial statements by reducing # of requirements to which companies must refer
Required enhanced disclosures to help financial statement users better understand amount, timing and uncertainty of revenue that is recognized
Asset liability approach is the basis for
Revenue recognition
Asset liability approach recognized and measures revenue based
On changes in assets and liabilities
Board decided that focusing on
Recognition and measurement of assets and liabilities
And changes in assets or liabilities over life of contract brings more discipline to measurement of revenue COMPARED TO EARNED AND REALIZED STANDARDS
The process of key concept of revenue recognition is the REVENUE RECOGNITION PRINCIPLE which
States that revenue is recognized when performance obligation is satisfied
Contract
Is an agreement between two or more parties that creates enforceable rights or obligations
Contract Can be?
Written, oral or implied from customary business practice
When is revenue recognized only?
When a valid contract exists
On entering contract with customer, a company obtains rights to
Receive consideration from customer and assumes obligations to transfer goods and services to customer (performance obligation)
The combination of those rights and performance obligation give rise to an net asset or net liability
The contract must meet 5 conditions:
Company applies revenue guidance to contract according to following criteria
- Contract must have commercial substance
- Parties approve contract
- Identification of rights of parties established
- Payment terms are identified
- It is probable that consideration will be collected
A key feature of revenue arrangement is that the contract between two parties is not recorded until when?
Until one or both of parties perform under contract
Until performance occurs
No net asset or net liability occurs
Performance obligation
Is the promises to provide a product or service to the customer
To determine whether a performance obligation exists, the company must provide what?
A distinct product or service to the customer
When is a product or service distinct?
&I when does this typically occur?
When the customer is able to benefit from good or service on its own or together with other readily available resources
This typically occurs when a company can sell a good or service on a standalone basis (sold separately)
To determine whether a company has to account for multiple performance obligations is
The company promise to sell good or service to customer must be separately identifiable from other promises within contract
What is the objective of separating performance obligations
Is to determine whether the nature of company’s promise is to transfer individual goods and services to customer or to transfer a combined item or items for which individual goods or services are inputs
When the service is distinct and not interdependent
Can be sold separately as two performance obligations
When a service is distinct but interdependent then it should be accounted for
As one performance obligations
Transaction price is
Amount of consideration a company expects to receive from a customer in exchange for transferring goods and services
Why is the transaction price contract often easily determined?
Because the customer agreed to pay a fixed amount to company over short period of time
In other contracts companies must consider the following factors
Variable consideration
TVM
No cash consideration
Consideration paid or payable to customer
In variable consideration, the price of good or service is dependent on what?
Future events
The future events may include?
Price increases, volume discounts, rebates, performance bonuses or royalties
Company estimates the amount of consideration it will receive from contract because?
It will determine the amount of revenue to recognize
What do companies use to estimate variable consideration?
Pg. 988
Expected value
- probability weighted amount in range of possible consideration amounts
OR
Most likely amount: the single most likely amount in a range of possible consideration outcomes
A company only allocates variable consideration of it is
Reasonably assured that it will be entered to that amount
Companies therefore may only recognize variable consideration if
- They have experience with similar contracts and are able to estimate cumulative amount of revenue
- Based on experience highly probable there will not be significant reversal of revenue previously recognized
What happens when the two criteria of recognizing variable consideration is not met?
Revenue recognition is constrained
Companies account for time value of money if involved
Significant financing component
When sales transaction involves significant financing component ( interest is accrued on consideration to be paid over time) the fair value is determined by?
Measuring consideration received or by discounting the payment using an imputed interest rate
Imputed interest rate is can be more determined when
Prevailing rate for similar instrustment of issuer with similar credit rating
Rate of interest that discounts minimal amount of instrument to current sale price of good or services
Companies do not have to reflect time value of money to determine transaction price if the time period payment is less than
Year
Companies sometimes receive what? In the form of goods services or other non cash consideration
Considerations
Companies generally recognize revenue on basis of what?
FV of what is recieved
A contribution is often a type of?
Asset
(Securities, land buildings or use of facilities)
But if could be the forgiveness of debt
Customers sometimes contribute goods and services such as
Equipment or labor as consideration for goods provided or services performed
The previous consideration should be recognized as
Revenue based on fair value of consideration recieved
Consideration paid or payable to customers include
Discounts , rebates , coupons, free products or services
Discount volume rebates coupons free products or services reduce what?
Consideration recieved and revenue recognized
In many cases companies provide cash discounts to customers for
A short period of time
In most cases companies record the revenue at
And sales discount if
Full price
If payment is made within discount period
Companies often have to allocate transaction price to
More than one performance obligation in contract
If the allocation is needed, transaction price allocated to performance obligations is based on
Relative fair values
The best measure of fair value is when a company
Could sell the good service for a standalone basis referred as standalone selling price
If info not available impatiens should use
Best estimate of what good or service might sell for a sandalone unit
A company satisfies its performance obligation when
A customer obtains control of good or service
The concept control is a deciding factor in determining?
When a performance obligation is satisfied
The customer controls product or service when
It has the ability to direct use of and obtain substantially all the remaining benefits from asset or service
Control also includes customers ability to
Prevent other companies from directing the use of or receiving benefits from asset or service
What are the change in control indicatiors?
- Company has the right to payment for asset
- The company has transferred legal title to asset
- Company has transferred physical possession of asset
- Customer has significant risks and rewards of ownership
- Customer has accepted asset
The change in control indicators are list of indicators not
Requirement or criteria
All of the indicators need to be met for management to conclude control has been transferred
FALSE!!!
All indicators do not need to be met
Companies recognize revenue if one of the following 3 criteria are met
Customer recieved and consumes benefits
The customer control asset as it created
Company does not have alternative use for asset created or enhanced
A company recognized revenue from performance obligation over time by measuring
Progress toward completion
Method for measuring progress should depict what?
The transfer of control from company to customer
For many service arrangements revenue is recognized on
Straight line basis BBC performance obligation is being satisfied over contract period
What methods do companies use to determine extent of progress toward completion?
Cost to cost and units of delivery methods
What r the objectives of methods
To measure extent of progress in terms of costs units or value added
Input measures
Cost incurred and labor hours worked
Output measures
Units of delivery measured as tons produced, floors of building completed
The most popular input measure used to determine progress toward completeioj is
Cost to cost basis
What are the accounting for revenue recognition issues?
Sales and returns and allowances Repurchase agreements Bill and hold Principal agent relationships Consignments Warranties No refundable upfront fees
Sales returns and allowances
Customers granted right to return product for various reasons (dissatisfaction of product)
Customers granted right to return product and receive any combination of the following
- Full or partial refund of any consideration paid
- Credit can be applied against amounts Owed or that will be owed
- Another product in exchange
Repurchase agreements
Allows them to transfer an asset to a customer but have unconditional (forward) obligation or unconditional right (call option) to repurchase asset at a later date
If the company has forward obligation or call option to repurchase asset for an amount greater than or equal to selling price, the transaction is what type of transaction by company?
Financing
Bill and hold arrangements
Contract under which an entity bills a customer for a product but the entity still retains physical possession of product until it is transferred to customer at a point in time in future
Bill and hold sales results when the buyer is
Not ready to take delivery but does take title and accepts billing
Principal agent relationships
Principals performance obligation is to provide goods or perform services for a customer
Examples include
Travel company facilitates booking of cruise excursions by finding customers
Priceline agent facilitates the sale of various services such as car rentals
Amounts that are collected on behalf of principle are not
Revenue of agent
Revenue of agent is the amount
Of commission it receives
Consignments
Manufacturers or wholesales deliver goods but retain title to goods until sold
Specialized method of marketing certain types of products makes use of agreement known as
Consignment
Consignor is
Manufacturer or wholesaler
Consignee is the
Dealer who is to act as an agent for consignor in selling merchandise
Consignor recognizes revenue only
After receiving notification of sale
Consignor makes a profit on
Sale
Carries merch as inventory
Consignor makes commission on
Sale
Consignee does not record merchandise as an
Asset, upon sale of merch , consignee has liability for net amount due to consignor
Consignor periodically receives from consignee a report called
Account sales that shows merchandise received, sold and expenses chargeable to consignment and cash remitted
Consignees only recognize
Commission revenue
What are the two types of warranties?
- Warranties that product meets agreed upon specifications in contract at time product is sold
•assurance type warranty (included in sales
price) - Warranties that provide additional service beyond assurance type warranty
•service type warranty (not included in sales
price)
• recorded as separate performance
obligation
Companies sometimes receive payments (upfront fees) from customers before
They deliver product or perform good or service
Upfront fees generally relate to what?
Initiation, activation or set up of good or service to be provided or performed in the future
In most cases upfront payments are not
Examples include
Refundable
Examples include membership in health club or buying club, activation fees for phone
In most situations these payments are for future delivery of products and services and therefore should not be
Recorded as revenue at the time of payment
Companies use what to recognize revenue
Asset liability approach
Contract assets are two types
- Unconditional rights to receive consideration bc the company has satisfied its performance obligation with customer
- Conditional rights to receive consideration because company satisfied one performance obligation but must satisfy another performance obligation in contract before it can bill customer
Companies should report unconditional rights to receive
Consideration as a receivable on the balance sheet
Conditional rights on balance sheet should be reported separately as
Contract assets
Contact liability
Company obligation to transfer goods or services to customer for which company has recieved consideration from customer
Contract liability is referred as
Unearned sales revenue , unearned service revenue etc
Contract modification
Companies sometimes change contract terms while it is onfoing
When a contract modification occurs companies determine
Whether a new contract results or whether it’s a modification of existing contract
Separate performance obligation
A company accounts for contract modification as a new contract if both of the following conditions are satisfied
Promised goods or services are distinct (sold separately and not interdependent)
Company has right to receive amount of consideration that reflects standalone selling price of goods or services
Prospective modification
Company should
Account for effect of change in period of change as well as future periods of change affects both
Not change previously reported results
Costs to fulfill contact
Companies divide fulfillment costs in two categories
- Those that give rise to an asset
2. Those that are expense as incurred
Companies only capitalize costs that are
Direct incremental and recoverable
Collectibility
Refers to customers credit risk, risk that a customer will be unable to pay the amount of consideration in accordance with contract
Under revenue guidance- as long as contract exists the amount recognized as revenue is not
Adjusted for customer credit risk
Whether a company gets paid for satisfying performance obligation is not
Consideration in determine revenue recognition.
Disclosure requirements for revenue recognition are designed to help financial statement users understand
Nature, amount timing and uncertainties of revenue
Companies disclose qualitative and quantitiative info about the following
Contract with customers
Disaggregatjon of revenue
Presentation of open and close balances in contract assets and liabilities
Significant judgments
Determine transaction price,allocation of transaction price and determine time of revenue
Assets recognize from costs incurred to fulfill contract
Close balance of asset recognized to obtain or fulfill contract , amount of amortization recognition
