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Theory of Financial Accounting II > Chapter 18: Revenue Recognition > Flashcards

Chapter 18: Revenue Recognition Flashcards

1
Q

Criteria for recognizing revenue over time

A

At least one of the following:
1. The customer simultaneously receives and consumes the benefits of the seller’s performance as the seller performs.

  1. The company’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced.
  2. The company’s performance does not create an asset with an alternative use. (The asset cannot be used by another customer). Requires one of the following two criteria to be met as well:
    a. another company would not need to substantially re-perform the work the company has completed to date if that other company were to fulfill the remaining obligation to the customer
    b. the company has a right to payment for its performance completed to date, and it expects to fulfill the contract as promised.
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2
Q

Percentage of completion method

A

recognizes revenues, costs, and gross profit as a company makes progress toward completion on a long-term project.

To defer recognition until completion would misrepresent efforts (costs) and accomplishments (revenues) of the period.

Must have methods for measuring extent of progress towards completion

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3
Q

Methods of measuring extent of progress towards completion

A

Cost-to-cost method (most popular)
units-of-delivery method

can use both input and output measures

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4
Q

Cost-to-cost basis

A

Measuring extent of progress towards completion by comparing costs incurred to date with the most recent estimate of the total costs required to complete the contract

costs incurred to date / most recent estimate of total costs = percentage complete

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5
Q

Revenue recognition for percentage of completion method

A

Percent complete = cost incurred to date / most recent estimate of total costs

Revenue (or gross profit) to be recognized to date = percent complete x estimated total revenue (or gross profit)

current period revenue = revenue (or gross profit) to be recognized to date - Revenue (or gross profit) recognized in previous periods

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6
Q

Revenues

A

Inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations

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7
Q

Five steps for revenue recognition

A

1) identify the contract with the customer (s)
2) identify the separate performance obligations in the contract
3) determine the transaction price
4) allocate the transaction price to the separate performance obligations
5) recognize revenue when each performance obligation is satisfied

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8
Q

Determining when a performance obligation is satisfied

A

Determining factor is change in control of consideration

control = ability to direct the use of and obtain substantially all of the remaining benefits

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9
Q

Contract assets

A

Two types

  • unconditional rights to receive consideration because the company has satisfied its performance obligation with a customer (receivable on balance sheet)
  • conditional rights to receive consideration because the company has satisfied one performance obligation, but must satisfy another performance obligation in the contract before it can bill the customer (contract asset on balance sheet)
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10
Q

Contract liability

A

Company’s obligation to transfer goods or services to a customer for which the company has already received payment from the customer

Unearned sales (service) revenue

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11
Q

Recognizing a contract asset

A

Journal entry when performance obligation is satisfied by right to receive payment is CONDITIONAL

Dr. Contract Asset
Cr. Sales Revenue

When right to receive payment is unconditional
Dr. Accounts Receivable
Cr. Contract Asset

Account tile must be clear between conditional and unconditional rights

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12
Q

Contract modification

A

Change of terms to ongoing contract

Must determine if it is a new contract with separate performance obligation
or
modification of original contract and not separate obligation (prospective modification)

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13
Q

Contract performance modification: Separate performance obligation

A

Meets BOTH of the following conditions:

  • promised goals/ services are distinct
  • company has the right to receive consideration that reflects the standalone selling price of the promised goods/ services

modification is effectively a new and separate contract with no affect on the accounting for the original contract

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14
Q

Contract modification: Prospective modification

A

New products/ services are not distinct and/or not priced at a standalone price

Account for the effect of the change in the period of change and any future periods affected (no retrospective changes/ restatement)

Revise allocated portion of transaction price only based on what is not yet paid

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15
Q

Treatment of costs to fulfill a contract

A

for contract periods over one year

  • capitalized costs that give rise to an asset
    - incremental costs company would NOT incur if contract was not obtained
    - direct labor, materials, etc… relating directly to the contract
    - costs that generate/ enhance resources used to satisfy performance obligations

ONLY costs that are direct, incremental and recoverable. Everything else is expensed

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16
Q

Collectibility

A

Risk that a customer will be unable to pay the amount of consideration in accordance with the contract.

As long as it is probable that customer will pay then contract exists and revenue is recognized and not adjusted for the credit risk

(just uses allowance for doubtful accounts/ bad debt

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17
Q

Revenue recognition disclosures

A

Qualitative and quantitative information about

  • contracts with customers
    - disaggregation of revenue
    - balances in contract assets and liabilities
    - performance obligations
  • significant judgements
    • determination / allocation of transaction price
    • changes in judgements
  • assets recognized from costs incurred to fulfill a contract
    - balances of capitalized costs
    • amortization amount and method
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18
Q

Disaggregation of Revenue

A

Splitting revenue info into categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors

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19
Q

Journal entry when contract is agreed upon/ entered into

A

No entry until performance is made by one side or the other

Payment received (promise not delivered) = unearned revenue
Promise delivered (no payment received)= sales revenue

Until performance occurs no net asset or net liability exists

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20
Q

Contract

A

An agreement between parties that creates enforceable rights or obligations

components:

  • commercial substance
  • approved by both parties
  • identification of the rights of the parties is established
  • payment terms are identified
  • is probable that the consideration will be collected

Can be written, oral, or implied from customary business practice

Gives rise to a net asset or net liability

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21
Q

Allocation of the transaction price to separate performance obligations

A

Based on the relative standalone prices

If standalone pricing is unavailable base on best estimate of such

proportional method of allocation

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22
Q

Estimation of standalone price

A

To estimate unknown standalone price use one of the following and THEN proportional method:

  • adjusted market assessment approach: evaluate the market and estimate market price (adjusted for company costs
  • Expected costs plus a margin
  • residual approach: whatever remains of the transaction price after observable standalone prices are accounted for
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23
Q

Transaction Price

A

Amount of consideration that a company expects to receive from a customer in exchange for transferring a good or service

May include multiple considerations:

  • variable consideration
  • time value of money
  • non-cash consideration
  • consideration paid, or payable, to the customer
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24
Q

Variable consideration

A

When the price of a good or service is dependent on future events
(price increases, volume discounts, rebates, credits, performance bonuses, royalties)

Company estimates the amount of consideration it will receive from the contract to determine amount of revenue to recognize by either:
- expected value
or 
- most likely amount
(whichever better predicts results)
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25
Q

Most likely amount variable consideration estimation

A

The single most likely amount in a range of possible consideration outcomes

may be appropriate method if the contract only has two possible outcomes (if variable consideration is binary)

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26
Q

Probability weighted method

A

sum of all possible transactions prices multiplied by their relative probability

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27
Q

Expected value variable consideration estimation

A

Probability-weighted amount in a range of possible consideration amounts

  • appropriate method if a company has a large number of contracts with similar characteristics
  • can be based on a limited number of discrete outcomes and probabilities

Estimate must be updated each report date

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28
Q

Conditions that indicate revenue is constrained

A
  • amount of consideration is highly susceptible to factors outside the company’s influence (market volatility, weather, third party judgement)
  • uncertainty over amount of consideration unlikely to be restricted for a long time
  • company experience with similar obligations is limited
  • the contract has a large number/ broad range of possible consideration amounts
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29
Q

Revenue constraint consideration

A

Company only allocates variable consideration if it is reasonably assured it will be entitled to that amount

  • have experience with similar contracts and can estimate the revenue
  • based on experience it is probable that there will not be significant reversal of revenue previously recognized

if not then revenue recognition is constrained

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30
Q

Imputed interest rate

A

The more clearly determinable of:

1) prevailing rate for a similar instrument of an issuer with a similar credit rating
2) a rate of interest that discounts the nominal amount of the instrument to the current sales price of the goods or services

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31
Q

Time value of money and transaction price

A

Time value of money needs to be considered if the contract involves a significant financing component - the timing of payment does not match the timing of transfer of goods or services (at least if by over a year)

Essentially notes receivable

fair value should be determined by discounting the payment using an imputed interest rate

any effects are reported as interest revenue

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32
Q

Non-cash transactions

A

Revenue is generally recognized on the basis of the fair value of what is received

  • if that is not determinable then the selling price of the services performed
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33
Q

Consideration paid or payable to customers

A

Discounts, volume rebates, coupons, free products or services

these reduce consideration received / revenue to be recognized

Gross (sales discount account) or net (sales discount forfeited account) methods

34
Q

Conditions for multiple performance obligations

A

1) obligations are a distinct product or service (could be purchased separately)

2) obligations are distinct within the contract
- not highly dependent/ interrelated with other promises
- if related products and obligation should be combined into one obligation

35
Q

Performance obligation

A

A promise to provide a product or service to a customer

may be explicit, implicit, or based on customary business practice

DISTINCT product or service that a customer is able to benefit from on its own or with other readily available resources

36
Q

Objective of new revenue recognition standard

A

Recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that the company receives or expects to receive in exchange for these goods or services

37
Q

Asset-liability approach for revenue recognition

A

Recognizes and measures revenue based on changes to assets and liabilities
- assets and liabilities arising from contracts with customers

Contracts:

  • initiate revenue transactions
  • indicate the terms of the transactions
  • specify promises by each party
38
Q

Revenue from contracts with customers

A

FASB and ISAB converged standard on revenue recognition

  • more robust framework
  • improves comparability
  • simplifying statement preparation
  • enhances disclosures

Asset-liability approach for revenue recognition

39
Q

Returned inventory account

A

Used for returns to keep separate from other inventory - provides transparency

combined with estimated inventory returns on balanced sheet

subject to impairment testing separate from inventory

40
Q

Return within same period of sale

A

Dr. Sales Returns and Allowances
Cr. Accounts Receivable (credit sales) or Cash/Payable (Cash sale)

Dr. Returned inventory
Cr. Cost of Goods Sold

41
Q

Adjusting entries for expected returns

A

Dr. Sales Returns and Allowances
Cr. Allowance for sales returns and allowances (credit sale)
(cash sale cr. accounts payable)

Dr. Estimated inventory Returns
Cr. Cost of goods sold

42
Q

Sales returns and allowances on income statement

A 
Sales revenue
Less sales returns and allowances
= Net Sales
Cost of Goods sold 
= Gross profit
43
Q

Sales Returns and Allowances on the balance sheet

A 
Accounts Receivable
Less; Allowance for sales returns and allowances 
Accounts receivable (net) 
Returned inventory (including estimated)

Accounts Payable (contains cash sales returned / est returned but not yet paid out)

44
Q

Repurchase agreements

A

Agreement to transfer an asset to a customer but have an unconditional (forward) obligation or unconditional right (call option) to repurchase the asset at a later date

If the forward obligation/ call option to repurchase is at amount greater than or equal to the selling price then the transaction is a financing transaction

If financing asset then asset not removed from books

Sale depends on if control is really transferred

45
Q

Recording a financing transaction

A

Dr. Cash
Cr. Liability to X company

then accrue interest
Dr. Interest Expense
Cr. Liability to X company

Pay financing
Dr. Liability to X company
Cr. Cash

46
Q

Put option (repurchase agreement)

A

Company holding an asset has the option to keep asset or to sell it back to originator (or third party)

generally exercised if fair value < repurchase price (check this)

recorded like financing transaction

47
Q

Bill and hold arrangement

A

A contract under which an entity bills a customer for a product but retains physical possession of the product until transferred to customer at a later date.

For revenue recognition customer must have obtained control of product, plus:

  • bill & hold arrangement is substantive
  • product identified separately as belonging to customer
  • product is ready for physical transfer
  • seller does not have ability to use product or sell it to another customer
48
Q

Principal-Agent relationship

A

Principals performance obligation is to provide goods/ services

Agents performance obligation is to arrange for principal to provide goods/ services to customers (ex: travel agents)

agent does not recognize the full amount paid as revenue - only their commission (net approach)

FASB has specific indicators for principal-agent relationship

49
Q

Consignments

A

Consignor ships merchandise to consignee who acts as an agent for the consignor in selling the merchandise

Consignor retains title/ control of merchandise. Receives revenue from sale less any commission/ expenses

Upon sale consignee has a liability for the net amount due to consignor

50
Q

Recording Consignment: Consignor Entries

A

Cost of finished goods/ Freight –> inventory (consignment)

On notification of sales/ expenses & remittance
Dr. Cash
Dr. Expenses (by consignee, inc commission)
Cr. Revenue from consignment sales

Then move inventory (consignment) to cost of goods sold

51
Q

Recording Consignment: Consignee entries

A

Expenses:
Dr. Receivable from consignor
Cr. Cash

Sale:
Dr. Cash
Cr. Payable to consignor

Notification of sales/ expenses and remittance
Dr. Payable to consignor
Cr. Receivable from consignor
Cr, Commission revenue (recognized on notification)
Cr. Cash

52
Q

Assurance-type warranty

A

Warranty that the product meets agreed-upon specifications in the contract at the time the product is sold

Included in sales price - no separate performance obligation is recorded

Estimate warranty liability is expensed in the period the goods provided/ services performed

53
Q

Service-type warranty

A

Additional service beyond assurance-type warranty

A separate performance obligation from the product (has a stand alone price)

must allocate part of the transaction price to warranty performance obligation

54
Q

Assurance-type warranty journal entries

A

No entry at time of purchase

Warranty costs in the same period as purchase:
Dr. Warranty Expense
Cr. Salaries and wages payable
Cr. Inventory

Adjusting entry for outstanding assurance warranty:
Dr. Warranty expense
Cr. Warranty liability

55
Q

Service-type warranty journal entries

A

At time of sale
Cr. Unearned warranty revenue

Then recognized revenue over period earned, usually on a straight line basis in adjusting entries

Dr. Unearned warranty revenue
Cr. Warranty Revenue

56
Q

Non-Refundable upfront fees

A

Payments received before delivery of service

must determine if should be applied to current period

if for future delivery it is not recorded as revenue till delivery made

initiation fee recognized over service period if partial payment for later discounted price

57
Q

Recognizing revenue from performance obligation over time

A

Measured by progress to completion based on transfer of control the customer

  • straight line (satisfaction over whole contract period)
  • cost-to-cost or units-of-delivery: progress measured by a certain unit of input or output

Cost-to-cost = costs to date as a percentage of expected total costs of completion

58
Q

Criteria for revenue recognized over period of time (vs at a point in time)

A

1) customer receives and consumes the benefits as the seller performs
2) customer controls the asset as it is created or enhanced

3) company does not have an alternative use for the asset created or enhanced and either:
a) the customer receives benefits as the company performs (the task would not need to be re-performed
or
b) the company has a right to payment and the right is enforceable

59
Q

Indicators the customer has obtained control of an asset

A

(Assessment from customer perspective)
1) company has the right to payment for the asset

2) company has transferred the legal title to the asset
3) company has transferred physical possession of the asset
4) customer has all significant risks and rewards of ownership
5) customer has accepted the asset

60
Q

Control of assets

A

Defined by ability to direct the use of and obtain substantially the remaining benefits of the assets

can prevent other companies from directing the use of / receiving the benefits of the assets

  • right to payment
  • transfer of legal title
  • transfer of physical possession
  • who holds risks and rewards of ownership
61
Q

Percentage of completion revenue entries

A

Accumulation of expenses:
Dr. Construction in progress (inventory account)
Cr. inventory/ payables/ cash etc…

Billings:
Dr. A/R
Cr. Billings on Construction in process (contra-inventory account)

To recognize revenues/ gross profit:
Dr. Construction in Process (CIP)(Gross Profit)
Dr. Construction Expenses
Cr. Revenue from long term contracts

Gross profit = total revenues less revenues recognized previously less current period costs

On completion:
Dr. billings on construction in process
Cr. Construction in process

62
Q

Completed contract method

A

Same accumulation accounts as percentage of completion

  • inventory (construction in progress)
  • contra-inventory (billings or construction in progress)

BUT revenue is not recognized until contract is completed

may still bill and collect money from customers

63
Q

Completed contract revenue journal entry

A

When contract is completed need to close out inventory and billing accounts and recognize revenue

Dr. Billings on construction in progress (close)
Cr. Revenue from long term contracts

Dr. Cost of construction
Cr. Construction is progress (close)

64
Q

Cost-to-Cost basis calculation of revenue

A

Costs incurred to date/ Most recent estimate of total costs = percent complete

percent complete x estimated total revenue (or gross profit) = revenue (or gross profit) to be recognized TO DATE

Revenue (or gross profit) to be recognized to date - revenue (or gross profit) recognized in prior period = current period revenue (or gross profit)

65
Q

Cost-to-cost basis

A

Measuring percentage completion by comparing costs incurred to date with most recent estimate of total costs to complete the contract

Cost of construction debited to construction in progress

Progress billings credited to billings or construction in progress

Recognize as revenue a percentage of estimated total price (or gross profit) less any previously recognized revenue (or gross profit)

66
Q

Measuring progress towards completion

A

cost-to-cost method
units-of-delivery method

identify measures as input or output and determine what measure of progress best suits the project

67
Q

Percentage of completion method

A

Recognizing revenues and gross profits each period based upon the progress of construction (the project)

  • only if it is possible to reasonable measure progress to completion
  • construction costs and gross profit for period recorded in inventory account (construction in progress)
  • progress billings go into a contra-inventory account (billings on construction in progress)
68
Q

Construction costs account

A

Inventory account

Debited for all construction costs and construction gross profit

credited full balance at completion of project to close

69
Q

Change in estimate percentage of completion - revenue recognition

A

Cumulative catch-up manner

account for the change in estimate in the period of change so all subsequent periods are as if revised estimate was original estimate

70
Q

Percentage of completion accounts on balance sheet

A

Net construction in progress and billings on construction in progress

Construction in progress > billings = current asset
“costs and recognized profit in excess of billings”

Construction in progress < billings = current liability
“billings in excess of costs and recognized profit”

if multiple projects do not net but segregate assets an liabilities

71
Q

Percentage of completion on income statement

A

Revenue from long-term contracts
(less) costs of construction
(=) gross profit

72
Q

Percentage of completion on balance sheet

A

Current assets
Accounts receivable
Inventory
Construction in progress
less: billings
= costs and recognized profit in excess of billings
(or a liability called billing in excess of costs and recognized profit if billings > construction)

Inventory accounts close out and disappear when project is completed

73
Q

Percentage of completion disclosures

A

Disclose:

  • methods of accounting
  • measurement
  • costs included
74
Q

Loss in current period on a profitable contract

A

When a significant increase in estimated total contract costs does not eliminate all profits but does require a current period adjustment of excess gross profit recognized in prior periods (estimated costs mean that percentage complete goes backwards)

Adjustment recorded as loss in current period (change in accounting estimates)

75
Q

Loss on an unprofitable contract

A

When cost estimates at the end of the current period indicate that a loss will result on completion of the project

Must recognize entire expected contract loss in current period (both under percentage-of-completion and completed-contract method

76
Q

Recording loss in a current period on a profitable contract

A

done in the percentage-of-completion method ONLY
- when percent complete math shows percentage complete dropped from previous period due to increased estimated costs

Revenue to recognize is less than costs incurred = loss, effectively adjusts excessive gross profit previously recognized

Dr. Construction Expense
Cr. Construction in progress (loss)
Cr. Revenue from long-term contracts

loss recorded on balance sheets

77
Q

Recording loss on an unprofitable contract (Percentage-of-completion method)

A

Have to back out previously recognized profits
- normal computation of revenue to be recognized in the current year

Current year revenue
+ reversal of previous year(s) gross profit
+ total estimated contract loss
= total construction expenses for current year

loss entered as a debit to construction in progress account

78
Q

Recording loss on an unprofitable contract under completed contract method

A

Loss recognized in year loss becomes evident

Dr. Loss from long-term contract
Cr. Construction in progress (loss)

Construction in progress account cannot excess contract price - if so must provide for loss

if billings > accumulated costs show liability on balance sheet

79
Q

Types of franchising arrangements

A

Manufacturer-retailer
Manufacturer- wholesaler
Wholesaler-retailer
Service sponsor - retailer (fastest growing/ most challenges)

80
Q

Services potentially provided by franchiser to franchisee

A

Depends on franchise arrangement

  • assistance in site selection (analyzing location/ negotiating lease)
  • evaluation of potential income
  • supervision of construction activity (inc. financing)
  • assistance with signs, fixtures, equipment
  • bookkeeping & advisory services (records and local regulations)
  • employee and management training
  • quality control
  • advertising and promotion
81
Q

Accounting for franchise agreements

A

Must determine what performance obligations are distinct vs. interrelated and when control is transferred / if it is transferred
- if provides access to rights (not control) then franchise revenue recognized over time

Royalties likely to be variable consideration, not recognized until uncertainty is resolved.

Theory of Financial Accounting II (8 decks)

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