Week 2

Question 1

What is revenue?

Answer 1

Income arising in the course of an entity’s ordinary activities.

• Excludes income from incidental transaction (e.g., gain from on disposal of property, plant, equipment), amounts collected on behalf of 3rd parties (e.g., salse tax), amounts collected on behalf of 3rd parties in agency relationship (e.g., travel agent gets commission on sale and not the value of the plane ticket), and contributions from stakeholders.

Question 2

What is income?

Answer 2

Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants.

• Think of the equation: A = L + E

Question 3

What are the 5 steps to recognize revenue?

Answer 3

1. Identify the contract with customer.
2. Identify performance obligations in the contract.
3. Determine the transaction price. (It is adjusted for the effects of the time value of money).
4. Allocate the transaction price to the performance obligations in the contract.
5. Recognize revenue when the entity satisfies the performance obligation. (When good or service is transferred to customer - can be over a period of time).

Question 4

What is performance obligation?

Answer 4

The seller makes a commitment to transfer goods and services to the buyer.

Question 5

What is consideration?

Answer 5

In return for goods or services, the buyer agrees to pay the transaction price when the obligation is complete.

Question 6

What is the general criteria that a contract must have for revenue recognition?

Answer 6

• The oral or written contract is approved by both parties.
• Each party’s rights regarding the goods and services can be easily defined.
• Payment terms are easily identified.
• The contract must have commercial substance. (Cash flows received differs from those given up).
• It is probable that the entity will collect the consideration.

Question 7

When is the transfer deemed to take place?

Answer 7

When customer obtains control of the asset. Control is the ability to direct use of, and obtain substantially all of the remaining benefits from, the asset.

Question 8

When does control shift to the customer with free-on-board (FOB) shipping point?

Answer 8

Control changes hands and revenue is recognized once the item leaves the vendor’s premises. For FOB destination, control does not change hands until the goods arrive at the buyer’s premises.

Question 9

When can you recognize revenue during the contract period?

Answer 9

• Customer uses the benefit when provided by the entity (e.g., weekly cleaning service).
• The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced (e.g., construction company building an office tower on land owned by its customer).
• The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date (e.g., custom work and you decide to cancel the contract - still need to pay something).

Question 10

What is contract liability?

Answer 10

Results when a customer has paid consideration but the entity still has a performance obligation to complete.

E.g., greenhouse grows flowers for a customer. Customer pays but we don’t deliver for some time.

Question 11

When are expenses recognized?

Answer 11

At the same time that revenue is recognized. This follows the matching principle.

Question 12

When are general and administrative expenses normally expensed?

Answer 12

When incurred.

Question 13

When are the costs of wasted resources expensed?

Answer 13

When squandered.

Only applies to abnormally high amount.

Question 14

When can you recognize an asset for the incremental costs of obtaining a contract?

Answer 14

If you expect to recover those costs p. 9

Question 15

What is variable consideration?

Answer 15

Any amount that is not known at the time of signing the contract.

When the contract includes a variable amount, such as performance bonus, the entity estimates the amount of the variable consideration to be received using either expected value technique (probability-weighted average of the possible outcomes) or the most likely amount (a single most likely amount from a range of possibilities).

• It is reassesed at the end of each reporting period.

Question 16

Name factors that could increase the likelihood that a significant reversal of the variable consideration will occur.

Answer 16

• The amount of consideration is highly susceptible to factors outside the entity’s influence.
• The uncertainty about the amout of consideration is not expected to be resolved for a long period of time.
• The entity has limited experience with similar types of contract.
• The contract has a large number and broad range of possible consideration amounts.

If any of the above are present, the variable consideration is not included in the transaction price until it is resolved.

Question 17

What is the calculation for expected value technique?

Answer 17

• Calculate the bonus payment times the probability for each option
• Add them up
• The total is the variable consideration
• Then add this to the contract price

Question 18

How do you measure a non-cash consideration?

Answer 18

At its fair value.

E.g., entity gets motor vehicle (instead of cash) for the sale of office equipment (entity’s ordinary business).

Question 19

If payment is made for other than a distinct good or service, what is the transaction price?

Answer 19

It is the transaction price reduced by the amount of consideration given up. (p. 14).

Question 20

What makes performance criteria distinct?

Answer 20

Both of the following criteria must be met:

1. The customer can benefit from the good or service on its own or together with other resources that are readily available.
2. The entity’s promise to transfer the good or service is separately identifiable from other promises in the contract.

• See ICP 1 for week 2. Also pg. 16
• Note that training and data upload was not considered distinct but maintenance was.
• Tip: if the entity also offers the goods or services for sale on a stand-along basis, then it is normally a distinct performance obligation.

Question 21

What is a contract asset?

Answer 21

When an entity has transferred a good or service as obliged under a contract, but has only a conditional right to the consideration that is dependant on future performance under the contract.

(slide #7 pg.3)

Think of construction; for the costs incurred during the year you would have:

DR Contract asset

CR Cash, accounts payable or other accounts

Question 22

What are contract costs?

Answer 22

An asset used to recognize costs related to:

• obtaining a contract; and
• fullfilling a contract

These costs are amortized on a systematic basis over the contract period and tested for impairment at each reporting period.

E.g., all of the costs incurred prior to the contract tender being accepted are not incremental to getting the contract awarded since these costs would have been incurred even if the contract was not accepted. So legal fees to write contract are included but travel to present tender are not.

Question 23

Which parts of the contract are on the statement of comprehensive income and which are on the statement of financial position?

Answer 23

Statement of comprehensive income:

• Revenue
• COGS, cost of sales or contract expense

Statement of financial position:

• Assets: Accounts Receivable, Contract Asset
• Liabilities: Contract Liability

Question 24

How do you journalize the variable consideration?

Answer 24

DR Cash xxxx

CR Revenue (subtract the amount of consideration)

CR Refund Liability (amount of consideration)

DR COGS (excluding amount for consideration)

DR Right to Recovery Asset (cost of amount that can be returned)

CR Inventory (full amount)

• See example on slide 29 pg.10

Question 25

What happens to revenue recognition when there is more than one performance obligation?

Answer 25

The revenue for each component is recognized separately as each performance obligation is completed.

Question 26

If the customer does not have the option to purchase the warranty separtely, is there one or two performance obligations?

Answer 26

(Normally) one performance obligation

It is the delivery of the product which includes the warranty. If the customer has the option to purchase the warranty separatly, then there are two performance obligations.

Question 27

How do you measure the transaction price of two or more performance obligations that have been bundled at a reduced price?

Answer 27

The transaction price should be allocated based on the relative observable stand-alone sales price of each obligation.

• Called relative fair value method
• If the stand-alone price is not directly observable, then use the adjusted market assessment (competitors prices for a similiar good or service) approach or an expected cost plus margin (expected costs to satisfy the obligation plus an appropriate margin) approach.

Question 28

What is the adjusted market assessment approach?

Answer 28

Using the prices charged by competitors for similar goods and services in the marketplace to help determine the stand-alone sales price.

Question 29

What is the expected cost plus a margin approach?

Answer 29

Assess what expected costs will be incurred for satisfying the performance obligation and add an appropriate margin on top of these costs.

Question 30

What is an own party award?

Answer 30

Where the vendor offers the customer a downstream opportunity to acquire goods or services that the vendor normally provides.

Question 31

What are the 2 performance obligations that a vendor has when it awards points when it sells a product?

Answer 31

1. Delivering the good or service that was sold
2. Meeting the loyalty plan commitment

Question 32

Which 2 additional general ledger accounts are used to keep track of construction related activities?

Answer 32

• Contract Assets (all eligible construction related costs, including earned revenue are debited to this account)
• Progress Billings (contra asset account) (interim billings are credited here)

Prior to the completion of the project, the net balance of these two accounts is reported on the statement of financial position as a current asset or liability.

Upon completion, these accounts are closed.

Question 33

What is another name of the contract assets accounts for construction?

Answer 33

Construction-in-progress

Question 34

For construction contracts, how do you record progress billings?

Answer 34

When measured over time:

DR Accounts receivable

CR Progress billings (contra asset)

When measured at a single point in time:

DR Accounts receivable

CR Contract liability

Question 35

For construction contracts, how do you record construction costs as incurred?

Answer 35

When measured over time:

DR Contract asset

CR Cash/accounts payable

When measured at a single point in time:

DR Construction-in-progress (inventory)

CR Cash/accounts payable

Question 36

For construction contracts, how do you record the profit and realize revenue and expense at the end?

Answer 36

When measured over time:

DR COGS

DR Contract asset (the profit element)

CR Revenue

This records the profit component on the contract and realized revenue and expenses for the fiscal year.

When measured at a single point in time:

DR Contract liability

CR Revenue

To recognize revenue when performance is complete

Question 37

For construction contracts, how do you close out billings to the contract asset/liability?

Answer 37

When measured over time:

DR Progress billings

CR Contract asset

To close out the billings account to the contract asset/ liability.

When measured at a single point in time:

DR Cost of goods sold — construction

CR Construction-in-progress (inventory)

To recognize the related construction costs to date.

Question 38

What is the cost recovery method?

Answer 38

If the entity expects to recover the costs incurred in satisfying the performance obligation, then it can recognize revenue to the extent of the costs incurred until such time that it can reasonably measure the outcome.

Question 39

What is a cost plus contract?

Answer 39

Where the customer must reimburse the entity for all the expenses plus an agreed-upon fee for completing the contract.

• Payment is based on actual costs
• Costs often verified by a third party
• Plus part is a percentage or a fixed amount of consideration
• These are not common in practice

Question 40

What are 3 possible outcomes that can occur for an entity in a fixed price contract?

Answer 40

1. Entity makes overall profit and is profitable in each period.
2. Entity makes overall profit but suffers a loss in one or more periods.
3. Entity suffers an overall loss.

Question 41

What is the 4 step process to determine the amount of revenue and COGS expense to recognize in each period?

Answer 41

1. Estimate the expected profit or loss on the contract.
2. Determine the stage of completion using either an input- or output-based method.
3. Calculate revenue.
4. Ascertain COGS (expense).

Note COGS account is the same as cost of sales account.

Question 42

What is the calculation for percentage complete using the output based method?

Answer 42

Percentage complete

=

work certified to date / contract value

• This is commonly calculated by an external surveyer etc…

Question 43

What is the calculation for percentage complete using the cost-to-cost approach input based method?

Answer 43

Percentage complete

=

costs incurred to date/estimated total cost

Question 44

What is the calculation to determine revenue for a period?

Answer 44

Period revenue

=

percentage complete x contract price - cumulative revenue previously recognized

Question 45

What is the difference between a principal and an agent?

Answer 45

The principal has an obligation to provide the goods or services. They recognize the gross amount of consideration.

The agent has an obligation to “arrange” for the principal to provide the goods or services. They recognize the fee or commision that is received.

Question 46

What is a consignment arrangement?

Answer 46

Entity delivers a product to a second party to sell; however, the second party has not obtained control of the product.

• Entity typically has control until product is sold
• Entity can require the return of the product
• Second party does not have an unconditional obligation to pay for the product.

Question 47

What is a bill and hold arrangement?

Answer 47

A contract where the seller bills the customer but the goods are not delivered to the customer until a future date.

Question 48

When is revenue recognized in bill and hold arrangement?

Answer 48

• Control has transfered to the customer
• Reason must be substantive (customer has requested it)
• Product must be separately identified
• Product must be ready to be delivered
• Seller does not have ability to use the product or sell to another customer

Question 49

What is the approach to figure out revenue and expense on a construction project in progress?

Answer 49

Cost incurred to date$2,918,900

Estimated cost to complete$2,861,100

Estimated total cost$5,780,000

% complete50.5%

Contract price$6,398,000

Current year revenue (% complete x contract price)$3,230,990

Current year expense$2,918,900

See examples in notes!

Question 50

When cash comes in over time in a contract, what do we need to think about?

Answer 50

The time value of money

Need to consider the present value.

Question 51

What is the amount to be recognized as a contract loss in the current period?

Answer 51

The sum of:

• the amount by which the revised total contract costs exceed the contract amount; and
• the cumulative profit on the contract recognized in previous periods.

So if we’re losing money on the contract in a period we don’t look at the percentage complete, just sum up the expected loss for that year and add to cumulative profit from before.

Question 52

For a construction contract, how to calculate contract asset/liability at the end of a period?

Answer 52

Revenue - Progress Bililngs

• If > 0 then Contract Asset
• If < 0 then Contract Liability

Look at practice problem 6.

Question 53

What to do if you recognize a loss with a contract?

Answer 53

Debit to COGS immediately on recognition of the potential loss with a provision for loss liability being the offsetting entry.

E.g., contract value = 38k

cost incurred = 25k

estimated remaining cost to complete = 15k

THEREFORE contract value ($38k) < costs ($40k). The $2k needs to be debited to COGS.

Practice problem 7

Question 54

Under ASPE, what are acceptable methods of accounting for long-term contracts?

Answer 54

• Percentage-of-completion method
• Completed-contract method
  
  • Revenue and expenses not recognized until the contract has been completed.
  • Costs are accumulated in the contruction-in-progress account.
  • Invoices are accumulated in the progress billings until contract completion.
  • Revenue recognized at faire value (under IFRS it’s at amount expected to be received).