Ch. 5 - Revenue Recognition and Operating Income

Question 1

Revenue is recognized when…

Answer 1

the company transfers the goods or services to the customer

Aka revenue is recognized when the customer gains control of the good or service

Question 2

What are the 5 steps to revenue recognition?

Answer 2

1. Identify the contract(s) with the customer
   –Parties to the contract should be identifiable
   –Terms of the sale should be specified
2. Identify the performance obligation(s) in the contract
   –Performance obligation(s) is a contractual promise to transfer goods or services to the customer
   –For contracts with more than one good or service, the company must identify the separate performance obligations for each contractual promise
3. Determine the transaction price
   –If the purchase price is variable, estimate revenue using the expected purchase price
4. Allocate the transaction price to the performance obligation
   –For contracts with more than one performance obligation, allocate the transition price to each performance obligation at its fair value (standalone selling price).
5. Recognize revenue as/when each performance obligation is satisfied
   –Performance obligation is satisfied when the customer obtains control of the goods or services
   –Performance obligations satisfied over a period of time should be recognized as revenue over time

Question 3

Receivables

Answer 3

Revenues earned and billed to the customer

Question 4

Contract assets

Answer 4

Costs incurred from a contract but not yet billed

Question 5

True or false: it is necessary to receive cash to recognize revenue

Answer 5

False–it is NOT

Question 6

What are some examples of when GAAP says to recognize revenue?

Answer 6

When:
-The customer has legal title to the goods or services purchased
-The company has physically transferred the goods sold or has performed the service
-The risks and rewards of ownership of the goods or services purchased transfer to the customer
-The customer has accepted the goods or services and has agreed to pay the seller

Question 7

GAAP requires companies to report sales revenue at the _________ ________ amount the company expects to receive

Answer 7

The net amount; this means companies are to deduct from gross sales the expected sales returns and other allowances.

Question 8

What are sales allowances?

Answer 8

These are things like the right of return, sales discounts for volume purchases, and retailer promotions (point-of-sale price markdowns and other promotions).