Revenue Recognition Flashcards
According to the installment method of accounting on what basis is gross profit recognized in income?
The basis would be in proportion to the cash collected.
The Gift a retail store received cash upon selling merchandise and issued gift certificates that are redeemable in merchandise. The gift certificates lapse one year after they are issued. What is the impact on the deferred revenue account for both (a) the redemption of certificates and (b) lapse of certificates (i.e. increase, decrease or no effect)?
At the time the certificates were issued the company would credit deferred revenue. Upon redemption or expiry, the deferred revenue would debited and revenue would be credited, decreasing the deferred revenue account (both situations).
On October 1, Finch Fuel Co. sold 100,000 litres of heating oil to Rose Co. at $3 per litre. Fifty thousand litres were delivered on December 15 and the remaining 50,000 litres were delivered on January 15 of the following year. Payment terms were: 50% due on October 1, 25% due on first delivery, and the remaining 25% due on second delivery. What amount of revenue should Finch recognize from this sale during the current year?
Generally sales revenue is recognized at the time of delivery. At that point revenue is realized and earned. Therefore, sales revenue recognized in the current year is $150,000 ($300,000 * 50,000/100,000).
Malis Corp records its long term construction contracts using the percentage of completion method. Contract #47 is a $2 million contract for which costs were originally estimated at $1.6 million. The records to date show the following: Costs incurred during the year: $900,000 (year 1); $600,000 (year 2), estimated costs to complete the project: $900,000 (year 1); $375,000 (year 2), contract billings: $500,000 (year 1); $625,000 (year 2), and collection of billings: $450,000 (year 1); $525,000 (year 2). What is the gross profit recorded on the contract in year 1 and year 2?
\n\n\n\n\n<u>Year 2</u>\n<u>Year 1</u>\n\n\nCosts to date\n$900,000\n\n\n\n\n<u>600,000</u>\n\n\n\nTotal costs to date\n1,500,000\n900,000\n\n\nCosts to complete\n<u>375,000</u>\n<u>900,000</u>\n\n\nTotal estimated cost\n1,875,000\n1,800,000\n\n\nTotal contract revenue\n<u>2,000,000</u>\n<u>2,000,000</u>\n\n\nEstimated total profit\n<u>125,000</u>\n<u>200,000</u>\n\n\nProfit earned to date\n100,000\n100,000\n\n\n(Total costs to date/total estimated cost X estimated total profit)\n\n\n\n\nProfit recognized to date\n100,000\n0\n\n\nProfit to be recognized\n<u>$0</u>\n<u>$100,000</u>\n\n\n\n
ABC Inc. is building a bridge in Vancouver. The contract stipulates that ABC Inc. will be paid a fee of $1.8 million for building the bridge. In year 1, the company completed 25% of the bridge; by the end of year 1 the total expected costs to complete the bridge including costs incurred in year 1, amounted to $1.6 million. By the end of year 2, the company had completed 70% of the bridge and revised upwards its expected costs to complete the bridge from $1.6 million to $1.85 million, due to increases in material costs. In year 3, the bridge was completed at a total cost of $1.83 million. What is the gain or loss that would be reflected in the financial statements, in connection with building the bridge, in years 2 and 3?
In year 2 the reported loss would include the total expected loss on the contract of $50,000 (i.e. $1.85 million of expected costs less $1.8 million of expected revenue) plus the $50,000 of previously recognized profit* for a total reported loss of $100,000. In year 3 by the time the bridge was completed, the loss amounted to only $30,000 (i.e. $1.8 million less $1.83 million), rather than the expected $50,000. Therefore the estimated loss provision was overstated by $20,000. As this is a change in estimate this $20,000 difference must be handled prospectively; consequently $20,000 of profit would be recognized in year 3.\n\n* The previously recognized profit in year 1 is computed as follows:\n\nExpected revenue of $1.8 million less expected costs of $1.6 million equals expected profit of $200,000. As the project was 25% complete by the end of year 1, $50,000 of profit would have been recognized (i.e. 25% of $200,000).
List 5 criteria that need to be met in order to recognize revenue for a sale of goods under IFRS?
All of the following criteria need to be met in order to recognize revenue:\n<ul>\n \t<li><u>significant risks and rewards of ownership must be transferred </u></li>\n \t<li>neither continuing managerial involvement or effective control over the goods sold is retained</li>\n \t<li>amount of revenue is measurable</li>\n \t<li>economic benefits are probable</li>\n \t<li>costs are reliably measurable</li>\n</ul>
Is the transfer of legal title necessary in order to recognize revenue on a sale of goods?
In many cases transfer of the risks and rewards of ownership coincides with the transfer of the legal title but not always the case and legal title is one factor only in the determination of when to recognize revenue. It is more important to look at the substance over form.
What are some examples of common situations when an entity retains significant risk and should not recognize revenue?
<span><u>Examples of entity retaining significant risks and rewards of ownership</u></span>\n\n<span>(a) Entity retains an <strong>obligation</strong> for unsatisfactory performance not covered by normal warranty provisions</span>\n\n<span>(b) Receipt of revenue from sale is <strong>contingent</strong> on the derivation of revenue by the buyer from its sale of the goods</span>\n\n<span>(c) Goods are shipped <strong>subject to installation and installation</strong> is significant part of the contract and has not yet been completed</span>\n\n<span>(d) Buyer has right to <strong>rescind the purchase</strong> for a reason specified in the sales contract and entity is uncertain about probability of return</span>
Does an entity have to transfer 100% of the risks of ownership in order to recognize revenue on a sale of goods?
No - the entity can retain some insignificant risk and still recognize revenue.
What is the guiding principle when recognizing revenue in transactions involving the rendering of services under ASPE?
In the case of rendering of services and long-term contracts, performance shall be determined using either the percentage of completion method or the completed contract method, whichever relates the revenue to the work accomplished.
What criteria should be considered to estimate revenue reliably in a situation involving the rendering of services (i.e. percentage of completion method) under IFRS?
Outcome of a transaction can be estimated reliably when <u>all</u> the following conditions are satisfied:\n\n(a) The amount of revenue can be measured reliably;\n\n(b) It is probable that the economic benefits associated with the transaction will flow to the entity;\n\n(c) The stage of completion of the transaction at the end of the reporting period can be measured reliably; and\n\n(d) The costs incurred for the transaction and the costs to complete the transaction can be measured reliably.
What are some examples of how to measure the extent of percentage of completion?
Various methods are suggested for measuring the extent of completion e.g. based on costs incurred to date compared with total costs, engineering surveys, hours worked, stage of work completed etc.
In using the percentage of completion method would progress payment or timing of cash collection generally be used in determining when to recognize revenue?
Progress payments and cash collection often do not reflect the services performed and the revenue recognition policy should not be tied to the cash collection.
What conditions need to be present in order to use the percentage of completion revenue recognition method?
A basic principle is that one has to be able to estimate reliably the revenues, costs, stage of completionetc. to use the percentage of completion method. Therefore, the ability to estimate future revenues as well as the ability to estimate the basis of revenue recognition (i.e. costs, hours worked, etc.) is critical.
Under ASPE in the case of the sale of goods under what 2 conditions would “performance” be achieved allowing for the recognition of revenue?
Performance is achieved when:\n<ol>\n \t<li>Seller has transferred <u>significant risks and rewards </u>of ownership retains no <u>continuing managerial involvement in, or effective control of, the goods transferred</u> to a degree usually associated with ownership; and</li>\n \t<li>Reasonable assurance exists regarding the <u>measurement</u> of the <u>consideration</u> that will be derived from the sale of goods, and the extent to which goods may be returned.</li>\n</ol>
Does the completed contract method under ASPE result in a smooting or fluctuating income?
The completed contract method will typically result in fluctuating income, as it is dependent on when the contract is finished, at which point all revenue is recognized.
When would it be appropriate to use the completed contract method under ASPE?
The completed contract method is only appropriate when performance consists of the execution of a single act or when the enterprise cannot reasonably estimate the extent of progress toward completion.
What 3 criteria under ASPE would indicate that “performance” in the revenue recognition earning process has been achieved?
ASPE makes specific reference to <u>performance </u>being achieved before revenue can be recognized for sale of goods or rendering of services based on 3 criteria:\n\n(A) Persuasive evidence of an arrangement exists\n\n(B) Delivery has occurred or services have been rendered; and\n\n(C) Sellers’ price to the buyer is fixed or determinable.
One of the conditions for determining whether performance has been achieved under ASPE is whether persuasive evidence of an arrangement exists. What are some examples of indications that this condition has been met ?
Some factors to consider in determining that there is persuasive evidence of an arrangement:\n\n- Whether customer has signed off\n\n- Whether customer has right to return product\n\n- Requirements to repurchase the product
What criteria would be necessary to say that “delivery” has occurred or that the services have been rendered, under ASPE, for the purpose of revenue recognition?
Generally, delivery occurs when the product is delivered to the customer’s site of business (or another site specified by the customer) and customer acceptance of the product. The exception to the rule would be the bill and hold arrangement.
What are the typical conditions necessary for a “bill and hold” arrangement, in ASPE??
Typical conditions for Bill and Hold Arrangement are:\n\n(a) Probable that delivery will be made;\n\n(b) Item is on hand, identified and ready for delivery to the buyer at the time the sale is recognized;\n\n(c) Buyer specifically acknowledges the deferred delivery instructions.
One criterion that needs to be met before performance is achieved under ASPE is that price must be ?fixed or determinable?. What are typical factors to consider in determining whether the price is ?fixed or determinable??
Factorsto consider would include:\n\n- Whether customer can cancel or terminate agreement\n\n- Is there a right of return ? if yes can we estimate returns\n\n- Whether customer will get refund if price reduced\n\n- In case of service, can customer cancel at any time ? if yes can seller estimate refunds
What are the 5 criteria in IFRS necessary for a contract?
A contract with a customer falls into the scope of the Standard when it is legally enforceable and meets the following criteria:\n\n1) The parties to the contract have approved the contract and are committed to their obligations (approval can be written, oral or in accordance with business practices);\n\n2) Each party’s rights to the goods and services can be identified;\n\n3) Payment terms for the goods and services can be identified:\n\n4) Contract has commercial substance (i.e. risk, timing or amount of the cash flows will change as a result of the contract); and\n\n5) Collection of consideration is probable.
If one is a bit unsure about cash collection, which is coming in over time, what is a method of revenue recognition that may be appropriate?
The installment method maybe appropriate, as this method is useful when payments are being made over time but there is uncertainty of cash collection and one wants to recognize revenue over time, on some basis, linked to the cash collection. Note - this is not the cash collection method, where the cash collected is recognized as revenue. Rather, the uncertainty of cash collection is used to determine when to recognize revenue.
If an entity is acting as a principal would its revenue be presented on a gross or net basis?
A popular issue in revenue recognition is how to present the revenue on the income statement, either as the gross amount or the net amount.
If an entity is acting as an agent would its revenue be presented on a gross or net basis?
It would be presented on a net basis.
What is the definition of the “principal” and of the “agent” for the presentation of revenue in the income statement (under ASPE)?
The principal has exposure to the significant risks and rewards associated with the sale of goods or the rendering of services and the agent does not.
