F2 M1 Revenue Recognition Introduction Flashcards
What are the criteria for recognizing contract revenue over time?
Any one of the following:
1. Company creates/enhances an asset that the customer controls while the company creates/enhances it;
2. Customer uses the company’s services as the company performs the services;
3. Company does not create an asset it can use in any other way and the company has an enforceable right to receive payment for performance to date.
Examples:
- Customer pays a nonrefundable deposit up front for a construction company to build a condo that the customer owns from inception;
- Customer agrees to make progress payments during construction;
- Construction company may not deliver the condo to another customer, and if customer fails to make progress payments, construction company has a right to full payment once it completes the condo.
How do you compute the percentage of completion used to arrive at gross profit from a construction contract?
Percentage of completion = Cumulative costs incurred to date / total estimated costs.*
- Make sure to use the most recent total estimated costs.
Example:
Acme began a construction project on 1/1/23 and has just completed its 12/31/24 fiscal year. At inception, the total estimated cost of the construction was $2,250,000. From 1/1/23 through 12/31/24, it incurred total costs of $1,800,000. As of 12/31/24, the estimated cost to complete the contract was $600,000. Therefore, as of 12/31/24, the percentage of completion was $1,800,000 / ($1,800,000 + $600,000) = 75%.
In a bill-and-hold arrangement, what criteria determine whether a customer has gained control of a product?
All of the following:
* The product is ready for transfer to the customer, but…
* There is a substantive reason for a bill-and-hold arrangement (e.g. customer has nowhere to store the product)
* So, the product has been separately identified as belonging to the cutomer (e.g. set aside in the seller’s warehouse), and…
* The seller cannot use the product or direct it to another customer.
When can a seller recognize revenue from a bill-and-hold arrangement?
When the customer has gained control of the product.
Note: The customer can gain control of the product before it is delivered.
A contract requires a vendor to perform multiple services that are similar in nature and provided in the same manner. Do they constitute multiple performance obligations or one performance obligation?
One performance obligation.
A contract requires a vendor to perform multiple services that are separately identifiable from each other. Do the services constitute one performance obligation or multiple performance obligations?
Multiple performance obligations
Each service is a separate performance obligation.
Acme buys a service contract that requires its vendor to perform multiple services, each of which is separately identifiable from the others. Acme can benefit from each service only when combined with Acme’s other available resources. Do the services constitute one performance obligation, multiple performance obligations, or no performance obligation?
Multiple performance obligations
Explanation: Because they are separately identifiable and Acme can benefit from them, regardless of whether Acme benefits from each service independently or in combination with other resources.
When is a contract modification accounted for as a separate contract?
When the scope of the original contract increases through the addition of distinct goods or services with stand-alone prices.
Distinct goods or services create additional performance obligations.
How should a discount on a total contract price be applied to a contract with multiple performance obligations?
Allocate it proportionally to all obligations within the contract.
Example:
Acme gives its customer a 20% discount on a $300,000 contract, which contains two performance obligations valued at $200,000 and $100,000. Of the $60,000 discount, $40,000 should be allocated to the former obligation and $20,000 to the latter.
How is revenue recognized when using output methods to measure progress toward completion?
Based on the value to the customer of goods of services transferred to date relative to the remaining goods or services promised.
Examples: units produced or delivered relative to total units to be produced or delivered, time elapsed relative to total estimated time, milestones achieved relative to all milestones to be achieved.
How is revenue recognized when using input methods to measure progress toward completion?
Based on the efforts or inputs toward satisfying a performance obligation relative to the total expected inputs.
Examples: costs incurred relative to total estimated costs, resources consumed relative to total estimated resources to be consumed, labor-hours expended relative to total estimated labor-hours.
Under the percentage of completion method, when should a company report a current liability for unearned revenue?
When progress billings exceed revenue recognized to date, a company should report the excess as a current liability.
Note: revenue = costs + earnings
Example:
At year-end, Acme had the following amounts related to its $9,000,000 construction contract.
Actual costs incurred and paid: $1,000,000
Estimated costs remaining to complete the contract : $6,000,000
Progress billings: $1,800,000
Totalestimatedcost = 1,000,000 + 6,000,000 = 7,000,000
Percentagecomplete = 1,000,000 / 7,000,000 = 14.29%
Revenuetodate = 9,000,000 × 14.29% = 1,286,000
Currentliability = 1,800,000 − 1,286,000 = 514,000
Dr. Accounts Receivable 1,800,000
Cr. Revenue (from long-term contract) 1,286,000
Cr. Contract Liability (“Billings in excess of costs and recognized earnings”) 514,000
Under the percentage of completion method, when should a company report a current asset for unearned revenue?
When revenue recognized to date exceeds progress billings, a company should report the excess as a current asset.
Note: revenue = costs + earnings
Example:
At year-end, Acme had the following amounts related to its $9,000,000 construction contract.
Actual costs incurred and paid: $2,000,000
Estimated costs remaining to complete the contract : $6,000,000
Progress billings: $1,800,000
Totalestimatedcost = 2,000,000 + 6,000,000 = 8,000,000
Percentagecomplete = 2,000,000 / 8,000,000 = 25%
Revenuetodate = 9,000,000 × 25% = 2,250,000
Currentasset = 2,250,000 − 1,800,000 = 450,000
Dr. Accounts Receivable 1,800,000
Dr. Contract Asset 450,000
Cr. Revenue (from long-term contract) 2,250,000
At the end of the first year of a $300,000 construction contract, Acme has incurred $280,000 of costs. Acme estimates it will cost $40,000 to complete the contract. What amount of gross profit (loss) should Acme report in its income statement for the first year?
Acme should report a $20,000 loss.
Estimated losses are recognized in full immediately (conservatism).
What indicates that a company is acting as an agent rather than a principal in a sales contract?
An agent does not control the good or service in any way before it is provided to the customer.
Example:
Acme Tickets earns a 5% commission on sales of airline tickets. Airlines set the prices of tickets, have responsibility for providing the transportation, and bear the risk of unsold tickets or cancelled flights. Acme Tickets is an agent. The airlines are principals.
In a principal-agent relationship, can the agent recognize revenue before the principal delivers the good or service to the customer?
Yes, but only if the agent has fulfilled all of its performance obligations.
Example 1: Acme tickets earns a 5% commission on sales of airline tickets, which airlines must redeem for transportation. As an agent, Acme can recognize revenue upon the sale of a ticket–and before a flight is completed–because Acme’s performance obligation is only to deliver a ticket and not to provide transportation.
Example 2: DropShip.com earns a 5% commission on sales of laptops, which a third-party supplier must deliver. Although DropShip.com is an agent, it cannot recognize commission revenue until a laptop is delivered because its performance obligation is to facilitate not only the sale but also the delivery of a laptop.
If a company sells a product but is required to repurchase the product at the customer’s request, what conditions require the company to account for the sale as a financing arrangement?
Financing arrangement: the customer is loaning cash to the company
When the repurchase price is equal to or greater than the original sale price and the expected market value.
Example: Acme sells a truck to Newco for $50,000. The sales contract contains a put option that requires Acme to repurchase the truck for $55,000 at Newco’s request. The expected market value of the truck is $52,500. Acme must account for the sale as a financing arrangement because $55,000 > $50,000 and $55,000 > $52,250.
When a sales contract contains a put option that requires the seller to account for the sale as a financing arrangement, when and in what amount can the seller recognize revenue from the sale?
(Assume the customer pays cash on the date of sale.)
When the put option lapses, the seller can recognize revenue in the amount of the sale price plus the difference between the repurchase price and the sale price.
Financing arrangement: the buyer is loaning cash to the seller
Example: On Jan. 1, Acme sells Newco a truck for $50,000. The sales contract contains a put option that requires Acme to repurchase the truck for $55,000 at Newco’s request by Dec. 31. The expected market value of the truck is $52,500. Newco lets the option lapse on Dec. 31. Acme records the following.
Jan. 1:
Dr. Cash $50,000
Cr. Financial Liability $50,000
Dec. 31:
Dr. Interest Expense $5,000 ($55,000 - $50,000)
Cr. Financial Liability $5,000
Dec. 31:
Dr. Financial Liability $55,000
Cr. Sales $55,000
When a warranty is bundled with an item and sold for one price, what determines whether the warranty is a distinct service from the item?
If the warranty can be purchased separately, it is a distinct service because it is promised to the customer in addition to the item.
What determines whether a warranty is a separate performance obligation from providing assurance that a product complies with agreed-upon specifications?
- If a warranty is required by law, it is not a separate performance obligation
- The longer the coverage period, the more likely the warranty is a separate performance obligation
- If the seller must perform specific tasks to assure the product complies with specifications, such tasks are not likely a separate performance obligation
If a warranty represents a separate performance obligation from an item with which it is sold, how much of the total price should be allocated to the warranty and to the item?
The total price should be allocated to the warranty and the item in proportion to the prices at which the warranty and the item are sold separately.
Example: Acme sells a radio transmitter and a five-year warranty for $45,000. The transmitter alone is worth $40,000. The warranty can be purchased separately for $10,000. Therefore, 20% of the $45,000 price, or $9,000, should be allocated to the warranty, and 80%, or $36,000, should be allocated to the transmitter.
Warranty = $10,000 / ($10,000 + $40,000) = 20%
Transmitter = $40,000 / ($10,000 + $40,000) = 80%
How should a company recognize a sale that includes a right of return for a full refund when the company can estimate the amount of items likely to be returned?
The company should recognize revenue for the total sale minus the amount likely to be returned, which it should recognize as a refund liability until the right to the return expires and/or all returns are settled.
Example: Acme sells $40,000 of merchandise for cash with a one-year right of return. The company estimates $5,000 of returns.
On the date of sale:
Dr. Cash $40,000
Cr. Sales $35,000
Cr. Refund Liability $5,000
90 days later, the customer returns $4,000 of merchandise, and Acme pays a refund:
Dr. Refund Liability $4,000
Cr. Cash $4,000
One year after the sale, the right of return expires:
Dr. Refund Liability $1,000
Cr. Sales $1,000
How should a company recognize a sale that includes a right of return for a full refund when the company cannot estimate the amount of items likely to be returned?
The company should recognize the entire sale as a refund liability until the right of return expires and/or all returns are settled.
Example: Acme sells $40,000 of merchandise for cash with a one-year right of return. The company cannot estimate the amount of returns.
On the date of sale:
Dr. Cash $40,000
Cr. Refund Liability $40,000
90 days later, the customer returns $4,000 of merchandise, and Acme pays a refund:
Dr. Refund Liability $4,000
Cr. Cash $4,000
One year after the sale, the right of return expires:
Dr. Refund Liability $36,000
Cr. Sales $36,000
What amounts make up the balance of a Construction in Progress account?
Cumulative costs incurred to date plus gross profit (loss) recognized to date
Example:
- Contract price: $10,000,000
- Estimated total costs: $8,000,000
- Year 1 actual costs: $2,000,000
- Percentage complete: $2,000,000 / $8,000,000 = 25%
- Revenue to recognize: 25% * $10,000,000 = $2,500,000
- Gross profit: $2,500,000 - $2,000,000 = $500,000
Record costs incurred:
Dr. Construction in Progress (CIP) 2,000,000 (costs)
Cr. Cash 2,000,000
Recognize revenue and gross profit:
Dr. Construction Expense 2,000,000
Dr. Construction in Progress (CIP) 500,000 (gross profit)
Cr. Construction Revenue 2,500,000
