Intermediate I Exam 3: Chapter 6

performance obligations

contracts between a seller and a customer contain one or more ____ - promises to transfer goods or services to a customer

functional intellectual property

examples of ____: software, drug formulas, and media content like books, music, and movies

symbolic intellectual property

examples of ____: trademarks, logos, brand names, and franchise rights

variable consideration

examples of _____: construction (incentive payments), entertainment and media (royalties), healthcare (medicare and medicaid reimbursements), manufacturing (volume discounts and product returns), telecommunications (rebates)

by the estimated returns

sellers estimate the returns that will result for a given volume of sales, so the seller reduces revenue _____

1. capable of being distinct (can be used on its own or in combo with other goods it could obtain elsewhere) 2. separately identifiable from other goods or services in the contract

a good or service is distinct if it is both:

license

a ___ may not be a separate performance obligation because it's not distinct from other goods provided in the transaction; online service grants a license to customers to access content at a website

1. neither the seller nor the customer has performed any obligations under the contract 2. both the seller and the customer can terminate the contract without penalty

a contract does not exist if:

bill-and-hold

a customer purchase goods but requests that shipment occur at a later date; the customer doesn't have physical possession of the asset until the seller has delivered it; revenue is recognized at delivery

prepayment

collection before delivery

indicators that a significant revenue reversal could occur

1. poor evidence on which ti bare an estimate 2. dependence of the estimate on factors outside the seller's control 3. a history of seller changing payment terms on similar contracts 4. a broad range of outcomes that could occur 5. a long delay before uncertainty resolves

2 options for adopting new revenue recognition principle

1. restate prior years presented in comparative financial statements to appear as if the company had always accounted for revenue under it 2. leave prior financial statements unchanged and in the beginning of the current year, record the adjustment necessary to connect to it

3 problems with previous realization principle

1. revenue recognition poorly tied to FASB's conceptual framework, which emphasizes recognizing assets and liabilities rather than the earnings process. 2. the focus on the earnings process led to similar transactions being treated differently in different industries. 3. difficult to apply to complex arrangements that involved multiple goods or services.

adjusted market assessment approach, expected cost plus margin approach, residual approach

3 methods for estimating stand-alone selling prices

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 (or as) each performance obligation is satisfied

5 steps for revenue recognition

contract asset, a/r

CIP in excess of billings is a ____, not ____

True

T or F: companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in change for those goods and services

true

T or F: for a long-term contract, the bundle is a single performance obligation

True

T or F: if a loss is expected overall, cost of construction is no longer equal to cost incurred during the period; you add the amount of the loss recognized to the amount of revenue recognized. this results in a large overstatement of income in that year and a large understatement over revenue in the next year because of change in estimates off future costs.

True

T or F: if the seller purchase distinct goods or services from the customer at fair value, it's a separate transaction.

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. Revenue recognition occurs upon sale to an end customer in a consignment arrangement

1/8

____ companies participate in LT contracts

sales returns

a portion of sales returned by customers; contra revenue account

collectibility

a seller must believe _____ is probable for a contract to exist for purposes of revenue recognition; this makes sure that revenue really reflects an inflow of net assets from the customer

a contract between a seller and a customer

all revenue recognition starts with _____

completed contract method

all revenue recognized at a single point in time - upon completion of the contract

licenses

allow the customer to access the seller's intellectual property; common in the software, technology, media, and entertainment industries

extended warranty

an additional service that covers new problems arising after a customer takes control of a product; it is a separate performance obligation; recorded as a deferred revenue liability and recognized as revenue over the extended warranty period

contract

an agreement that creates legally enforceable rights and obligations

based on seller's input

another approach to estimating progress toward completion; the proportion of the effort expended thus far relative to the total effort expected ti satisfy the performance obligation; measures include costs incurred, labor hours expanded, machine hours used, or time lapsed

agent

arranges for another company to provide the good or service

contract asset, construction in progress in excess of billings, contract liability, billings in excess if construction in progress

at the end of each period, the balances in CIP and BoCC are compared. if net is a debit, it is a _____ on the BS, _____. of net is a credit, it is a ____ on the BS, _____.

billings on construction contract

contra account to the CIP asset

contract liability

billings in excess of CIP is treated as a _____

cost-to-cost ratio

compares total cost incurred to date to the total estimated cost to complete the project; sellers must exclude costs that don't affect progress toward completion

input/output methods

can be used to estimate progress toward completion when performance obligations are satisfied over time

receivable

collection after delivery

oral, implicit

contracts can be _____ and _____ based on the typical business practices that a company follows; all parties to the contract are committed to performing their obligations and enforcing their rights

principal

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

revenue recognition

criteria help ensure that an income statement reflects the actual accomplishments of a company for the period

agent

doesn't control goods or services but neither facilitates transfers between sellers and customers; receives a commission for helping sellers provide goods and services to buyers

delivery

equal to the cash price of the good or service

1. if the seller has primary responsibility for providing a product or service that the customer finds acceptable 2. if the seller has discretion in setting prices 3. if the seller is vulnerable to risks associated with holding inventory or having inventory returned to it

for a principal, control is indicated if:

1. they conclude that the customer controls the product 2. there is good reason for bill-and-hold 3. the product is identified as belonging to the customer and is ready for shipment

for bill-and-hold, sellers can recognize revenue prior to delivery only if:

(total estimated revenue x percent completed to date) - revenue recognized in prior periods

formula for revenue recognized this period

the seller is expected ti change the functionality over the license period and the customer is required to use the updated version

functional IP can require revenue recognition over time when ____; an example is virus protection software

debited, credited

gross profit is ____ to CIP and gross loss is ____ to CIP

equal to any nonrefundable payments it has received

if a contract doesn't exist, the seller can still recognize an amount of revenue ______, so long as the seller has transferred control of the goods or services and doesn't have any further obligations to transfer goods or services to the customer

when the option is exercised or expires

if additional goods are performance obligations, when is revenue recognized?

contract assets

if it has an unconditional right to receive payment after satisfying a performance obligation

accounts receivable

if it has an unconditional right to receive payment after satisfying a performance obligation; seller has satisfied all performance obligations and is just waiting to be paid

contract liabilities

if it received payment prior to satisfying a performance obligation; deferred revenue is an example

principal, agent

if more than one company is involved in providing goods and services to a customer, there is a ___ and an ____

the warranty should be treated as an extended warranty

if one of the two: 1. the customer has the option to purchase the warranty separately from the seller 2. the warranty provides a service to the customer beyond only assuring that the seller delivered a product or service that was free from defects

most likely amount

if only two outcomes are possible, the best indication

costs and GP, costs

if revenue is recognized over the term, CIP contains ____. If revenue is recognized upon completion, CIP contains ____.

at the point in time when the performance obligation has been completely satisfied, usually at the end

if the performance obligation doesn't meet any of the three criteria, recognize revenue ______

update the transaction price in the current period

if the seller changes his mind on whether a constraint is needed, ______

refund

if the seller pays more for the goods than fair value, the excess payments are viewed as a ___, subtracted from the amount the seller is entitled to receive when calculating transaction price

delivery, financing

if the time value of money is significant, a contract is viewed as including ____ and ____ components

in the period that it becomes evident

if there is a loss on the entire project, it must be recognized ____; this is still treated as a change in accounting estimate

at the time of the sale, as they occur during the period, at the end of the period

in actuality, sellers record sales revenue ______, record sales returns____, and account for additional estimated returns _____ (as a refund liability); the seller might postpone recognizing any revenue until the uncertainty about returns is resolved

income statement disclosures

include bad debt expense and any interest revenue or interest expense associated with significant financing components of long-term contracts

financing

interest considered paid to the customer (prepayment) or to the seller (receivable)

debit cost of construction, credit revenue from LT contracts, credit CIP

journal entry for loss in one period (LT Contracts)

debit CIP, debit cost of construction, credit revenue from LT Contracts

journal entry for recognizing revenue (LT Contracts)

debit a/r, credit sales, debit cash, credit a/r

journal entry for revenue recognition at a single point in time

debit cash, credit deferred revenue, debit deferred revenue, credit service revenue

journal entry for revenue recognition over a period of time

debit billings on construction contract, credit CIP

journal entry to close out billings and CIP accounts

debit cash, credit a/r

journal entry to record cash collections

debit construction in progress, credit cash, materials, etc

journal entry to record construction costs

debit a/r, credit billings on construction contract

journal entry to record progress billings

over time

more long-term contracts qualify for revenue recognition _____

over time

most long-term construction contracts qualify for revenue recognition _____

prepayments

not a performance obligation; nonrefundable upfront fees for particular activities; it is allocated to the various performance obligations in the contract, initially recorded as deferred revenue and recognized when (or as) each performance obligation is satisfied

right of return

not a performance obligation; right to return merchandise if customers decide they don't want it, aren't satisfied with it, or are unable to resell it; it's a potential failure to satisfy the original performance obligation to provide gooses that the customer wants to keep; a form of variable consideration

quality-assurance warranty

obligates the seller to repair or replace defective products; not a performance obligation; it is a cost of satisfying the performance obligation; it is recognized as a warranty expense and related contingent liability; the exact cost is not known at the time of sale, so it is estimated

output-based measures

one approach to estimating progress toward completion (number of units produced/delivered, achievement of milestones, surveys on appraisals of performance completed to date); a shortcoming is that they may provide a distorted view of actual progress to date. info may also be costly to obtain

material right

options for additional goods and services are considered performance obligations if they provide a ______ to the customer that the customer would not receive otherwise; we must estimate the stand-alone selling price of the option and take into account the likelihood that the customer will exercise the option

transfers control of goods/services over to the customer

performance obligations are satisfied when the seller ______

examples of disclosure notes

product lines, geographic areas, types of customers, types of contracts

distinct, stand-alone basis

promises to provide goods and services are performance obligations when the goods and services are ____. we separate contracts into parts that can be viewed on a _____

principal

provides the good/service to the customer

gift cards

recognized as deferred revenue

percentage of completion method

recognized revenue in each year of the contract according to the progress toward completion that occurred during that year

agent

records as revenue only the commission it receives

principal

records revenue equal to the total sales price paid by customers as well as cost of goods

previous realization principle

required that we recognize revenue when both the earnings process is virtually complete and there is reasonable certainty as to the collectibility of the assets to be received in exchange for goods and services

in proportion

revenue his recognized _____ to the amount of the performance obligation that has been satisfied

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 alternate use to the seller, and the seller has the legal right to receive payment for progress to date

revenue is recognized over time if either:

when (or as) the performance obligation is satisfied

revenue with respect to each performance obligation is recognized _____; the timing for each is determined individually

contract modifications

seller and customer agree to modify a contract in some way, such as changing the transaction price, changing the performance obligations, or adding another performance obligation

adjusted market assessment approach

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

expected cost plus margin approach

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

balance sheet disclosures

seller reports contract liabilities and contract assets in separate lines

will not

sellers are limited to recognizing variable consideration to the extent that it is probable that a significant revenue reversal ___ occur in the future

the period between delivery and payment is less than a year

sellers can assume the financing component is not significant if ____

constraint on variable consideration

sellers lack sufficient information to make a good estimate of ____; a seller might overestimate ___, recognize revenue based on a transaction price that is too high, a later have to reverse that revenue to correct the estimate; sellers only include an estimate of ____ in the transaction price to the extent it is probable that a significant reversal of revenue recognized to date will not occur when the uncertainty associated with the ____ is resolved in the future

disclosure notes

sellers must separate this revenue into categories that help investors understand their nature, amount, timing, and uncertainty of revenue and cash flows; detailed disclosures about revenue; include amounts that were previously deferred revenue and changes in transaction prices; explain significant changes in contract assets and liabilities that occurred; the objective is to help users of financial statements understated the revenue and cash flows arising from contracts with customers; the downside is the sellers are providing information to competitors, suppliers, and customers

income statement

sellers report net sales revenue in the ____, equal to gross sales revenue less actual and estimated returns

lending money, performing audits, providing consulting advice

services performed over a period of time include

warranties

sold with a product and obligates the seller to make repairs or replace products that are found to be defective or unsatisfactory; not sold separately and can be stated explicitly or implicitly based on normal business practice

stand-alone selling price

the amount at which the good or service is sold separately under similar circumstances; if not directly observed, should be estimated

transaction price

the amount the seller expects to be entitled to receive form the customer in exchange for providing goods or services

transaction price

the amount the seller expects to be entitled to receive from the customer

construction in progress

the contractor's WIP, inventory

lends, borrows

the customer ___ money to the seller in the prepayment case and gets compensation for TVM; the customer ____ money from the seller in the receivable case and is having to pay compensation for TVM

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

the customer is more likely to control a good/service the customer has:

the amount of revenue that a company can record

the distinction between a principal and an agent is important because it affects ____

1. if the customer would pay a substantially different amount if it paid cash at the time the good or service was delivered 2. more like as the time between delivery and payment increases or if the interest note (implicit) is large

the financing component is significant if:

franchises

the franchisor grants to the franchisee a right to sell the franchisor's products and use its name for a specified period of time; franchisor provides startup services and ongoing products and services; involves a license to use the franchisor's IP and initial sale of products/services and ongoing sales of products/services; franchisor evaluates each part of the franchise arrangement to identify the performance obligation

revenue, cost of construction, and gross profit

the income statement includes:

revenue

the inflow of cash or A/R that a business receives when it provides goods or services to its customers; single largest number reported in the financial statements

construction costs

the labor, materials, and overhead costs directly related to the construction of the building

variable consideration

the portion of a transaction price that depends on the outcome of future events

transferring the good/service

the seller recognizes revenue when it satisfies a performance obligation by _____

expected value

the sum of each possible amount multiplied by its probability; if many outcomes are possible, the best

symbolic intellectual property

transfer a right of access, so sellers recognize revenue over time; there is no significant stand-alone functionality; the seller will undertake ongoing activities during the license period that benefit the customer; the seller can make changes to the IP, or could perform marketing or other activities that affect the value of the license to the customer

functional intellectual property

transfer a right of use, so sellers typically recognize revenue at a point in time; has significant stand-alone functionality, meaning that it can perform a function or task, or be played over various types of media; the benefit the customer receives isn't affected by the sellers ongoing activity

control

transfer occurs when the customer has ____ of the good/service; ___ means that the customer has direct influence over the use of the good/service and obtain its benefits

cost revisions

typical because costs are estimated over long periods of time

residual approach

used to estimate a stand-alone selling price that is very uncertain, by subtracting the sum of the known or estimated stand-alone selling prices of other goods in the contract from the total transaction price if the contract

expected value, most likely amount

variable consideration is estimated as either the ____ or the ___

relative stand-alone selling prices

we allocate the transaction price to performance obligations in proportion to their ____

after delivery

we recognize an a/r when payment occurs ___; the seller can be viewed as making a loan to the customer between delivery and payment

before delivery

we recognize deferred revenue if payment occurs _____; the customer can be viewed as making a loan to the seller by paying in advance

allocate the transaction price to each and recognize revenue as each is satisfied

when there are multiple performance obligations, you have to _____