Chapter 6 - Revenue & Inventories Flashcards
What is step 1 in ‘The Five Step Model’ for revenue?
Identify the contract with the customer.
- Written/verbal/implied
- Approved by all parties
- Clear identification of party rights/payment terms
- Contract of commercial substance
- Probable that consideration will be collected
What is step 2 in ‘The Five Step Model’ for revenue?
Identify the performance obligations of the contract.
- Distinct G/S
- Bundle of Gs/Ss
- Series of distinct Gs/Ss (e.g. over time)
What is step 3 in ‘The Five Step Model’ for revenue?
Determine transaction price
- Total amount of consideration receivable
- May include fixed/variable elements
- Based off most likely outcome or expected value (if most likely outcome not available)
What is step 4 in ‘The Five Step Model’ for revenue?
Allocate transaction price to the performance obligations.
- Overall transaction price allocated to the distinct parts of the obligation, based on their individual selling prices.
What is step 5 in ‘The Five Step Model’ for revenue?
Revenue recognition as and when a performance obligation is satisfied.
- Obligation satisfied when control of Gs/Ss transferred to customer
Either at:
- Point in time (transfer of goods)
- Over period of time (e.g. services)
What are deposits/advanced sales and how are they recorded?
Consideration received before performance obligations have been satisfied.
No transfer of goods yet and no performance obligation filled, so can’t recognise revenue.
So create a deferred income liability.
Dr Cash
Cr Deferred income liability (CL/NCL)
How do you record non-refundable deposits?
Same as deposits.
These are still liabilities, as if the product is never offered to the customer then they have a right to ask for their money back (because still no transfer of goods/obligation filled, and so entitled to money back).
It more refers to, if the product is offered, then customer can’t get their money back.
STILL NO REVENUE RECORDED.
What is deferred consideration and how is it recorded?
If an entity offers an “interest free” period, the revenue receivable needs recognising in 2 separate parts:
1) The fair value (FV) on date of sale, recognised on day of delivery of G/S.
2) Financing income, recognised over credit period. (Interest still being paid in effect by the company).
Performance obligations are met at the point the item is initially delivered, before the credit period starts.
How do you deal with goods and services under one contract (unbundling)?
If it is cheaper to purchase the items together than individually (i.e. a discount for buying together), the discount is split between the components in proportion to their fair values.
FV of service element = cost of service + reasonable profit.
How do you account for warranties regarding revenue?
Warranties which provide a distinct legal service (perhaps would be bought on it’s own by a customer) are treated as a separate performance obligation.
Warranties that just provide assurance that a product is manufactured to a certain standard is not unbundled.
What criteria does a performance obligation over a period of time need to meet?
One of following:
1) Customer simultaneously receives and consumes the benefits as the performance obligation is satisfied - e.g. cleaning contract.
2) Entity’s performance creates/enhances (i.e. builds) an asset that the customer controls while this is done - e.g. construction contracts, e.g. ship.
3) Entity’s performance does not create an asset with alternative use to the entity, and so has an enforceable right to payment for performance completed to date - e.g. website development.
What is ‘Stage of Completion’ and how is it applied?
Applied to the last 2 criteria for performance obligations satisfied over time.
Entity recognises revenue by measuring progress towards completion, using output (sales value) or input (costs incurred) against sales price.
If outcome cannot be estimated reliably, e.g. early stages of contract, recognise as extent that costs can be recovered from the customer (not the costs that have been incurred).
What are contract assets/contract liabilities?
These are contracts where performance obligations are recognised over time.
It links together the costs incurred and profit to date versus what we have billed/invoiced the client for.
Contract asset - where we have not invoiced enough yet, so this amount is recoverable from the client but they are no yet aware.
Contract liability - too much has been invoiced.
Costs incurred to date + Profit to date - Amounts invoiced to date = Contract Asset / (Contract Liability)
What are Consignment Sales?
A “sale or return” basis.
Original seller cannot recognise the sale as revenue until the buyer sells the goods onto a TP.
These goods should still also be classed as inventory in the original seller’s accounts, even if the buyer is ‘holding’ these items.
What are bill and hold arrangements?
Goods are only delivered once a final instalment is received.
They are simply being held, they cannot be sold to someone else and so you are committed to buying them.
So full amount of revenue can be recognised at the time the contract is agreed.
What is a repurchase agreement?
A ‘sale that isn’t really a sale’ - has no commercial substance.
Seller agrees or has an option to repurchase goods at late date.
Risks & rewards have been retained by the seller and so the arrangement represents a financing arrangement.
This is not a sale, but a financing agreement and should be recorded like so in the accounts.
And so a loan should be recorded, and if any relevant interest this should increase the loan and create an interest expense.
How do you record revenue regarding subscriptions to publications?
If publications of similar value, recognised revenue on a SL basis over the period the publications are DESPATCHED.
If value varies, recognise revenue in relation to estimated sales values of those publications DESPATCHED.
How do you record revenue regarding servicing fees?
No such thing as ‘free’ servicing/warranties etc.
Need to unbundle this out of the sales price.
Record the revenue related to servicing as deferred revenue and recognise it over the service period.
How is revenue recorded regarding licencing?
Licencing revenue should be accounted for according to substance of the agreement:
- Either at a point in time, e.g. a full rights sale.
- Or over a period of time, e.g. x number of royalties per month.
How do you record revenue regarding sale by an agent?
If acting as an ‘agent’, revenue should only reflect the commission earned (NET basis).
How do you record revenue regarding sale by an principal?
If acting as a ‘principal’ revenue should reflect the gross value of the Gs/Ss with a corresponding deduction for COS.
A principal:
- Has responsibility for providing Gs/Ss to the customer.
- Bears inventory and customer credit risks.
- Can establish prices charged to customer.
What is the total inventory value for retail/manufacturing companies?
Retail - total of goods purchased and held for resale.
Manufacturing - total of:
- Finished Goods
- Work in progress goods (being produced)
- Raw materials (awaiting use)
