Revenue Recognition (17.2) Flashcards
5 step process for recognizing revenue
Identify the contract(s) with a customer.
Identify the separate or distinct performance obligations in the contract.
Determine the transaction price.
Allocate the transaction price to the performance obligations in the contract.
Recognize revenue when (or as) the entity satisfies a performance obligation.
Describe the revenue recognition principle - when is revenue recognized?
In a sale of goods where the goods are exchanged for cash and returns are not allowed, the recognition of revenue is straightforward: it is recognized at the time of the exchange.
The central principle is that a firm should recognize revenue when it has transferred a good or service to a customer. This is consistent with the familiar accrual accounting principle that revenue should be recognized when earned.
is revenue recognition dependent on receiving cash?
The recognition of revenue is not dependent on receiving cash payment. If a sale of goods is made on credit, revenue can be recognized at the time of sale, and an asset, accounts receivable, is created on the balance sheet.
How is revenue recorded when payment is received prior to the transfer of goods?
If payment for the goods is received prior to the transfer of the goods, a liability, unearned revenue, is created when the cash is received (offsetting the increase in the asset cash.) Revenue is recognized as the goods are transferred to the buyer.
define a contract
an agreement between two or more parties that specifies their obligations and rights. Collectability must be probable for a contract to exist
*note: “probable” is defined differently under IFRS and U.S. GAAP so an identical activity could still be accounted for differently by IFRS and U.S. GAAP reporting firms.
define a performance obligation (step 2 in revenue recognition process)
A performance obligation is a promise to deliver a distinct good or service. A “distinct” good or service is one that meets the following criteria:
The customer can benefit from the good or service on its own or combined with other resources that are readily available. The promise to transfer the good or service can be identified separately from any other promises.
Can a transaction price ever be variable (vs. fixed)?
A transaction price is usually a fixed amount but can also be variable, for example, if it includes a bonus for early delivery.
If revenue cannot be estimated reliably, how is it recorded?
a firm may need to recognize a liability for a refund obligation (and an offsetting asset for the right to returned goods) if revenue from a sale cannot be estimated reliably.
How is revenue recognized for long-term contracts?
For long-term contracts, revenue is recognized based on a firm’s progress toward completing a performance obligation.
Progress toward completion can be measured from the input side (e.g., using the percentage of completion costs incurred as of the statement date).
Progress can also be measured from the output side, using engineering milestones or percentage of the total output delivered to date.
How is revenue recognized for a principal vs. an agent?
Consider a travel agent who arranges a first-class ticket for a customer flying to Singapore. The ticket price is $10,000, made by nonrefundable payment at purchase, and the travel agent receives a $1,000 commission on the sale. Because the travel agent is not responsible for providing the flight and bears no inventory or credit risk, she is acting as an agent. Because she is an agent, rather than a principal, she should report revenue equal to her commission of $1,000, the net amount of the sale. If she were a principal in the transaction, she would report revenue of $10,000, the gross amount of the sale, and an expense of $9,000 for the ticket.
Revenue Recognition: Performance obligation and progress towards completion.
A contractor agrees to build a warehouse for a price of $10 million and estimates the total costs of construction at $8 million. During the first year of construction, the builder incurs $4 million of costs. How much revenue is recorded?
During the first year of construction, the builder incurs $4 million of costs, 50% of the estimated total costs of completion. Based on this expenditure and a belief that the percentage of costs incurred represents an appropriate measure of progress towards completing the performance obligation, the builder recognizes $5 million (50% of the transaction price of $10 million) as revenue for the year.
