Becker FAR F2

Revenue Recognition

When an entity satisfies a performance obligation by transferring a good or service to a customer

ALL entities that enter into contracts w/customers must recognize revenue, EXCEPT for leases, insurance, non-warranty guarantees, and financial isntruments

5 Step approach to Revenue Recognition

I - Identify the contract w/customer

S - Separate performance obligations

T - Transaction price determination

A - Allocate the price to each performance obligation

R - Recognize revenue

1. Identify the contract w/customer

-Agreement between 2 or more parties and creates rights and obligations (can be verbal, written, or implied)

Criteria for Identifying a Contract

1. All parties approved the contract

2. Rights of each party are identified

3. Payment terms are identified

4. Contract has COMMERCIAL SUBSTANCE

5. Probable collection of consideration

2. Performance Obligation

promise to transfer a good or service to a customer; Distinct bundle or separate

Distinct Performance obligations MUST be...

1. Separately identifiable

2. customer can benefit independently

Separately identifiable if...

-Does not integrate w/others

-Does not customize or modify

-Does not depend on or relate to others

Non-separately identifiable Perf. Obligation

-Highly interrelated or interdependent

-Provides a significant service of integrating

3. Determine the transaction price based on effects of...

-Variable consideration (est. by range of amounts)

-Significant financing (consider time value of money)

-non cash considerations and any consideration payable to customer (reduction in transaction price and revenue)

4. Allocate price to performance obligation

Steps 2 and 3 combined

-Allocate stand alone selling price and any discount or variable consideration or ach good or service

-Should be determined for each performance obligation

5. Recognize Revenue

...when or as an entity satisfies performance obligation

Satisfy over time or at a point in time

Recognize revenue over time if any of the following is met...

1. creates or enhances an asset that the customer controls

2. Customer simultaneously receives and consumes the benefit

3. Does not create an asset w/alternative use

Output method

based on value to customers (how much you will vs. already did contribute)

Input method

Based on the entity's efforts to the satisfaction of PO (cost incurred vs. total expected cost)

Recognize revenue when each performance obligation is satisfied at a POINT IN TIME

Recognize when the customer takes control

-customer has accepted the asset

-entity has right to payment and customer has obligation to pay

-transferred physical possession of the asset

-customer has legal title to asset

-customer has significant rewards and risks

Contract Asset

reflects entity's right to consideration in exchange for goods or services that the entity transferred to customer

(receivable if payment due date conditioned by time)

Contract Liability

Must be booked when an entity has the obligation to transfer goods or services to a customer

Construction Contract Revenue Recognized over time if any of the following are met...

1. The entity's performance creates or enhances an asset that the customer controls (WIP)

2. The entity's performance does not create an asset w/Alternative use AND entity has enforceable right to receive payment for performance completed.

Use Input Method (Cost to cost) if profitable...

a. reasonable estimate profitability

b. provide a reliable measure of progress toward completion

Determination of revenue recognized (% of total income)

a. costs to date/total estimated costs

b. indicated by a measure of progress towards completion

Balance Sheet Presentation (of Construction Contract Revenue OVER TIME)

-Construction costs and estimated Gross profit are in "Construction in Progress" (inventory)

-Billings on construction are in "Progress billings" (contra-inventory)

B.S. Presentation Assets and Liabilities

Current Asset

- Due on accounts (Receivable)

-Cost and estimated earnings of uncompleted contract > Progress Billings

Current Liability

-Progress billings > cost and estimated earnings on uncompleted contract

Steps to determine Gross Profit

1. Compute GP of completed contract (contract price - estimated cost)

2. Compute % of completion (total Cost to date/total est. cost)

3. Compute GP Earned (profit to date) (steps 1*2)

4. Compute GP for Current Year (PTD at current FYE - beg. PTD)

Estimated Total Costs

total costs for a long term contract from inception to completion

Estimated costs to complete

Added costs incurred to date

(Projected expenses needed to finish a project.)

Construction Contract Revenue at POINT IN TIME

When LT construction contract doesn't meet criteria for recognizing revenue over time

Revenues and gross profit are recognized when contract is completed (deferred rev. and exp.)

T/F - Estimated GP is not recognized until contract is completed

TRUE

GP = Contract price - total costs

Excess of CIP or PB is classified as current asset or current liability

Loss on total contract

Advances + estimated additional payments = total expected Revenue

Recorded cost + estimated cost to complete = total expected cost

revenue-cost = profit (loss)

Incremental Costs to obtain a contract

-Recognized as an asset if the entity expects that it will recover these costs

-Recognize an expense if the costs would have been incurred regardless of whether the contract was obtained

Costs to fulfill a contract

these are costs incurred to fulfill a contract

Assets if... 1. related directly to contract, 2. enhance/generate entity resources, 3. expect to be recovered

Contract modification

Change in price or scope of contract approved by both parties

NEW if scope increases AND prices increases

EXISTING = adjustment to revenue to reflect change in transaction price

Principal

entity controls the good or service before transferred to customer

-revenue recognized when gross consideration is expected

Agent

entity arranges outside party to provide goods/services

-revenue recognized when the fee/commission is paid for performing specific function

Indicators of Principal vs. Agent

AGENT if...

-Another party is responsible

-No inventory risk

-Cannot establish or modify price

Types of Repurchase Agreements

Entity sells an asset and either promises to or has an option to repurchase asset

-Forward options (MUST repurchase)

-Call Options (CAN repurchase)...aka "Right"

-Put Options (MUST repurchase at customer request)

Forward or Call Option: Recognizing Revenue

repurchase price < original selling price = LEASE

repurchase price < original selling price - FINANCING ARRANGEMENT (recognize asset, liability, and interest expense)

Put Option: Recognizing Revenue

repurchase price < original selling price

1. Lease (if customer has significant economic incentive)

2. Sale w/right of return (NO economic incentive)

repurchase price < original selling price

1. FINANCING ARRANGEMENT

2. Sale w/Right of return

Bill and Hold Arrangement

Entity bills a customer for a product but retains physical possession of the product until it is transferred to the customer when buyer is ready to take delivery in the future.

Revenue is recognized depending on when the customer obtains control of the product.

Bill and Hold Arrangement CRITERIA

1. Substantive reason for arrangement

2. Product separately identified to customer

3. Ready for transfer to customer

4. Entity cannot use or redirect product held

Consignment

when the dealer or distributor has not obtained control of the product

Revenue is recognized when the dealer sells product to customer OR dealer obtains control of product

Consignment Conditions

-Entity controls product until event occurs

-Dealer has NO UNCONDITIONAL OBLIGATION to pay entity for product

-Entity can require return of product

Warranties (Built in or Added on)

If purchased separately... Distinct Service (due to promise with product)

If not separately... NO separate performance obligation

Factors to consider for Warranties

-If required by law, NOT Separate

-Longer than coverage period = performance obligation

-Specific tasks performed = NOT a performance obligation

Refund liabilities & right to return

1. Keep revenue for transferred products

2. Give back a refund liability

3. Get back an asset related to the subsequent recovery of products when refund liability is settled

Refund Liability

Amount entity does NOT expect to receive

Formula for recognizing Loss on LT Construction type Contracts OVER TIME

[(Total Cost to date)/(Total estimated cost of project)] * (total estimated GP) - (GP recognized to date)

Change in Accounting Estimate

PROSPECTIVE

1. It's not an error

2. Do NOT restate prior years

3. Follow Prospective Approach

-Must be disclosed in notes if Material

Change in Accounting Principle

RETROSPECTIVE

-Change from one acceptable accounting method to another

-Cannot change principles without Justification

Noncomparative Financial Statements (Change in ACC Principle)

1. Use New method in year presented

2. Find earnings as if method was always used

3. Adjust beginning R/E, NET of Tax!!

Comparative Financial Statements (Change in ACC Principle)

1. Use new method in ALL years

2. Calculate cumulative effect

3. Present effect NET of Tax to Beginning R/E

General Rules of Change in ACC Principle

-Adjust Beg. R/E, Net of tax for earliest period

-Use the new accounting principle for ALL periods presented

Exemptions to Change in ACC Principle

-Changes TO LIFO

-Changes in Depreciation Method

Account these as Prospective like estimates

Change in Accounting Entity

-RETROSPECTIVE: for comparative financial statements, adjust beginning retained earnings for the earliest period presented

-as a result of merger, acquisition, divestitures

Error Correction (PPA)

Corrections of errors in recognition, measurement, presentation, or disclosure from:

-math mistakes

-misapplication of GAAP

-oversight or misuse of facts

Change from Non-GAAP to GAAP

Comparative Financial Statements (Error Correction)

1. For year w/error presented, correct error in those prior Fin. St.

2. For year without error presented, adjust Net of Tax Beg. R/E of earliest period

Noncomparative Financial Statements (Error Correction)

Reported as an adjustment to beginning balance of R/E, Net of Tax

Accrual Accounting

-in accordance w/U.S. GAAP

-match revenues with expenses

Unearned Revenue (Deferred)

Cash received before revenue is earned

Prepaid Expense (Deferred)

Cash paid before expense is incurred

Accrued Expense (A/P)

Cash paid after expense incurred

AJE for Unearned Revenue

Dr. Unearned revenue

Cr. revenue

AJE for Prepaid Expense

Dr. Expense

Cr. Prepaid Expense

AJE for Accrued Revenue

Dr. A/R

Cr. Revenue

AJE for Accrued Expense

Dr. Expense

Cr. Accrued Liability

What would be an error correction that would need an AJE?

Sometimes an entity may record cash receipts to revenue/expense when they should have recorded an asset/liability

Rules for Recording an AJE

1. Must be recorded by end of entity FY BEFORE preparation of financial statements

2. Never involve "Cash" account

3. All AJE hit one Income statement account and one Balance Sheet Account

Questions to ask when working through AJE

-What was done?

-What should have been done?

-How do we get there to fix it?

AJE - Expense Terms

Debit to increase

Credit to decrease

AJE - Revenue Terms

Credit to Increase

Debit to decrease

Summary of Significant Accounting Policies

-Required by US GAAP

-1st or 2nd footnote

Disclosures in Significant ACC Policies

-measurement bases used in preparing Financial Statements

-specific accounting policies and methods used (basis of consolidation, depreciation methods, amortization of intangibles, inventory pricing, etc.)

Items NOT in summary of significant policies

-composition of detailed dollar amounts of ACC balances

-details on change in ACC principles

-dates of maturity and amount of LT Debt

-Yearly depr. computation

STILL IN FOOTNOTES THOUGH

Remaining Notes to Financial Statements

Contains all other information relevant to decision makers

includes facts not presented on face of Financial Statement or Summary of Significant ACC. Policies. Also includes other information about significant asset and/or liability accounts

Disclosure of Risk and Uncertainties

-Risk/Uncertainty around major operations, products, geographical distributions

-Relative importance of each business

-Use of accounting estimates in financial statement preparation

Certain Significant Estimates

When it is reasonably possible that an estimate will change in the near term and the effect will be material, an estimate of the effect should be disclosed

Examples of certain significant estimates

Inventory subject to technological obsolescence

Deferred tax asset valuation allowance

Capitalized computer software costs

Vulnerability due to concentrations

arise when an entity is exposed to risk of loss that could be mitigated through diversification

Disclose Vulnerability if...

1. concentration exists at financial statement date

2. risk of near-term severe impact (significant financial disruptive event)

3. events causing sever impact are possible!

Examples of Vulnerability due to concentrations

-volume of business with certain customer

-revenue from a particular product or service

-available supply from resources

-market/geographical area

Subsequent Event

An event or transaction that occurs after the balance sheet date but prior to the issuance of the financial statements and the auditor's reports that may materially affect the financial statements.

Recognized Subsequent Event (Type 1)

Additional info about Conditions existing on or before the balance sheet date

- Requires a F/S adjustment (commonly as a settlement of litigation or loss on uncollectible receivable)

Non recognized Subsequent Event (Type 2)

Conditions that do not exist at balance sheet date

- No adjustment needed

-Should be disclosed if needed to prevent misleading financial statement presentation

Public Firms & Subsequent Events

Must evaluate events until Fin. St. are issued (when widely distributed to users)

Private Firms & Subsequent Events

Must evaluate events until Fin. St. are AVAILABLE to be issued (after prepared and finalized)

Reissuance of Financial Statements

entity should not recognize events occurred between the date the original financial statements were issued and date reissued unless adjustment required by GAAP

Revised Financial Statements

Revised to correct error Retrospectively under GAAP, considered "reissued"

SEC filers = no disclosure required

Non SEC filers = disclose date through evaluation of issued/available and revised.

Fair Value

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

"Exit Price"

How are non-financial assets measured?

Using the highest and best use of asset (Ex. Land)

Does the Market based approach include transaction price?

No, it does not.

Principal Market

the market with the greatest volume or level of activity for the asset or liability (Price in market is FMV even if more advantageous price)

Most Advantageous Market

market with the best price for the asset or liability after considering transaction costs

Orderly Transaction

asset/liability exposed to market long enough to allow usual marketing activities; cannot be a forced transaction.

Market Participants

Market participants are not related parties. They are independent of the reporting entity. They also are knowledgeable and willing and able (but not compelled) to engage in transactions involving the asset or liability.

What's the goal of determining the Most Advantageous Market?

-To maximize the selling price of an asset

-To minimize the payment to transfer liability

Selling price (increase) - transaction price (decrease) = NRV (increase)

Highest and Best Use: Nonfinancial Assets

Generate economic benefit by:

- using the asset in high/best use OR

-selling the asset to another market participant who would use

Highest and Best Use: Liabilities and Financial Assets

Not relevant for Highest/Best use because

-such items have NO alternative use

-FV doesn't depend on use with group of assets or liabilities

FV Valuation Techniques (MIC)

Market Approach, Income Approach, Cost Approach

Market Approach

Use prices and other relevant information from market transactions involving identical or comparable assets and liabilities

Income Approach

converts future amounts, including cash flows or earnings, to a single discounted amount to measure fair value

Cost Approach

Uses current replacement costs to measure the FV of assets