module 5 Flashcards
general revenue recognition rules
Recognize revenue when the company transfers the good or service to
the customer
▪ When the customer obtains control of the good or service
▪ It is not necessary to receive cash to recognize revenue
performance obligation
Every sale involves a contract (express or implied)
between the customer and the company whereby the
company agrees to transfer a good or service to the
customer and the customer agrees to pay for it.
▪ All that is necessary for the company to recognize
revenue is for the good to be transferred or the service
performed.
▪ It is at that point the company’s performance
obligation under the contract is satisfied and revenue
can be recognized.
Sales on Credit
Many sales are on credit, meaning the customer has agreed
to pay the company in the future
▪ The company recognizes revenue when the good or service is
transferred to the customer, and records an account
receivable to be collected later
▪ Revenue recognition is unaffected by the delayed receipt of
cash if the company has fulfilled its performance obligation
5 Steps of Revenue Recognition
1) Identify the contract(s) with the customer
2)Identify the performance obligation(s) in the contract
3) Determine the transaction price
4)Allocate the transaction price to the performance obligation(s)
5)Recognize revenue as/when each performance obligation is
satisfied
Evidence that the performance obligation has been
satisfied occurs when the customer has …
Legal title to the good or has received the service.
▪ Physical possession of the good.
▪ Assumed the risks and rewards of owning the good or
receiving the service.
▪ Accepted the good or service and has an obligation to pay
the company.
Nonrefundable up-front fees. (when revenue is recongnized)
Recognize as revenue when the
goods or services are provided (per contract terms)
bill- and-hold arrangements
Recognize when control of the
goods transfers to the customer
Consignment sales
Recognize commission when goods are
sold.
Franchises
Recognize as the as the goods or services are
delivered.
Variable Consideration
Recognize the expected amount to be
received when goods or services are provid
Cost-to-Cost Method
Recognize revenue as a proportion of total costs incurred
to fulfill the contract
prepayments by customer
When a company receives cash in advance of incurring costs
under the contract, it records a liability that represents the
obligation to deliver the product for which it has been paid.
Costs paid in excess of billings
When a company incurs costs in excess of the amount it bills
the customer, it recognizes that excess as a current asset.
Sales Allowences
Many companies offer customers a variety of sales
allowances, including
▪ Rights of return,
▪ Sales discounts for volume purchases, and
▪ Retailer promotions (point-of-sale price markdowns, and other
promotions).
Three metrics to analyze sales allowances (slide 23)
- Additions charged to Gross Sales
- Allowance as Percentage of Gross Sales
- Adequacy of the allowance amount
Unearned deferred revenue
In some industries, it is common to receive cash before
recording revenue
▪ This creates a liability (Unearned Revenue) for the company’s
obligation to deliver a good or perform a service at a future date
▪ When the good is provided or the service rendered, the
unearned revenue liability is reduced and revenue is recognized
Analysis of Unearned Revenue
If deferred revenue liabilities decrease, we infer the company’s
current reported revenue was collected from customers in a
prior accounting period and there have been fewer new
prepayments for which revenue will be recognized in the future
The magnitude of accounts receivable is measured with the
following two ratios:
Accounts receivable turnover = Sales/
Average A/R
2) Days sales outstanding (DSO)= 365/
A/R Turnover
When accounts receivable have grown more quickly than
sales, we observe:
▪ Lower accounts receivable turnover ratio
▪ Higher percentage of accounts receivable to sales
▪ Lengthening of the DSO
▪ Generally, such a trend is not favorable for two possible
reasons
▪ The company is becoming more lenient in granting credit to its
customers
▪ Credit quality is deteriorating
Discontinued Operations
Companies often divest of business segments
▪ When this occurs, the company reports the event at the bottom
of the income statement by segregating income from continuing
versus discontinued operations
▪ The discontinued operations line item has two components
▪ Net income (or loss) from the segment’s business activities prior to the
divestiture
▪ Any gain (or loss) on the sale of the business
transitory
Transitory items won’t recur and thus, they are largely
irrelevant to predicting future performance.
▪ Investors tend to focus on income from continuing
operations because that is the level of profitability that is
likely to persist (continue) into the future.
