Chapter 18

Warranties

Two types of warranties to customers: 1. Product meets agreed-upon specifications in contract at time product is sold. Warranty is included in sales price (assurance-type warranty). 2. Not included in sales price of product (service-type warranty). Recorded as a separate performance obligation.

Recognize revenue from bill and hold arrangement

(a) The reason for the bill-and-hold arrangement must be substantive. (b) The product must be identified separately as belonging to customer. (c) The product currently must be ready for physical transfer to customer. (d) Company cannot have the ability to use the product or to direct it to another customer.

Change in Control Indicators

1. Company has a right to payment for asset. 2. Company has transferred legal title to asset. 3. Company has transferred physical possession of asset. 4. Customer has significant risks and rewards of ownership. 5. Customer has accepted the asset.

5 step process for revenue recognition

1. Identify the contract with customers 2. Identify the separate performance obligations in the contract 3. Determine the transaction price 4. Allocate the transaction price to the separate performance obligations 5. Recognize revenue when each performance obligation is satisfied

Apply revenue guidance to a contract when

1. The contract has commercial substance. 2. The parties have approved the contract 3. Identification of the rights of the parties is established 4. Payment terms are identified 5. It is probable that the consideration will be collected

Revenue recognition over time

A company satisfies a performance obligation and recognizes revenue over time if at least one of the following three criteria is met: 1. The customer simultaneously receives and consumes the benefits of the seller's performance as the seller performs. 2. The company's performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced 3. The company's performance does not create an asset with an alternative use.

Separate Performance Obligation

Accounts for as a new contract if both of the following conditions are satisfied: Promised goods or services are distinct (i.e., company sells them separately and they are not interdependent with other goods and services) The company has the right to receive an amount of consideration that reflects the standalone selling price of the promised goods or services.

Principle-Agent Relationships

Agent's performance obligation is to arrange for principal to provide goods or services to a customer. Amounts collected on behalf of the principal are not revenue of the agent. Revenue for agent is amount of commission received. Priceline (agent) facilitates sale of various services such as car rentals at Hertz (principal).

Transaction price

Amount of consideration that company expects to receive from a customer. In a contract is often easily determined because customer agrees to pay a fixed amount. Other contracts, companies must consider: Variable consideration Time value of money Noncash consideration Consideration paid or payable to the customer

Allocating Transaction Price to Separate Performance Obligations

Based on their relative fair values. Best measure of fair value is what the company could sell the good or service for on a standalone basis. If not available, companies should use their best estimate of what the good or service might sell for as a standalone unit.

Contract Modifications

Change in contract terms while it is ongoing. Companies determine whether a new contract (and performance obligations) results or whether it is a modification of the existing contract.

Disclosure

Companies disclose qualitative and quantitative information about the following: Contracts with customers. Significant judgments. Assets recognized from costs incurred to fulfill a contract.

Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied

Company satisfies its performance obligation when the customer obtains control of the good or service.

Prospective Modification

Company should: Account for effect of change in period of change as well as future periods if change affects both. Not change previously reported results.

Bill-and-Hold Arrangements

Contract under which an entity bills a customer for a product but the entity retains physical possession of the product until a point in time in the future. Result when buyer is not yet ready to take delivery but does take title and accepts billing.

Distinct

Customer can benefit from a good or service on its own or with other readily available resources.

Noncash Consideration

Goods, services, or other noncash consideration. Companies sometimes receive contributions (e.g., donations and gifts). Customers sometimes contribute goods or services, such as equipment or labor, as consideration for goods provided or services performed. Companies generally recognize revenue on the basis of the fair value of what is received.

Consignments

Manufacturers (or wholesalers) deliver goods but retain title to the goods until they are sold. Consignor makes a profit on the sale. Carries merchandise as inventory. Consignee makes a commission on the sale

Consideration Paid or Payable to Customers

May include discounts, volume rebates, coupons, free products, or services. In general, these elements reduce the consideration received and the revenue to be recognized.

Recognizing revenue from a performance obligation over time

Measure progress toward completion Method for measuring progress should depict transfer of control from company to customer. Objective of methods is to measure extent of progress in terms of costs, units, or value added.

Variable Consideration allocation

Only allocate variable consideration if it is reasonably assured that it will be entitled to the amount. Companies only recognizes variable consideration if 1. they have experience with similar contracts and are able to estimate the cumulative amount of revenue, and 2. based on experience, they do not expect a significant reversal of revenue previously recognized. If these criteria are not met, revenue recognition is constrained (i.e. Be conservative and wait till deliverables are met to recognize the "upside" of variable consideration).

Nonrefundable Upfront Fees

Payments from customers before delivery of a product or performance of a service Generally relate to initiation, activation, or setup of a good or service to be provided or performed in the future. Most cases, upfront payments are nonrefundable. Examples include: Membership fee in a health club Activation fees for phone, Internet, or cable

Loss in Current Period on a Profitable Contract

Percentage-of-completion method only, the estimated cost increase requires a current-period adjustment of gross profit recognized in prior periods.

Variable Consideration

Price dependent on future events. Might include discounts, rebates, credits, performance bonuses, or royalties. Companies estimate amount of revenue to recognize. Expected value Most likely amount

Expected Value

Probability-weighted amount in a range of possible consideration amounts May be appropriate if a company has a large number of contracts with similar characteristics. Can be based on a limited number of discrete outcomes and probabilities.

Performance obligation

Promise to provide a distinct product or service to a customer The objective is to determine whether the nature of a company's promise is to transfer individual goods and services to the customer or to transfer a combined item (or items) for which individual goods or services are inputs.

Completed-Contract Method

Recognize revenues and gross profit only when the contract is completed Under this method, companies accumulate costs of long-term contracts in process, but they make no interim charges or credits to income statement accounts for revenues, costs, or gross profit

Percentage-of-Completion Method

Recognize revenues and gross profits each period based upon the progress of the construction Buyer and seller have enforceable rights

New Revenue Recognition Standard

Revenue from Contracts with Customers adopts an asset-liability approach. Companies: Account for revenue based on the asset or liability arising from contracts with customers. Are required to analyze contracts with customers Contracts indicate terms and measurement of consideration. Without contracts, companies cannot know whether promises will be met.

Sales Returns and Allowances

Right of return is granted for product for various reasons (e.g., dissatisfaction with product). Company returning the product receives any combination of the following. 1. Full or partial refund of any consideration paid. 2. Credit that can be applied against amounts owed, or that will be owed, to the seller. 3. Another product in exchange.

Accounting for revenue recognition issues

Sales returns and allowances Repurchase agreements Bill and hold Principal-agent relationships Consignments Warranties Nonrefundable upfront fees

Most Likely Amount

The single most likely amount in a range of possible consideration outcomes. May be appropriate if the contract has only two possible outcomes.

Loss on an Unprofitable Contract

Under both percentage-of-completion and completed-contract methods, the company must recognize in the current period the entire expected contract loss.

Time Value of Money

When contract (sales transaction) involves a significant financing component. Interest accrued on consideration to be paid over time. Fair value determined either by measuring the consideration received or by discounting the payment using an imputed interest rate. Company reports as interest expense or interest revenue. Companies are not required to reflect the time value of money if the time period for payment is less than a year.