Revenue Recognition Advanced Topics Flashcards
What is the five-step approach?
in order to properly apply the revenue recognition standard, an entity should implement the five-step approach described below:
identify the contract with the customer
identify the separate performance obligations in the contract
determine the transaction price
allocate the transaction price to the separate performance obligations
recognize revenue when or as the entity satisfies each performance obligation
the revenue from long-term construction contracts may be recognized over time or at a point in time
Construction contract revenue recognized over time
revenue on a construction contract is recognized over time if either one of the criteria below is met:
the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced
the entity’s performance does not create an asset with alternative use to the entity, and the entity has an enforceable right to receive payment for performance completed to date
income recognized is the percentage of estimated total income either that incurred costs to date bear to total estimated costs based on the most recent cost information or that may be indicated by such other measure of progress toward completion appropriate to the work performed
when long-term construction contract revenue is recognized over time, construction costs and estimated gross profit earned are accumulated in the construction in progress (CIP) account (an inventory account) and billings on construction are accumulated in the progress billings account (a contra-inventory account); the two account are netted against each other for balance sheet reporting
the following are important points to remember in accounting for contracts where revenue is recognized over time:
JEs and interim balance sheet treatment are the same as they are for construction contract revenue recognized at a point in time except that the amount of estimated gross profit earned in each period is recorded by charging the CIP account and crediting realized gross profit
an estimated loss on the total contract is recognized immediately in the year it is discovered; however, any previous gross profit or loss reported in prior years must be adjusted for when calculating the total estimated loss
Construction contract revenue recognized at a point in time
when a long-term construction contract does not meet the criteria for recognizing revenue over time, revenue and gross profit are recognized when the contract is completed
when construction contract revenue is recognized at a point in time, construction costs are accumulated in the CIP account (an inventory account) and billings on the construction are accumulated in the progress billings account (a contra-inventory account); the two accounts are netted against each other for balance sheet reporting
the following are important points to remember in accounting for contracts when revenue is recognized at a point in time:
estimated gross profit is not recognized each period as part of CIP; unless a loss is recognized on the contract, no gross profit is recognized until the contract is completed
at interim balance sheet dates, the excess of either the CIP account or the progress billings account over the other is classified as a current asset or a current liability
losses should be recognized in full in the year they are discovered; losses are recorded immediately; any profit would be recorded at completion of the contract
Incremental costs of obtaining a contract
the incremental costs of obtaining a contract are costs incurred that would not have been incurred in the contract had not been obtained, and are recognized as an asset (capitalized and amortized) if the entity expects that it will recover these costs; an entity will recognize an expense if the costs would have been incurred regardless of whether the contract was obtained
Costs to fulfill a contract
the costs that are incurred to fulfill a contract that are not within the scope of another standard will be recognized as an asset if they meet all of the following criteria:
relate directly to a contract, generate or enhance the resources of the entity, and expect to be recovered
costs to be expensed include SG&A, wasted labor and material, and costs tied to satisfied performance obligations
Contract modifications
a contract modification represents a change in the price or scope (or both) of a contract approved by both parties; when a modification occurs, it is either treated as a new contract or as a modification of the existing contract; the modification is treated as a new contract if:
the scope increases due to the addition of distinct goods/services & the price increase appropriately reflects the stand-alone selling prices of the additional goods/services
if not accounted for as a new contract, the modification is treated as part of the existing contract (for non-distinct goods/services) with an adjustment to revenue to reflect the change in the transaction price
Principal vs Agent
whenever an entity uses another party to provide goods/services to a customer, the entity needs to determine whether it is acting as a principal or an agent
principal - the entity controls the good or service before it is transferred to the customer; when this is the case, the revenue recognized is equal to the gross consideration an entity expects to receive
agent - the entity arranges for the other party to provide the good/service to the customer; when this is the case, the revenue recognized is equal to the fee or commission for performing the agent function
Repurchase agreements
a repurchase agreement is a contract by which an entity sells an asset and also either promises to or has the option to repurchase the asset; the 3 main forms of repurchase agreements include: an entity’s obligation to repurchase the asset (a forward), an entity’s right to repurchase the asset (a call option), and an entity’s obligation to repurchase the asset at the customer’s request (a put option)
forward/call option - the entity’s accounting for the contract will be based on whether it must (forward) or can (call) repurchase the asset for either: less than the original selling price (it will be a lease) or equal to/more than the original price (it will be a financing arrangement)
if the contract is a financing arrangement, the entity will recognize the asset, recognize a financial liability for any consideration received from the customer, and recognize as interest expense the difference between the amount of consideration received from the customer and the amount of consideration to be paid by the customer
put option - if the entity has an obligation to repurchase the asset at the customer’s request for less than the original selling price, the entity will account for the contract as either: a lease (if the customer has a significant economic incentive to exercise the right) or a sale with a right of return (if the customer does not have a significant economic incentive to exercise the right)
if the repurchase price is equal to or greater than the original selling price, the entity accounts for the contract as either: a financing arrangement (if the repurchase price is more than the expected market value of the asset) or a sale with a right of return (if the repurchase price is less than or equal to the expected market value for the asset and the customer does not have a significant economic incentive to exercise the right)
Bill-and-hold arrangements
bill-and-hold arrangements are contracts in which the entity bills a customer for a product that it has not yet delivered to the customer; revenue cannot be recognized in a bill-and-hold arrangement until the customer obtains control of the product; generally, control is transferred to the customer when the product is shipped to or delivered to the customer (depending on the terms of the contract); for a customer to have obtained control of a product in a bill-and-hold arrangement, all of the following criteria must be met:
there must be a substantive reason for the arrangement (ex. the customer has requested the arrangement because it does not have space for the product)
the product has been separately identified as belonging to the customer
the product is currently ready for transfer to the customer
the entity cannot use the product or direct it to another customer
Consignment
consignment is when the dealer or distributor has not obtained control of the product; revenue is recognized when the dealer or distributor sells the product to a customer, or when the dealer or distributor obtains control of the product
indicators of a consignment arrangement include:
the entity controls the product until a specified event occurs (the sale of the product to the customer or a specific time period expires)
the dealer does not have an unconditional obligation to pay the entity for the product (although it might be required to pay a deposit)
the entity can require the return of the product or transfer the product to another party
Warranties
the accounting for a warranty will depend on whether a customer has the option to purchase the warranty separately; it if can be purchased separately, the warranty will be considered a distinct service because it is promised to the customer in addition to the product covered by the contract; an entity will therefore account for the warranty as a performance obligation and allocate a portion of the overall transaction price to that obligation; if the warranty cannot be purchased separately, then there is no separate performance obligation
the following factors should be considered when determining whether the warranty represents a service in addition to the assurance that a product is compliant with agreed-upon specifications:
if the law requires the warranty, this would indicate that it is not a performance obligation
the longer the coverage period, the higher the likelihood that it is a performance obligation
if an entity must perform specific tasks to provide assurance regarding product compliance with agreed-upon specifications, these tasks are likely not a performance obligation
if a warranty provides a service to a customer that is beyond the assurance that the product will comply with agreed-upon specifications, the promised service will represent a performance obligation that will require the transaction price to be allocated to both the product itself and the service
Refund liabilities and the right to return
an entity should recognize a refund liability if it receives or will receive consideration from a customer and anticipates having to refund a portion or all of that consideration; the refund liability represents the amount an entity does not expect to be entitled to receive
for products with a right of return (which may involve the customer receiving a refund, a credit, or another product in exchange for the original product), an entity should recognize:
revenue for transferred products equaling the amount of consideration the entity expects to be entitled to receive (revenue will not be recognized for products that entities anticipate having to return)
a refund liability
an asset related to the subsequent recovery of products when the refund liability is settled
