Intermediate Chapter 17 Notes
Intermediate Chapter 17 Notes 3310
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This 8 page Class Notes was uploaded by Emily Sears on Saturday January 30, 2016. The Class Notes belongs to 3310 at Auburn University taught by Dr. Duane Brandon in Spring 2016. Since its upload, it has received 48 views. For similar materials see Intermediate Accounting I in Accounting at Auburn University.
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Date Created: 01/30/16
CHAPTER 17: Advanced Issues in Revenue Recognition When canCompanies Recognize Revenue? After 10 years of discussion, in May 2014 the FASB and the IASB completed their revenue recognition project and issued Revenue from Contracts with Customers A company should recognize revenue to depict the transfer of promised goods or services to customers inan amount that reflect the consideration to which the entity expects to be entitled in exchange for those goods or services. The 5-Step Revenue RecognitionModel 1. Identify the contract with a customer 2. Identify the performance obligations in the contract 3. Determine the transaction price 4. Allocate the transaction price to the performance obligations in the contract 5. Recognize revenue when (or as) the company satisfies a performance obligation Contract excluded from new revenue standard: Leases, insurance contracts, financial instruments, guarantees Step1- Identify Contract with the Customer Customer- party that enters into contract to obtain goods/services Contract- an agreement (written, oral, or implied by customary business practice) between two or more parties that creates enforceable rights and obligations Contract must meet all of the following criteria: All parties approve the contract and commit to performing obligations Each party’s rights can be identified Payment terms can be identified The contract has commercial substance (ex: affects cash flows) It is probable that the company will collect the consideration Issues in Identifying a Contract: Termination Rights (either party can unilaterally cancel the contract) Combining Contracts (must combine two or more related contracts if certain conditions are met) Contract Modifications (Exhibit 17.2) Collectability (must be probable that the seller will collect expected consideration) Step2- Identify Performance Obligations Performance Obligation- a promise (explicit or implicit) in a contact with a customer to transfer goods or services Seller must evaluate the promised goods/services to determine whether each good/service is distinct (within the context of the contract) If the promise to deliver goods/services is distinct, the performance obligation is accounted for separately Note, satisfaction of performance obligations ultimately determines the amount/timing of revenue recognition Step3- Determine Transaction Price Determine the transaction price (amount of consideration to be recognized) by examining contract and how the company normally conducts business The seller must take into account additional factors that affect the transaction price such as: Time value of money (discount the promised amount of future consideration) Variable consideration (determine if there is applicable constraint on the consideration) (ex: discounts, penalties, rebates, bonuses, price concessions) Noncash consideration (estimate fair value) Consideration payable toa customer (discounts, refunds, coupons, rebates, etc) Step4- Allocate Transaction Price to Performance Obligations Contracts with customers sometimes contain multiple distinct performance obligations. Example: AT&T or Verizon sell phones along with a service contract that provides voice, text and data The seller allocates the transaction price to each performance obligation in proportion to the relative stand along selling prices of those goods and services. See Exhibit 17.5 for methods to estimate the stand-alone price Step5- When ShouldYou Recognize Revenue? Must determine when a performance obligation is satisfied in order to recognize revenue Seller satisfies an obligation by transferring control of a good or service to a customer (at a point in time or over time) Indicators that the customer has control Seller is entitled to payment Legal title transferred Physical possession Risks and rewards of ownership transferred Customer has accepted goods/services A performance obligation is satisfied at either a point in time (retail store) or over time (subscription) For a performance obligation to be satisfied over time, at least one of these conditions must be met: 1. Customer simultaneously receives and consumes the benefits of the seller’s performance as the seller performs (ex: service contracts) 2. Seller’s performance creates or enhances an asset (ex: WIP) that the customer controls (ex: construction or R&D contracts) 3. Seller’s performance does not create an asset with an alternative use to the seller. In addition, the seller has a right to payment for performance completed to date (ex: consulting contracts unique to the customer) Output methods or input methods are used to measure progress over time Presentation Issues When a seller ha satisfied a performance obligation but the customer has not yet paid, the seller records either a receivable or a contract asset A receivable represents the seller’s unconditional right to receive consideration from a customer A contract asset arises when the seller’s right to consideration from a customer is conditional upon something other than the passage of time A contract liability represents the seller’s performance obligation and arises when a customer’s payment of consideration occurs prior to the seller’s performance under the contract Disclosure Issues Companies should disclose both qualitative and quantitative information about contracts with customers and any significant judgments about applying guidance, including: Disaggregation of revenue into categories Reconciliation of the opening and closing balances of contract assets and liabilities. Information about significant changes in contract balances Information about performance obligations Significant judgments Long-Term Contracts Long-term contracts may involve projects such as buildings, airplanes, ships, roads, bridges, and dams, which can take several years to complete. Most long-term contracts are accounted for as a single performance obligation (because the separate obligations within the contract are not distinct) which is normally satisfied over time because: The buyer and seller obtain enforceable rights, including the right of the buyer to enforce specific performance The buyer usually makes progress payments providing evidence of the buyer’s ownership interest The buyer has the right to take over the work in progress Recognition of Net Assets Net Assets = Assets – Liabilities The period in which a company recognizes revenue and expenses is also the period in which it recognizes an increase in the value of its net assets. Consider the case where revenue is recognized at point of sale: Accounting for L-T Contracts Over Time- % CompletionMethod Revenue and expense (and thus, profit) is recognized each period in proportion to the estimated progress made (based on an input or output method) The company uses an inventory account, Construction in Progress, to record all project costs and adds the gross profit recognized, so that at the end of the period, inventory is valued at net realizable value. As the company completes portions of the contract, it may bill the customer for a partial payment for which the company debits a receivable account and credits the Partial Billings account, as a contra account to Construction in Progress This results in the net balance sheet amount being an asset if Construction in Progress exceeds Partial Billings or a liability if Partial Billings exceeds Construction in Progress. Accounting for L-T Contracts Over Time- Completed Contract Method For companies engaged in long-term construction projects that span multiple years, the Completed Contract Method is applied for revenue recognition when estimates of progress cannot be made Revenue and expense (and, thus, profit) is recognized only upon completion of the contract Thus, during the construction process, inventory is valued at the costs incurred less any partial billings (there is no gross profit to include) Expected Losses on L-T Contracts Two types of losses (ex: negative gross profit): 1. Estimates of future costs indicate that there is a loss in the current period, but there will be a profit on the total contract. Recognize current-period loss and treat as a change in accounting estimate. 2. Estimates of future costs indicate that there will be an overall loss on the entire contract. Recognize entire loss in current period. These requirements apply to both % Completed Method and Completed Contract Method CONSERVATISM PRINCIPLE!
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