Chapter 6 Flashcards
We can sum up this chapter with
Risk (uncertainty)
attempt to address
when, what and how much to be recognized
In case writing you should always show
2 weak arguments as well, why your argument is better
recognition of losses and profits
losses quickly and profits slowly
the greater the risk of something going wrong
the slower you will recognize
major risks
- a MAJOR portion of the performance won’t be achieved
- big risk of not collecting some or all of purchase price (being paid)
- measurability (cost/revenues/profit/returns/degree of completion)
suggested approach to examine any scenario
Performance (all, some or none)
Measurability (revenues, costs and performance done)
Collectability (issue?)
revenue recognition does not coincide with
cash flows. Don’t need for all to occur at one point in time
PMC is used with
IFRS and ASPE
Focus with ASPE
earnings (income statement)
Focus with IFRS
rights and obligations (increase in assets or liabilities on balance sheet will mean recognizing revenue)
never forget the concept
MATCHING concept. Once you’ve decided what to recognize and when in a case scenario or mini question, briefly mention the costs that must be matched to the revenues
Multiple deliverables
when you can sell one item without the other
Split of revenues recognized
relative fair value of each if available or relative cost of providing the service: CASE MATERIAL
when to recognize revenue for production
before the sale: when there is no risk to seller (fuel, commodities)
when to recognize revenue for performance
most common: could be at one point or several in time
when to recognize revenue for collection
rare- applied in cases where collection is uncertain
collecting interest revenue on notes receivable/payable
the most determinable of these:
- prevailing rate for similar instrument of issuer with similar credit rating
- a rate of interest that discounts the nominal amount of instrument to current cash sales
Fair value method
IFRS/ASPE: when the FV of both elements of multiple deliverable are known –> prorate the total amount according to the proportion of fair value of each to their total separately
incremental method
ASPE: if the FV of only one is known –> use that and the balance will be deferred as the price of the other item
ethical issue with multiple deliverable methods
managers may try to over estimate the revenues they recognize up front and underestimate future liability
Loan provided to a customer with no interest to the cx
ABC company will recognize the full amount as performance is completed but part as service revenue and part as interest revenue
*do not forget to expense costs incurred
Barter transactions
non-monetary: little or no monetary assets are received as consideration when goods and services are sold –> recorded at fair value of assets received, unless fair value of those given up is easier to determine
–> if no commercial substance then record at book value
commercial substance
significant change in timing, amount or risk of expected future cash flows
Legal issue and contract law
a sale is a contract, shipping may determine when title passes
risk
increase in the risk that inbound cash flow will not occur as a result of transaction: business accepts junior secured status on a debt in exchange for larger repayment amount
timing
business agrees to a delayed payment in exchange for larger amount
amount
business receives cash sooner in exchange for receiving a smaller amount
if no commercial substance
transaction should not be recognized: sale of asset to owner of sole proprietorship, leases back to the business,
agent vs. principal
ask who is bearing the risk?
agent: record revenues net
principal: sales expense gross
cash discount
discount offered by seller for paying cash early on credit sales
cash discount can be recognized two ways
- gross method
2. net method
gross method
initially record sale at gross price (full price no discount)
- if customer pays within discount period: dr cash & sale discount (contra sales) and cr. AR
- if customer pays after discount period: dr. cash and cr. AR
net method
company would initially record at net price = gross price - sales discount dr. AR cr. Sales
- payment within discount period: dr. cash cr. AR
- payment after discount period: dr. cash full amount (gross) cr. AR & sales discount forfeited (other revenues)
earnings approach
focuses on earnings process and how a company adds value for its customers
contract-based approach
focuses on contractual rights and obligations created by sales contracts
revenue recognition earnings approach (ASPE)
PMC
- performance is achieved
- -> risks and rewards transferred and/or earnings process is substantially complete
- -> measurability is reasonably assured - collectability is reasonably assured
risks and rewards of ownership
core concept of earnings approach: who has possession and who has legal title
shipping terms may
determine when legal title passes
buyback agreement
loan with items being transferred held as collateral
bill and hold transaction
bona fide business reasons for structuring a sale (lack of space), professional judgement must be exercised to see if classified as a sale
Problems with earnings approach
- multiple and conflicting guidance
- difficult to apply bc of different views on when to recognize
- risk and rewards split between buyers and seller, hard to know when transferred
- a lot of subjectivity
- omit when receivables should be recorded if revenues not yet earned
under contract based approach, contract recognized when
- entity becomes party to the contract
- contractual rights are collectible/measurable
- performance obligation is measurable
under contract based approach, revenue recognized when
control passes/performance occurs –> physical control of asset and legal title
*net position = net amounts
comparing earning and contract based
- IFRS triggers entries before ASPE, focus on balance sheet –> the difference between contract assets and liabilities in IFRS is profit/loss to be recognized on I/S
- ASPE’s focus on income statement what is earned
revenues under _____ may take longer to be recognized
IFRS
problems with contract based approach
not been tested, relatively new,
measurement uncertainty result from
- consideration
- returns
- collectability
consideration
payment relating to goods sold depends on the resale of goods by the buyer, revenue would not be recognized
return
right of returns exists; might have to postpone reported sales until the privilege expired
collectability
revenue is recognized and any potential uncollectible amount is accrued
factors to consider when deciding gross or net income
- whether company acts as a principal in transaction or as an agent
- whether the company take titles to goods being sold
- whether the company has the risks and rewards of ownership of goods being sold
revenue from sale of goods shall be recognized when ALL satisfied
- entity transferred to the buyer risks and rewards of ownership
- entity retains no continuing managerial involvement to the degree associated with ownership nor effective control over goods sold
- amount of revenue can be measured reliably
- probable that economic benefits associated with transaction flow to the entity
- costs incurred or to be incurred can be measured
goods sold with warranty and returns not estimable
Dr. AR Cr. Inventory and Deferred gross profit
when uncertainties are resolved (payment received, return expired), recognize revenue
dr. COGS and deferred gross profit (liability) and cr. sale
when cash is received
dr. cash
cr. AR
revenue recognized for bill and hold sales if
- probable that delivery will be made
- item on hand, identified and ready for delivery to the buyer is recognized
- buyer specifically acknowledges the deferred delivery instructions
- usual payment terms apply
rendering of services recognized if
- amount of revenue can be measured reliably
- probable that economic benefits associated with transaction will flow to the entity
- stage of completion of transaction at the B/S date can be measured reliably
- cost incurred and cost to complete can be measured
advertising commission
only recognize when advertisement appears in front of public
recognize interest
effective interest method or other straight line method
recognize royalties
accrual basis in accordance with substance of relevant agreement and degree of trust for large companies
recognize dividends
right to receive payment is established
onerous contract
the cost required to fulfill agreement is higher than the revenue
