Chapter 5 Take 2
When does a contract no exist?
(a) Neither the seller nor the customer has performed any obligations under the contract (b) Both the seller and the customer can terminate the contract without penalty. *Essentially either the seller or the customer must have done something that has commercial substance for the seller to start accounting for revenue."
The seller recognizes revenue at a single point in time when control passes to the customer, which is more likely if the customer has:
- 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
Goods or services that are not distinct are:
- Combined and treated as a single PO [Sellers also treat as a single PO a series of distinct g or s that are substantially the same and have the same pattern of transfer]
How should you handle prepayments?
- Include them in the transaction price - Allocated to the various PO's in the contract - Initially recorded as deferred revenue - Recognized as revenue when (or as) each PO is satisfied
Five Steps Used to Apply the Principle:
1 Identify the contract with a customer 2 Identify the PO(s) in the contract 3 Determine the transaction price 4 Allocate the transaction price to each PO 5 Recognize revenue when (or as) each PO is satisfied
Special Issues for Step 2: Identify the PO(s) :
1 Prepayments 2 Warranties 3 Customer Options for Additional G or S
[Step 2 : Identify the PO(s) in the contract] Promises to provide goods and services are PO's when the goods and services are distinct. A good or service is distinct if it is both:
1. Capable of being distinct. The customer could use the g or s on its own or in combo w/ other g or s it could obtain elsewhere. 2. Separately identifiable from other goods or services in the contract. The g or s is distinct in the context of the contract because it is not highly interrelated with other g and s in the contract.
Criteria for Recognizing Revenue Over a Period of Time:
1. The customer consumes the benefit of the seller's work as it is performed, as when a company provides cleaning services to a customer for a period of time. 2. The customer controls the asset as it is created, as when a contractor builds an extension onto a customer's existing building. 3. The seller is creating an asset that has no alternative use to the seller, and the seller has the legal right to receive payment for progress to date, as when a company manufactures customized fighter jets for the U.S. Air Force.
Contract
An agreement that creates legally enforceable rights and obligations.
Why doesn't a contractually stated "list price" necessarily represent a stand-alone selling price?
Because the seller might actually sell the g or s for a different amount.
Core Revenue Recognition Principle:
Companies recognize 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 or services. When: upon transfer to customers How much: amount the seller is entitled to receive
When can performance obligation be satisfied?
Either at a point in time or over a period of time.
What is Revenue?
Inflow of cash or accounts receivable that a business receives when it provides goods or services to its customers.
What other methods can be used to estimate progress toward completion when PO's are satisfied over time?
Input-based and output-based methods
Discounts in Contracts with Multiple PO's : If there is no evidence that the discount relates to only one of the PO's, then :
It is spread between them in the allocation process.
Explain the term "control."
Means that the customer has direct influence over the use of the good or service and obtains its benefits.
Are Prepayments performance obligations?
No, because they aren't a promise to transfer a product or service to a customer *Instead these up-front fees is an advance payments for future products or services
Performance Obligations:
Promises by the seller to transfer goods or services to a customer.
Revenue Recognition was previously based on the:
Realization Principle
SFAC No. 6 : Defines "probable" to be :
Reasonably be expected or believed on the basis of available evidence or logic but is neither certain nor proved.
What is a "stand-alone selling price"?
The amount at which the g or s is sold separately under similar circumstances. [Seller should estimate price if they cannot reference the actual stand-alone selling prices]
What is the Transaction Price?
The amount the seller expects to be entitled to receive for the customer in exchange for providing goods and services. [When paid with other assets like property instead of cash, measure the asset received at fair value]
Discounts in Contracts with Multiple PO's : If there is clear evidence that the discount related to only one of the PO's, then :
The entire discount would be allocated to that one good or service.
How are transaction prices allocated with more than one PO?
The sellers allocates the transaction price to each one on proportion to the stand-alone selling prices of the goods or services underlying all the PO's in the contract.
Revenue with respect to a PO is recognized :
When (or as) the PO is satisfied.
When does a contract exist for purposes of revenue recognition?
When seller believes collectibility is probable for a contract to exist.
When are PO's satisfied?
When the seller transfers control of goods or services to the customer.