Chapter 2 - Revenue Recognition
Core revenue recognition principle costs of 2 components
*Revenue is to be recognized upon the transfer of promised goods and services to customers; and *The amount of revenue recognized represents the consideration the entity expects to receive in exchange for those goods and services
Completed Contract Method
*Revenues recognized at a point in time - when construction is complete No profit/revenues entries made until completion *Costs incurred are held in CIP account (B/S) until completion
Percentage-of-Completion Method
*Revenues recognized over time - as construction is completed *Appropriate portion of total revenue expected from the contract is recorded at end of each period (I/S) *Billings and collections are recorded in B/S accounts *Costs charged against income in proportion to revenues recognized during period *anticipated losses recognized immediately (I/S) *Measuring progress - output method or input method
Distinct performance obligation
*The customer must be able to benefit from the good or services on its own or together using other resources that are readily available to the customer; and *The promise to transfer the good or services is separately identified from other promises in the contract If "distinct" criteria are not met, then combine with other promised goods/services until bundle is distinct.
#1 Identify contracts with customers
-MUST be determined that the counterparty to the transaction, which is for the provision of goods or services in the seller's ordinary course of business, is a customer. -MUST be legally binding contract. Does not have to be signed If either party can terminate the arrangement without penalty, it is not considered a contract Collection MUST be probable If they do not meet criteria of a contract - revenue received is recognized as a LIABILITY such as deferred or unearned revenue (until all consideration has been received or contract terminated and consideration received is nonrefundable)
LT project on income statement
-Revenues earned to date (total contract price x % complete) - revenues prev reported -Cost of sales equal to costs (not profits) added to CIP during the current period
Revenues are recognized by applying a 5 step process
1) Identify contracts with customers - determine when an arrangement is considered a contract with customers and determine when multiple contracts with the same customer should be combined and accounted for as a single contract 2) Identify all separate performance obligations within each contract 3) Determine the total consideration for the contract 4) Allocate the total consideration among the separate performance obligations 5) Recognize revenue, either: -When the entity HAS satisfied its performance obligations, which is generally associated with revenues resulting from delivering products, or -While the entity IS satisifying its performance obligations, which is generally associated with revenues resulting from providing serivces
"Constraint" on variable consideration
A constraint is the amount of variable consideration that can be recognized. the constraint is designed to prevent an entity from recognizing revenues in one period only to be required to reverse it in a subsequent period. In applying the constraint, the entity should consider the likelihood and the magnitude of a potential reversal variable consideration is required to be reassessed each period such that the transaction price at the end of any given period reflects the circumstances at that time.
Modification - When is a new, separate contract needed
A contract modification is considered a new, separate contract when the modification calls for an increase in the scope of the contract involving additional distinct goods and services and there is an increase in the contract price that is reflective of the additional goods and services. A modification of this sort is accounted for by applying the 5-step process.
Modification - cancellation of existing contract with a new
A contract modification is treated as a cancellation of the existing contract accompanied by a new contract when the performance obligations that remain unsatisfied are distinct from those that have been satisfied up through the date of modification. When this is the case, total consideration for the new contract will equal to: -The remainder of the consideration from the original contract that has not yet been recognized, plus -Any additional consideration resulting from the modification
When a customer has control
A customer HAS CONTROL over goods and services when the customer has - the ability to direct the use of the goods and services, - can prevent others from benefiting from them, and - can obtain benefits from the goods or services in the form of cash flows when control is uncertain, other factors indicate customer has control: - legal title to goods - physical - significant risks and rights associated with ownership of the goods - accepted the goods
Consideration Paid to a customer
A seller may make a payment to a customer in cash or in the form of a credit, or coupon or voucher. It may also be paid to another party purchasing the entity's goods or services from the customer, such as in the form of a rebate.
Collectibility of Receivables is Uncertain
Accounts Receivable (A/R) Cash Sales Revenue Cost of Goods Sold Inventory Credit Loss expense* Allowance for credit losses* *These amounts may also be referred to as bad debt expense and allowance for doubtful accounts A/R less the allowance for credit losses is the amount expected to be collected, or Net Realizable Value (NRV) Only amounts the entity expects to be entitled to for the transfer of goods/services must be collectible in order for those amounts to be recognized as revenue
Performance Obligation
An enforceable promise to transfer goods or services to a customer. An activity that does not result in the transfer of goods or services to a customer is NOT a performance obligation.
Recognition of revenues over time
Any of the following 3 circumstances will indicate that a performance obligation is being satisfied over time and as a result will be recognized while the performance obligation is being satisfied. 1) the customer consumes the goods or services as they are being delivered 2) the customer has control over the asset as they are being delivered 3) the entity as no alternative use for the goods or services and is entitled to payment for performance completed to date
LT project on balance sheet
Billings and CIP are netted on the B/S -current contract asset: CIP in excess of billings -current liability: billings in excess of CIP
% of completion JE
Billings: Construction receivable Billings Collections: Cash Construction receivable Recognize profit CIP Gross profit on CIP OR CIP Construction expense Construction revenue
When collection is not probable
Cash Unearned (deferred) revenue Cost of goods sold Inventory *All receipts from the customer for the goods/services that are the subject of the arrangement are reported as a liability *the liability represents the entity's obligation to provide such goods/services or to refund the consideration received When able to book revenue: Unearned revenue Revenue
Option to Purchase Additional Goods or Services
Contract with a customer to purchase additional goods or services at a discount. Does NOT apply if the discount may be comparable to a discount that is available to a wide range of individuals and noncustomers because the customers making the purchase are not receiving anything of value. When a discount exceeds what is available to noncustomers, the customer is receiving something of value and both the goods sold and the discount represent distinct performance obligations. As a result, the gross sales price will be allocated between the sales of the merchandise in the current period and the discount on future purchases. Recognize sales on item now and sales on discount when co. estimates the discounts will be used.
Combining contracts
Contracts should be combined if one or more of the following criteria are met: -Contracts negotiated as a single package with a single commercial objective; -Amount of consideration to be paid in one contract depends on the price or performance of the other contracts (multiple deliverables) -Goods or services promised in the contracts are a single performance obligation
Discounts
Equal to difference between total of standalone sales prices and total consideration, allocated proportionately among performance obligations. May be allocated to some but not all performance obligations when 4 criteria apply: 1) Each distinct good or service in the contract is also sold as a standalone good or service on a regular basis; 2) Some distinct good or service in the contract is also sold as a standalone good or service on a regular basis; 3) The discount on the contract is comparable to the discount on the distinct goods and services sold in a bundle as a discount; and 4) If allocated to some, but not all performance obligations, the residual approach is not applied until after the discounts have been allocated
Onerous Performance Obligation
Expected cost of satisfying a performance obligation is greater than the amount of revenue allocated to that performance obligation, that performance obligation will incur a loss and it is referred to as an onerous performance obligation and the loss will be reported on the F/S and the loss is reported immediately
Service-type warranty
Generally provides a customer with repairs in the form of parts and labor in addition to making certain that the product performs as was promised. **Separately identifiable promise in a contract; and **It is a distinct performance obligation **Sales revenue allocated to each obligation based on their relative standalone prices Warranty revenue is recognized over term of warranty
Sales with Right of Return
Goods may be sold under terms that allow the customer to return the goods for a refund. When that is the case, the entity recognized revenue in amount equal to the portion that is expected to be retained by the entity -Estimated amount of returns recognized as refund liability -Asset recognized based on right to recover goods from the customer
Percentage of completion gross profit
Gross profit is added to CIP 1) total contract price - total construction costs = total estimated profits 2) Costs incurred to date / total construction costs = % complete 3) total estimated profit x % complete = Gross profit to date 4) GP to date - GP to date at end of last period = GP in current period
Multiple element arrangement
If a bundle of goods is sold at a discount and is also included in a bigger bundle with a discount that exceeds the one on the smaller bundle, the discounts are allocated on a step basis 1) First, the discount that applies to the smaller bundle will be allocated among the items in that bundle 2) Next, the remaining discount is allocated among all items using the standalone sales prices for those items that were not included in the small bundle and using the standalone sales prices minus the discount already allocated to the items in the small bundle
Input method
Measuring progress toward completion of a performance obligation is the effort put forth by the entity, including amounts spent on raw materials that will be used in deriving a meaningful measurement. -Resources consumed -Labor hours expended -Costs incurred -Time elapsed -Machine hours used
Output method
Measuring progress toward satisfaction of the performance obligation is the value the customer can or does derive from the goods or services that have been transferred to the customer up to that point -Surveys of work completed -Appraisals of results achieved -Milestones reached -Time elapsed or -Units produced or delivered
If there is no observable price - how to estimate standalone price
Must estimate the standalone selling price using one of the following: Measured as of date of the inception of the contract May be estimated if not known, using one of 1) Adjusted market assessment approach -evaluate the market, see what a customer might be willing to pay or also look at competitors 2) Expected cash plus a margin approach -forecast expected cost and add an appropriate profit margin for that good or service 3) May only use residual value method approach if either (PLUG): - Some goods or services are sold for different amounts to different customers - The goods or services not previously been sold as a standalone product or service and a price has not been yet set
Noncash consideration
Noncash consideration is measures at fair vaue -When the FV is not determinable, it will be measured by reference to the standalone selling price of goods or services exchanged -Resources contributed by the customer to assist the entity in satisfying a performance obligation is accounted for as noncash consideration if the entity obtains control
Standalone selling price
Price the entity sells a good or service for separately in comparable transaction. If they sell it separately, we have an observable price, so we can use that price as the best evidence of the standalone price
Licensing - right to use intellectual property
Property is functional as is and that the licensor does not have any obligation to maintain the property. Revenue is recognized in the period in which it is made available
Licensing - access to intellectual property
Property is more symbolic than functional. Licensor has an obligation to support or maintain the intellectual property, which the customer will have access to over a period of time. Revenue is recognized over the term of the license
Assurance-type warranty
Protects the customer from obtaining a product that is not capable of performing at the level that the seller indicated that it would. Warranties generally only from the seller. These warranties represents a contingent liability that is probable and estimable and should be accrued in the period incurred, generally the period of sale Cash (or A/R) Sales Revenue Cost of Sales Inventory Warranty Expense Estimated warranty liability
Nonrefundable Upfront fees
Received by the entity are ONLY recognized in income if they are in exchange for the satisfaction of a performance obligation, indicating that the customer received something of value in exchange *If nothing is exchanged at time of upfront fee: Considered part of total consideration for the contract and is allocated among distinct performance obligations with other consideration
Variable consideration
Result from discounts or rebates provided to buyers; credits, price concessions, or incentives; performance bonuses; or penalties. May also result from contingencies such as an exchange of resources that will be made based on the occurrence or nonoccurence of a future event, or a performance bonus based on achieving a milestone.
Recognizing Revenue as Performance obligations are satisfied
Revenue is recognized when a performance obligation IS satisfied or, in some circumstances, while it is being satisfied. A performance obligation is considered satisfied when the entity as transferred the promised goods or services to the customer, which occurs when the customer has CONTROL of those goods or services
Allocation of Variable consideration
VC may relate to one or more distinct performance obligations in a contract without relating to them all, or one or more goods or services called for within a distinct performance obligation without relating to them all. Generally required to be allocated to all performance obligations on the same basis as the allocation of other consideration. May be allocated to specific performance obligations or specific goods or services if 2 criteria apply: 1) Variable payment must be associated with efforts/outcomes to satisfy a specific performance obligation or to deliver a distinct good or service 2) Allocation of entire amount of VC is consistent with objectives of revenue recognition standard
Amount recognized by principal
When the seller is a principal in the transaction, the entire amount of revenue will be recognized and amounts paid to 3rd parties will be recognized as expenses or as component of cost of sales.
Amount recognized by agent
When the seller is an agent, only the net amount, which is the amount of revenue to be retained after paying the principal, is recognized. -A principal has the obligation to provide goods or services -An agent has the obligation to arrange for another party, the principal, to provide goods and services **Principal controls goods or services before the transfer and may either satisfy the performance obligation or may engage another to do so
Transaction price
the amount of consideration that the entity expects to be entitled to in exchange for transferring goods or services in a satisfactory manner, excluding amounts to be collected on behalf of others, such as sales taxes.