F2M1 Flashcards
Revenue Recognition Introduction
Time value of money
Price * (1/(1+discount rate)^amount of time)
Calculation for gross profit or loss in each period for long term construction contracts for recognizing revenue over time:
Step1: Compute gross profit of completed contract
* Contract price – estimated total cost = gross profit
Step 2: Compute percentage of completion:
* Total cost to date / total estimated cost of contract
Step 3: Compute gross profit earned (profit to date)
* Gross profit * percentage of completion = profit to date
Step 4: Compute gross profit earned for current year:
* Profit to date at current fiscal year end – profit to date at beginning of period = current year to date gross profit
Pass Key: Pay attention to the terminology in long term construction contract questions. Estimated total costs can be confused with estimated costs to complete. Estimated total costs is the total cost for a longterm contract from inception to completion. Estimated costs to complete would be added to costs incurred to date to arrive at estimated total costs.
So estimated costs to complete is just the remainder of costs from the current time to then complete the contract.
5 step revenue approach
Step 1: Identify the contracts with the customer
Step 2: Identify the separate performance obligations in the contract
Step 3:Determine the transaction price
Step 4: Allocate the transaction price
Step 5: Recognize revenue when or as the entity satisfies each performance obligation
Step 1: Identify the contracts with the customer
It is a contract if all parties have approved and are committed to the terms, the rights and payment terms are identified, contract has commercial substance (future cash flows), an it is probably the entity will collect almost all the consideration due under the contract
When multiple are treated as one contract: consideration is tied to the performance or price of another contract, or the goods/services promised represent a single performance option
Modification: change in price or scope, there needs to be an adjustment to the revenue
New contract: if the modification leads to the scope of the contract increasing due to the addition of distinct goods/services and the price accurately reflects the stand alone selling price of the addition, then it is treated as a new contract.
Step 2: Identify the separate performance obligations in the contract
Single performance obligation: the promise to transfer goods/services is distinctly separate from others in the contract and the customer can benefit from the goods/services independently or combined with the customers own resources.
Separately identifiable: if the transfer of goods/services by the entity does not combine the goods/services with others in the contract, the goods/services do not customize or modify others in the contract, or the goods/services dont depend or relate to others in the contract.
Step 3: Determine the transaction price
Variable consideration: estimated by using a range of expected values (sums probability - weighted amount) or most liekly amount. Should only be included in price if a significant revenue reversal will not be required.
Time value of money should be an adjustment if the timing significantly benefits either party.
if payment is expected to be less than one year, discounting the transaction price is unnecessary.
Non-cash consideration: should be measured at fair value at contract inception
Consideration payable to the customer (cash, credits, vouchers) are treated as a reduction in transaction price and recognized revenue. unless the customer is transferring goods/services to the entity.
Step 4: Allocate the transaction price to the separate performance obligations
Discounts: If the sum of each good/service (obligations) on its own is greater than the total consideration, the total should be allocated proportionally to all obligations.
Variable consideration may be attributable different components of the contract at a larger or smaller level.
Transaction changes are allocated at the same basis used at inception
Step 5: Recognize revenue when or as the entity satisfies each performance obligation
recognized Over time if any of these apply: Its a work in process (customer controls asset, but entity still works on it), customer receives benefits simultaneously as entity performs (ex: cleaning service or payroll processing system), entitys work does not create an asset with a different use than its original intent and the entity has the right to payment (ex: asset cannot be directed to another customer).
Recognize revenue over time can be measured using output methods (current amount of goods/services provided or delivered compared to the total obligation) or the input methods (amount of time, resources, etc the entity has put towards completion compared to the total amount required to complete it)
Revenue recognized at a point in time: when the customer obtains control over the asset. control over the asset requires: customer accepted the asset, customer has the legal title and the associated risks and rewards, entity has transferred physical possession of the asset, and entity has the right payment while the customer has an obligation to pay.
Contract asset
entitys right to consideration when the contract is fulfilled. booked if a portion of the contract is completed, but payment is not required until full completion.
if revenue is due upon passage of time and not based on whether or not the physical asset has been delivered, this should be presented separately as a receivable
Contract Liability
booked when the entity has received consideration but still has to complete its commitment to transfer goods/services
Construction in progress
an inventory account where construction costs and estimated gross profit earned are accumulated if recognized revenue over a period of time.
if revenue is recognized at a point in time: only construction costs are accumulated here.
netted with Progress Billings account on the balance sheet
Progress Billings
a contra-inventory account where billings on construction are accumulated here.
netted with Construction in Progress to appear on balance sheet.
Revenue recognition of a long term contract:
estimated losses for revenue recognized over time are recognized when?
Immediately in the year it is discovered.
any previous gross profit or loss reported in prior years must be adjusted for when calculating the total estimated cost.
Construction contract revenue recognized at a point in time
Recognized at a point in time if the customer does not control the asset as it is created and the entity does not have an enforceable right to payment for the performance completed to date.
at completion: Gross profit (loss) = contract price – total costs
Expected loss on total contract is determined by: total contract revenue= advances + additional revenue expected
total contract costs = estimated costs to complete + recorded costs to date
Estimated profit or loss: total contract revenue – total contract costs
Loss are recorded immediately, while profit is recorded at completion of contract.
At interim balance sheet dates, when Construction in Progress and Progress Billings are netted, they are classified as a current asset or liability.
Losses should be recognized in the full year they are discovered.
