Intermediate Acctg 9th Ed McGraw Hill Ch-05 Revenue Recognition - Learning Objectives

LO5-5 Determine whether a contract exists, and whether some frequently encountered features of contracts qualify as performance obligations.

A contract exists when it has commercial substance and all parties to the contract are committed to performing the obligations and enforcing the rights that it specifies. Performance obligations are promises by the seller to transfer goods or services to a customer. A promise to transfer a good or service is a separate performance obligation if it is DISTINCT, which is the case if it is both CAPABLE OF BEING DISTINCT (meaning that the customer could use the good or service on its own or in combination with other goods and services it could obtain elsewhere), and IT IS SEPARATELY IDENTIFIABLE (meaning that the good or service is not highly interrelated with other goods and services in the contract, so it is distinct in the context of the contract). Prepayments, rights to return merchandise, and normal quality-assurance warranties do not qualify as performance obligations, because they don't transfer a good or service to the customer. On the other hand, extended warranties and customer options to receive goods or services in some preferred manner (for example, at a discount) qualify as performance obligations.

LO5-4 Allocate a contract's transaction price to multiple performance obligations.

A contract's transaction price is allocated to its performance obligations. The allocation is based on the STAND-ALONE SELLING PRICES of the goods and services underlying those performance obligations. The stand-alone selling price must be estimated if a good or service is not sold separately.

LO5-1 State the core revenue recognition principle and the five key steps in applying it.

Companies recognized 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 and services. That core principle is implemented by (1) Identify a contract with a customer, (2) Identifying the performance obligations in the contract, (3) determining the transaction price of the contract, (4) allocating that price to the performance obligations, and (5) recognizing revenue when (or as) each performance obligation is satisfied.

LO5-10 Discuss the primary difference between U.S. GAAP and IFRS with respect to revenue recognition.

IFRS interpret the word "probable" as indicating a lower probability threshold than does U.S. GAAP. As a consequence, a seller could conclude a contract meets the "probable that it will collect the amounts it's entitled to receive" threshold and recognize revenue under IFRS but not under U.S. GAAP. Also, IFRS doesn't tie the timing of revenue recognition for licenses to whether a license involves "functional" versus "symbolic" intellectual property, so IFRS might allow revenue recognition at a point in time for "symbolic IP" licenses that would require revenue recognition over time under U.S. GAAP.

LO5-7 Determine the timing of revenue recognition with respect to licenses, franchises, and other common arrangements.

If the seller's activity over the license period is expected to affect the benefits the customer receives from the intellectual property being licensed, as with symbolic IP, the seller recognizes revenue over the license period. Otherwise, the seller recognizes revenue at the point in time that customer obtains access to the seller's intellectual property. Franchises are an example of contracts that typically include licenses as well as other performance obligations. Revenue for bill-and hold sales should be recognized when the seller transfers control of goods to the customer, even if the seller retains physical possession of the goods, and for consignment sales when goods are delivered to the end customer. Revenue for gift cards should be recognized when the gift card is redeemed, expires, or viewed as broken.

LO5-9 Demonstrate revenue recognition for long-term contracts, both at a point in time when the contract is completed and over a period of time according to the percentage completed.

Long-term contracts usually qualify for revenue recognition over time. We recognize revenue over time by assigning a share of the project's revenues and costs to each reporting period over the life of the project according to the percentage of the project completed to date. If long-term contracts don't qualify for revenue recognition over time, we recognize revenues and expenses at the point in time when the project is complete.

LO5-8 Understand the disclosures required for revenue recognition, accounts receivable, contract assets, and contract liabilities.

Much disclosure is required for revenue recognition. For example, a seller recognizes contract liabilities, contract assets, and accounts receivable on separate lines of its balance sheet. If the customer makes payment to the seller before the seller has satisfied performance obligations, the seller records a contract liability, such as deferred revenue. If the seller satisfies a performance obligation before the customer has paid for it, the seller records either a contract asset or an account receivable. The seller recognizes an account receivable if only the passage of time is required before payment is due. If instead the seller's right to payment depends on something other than the passage of time, the seller recognizes a contract asset.

LO5-2 Explain when it is appropriate to recognize revenue at a single point in time.

Revenue should be recognized AT A SINGLE POINT IN TIME when control of a good or service is transferred to the customer on a specific date. Indicators that transfer has occurred and that revenue should be recognized include -the seller having the right to receive payment, -the customer having legal title and physical possession of the asset, -the customer formally accepting the asset, and -the customer assuming the risks and rewards of ownership.

LO5-3 Explain when it is appropriate to recognize revenue over a period of time.

Revenue should be recognized OVER TIME when a performance obligation is satisfied over time. That occurs if (1) the customer consumes the benefit of the seller's work as it is performed, (2) the customer controls the asset as the seller creates it, or (3) the asset has no alternative use to the seller and the seller can be paid for its progress even if the customer cancels the contract.

LO5-6 Understanding how variable consideration and other aspects of contracts affect the calculation and allocation of the transaction price.

When a contract includes consideration that depends on the outcome of future events, sellers estimate that variable consideration and include it in the contract's transactions price. The seller's estimate is based either on the most likely outcome or the expected value of the outcome. However, a constraint applies - variable consideration only should be included in the transaction price to the extent it is probable that a significant revenue reversal will not occur. The estimate of variable consideration is updated each period to reflect changes in circumstances. A seller also needs to determine if it is a principal (and recognizes as revenue the amount received from the customer) or an agent (and recognizes its commission as revenue), consider time value of money, and consider the effect of any payments by the seller to the customer. Once the transaction price is estimated, we allocate it to performance obligations according to their stand-alone selling prices, which can be estimated using the adjusted market assessment approach, the expected cost plus margin approach, or the residual approach.