Chapter 5: Revenue Recognition

Donau company sells a video streaming device for $100. A one-year subscription for unlimited video streaming costs $120. Alternatively, customer can rent videos on demand or subscribe to a competing service. On February 1, Robert purchase both the streaming device and signs-up for one year of service. How much revenue should Donau recognize for the month of February?

$110; $100 for the device and $10 for one month of service.

sellers can recognize revenue prior to delivery only if

(a) they conclude that the customer controls the product, (b) there is a good reason for the bill-and-hold arrangement, and (c) the product is specifically identified as belonging to the customer and is ready for shipment

situations affecting the transaction price

(a) variable consideration and the constraint on its recognition, (b) sales with a right of return (a particular type of variable consideration), (c) identifying whether the seller is acting as a principal or an agent, (d) the time value of money, and (e) payments by the seller to the customer.

Distinct Good or Service

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

Five steps to apply revenue recognition

1. identify the contract with a customer. 2. identify the performance obligation(s) in the contract. 3. determine the transaction price 4. Allocate the transaction price to each performance obligation 5. recognize revenue when (or as) each performance obligation is satisfied

Revenue is recognized over time if either

1. the customer consumes the benefit of the seller's work as it is performed 2. the customer controls the asset as it is created 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

What is a key difference in accounting for a long-term contract and for a typical sale?

A long-term contract creates a physical asset in the same period it creates a financial asset.

Estimating variable consideration

A seller estimates variable consideration as either (a) the expected value (calculated as the sum of each possible amount multiplied by its probability), or (b) the most likely amount, depending on which estimation approach better predicts the amount that the seller will receive

which of the following likely will lead to revenue recognition at a point in time?

Buyer has legal title to the asset; Buyer has accepted the asset.

Core Revenue Recognition Principle

Companies 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 or services.

Estimate for refunds journal entry

Debit sales returns; credit refund liability

When can time value of money be ignored?

If delivery and payment occur relatively near each other, the time value of money is not significant and can be ignored. As a practical matter, a seller can assume the time value of money is not significant if the period between delivery and payment is less than a year.

consignment

In these 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.

Principal vs. Agent

Principal - >acts as dealer and transacts business for or from its own inventory >charges a markup/down Agent >it is the broker between the buying and selling parties > charges a commission

(Licenses) Functional Intellectual Property:

Some licenses transfer a right of use to IP that has significant standalone functionality, meaning that it can perform a function or a task, or be played or aired Licenses of functional IP transfer a right of use, so sellers typically recognize revenue at a point in time.

Time Value of Money (TVM)

The idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. We recognize an account receivable when payment occurs after delivery, and we recognize deferred revenue when payment occurs before delivery. In the case of an account receivable, the seller is making a loan to the customer between delivery and payment. In the case of a payment prior to delivery, the customer is making a loan to the seller by paying in advance. As with any other loan, there is an interest charge (a "time value of money") implicit in these arrangements.

Adjusted market assessment approach

The seller considers what it could sell the product or services for in the market in which it normally conducts business, perhaps referencing prices charged by competitors.

Residual Approach

The seller estimates an unknown (or highly uncertain) stand-alone selling price by subtracting the sum of the known or estimated stand-alone selling prices of other goods or services in the contract from the total transaction price of the contract

Expected cost plus margin approach

The seller estimates its costs of satisfying a performance obligation and then adds an appropriate profit margin

TrueTech Coupon Example

TrueTech offers a promotional coupon with every Tri-Box it sells for the normal price of $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, 2018? The coupon provides a material right to the customer, because it provides a discount of $150 × 40% = $60, so it is a performance obligation. Therefore, TrueTech must allocate the $240 transaction price to two performance obligations: the Tri-Box and the coupon. Because TrueTech expects only 80% of the coupons to be used, it estimates the stand-alone selling price of a coupon to be $60 × 80% = $48.* The sum of the stand-alone selling prices of the performance obligations is $288, equal to the Tri-Box module ($240) plus the coupon ($48). The Tri-Box module ($240) represents five-sixths (or 83.33%) of the total ($240 ÷ $288), and the coupon comprises one-sixth (or 16.67%) of the total ($48 ÷ $288), so TrueTech allocates five-sixths of the $240 transaction price to the Tri-Box module and one-sixth to the coupon, as follows: January 1, 2018: Cash 24,000 Sales revenue ($240 × 5/6 × 100 units) 20,000 Deferred revenue—coupons ($240 × 1/6 × 100 units) 4,000 When the coupons are later redeemed or expire, TrueTech will debit deferred revenue—coupons and credit revenue. *It may seem strange that we consider the likelihood that the customer will use the coupon when estimating the coupon's stand-alone selling price, but think about it from TrueTech's perspective. Each coupon saves a customer $60, but on average TrueTech will only have to provide discounts of $48, so $48 is its estimate of the average stand-alone value of its performance obligation.

franchise arrangement

a franchisor grants to the franchisee the right to sell the franchisor's products and use of its name.

allowance for sales returns, that reduces the book value, sometimes called the carrying value or carrying amount, of [ ]

accounts receivable

Licenses ("IP")

allow the customer to use the seller's intellectual property

extended warranties

an additional, extended service that covers new problems arising after the buyer takes control of the product.

contract

an agreement that creates legally enforceable rights and obligations. key is that all parties to the contract are committed to performing their obligations and enforcing their rights.

Construction in progress

asset account equivalent to the asset work-in-progress inventory in a manufacturing company.

For the purpose of allocating the transaction price to multiple performance obligations, the stand-alone selling price of a specific good or service may be estimated if it

cannot be directly observed

In a consignment, the [ ] owns the goods; the [ ] holds the goods in order to sell them to a buyer.

consignor; consignee

sales returns account

contra account that has the effect of reducing revenue

allowance for sales returns

contra account to accounts receivable that reduces the receivables balance for estimated future returns.

Billings on construction contract

contra account to the asset construction in progress; subtracted from construction in progress to determine balance sheet presentation. prevents "double counting" assets by reducing CIP whenever an account receivable is recognized.

Principal

controls goods or services and is responsible for providing them to the customer

Which of the following are included in the journal entry required to record the collection of cash from a costumer related to a long-term construction contract?

debit CIP; debit cash; credit a/r

Agent

doesn't control goods or services, but rather facilitates transfers between sellers and customers.

For the purpose of allocating the transaction price to multiple performance obligations, if a stand-alone selling price cannot be directly observed, the seller should

estimate it.

common note disclosures relating to revenue include:

major product lines; timing of recognition; outstanding performance obligations.

quality-assurance warranties

obligation by the seller to make repairs or replace products that are later demonstrated to be defective for some period of time after the sale.

Revenue is recognized when the [ ] obligation is satisfied

performance

Which of the following are often provided by the franchisor at start-up of a new franchise?

remodeling of a franchisee's facilities; training of franchisee's employees

Symbolic intellectual property

symbolic intellectual property, like trademarks, logos, brand names and franchise rights, has usefulness to the customer that depends on the seller's ongoing activities, so it transfers a right of access for which the seller recognizes revenue over the period of time the customer accesses the IP.

stand-alone selling price

the amount at which the good or service is sold separately under similar circumstances

transaction price

the amount the seller expects to be entitled to receive from the customer in exchange for providing goods and services

Bill-and-Hold Arrangements

transactions where a buyer accepts title and billings but delays the physical receipt of the goods