28.1—Revenue Recognition

How does a company recognize revenue when it makes a sale in an exchange of product for cash?

when ownership changes i.e. the moment of the sale

transfer of title

TRUE or FALSE: the recognition of revenue is not dependent on receiving cash payment.

True

Just dependent on title

How does a company recognize revenue when it makes a sale in an exchange of product for credit?

Transfer of title, however, an accounts receivable account must be booked

Revenue is recognized in the period in which it is ______.

earned

This is not necessarily the period in which cash is actually collected

TRUE or FALSE: revenue is reported without returns and allowances being netted out.

False

Returns and allowances are netted out

TRUE or FALSE: a firm should recognize revenue even when it is probably that it will not have to reverse it.

False

If there is a probable chance that revenue will not be collected, than revenue should not be recognized

Indicators that a customer has gained title

1.) Physical possession by the customer

2.) Acceptance of the good or service by the customer

3.) Customer takes on risk and benefits from ownership

4.) Customer holds legal title

5.) Seller having the right of payment

How is revenue recognized in a Long-Term Contract?

based on a firm’s progress toward completing a performance obligation over the period of the contract

Performance Obligation

a promise to deliver a distinct good or service

Criteria for a good or service to be considered distinct

(just has to meet one of two)

1.) The customer can benefit from the good or service on its own or combined with other resources readily available

2.) The promise to transfer the good or service can identified separately form any other promises

How is a completing a performance obligation measured?

Input or Output side

Measuring completion of a performance obligation through the input side

the % of completion costs incurred

Measuring completion of a performance obligation through the output side

Engineering milestones or % of total output delivered

What are the criteria for which a performance obligation is satisfied over a period of time

(meet one of three)

1.) Customer receives and benefits from the good or service over time as the supplier meets the obligations of the contract

2.) The supplier enhances an existing asset or creates a new asset that the customer controls over the period in which the asset is created or enhanced

3.) The asset has no alternative use for the supplier, and the supplier has the right to enforce payment for work completed to date

In a Long-Term Contract, what costs are capitalized?

Costs to secure the contract, sales commission

What approach do GAAP and IFRS take on recognizing revenue?

Principle-based approach

5 Step Converged Process for Recognizing Revenue

1.) ID the contract(s) with a customer

2.) ID the separate or distinct 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 entity satsifies the performance obligation(s)

Contract

an agreement between two or more parties that specifies their obligations and rights

What must be probable for a contract to exist?

Collectibility

Required disclosures under the converged standards for revenue recognition

Contracts with customers by category

Assets liabilities related to contracts

Outstanding performance obligations and the transaction prices allocated to them

Management judgments used to determine the amount and timing of revenue recognition

Transaction Price

the amount a firm expects to receive from a customer in exchange for transferring a good or service

TRUE or FALSE: the transaction price must be fixed; cannot be variable

false

can be either fixed or variable, usually fixed

Various Circumstances to familiar with when interpreting revenue recognition

1.) Long-Term Contracts

2.) Acting as an agent

3.) Franchising and Licensing

4.) Service vs License

5.) Bill-and-Hold Agreements