Financial Reporting "Test your knowledge" Flashcards
Revenue Recognition (Contracts)
Fidgets Inc. sells fidget devices to parents and schools to help students focus during class. It had the following transactions:
Transaction 1
On January 1, Fidgets agreed to sell 4,000 fidget devices to a local elementary school for $6,400. The sale was agreed to on the phone between the sales manager and the school principal. The fidget devices will be delivered January 31 and the school has agreed to pay for the devices in advance. A cheque has been received.
Transaction 2
On February 5, Fidgets agreed to sell an additional 1,000 fidget devices to the same elementary school for an agreed-upon amount of $1,100.
Fidgets normally sells its fidget devices for $1.60 each on orders of between 1,000 and 4,999. On orders of over 5,000, the price drops to $1.50.
Required
a) Determine whether Transaction 1 represents a contract.
b) Assuming that Transaction 1 does represent a contract, consider whether Transaction 2 should be considered as a separate contract or in combination with the original contract.
Answer
a) This transaction represents a contract because the following criteria from IFRS 15 have been met:
The contract has been approved by all parties.
MET — The sale was agreed to on the phone by the sales manager and the
school principal.
The rights regarding goods and services to be transferred can be identified.
MET — The sales manager and the school principal have determined that
Fidgets will provide 4,000 fidget devices in exchange for $6,400.
The payment terms can be identified.
MET — The school has agreed to pay for the devices before they are delivered
on January 31. A cheque has already been received.
The contract has commercial substance.
MET — Fidgets will receive $6,400 for the transaction, a clear change in cash
flows.
It is probable that the entity will collect the consideration to which it is entitled,
considering only the customer's ability and intention to pay.
MET — A cheque has already been received; therefore, the school has clearly
indicated its ability and intention to pay.
b) The contracts were negotiated in a close time period, and it appears clear that the second contract’s pricing is a result of the first order — allowing the school to achieve the 5,000-unit benchmark and the lower retail price. The two contracts should be considered as one and reported accordingly.
An order of 4,000 units would sell for $1.60 and be priced at $6,400, and a separate order of 1,000 units would sell for $1.60 and be priced at $1,600 — totalling $8,000. However, an order of 5,000 units would sell for $1.50 and be priced at $7,500. Here, the school paid $6,400 up front and then $1,100 later. Although the delivery was 4,000 units and then 1,000 units, it is clear that the pricing is for the 5,000 units in total.
The two transactions should be considered as one contract.
Revenue Recognition (Distinct goods or services)
Fitzip is a fitness tracker that monitors a user’s daily steps, average heartrate and sleep patterns. Users can see their step count on the face of the Fitzip. The Fitzip requires the user to download an app on their phone to be able to read more advanced metrics and historical data based on the output from the tracker. Customers can buy a wristband with which to wear the tracker, and a variety of bands can be purchased to match their fashion needs. If the wristband is not used, the tracker can be placed in a pocket. Fitzip is currently selling a starter package that includes the tracker, app and wristband.
Required
Describe the distinct performance obligations associated with this contract. Explain why the performance obligations are or are not considered to be separate (distinct).
Answer
There are three promises to the customer:
• Tracker: The tracker can be used on its own, as users can see their step count on the
tracker itself so it provides some benefit alone.
• App: The app is only useful in conjunction with the tracker. The tracker and the app will
need to be assessed together.
• Wristband: The wristband is used for the tracker, but it can be used with other trackers
and users can purchase multiple wristbands to meet their fashion needs. The wristband,
therefore, can likely be sold on its own and has its own value.
The tracker and the app will be assessed together. The wristband is a distinct good.
Revenue Recognition (Variable Consideration)
Bombay Ltd., a construction company, has two contracts in progress. Details of these contracts are as follows:
Contract A
This contract was negotiated for $8,000,000 plus a 10% incentive payment payable by the customer to Bombay if the contract is fully completed on time. The engineers have assessed that it is 75% probable that Bombay will receive the incentive payment.
Contract B
This contract was negotiated based on Bombay meeting specific performance objectives. At this time, it appears that the contract will be 10% likely to earn revenues of $2,000,000, 20% likely to earn revenues of $1,000,000, 30% likely to earn revenues of $1,500,000, and 40% likely to earn revenues of $1,200,000.Bombay Ltd., a construction company, has two contracts in progress. Details of these contracts are as follows:
Contract A
This contract was negotiated for $8,000,000 plus a 10% incentive payment payable by the customer to Bombay if the contract is fully completed on time. The engineers have assessed that it is 75% probable that Bombay will receive the incentive payment.
Contract B
This contract was negotiated based on Bombay meeting specific performance objectives. At this time, it appears that the contract will be 10% likely to earn revenues of $2,000,000, 20% likely to earn revenues of $1,000,000, 30% likely to earn revenues of $1,500,000, and 40% likely to earn revenues of $1,200,000.Re
Required
Calculate the total consideration for each contract.
Answer
Contract A should be measured using the most likely amount, as Bombay will either receive the consideration or not. The value of Contract A is therefore $8,800,000: $8,000,000 fixed consideration + 10% variable consideration, which is considered likely to be received.
Contract B should be measured using the expected value, as there are a variety of possible outcomes:
$2,000,000 × 10% + $1,000,000 × 20% + $1,500,000 × 30% + $1,200,000 × 40% = $1,330,000.
RunFast Inc. sold 100 elliptical machines to a chain of fitness facilities. Payment was due on delivery in the amount of $300,000. The inventory has a cost of $200,000. The equipment has a 120-day return policy that allows for equipment to be returned if it has any performance issues. Based on past history, 5% of equipment will be returned.
At the end of the 120 days, 4% of goods were returned. Assume the cost to recover inventory and any decrease in value equates to 10% of the cost of the machine.
Required
a) Provide the journal entry RunFast should record on the date of sale.
b) Provide the journal entry RunFast should record on the return of the goods and expiration of the return period.
Answer
a) Date of sale
DR. Cash $300,000
CR. Revenue $285,000
CR. Refund Liability 15,000
~ Record a refund liability for the 5% of goods expected to be returned ($300,000 × 5%) and recognize revenue on the remainder of the $300,000.
DR. COGS $191,000
DR. Asset - right to recover 9,000
CR Inventory $200,000
~ Debit “asset — right to recover” for the 5% of goods expected to be returned, less the 10% to reflect the cost expected to recover and any decrease in value [$200,000 × 5% × (1 – 10%)], and debit cost of goods sold (COGS) for the remainder of the $200,000.
b) Return of goods and expiration of return period
DR. Refund Liability $15,000
CR. Revnue $3,000
CR. Cash 12,000
~ Record the refund of 4% ($300,000 × 4%). The amount accrued as a refund liability is then removed, and the difference between expected returns and actual returns is adjusted to revenue.
DR. COGS $1,800
DR. Inventory 7,200
CR. Asset - right to return $9,000
~ Record the refund of 4% ($300,000 × 4%). The amount accrued as a refund liability is then removed, and the difference between expected returns and actual returns is adjusted to revenue.
Revenue Recognition (Significant Financing Components)
On January 1, Year 1, Marvel Motors Ltd. (Marvel) accepted an $88,200, two-year, interest-free note receivable from a customer as full consideration for the purchase of a car. The customer could have opted to purchase the car for $80,000 cash.
Marvel, whose fiscal year end is December 31, prepares its financial statements in accordance with IFRS. The original cost of the car to Marvel was $72,000. The note receivable was paid in full by the customer on December 31, Year 2.
Required
a) What is the amount of revenue Marvel should record at January 1, Year 1?
b) What is the amount of interest Marvel should record at December 31, Year 1, and December 31, Year 2?
a) Marvel should record the revenue at the fair value of the car at the date of sale: $80,000.
b) The effective interest rate of the note is 5%, calculated as:
NPER (number of periods) = 2 PMT (payment) = $0 PV (present value) = –$80,000 FV (future value) = $88,200 = RATE (nper,pmt,pv,fv) = 5%
Interest at December 31, Year 1 = $80,000 × 5% = $4,000
Interest at December 31, Year 2 = ($80,000 + $4,000) × 5% = $4,200
Revenue Recognition (Allocation of Discount)
Ripley’s Office Supplies Ltd. (Ripley’s) sold and delivered a photocopier along with an agreement to maintain the machine for a two-year period for total consideration of $8,400 cash. On a stand-alone basis, Ripley’s sells the photocopier for $7,500 and the maintenance agreement for $1,500.
Required
Determine the revenue to be allocated to each performance obligation.
The transaction price of $8,400 must be allocated to the two performance obligations based on their relative selling prices:
Stand-alone % of Contract Assigned
price value value Price Photocopier $7,500 83.3 % x 8,400 = $7,000 Maintenance Agreement 1,500 16.7% x 8,400 = 1,400 Total $9,000 100% $8,400
Revenue Recognition (Change in transaction price)
Bridge Over Water Inc. has a $4,000,000 fixed-price contract with Water City to construct a bridge over a river. In the contract, there is a provision for an additional early-completion bonus payable to Bridge Over Water.
There are two distinct deliverables in the contract: (1) the bridge and (2) the approach ramps. 80% of the transaction price was allocated to the bridge and 20% to the approach ramps.
The performance obligations were completely satisfied by October 31, 20X6. As a result, Bridge Over Water earned a $300,000 early-completion bonus.
Assume no amount has been recorded for the variable consideration.
Required
Determine the amount of the change in the transaction price that should be allocated to each of the two performance obligations.
