Lesson 2

Question 1

What is a repurchase agreement?

Answer 1

Allows a firm to transfer an asset to a customer but have an unconditional (forward) obligation or unconditional right (call option) to repurchase the asset at a later date.

Question 2

How are repurchase agreements commonly reported?

Answer 2

As financing. If the firm as a forward obligation or call option to repurchase the asset for an amount greater than or equal to its selling price, then the transaction is a financing transaction.

Question 3

What is a put option?

Answer 3

When the purchasing firm as the option to “put” the asset back to the selling firm.

Question 4

What is a bill-and-hold arrangement?

Answer 4

It is a contract under which an entity bills a customer for the product but the entity retains physical possession of the product until it is transferred to the customer at a point in time in the future.

Question 5

Why would a customer request a bill-and-hold arrangement? (3 things)

Answer 5

1. lack of available space for the product
2. delays in its production schedule
3. more than sufficient inventory in its distribution channel

Question 6

What is a principal-agent relationship?

Answer 6

The principal’s performance obligation is to provide goods or perform services for a customer.
The agent’s performance obligation is to arrange for the principal to provide these goods or services to a customer.

Question 7

How does the principal-agent relationship work under a consignment?

Answer 7

The consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer), who is to act as an agent for the consignor in selling the merchandise.

Question 8

Why are both the consignor and consignee interested in selling?

Answer 8

The consignor - to make a profit or develop a market
The consignee - to make a commission on the sale.

Question 9

How should a consignee record the sale of merchandise on their books?

Answer 9

DO NOT record as an asset on its books, but a liability for the net amount due to the consignor.

Question 10

Consignees only recognize what kind of revenue?

Answer 10

Commission revenue

Question 11

What are the two types of warranties?

Answer 11

Assurance-type
Service-type

Question 12

What is an assurance-type warranty?

Answer 12

warranties that the product meets agreed upon specifications in the contract at the time the product is sold.

Question 13

What is a service-type warranty?

Answer 13

Warranties that provide an additional service beyond the assurance type warranty.
It is recorded as a separate performance obligation.

Question 14

What are upfront fees?

Answer 14

generally relate to the initiation, activation, or setup of a good or service to be provided or performed in the future.
In most cases, they are nonrefundable.

Question 15

How should upfront fees be recognized as revenue?

Answer 15

Example
If a membership is cancelled after two years. The upfront fee and the monthly subscription of membership should be allocated over the course of the membership life.

Question 16

Summary

Answer 16

Sales returns and allowances
Return of product by customer (e.g., due to dissatisfaction with the product) in exchange for refunds, a credit against amounts owed or that will be owed, and/or another product in exchange.
Seller may recognize (a) an adjustment to revenue for products expected to be returned, and (b) an asset (and corresponding adjustment to cost of goods sold) for the goods returned from customers.

Repurchase agreements
Seller has an obligation or right to repurchase the asset at a later date.
Generally, if the company has an obligation or right to repurchase the asset for an amount greater than its selling price, then the transaction is a financing transaction.

Bill-and-hold
Result when the buyer is not yet ready to take delivery but does take title and accept billing.
Revenue is recognized depending on when the customer obtains control of that product.

Principal-agent
Arrangement in which the principal’s performance obligation is to provide goods or perform services for a customer. The agent’s performance obligation is to arrange for the principal to provide these goods or services to a customer.
Amounts collected on behalf of the principal are not revenue of the agent. Instead, revenue for the agent is the amount of the commission it receives. The principal recognizes revenue when the goods or services are sold to a third-party customer.

Consignments
A principal-agent relationship in which the consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer), who is to act as an agent for the consignor in selling the merchandise.
The consignor recognizes revenue only after receiving notification of the sale and the cash remittance from the consignee (consignor carries the merchandise as inventory throughout the consignment). The consignee records commission revenue (usually some percentage of the selling price).

Warranties
Warranties can be assurance-type (product meets agreed-upon specifications) or service-type (provides additional service beyond the assurance-type warranty).
A separate performance obligation is not recorded for assurance-type warranties (considered part of the product). Service-type warranties are recorded as a separate performance obligation. Companies should allocate a portion of the transaction price to service type-warranties, when present.

Nonrefundable upfront fees
Upfront payments generally relate to initiation, activation, or setup activities for a good or service to be delivered in the future.
The upfront payment should be allocated over the periods benefited.

Question 17

Bret Company sold 3,000 Holsks during 2020 at a total price of $12,000,000, with a warranty guarantee that the product was free of any defects. The cost of Holsks sold is $7,200,000. The term of the assurance warranty is two years, with an estimated cost of $80,000. In addition, Bret sold extended warranties related to 1,100 Holsks for 3 years beyond the 2-year period for $110,000.

Which amount should Bret recognize Unearned Warranty Revenue in 2020?

Answer 17

$110,000
The service-type warranties represent a separate service and are an additional performance obligation. Thus, the Unearned Warranty Revenue for 2020 is $110,000.

Question 18

How is an option to purchase a warranty recorded?

Answer 18

Revenue in the period that the service-type warranty is in effect.

Question 19

Hendrix Inc., an equipment dealer, sells equipment on January 1, 2020, to Jimi Company for $200,000. Also, on January 1, 2020, Hendrix agrees to repurchase this equipment from Jimi Company on December 31, 2021, for a price of $233,280.

How should Hendrix Inc. record this transaction on January 1, 2020?

Answer 19

A liability of $200,000

Hendrix Inc. agrees to repurchase from Jimi Company is an unconditional obligation. In this case, Hendrix Inc. continues to have control of the asset because it has agreed to repurchase the asset at an amount greater than the selling price. Therefore, this agreement is a financing transaction and not a sale. This asset is not removed from the books of Hendrix, Inc. Hendrix Inc. records the financing as Liability to Jimi Inc. of $200,000.