Chapter 18 Textbook Outline
Chapter 18 Textbook Outline Acc 302
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Date Created: 03/28/16
Chapter 18 – Revenue Recognition Textbook Notes The asset-liability approach is the basis for revenue recognition. o The asset-liability approach recognizes and measures revenue based on changes in assets and liabilities. o (a) the recognition and measurement of assets and liabilities and o (b) changes in those assets or liabilities over the life of the contract brings more discipline to the measurement of revenue, compared to the ”earned and realized” criteria in prior standards. Revenue recognition principle - recognition of revenue when the performance obligation is satisfied. 5 Step Process: Step 1: Identifying the Contract with Customers A contract is an agreement between two or more parties that creates enforceable rights or obligations. o Contracts can be written, oral, or implied from customary business practice. Revenue from a contract with a customer cannot be recognized until a contract exists. o On entering into a contract with a customer, a company obtains rights to receive consideration from the customer and assumes obligations to transfer goods or services to the customer (performance obligations). o The combination of those rights and performance obligations gives rise to an (net) asset or (net) liability. o If the measure of the remaining rights exceeds the measure of the remaining performance obligations, the contract is an asset (a contract asset). o Conversely, if the measure of the remaining performance obligations exceeds the measure of the remaining rights, the contract is a liability (a contract liability). Companies sometimes change the contract terms while it is ongoing; this is referred to as a contract modification. o When a contract modification occurs, companies determine whether a new contract (and performance obligations) results or whether it is a modification of the existing contract. Separate Performance Obligation - A company accounts for a contract modification as a new contract if both of the following conditions are satisfied: o The promised goods or services are distinct (i.e., the company sells them separately and they are not interdependent with other goods and services), and o The company has the right to receive an amount of consideration that reflects the standalone selling price of the promised goods or services. Step 2 - Identifying Separate Performance Obligations o A performance obligation is a promise in a contract to provide a product or service to a customer. o This promise may be explicit, implicit, or possibly based on customary business practice. To determine whether a performance obligation exists, the company must provide a distinct product or service. Step 3: Determining the Transaction Price o The transaction price is the amount of consideration that a company expects to receive from a customer in exchange for transferring goods and services. o The transaction price in a contract is often easily determined because the customer agrees to pay a fixed amount to the company over a short period of time. o In other contracts, companies must consider the following factors: Variable consideration Most likely amount - The single most likely amount in a range of possible consideration outcomes. Companies therefore may only recognize variable consideration if: o (1) they have experience with similar contracts and are able to estimate the cumulative amount of revenue, and o (2) based on experience, it is highly probable that there will not be a significant reversal of revenue previously recognized. Time value of money Imputed Interest Rate o The imputed interest rate is the more clearly determinable of either (1) the prevailing rate for a similar instrument of an issuer with a similar credit rating, or (2) a rate of interest that discounts the nominal amount of the instrument to the current sales price of the goods or services Noncash consideration Companies generally recognize revenue on the basis of the fair value of what is received. Consideration paid or payable to the customer Consideration paid or payable may include discounts, volume rebates, coupons, free products, or services. Step 4: Allocating the Transaction Price to Separate Performance Obligations o If an allocation is needed, the transaction price allocated to the various performance obligations is based on their relative fair values. The best measure of fair value is what the company could sell the good or service for on a standalone basis, referred to as the standalone selling price. Step 5: Recognizing Revenues When each Performance Obligation is Satisfied o A company satisfies its performance obligation when the customer obtains control of the good or service. o Companies recognize revenue over a period of time if the customer receives and consumes the benefits as the seller performs and one of the following two criteria is met: 1. The customer controls the asset as it is created or enhanced (e.g., a builder constructs a building on a customer’s property). 2. The company does not have an alternative use for the asset created or enhanced (e.g., an aircraft manufacturer builds specialty jets to a customer’s speciﬁcations) and either (a) the customer receives beneﬁts as the company performs and therefore the task would not need to be re-performed, or (b) the company has a right to payment and this right is enforceable o A company recognizes revenue from a performance obligation over time by measuring the progress toward completion. The method selected for measuring progress should depict the transfer of control from the company to the customer. The most common are the cost-to-cost and units-of-delivery methods. The objective of all these methods is to measure the extent of progress in terms of costs, units, or value added. Input measures (e.g., costs incurred and labor hours worked) are efforts devoted to a contract. Output measures (with units of delivery measured as tons produced, floors of a building completed, miles of a highway completed, etc.) track results Neither is universally applicable to all long-term projects. Their use requires the exercise of judgment and careful tailoring to the circumstances. Other Revenue Recognition Issues o Right of return Right of return for the product for various reasons (e.g., dissatisfaction with the product) and to receive any combination of the following. 1. A full or partial refund of any consideration paid. 2. A credit that can be applied against amounts owed, or that will be owed, to the seller. 3. Another product in exchange. What to recognize: Revenue for the transferred products in the amount of consideration to which the company is reasonably assured to be entitled (considering products expected to be returned. A refund liability. An asset (and corresponding adjustment to cost of sales) for its right to the asset from the company on settling the refund liability. o Consignments Manufacturers (or wholesalers) deliver goods but retain title to the goods until they are sold. This specialized method of marketing certain types of products makes use of an agreement called consignments. Under this arrangement, the consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer), who is to act as an agent for the consignor in selling the merchandise. Both consignor and consignee are interested in selling—the former to make a profit or develop a market, the latter to make a commission on the sale. The consignee accepts the merchandise and agrees to exercise due diligence in caring for and selling it. The consignee remits to the consignor cash received from customers, after deducting a sales commission and any chargeable expenses. In consignment sales, the consignor uses a modified version of the point-of-sale basis of revenue recognition. That is, the consignor recognizes revenue only after receiving notification of the sale and the cash remittance from the consignee. The consignor carries the merchandise as inventory throughout the consignment, separately classified as Inventory (consignments). The consignee does not record the merchandise as an asset on its books. Upon sale of the merchandise, the consignee has a liability for the net amount due the consignor. The consignor periodically receives from the consignee a report called account sales that shows the merchandise received, merchandise sold, expenses chargeable to the consignment, and the cash remitted. Revenue is then recognized by the consignor. o Repurchase agreements Companies enter into repurchase agreements, which allow them to transfer an asset to a customer but have an obligation or right to repurchase the asset at a later date. o Warranties Companies often provide one of two types of warranties to customers: 1. Warranties that the product meets agreed-upon speciﬁcations in the contract at the time the product is sold. This type of warranty is included in the sales price of a company’s product and is often referred to as an assurance-type warranty. 2. Warranties that provide an additional service beyond the assurance-type warranty. This warranty is not included in the sales price of the product and is referred to as a service-type warranty. As a consequence, it is recorded as a separate performance obligation o Bill and hold A bill-and-hold arrangement is a contract under which an entity bills a customer for a product but the entity retains physical possession of the product until it is transferred to the customer at a point in time in the future. o Nonrefundable upfront fees Companies sometimes receive payments (upfront fees ) from customers before they deliver a product or perform a service. Upfront payments generally relate to the initiation, activation, or setup of a good or service to be provided or performed in the future. In most cases, these upfront payments are nonrefundable. o Principal-agent relationships In a principal-agent relationship, the principal’s performance obligation is to provide goods or perform services for a customer. The agent’s performance obligation is to arrange for the principal to provide these goods or services to a customer. Presentation: o Contract assets are of two types: (1) unconditional rights to receive consideration because the company has satisfied its performance obligation with a customer, and (2)conditional rights to receive consideration because the company has satisfied one performance obligation but must satisfy another performance obligation in the contract before it can bill the customer. Companies should report unconditional rights to receive consideration as a receivable on the balance sheet. Conditional rights on the balance sheet should be reported separately as contract assets. o A contract liability is a company’s obligation to transfer goods or services to a customer for which the company has received consideration from the customer. A contract liability is generally referred to as Unearned Sales Revenue, Unearned Service Revenue, or another appropriate account title. o Companies may also report assets associated with fulfillment costs related to a revenue arrangement. o Companies divide fulfillment costs (contract acquisition costs) into two categories: 1. Those that give rise to an asset. 2. Those that are expensed as incurred. Companies recognize an asset for the incremental costs if these costs are incurred to obtain a contract with a customer. Companies only capitalize costs that are direct, incremental, and recoverable. o Collectibility refers to a customer’s credit risk, that is, the risk that a customer will be unable to pay the amount of consideration in accordance with the contract. Under the revenue guidance—as long as a contract exists (it is probable that the customer will pay)—the amount recognized as revenue is not adjusted for customer credit risk. o To achieve that objective, companies disclose qualitative and quantitative information about all of the following: Contracts with customers. These disclosures include the disaggregation of revenue, presentation of opening and closing balances in contract assets and contract liabilities, and significant information related to their performance obligations. Significant judgments. These disclosures include judgments and changes in these judgments that affect the determination of the transaction price, the allocation of the transaction price, and the determination of the timing of revenue. Assets recognized from costs incurred to fulfill a contract. These disclosures include the closing balances of assets recognized to obtain or fulfill a contract, the amount of amortization recognized, and the method used for amortization.
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