Chapter 17 Revenue Recognition Flashcards
What is the main principle of accounting we talked about in this chapter?
ASC 606 “Revenue from Contracts with Customer”
What is the approach used for Revenue Recognition
Asset - Liability Approach
What is the Asset-Liability Approach
Recognition and measurement of revenue are based on:
a.) the recognition and measurement of assets and liabilities
b.) changes in those assets and liabilities over the life of the contract
How do we analyze revenue transactions
we analyze on contractual provisions of revenue arrangements
What does revenue recognition start with
Valid contract between seller and customer
What do rights and performance obligations lead to
net asset or net liability
What is step one in the revenue recognition process
1.) Identify the contract with customer
What must happen for a J.E to be recorded under a contract
both or one of the parties must perform under the contract
What is step 2 in the Revenue Recognition Process
Identify performance obligations
What is step 3 in rev. recognition process
Determine transaction price
What is step 4 in rec. recogniton
Allocate transaction price to each performance obligation
What is step 5 in revenue recogniton
Recognize revenue as/when each performance obligation is satisifed
What is a contract…
Agreement between two or more parties that creates an enforceable rights or obligation
A contract can be…
written, oral or implied from customary business practice
What constitutes a valid contract
1.) The contract has commercial substance
2.) The parties approved the contract
3.) The contract identified the rights of the parties
4.)Payment terms are identified
5.) It is probable that the consideration will be collected
If the contract is wholly unperformed or each party can terminate the contract without compensation what should happen
No revenue should be recognized
What is a performance obligation
A promise in a contract to provide a product/service to a customer.
- can be implicit, explicit, or based on customary business practice
What must happen for a product/service to be a performance obligation
must be distinct and distinct within the contract
what does distinct mean
customer is able to benefit from product/service on its own or with readily available resources
- it can be sold separately (has a standalone selling price)
What does distinct within the contract mean
the goods and services are not highly interdependent or interrelated
What is the definition of transaction price
The amount of consideration that a company expects to receive from a customer
What are the different types of transactions that can be received from a contract?
- Fixed amount
- Variable consideration
- Time value of money
- Non cash considerations
- Considerations paid or payable to the customer
What is the definition of a variable consideration
The price is dependent on a future event
When do you recognize revenue related to a variable consideration?
- It is reasonably assured that it will be entitled to the amount
-they have experience with similar contracts and can estimate the cumulative amount of revenue
-it is highly probable that there will not be a significant reversal
What are the two methods to estimating the variable consideration?
Expected Value Method and Most Likely amount
What are the characteristics of the expected value method for variable consideration
- It is the probability-weighted amount in a range of possible consideration amount
-May be appropriate if a company has a large number of contracts with similar characteristics
-can be based on a limited number of discrete outcomes and probabilities
What are the characteristics of the most likely amount method for variable consideration
The single most likely amount in a range of possible consideration amounts
may be appropriate if there are only two possible outcomes
What is determining the transaction price by time value of money
revenue recognized reflects the price the customer would have paid if the cash payment had been made when the goods/services were transferred
When should the time of value of money be considered for a transaction price
when the contract involves a significant financing component (consideration is expected be received over 1 year after product is delivered)
How is the fair value determined when measuring the transaction price by time value of money
Fair value is determined by measuring the consideration received or by discounting the payment using an imputed interest rate (like notes/bonds)
How do you account for the transaction price when it is a non cash consideration?
Recognize revenue on the basis of the fair value of what is received, if it can’t be determined then you record based on the estimated selling price of goods/services
How do you account for consideration paid or payable to customers when determining transaction price?
- may include discounts, coupons or rebates
-these elements reduce the consideration received adn the revenue to be recognized
Sansung Company offers its customers a 3% volume discount if they purchase at least $2 million of its product during the
calendar year. On March 31, 2021, Sansung has made sales of $700,000 to Artic Co. In the previous 2 years, Sansung sold over $3,000,000 to Artic in the period April 1 to December 31. Assume that Sansung prepares financial statements quarterly.
Samsung should reduce its revenue by 3% so $21,000 since it is probable the discount will be provided
What is allocating the transaction price based off of?
Based on relative fair values
What is the best measure of fair value when allocating transaction prices to separate performance obligations?
what the company would sell on a standalone basis
What is the equation to determine how much of the transaction to allocate to each performance obligation
standalone price/sum of all standalone prices X transaction price
If you can’t go off of a standalone price when determining relative fair value what approaches can you take to estimate the price?
1.) Adjusted market assessment approach
2.) Expected cost plus a margin approach
3.) Residual approach
What is the adjusted market approach
a way to estimate relative fair value by referring to prices in the market for that good/service
what is the expected cost plus a margin approach
you determine relative fair value by forecasting the price and then adding a margin
what is the residual approach
when you estimate the relative fair value by taking the total transaction price subtracted by the standalone prices you know for the other performance obligations
When does a company satisfied its performance obligation
when the customer obtains control of the goods/services
What are the five indicators of a change in control
- Company has a right to payment for an asset
- Company has transferred legal title to asset
- transferred physical possession of asset
- customer has significant risk and rewards of ownership
- Customer has accepted asset
How do sales returns and allowances affect revenue recognition
Recognize revenue and COGS at gross amount at time of sale
How do you record entries for sales returns and allowances in terms of revenue recognition
At time of sale:
A/R
Sales Revenue
COGS
Inventory
When a return occurs:
Sales Returns and allowances
A/R
Returned Inventory
COGS
Adjusting entry at the end of the period (to account for the rest of the estimated returns):
Sales returns and allowances
Allowances for Sales
returns and allowances
Estimated Inventory Returns
COGS
if AR has already been collected and there is a refund how do you record then for sales returns and allowances
Refund liability
What is a repurchase agreement in terms of revenue recogntion
When there is a transfer of an asset to a customer but there is an unconditional obligation (forward) or conditional right (call option) to repurchase the asset at a later date
If the obligation or right to repurchase is greater than or equal to the selling price for a CALL or PUT OPTION then the transaction is treated as a…
financing transaction - not considered a sale
If obligation or right to repurchase is for the amount less than selling price for a CALL or PUT OPTION then the transaction is treated as a
lease
On Jan. 1, Anderson Co. enters into a contract with Tanner Co. for the
sale of an excavator for $350,000. The contract includes a call option
that gives Anderson the right to repurchase the excavator for $385,000 on or before Dec. 31. Tanner pays the entity $350,000 on Jan.1. On Dec. 31, the option lapses unexercised.
How would you do the J.E
Jan 1st
Cash
Financial Liability
During the year
Interest expense
Financial liability
End of year
Financial Liability
Revenue
What is a transfer of an asset to a customer but they have an obligation to repurchase the asset at the customer request
Put option repurchase agreement
if the customer does not have a significant economic incentive to exercise the right to a repurchase agreement for a PUT option, then the transaction is treated as a
a sale with a right to return
what is a Bill-and- Hold Arrangement
contract under which an entity bills a customer for a product but the entity retains physical possession of the product until a point in time in the future
When does a bill and hold arrangement happen
happens when the buyer is not ready to take delivery but does take title and accepts billings
Butler Company sells $450,000 (cost $280,000) of fireplaces on March 1, 2024, to a local coffee shop, Baristo, which is planning to expand its locations around the city. Under the agreement, Baristo asks Butler to retain these fireplaces in its warehouses until the new coffee shops that will house the fireplaces are ready. Title passes to Baristo at the time the agreement is signed
For Baristo to obtain control what must happen for revenue to be recognized at the signing of the contract?
1.) The reason for the bill and hold arrangement must be substantive
- The product must be identified as belonging separate to Baristo
- The product currently must be ready for physical transfer
- Butler cants have the ability to use the producgts or direct it to another customer
What is a principal agent relationship
When an agent has a performance obligation to provide goods/services to a principal
what are goods held on consignment an example of
Principal-Agent Relationships
how are the amounts collected on behalf of the principal recorded for the agent
agent does not record any revenue for the product/service, only revenue for the commission received from selling the product
What are the two different types of warranties
Assurance type and service type
what are the characteristics of an assurance type warranty
- Included with sale
- no separate performance obligation
-expensed in period the good/service is provided - CREATES A WARRANTY LIABILITY
what are the characteristics of an service-type warranty
- an option to purchase a warranty
- recorded as a separate performance obligation
- recognize revenue and in the period warranty is in effect
- CREATE EXPENSE when used and an unearned revenue before time it comes into effect
What are non refundable upfront fees
Payments from customer before delivery of a product or performance of the service
-usually not refundable
What do nonrefundable upfront fees relate to?
activation, initiation, or setup of a good/service that will be provided in the future
How are nonrefundable upfront fees recorded as usually?
recorded as revenue at the time of payment as they relate to future delivery of goods/services
What is a contract modification?
a change to the contract while the terms are ongoing
how is a contract modification accounted for?
- a seperate contract (seperate performance obligation) IF BOTH…
A. the promised goods are distinct
B. the company has the right to received consideration reflects the standalone selling price
If a contract modification is NOT accounted for as a seperate contract then what happens?
it is accounted for as a termination of the original contract and the creation of a new one where the price is allocated by blending the amounts and the change is made prosepctively
What happens to the remaining transaction price when the contract modification is not accounted for as a separate contract
The remaining transaction is prospectively allocated to the single performance obligation in the new contract
What is prospective modification
account for change in current and future periods
What is a contract asset
There are two types….
Unconditional right to receive consideration because the company has satisfied its performance obligation with a customer (AR)
A conditional right to receive consideration because the company has satisfied one performance obligation but must satisfy another performance obligation before they can bill the customer (Contract Asset)
* think about how this summer the customer didn’t get billed until all sprints of project were done
What is a contract liability
company’s obligation to transfer goods/services to a customer for which the company has received consideration from the customer (unearned revenue)
can you have a contract asset and liability at the same time
NO
In terms of cost of obtaining a contract when should you recognize an asset
when the cost would not have been incurred if the contract had not been obtained and if the entity expects to recover costs
In terms of the cost of obtaining a contract, when should you recognize an expense
when the cost would have been incurred regardless of whether contract was obtained
eg. travel expense to deliver proposal
What are the traits to recognize an asset in terms of cost to fulfill a contract
direct, incremental, and recoverable costs
ex. direct labor and materials
What are the disclosures companies provide in terms of ASC 606
- disaggregation of revenue
- reconciliation of contract balances
- remaining performance obligations
- cost to obtain or fulfill contracts
- other qualitative disclosures (judgement and changes)
When does revenue recognition over time occur
occurs if at least one of the following criteria is met and can reasonably estimate progress towards satisfaction of performance obligation…
- the customer simultaneously receives and consumes the benefits of the seller as the seller performs
- the company’s performance creates or enhances an asset (WIP) that the customer controls as the asset is enhanced
- The company’s performance does not create an asset with an alternative use
What are the two methods for accounting long term revenue contracts
- percentage-of-completion method
- cost-recovery (zero profit) method
what are the characteristics of the % completion method
- recognize revenues and profits each period based upon the progress of construction
- buyer and seller have enforceable rights
what are the characteristics of cost-recovery method
- recognize revenues only to the extent of costs
- recognize GP only when the contract is complete
What happens if there is a loss in the current period on a profitable contract
% of completion method only, the estimated cost increase requires a current-period adjustment of GP recognized in prior periods
What do you do if there is a loss on an unprofitable contract
the company must recognize in the current period the entire expected contract loss
