FAR SEC 3 Flashcards
When the outcome of the contract is not reasonably measurable but the costs incurred in satisfying the performance obligation are expected to be recovered, how should revenue be recognized?
When the outcome of the contract is not reasonably measurable but the costs incurred in satisfying the performance obligation are expected to be recovered, revenue must be recognized only to the extent of the costs incurred. Revenue recognized is based on a zero profit margin until the entity can reasonably measure the outcome of the performance obligation.
Should earnings per share (EPS) be reported on the face of the income statement for cumulative effect of a change in accounting principle?
No.
Should earnings-per-share data be reported on the face of the income statement for income from continuing operations?
EPS data for income from continuing operations and net income must be reported on the face of the income statement. EPS data for a discontinued operation may be disclosed on the face of the income statement or in a note.
Should earnings-per-share data be reported on the face of the income statement for income from discontinued operations?
EPS data for a discontinued operation may be disclosed on the face of the income statement or in a note.
A company’s convertible debt securities are both a potential common stock and potentially dilutive in determining earnings per share. What would be the effect of these securities on the calculation of basic earnings per share (BEPS) and dilutive earnings per share (DEPS)?
Securities classified as potential common stock should be included in the computation of the number of common shares outstanding for DEPS if the effect of the inclusion is dilutive. Dilutive potential common stock decreases DEPS. BEPS is not affected by potential common stock.
Basic Earnings per Share (BEPS)
Basic EPS = (Net income - preferred dividends) ÷ weighted average of common shares outstanding during the period.
OR
BEPS = (Income Available to Common Shareholders)/(Weighted-average Number of Common Shares Outstanding)
Basic earnings per share does not factor in the dilutive effects of convertible securities.
Formula for Diluted Earnings per Share
The Formula for Diluted Earnings per Share
DEPS= (BEPS numerator + Effect of dilutive PCS)/(BEPS denominator + Effect of dilutive PCS)
What are the 4 criteria for considering that a contract exists from an accounting standpoint under ASC 606 Contracts with Customers?
A contract is accounted for under the revenue recognition standard if all the following criteria are met: (1) The contract was approved by both parties, (2) the contract has commercial substance, (3) each party’s rights regarding (a) goods or services to be transferred and (b) the payment terms can be identified, and (4) it is probable that the entity will collect the consideration to which it is entitled according to the contract.
When are share options antidilutive?
If the average price of the share options over the period is “out of the money”, the share options are antidilutive. Antidilutive shares cannot be added to the BEPS denominator as the Effect of PCS in the denominator for calculating DEPS.
The correction of an error in the financial statements of a prior period should be reported, net of applicable income taxes, in the current
Retained earnings statement as an adjustment of the opening balance.
Which of the following describes the appropriate reporting treatment for a change in accounting estimate?
All changes in accounting estimates are made prospectively. No changes are made in prior financial statements, and the beginning balances are not adjusted. The effects of all changes in accounting estimate are accounted for in the period of the change and future periods if the change affects both.
Under the guidance for recognition of revenue from contracts with customers (ASC 606), a contract modification is accounted for as a separate contract if the additional promised goods are _________(1) and the price for these additional goods is __________ (2).
A contract modification exists when the parties approve a change in the scope or price of a contract. A contract modification is accounted for as a separate contract if (1) it results in the addition to the contract of promised goods or services that are distinct and (2) the price for these additional goods or services is their standalone selling price.
Preferability Criterion - When to Change Accounting Principle?
If financial information is to be comparable and consistent, entities must not make voluntary changes in accounting principles unless they can be justified as preferable.
The three types of accounting changes are
A change in accounting principle,
A change in accounting estimate, and
A change in the reporting entity.
What are the three situations that fit the definition of a change in accounting principle?
A change in accounting principle occurs when an entity (1) adopts a generally accepted principle different from the one previously used, (2) changes the method of applying a generally accepted principle, or (3) changes to a generally accepted principle when the principle previously used is no longer generally accepted.
Is the initial adoption of an accounting principle the same as a change in principle?
No. A change in principle does not include the initial adoption of a principle because of an event or transaction occurring for the first time.
What is the temporal scope of changes in accounting principle?
Direct effects (including on income tax) are applied retrospectively, whereas indirect effects are recognized and reported in the period of change.
Retrospective application is required for all direct effects and the related income tax effects of a change in principle. An example of a direct effect is an adjustment of an inventory balance to implement a change in the method of measurement.
Retrospective application must not include indirect effects. These are changes in current or future cash flows from a change in principle applied retrospectively. An example of an indirect effect is a required profit-sharing payment based on a reported amount that was directly affected (e.g., revenue).
What are direct effects (from a change in accounting principle)?
Retrospective application is required for all direct effects and the related income tax effects of a change in principle.
An example of a direct effect is an adjustment of an inventory balance to implement a change in the method of measurement.
What are indirect effects (from a change in accounting principle)?
Retrospective application must not include indirect effects. These are changes in current or future cash flows from a change in principle applied retrospectively.
An example of an indirect effect is a required profit-sharing payment based on a reported amount that was directly affected (e.g., revenue).
Indirect effects are recognized and reported in the period of change.
How does retrospective application work for a change in accounting principle?
Retrospective application requires the carrying amounts of (1) assets, (2) liabilities, and (3) retained earnings (or other components of equity or net assets) at the beginning of the first period reported to be adjusted for the cumulative effect (CE) of the new principle on the prior periods.
All periods presented must be individually adjusted for the period-specific effects (PSE) of the new principle.
It may be impracticable to determine the CE of a new principle on any prior period.
The new principle then must be applied as if the change had been made prospectively at the earliest date practicable.
Impracticability Exceptions. It may be practicable to determine the CE of applying the new principle to all prior periods but not the PSE. In these circumstances, CE adjustments must be made to the beginning balances for the first period to which the new principle can be applied.
For retrospective application of a change in accounting principle, which balance sheet items are adjusted at the beginning of the first period reported for the cumulative effect (CE) of the change?
Retrospective application requires the carrying amounts of (1) assets, (2) liabilities, and (3) retained earnings (or other components of equity or net assets) at the beginning of the first period reported to be adjusted for the cumulative effect (CE) of the new principle on the prior periods.
For retrospective application of a change of accounting principle, what are the Impracticability Exceptions?
Normal Case is full Retrospective Application (Not Exception): Retrospective application requires the carrying amounts of (1) assets, (2) liabilities, and (3) retained earnings (or other components of equity or net assets) at the beginning of the first period reported to be adjusted for the cumulative effect (CE) of the new principle on the prior periods. All periods presented must be individually adjusted for the period-specific effects (PSE) of the new principle.
Exception (1): It may be impracticable to determine the CE of a new principle on any prior period. The new principle then must be applied as if the change had been made prospectively at the earliest date practicable.
Exception (2): It may be practicable to determine the CE of applying the new principle to all prior periods but not the PSE. In these circumstances, CE adjustments must be made to the beginning balances for the first period to which the new principle can be applied (meaning the first period when PSE can be stated???).
What is prospective adjustment?
Its effects must be accounted for only in (1) the period of change and (2) any future periods affected (prospectively). The prospective application must be applied from the beginning of the accounting period in which the accounting estimate was changed.
What is a Change in Accounting Estimate?
A change in accounting estimate results from new information. It is a reassessment of the future status, benefits, and obligations of assets and liabilities. Its effects must be accounted for only in (1) the period of change and (2) any future periods affected (prospectively).
What are the temporal restrictions on adjustments due to Change in Accounting Estimate?
For a change in estimate, the entity must not
Restate or retrospectively adjust prior-period statements or
Report pro forma amounts for prior periods.
Essentially, retrospective adjustments are disallowed.
How are changes in estimate inseparable from changes in principle treated?
A change in estimate inseparable from a change in principle is accounted for as a change in estimate, i.e., prospective application. An example is a change in a method of depreciation, amortization, or depletion of long-lived, nonfinancial assets.
Change in Reporting Entity
A change in the reporting entity results in statements that are effectively those of a different entity.
Most such changes occur when
1) Consolidated or combined statements replace those of individual entities,
2) Consolidated statements include different subsidiaries, or
3) Combined statements include different entities.
A business combination or consolidation of a variable interest entity is not a change in the reporting entity.
A change in the reporting entity is retrospectively applied to interim and annual statements.
The three main causes of changes in reporting entity are _______________.
Most such changes occur when
Consolidated or combined statements replace those of individual entities,
Consolidated statements include different subsidiaries, or
Combined statements include different entities.
What is a variable interest entity?
A variable interest entity (VIE) refers to a legal business structure in which an investor has a controlling interest despite not having a majority of voting rights. Characteristics include a structure where equity investors do not have sufficient resources to support the ongoing operating needs of the business. In most cases, the VIE is used to protect the business from creditors or legal action. A business that is the primary beneficiary of a VIE must disclose the holdings of that entity as part of its consolidated balance sheet.
What circumstances definitely are not changes in reporting entity?
A business combination or consolidation of a variable interest entity is not a change in the reporting entity. Note that business combinations or consolidations of entities other than VIEs would be considered changes of reporting entity.
What is a business combination?
A merger or acquisition is a business combination. A business combination is defined as a transaction or other event in which an acquirer (an investor entity) obtains control of one or more businesses.
What is the temporal scope of application for a Change in Reporting Entity?
A change in the reporting entity is retrospectively applied to interim and annual statements.
What are the 3 causes of Error Correction?
An error in prior statements results from
A mathematical mistake,
A mistake in the application of GAAP, or
An oversight or misuse of facts existing when the statements were prepared.
A change to a generally accepted accounting principle from one that is not generally accepted is an error correction, not an accounting change.
How is a change from non-GAAP to GAAP principle treated?
A change to a generally accepted accounting principle from one that is not generally accepted is an error correction, not an accounting change or “change in accounting principle”.
How are error corrections reported on the financial statements?
Error corrections must be reported in single-period statements as adjustments of the opening balance of retained earnings.
If comparative statements are presented, corresponding adjustments must be made to net income (and its components) and retained earnings (and other affected balances) for all periods reported.
Corrections of prior-period errors must not be included in net income UNLESS there are comparative financial statements that show multiple periods on one statement.
What is Error Analysis (correcting journal entry)?
A correcting journal entry combines the reversal of the error with the correct entry. Thus, it requires a determination of the
Journal entry originally recorded,
Event or transaction that occurred, and
Correct journal entry.
Error analysis addresses
Whether an error affects prior-period statements,
The timing of error detection,
Whether comparative statements are presented, and
Whether the error is counterbalancing.
Are prior period restatements always required for errors affecting prior-period statements?
No. An error affecting prior-period statements may or may not affect prior-period net income. For example, misclassifying an item as a gain rather than a revenue does not affect income and is readily correctable. No prior-period adjustment to retained earnings is required.
Counterbalancing vs. Noncounterbalancing Errors
An error that affects prior-period net income is counterbalancing if it self-corrects over two periods. However, despite the self-correction, the financial statements remain misstated. They should be restated if presented comparatively in later periods. The flowcharts on inventory errors in Study Unit 7, Subunit 7, illustrate this concept.
An example of a noncounterbalancing error is a misstatement of depreciation. Such an error does not self-correct over two periods. Thus, a prior-period adjustment will be necessary.
How can entities make voluntary changes in accounting principles?
Entities can only make voluntary changes in accounting principle if they can be justified as “preferable”. The reason for this is that unnecessary changes in principle would reduce comparability and consistency.
What are the types of accounting changes?
1) change in accounting principle.
2) change in accounting estimate.
3) change in reporting entity.
When does a change in accounting principle occur?
A change in accounting principle occurs when an entity
(1) adopts a generally accepted principle different from the one previously used,
(2) changes the method of applying a generally accepted principle, or
(3) changes to a generally accepted principle when the principle previously used is no longer generally accepted.
What is the major exceptional case for a change in accounting principle?
A change in principle does not include the initial adoption of a principle because of an event or transaction occurring for the first time.
When is retrospective application required for changes in accounting principle?
Retrospective application is required for all direct effects and the related income tax effects of a change in principle.
An example of a direct effect is an adjustment of an inventory balance to implement a change in the method of measurement.
Retrospective application must not include indirect effects. These are changes in current or future cash flows from a change in principle applied retrospectively.
An example of an indirect effect is a required profit-sharing payment based on a reported amount that was directly affected (e.g., revenue).
Indirect effects are recognized and reported in the period of change.
For changes in accounting principle, what distinguishes direct effects from indirect effects?
Direct effects are changes to the current period statements from the Cumulative Effect (CE) of the retrospectively applied adjustments for change in principle.
Indirect effects are those effects of the change in cash flow that have a bearing on current or future cash flows. Indirect effects are recognized and reported in the period of change.
What is retrospective application?
Retrospective application requires the carrying amounts of (1) assets, (2) liabilities, and (3) retained earnings (or other components of equity or net assets) at the beginning of the first period reported to be adjusted for the cumulative effect (CE) of the new principle on the prior periods.
All periods presented must be individually adjusted for the period-specific effects (PSE) of the new principle.
When is the cumulative effect of the retrospective adjustments reported?
It is reported for the BEGINNING OF THE PERIOD in the statements for the current period in which the change of principle is being implemented.
How should all periods presented in the statements at the time of change in principle be adjusted?
All periods presented must be individually adjusted for the period-specific effects (PSE) of the new principle.
In what 2 cases would prospective application of a change in accounting principle be warranted?
1) It may be impracticable to determine the CE of a new principle on any prior period.
The new principle then must be applied as if the change had been made prospectively at the earliest date practicable.
2) Prospective application is warranted if the change in principle is inseparable from a change in estimate.
What is the exception to the requirement to individually adjust for the period-specific effects (PSE) of the new principle in each period presented?
It may be practicable to determine the CE of applying the new principle to all prior periods but not the PSE.
In these circumstances, CE adjustments must be made to the beginning balances for the first period to which the new principle can be applied.
What is the application method for a change in accounting estimate?
Prospective application.
What is a change in accounting estimate?
A change in accounting estimate results from new information. It is a reassessment of the future status, benefits, and obligations of assets and liabilities. Its effects must be accounted for only in (1) the period of change and (2) any future periods affected (prospectively).
The prospective application must be applied from the beginning of the accounting period in which the accounting estimate was changed.
For a change in estimate, the entity must not
Restate or retrospectively adjust prior-period statements or
Report pro forma amounts for prior periods.
What happens when a change in estimate is inseparable from a change in accounting principle?
A change in estimate inseparable from a change in principle is accounted for as a change in estimate, i.e., prospective application.
An example is a change in a method of depreciation, amortization, or depletion of long-lived, nonfinancial assets.
Why would interest expense on convertible bonds be added back when calculating DEPS?
For DEPS, the dilutive action is always assumed, so conversion of the bonds is assumed. If the bonds are converted, the interest isn’t paid, so it is added back net of tax effects.
In computing DEPS, why is dividend income adjusted for the conversion of preferred stock to common shares?
There is a conversion ratio from preferred to common shares, and the dividend rate for common shares usually differs from the preferred dividend rate.
What is PCS?
PCS is dilutive potential common shares (PCS).
What are earnings per incremental share?
Earnings per incremental share are the earnings per share calculated for blocks of shares being considered under the If-Converted Method for DEPS.
What is the core principle for recognizing revenue from contracts with customers?
The core principle is that an entity recognizes revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in the exchange.
What are the 4 categories of contracts that exceptional to the core principles of contracts with customers revenue recognition?
This guidance applies to all contracts with customers except the following:
-Leases
-Financial instruments
-SPECIAL TOPICS. Contractual rights and obligations within the scope of specific topics, such as receivables, derivatives and hedging, insurance, and guarantees (other than product or service warranties)
-COOPERATIVE SALES AGREEMENTS. Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers
What are the steps of the five-step model for recognizing revenue from contracts with customers?
Step 1: Identify the contract(s) with a customer.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations in the contract.
Step 5: Recognize revenue when (or as) a performance obligation is satisfied.
What are the Step 1 criteria (five-step contract revenue model) for a contract to be identified under ASC 606?
A contract is accounted for under ASC 606 if all of the following criteria are met:
1) The contract was approved by the parties.
2) The contract has commercial substance.
3) Each party’s rights can be identified regarding
-Goods or services to be transferred and
-The payment terms.
4) It is probable that the entity will collect substantially all of the consideration to which it is entitled according to the contract.
-Probable means the future event is likely to occur.
How is revenue from a purported contract treated if the (4) criteria for Step 1 (five-step contract revenue model) are not met?
If the criteria described above are not met (e.g., if collectibility cannot be reliably estimated), the consideration received is recognized as a LIABILITY, and no revenue is recognized until the criteria are met.
If a contract cannot be identified but consideration has been received, what 3 sufficient conditions would need to apply in order for the revenue to be recognized?
However, even when the criteria described above are not met, revenue in the amount of nonrefundable consideration received from the customer is recognized if at least one of the following has occurred:
-The contract has been terminated.
-Control over the goods or services was transferred to the customer and the entity has stopped transferring (and has no obligation to transfer) additional goods or services to the customer.
-The entity (1) has no obligation to transfer goods or services and (2) has received substantially all consideration from the customer.
What is a contract modification?
A contract modification exists when the parties approve a change in the scope or price of a contract.
1) It is accounted for as a separate contract if the following conditions are met:
i) The scope of the contract increases because of the addition of promised goods or services that are distinct, and
ii) The price of the contract increases by an amount of consideration that reflects the entity’s standalone selling prices of the additional promised goods or services.
What are contract performance obligations?
A performance obligation is a promise in a contract with a customer to transfer to the customer
1) A good or service that is distinct or
2) A series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer.
What conditions make promised goods or services distinct?
Promised goods or services are distinct if
1) The customer can benefit from them either on their own or together with other resources that are readily available (capable of being distinct) and
2) The entity’s promise to transfer them to the customer is separately identifiable from other promises in the contract (distinct within the context of the contract). A separately identifiable good or service
a) Does not significantly modify or customize another good or service promised in the contract and
b) Is not highly dependent on, or highly interrelated with, other goods or services promised in the contract.
What are the conditions for separately identifiable goods or services?
A separately identifiable good or service
a) Does not significantly modify or customize another good or service promised in the contract and
b) Is not highly dependent on, or highly interrelated with, other goods or services promised in the contract.
What is a material right?
Customer options to acquire additional goods or services for free or at a discount have many forms, such as sales incentives, coupons, customer award points, or other discounts on future goods or services.
1) When the option to acquire additional goods or services (e.g., a coupon or discount voucher) provides a material right to the customer, it results in a separate performance obligation in the contract.
a) A material right is an option that the customer would not receive without entering into that contract. An example is a discount in addition to the range of discounts typically given for those goods or services.
b) But an option to acquire an additional good or service at a price that reflects its standalone selling price does not provide a material right.
How is the transaction price determined (Step 3, five-step revenue recognition model)?
The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer.
1) It excludes amounts collected on behalf of third parties (e.g., sales taxes).
2) Any consideration payable to the customer, such as coupons, credits, or vouchers, reduces the transaction price.
3) To determine the transaction price, an entity should consider the effects of the time value of money and variable consideration.
At step 3 (five-step model, contract revenue recognition), how does revenue recognized relate the transaction price to the time factor?
The revenue recognized must reflect the price that a customer would have paid for the promised goods or services if the cash payment had been made when they were transferred to the customer (i.e., the cash selling price).
-Thus, the transaction price is adjusted for the effect of the time value of money when the contract includes a significant financing component.
Which factors determine whether a contract includes a significant financing component?
The following factors should be considered in assessing whether a contract includes a significant financing component:
1) The difference between
-The cash selling price of the promised goods or services and
-The amount of consideration to be received
2) The combined effect of
-The expected time between the payment and the delivery of the promised goods or services and
-Market interest rates
When should the transaction price definitely not be adjusted for the effect of the time value of money?
The transaction price should not be adjusted for the effect of the time value of money if
1) The time between the payment and the delivery of the promised goods or services to the customer is 1 year or less
2) The customer paid in advance and the transfer of goods or services is at the discretion of the customer
-An example is a bill-and-hold contract in which the seller provides storage services for goods it sold to the buyer.
3) A substantial amount of the consideration promised is variable and its amount or timing varies with future circumstances that are not within the control of the entity or the customer
-An example is consideration in the form of a sales-based royalty.
How should interest income or expense be recognized in relation to step 3 (five-step model, contract revenue recognition)?
Interest income or expense is recognized using the effective interest method.
-It must be presented in the income statement separately from revenue from contracts with customers.
What causes may result in contact price varying (variable consideration)?
If a contract includes a variable amount, an entity must estimate the consideration to which it will be entitled in exchange for transferring the promised goods or services to a customer. For example, the contract price may vary because of the following:
-Refunds due to a right of return provided to customers (Study Unit 7, Subunit 1)
-Prompt payment discounts (Study Unit 6, Subunit 1)
-Volume discounts
-Other uncertainties in contract price based on the occurrence or nonoccurrence of some future event
What are the methods for estimating variable consideration?
Variable consideration is estimated using one of the following methods:
1) The expected value is the sum of probability-weighted amounts in the range of possible consideration amounts. This method may provide an appropriate estimate if an entity has many contracts with similar characteristics.
2) The most likely amount is the single most likely amount in a range of possible consideration amounts. This method may provide an appropriate estimate if the contract has only two possible outcomes. For example, a construction entity either will receive a performance bonus for finishing construction on time or will not.
When must the estimated transaction price be updated (if there is variable consideration)?
The estimated transaction price must be updated at the end of each reporting period.
What is the constraint on recognizing revenue from variable consideration?
Constraint
Revenue from variable consideration is recognized only to the extent that it is probable that a significant reversal will not occur when the uncertainty associated with the variable consideration is subsequently resolved.
Define volume discounts.
A volume discount offered as an incentive to increase future sales requires the customer to purchase a specified quantity of goods or services to receive a discount. The discount may be applied (a) prospectively on additional goods purchased in the future or (b) retrospectively on all goods purchased to date.
1) A prospective volume discount that provides a material right to the customer is accounted for as a separate performance obligation in the contract (Study Unit 10, Subunit 4).
2) Retrospective volume discounts are accounted for as variable consideration. The uncertainty of the contract price for current goods sold is based on the occurrence or nonoccurrence of some future event (i.e., whether the customer completes the specified volume of purchase).
What is consideration payable to a customer?
Consideration payable to a customer includes cash amounts that an entity pays, or expects to pay, to the customer (or to other parties that purchase the entity’s goods or services from the customer).
1) Consideration payable to a customer is recognized as a reduction of the transaction price and therefore of revenue.
2) Revenue is reduced for consideration payable to a customer at the later of when the entity
a) Recognizes revenue for the transfer of the related goods or services to the customer or
b) Promises to pay the consideration to the customer.
What is consideration payable to a customer?
Consideration payable to a customer includes cash amounts that an entity pays, or expects to pay, to the customer (or to other parties that purchase the entity’s goods or services from the customer).
-Consideration payable to a customer is recognized as a reduction of the transaction price and therefore of revenue.
When is revenue reduced for consideration payable to a customer?
Revenue is reduced for consideration payable to a customer at the later of when the entity
1) Recognizes revenue for the transfer of the related goods or services to the customer or
2) Promises to pay the consideration to the customer.
What happens in Step 4 of the five step model for contracts with customers revenue recognition?
After separate performance obligations are identified and the total transaction price is determined, the transaction price is allocated to performance obligations on the basis of relative standalone selling prices.
What is the method for Step 4 of the five step model of contracts with customers revenue recognition?
Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract
1) MULTIPLY TOTAL CONSIDERATION BY RELATIVE STANDALONE PRICES. After separate performance obligations are identified and the total transaction price is determined, the transaction price is allocated to performance obligations on the basis of relative standalone selling prices.
2) A standalone selling price is the price at which an entity would sell a promised good or service separately to a customer.
-The best evidence of a standalone selling price is the observable price of a good or service when it is (a) sold separately (b) in similar circumstances and (c) to similar customers (e.g., the list price of a good or service).
3) If the standalone price is not directly observable, it must be estimated. The following are suitable approaches:
a) DEFINITION OF STANDALONE PRICE. Adjusted market assessment. An entity evaluates the market in which it sells goods or services and estimates the price that a customer in that market would be willing to pay for them.
-For example, the prices of competitors for similar goods or services adjusted for the entity’s costs and margins are estimates of standalone selling prices.
b) Expected cost plus an appropriate margin. An entity forecasts its expected costs of satisfying a performance obligation and adds an appropriate margin for that cost.
c) Residual. An entity estimates the standalone selling price by reference to the total transaction price minus the sum of the observable standalone selling prices of other goods or services promised in the contract. The residual approach may be used only in limited circumstances.
What is a standalone selling price?
A standalone selling price is the price at which an entity would sell a promised good or service separately to a customer.
-The best evidence of a standalone selling price is the observable price of a good or service when it is (a) sold separately (b) in similar circumstances and (c) to similar customers (e.g., the list price of a good or service).
What should be done in step 4 of the five step model for contracts with customers revenue recognition if the standalone price is not observable?
If the standalone price is not directly observable, it must be estimated. The following are suitable approaches:
1) PRICES OF COMPARABLE GOODS. -Adjusted market assessment. An entity evaluates the market in which it sells goods or services and estimates the price that a customer in that market would be willing to pay for them.
For example, the prices of competitors for similar goods or services adjusted for the entity’s costs and margins are estimates of standalone selling prices.
2) COST + MARGIN. Expected cost plus an appropriate margin. An entity forecasts its expected costs of satisfying a performance obligation and adds an appropriate margin for that cost.
3) RESIDUAL. An entity estimates the standalone selling price by reference to the total transaction price minus the sum of the observable standalone selling prices of other goods or services promised in the contract. The residual approach may be used only in limited circumstances.
What is the adjusted market assessment method for estimating unobservable standalone costs?
Adjusted market assessment. An entity evaluates the market in which it sells goods or services and estimates the price that a customer in that market would be willing to pay for them.
-For example, the prices of competitors for similar goods or services adjusted for the entity’s costs and margins are estimates of standalone selling prices.
What is the Expected Cost Plus an Appropriate Margin method for estimating unobservable standalone cost?
Expected cost plus an appropriate margin. An entity forecasts its expected costs of satisfying a performance obligation and adds an appropriate margin for that cost.
What is the Residual method for estimating unobservable standalone cost?
Residual. An entity estimates the standalone selling price by reference to the total transaction price minus the sum of the observable standalone selling prices of other goods or services promised in the contract. The residual approach may be used only in limited circumstances.
How are relative standalone prices used to estimate the cost allocation in Step 4 of the five step model of contracts with customers revenue recognition?
(Standalone Price of Item X)/(Sum of Standalone Selling Prices, All Items) * [Actual Total Consideration = Allocation of the Contract Price to Item X
See Example 3-16
When and how is revenue recognized in step 5 of the five step model for contracts with customers revenue recognition?
An entity recognizes revenue when (or as) it satisfies a performance obligation by transferring a promised good or service (an asset) to a customer.
-An asset is transferred when (or as) the customer obtains control of that asset.
What is the definition of transferring control of the asset to the customer?
Control of an asset is transferred when the customer satisfies both of conditions (1-2):
1) Has the ability to direct the use of the asset and
2) Obtains substantially all of the remaining benefits (potential cash flows) from the asset.
What are the two temporal modalities in which a performance obligation can be satisfied?
A performance obligation can be satisfied either over time or at a point in time.
What is shown on the Impracticability Exceptions flow chart?
