Chapter 6 lecture Revenue recognition Flashcards
inflows or other enhancements of assets or settlement of liabilities from delivering or producing goods, rendering services, or other activities from the sellers ongoing central operations
revenue
revenue recognition is determined by the change in
assets and liabilities
- identify contracts with customer
- identify performance obligations in the contract
- determine the transaction price
- allocate the transaction price to performance obligations
- recognize revenue when (or as) each performance obligation is satisfied through a transfer of control
five-step revenue recognition process
what do you all need to have a valid contract
- contract has commercial substance
- The contract has been approved
- rights and obligations are identified
- payment terms are identified
- collection is probable
there is a separate performance obligation when each of the following criteria is met
- capable of being distinct
- distinct within a contract
- materiality
- the customer can benefit from it on its own
- the customer can use it inderdependently or with something they already have
- example (a smartphone is distinct good because customers can use it without needing anything else from the seller)
- example (a warranty bundled with a product is not distinct if it is integral to the products use)
capable of being distinct
- it is seperately identifiable from other goods/services in the agreement
- it is not interdependent with other goods/services in a wasy that it loses its value when seperated
- example (selling a laptop and a saftware subscription seperately -each has its own standalone function)
- example (if a company sells custom software development that integrates deeply with a proprietary database, these may not be distinct bc the software has no standalone use without the database)
distinct within a contract
- only going to account for things if they’re big enough “to matter”
- rule of thumb > 5% contract value
materiality
- Good A-$100, Good B-$90, Good C-$1- Good C is not materials
- Option- gym membership then you get an option to purchase yoga at a discocunt, Material- if there is something that would casue the customer to want to use the option
- 20% discount on yoga- yes material => seperate performance obligation
- 20% discount, but general public also gets 20% discount - no, not material
another way of looking at number 3 in the five-step revenue recognition process
determine transaction price
how much revenue will we record
3 primary (non-exclusive) ways to determine the transaction price
- fixed consideration
- variable consideration
- consideration payable to the customer
- transaction price is fixed and easily determinable in the contract
- not contingent on other events
- the vast majority of things that we (individuals) purchase in our daily lives are fixed consideration
- counter-example: Mexican restaurant in Madison that had a price on the menu, but the lady that rang you up put a different price
- For example: you can’t negotiate at Walmart
(3 primary ways to determine transaction price)
fixed considerations
- price depends on future events or varies due to discounts or incentives
- examples: rebates, cash discounts, price concessions/discounts on volume
- use either the ‘expected value’ method or the most likely amount method
(3 primary ways to determine transaction price)
variable consideration
- payments that the seller makes to the buyer reduce the transaction price
- rebates
- volume discounts
- slotting fees
(3 primary ways to determine transaction price)
consideration payable to the customer
we will allocate transaction price to performance obligations only when
there is more than one performance obligation
whenever possible we will allocate the transaction price based on
observable standalone prices
observable standalone prices are not always available. when not, there are 3 alternative methods that can be used
- adjusted market assessment approach
- expected cost + margin approach
- residual approach (only use if we cannot do the other)
- estimate the price a customer would pay in a market
- competitor would sell a similar good for,,,
- standalone price, except the standalone price is estimated
(which of the 3 alternative methods to observable standalone prices is this?)
adjusted market assessment approach
- our cost to manufacture item plus margin we expect to earn on it
(which of the 3 alternative methods to observable standalone prices is this?)
expected cost plus a margin approach
- use standalone prices for the performance obligations that you know and then plug the transaction price for the unknown performance obligation
- seldomly used
(which of the 3 alternative methods to observable standalone prices is this?)
residual approach
revenue is recognized
- when each performance obligation is _____
- when?
- separately or together?
- satisfied
- over time or at a point in time
- seperately
When recording revenue such as on costruction projects
Cost to cost method equation is?
total costs incurred/ total expected cost = % complete * transaction price
provides the good or service to the customer
principal or agent
principal
arranges for another company to provide the good or service to the customer
principal or agent
agent
determination of principal agent is based around ?
control
(if you have control, you are principal
- who has primary responsibility for fulfilling the performance obligation
- who has discretion in setting prices for goods or services
- who bears inventory risks
3 things to determine if something is the principal or the agent
Expected value method
Bonus amount Probability of outcome
$0 15%
$5000 40%
$10,000 45%
find the expected value of each
- $0, 15 % = $0
$0 * 15% - $5000, 40% = $2000
$5000 * 40% - $10,000, 45% =$4500
$10,000 * 45%
Most likely method
Bonus amount Probability of outcome
$0 15%
$5000 40%
$10,000 45%
find the expected value of each
$10,000 variable consideration
(bc its the most likely)
