Acct 5110 final review

WHEN CAN COMPANIES RECOGNIZE

REVENUE

A company should recognize revenue to depict the

transfer of promised goods or services to customers in

an amount that reflects the consideration to which the

entity expects to be entitled in exchange for those goods

or services

5 step revenue recognition model

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

step 1

Identify contract with 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 (i.e., affects cash flows).

• It is probable that the company will collect the consideration

Issues in Identifying a Contract

Termination

combining contracts

contract modifications

Collectability

Termination Rights - who can terminate

Either party can unilaterally cancel the

contract

Combining Contracts

must combine two or more related contracts

if certain conditions are met

Collectability

It must be probable that the seller will collect

expected consideration

Step 2

Identifying Performance Obligations

Performance Obligation

a promise (explicit or implicit) in a contract with a customer to transfer goods or services

STEP 3

Determine the transaction price

transaction price

(i.e., 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

Variable consideration

Non-Cash consideration

Consideration payable to a customer

Step 4:

ALLOCATE TRANSACTION PRICE TO

PERFORMANCE OBLIGATIONS

Step 5

When should you recognize revenue ?

Indicators that customer has control

• Seller is entitled to payment

• Legal title transferred

• Physical possession

• Risks and rewards of ownership transferred

• Customer has accepted goods/services

When should you recognize revenue ?

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 (e.g., service contracts)

2. Seller's performance creates or enhances an asset (e.g. WIP) that the customer controls (e.g., 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 (e.g., consulting contracts unique to the customer)

What methods are used to measure progress over time?

Output methods or input methods

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

Most long-term contracts are accounted for as a single

performance obligation which is normally satisfied over

time because (3 reasons)

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

Net Assets =

Assets - Liabilities

The period in which a company recognizes revenue and

expenses is also the period

it recognizes an increase in the value of its net assets

What are the two types of losses in recognizing losses?

1. Current-period loss with future profit on the total contract. 2. Overall loss on the entire contract.

How should a current-period loss be treated if future costs indicate a profit on the total contract?

Recognize the current-period loss and treat it as a change in accounting estimate.

What should be done if estimates indicate an overall loss on the entire contract?

Recognize the entire loss in the current period.

what kind of account is construction in progress

inventory

what is the contra account to construction in progress

partial billing

How many types of accounting changes are there

3

Change in an Accounting Principle

This type of change occurs when a company adopts a GAAP different from the one used previously for reporting purposes

Change in an Accounting Estimate

This type of change is required

because an earlier estimate has proven to require modifying as new events occur, more experience is acquired, or additional information is obtained

Change in a Reporting Entity

This type of change is caused by a

change in the entity being reported

What is similar to change

error corrections

The retrospective application of a new accounting principle

restate its financial statements of prior periods,

Adjust for the change prospectively

change currently and going forward

A change in an accounting principle is accounted for by the

retrospective application of the new accounting principle

A change in an accounting estimate is accounted for

prospectively

A change in a reporting entity is accounted for by the

retrospective adjustment so that all the financial statements

presented are for the same entity

An error is accounted for as a

prior period adjustment - similar to retrospective

What does the SEC require in annual reports regarding financial statements?

Complete comparative financial statements presenting three years for income statement and two years for balance sheet.

How many years of summary financial data does the SEC require in annual reports?

Summary financial data for the previous five years.

How is a change in the amortization or depreciation method treated under GAAP?

As a change in an estimate.

What must a company do if it cannot determine the effect of a change in accounting principle on prior periods?

The company must apply the new accounting principle as if the change was made prospectively as of the earliest date practicable.

What justification must management provide when changing an accounting principle?

Management must justify the change on the grounds that the new principle is preferable to the old.

What does the SEC require from auditors when a company changes its accounting principle?

The SEC requires the auditor to submit a letter indicating whether the change is to an alternative principle that is preferable under the circumstances.

What does FASB provide when a company changes an accounting principle?

FASB provides transition rules that define the accounting method a company uses to conform to a new principle required by the issuance of new GAAP.

2 exceptions of changing accounting principal

if dealing with depreciation and if you are changing to LIFO

A change in reporting entity occurs

any tme you change who you are reporting for. Ex. acquiring or selling a subsidiary

what does an error need to be in order to be corrected

a material error

Error examples

1. The use of an accounting principle that is not generally accepted.

2. The use of an estimate that was not made in good faith.

3. Mathematical miscalculations.

4. The omission of a deferral or accrual.

Required steps for correcting an error:

1. Analyze the original erroneous journal entry and determine all the debits and credits that were recorded. 2. Determine the correct journal entry and the appropriate debits and credits. An offsetting adjustment is made to the beginning balance of Retained Earnings to report the cumulative effect of the error correction.

3. Adjust the financial statements of each prior period to reflect the specific effects of correcting the error.

4. Prepare the correcting entry (or entries) and disclose pertinent information.

SEC

Delegates its legal authority (granted by Congress) to set GAAP for U.S. companies to the FASB and to set IFRS for international companies to the IASB

FASB

issued Statements of Financial Accounting Standards (SFASs) through mid-2009.

Decision usefulness

is identifiedand defined in terms of fundamental (necessary) qualitative characteristics and enhancing qualitative characteristics

two things needed for decision usefulness

relevant and faithfully represented

Predictive Value

if it can be used to correctly forecast the outcome

of some event(s) of a firm

Information is relevant if it has

the potential to make a difference in a decision

Confirmatory Value

if it can confirm or correct prior expectations

Materiality

the nature and magnitude of an omission or

misstatement of accounting information that would influence the judgment of a reasonable person relying on the information

Faithful Representation

the transaction reflects the economic substance rather than legal form

Complete

the information provides a user with full disclosure of all

the information necessary to understand the information being reported, with all necessary facts, descriptions, and explanations

Neutral

the information is not biased, slanted, emphasized, or

otherwise manipulated to achieve a predetermined result or to influence users' behavior in a particular direction

Free from Error

the information is measured and described as

accurately as possible, using a process that reflects the best

available inputs

Adjusting entries

are journal entries made at the end of the period so

that a company's financial statements include the correct amounts for the current period

Closing entries

are used to transfer temporary account balances

to permanent accounts

The Closing 4-step process:

1. Close revenue/gain accounts to Income Summary Account

2. Close expense/loss accounts to Income Summary Account

3. Close Income Summary account to Retained Earnings Account

4. Close Dividends to Retained Earnings

Reversing entries

are optional and simplify the recording of a later

transaction related to the adjusting journal entry

5-step recognition process:

(1) Identify contract with customer

(2) Identify performance obligations

(3) Determine transaction price

(4) Allocate transaction price to performance obligations

(5) Recognize revenue when (or as) the entity satisfies performance obligations

Expense recognition principles:

association of cause and effect

systematic and rational allocation

immediate recognition

association of cause and effect presumed to be directly related

to specific revenues (e.g.,. COGS, sales commissions)

presumed to be directly related to specific revenues (e.g.,. COGS, sales commissions)

systematic and rational allocation

allocate among periods in which benefits are provided

immediate recognition

recognize in current period

Income Statement componets

1. Income from continuing operations

2. Results from discontinued operations

3. Net income

4. Earnings per share

Net method

record net invoice price at time of sale (i.e., assume

discount will be taken).

Gross method

record total invoice price at time of sale (i.e., assume

discount will not be taken)

Bad debts can be estimated based on

sales or on accounts receivable

Relationship to sales is which approach

income statement approach

Relationship to sales calculation method

• Percentage of net credit sales

Relationship to accounts receivable calculation methods

• Percentage of outstanding accounts receivable

• Aging of accounts receivable

Relationship to accounts receivable - which approach

balance sheet approach

3 kinds of inventory companies

Retail companies

Manufacturing companies

service companies

Bond

a type of note in which a company agrees to pay the

holder the face value at the maturity date and usually to pay

interest periodically at a specified rate on the face value

Bond Certificate

a legal document that specifies details

Bond Indenture

a document (contract) that defines the rights

of the bondholders

The face (or par) value

is the amount that the issuer agrees to

pay at maturity.

The stated, face, nominal, coupon, or contract rate

is the rate at which the issuer of the bond agrees to pay interest each period until maturity.

The yield (effective rate)

is the market rate at which the bonds are actually sold

No significant influence

- passive investments (generally <20% ownership). The "fair value" method is used to account for these securities. This method results in "unrealized holding gains and losses.