Revenue Recognition Flashcards
What is revenue
Inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of the two) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations
What are the 3 criteria for revenue recognition?
- The goods and services have been provided to the customer or client (the revenue is earned).
- The company is reasonably assured of collecting receivables (the revenue is realizable).
- The company can determine the expenses incurred in providing the goods and services. This criterion is not a constraint on recognition in most situations. “Earned” and “realizable” are the primary criteria.
If all 3 are not met, revenue is deferred
What is the installment sale basis?
The installment basis is a version of the cash basis of accounting. The method is typically employed in one of two situations.
a. Collectability Questionable – The collectability of receivables might be questionable. If so, these questions might warrant use of the installment sales basis.
b. Extended Time Period – If receivables will be collected over an extended time period, the installment sales basis might be appropriate.
What is the gross profit formula under the installment sale basis?
a. In applying the installment method, the gross profit percentage is calculated for merchandise sold.
b. This percentage is: (sales - cost of goods sold) / sales.
c. When cash is collected, the amount received is divided between recovery of cost and gross profit received. If no cash is received, no profit is recognized.
d. The amount of recognized gross profit = (cash received in period) x (gross profit percentage). The remaining portion of the cash received is considered a return of cost.
What happens with repossession under the installment method?
Occasionally, an item sold is repossessed due to nonpayment by the customer. Under the installment method of revenue recognition, the remaining receivable and deferred gross profit balances are closed, the repossessed inventory is recorded at fair value, and a gain or loss is recorded.
What is the cost recovery method?
The cost recovery method is more conservative than the installment method. No gross profit is recognized on cash collections until the cost of the item sold is fully recovered. After that point, all collections constitute gross profit.
What are the six criteria for a right of return?
- The seller’s price to the buyer is substantially fixed or determinable at the date of sale;
- The buyer has paid the seller, or the buyer is obligated to pay the seller, and the obligation is not contingent on the resale of the product;
- The buyer’s obligation to the seller would not be changed in the event of theft, physical destruction, or damage to the product;
- The buyer acquiring the product for resale has economic substance apart from that provided by the seller;
- The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer;
- The amount of future returns can be reasonably estimated.
How are net sales recorded if all 6 criteria are met?
- Reported net sales for the year equals total sales less actual returns on those sales during the year less estimated returns at year-end.
- Accounts receivable is reported net of deferred gross profit on the estimated returns at year-end. The journal entries are similar to those for the installment method.
How are net sales recorded if all 6 criteria are not met?
- If all six criteria are not met, revenue recognition is postponed until the return privilege has substantially expired, or the six criteria have been met. Reported net sales equals total sales less actual returns on those sales during the year less sales with a return privilege that is still effective.
- Accounts receivable is reported net of deferred gross profit on sales with a return privilege still effective.
When is revenue recognized when goods are on consignment?
The consignor (owner of the goods) recognizes revenue when the goods are sold by the consignee.
What happens with selling expenses for goods on consignment
Any amounts paid to the consignee for handling and selling the consignor’s goods are treated as selling expenses by the consignor.
When is the initial franchise fee recognized as revenue
When the franchisor sells a franchise to a franchisee, the latter can sell the franchisor’s products under the franchise agreement. The franchisor charges an initial fee and continuing fees. The initial franchise fee is recognized by the franchisor as revenue when all material services or conditions have been substantially performed or satisfied by the franchiser.
what happens when there are questions about the collectability of the franchise fee
If there are questions about the collectability of the initial franchise fee or if the amount will be collected over an extended time period and no estimate of uncollectibility can be made, it is appropriate to employ the installment sales basis or the cost recovery basis to recognize the revenues related to the initial franchise fee.
what happens when the franchise fee is collected over an extended time period
If the goods and services related to the initial franchise fee are to be provided over an extended time period, it is appropriate to employ the percentage of completion method or the completed contract method to recognize the revenues related to the initial franchise fee
How is revenue recognized for R & D Arrangements?
Revenue is recognized at milestones only if the milestone meets the following criteria to be considered substantive (complete). The consideration earned by achieving the milestone must :
- Be commensurate with either (a) the vendor’s performance in achieving the milestone, or (b) the enhancement of the value of the item delivered as a result of achieving the milestone. In other words, the consideration must in-line with the value provided by the vendor;
- Relate only to work already performed;
- Be reasonable relative to all deliverables and payment terms in the arrangement.
