ACCT 351 Ch. 6 - Revenue Recognition

Variable Consideration

Transaction Price: The amount the seller expects to receive from the customer. Variable Consideration: Portion of a transaction price depends on the outcome of uncertain future events - Examples: • Construction—Incentive payments • Entertainment and media—Royalties • Health care—Medicare and Medicaid reimbursements • Manufacturing—Volume discounts and product returns • Telecommunications—Rebates - Methods of estimation (Two Alternatives): • Expected value : Probability-weighted amount is used. (More appropriate if there are several possible outcomes.) • Most likely amount: The best estimate is used. (More suitable if only two outcomes are possible) Select method based on ability to best predict the amount the seller will receive

In Class Check: Variable Consideration (2) Matador enters into a contract offering variable consideration. The contract pays Matador $2,000/month for six months of continuous consulting services. In addition, there is a 60% chance the contract will pay an additional $4,000 and a 40% chance the contract will pay an additional $6,000, depending on the outcome of the consulting contract. Matador concludes that this contract qualifies for revenue recognition over time. Assume Matador estimates variable consideration as the expected value. What is the amount of revenue Matador would recognize for the first month of the contract? a. $2,000 b. $2,667 c. $2,800 d. $2,400

c. $2,800 2000x6months+(60%x4,000)+(40%x6,000) = 16,800 16,800/6months = $2,800 each month

BE6-24 Timing of revenue recognition; licenses Saar Associates sells two licenses to Kim & Company on September 1, 2024. First, in exchange for $100,000, Saar provides Kim with a copy of its proprietary investment management software, which Saar does not anticipate updating and which Kim can use permanently. Second, in exchange for $90,000, Saar provides Kim with a three-year right to market Kim's financial advisory services under the name of Saar Associates, which Saar advertises on an ongoing basis. How much revenue will Saar recognize in 2024 under this arrangement?

$110,000 rev rec 2024 $100,000 (Functional IP - at a point in time) + $90,000 x 4/36 months = $10,000 (Symbollic IP - over time) = $110,000

BE6-29 Timing of revenue recognition; consignment Kerianne paints landscapes, and in late 2024 placed four paintings with a retail price of $250 each in the Holmstrom Gallery. Kerianne's arrangement with Holmstrom is that Holmstrom will earn a 20% commission on paintings sold to gallery patrons. As of December 31, 2024, one painting had been sold by Holmstrom to gallery patrons. How much revenue with respect to these four paintings should Kerianne recognize in 2024?

$250 for 1 painting sold to a 3rd party (the $50 of commission is recognized as an expense)

BE6-1 Revenue recognition at a point in time On July 1, 2024, Apache Company, a real estate developer, sold a parcel of land to a construction company for $3,000,000. The book value of the land on Apache's books was $1,200,000. Terms of the sale required a down payment of $150,000 and 19 annual payments of $150,000 plus interest at an appropriate interest rate due on each July 1 beginning in 2025. How much revenue will Apache recognize for the sale (ignoring interest), assuming that it recognizes revenue at the point in time at which it transfers the land to the construction company?

$3,000,000 on July 1, 2024 It was transferred to the customer at this time, so they are entitled to this amount as seller

Variable Consideration Alternative 1: Most Likely Amount TrueTech enters into a contract with ProSport Gaming to add ProSport's online games to the Tri-Net network. The terms of the contract are: • On January 1, 2023, ProSport pays TrueTech an up-front fixed fee of $300,000 for six months of featured access • ProSport also will pay TrueTech a bonus of $180,000 if Tri-Net users access ProSport games for at least 15,000 hours during the six- month period TrueTech estimates a 75% chance that it will achieve the usage target and receive the $180,000 bonus. Journal entry each month Deferred Rev 50,000 Bonus Receiv. 30,000 ----Serv Rev 80,000

$300,000 + $180,000 = $480,000 $480,000 ÷ 6 months = $80,000 $300,000 ÷ 6 months = $50,000 $180,000 ÷ 6 months = $30,000 It they receive bonus: Cash 180,000 ----Bonus Receiv 180,000 If they don't get bonus: Serv Rev 180,000 ----Bonus Receiv 180,000

Variable Consideration Alternative 1: Expected Value Method TrueTech enters into a contract with ProSport Gaming to add ProSport's online games to the Tri-Net network. The terms of the contract are: • On January 1, 2023, ProSport pays TrueTech an up-front fixed fee of $300,000 for six months of featured access • ProSport also will pay TrueTech a bonus of $180,000 if Tri-Net users access ProSport games for at least 15,000 hours during the six- month period TrueTech estimates a 75% chance that it will achieve the usage target and receive the $180,000 bonus. Journal entry at inception Cash 300,000 ----Deferred Rev 300,000

$480,000 x 75% chance = $360,000 $300,000 x 25% chance = $75,000 Expected value of contract price at inception = $435,000

BE6-3 Timing of revenue recognition On May 1, 2024, Varga Tech Services signed a $6,000 consulting contract with Shaffer Holdings. The contract requires Varga to provide computer technology support services whenever requested over the period from May 1, 2024, to April 30, 2025, with Shaffer paying the entire $6,000 on May 1, 2024. How much revenue should Varga recognize in 2024?

$6,000 x 8/12 months in 2024 = $4,000 rev rec in 2024 (the remaining $2,000 in 2025 is deferred rev) "the customer consumes the benefit of the seller's work as it's performed"

BE6-30 Timing of revenue recognition; gift card GoodBuy sells gift cards redeemable for GoodBuy products either in store or online. During 2024, GoodBuy sold $1,000,000 of gift cards, and $840,000 of the gift cards were redeemed for products. As of December 31, 2024, $30,000, of the remaining gift cards had passed the date at which GoodBuy concludes that the cards will never be redeemed. How much gift card revenue should GoodBuy recognize in 2024?

$840,000 (redeemed) + $30,000 (will never be redeemed, so this money is theirs now) = $870,000 rev rec 2024

Identify the performance obligation(s) Example: TrueTech offers a promotional coupon with every Tri-Box it sells for $240. The coupon gives the Tri-Box customer an opportunity to buy a headset that normally sells for $150 for only $90 (a 40% discount). The coupon must be redeemed within one year of the Tri-Box purchase. TrueTech estimates that 80% of customers will take advantage of the coupon. How would TrueTech account for the cash sale of 100 Tri-Boxes sold under this promotion on January 1, 2023?

1) deliver the Tri-box 2) deliver the discounted headset

Right of return

Exists when the customer can return the good if not satisfied or unable to resell it Viewed as a failure to satisfy the original performance obligation Sellers report net sales revenue in the income statement, equal to gross sales revenue less actual and estimated returns.

Special Issues for Step 2: Identify the Performance Obligation(s) (continued) Performance obligations:

Extended warranties. A warranty is an extended warranty if either - The customer has the option to purchase the warranty separately, or - The warranty provides a service to the customer beyond quality assurance Options that provide a material right (a material right is something the customer would not receive otherwise, so the seller is obligated to provide it)

BE6-9 Performance obligations; warranties (BE 6-8: Vroom Vacuums sells the Tornado vacuum cleaner. Each Tornado has a one-year warranty that covers any product defects. When customers purchase a Tornado, they also have the option to purchase an extended three-year warranty that covers any breakage or maintenance. The extended warranty sells for the same amount regardless of whether it is purchased at the same time as the Tornado or at some other time. How many performance obligations exist in the implied contract for the purchase of a vacuum cleaner?) Assume the same facts as in BE 6-8 but that customers pay 20% less for the extended warranty if they buy it at the same time they buy a Tornado. How many performance obligations exist in the implied contract for the purchase of a vacuum cleaner?

1) Vacuum cleaner with 1 year warranty included 2) Discounted extended-warranty (since it is now included in the package)

A customer (buyer) is more likely to control a good or service if the customer has:

- An obligation to pay the seller - Legal title to the asset - Physical possession of the asset - Assumed the risks and rewards of ownership - Accepted the asset

E6-3 Allocating transaction price Video Planet (VP) sells a big screen TV package consisting of a 60-inch plasma TV, a universal remote, and on-site installation by VP staff. The installation includes programming the remote to have the TV interface with other parts of the customer's home entertainment system. VP concludes that the TV, remote, and installation service are separate performance obligations. VP sells the 60-inch TV separately for $1,700, sells the remote separately for $100, and offers the installation service separately for $200. The entire package sells for $1,900. Required: How much revenue would be allocated to the TV, the remote, and the installation service?

- Package $1,900 - TV standalone $1,700 / ($2,000) = 85% - Remote standalone $100 / ($2,000) = 5% - Installation standalone $200 / ($2,000) = 10% $1,900 package ->x85% TV =$1,615 ->x5% remote =$95 ->x10% installation =$190

CompStores ordered 1,000 Tri-Box systems on December 20, 2022, at a price of $250 per unit. Assume that CompStores and TrueTech can cancel the order without penalty prior to delivery. TrueTech made delivery on January 1, 2023, and received $250,000 on January 25, 2023. When does TrueTech's arrangement with CompStores qualify as a contract for purposes of revenue recognition?

...

E 6-22 On February 1, 2024, Arrow Construction Company entered into a three-year construction contract to build a bridge for a price of $8,000,000. During 2024, costs of $2,000,000 were incurred, with estimated costs of $4,000,000 yet to be incurred. Billings of $2,500,000 were sent, and cash collected was $2,250,000. In 2025, costs incurred were $2,500,000 with remaining costs estimated to be $3,600,000. 2025 billings were $2,750,000, and $2,475,000 cash was collected. The project was completed in 2026 after additional costs of $3,800,000 were incurred. The company's fiscal year-end is December 31. This project does not qualify for revenue recognition over time. Required: 1. Calculate the amount of revenue and gross profit or loss to be recognized in each of the three years. (check notes for journal entries and partial balance sheet)

1) --------rev rec---gross profit/loss 2024..........0..........................0 2025..........0...................(100,000) 2026...8,000,000.......(200,000) total...8,000,000.......(300,000)

E 6-19 Long-term contract; revenue recognition over time and at a point in time Assume Avaya contracted to provide a customer with Internet infrastructure for $2,000,000. The project began in 2024 and was completed in 2025. Data relating to the contract are summarized below: -----------------------------------2024------2025 Costs incurred during the year 300,000...1,575,000 Estimated costs to complete as of 12/31 1,200,000...0 Billings during the year 380,000...1,620,000 Cash collections during the year 250,000...1,750,000 Required: 1. Compute the amount of revenue and gross profit or loss to be recognized in 2024 and 2025, assuming Avaya recognizes revenue over time according to percentage of completion. 2. Compute the amount of revenue and gross profit or loss to be recognized in 2024 and 2025, assuming this project does not qualify for revenue recognition over time.

1) 2024: =2,000,000 x (300,000/300,000+1,200,000) <-20% =$400,000 rev rec 400,000 rev rec - 300,000 cost of construction = 100,000 gross profit 2025: 2,000,000 contract - 400,000 rev rec in 2024 = $1,600,000 rev rec 1,600,00 rev rec - 1,575,000 cost of construction = $25,000 gross profit 2) Nothing in 2024 2025: contract price - actual cost 2,000,000 - (300,000+1,575,000) =$125,000

E 6-21 On February 1, 2024, Arrow Construction Company entered into a three-year construction contract to build a bridge for a price of $8,000,000. During 2024, costs of $2,000,000 were incurred with estimated costs of $4,000,000 yet to be incurred. Billings of $2,500,000 were sent, and cash collected was $2,250,000. In 2025, costs incurred were $2,500,000 with remaining costs estimated to be $3,600,000. 2025 billings were $2,750,000, and $2,475,000 cash was collected. The project was completed in 2026 after additional costs of $3,800,000 were incurred. The company's fiscal year-end is December 31. Arrow recognizes revenue over time according to percentage of completion. Required: 1. Calculate the amount revenue and gross profit or loss to be recognized in each of the three years. (*look at notes for journal entries and partial balance sheet)

1) 2024: =8,000,000x(2,000,000/6,000,000) =$2,666,667 rev rec 2024 2,666,667 rev rec - 2,000,000 costs = $666,667 gross profit 2025: =8,000,000x(4,500,000/8,100,000) -2,666,667 rev rec 2024 =$1,777,778 rev rec 2025 (100,000) est loss 2025 from chart - 666,667 gross profit 2024 = 766,667 gross loss 2026: 8,000,000-(2,666,667 + 1,777,778) =$3,555,555 rev rec 2026 (300,000 2026) - (100,000 2025) = ($200,000) gross loss

Recognizing Revenue for Contracts that Contain Multiple Performance Obligations: Identify the Performance Obligations A good or service is distinct if it is both:

1) capable of being distinct 2) Separately identifiable from other goods or services in the contract

E 6-20 On June 15, 2024, Sanderson Construction entered into a long-term construction contract to build a baseball stadium for $220 million. The expected completion date is April 1, 2026. ($ in millions): -----------------------------------2024...2025...2026 Costs incurred during year.........$40m $80m $50m Est cost to complete Dec 31st...$120m $60m -- Required: 1. How much revenue and gross profit will Sanderson report in its 2024, 2025, and 2026 income statements related to this contract, assuming Sanderson recognizes revenue over time according to percentage of completion? 2. How much revenue and gross profit will Sanderson report in its 2024, 2025, and 2026 income statements related to this contract, assuming this project does not qualify for revenue recognition over time?

1) 2024: =$220,000,000 x ($40,000,000/$40,000,000+$120,000,000) <-25% =$55,000,000 rev rec 2024 55,000,000 rev rec 2024 - 40,000,000 costs = $15,000,000 gross profit 2025: = $220,000,000 x ($40,000,000+$80,000,000/$40,000,000+$80,000,000+$60,000,000) -$55,000,000 rev rec 2024 =$91,674,000 rev rec 2025 91,674,000 rev rec - 80,000,000 costs = $11,674,000 2026: =$220,000,000-(55,000,000 rev rec 2024 + 91,674,000 rev rec 2025) =$73,326,000 rev rec 2026 2) Nothing in 2024 or 2025 2026: $220m rev rec $50m gross loss

BE 6-36 Long-term contract; revenue recognition; loss on entire project Franklin Construction entered into a fixed-price contract to build a freeway-connecting ramp for $30 million. Construction costs incurred in the first year were $16 million and estimated remaining costs to complete at the end of the year were $17 million. How much gross profit or loss will Franklin recognize in the first year if it recognizes revenue over time according to percentage of completion? What if instead Franklin recognizes revenue upon contract completion?

1) =$30m x ($16m/$33m)<-48.49% = $14,545,454.5 rev rec (percentage of completion) $14,545,454.5 rev rec - 16,000,000 cost of construction = $1,454,545.5 gross loss 2) (upon completion) gross loss = contract price - total expected cost =$30m-$33m =$3,000,000 gross loss

E6-7 A New York City daily newspaper called Manhattan Today charges an annual subscription fee of $135. Customers prepay their subscriptions and receive 260 issues over the year. To attract more subscribers, the company offered new subscribers the ability to pay $130 for an annual subscription that also would include a coupon to receive a 40% discount on a one-hour ride through Central Park in a horse-drawn carriage. The list price of a carriage ride is $125 per hour. The company estimates that approximately 30% of the coupons will be redeemed. Required: 1. How much revenue should Manhattan Today recognize upon receipt of the $130 subscription price? 2. How many performance obligations exist in this contract? 3. Prepare the journal entry to recognize sale of 10 new subscriptions, clearly identifying the revenue or deferred revenue associated with each performance obligation.

1) $0...Revenue is recognized when the newspapers are delivered to customers 2) 2 obligations - delivery of newspapers and the ride coupon 3) discount (coupon) = $125 carriage x 40% discount x 30% expected to redeem = $25 stand-alone selling price of the coupon - Subscription $135/(150) = 90% - Coupon $15/(150)=10% $130 package ->x90% =$118 subscription ->x10% = $13 coupon Journal entry x 100 subscriptions: Cash 1,300 ---Deferred Rev-Subscriptions 1,170 ---Deferred Rev-Discount Coupons 130

E6-9 Variable consideration; estimation and constraint Thomas Consultants provided Bran Construction with assistance in implementing various cost-savings initiatives. Thomas's contract specifies that it will receive a flat fee of $50,000 and an additional $20,000 if Bran reaches a prespecified target amount of cost savings. Thomas estimates that there is a 20% chance that Bran will achieve the cost-savings target. Required: 1. Assuming Thomas uses the expected value as its estimate of variable consideration, calculate the transaction price. 2. Assuming Thomas uses the most likely value as its estimate of variable consideration, calculate the transaction price. 3. Assume Thomas uses the expected value as its estimate of variable consideration, but is very uncertain of that estimate due to a lack of experience with similar consulting arrangements. Calculate the transaction price.

1) $50,000 + (20% x 20,000) + (80% x 0) = $54,000 2) $50,000 + 0 = $50,000 3) $50,000

P6-2 Creative Computing sells a tablet computer called the Protab. The $780 sales price of a Protab Package includes the following: • One Protab computer. • A six-month limited warranty. • A coupon to purchase a Creative Probook e-book reader for $200, a price that represents a 50% discount from the regular Probook price of $400. It is expected that 20% of the discount coupons will be utilized. • A coupon to purchase a one-year extended warranty for $50. Customers can buy the extended warranty for $50 at other times as well. Creative estimates that 40% of customers will purchase an extended warranty. • A Protab alone would sell for $760. 1. Performance obligations? 2. Allocate the packages. 3. Prepare a journal entry to record sales of 100,000 Protab Packages (ignore any sales of extended warranties).

1) 2 obligations - Protab Computer delivery and coupon from the Probook 2) - Protab Stand-alone: ($760x100,000) = $76,000,000/(80,000,000)=95% - Probook stand-alone: ($200 x 100,000 x 20%) = 4,000,000/(80,000,000) = 5% $78,000,000 package ->x95% = $74,100,000 Protab ->x5% =$3,900,000 Probook 3) Journal x100,000 units Cash 78,000,000 ---Sales Rev 74,100,000 ---Deferred Rev 3,900,000

E6-6 Clarks Inc., a shoe retailer, sells boots in different styles. In early November, the company starts selling "SunBoots" to customers for $70 per pair. When a customer purchases a pair of SunBoots, Clarks also gives the customer a 30% discount coupon for any additional future purchases made in the next 30 days. Customers can't obtain the discount coupon otherwise. Clarks anticipates that approximately 20% of customers will utilize the coupon, and that on average those customers will purchase additional goods that normally sell for $100. Required: 1. Performance obligations? 2. Assume Clarks cannot estimate the standalone selling price of a pair of SunBoots sold without a coupon. Prepare a journal entry to record revenue for the sale of 1,000 pairs of SunBoots, assuming that Clarks uses the residual method to estimate the stand-alone selling price of SunBoots sold without the discount coupon.

1) 2 obligations - sunboots delivery and a usable discount coupon 2) deferred revenue = 1,000 pairs x $100 average purchase price x 30% discount x 20% customers estimated usage = $6,000 Cash 70,000 ---Sales Rev 64,000 ---Deferred Rev (coupons) 6,000 (cash is 1,000 pairs x $70)

BE6-8 Performance obligations; warranties Vroom Vacuums sells the Tornado vacuum cleaner. Each Tornado has a one-year warranty that covers any product defects. When customers purchase a Tornado, they also have the option to purchase an extended three-year warranty that covers any breakage or maintenance. The extended warranty sells for the same amount regardless of whether it is purchased at the same time as the Tornado or at some other time. How many performance obligations exist in the implied contract for the purchase of a vacuum cleaner?

1) Vacuum Cleaner with included 1 year warranty delivered

E6-2 Service revenue Ski West, Inc., operates a downhill ski area near Lake Tahoe, California. An all-day adult lift ticket can be purchased for $85. Adult customers also can purchase a season pass that entitles the pass holder to ski any day during the season, which typically runs from December 1 through April 30. Ski West expects its season pass holders to use their passes equally throughout the season. The company's fiscal year ends on December 31. On November 6, 2024, Jake Lawson purchased a season pass for $450. Required: 1. When should Ski West recognize revenue from the sale of its season passes? 2. Prepare the appropriate journal entries that Ski West would record on November 6 and December 31. 3. What will be included in the Ski West 2024 income statement and balance sheet related to the sale of the season pass to Jake Lawson?

1) over a period of time (the ski season) 2) Nov. 6th: Cash 450 -----Deferred Rev 450 Dec. 31st: Deferred Rev 90 -----Service Rev 90 ($450/5months =$90) 3) $90 in income statement. The remaining $360 of deferred rev is in balance sheet as a current liability.

Time Value of Money If the time value of money is a significant part of the contract, the seller should view the transaction price as consisting of two components :

1. A delivery component, equal to the cash price of the good or service, and 2. A financing component, which is interest considered paid to the customer (in the case of a prepayment) or to the seller (in the case of a receivable) Sellers can assume the financing component is not significant if the period between delivery and payment is less than a year

5 Steps to Recognizing Revenue

1. Identify the contract 2. Identify the performance obligations 3. Determine the transaction price 4. Allocate the transaction price 5. Recognize revenue when (or as) each performance obligation is satisfied IIDAR

Revenue is recognized over a period of time if any of following three criteria is met :

1. The customer consumes the benefit of the seller's work as it is performed (Ex: a cleaning service) 2. The customer controls the asset as it is created (Ex: constructing a building extension) 3. The seller is creating an asset that has no alternative use to the seller and the seller has the legal right to receive payment for progress to date (Ex: an order of jets customized for the U.S. Air Force)

Nazarian Contractors received a contract to construct a mental health facility for $2,500,000. Construction was begun in 2022 and completed in 2023. Cost and other data are presented below: ...................................................................................2022...................2023 Costs incurred during the year..............1,500,000.........1,300,000 Estimated costs to complete..................1,200,000.................0 Billings during the year..............................1,200,000.........1,300,000 Cash collections during the year.........1,000,000..........1,500,000 Assume that Nazarian recognizes revenue on this contract over time according to percentage of completion. Required: Compute the amount of gross profit (or loss) recognized during 2022 and 2023.

2022: Contract Price ......................................2,500,000 Actual cost to date 1,500,000 est total cost to complete 1,200,000 total est costs 2,700,000 Est loss 2022..........................................(200,000) 2023: Contract Price.............................2,500,000 Cost incurred: 2022...1,500,000 2023...1,300,000 Total cost........................................2,800,000 total loss.........................................(300,000) recognized in 2022....................(200,000) recognized in 2023....................(100,000)

Bill-and-Hold Sales

A bill-and-hold sale is an arrangement where a customer purchases goods but requests that the seller not ship the product until a later date Since the customer doesn't have physical possession of the asset until the seller has delivered it, transfer of control has not occurred, so revenue typically should not be recognized until actual delivery to the customer occurs

Residual Approach Example Assume TrueTech sells 1,000 Tri-Boxes with a one-year Tri-Net subscription at $250. The stand-alone selling price of the Tri-Box is $240. The stand-alone selling price of the one-year subscription is highly uncertain because TrueTech hasn't sold that service previously and hasn't established a price for it. Assume CompStores orders 1,000 Tri-Box Systems at the normal wholesale price of $250 each, TrueTech records the following journal entry Under the residual approach:

A/R 250,000 ----Sales Rev 240,000 ----Deferred Rev 10,000

BE6-17 Principal or agent Assume that Amazon.com sells the MacBook Pro, a computer produced by Apple, for a retail price of $1,500. Amazon arranges its operations such that customers receive products directly from Apple Stores rather than Amazon. Customers purchase from Amazon using credit cards, and Amazon forwards cash to Apple equal to the retail price minus a $150 commission that Amazon keeps. In this arrangement, how much revenue will Amazon recognize for the sale of one MacBook Pro?

Amazon (Agent) Revenue $150 (COGS) 0 Gross Profit $150 Agent = record only the commission

BE6-2 Timing of revenue recognition Estate Construction is constructing a building for CyberB, an online retailing company. Under the construction agreement, if for any reason Estate can't complete construction, CyberB would own the partially completed building and could hire another construction company to complete the job. When should Estate recognize revenue: as the building is constructed, or after construction is completed?

As the building is constructed The revenue is recognized over a period of time because "the customer controls the asset as its created"

Right of Return Example: Assume that TrueTech sold 1,000 Tri-Boxes to CompStores for $240 each. TrueTech estimates that CompStores will return five percent of the Tri-Boxes purchased.

Sales Rev ($240x1,000triboxes) $240,000 Less: Estimated returns (%5) (12,000) Net sales Rev $228,000

Gift Cards

Sales of gift cards are recognized as deferred revenue liability and then Revenue is recognized when a gift card is redeemed or the likelihood of redemption is viewed as remote

BE 6-34 Long-term contract; revenue recognition over time; balance sheet (BE 6-33: A construction company entered into a fixed-price contract to build an office building for $20 million. Construction costs incurred during the first year were $6 million, and estimated costs to complete at the end of the year were $9 million. The company recognizes revenue over time according to percentage of completion. How much revenue and gross profit or loss will appear in the company's income statement in the first year of the contract?) Refer to the situation described in BE 6-33. Assume that, during the first year the company billed its customer $7 million, of which $5 million was collected before year-end. What would appear in the year-end balance sheet related to this contract?

CA: A/R 2,000,000 ---Costs and Profit in Excess of Billings 1,000,000 $7m-$5m=$2m for A/R ($6m cost + $2m profit) - $7m billings = 1,000,000

BE6-4 Allocating the transaction price Sarjit Systems sold software to a customer for $80,000. As part of the contract, Sarjit promises to provide "free" technical support over the next six months. Sarjit sells the same software without technical support for $70,000 and a stand-alone six-month technical support contract for $30,000, so these products would sell for $100,000 if sold separately. Prepare Sarjit's journal entry to record the sale of the software.

Cash 80,000 -----Sales Rev 56,000 -----Deferred Rev 24,000 - Software package $80,000 - Software 70,000 / (100,000) = 70% - Tech-Support 40,000 / (100,000) = 30% 80,000 transaction price ->x70% = $56,000 software ->x30% = $24,000 tech-support

Special Issues for Step 1: Identify the Contract

Contracts can be explicit or implicit, oral or written A contract only exists if it: - Has commercial substance - Has been approved by the seller and customer - Specifies the rights of both parties - Specifies payment terms - Is probable that the seller will collect the amount it is entitled to receive under the contract A contract does not exist if: - Neither the seller nor the customer has performed any obligations, and - Both parties can terminate the contract without penalty

Identify the performance obligation(s) Example: TrueTech offers a promotional coupon with every Tri-Box it sells for $240. The coupon gives the Tri-Box customer an opportunity to buy a headset that normally sells for $150 for only $90 (a 40% discount). The coupon must be redeemed within one year of the Tri-Box purchase. TrueTech estimates that 80% of customers will take advantage of the coupon. How would TrueTech account for the cash sale of 100 Tri-Boxes sold under this promotion on January 1, 2023? Selling prices?

Estimated stand-alone selling price of the coupon: Discount = $150 × 40% = $60 Estimated stand-alone selling price = $60 × 80% = $48 Total of stand-alone selling prices = $240 + $48 = $288 Tri-Box: $240/$288 = 83.33% (or 5/6) Coupon: $48/$288 = 16.67% (or 1/6) So Cash 24,000 ----Sales Rev 20,000 ----Deferred rev(coupons) 4,000

Franchises

In a franchise arrangement, a franchisor grants to the franchisee the right to sell the franchisor's products and use its name for a specified time period Franchises often include a license to use intellectual property, as well as initial sales of products and services transferred at the start of the franchise as well as ongoing sales over the life of the franchise Franchisor must evaluate each part of the franchise agreement to identify the performance obligations

Recognizing Revenue at a Single Point in Time Example: TrueTech sells the Tri-Box, a gaming console that allows users to play video games individually or in multiplayer environments over the Internet. When should TrueTech recognize revenue for the following sale of 1,000 Tri-Boxes to CompStores? December 20, 2022: CompStores orders 1,000 Tri -Boxes at a price of $240 each, promising payment within 30 days after delivery January 1, 2023: TrueTech delivers 1,000 Tri-Boxes to CompStores, and title to the Tri-Boxes transfers to CompStores January 25, 2023: TrueTech receives $240,000 from CompStores

January 1, 2023: When its delivered

Licenses - Functional IP

Licenses of functional Intellectual Property transfer a right of use, so sellers typically recognize revenue at a point in time. Has significant standalone functionality (can perform a function or a task, or be played or aired) The benefit the customer receives from the license isn't affected by the seller's ongoing activity Therefore, viewed as transferring a right of use Example: a music download Revenue is recognized at the point in time that the customer can start using the IP.

If revenue is recognized upon project completion then there is

NO journal entry for the any years UNTIL the last one when the projects fully complete

BE 6-35 Long-term contract; revenue recognition upon completion (BE 6-33: A construction company entered into a fixed-price contract to build an office building for $20 million. Construction costs incurred during the first year were $6 million, and estimated costs to complete at the end of the year were $9 million. The company recognizes revenue over time according to percentage of completion. How much revenue and gross profit or loss will appear in the company's income statement in the first year of the contract?) Refer to the situation described in BE 6-33. Assume that the building was completed during the second year, and construction costs incurred during the second year were $10 million. How much revenue and gross profit or loss will the company recognize in the first and second year if it recognizes revenue upon contract completion?

Nothing Y1 Y2: Revenue 20,000,000 less: Cost Y1 (6,000,000) less: Cost Y2 (10,000,000) Y2 Gross profit $4,000,000

Contract Containing Multiple Performance Obligations Example: TrueTech manufactures the Tri-Box System, a multiplayer gaming system allowing players to compete with each other over the Internet. The Tri-Box System includes the physical Tri-Box module as well as a one-year subscription to the Tri-Net multiuser platform of Internet-based games. TrueTech sells individual one-year subscriptions for $60. Customers can access the Tri-Net using a Tri-Box as well as other gaming modules. TrueTech sells individual Tri-Box modules for $240. Customers can use a Tr i -Box to access the Tri-Net as well as other multiuser gaming platforms. As a package deal, TrueTech sells the Tri-Box System (i.e., module plus subscription) for $250. On January 1, 2023, TrueTech delivers 1,000 Tri-Box Systems to CompStores at a price of $250 per system. On January 25, 2023, TrueTech receives $250,000 from CompStores recognition?

On January 1, 2023, TrueTech records the revenue from the Tri- Box modules (that performance obligation is satisfied) but defers revenue for the Tri-Net subscriptions. A/R 250,000 ----Sales Rev 200,000 ----Deferred Rev 50,000 In each of the 12 months following the sale, TrueTech records the following entry to recognize Tri-Net subscription revenues. Deferred Rev 4,167 ----Service Rev 4,167 (deferred rev is $50,000/12)

Principal

Performance Obligation: To provide goods and services (so is vulnerable to risks associated with holding inventory) Recording Revenue: Total sales price revenue paid by customers Also recognizes cost of goods sold

Agent

Performance obligation: To facilitate a transaction between a principal and a customer Recording Revenue: Only the commission it receives on the transaction

Special Issues for Step 2: Identify the Performance Obligation(s) Not performance obligations:

Prepayments (part of the transaction price) Quality-assurance warranties (part of the performance obligation to deliver products of acceptable quality) Right of return (represents a potential failure to satisfy the original performance obligation)

Principal or Agent Example: Mike buys a Tri-Box module from an online retailer for $290. Let's consider accounting for that sale by two retailers, PrinCo and AgenCo: • PrinCo purchases Tri-Box modules directly from TrueTech for $240, has the modules shipped to its distribution center in Kansas, and then ships individual modules to buyers when a sale is made. PrinCo offers occasional price discounts according to its marketing strategy. • AgenCo serves as a web portal by which multiple game module manufacturers like TrueTech can offer their products for sale. The manufacturers ship directly to buyers when a sale is made. AgenCo receives a $50 commission on each sale that occurs via its web portal.

PrinCo (principal): Revenue $290 Less: COGS $240 Gross profit $50 AgenCo (agent): revenue $50 Less: COGS 0 Gross profit $50

Recognizing Revenue Over a Period of Time Example: TrueTech sells one-year subscriptions to the Tri-Net multiuser platform of Internet-based games. TrueTech sells 1,000 subscriptions for $60 each on January 1, 2023. Journal Entry at inception Cash ($60x1,000) 60,000 ----Deferred Revenue 60,000 At the end of each of the 12 months following the sale, TrueTech would record the following entry to recognize Tr i-Net subscription revenue: Journal entry each month Deferred revenue ($60,000/12) 5,000 ----Service Revenue 5,000

Recognized over time Cash was received in advance of providing the service

Easy format to calculate rev rec and gross profit/loss

Revenue recognized to date Less: revenue recognized in first few years .................revenue recognized (Cost of Construction) .................Profit/(loss)

Revenues

Revenues are inflows of assets of an entity or settlements of its liabilities from delivering goods or rendering services that constitute the entity's ongoing major operations. It is important not only to determine how much revenue to recognize (record), but also when to recognize it

Contract Containing Multiple Performance Obligations Example: TrueTech manufactures the Tri-Box System, a multiplayer gaming system allowing players to compete with each other over the Internet. The Tri-Box System includes the physical Tri-Box module as well as a one-year subscription to the Tri-Net multiuser platform of Internet-based games. TrueTech sells individual one-year subscriptions for $60. Customers can access the Tri-Net using a Tri-Box as well as other gaming modules. TrueTech sells individual Tri-Box modules for $240. Customers can use a Tr i -Box to access the Tri-Net as well as other multiuser gaming platforms. As a package deal, TrueTech sells the Tri-Box System (i.e., module plus subscription) for $250. On January 1, 2023, TrueTech delivers 1,000 Tri-Box Systems to CompStores at a price of $250 per system. On January 25, 2023, TrueTech receives $250,000 from CompStores Obligations?

Step 1: Identify the contract: Yes Step 2: Identify the performance obligation(s) - Tri-Box module - Tri-Net subscription

Residual approach:

Subtract the sum of the known or estimated stand-alone selling prices of other goods and services in the contract from the total transaction price of the contract

Licenses - Symbolic IP

Symbolic IP: Transfer seller's IP with the understanding that the seller will undertake ongoing activities. - Lacks significant standalone functionality • The benefit the customer receives from the license is affected by the seller's ongoing activity • Therefore, the license transfers a right of access to the seller's IP Examples: Trademarks, logos, brand names, franchise rights • Recognize revenue over the license period Exception: Functional IP is viewed as transferring a right of access (and requiring revenue recognition over time) if both • The seller is expected to change the functionality over time and • The customer is required to use the updated version Example: virus protection software

Consignment Arrangements

The "consignor" physically transfers the goods to the other company (the consignee), but the consignor retains legal title If a buyer is found, the consignee remits the selling price (less commission and approved expenses) to the consignor If the consignee can't find a buyer within an agreed-upon time, the consignee returns the goods to the consignor Given that the consignor retains the risks of ownership, it postpones revenue recognition until sale to a third party occurs

Residual Approach Example Assume TrueTech sells 1,000 Tri-Boxes with a one-year Tri-Net subscription at $250. The stand-alone selling price of the Tri-Box is $240. The stand-alone selling price of the one-year subscription is highly uncertain because TrueTech hasn't sold that service previously and hasn't established a price for it. Under the residual approach:

Total price of Tri-Box with Tri-Net subscription $250,000 Stand alone price of Tri-box $240,000 Estimated stand alone price of tri-net subscription $10,000

Contract Containing Multiple Performance Obligations Example: TrueTech manufactures the Tri-Box System, a multiplayer gaming system allowing players to compete with each other over the Internet. The Tri-Box System includes the physical Tri-Box module as well as a one-year subscription to the Tri-Net multiuser platform of Internet-based games. TrueTech sells individual one-year subscriptions for $60. Customers can access the Tri-Net using a Tri-Box as well as other gaming modules. TrueTech sells individual Tri-Box modules for $240. Customers can use a Tr i -Box to access the Tri-Net as well as other multiuser gaming platforms. As a package deal, TrueTech sells the Tri-Box System (i.e., module plus subscription) for $250. On January 1, 2023, TrueTech delivers 1,000 Tri-Box Systems to CompStores at a price of $250 per system. On January 25, 2023, TrueTech receives $250,000 from CompStores Transaction $?

Transaction price = $250/system x 1,000 systems = $250,000 The transaction price of one Tri-Box System is $250 The stand-alone price of a Tri-Box module is $240 The stand-alone price of a Tri-Net subscription is $60 Tri-box modules: $240/($240+$60)=80% Tri-net subscriptions: $60/($240+$60)=20% so $250 transaction price ->80% =$200 module ->20% =$50 subscriptions

Time Value of Money - Receivable On January 1, 2023, TrueTech enters into a contract with GameStop Stores to deliver four $240 Tri-Box modules that have a combined fair value of $960. • Receivable Case: TrueTech delivers the modules on January 1, 2023, and GameStop agrees to pay TrueTech $1,056 on December 31, 2023 .

When Delivery occurs: *$960 = $1,056 x 0.90909 PV of 1, n=1, I = 10% January 1, 2023 Notes receivable 1,056 ----Disc on notes receivable 96 ----Sales rev 960 When subsequent collection occurs: December 31, 2023 Cash 1,056 Disc on notes receivable 96 ----Interest revenue (960x10%) 96 ----Notes receivable 1,056

Time Value of Money - Prepayment On January 1, 2023, TrueTech enters into a contract with GameStop Stores to deliver four $240 Tri-Box modules that have a combined fair value of $960. • Prepayment Case: GameStop pays TrueTech $873 on January 1, 2023, and TrueTech agrees to deliver the modules on December 31, 2023

When collection occurs: *$873=$960x0.90909 (PV of $1, n=1, I=10%) January 1, 2023: Cash 873 ----Deferred Rev 873 When subsequent delivery occurs: December 31, 2023: Interest Exp (873x10$) 87 Deferred rev 873 ----Sales Rev 960

Revenue recognized this period =

[total estimated revenue x (Actual Cost/Total Cost =percentage completed to date)] - revenue recognized in prior periods

In Class Check: Revenue Recognition Over Time CSUN Construction entered into a contract to construct a tunnel for a fixed price of $12,000,000. CSUN recognizes revenue over time according to percentage of completion. Here are some facts: ...........Cost incurred Est additional cost to complete 2021 $3,000,000 $6,000,000 2022 5,000,000 2,000,000 2023 2,500,000 0 How much revenue would CSUN recognize in 2021? a. $4,000,000 b. $5,000,000 c. $6,000,000 d. $12,000,000

a. $4,000,000 Using the formula 12m x (3m/(3m+6m)) = $4m rev rec (percentage complete is 33.33%)

In Class Check: Variable Consideration 1 Matador enters into a contract offering variable consideration. The contract pays Matador $2,000/month for six months of continuous consulting services. In addition, there is a 60% chance the contract will pay an additional $4,000 and a 40% chance the contract will pay an additional $6,000, depending on the outcome of the consulting contract. Matador concludes that this contract qualifies for revenue recognition over time. Assume Matador estimates variable consideration as the most likely amount. What is the amount of revenue Matador would recognize for the first month of the contract? a. $2,000 b. $2,667 c. $2,800 d. $2,400

b. $2,667 The most likely amount is 60% (200x6months)+4,000=16,000 16,000/6months = 2,667 per month

In Class Check: Revenue Recognition CSUN Construction entered into a contract to construct a tunnel for a fixed price of $12,000,000. CSUN recognizes revenue over time according to percentage of completion. Here are some facts: ...........Cost incurred Est additional cost to complete 2021 $3,000,000 $6,000,000 2022 5,000,000 2,000,000 2023 2,500,000 0 How much revenue would CSUN recognize in 2022? a. $5,000,000 b. $5,600,000 c. $8,000,000 d. $9,600,000

b. $5,600,000 $12m x (3m+5m/3m+5m+2m) = $9.6m rev rec - $4m rev rec in 2021 = $5.6m rev rec in 2022 (percentage complete is 80%)

Check slides for examples of

balance sheet, journal entries, recognizing rev over time...etc.

In Class Check: Contracts with Multiple Performance Obligations Matador Co. wrote a contract that involves two performance obligations. Product A has a stand-alone selling price of $100, and product B has a stand-alone selling price of $200. The price for the combined product is $240. How much of the transaction price would be allocated to the performance obligation for delivering product A? a. $ 40 b. $ 60 c. $ 80 d. $100

c. $ 80 240/($100+$200)=$80 OR [(100/($100+$200)]x$240=$80

In Class Check: Special Issues in Revenue Recognition Matador Inc. offers a discount on an extended warranty on its eyePhone when the warranty is purchased at the time the eyePhone is purchased. The warranty normally has a price of $300, but Matador offers it for $240 when purchased along with an eyePhone. Matador anticipates a 75% chance that a customer will purchase the extended warranty along with the eyePhone. Assume Matador sells 1,000 eyePhones with the extended warranty discount offer. What is the total stand- alone selling price that Matador would use for the extended warranty discount option for purposes of allocating revenue among the performance obligations in those 1,000 eyePhone contracts? a. $240,000 b. $60,000 c. $45,000 d. $0

c. $45,000 $60x75%x1,000 phones = $45,000 ^ $300x20%=$60 $60x75%=$45 $45x1,000=$45,000

When the contract does not qualify for recognizing revenue over time...

no revenue or cost of construction is recognized until the contract is complete

Overall Loss

projected to occur for the entire project

Core Principle

recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods and services - When: upon transfer to customers - How much: amount the seller is entitled to receive

BE 6-33 Long-term contract; revenue recognition over time; profit recognition A construction company entered into a fixed-price contract to build an office building for $20 million. Construction costs incurred during the first year were $6 million, and estimated costs to complete at the end of the year were $9 million. The company recognizes revenue over time according to percentage of completion. How much revenue and gross profit or loss will appear in the company's income statement in the first year of the contract?

revenue recognized this period = (total est revenue x %completed to date(actual cost/(est + actual cost)) - revenue recognized in prior periods =$20m x ($6m/$15m)<-40% =$8,000,000 rev rec Rev Rev 8,000,000 - cost of construction 6,000,000 = $2,000,000 gross profit

Gross Profit/loss =

sales rev - cost of construction

Periodic loss

that occurs for a project that is projected to be profitable overall