ACCTG 371 TEST 3

Revenue is recognized over a period of time if....

one of three conditions is met 1. customer consumes the benefit of the seller's work as it is performed (ex. cleaning service) 2. customer controls the assets as it is created (ex. a building extension) 3. seller is creating an asset that has no alternative use to the seller and the seller has legal right to receive payment for progress to date even if the contract is cancelled (ex. order of jets customized for US Air force)

Variable Consideration

part of the transaction price depends on the outcome of some future event -ex. royalties, reimbursements, discounts, returns, incentive payments, rebates - methods of estimation -> expected value, most likely amount

Is the seller a principal or agent? Performance Obligation

principal - to deliver goods and services (so is vulnerable to risks associated with holding inventory) agent - to facilitate a transaction between a principal and a customer

Is the seller a principal or agent? Recording Revenue

principle - total sales price paid by customers, also recognizes cost of goods sold agent - only the commission it receives on the transaction

Activity Ratios

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Determine the transaction price

- SINGLE & MULTIPLE: amount seller is entitled to receive from customer

Recognize revenue when (or as) each performance obligation is satisfied

- SINGLE: at a point in time or over a period of time - MULTIPLE: at whatever time is appropriate for each performance obligation

Allocate the transaction price

- SINGLE: no allocation required - MULTIPLE: allocate portion to each performance obligation

Franchises

- a franchisor grants to the franchisee the right to sell the franchisor's products and use its name - often include a license as well as goods and services transferred at the start of the franchise as well as over the life of the franchise - each of these aspects must be evaluated to determine if they qualify as separate performance obligations and accounted for accordingly

Right of Access

- a license provides a right of access to the seller's intellectual property if the seller's ongoing activities affect the benefit the customer receives (ex. NFL trademark) - revenue is recognized over the period of time for which access is provided

Bill-and-Hold Sales

- an arrangement where a customer purchases goods but requests that the seller not ship the product until a later date - since the customer does not have physical possession of the asset until the seller has delivered it, transfer of control has not occurred, so revenue typically should not be recognized until actual delivery to the customer occurs

Special Issues for step 1: Identify the contract

- contracts can be explicit or implicit, oral or written - contract existing or not

Control

- customer has direct influence over the use of the good or service and obtains its benefits

Identify the contract

- legal rights of seller and customer established

Indicators that a significant revenue reversal could occur include:

- poor (limited) evidence on which to base an estimate - dependence of the estimate on factors outside the seller's control - a history of the seller changing payment terms on similar contracts - a broad range of outcomes that could occur - a long delay before uncertainty resolves

Profitability Analysis Using Financial Ratios

- ratios help to evaluate a firm's performance and financial position - although ratios provide more meaningful information than numbers alone, ratios are most useful when analyzed relative to some standard of comparison (may be previous performance of same company or industry average)

License

- right of use - right of access

Gift Cards

- sales of gift cards are recognized as deferred revenue, and then revenue is recognized when a gift card is redeemed or the likelihood of redemption is viewed as remote

Identify the performance obligation(s)

- single or multiple

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

Right of Use

- transfers a right of use if the seller's activities during the license period are not expected to affect the intellectual property being licensed to the customer (ex. music download) - revenue is recognized at the start of the license period, when the right is transferred

Special Issues for Step 3: Determining the Transaction price

-> estimating the transaction price involves a variety of considerations including: - estimating variable consideration and determining whether it is constrained -identifying whether the seller is acting as a principal or an agent -considering the time value of money - accounting for payments by the seller to the customer -> constraint on recognizing variable consideration ->indicators -> one type of variable consideration is provided by a right of return

One type of variable consideration is provided by a right of return

-> exists when the customer can return the good if not satisfied or unable to sell it -> viewed as a failure to satisfy the original performance obligation -> the seller reduces revenue by the estimated returns and either 1. records a liability for cash the seller anticipates refunding to customers 2. reduces accounts receivable if the seller has not yet been paid

Presentation and Disclosure

-> income statement: bad debt expense & interest revenue/expense -> balance sheet: contract liabilities, contract assets, and accounts receivable -> disclosure notes: nature, amount, timing, and uncertainty of revenue and cash flows - outstanding performance obligations, discuss how performance obligations typically are satisfied, and describe the important contractual provisions like payment terms and policies for refunds, returns, and warranties

Prepayments

-> not part of performance obligations ->part of transaction price

Extended warranties

-> part of performance obligations -> it is an extended warranty if either: 1. the customer has the option to purchase the warranty separately 2. the warranty provides a service to the customer beyond quality assurance

Options

-> part of performance obligations -> options that provide a material right (material right is something the customer wouldn't get otherwise, so the seller is obligated to provide it)

Problems with the realization principle

-> revenue recognition was poorly tied to the FASB's conceptual framework -> focus on the earnings process led to similar transactions being treated differently in different industries -> difficult to apply complex arrangements that involve multiple goods or services

Step 2: Identify the performance obligations

-> the goal is to separate the contract into parts that can be viewed on a stand-alone basis -> goods and services are viewed as separate performance obligations if they are distinct

Right of Return

->not part of performance obligations -> part of the performance obligation to deliver acceptable goods and services

Quality-assurance warranties

->not part of performance obligations -> part of the performance obligations to deliver goods and services that are free of defects

Special Issues in relationship to the five steps to revenue recognition

1. specific requirements for contract existence 2. prepayments, warranties, customer options 3. variable consideration, right of return, principal versus agent, time value of money, payments by seller 4. various approaches to estimating stand alone selling prices 5. licenses, franchises, bill and hold arrangements, consignments arrangements, gift cards DISCLOSURE: lots of it!

A good or service is distinct if it is BOTH:

1. capable of being distinct 2. separately identifiable from other goods or services in the contract - ex. construction contracts from this criteria -> goods and services that are not distinct are combined and treated as a single performance obligation

A contract only exists if:

1. has commercial substance 2. has been approved by the seller and customer 3. specifies the rights of the seller and customer 4. specifies payment terms 5. is probable that the seller will collect the amount it is entitled to receive under the contract

Five Steps to Revenue Recognition (ASU)

1. identify the contract 2. identify the performance obligations (PO) 3. determine the transaction price 4. allocate the transaction price 5. recognize revenue (or as) each performance obligation is satisfied

A contract does not exist if:

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

Customer is more likely to control a good or service if they have....

1. obligation to pay (the seller) 2. legal title (to the asset) 3. physical possession (of the asset) 4. (assumed the) risks and rewards of ownership 5. accepted (the asset) -sellers should evaluate these indicators individually and in combination to decide whether control has been transferred and revenue can be recognized

If we suspect a contract has multiple performance obligations steps...

2 and 4 of the revenue recognition process come into play -2. identify the performance obligations - 4. allocate the transaction price to each performance obligation

New revenue recognition

Accounting Standards Update (ASU) - almost completely converged with the IFRS version - core principle created

Which of the following is not an indicator that control of a good has passed from the seller to the buyer? a. buyer has legal title b. buyer has an unconditional obligation to pay c. buyer has scheduled delivery d. buyer has assumed the risk and rewards of ownership

C. whether the buyer has scheduled deliver is not an indicator of passage of control. Delivery, so that the customer has physical possession is an control indicator

Definiton of Revenues

Inflows or other enhancements of assets of an entity or settlements of its liabilities from delivering or producing goods/services

Special Issues for Step 2: Identify Performance Obligations

Not performance obligations - >prepayments, quality-assurance warranties, right of return Performance obligations -> extended warranties, options

Special Issues for Step 5: Recognize Revenue when (or as) each performance obligation is satisfied

Some of the common arrangements can have complicated revenue recognition timing: -licenses -franchises - bill and hold arrangements -consignment arrangements -gift cards

Accounting for long term contracts

Step 2 and 5 are critical for long term contracts - step 2: identify the performance obligations: usually have a single performance obligation, because don't meet the separately identifiable criterion necessary for goods and services to be viewed as distinct - step 5: recognize revenue when (or as) each performance obligation is satisfied: recognize revenue over time according to the progress toward completion (long term contracts often qualify), recognizing revenue upon contract completion

Adjust market assessment approach

The seller considers the price it would receive if the product or services were sold in the market in which it normally conducts business. The seller often references prices charged by competitors. -price if the product or services were sold in the market

Residual Approach

The seller estimates an unknown stand-alone selling price by subtracting the sum of the known or estimated stand-alone selling prices of other goods and services in the contract from the total transaction price of the contract. The residual approach is allowed only if the stand-alone selling price is highly uncertain, which is the case if the seller hasn't previously sold such a good or service and hasn't yet determined a price for it, or if the seller provides the same good or service to different customers at substantially different prices. - subtract the sum of the know or estimated stand along selling prices of other goods and services in the contact from the total transaction price of the contract

Expected Cost plus margin approach

The seller estimates the costs of satisfying a performance obligation and then adds an appropriate profit margin. - estimate the costs of satisfying a performance obligation and then add an appropriate profit margin

Long Term Contract Losses

Two types: 1. periodic loss - occurs for a project that is projected to be profitable 2. overall loss - projected to occur for the entire project - sellers must update their estimates and recognize losses as necessary, but the specifics depend on the timing of revenue recognition

Special Issues for Step 4: Allocate the transaction price to the performance obligations

Various approaches available to estimate stand alone selling prices 1. adjusted market assessment approach 2. expected cost plus margin approach 3. residual approach

Robertson Construction entered into a contract to construct a tunnel for a fixed price of $12,000,000. Robertson recognizes revenue over time according to percentage of completion. Here are some facts: Cost Incurred& Estimated Additional Cost to Complete 2016 - 3,000,000 & 6,000,000 2017 - 5,000,000 & 2,000,000 2018 - 2,500,000 & 0 How much revenue would Robertson recognize in 2016? a. $4,000,000 b. $5,000,000 c. $6,000,000 d. $12,000,000

a. $3M ÷ ($3M + $6M) = 33.33% (or 1/3) complete. $12M x 1/3 = $4M revenue recognized in 2016.

Allen Co. wrote a contract that involves two separate performance obligations. Allen cannot estimate the stand-alone selling price of product A. Product B has a stand-alone selling price of $200. The price for the combined product is $240. How much of the transaction price would be allocated to the performance obligation for delivering product A? a. $ 40. b. $ 60. c. $ 80. d. $100.

a. Allen would use the residual method $240 - 200 = $40

Which of the following is an indicator that revenue for a service should be recognized over time? a. the seller is enhancing an asset that the buyer controls as the service is performed b. the seller is providing continuous effort to the buyer c. the seller can estimate the percent of work completed d. the sales price is fixed and determinable

a. this is one of the three conditions that must be met for revenue to be recognized over a period of time

Revenue recognition ensures....

appropriateness of the timing and amount of revenue reported

Robertson Construction entered into a contract to construct a tunnel for a fixed price of $12,000,000. Robertson recognizes revenue over time according to percentage of completion. Here are some facts: Cost Incurred& Estimated Additional Cost to Complete 2016 - 3,000,000 & 6,000,000 2017 - 5,000,000 & 2,000,000 2018 - 2,500,000 & 0 What is Robertson's percentage completion in 2016? a. 25% b. 33.33% c. 37.5% d. 100%

b. $3M ÷ ($3M + $6M) = 33.33% (or 1/3) complete

Robertson Construction entered into a contract to construct a tunnel for a fixed price of $12,000,000. Robertson recognizes revenue over time according to percentage of completion. Here are some facts: Cost Incurred & Estimated Additional Cost to Complete 2016 - 3,000,000 & 6,000,000 2017 - 500,000 & 6,500,000 2018 - 6,500,000 & 0 What is Robertson's percentage completion in 2017? a. 5% b. 35% c. 65% d. 100%

b. ($3M + $0.5M) ÷ ($3M + $0.5M + $6.5M) = 35% complete.

Robertson Construction entered into a contract to construct a tunnel for a fixed price of $12,000,000. Robertson recognizes revenue over time according to percentage of completion. Here are some facts: Cost Incurred & Estimated Additional Cost to Complete 2016 - 3,000,000 & 6,000,000 2017 - 500,000 & 6,500,000 2018 - 6,500,000 & 0 How much revenue would Robertson recognize in 2017? a. $0 b. $200,000 c. $300,000 d. $4,200,000

b. ($3M + $0.5M) ÷ ($3M + $0.5M + $6.5M) = 35% complete. $12M x 35% = $4.2M = total revenue to date. $4.2M - $4M = $0.2M = revenue recognized in 2017. (Note: $ 0.2M revenue - 0.5M cost of construction $(0.3M) gross loss in 2017

Robertson Construction entered into a contract to construct a tunnel for a fixed price of $12,000,000. Robertson recognizes revenue over time according to percentage of completion. Here are some facts: Cost Incurred& Estimated Additional Cost to Complete 2016 - 3,000,000 & 6,000,000 2017 - 5,000,000 & 2,000,000 2018 - 2,500,000 & 0 How much revenue would Robertson recognize in 2017? a. $5,000,000 b. $5,600,000 c. $8,000,000 d. $9,600,000

b. ($3M + $5M) ÷ ($3M + $5M + $2M) = 80% complete. $12M x 80% = $9.6M = total revenue to date. $9.6M - $4M = $5.6M = revenue recognized in 2017

Braun Computer Company sells computers with an unconditional right to return the computer if the customer is not satisfied. Braun has a long history selling these computers under this returns policy and can provide precise estimates of the amount of returns associated with each sale. Braun most likely should recognize revenue: a. When Braun delivers a computer to a customer, ignoring potential returns. b. When Braun delivers a computer to a customer, in an amount that is reduced by the expected returns. c. When a customer returns a computer. d. When Braun receives cash from the customer.

b. Braun can estimate returns reliably enough for the constraint on recognizing variable consideration to not apply, so Braun would adjust the transaction price for expected returns and recognize revenue in that amount upon delivery.

Alex Guerin is an artist who sells his work under consignment (he displays his work in local barbershops, and customers purchase his work there). Guerin recently transferred a painting on consignment to a local barbershop. After Guerin has transferred a painting to a barbershop, the painting: a. Should be counted in the barbershop's inventory, as the barbershop now possesses it. b. Should be counted in Guerin's inventory until the barbershop sells it. c. We lack sufficient information to know who should carry the painting in inventory. d. Should be counted in either Guerin's or the barbershop's inventory, depending on which incurred the cost of preparing the painting for display.

b. Consignment arrangements normally do not qualify for revenue recognition until delivery is made to the end customer. Prior to that point, control of goods is viewed as having been retained by the consignor, not by the consignee, so the consignor retains the goods in the consignor's inventory. In this case, that means that Guerin will retain the painting in its inventory until the painting is sold to an end customer.

Siddhi enters into a contract offering variable consideration. The contract pays Siddhi $2,000/month for six months of continuous consulting services. In addition, there is a 60% chance the contract will pay an additional $6,000, depending on the outcome of the consulting contract. Siddhi concludes that this contract qualifies for revenue recognition over time. Assume Siddhi estimates variable consideration as the most likely amount. What is the amount of revenue Siddhi would recognize for the first month of the contract? a. $2000 b. $2666 c.$2800 d. $2400

b. the most likely outcome is that Siddhi receives $4,000 bonus (likelihood = 60%), in which case Siddhi would be paid a total of ($2,000 * 6 months) +4,000 or 16,000. Therefore Siddhi would recognize $16,000/6 = $2,666 each month

Robertson Construction entered into a contract to construct a tunnel for a fixed price of $12,000,000. Robertson recognizes revenue over time according to percentage of completion. Here are some facts: Cost Incurred& Estimated Additional Cost to Complete 2016 - 3,000,000 & 6,000,000 2017 - 5,000,000 & 2,000,000 2018 - 2,500,000 & 0 What is Robertson's percentage completion in 2017? a. 50% b. 66.67% c. 80% d. 88.89%

c. ($3M + $5M) ÷ ($3M + $5M + $2M) = 80% complete.

Allen Co. wrote a contract that involves two performance obligations. Product A has a stand alone selling price of $100, and product B has a stand alone selling price of $200. The price for the combined product is $240. How much of the transaction price would be allocated to the performance obligation fro delivering product A? a. 40 b. 60 c. 80 d. 100

c. (100/(200+100)) * 240 = 80

Robertson Construction entered into a contract to construct a tunnel for a fixed price of $12,000,000. Robertson recognizes revenue over time according to percentage of completion. Here are some facts: Cost Incurred& Estimated Additional Cost to Complete 2016 - 3,000,000 & 6,000,000 2017 - 5,000,000 & 2,000,000 2018 - 2,500,000 & 0 How much revenue would Robertson recognize in 2018? a. $0 b. $2,000,000 c. $2,400,000 d. $12,000,000

c. 100% complete. $12M x 100% = $12M = total revenue to date. $12M - ($4M + $5.6M) = $2.4M = revenue recognized in 2018

Which of the following is typically true for a bill-and-hold arrangement? a. Revenue is recognized when goods are manufactured. b. Revenue is recognized when the arrangement is made. c. Revenue is recognized when the delivery of goods is made. d. Revenue is recognized at the point in time at which payment from the customer is received.

c. Bill-and-hold arrangements normally do not qualify for revenue recognition until delivery is made to the customer. Prior to that point, control of goods usually is not viewed as having passed to the customer.

Clayton Consulting operates a website that links experienced statisticians with businesses that need data analyzed. Statisticians post their rates, qualifications, and references on the website, and Clayton receives 25% of the fee paid to the statisticians in exchange for identifying potential customers. Lovelace Associates contacts Clayton and arranges to pay a consultant $4,500 in exchange for analyzing some data. Clayton's income statement would include the following with respect to this transaction: a. Revenue of $4,500 b. Revenue of $4,500, and cost of services of $3,375 c. Revenue of $1,125 d. Revenue of $5,625 and cost of services of $4,500

c. Clayton is an agent. It doesn't have primary responsibility for delivering the statistics services and doesn't collect payment from the customer. Rather, Clayton's primary performance obligation is to facilitate transactions between customers and statisticians. Therefore, Clayton would recognize as revenue only its commission of $1,125 (computed as 25% x $4,500).

Noah sells gift cards redeemable for Noah products either in-store or online. During 2016, Noah sold $6,000,000 of gift cards, and $5,400,000 of the gift cards were redeemed for products. As of December 31, 2016, $450,000 of the remaining gift cards had passed the date at which Noah concludes that the cards will never be redeemed. How much gift card revenue should Noah recognize in 2016? a. $5,400,000 b. $5,550,000 c. $5,850,000 d. $6,000,000

c. The sale of a gift card creates deferred revenue, as it is a prepayment by a customer for goods or services to be delivered at a future date. Revenue is recognized when goods or services are delivered or when the likelihood of redemption is remote. In this case, $5,400,000 were redeemed and another $450,000 were viewed as broken, yielding total revenue of $5,850,000.

Which of the following is not an indicator that the constraint on recognizing variable consideration should be applied? a. A broad range of outcomes could occur b. Poor or limited evidence on which to base an estimate c. A short delay before uncertainty resolves d. A history of the seller changing payment terms on similar contracts

c. a long delay before uncertainty resolves is an indicator that the constraint applies

Hooper Inc. offers a discount on an extended warranty on its eyePhone when the warranty is purchased at the time the eyePhone is purchased. The warranty normally has a price of $300, but Hooper offers it for $240 when purchased along with an eyephone. Hooper anticipates a 75% chance that a customer will purchase the extended warranty along with the eyePhone. Assume Hooper sells 1,000 eyePhones with the extended warranty discount offer. What is the total stand-alone selling price that Hooper would use for the extended warranty discount option for purposes of allocating revenue among the performance obligations of those 1,000 eyePhone contracts? a. $240,000 b. $60,000 c. $45,000 d.$0

c. the $60 discount has a 75% chance of being taken by a customer, so the stand-alone selling price associated with 1,000 eyePhones is $45,000 ($60 * 75% * 1,000 phones)

Siddhi enters into a contract offering variable consideration. The contract pays Siddhi $2,000/month for six months of continuous consulting services. In addition, there is a 60% chance the contract will pay an additional $4,000 and a 40% chance the contract will pay an additional $6,000, depending on the outcome of the consulting contract. Siddhi concludes that this contract qualifies for revenue recognition over time. Assume Siddhi estimates variable consideration as the expected value. What is the amount of revenue Siddhi would recognize for the first month of the contract? a. $2,000 b.$2,666 c. $2,800 d.$2,400

c. the expected value of the transaction price is $16,800 computed as: $2,000 * 6 months + (60% * $4,000) + (40% * $6,000). Therefore Siddhi would recognize $16,800/6 = $2,800 each month

Expected values

calculated by summing the product of each possible amount and its probability

Core Princinple

companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchanged for those goods and services WHEN: upon transfer to customers HOW MUCH: amount the seller is entitled to recieve

Zack developed software that helps farmers to plow their fields in a manner that prevents erosion and maximizes the effectiveness of irrigation. Spurlock paid a licensing fee of $60,000 for a copy of the software. Although Spurlock can use the software as long as it wants, Zack expects that Spurlock will use the software for approximately 5 years. Zack does not anticipate any further interaction with Spurlock following transfer of the license. How much revenue should Zack recognize in the first year of the contract? a. $0 b. $12,000 c. $15,000 d. $60,000

d. Because Zack will have no continuing involvement, the license transfers a right of use, and all license revenue can be recognized upon transfer of control of the software to the customer.

Which of the following is not true about accounting for revenue from franchise arrangements? a. Franchise arrangements often include a performance obligation for a license as well as for delivery of goods and services. b. Franchise arrangements typically include one or more performance obligations for which revenue is recognized at a point in time. c. Franchise arrangements typically include one or more performance obligations for which revenue is recognized over a period of time. d. Franchise arrangements typically include one performance obligation because the goods and services included in the arrangement are not separately identifiable.

d. Franchise arrangements typically include multiple performance obligations because the goods and services included in the arrangement are both capable of being distinct and are separately identifiable.

Which of the following is not true? a. License fees are recognized over time for any license that is viewed as providing a right of access. b. Licensing fees are recognized as revenue over time for any licenses for which the seller expects its ongoing activities to affect the benefits that the buyer receives from intellectual property. c. License fees are recognized as revenue at a point in time if the buyer expects that the seller's future activities will not affect the benefit the buyer derives from the intellectual property. d. Licensing fees always are recognized as revenue at the end of the license period, when the seller has completed its performance obligation to provide access to its intellectual property.

d. If the seller provides access to its intellectual property, revenue is recognized over the period of time for which access is provided, not deferred until the end of the license period.

If a company can't recognize revenue over time it....

delays revenue recognition until the point in time that transfer has completely occured

To recognize revenue over time a seller needs to...

estimate progress towards completion 1. output-based estimate -> measured as the proportion of the goods or services transferred to date 2. input-based estimate -> measured as the proportion of effort expanded thus far relative to the total effort expected to satisfy the performance obligation

Payments by the Seller to the Customer

if the seller purchases distinct goods or services from the customer: - at a fair value of those goods or services, the seller accounts for that purchase as a separate transaction - pays more than the fair value of those goods or services, those excess payments are viewed as a refund (subtracted from the amount the seller is entitled to receive when calculating the transaction price of the sale to the customer

Most likely amount

if there are two probable outcomes, the most likely amount might be the best indication of the amount the seller would receive - 20% or 80% (80% is most likely amount)

Constraint on recognizing variable consideration

seller only include an estimate of variable consideration in the transaction price to the extent it is probable that a significant revenue reversal will not occur when the uncertainty associated with the variable consideration is resolved

Revenue Reognition - Prior GAPP

used realization principle for recognizing revenue when BOTH 1- earnings process is virtually complete and 2 - there is reasonable certainty as to the collectibility of the assets to be recieved