ACC 303 Chapter 17: Revenue Recognition (WIP, up to the start of 17.3)

Revenue from Contracts with Customers Standard

New comprehensive revenue recognition standard that:

1: Provides a more robust framework for addressing revenue recognition issues.

2: Improves comparability of revenue recognition.

3: Simplifies the preparation of financial statements by reducing the number of requirements to which companies must refer.

Asset Liability Approach

Recognizes and measures revenue based on changes in assets and liabilities.

Revenue Recognition Principle

Revenue is recognized when the performance obligation is satisfied.

The Five Step Process

Step 1: Identify the Contract with Customers

Step 2: Identify Separate Performance Obligations

Step 3: Determine the Transaction Price

Step 4: Allocate the Transaction Price to Separate Performance Obligations.

Step 5: Recognize Revenue as Each Performance Obligation Is Satisfied.

Step 1: Identify the Contract

A contract exists if:

It has commercial substance

The parties approved the contract.

Identification of parties’ rights is established.

Payment terms are identified.

It is probable that the consideration will be collected.

Contract

An agreement, written, oral, or implied, between two or more parties that creates enforceable rights or obligations. Revenue only exists with a valid contract. Revenue is only recognized when both parties have performed their obligations.

Collectability

If it is probable that the transaction price will not be collected, that is an indication that the parties are not committed to their obligations. Thus, revenue is not recognized.

Performance Obligation

A promise to provide a product or service to a customer.

Step 2: Identify Separate Performance Obligations

A product or service is distinct when the company can sell a good or service on a stand-alone basis. If two goods are highly interdependent, they are considered a single service or obligation.

Transaction Price

The amount of consideration that a company expects to receive for their goods and services.

Variable Consideration

When price is dependent on future events, companies may use either the expected value, or the most likely amount in a range of possible outcomes.

Step 3: Determine transaction price

Usually easy, as this is decided in advance. Otherwise, they must factor in variable consideration, noncash consideration, time value of money, and consideration paid or payable to the customer.

Time Value of Money

Used if the contract has a significant financing component. Fair value is determined by discounting the payment using an imputed interested rate, either:

1: The prevailing rate for a similar instrument of an issuer with a similar credit rating.

2: The 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 when given noncash consideration.

Consideration Paid or Payable to Customers

Includes discounts, volume rebates, coupons, free products or services. These elements reduce the consideration received and revenue recognized.

Standalone Selling Price

What the company could sell the good or service for on a standalone basis. The best measure of fair value.

Step 4: Allocating the Transaction Price to Separate Performance Obligations

If an allocation is necessary, it is done based on relative fair value, or the company’s best estimate. FV can be calculated by either the adjusted market assessment approach, expected cost plus a margin approach, or the residual approach.

Step 5: Recognizing Revenue When Each Performance Obligation Is Satisfied

Performance obligations are satisfied when the customer gains control of the good or service, determined by when the customer has the ability to direct the use of and obtain all of its remaining benefits.

For many service arrangements, revenue is recognized on a straight-line basis. Otherwise, costs are applied via either the cost-to-cost or units-of-delivery methods.

Sales Returns and Allowances

Contra account to Sales Revenue. Adjusting journal entry made at the end of the period.

Recorded as:

Dr. Sales Returns and Allowances 200
Cr. Accounts Receivable 200

Dr. Returned Inventory 80
Cr. Cost of Goods Sold 80

Accounting for expected sales returns

To account for expected returns:

Dr. Sales Returns and Allowance 100
Cr. Refund Liability 100

To record expected returns:

Dr. Estimated Inventory Returns 40
Cr. Cost of Goods Sold 40

Repurchase Agreements

Allows the company to transfer an asset to a customer with a call option to repurchase at a later date. Reported as borrowing.

The company continues to recognize the assets and recognizes a financial liability for cash received. Interest is recognized for the amount received when transferring and when the asset is bought back.

Lease Agreement

Repurchase agreement where the repurchase is for less than its selling price.

Financing Agreement

Repurchase agreement where the repurchase is for more than its selling price.

Repurchase Agreement Journal Entries

Initial Sale
Dr. Cash
Cr. Liability to Lane Company

Recording interest and retirement of liability
Dr. Interest Expense
Cr. Liability to Lane Company

Recording repurchase and closing out liability
Dr. Interest Expense 11,000
Cr. Liability to Lane Company 11,000
Dr. Liability to Lane Company 121,000
Cr. Cash 121,000

Bill-and-Hold Arrangements

A contract under which a company bills a customer for a product, but retains physical possession of the product until it is transferred to the customer later. Occurs when buyer cannot take delivery, but does take title and accepts billing.

Bill-and-Hold Journal Entry

Dr. Accounts Receivable 450,000
Cr. Sales Revenue 450,000
Dr. Cost of Goods Sold 280,000
Cr. Inventory 280,000

Principal-agent relationship

The principles obligation is to provide goods or perform services for the customer. The agent’s obligation is to arrange for the principle to provide these goods or services to a customer.

Agents revenue is the commission received, not what the principal receives.

Consignment

Manufacturers deliver goods and retain title to the goods until sold. Consignor delivers goods, consignee is an agent who sells them.

Consignee does not record the merchandise as an asset, and gains a liability for the amount due to the consignor.

Consignor occasionally receives account sales that show merchandise received, sold, expenses chargeable, and the cash remitted. The consignor then recognizes revenue.

Consignor journal entries

Dr. Inventory (Consignments) 36,000
Cr. Finished Goods Inventory 36,000

Payment of Freight Costs by Consignor
Dr. Inventory (Consignments) 3,750
Cr. Cash 3,750

Notification of sales and expenses and remittance or amount due
Dr. Cash 33,750
Dr. Advertising Expense 2,250
Dr. Commission Expense 4,000
Cr. Revenue from Consignment Sales 40,000

Adjustment of Inventory on consignment for cost of sales:
Dr. Cost of Goods Sold 26,500
Cr. Inventory (Consignments) 26,500

Consignee Journal Entries

Payment of Advertising from Consignor:
Dr. Receivable from Consignor 2,250
Cr. Cash 2,250

Sale of consigned merchandise:
Dr. Cash 40,000
Cr. Payable to Consignor 40,000

Notification of sales and expenses and remittance or amount due:
Dr. Payable to Consignor 40,000
Cr. Receivable from Consignor 2,250
Cr. Commission Revenue 4,000
Cr. Cash 33,750

Consignees only recognize commission revenue.

Warranties

Assurance-type, where the product is guaranteed to meet specific standards when sold.
or
Service-type, where an additional service is provided beyond the assurance-type warranty, not included in the cost of the sale.

There is no additional performance obligation for assurance type warranties. Service-types are typically considered an additional performance obligation.

Warranty Journal Entries

Sale of Product With Extended warranties
Dr. Cash 6,018,000
Cr. Sales Revenue 6,000,000
Cr. Unearned Warranty Revenue 18,000

To Record COGS and reduce inventory
Dr. Cost of Goods Sold 4,000,000
Cr. Inventory 4,000,000

To Record Warranty costs incurred
Dr. Warranty Expense 28,000
Cr. Salaries and Wages Payable 3,000
Cr. Inventory (Parts) 25,000

To record adjusting journal entry related to its assurance warranty at the end of the year:
Dr. Warranty Expense 44,000
Cr. Warranty Liability 44,000

Recognizing Warranty Revenue
Dr. Unearned Warranty Revenue 1,500
Cr. Warranty Reveue 1,500

Nonrefundable Upfront Fees

Not recorded as revenue at the time of payment. It is allocated over the periods benefitted.

Percentage of Completion Method

Recognizes revenue before delivery. Long-term construction contract.
When estimates of progress toward completion, revenues, and costs are reasonably dependable, and:
Contract clearly specifies enforceable rights regarding goods or services by the parties, the consideration to be exchanged, and the manner and terms of settlement
Buyer can be expected to satisfy all obligations.
Contractor can be expected to perform under the contract.

Cost Recovery Method (Zero-Profit)

Recognizes revenue before delivery. Long-term construction contract.
Use when one of the following applies
1: Company has primarily short-term contracts.
2: Company cannot meet the conditions for using P-O-C method, or
3: There are inherent hazards beyond the normal, recurring business risks in the contract.

Percentage of Completion Revenue

Costs incurred to date / Most recent estimate of total costs = Percent Complete

Percent Complete * Estimated total revenue (Or gross profit) = Revenue to be recognized to date.

Revenue (or gross profit) to be recognized to date - Revenue (or gross profit) recognized in prior periods = Current-period revenue (Or gross profit)

Based on cost numbers, not fair value.

Cost Recovery Method

Revenue is incurred at an identical rate to costs until the end, at which point all other revenues are recognized.

Cost Recovery Journal Entries

To recognize costs and related expenses
Dr. Construction Expenses 1,000,000
Cr. Revenue from Long-Term Contracts 1,000,000

Dr. Construction in Process (Gross Profit) 450,000
Dr. Construction in Expenses 1,134,000
Cr. Revenue from Long-Term Contracts 1,584,000

To record completion of the contract
Billings on Construction in Process 4,500,000
Construction in Process 4,500,000

Generally must be done across multiple years.

Application of Percentage of Completion Method

Year
Estimated Cost
Less
Costs to date
E. Costs to complete
E. Total Costs = CTD + E. CTC
E. Total G. Profit = EC - E. TC
Percent Complete = CTD / E. TC

Do this once for each year.

Computation of Recognizable Loss

1. Find percent complete.

2. Multiply by revenue recognized.

3. Subtract construction in process.

4. Subtract period costs incurred.

5. The result is loss recognized in period.