Intermediate Accounting: Revenue Recognition

As progress is made toward completion of the contract. Two methods are used for revenue and gross profit recognition over time for long-term construction-type contracts. The entity measures the progress toward complete satisfaction of each performance obligation using the output method or the input method. The input method recognizes revenue on the basis of (1) the entity's inputs to the satisfaction of the performance obligation relative to (2) the total expected inputs to the satisfaction of that performance obligation. In long-term construction contracts, costs incurred relative to total estimated costs often are used to measure the progress toward completion. This method is the cost-to-cost method. The output method recognizes revenue based on direct measurement of (1) the value of goods or services transferred to the customer to date relative to (2) the remaining goods or services promised under the contract. An entity may have a right to consideration from a customer in an amount corresponding directly with the value to the customer of performance to date. Using a practical expedient, revenue may be recognized at the amounts to which the entity has a right to invoice the customer.

A building contractor has a contract to construct a large building. It is estimated that the building will take 2 years to complete. Progress billings will be sent to the customer at quarterly intervals. Which of the following describes the preferable point for revenue and gross profit recognition for this contract?

As progress is made toward completion of the contract. An entity must recognize revenue when (or as) it satisfies each performance obligation in the contract by transferring the promised good or service to a customer. Because the customer controls the building as it is constructed, the contract meets the criteria for recognition of revenue over time. Thus, the contractor must recognize revenue as progress is made toward completion of the contract.

A building contractor has a fixed-price contract to construct a building on the customer's land. The building is expected to be completed in 2 years. Progress billings will be sent to the customer at quarterly intervals. Which of the following describes the preferable point for revenue recognition for this contract if its outcome can be reasonably measured?

Gross Profit Previously Recognized - Yes Amounts Billed to Date - No The cost-to-cost method provides for the recognition of gross profit based on the relationship between the costs incurred to date and estimated total costs for the completion of the contract. The amount of gross profit (based on the latest available estimated costs) recognized in the second year of a 4-year contract is calculated as follows: The total anticipated gross profit is multiplied by the ratio of the costs incurred to date to the total estimated costs, and the product is reduced by previously recognized gross profit. Gross profit previously recognized is therefore used to calculate gross profit to be recognized in the second year. However, amounts billed to date have no effect on the amount of gross profit to be recognized in the second year.

A company used the input method based on costs incurred to measure the progress toward completion of a 4-year construction contract. Which of the following items should be used to calculate the gross profit recognized in the second year?

Directly observable prices. After separate performance obligations are identified and the transaction price is determined, the transaction price is allocated to performance obligations in the contract based on their standalone selling prices. The standalone selling price is the price at which an entity would sell a promised good or service separately to a customer. The best evidence of a standalone selling price is the observable price of a good or service when it is sold separately in similar circumstances and to similar customers (e.g., a contractually stated price or list price of a good or service).

A contract with a customer has more than one performance obligation. The transaction price most likely is allocated to the performance obligations based on

Loss recognition. The patent was amortized in a systematic and rational manner. When it was determined that the costs associated with the patent (recorded as an asset) no longer provided future economic benefits, the remaining unamortized costs were written off. That is, the loss was recognized immediately.

A patent, purchased in Year 1 and amortized over a 15-year life, was determined to be worthless in Year 6. The write-off of the asset in Year 6 is an application of which of the following principles?

Obtains control of the asset Revenue is recognized when a performance obligation is satisfied by transferring a promised good or service to a customer. It happens when the customer obtains control of the good or service (i.e., an asset). Control of an asset is transferred to the customer when the customer (1) has the ability to direct the use of the asset and (2) obtains substantially all of the remaining benefits (potential cash flows) from the asset.

A promised asset is transferred in full satisfaction of a performance obligation in a contract when the customer

Three performance obligations: (1) Software license, (2) installation services, and (3) technical support services. The transfer of the software license and the performance of installation services are separately identifiable from other promises in the contract. The installation services do not significantly modify or customize the software itself. In addition, on the basis of the entity's customary business practice, at contract inception, it made an implicit promise to provide technical support services. The entity's past practice of providing these services creates a valid expectation that the customer will receive these services. Consequently, the entity identifies the following performance obligations in the contract: (1) software license, (2) installation services, and (3) technical support services.

A software developer enters into a contract with a new customer to sell a software license and perform installation services. The entity sometimes sells the license and installation services separately. The installation service is routinely performed by other entities and does not significantly modify the software. The entity historically provided to new customers technical support for a 5-year period for no additional consideration. The contract does not specify the terms or conditions for the technical support services. Under ASC 606, which of the following represents the performance obligations identified by the entity in this contract?

Current replacement cost. Replacement (current) cost is the amount of cash that would have to be paid for a current acquisition of the same or an equivalent asset.

According to the FASB's conceptual framework, certain assets are reported in financial statements at the amount of cash or its equivalent that would have to be paid if the same or equivalent assets were acquired currently. What is the name of the reporting concept?

Decision usefulness. An item and information about the item should be recognized when the following four fundamental recognition criteria are met: (1) The item meets the definition of an element of financial statements; (2) it has a relevant attribute measurable with sufficient reliability; (3) the information about the item is capable of making a difference in user decisions; and (4) the information is representationally faithful, verifiable, and neutral. Decision usefulness is the objective of general-purpose financial reporting.

According to the FASB's conceptual framework, recognition is the process of formally incorporating an element into the financial statements of an entity. Recognition criteria include all of the following except

$200,000 As soon as an estimated loss on any project becomes apparent, it must be recognized in full. The total of the costs incurred in Year 1 plus estimated costs to complete is $6,200,000 ($1,860,000 + $4,340,000). Because this sum exceeds the $6 million fixed-price construction contract amount, a $200,000 loss should be recognized.

Ailouros Construction, Inc., has consistently used the input method based on costs incurred to measure the progress toward completion of a project. During Year 1, Ailouros started work on a $6 million fixed-price construction contract. The accounting records disclosed the following data for the year ended December 31, Year 1: Costs incurred $1,860,000 Estimated costs to complete 4,340,000 Accounts receivable 600,000 Collections 1,400,000 How much loss should Ailouros have recognized in Year 1?

Only to the extent of the costs incurred. When the outcome of the contract is not reasonably measurable but the costs incurred in satisfying the performance obligation are expected to be recovered, revenue must be recognized only to the extent of the costs incurred. Revenue recognized is based on a zero profit margin until the entity can reasonably measure the outcome of the performance obligation.

An entity entered into a contract to construct a building. Based on the contract's terms, the entity appropriately determined that the performance obligation in the contract will be satisfied over time. At an early stage of the contract, the entity cannot reasonably measure the outcome of the contract, but it expects to recover the costs incurred in the construction of the building. The revenue from the contract should be recognized

A zero profit margin. When the outcome of the contract is not reasonably measurable but the costs incurred in satisfying the performance obligation are expected to be recovered, revenue must be recognized only to the extent of the costs incurred. Revenue recognized is based on a zero profit margin until the entity can reasonably measure the outcome of the performance obligation.

An entity recognizes revenue from a long-term contract over time. However, early in the performance of the contract, it cannot reasonably measure the outcome, but it expects to recover the costs incurred. Revenue should be recognized based on

Matching. Matching credit loss expense with related revenues is an application of the matching principle. Matching is synonymous with associating cause and effect. It is based on a direct relationship between the expense and the revenue.

Ande Co. estimates credit loss expense on uncollectible accounts using the ratio of past actual losses from uncollectible accounts to past net credit sales, adjusted for anticipated conditions. The practice follows the accounting concept of

Expensed in the period in which the related revenue is recognized. The expense recognition principle of associating cause and effect (matching) applies when a direct cause-and-effect relationship can be demonstrated between costs and particular revenues. A typical example of expenses recognized by the association of cause and effect is cost of goods sold that is recognized in the periods in which the related revenue is recognized. Association of costs with revenues also can be applied to services. Association of costs with specific products is not necessary.

Costs that can be reasonably associated with specific revenues but not with specific products should be

$20,000 The input method based on costs incurred provides for the recognition of gross profit based on the relationship between the costs incurred to date and estimated total costs for the completion of the contract. The total anticipated gross profit is multiplied by the ratio of the costs incurred to date to the total estimated costs, and the product is reduced by previously recognized gross profit. At the end of Year 1, Project 1 is 66 2/3% complete [$240,000 ÷ ($240,000 + $120,000)] and Project 2 is 87 1/2% complete [$280,000 ÷ ($280,000 + $40,000)]. Each project's percentage of completion is multiplied by its expected total gross profit. Accordingly, Catus recognizes $40,000 [($420,000 contract price - $240,000 costs incurred - $120,000 additional estimated costs) × 66 2/3%] of gross profit for Project 1. However, Project 2 estimates indicate a loss of $20,000 ($300,000 - $280,000 - $40,000). Because the full amount of a loss is reported immediately irrespective of the accounting method used, a gross profit of $20,000 [$40,000 Project 1 + $(20,000) Project 2] is recognized.

Fact Pattern: Data pertaining to Catus Co.'s long-term construction jobs, which commenced during Year 1, are as follows:Project 1Project 2Contract price$420,000$300,000Costs incurred during Year 1240,000280,000Estimated costs to complete120,00040,000Billed to customers during Year 1150,000270,000Received from customers during Year 190,000250,000 Question: 57If Catus uses the input method based on costs incurred to measure the progress toward completion of the project, what amount of gross profit (loss) should Catus report in its Year 1 income statement?

$(20,000) Catus cannot reasonably measure the progress toward satisfaction of the performance obligation (contract) but expects to recover the costs incurred. Accordingly, it recognizes revenue from the contracts to the extent of the cost incurred (zero profit margin). For Project 1, no gross profit is recognized in Year 1. However, as soon as an estimated loss on any project becomes apparent, it must be recognized in full. Catus therefore recognizes a loss of $20,000 on Project 2 ($300,000 contract price - ($280,000 + $40,000) estimated contract costs).

Fact Pattern: Data pertaining to Catus Co.'s long-term construction jobs, which commenced during Year 1, are as follows:Project 1Project 2Contract price$420,000$300,000Costs incurred during Year 1240,000280,000Estimated costs to complete120,00040,000Billed to customers during Year 1150,000270,000Received from customers during Year 190,000250,000 Question: 56If Catus cannot reasonably measure the progress toward completion of the projects but expects to recover the costs incurred, what amount of gross profit (loss) should Catus report in its Year 1 income statement?

$48,000 In Year 2, the entity delivered 40 units (100 units from the initial contract + 30 units from the contract modification - 90 units delivered in Year 1 to the customer). The price for the additional 30 units resulting from the contract modification does not reflect their standalone selling price, and the remaining units to be delivered are distinct from those already transferred. Accordingly, the entity must account for the modification of the contract as (1) a termination of the original contract and (2) the creation of a new contract. The modified total transaction price of $60,000 [($1,500 × 20) + $30,000] is allocated to all the remaining 50 units to be delivered. Thus, the blended price per unit to be delivered is $1,200 ($60,000 ÷ 50). The total revenue recognized in Year 2 is $48,000 ($1,200 × 40).

Fact Pattern: On May 1, Year 1, an entity entered into a contract to deliver 100 units of its product to a customer for $150,000. The units are transferred to the customer over a 9-month period. On November 1, Year 1, after 80 units were transferred to the customer, the contract was modified to require the delivery of an additional 30 units for an additional $30,000. The entity determined that (1) the price for the additional 30 units does not reflect the standalone selling price of the product and (2) the remaining units to be delivered are distinct from those already transferred. During Year 1, the entity delivered a total of 90 units to the customer What is the total amount of revenue that was recognized by the entity in Year 2 upon the delivery of the remaining units?

$1,200 Because the price for the additional 30 units does not reflect their standalone selling price, the contract modification must not be accounted for as a separate contract. However, the remaining units to be delivered are distinct from those already transferred. Accordingly, the entity must account for the modification as (1) a termination of the original contract and (2) the creation of a new contract. The modified total transaction price of $60,000 [($1,500 × 20) + $30,000] is allocated to all of the remaining 50 units to be delivered. Consequently, the amount recognized as revenue for each unit delivered after the contract modification is a blended price of $1,200 ($60,000 ÷ 50).

Fact Pattern: On May 1, Year 1, an entity entered into a contract to deliver 100 units of its product to a customer for $150,000. The units are transferred to the customer over a 9-month period. On November 1, Year 1, after 80 units were transferred to the customer, the contract was modified to require the delivery of an additional 30 units for an additional $30,000. The entity determined that (1) the price for the additional 30 units does not reflect the standalone selling price of the product and (2) the remaining units to be delivered are distinct from those already transferred. During Year 1, the entity delivered a total of 90 units to the customer. What amount of revenue per unit was recognized by the entity for the 10 units delivered to the customer between November 1, Year 1, and December 31, Year 1?

Evenly over the contract year as the services are performed. The performance obligation is satisfied over time because the customer simultaneously receives and consumes the benefits as the entity performs. The entity recognizes revenue based on a transaction price in the form of an annual fee as it satisfies the performance obligation to deliver insect control services for 1 year. Accordingly, the entity must recognize revenue over time by measuring the progress toward satisfaction of the 1-year performance obligation. That progress is measured by time elapsed (an example of an input method). Because inputs are incurred evenly over time (one scheduled visit every month), recognition of revenue on a straight-line basis is appropriate in this case.

For $50 a month, Rawl Co. visits its customers' premises and performs insect control services. If customers experience problems between regularly scheduled visits, Rawl makes service calls at no additional charge. Instead of paying monthly, customers may pay an annual fee of $540 in advance. For a customer who pays the annual fee in advance, Rawl should recognize the related revenue

Present Value - No Minimum Amount in the Range of Possible Amounts - No The amount of variable consideration must be estimated by applying consistently throughout the contract period one of two methods: (1) expected value or (2) most likely amount. The expected value method may provide an appropriate estimate if an entity has a large number of contracts with similar characteristics. The expected value is the sum of probability-weighted amounts in the range of possible consideration amounts. The most likely amount method may provide an appropriate estimate if the contract has only two possible outcomes. The most likely amount is the single most likely amount in a range of possible consideration amounts.

For recognition of revenue from contracts with customers, which of the following methods, if any, is (are) acceptable for estimating the amount of variable consideration?

$150,000 The expected gross profit is $500,000 ($2,500,000 price - $2,000,000 expected cost). Cumulative recognized gross profit in Year 2 is $350,000 {$500,000 × [($500,000 + $900,000) ÷ $2,000,000]}. Recognized gross profit in Year 3 is $150,000 [($2,500,000 price - $500,000 - $900,000 - $600,000) actual gross profit - $350,000 previously recognized].

Frame Construction Company's contract requires the construction of a bridge in 3 years. The expected total cost of the bridge is $2,000,000, and Frame will receive $2,500,000 for the project. The actual costs incurred to complete the project were $500,000, $900,000, and $600,000, respectively, during each of the 3 years. Progress payments received were $600,000, $1,200,000, and $700,000, respectively. Frame uses the input method based on costs incurred to recognize revenue from a performance obligation satisfied over time. What amount of gross profit should Frame report during the last year of the project?

$150,000 The input method based on costs incurred provides for the recognition of gross profit based on the relationship between the costs incurred to date and estimated total costs for the completion of the contract. The total anticipated gross profit is multiplied by the ratio of the costs incurred to date to the total estimated costs, and the product is reduced by previously recognized gross profit. The percentage-of-completion at 12/31/Yr 4 is 75% [$1,800,000 ÷ ($1,800,000 + $600,000)]. The total anticipated gross profit is $600,000 ($3,000,000 contract price - $2,400,000 expected total costs). Consequently, a gross profit of $150,000 [($600,000 total gross profit × 75%) - $300,000 previously recognized gross profit] is recognized for Year 4.

Haft Construction Co. has consistently used the input method based on costs incurred to measure progress toward completion of the project. On January 10, Year 3, Haft began work on a $3 million construction contract. At the inception date, the estimated cost of construction was $2,250,000. The following data relate to the progress of the contract:Gross profit recognized at 12/31/Yr 3$ 300,000 Costs incurred 1/10/Yr 3 through 12/31/Yr 4 1,800,000 Estimated cost to complete at 12/31/Yr 4 600,000 In its income statement for the year ended December 31, Year 4, what amount of gross profit should Haft report?

Current cost. Current (replacement) cost is the amount of cash that would have to be paid for current acquisition of the same or an equivalent asset. For example, given the LIFO inventory flow assumption, the cost of goods sold may be the current cost.

Items currently reported in financial statements are measured by different attributes. The amount of cash or its equivalent that would have to be paid if the same or an equivalent asset were acquired currently defines the attribute of

Different measurement attributes are used for different items depending on the nature of the item. Current accounting practice is based on (1) nominal units of money (unadjusted for changes in purchasing power) and (2) quantifiable attributes. Attributes used in practice include (1) historical cost (historical proceeds), (2) current cost, (3) current market value, (4) net realizable (settlement) value, and (5) present (or discounted) value of future cash flows. The use of different attributes will continue.

Items reported in financial statements must have a relevant attribute that can be measured in monetary units. According to the conceptual framework,

$350,000 In Year 1, one-half of the estimated costs of this construction project were incurred [$1,750,000 ÷ ($1,750,000 + $1,750,000)]. The company should therefore recognize one-half of the estimated gross profit in Year 1. At year-end, the estimated gross profit is $700,000, equal to the contract price minus total estimated costs [$4,200,000 - ($1,750,000 + $1,750,000)]. In Year 1, $350,000 should be recognized as gross profit ($700,000 × 50%).

Kechara Corp. started a long-term construction project on a customer's land in Year 1. The following data relate to this project: Contract price $4,200,000 Costs incurred in Year 1 1,750,000 Estimated costs to complete 1,750,000 Progress billings 900,000 Collections on progress billings 800,000 The project is accounted for using the input method based on costs incurred to measure progress toward completion of the contract. In Kechara's Year 1 income statement, what amount of gross profit should be reported for this project?

$3,300,000 The progress to completion is based on the relationship of the cumulative costs incurred to date to estimated total costs at completion. Thus, the cumulative amount incurred at 12/31/Year 1 was $1,500,000 ($7,500,000 × 20%). At 12/31/Year 2, the cumulative amount incurred was $4,800,000 ($8,000,000 × 60%). The difference of $3,300,000 ($4,800,000 - $1,500,000) equals contract costs incurred during Year 2.

Lake Construction Company has consistently used the input method based on costs incurred to recognize revenue from a performance obligation satisfied over time. During Year 1, Lake entered into a fixed-price contract to construct an office building for $10 million. Information relating to the contract is as follows: December 31 Year 1 Year 2 Percentage of completion 20% 60% Estimated total costs at completion $7,500,000 $8,000,000 Gross profit recognized (cumulative) 500,000 1,200,000 Contract costs incurred during Year 2 were

Revenue Cost of Goods Sold Gross Profit A.$400,000 $350,000 $50,000 Revenue must be recognized over time, that is, over the 2 years of the construction period, because (1) the robot has no alternative use to the entity and (2) the entity has an enforceable right to payment for the performance completed to date. In Year 1, 50% ($250,000 ÷ $500,000) of expected costs has been incurred. Using the input method based on costs incurred, the entity recognizes 50% of the expected revenue from the contract for Year 1 ($800,000 contract price × 50% = $400,000). The total gross profit from the contract is expected to be $300,000 ($800,000 - $500,000). Thus, $150,000 ($300,000 × 50%) of gross profit ($400,000 revenue - $250,000 cost of goods sold) is recognized in Year 1. In Year 2, the contract is completed, and the total gross profit from the contract is $200,000 [$800,000 contract price - ($250,000 + $350,000) total costs incurred]. Because $150,000 of gross profit was recognized in Year 1, $50,000 ($200,000 - $150,000) of gross profit is recognized in Year 2. The total revenue from the contract is $800,000. Revenue of $400,000 was recognized in Year 1, so Year 2 revenue is $400,000 ($800,000 - $400,000). Cost of goods sold in Year 2 equals the actual costs incurred of $350,000.

On January 1, Year 1, an entity enters into a contract with a customer to build a robot. The construction of the robot is expected to be completed at the end of Year 2. The entity also determines thatIt has no alternative use for the robot.It has an enforceable right to payment for the performance completed to date.The progress toward complete construction of the robot is reasonably measurable using the input method based on costs incurred. The contract price is $800,000, and expected total costs are $500,000. The following additional information relates to the actual and expected costs incurred: Year 1Year 2Costs incurred during each year$250,000 $350,000 Costs expected in future 250,000 0What amounts of revenue, cost of goods sold, and gross profit are recognized by the entity for Year 2?

Year 2 Interest Expense - $1,272 Contract Liability on December 31, Year 2 - $22,472 Until the product is delivered to the customer, all payments received are recognized as a contract liability. Because the contract includes a significant financing component, interest expense is recognized using the effective interest method. The contract liability at the beginning of Year 2 equals $21,200 ($20,000 × 1.06). Thus, Year 2 interest expense equals $1,272 ($21,200 × 6%), and the contract liability at the end of Year 2 equals $22,472 ($21,200 × 1.06).

On January 1, Year 1, an entity receives a payment of $20,000 for delivering a product to a customer at the end of Year 3. Based on the contract's terms, the performance obligation will be satisfied at a point in time (upon delivery of the product). The entity determined that (1) the contract includes a significant financing component and (2) a financing rate of 6% is an appropriate discount rate. What amount of interest expense and contract liability will be recognized in the entity's December 31, Year 2, financial statements?

$4,000 Because the contract allows the customer a right of return, the consideration received from the customer is variable. Revenue from variable consideration is recognized only to the extent that it is probable that a significant reversal will not occur. The entity estimates that 10 machines will be returned. Thus, it recognizes revenue only for the sale of 40 (50 - 10) machines, and on November 1, Year 1, a revenue of $4,000 (40 × $100) is recognized.

On November 1, Year 1, an entity sold 50 machines to a customer for $100 each. The cost of each machine is $20. The entity allows customers to return any unused machine within 6 months and receive a full refund. The entity uses the expected value method to estimate the variable consideration. Based on the entity's experience and other relevant factors, it reasonably estimates that 10 machines (6 in Year 1 and 4 in Year 2) will be returned. What amount of revenue is recognized by the entity from the sale of these machines on November 1, Year 1?

Based on the progress toward complete satisfaction of the performance obligation for each project. For each performance obligation satisfied over time, an entity must recognize revenue over time. For this purpose, the entity measures the progress toward complete satisfaction using the output method or the input method.

Saskia Company's construction projects extend over several years, and collection of receivables is reasonably certain. Each project has a firm contract price, reliable estimates of the extent of progress and cost to finish, and a contract that is specific as to the rights and obligations of all parties. The contractor and the buyer are expected to fulfill their contractual obligations on each project. Saskia should recognize revenue from the projects

Salespersons' monthly salaries. Expenses should be recognized when a benefit has been consumed. The consumption of benefit may occur when (1) the expenses are matched with the revenues, (2) they are allocated on a systematic and rational basis to the periods in which the related assets are expected to provide benefits, or (3) the cash is spent or liabilities are incurred for goods and services that are used up either simultaneously with the acquisition or soon after. An example of a cost that (1) cannot be directly related to particular revenues but (2) is incurred to obtain benefits that are exhausted in the same period in which the cost is incurred is salespersons' monthly salaries.

Some costs cannot be directly related to particular revenues but are incurred to obtain benefits that are exhausted in the period in which the costs are incurred. An example of such a cost is

The service is provided. Revenue is recognized when (or as) the performance obligation is satisfied by transferring a promised good or service (an asset) to a customer. The performance obligation was satisfied at the point in time when the customer obtained control over the promised asset (the service provided). Control is indicated because, for example, the entity had a present right to payment and the customer accepted the service.

The Star Company is a service entity that requires customers to place their orders 2 weeks in advance. Star bills its customers on the 15th day of the month following the date of service and requires that payment be made within 30 days of the billing date. Conceptually, Star should recognize revenue from its services at the date when

Present value of future cash flows An appropriate measurement attribute for noncurrent receivables and liabilities is the present (discounted) value of future cash inflows or outflows, respectively, expected to be required to realize an asset or satisfy a liability.

The appropriate attribute for measuring noncurrent payables is

An observable price. The standalone selling price is the price at which an entity would sell a promised good or service separately to a customer. The best evidence of a standalone selling price is the observable price of a good or service when it is sold separately in similar circumstances and to similar customers (e.g., a contractually stated price or list price of a good or service).

The best evidence of a standalone selling price, given different performance obligations in the contract, is

Total costs incurred to date to total estimated costs. The input method based on costs incurred (cost-to-cost) method provides for the recognition of gross profit based on the relationship between costs incurred to date and estimated total costs for completion of the contract. (But other measures of progress are permitted.) The amount recognized in the third year of a 5-year contract is calculated as follows: The total anticipated gross profit (based on the latest available estimated costs) is multiplied by the ratio of costs incurred to date to the latest available total estimated costs, and the product is reduced by previously recognized gross profit.

The calculation of the gross profit recognized in the third year of a 5-year construction contract accounted for by the input method based on the costs incurred (cost-to-cost) method includes the ratio of

List A - Single principles-based List B- Eliminates most industry-specific guidance The revenue recognition standard provides a single principles-based model (the five-step approach) that can be applied to all contracts with customers regardless of the industry-specific or transaction-specific fact pattern.

The revenue recognition from contracts with customers standard (ASC 606) provides a <List A> model that <List B>.

Retains Most Industry-Specific Guidance - No Converges U.S. GAAP and IFRS - Yes The converged revenue recognition standard was jointly issued by the FASB and IASB. Because the same standard is applied under U.S. GAAP and IFRS, comparability is globally improved. Moreover, the standard provides a single, principles-based revenue recognition model that eliminates most industry-specific guidance. Thus, it improves comparability across industries.

The revenue recognition standard for revenue from contracts with customers improves comparability because it

Product or service warranty contracts. An entity must apply the guidance on revenue from contracts with customers to all contracts with customers except for (1) lease contracts, (2) insurance contracts, (3) financial instruments, (4) guarantees (other than product or service warranties), and (5) nonmonetary exchanges between entities in the same line of business to facilitate sales to customers. Accordingly, product or service warranties are within the scope of the standard.

The scope of the FASB's standard on revenue from contracts with customers (ASC 606) includes

Estimation of the Price in the Seller's Market - Yes Residual Approach - Yes The adjusted market assessment, the expected cost plus an appropriate margin, and a residual are among the acceptable estimates of the standalone selling price of a performance obligation when that price is not directly observable. Using the adjusted market assessment approach, an entity evaluates the market in which it sells goods or services and estimates the price that a customer in that market would be willing to pay for them. Using the expected cost plus an appropriate margin approach, an entity forecasts its expected costs of satisfying a performance obligation and adds an appropriate margin for that cost. In limited circumstances, a residual approach also may be used. A residual is the total transaction price minus the observable prices for other items promised in the contract. The residual approach may be applied only when the standalone price is (1) highly variable or (2) uncertain.

The standalone selling price of a performance obligation in a contract with a customer may not be directly observable. Alternatives for estimating the standalone selling price include

A substantial amount of the consideration is contingent on a future event that is not within the control of the seller. The transaction price should not be adjusted for the effect of the time value of money if - The time between the payment and the delivery of the promised good or service to the customer is 1 year or less. - The transfer of goods or services is at the discretion of the customer (e.g., a bill-and-hold contract in which the seller provides storage services for goods it sold to the buyer). - A substantial amount of the consideration promised is variable, and its amount or timing varies on the basis of future circumstances that are not within the control of the entity or the customer. An example is a sales-based royalty contract in which the amount of consideration depends on sales by the customer to third parties.

The transaction price from contracts with customers generally should not be adjusted for the effect of the time value of money when

Interest income or expense that is presented in the income statement separately from revenue. The transaction price should be adjusted for the effect of the time value of money when the contract includes a significant financing component. The interest income or expense is recognized using the effective interest method. Interest income or expense must be presented in the income statement separately from revenue from contracts with customers.

Under ASC 606, adjustment of the transaction price to reflect the time value of money results in

The selling price of the product and the consideration promised in the contract differ significantly. The transaction price should be adjusted for the effect of the time value of money when the contract includes a significant financing component. A significant difference between (1) the selling price of the product and (2) the consideration promised in the contract may indicate that the financing component is significant.

Under ASC 606, the transaction price generally should be adjusted for the effect of the time value of money when

Undiscounted Cash Flows - No Variable Consideration - Yes The revenue recognized must reflect the price that a customer would have paid for the promised goods or services if the cash payment had been made when the goods or services were transferred to the customer (the cash selling price). Thus, the transaction price should be adjusted for the effect of the time value of money when the contract includes a significant financing component. Also, an entity must estimate the amount of consideration to which it will be entitled in exchange for transferring the promised goods or services to a customer. For example, the transaction price may vary due to discounts, refunds, incentives, or contingencies (uncertainties based on the occurrence or nonoccurence of a future event). Thus, variable consideration also determines the transaction price. In this case, variable consideration must be estimated at the inception of the contract.

Under ASC 606, which of the following, if any, determines the transaction price of a contract with a significant financing component?

In the period earned as sales occur. Assuming the entity satisfied the performance obligation to which the sales-based royalties relate, revenue for sales-based royalties from licensed intellectual property, such as a patent, is recognized as the subsequent sales occur.

Under a contract with another entity, a company will receive sales-based royalties from the assignment of a patent for 3 years. The royalties received should be reported as revenue

Not include amounts collected on behalf of third parties. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. It excludes amounts collected on behalf of third parties. Thus, the amount collected for taxes must not be included in the transaction price. Furthermore, any consideration payable to the customer, such as coupons, credit, or vouchers, reduces the transaction price. Also, the effect of the time value of money and variable consideration should be considered in determining the transaction price.

Under the FASB's standard for recognition of revenue from contracts with customers, the transaction price may

List A - Distinct List B - The standalone selling price A contract modification exists when the parties approve a change in the scope or price of a contract. A contract modification is accounted for as a separate contract if (1) it results in the addition to the contract of promised goods or services that are distinct and (2) the price for these additional goods or services is their standalone selling price.

Under the guidance for recognition of revenue from contracts with customers (ASC 606), a contract modification is accounted for as a separate contract if the additional promised goods are <List A> and the price for these additional goods is <List B>.

To provide disclosures required by generally accepted accounting principles The primary purpose of notes to the financial statements is to supplement or further explain the information on the face of the statements. Notes should contain information useful to investors and creditors for making decisions about providing resources to the entity. Examples of such information are descriptions of accounting policies used and disclosures required by GAAP.

What is the purpose of information presented in notes to the financial statements?

The contracts are negotiated as a package with a single commercial objective. The entity must combine two or more contracts entered into at or near the same time with the same customer if at least one of the following criteria is met: - The contracts are negotiated as a package with a single commercial objective. - The consideration to be paid in one contract depends on the price or performance of the other contract. - The goods or services to be provided in the contracts are a single performance obligation.

When applying the guidance for revenue recognition from contracts with customers, which of the following is a criterion for combining two contracts with a customer into a single contract?

Input method. When revenue is recognized over time, the progress toward complete satisfaction of a performance obligation must be measured. This progress must be measured either by the output method or the input method. To determine the appropriate method, an entity must consider the nature of the good or service that it promised to transfer to the customer. The chosen method should measure the entity's performance in transferring control of the promised asset to the customer. The input method recognizes revenue on the basis of (1) the entity's inputs to the satisfaction of the performance obligation relative to (2) the total expected inputs to the satisfaction of that performance obligation. Examples of input methods include (1) resources consumed, (2) labor hours expended, (3) costs incurred, (4) time elapsed, or (5) machine hours used. When an entity's inputs are incurred evenly over time, recognition of revenue on a straight-line basis may be appropriate.

When revenue from contracts with customers is recognized over time, the progress toward complete satisfaction of a performance obligation may be measured using the

Adjusted Market Assessment - Yes Expected Cost Plus an Appropriate Margin - Yes The transaction price is allocated to performance obligations in the contract based on their standalone selling prices. The best evidence of a standalone selling price is the observable price of a good or service when it is sold separately in similar circumstances and to similar customers. The adjusted market assessment and the expected cost plus an appropriate margin are acceptable estimates of the standalone selling price of a performance obligation when that price is not directly observable. Using the adjusted market assessment approach, an entity evaluates the market in which it sells goods or services and estimates the price that a customer in that market would be willing to pay for them. Using the expected cost plus an appropriate margin approach, an entity forecasts its expected costs of satisfying a performance obligation and adds an appropriate margin for that cost.

Which of the following can be used to estimate the standalone selling price of a performance obligation in a contract with customers when that price is not directly observable?

Amortization of intangible assets. The expense recognition principle of systematic and rational allocation is applied to the amortization of intangible assets because of the absence of a direct means of associating cause and effect. The costs benefit two or more periods (they generate revenue in those periods) and should be systematically and rationally allocated.

Which of the following is an application of the principle of systematic and rational allocation?

Sales commissions. If a direct cause-and-effect relationship can be established between costs and revenues, the costs should be recognized as expenses when the related revenue is recognized. Costs of products sold or services provided and sales commissions are examples of costs that can be associated with specific revenues.

Which of the following is an example of the expense recognition principle of associating cause and effect?

The costs to fulfill the contract are expected to be recovered. One of the criteria for capitalizing the costs to fulfill a contract is that such costs are expected to be recovered. A contract is accounted for under the revenue recognition standard if all the following criteria are met: (1) The contract was approved by both parties, (2) the contract has commercial substance, (3) each party's rights regarding (a) goods or services to be transferred and (b) the payment terms can be identified, and (4) it is probable that the entity will collect the consideration to which it is entitled according to the contract.

Which of the following is not a criterion that must be met for a contract with a customer to be accounted for under the revenue recognition standard (ASC 606)?

Profit maximization. Profit maximization is not a theoretical basis for the allocation of expense. The allocation of expenses on such a basis would subvert the purpose of GAAP to present fairly the results of operations and financial position because expenses would not be reported.

Which of the following is not a theoretical basis for the allocation of expenses?

The federal income tax savings using the immediate write-off method exceed the savings obtained by allocating the cost to several periods. In applying the principle of expense recognition, costs are analyzed to determine whether they can be matched with revenue, e.g., cost of goods sold. If not, a systematic and rational allocation should be attempted, e.g., depreciation. If neither principle applies, costs are recognized immediately. Accordingly, even though federal income tax savings could be obtained by the immediate write-off method, GAAP might require another treatment of the expense.

Which of the following most likely is not a basis for the immediate recognition of a cost during a period?

The customer simultaneously receives and consumes the benefits from performance as the entity performs. An entity recognizes revenue when (or as) it satisfies each performance obligation in the contract by transferring the promised good or service (an asset) to a customer. An asset is transferred when the customer obtains control of that asset. When the customer simultaneously receives and consumes the benefits from performance as the entity performs, revenue is recognized over time.

Which of the following situations may result in recognition over time of revenue from a contract with a customer by an entity?

To match the costs of production with revenues as earned. If costs benefit more than one accounting period, they should be systematically and rationally allocated to all periods benefited. This is done by capitalizing the costs and depreciating or amortizing them over the periods in which the asset helps generate revenue. The term "matching" is most narrowly defined as the expense recognition principle of associating cause and effect, but it is sometimes used more broadly (as here) to apply to the entire process of expense recognition or even of income determination.

Why are certain costs of doing business capitalized when incurred and then depreciated or amortized over subsequent accounting cycles?