Revenue & Expense Recognition Flashcards
What are the two main factors in recognizing revenues and gains?
Being realized or realizable
Being earned
What are different reasons for immediate recognition of expenses?
Cost for the period provide no discernible future benefits
Costs incurred as assets in prior periods no longer provide discernible benefits
Allocating costs to revenues or to periods serves no useful purpose
What is the difference between accruals and deferrals?
Accruals = revenue earned/expense incurred prior to cash payment
Deferral = cash payment prior to revenue earned/expense incurred (thus deferred expenses = prepaid expenses)
What are the purposes of Other Comprehensive Bases of Accounting (OCBOAs)?
- to comply with regulations
- to file a tax return
- to record cash inflows and outflows
Also, any “definite set of criteria have substantial report” is an OCBOA
What is income-tax basis accounting?
Events are recognized as they impact taxes – as they affect taxable income and deductible expenses
Nontaxable income and nondeductible expenses are still included in the determination of income, however
How do you change cash-basis amounts to accrual basis?
For revenue, add receivables and uncollectible accounts written off, then subtract unearned revenue
For purchases, subtract increases in inventory and add A/P (to get COGS)
For expenses, subtract prepaid expenses and add accrued expenses payable
What are consignments?
Transfer of goods to someone who acts an agent – not a sale
Involves formation of principal-agent relationship
Sale involves transfer of goods from consignor directly to customer
How do consignors recognize sales revenue?
Recognized by consignor when consignee sells good to customer
Commission to consignee is selling expense – not netted against sales revenue
How do consignees recognize sales revenue?
Recognized as amount billed to customer less amount paid to consignor (i.e. it IS netted)
When are initial franchise fees recorded by franchisees?
When the franchisor substantially performs his part related to the sale
When are franchisor services considered substantially performed?
- franchisor has no obligation or intention to refund cash received or forgive unpaid receivables
- substantially all initial services required of the franchisor (in the franchise agreement) have been performed
- there are no other material obligations for the determination of substantial performance
When should the initial franchise fee be deferred?
If it is probable that the continuing service payments are too small to adequately compensate the franchisor for his continuing services (and profit)
Deferred amount should be enough to cover costs and make reasonable profit
What are area franchise fees?
Fees for franchisees in a given area
Should be recognized by franchisor in proportion to initial mandatory services provided to each one
When should the franchisor recognize revenue that may have to be refunded if he fails to perform future services?
Not until the franchisee has no right to a refund
When can installment or cost recovery accounting methods be used to recognize franchise fee revenue?
Only when revenue is collectible over a period and there’s no reasonable basis to estimate collectibility
When would a franchisor repossess franchise rights?
If a franchisee does not open an outlet
If the franchisor repossesses franchise rights and refunds the franchisee, how is it recorded?
Original sale is cancelled
Previously-recognized revenue is a reduction in revenue for the period when the franchise is repossessed
If the franchisor repossesses franchise rights and does not refund the franchisee, how is it recorded?
Original sale is not cancelled
Previously-recognized revenue is not adjusted
Estimated uncollectible accounts from unpaid receivables are recognized
If a franchisor entered into an agreement to be paid an initial fee, future installments, and a percentage of the franchisee’s yearly revenue, how would the franchisor’s revenue be recorded?
Down payment
+ PV of installment (to beginning of year)
+ % of revenues
+ Interest Income (to accrete the installments – multiply their PV by the discount rate)
How should costs related to continuing franchise fees, as well as indirect costs, be reported?
Expense as incurred
For franchises, how should direct costs be reported?
Direct incremental costs for franchise sales should be deferred until the related revenue is recognized
Exception: deferred costs cannot be greater than (anticipated revenue - est. additional related costs)
How should advance royalties be reported?
Deferred until earned (like any normal revenue)
What are the two methods for recognizing income on long-term construction?
Percentage-of-completion method – preferable when costs to complete and % progress are estimable
Completed contract method - preferable when estimates are hard or inherent hazards are present
How should income be recognized in the percentage-of-completion method?
Proportionate to the cost
Actual cost to date / Est. total cost = % of cost to date x Total est. contract income (Rev. - Est. Total Cost) - Income previously recognized = Income to be recognized
Income is recognized by debiting Construction in Progress (CIP)
Other methods may be appropriate too, such as ones based on % of physical completion
Can progress billings be used to recognize construction income?
No, since they do not meaningfully relate to actual progress made
E.g. bigger billings are made at beginning to give the construction crew more capital for the job
