ACIS 3115 Midterm 2

Revenue

Inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations

Measuring and reporting revenue is a critical aspect of financial reporting

It is important not only to determine how much revenue to recognize (record), but also when to recognize it

Companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods or services.

Five steps used to apply the principle

1. Identify the contract

   1. Legal rights of seller and customer

2. Identify the performance obligation(s)

   1. Single, multiple

3. Determine the transaction price

   1. Amount seller is entitled to receive from customer (single), amount seller is entitled to receive from customer (multiple)

4. Allocate the transaction price

   1. No allocation required (single), Allocate a portion to each performance obligation (multiple)

5. Recognize revenue when (or as) each performanc eobligation is satisfied

   1. At a point in time, over a period of time, at whatever tim eis appropriate for each performance obligation

A customer is more likely to control a good or service if the customer has

• An obligation to pay the seller

• Legal title to the asset

• Physical possession of the asset

• Assumed the risks and rewards of ownership

• Accepted the asset

Recognizing revenue at a single point in time (delivering items from one place to another)

Dr. Accounts receivable

Cr. Sales revenue

Recieve money from sale

Dr. Cash

Cr. Accounts receivable

Special issues in revenue recognition

Step 1: Specific requirements for contract existence

Step 2: Prepayments, warranties, customer options for additional goods or services

Step 3: Variable consideration, right of return, seller as principal or agent, time value of money, payments by seller to customer

Step 4: Various approaches to estimating stand-alone selling prices

Step 5: Licenses, franchises, bill-and-hold arrangements, consignment arrangements, gift cards

Disclosure: Disclosures on face of and in notes to the financial statements required

Special issues for step 1: identify the contract

• Contracts can be explicit or implicit, oral or written

• A contract exists for purposes of revenue recognition only if:

– The buyer and seller have approved the contract and are committed to perform their respective obligations

– Each party’s rights regarding the goods or services to be transferred can be identified

– Payment terms can be identified

–The contract has commercial substance, affecting the risk, timing, or amount of future cash flows

– It is probable that the seller will collect substantially all of the amount it is entitled to receive

• A contract does not exist if:

– Neither the seller nor the customer has performed any obligations under the contract, and

– Both the seller and the customer can terminate the contract without penalty

Not performance obligations

Prepayments are nonrefundable up-front fees for particular activities (part of the transaction price)

Quality-assurance warranties obligate the seller to make repairs or replace products that later are found to be defective or unsatisfactory (part of the performance obligation to deliver products of acceptable quality)

Performance obligations

• Extended warranties. A warranty is an extended warranty if either

– The customer has the option to purchase the warranty separately, or

– The warranty provides a service to the customer beyond quality assurance

• Options that provide a material right (a material right is something the customer would not receive otherwise, so the seller is obligated to provide it)

– Examples include software upgrades and customer loyalty programs

Determine the transaction price

Estimating the transaction price involves a variety of considerations, including:

a)͏ Variable consideration and the constraint on its recognition

b) Sales with a right of return (a particular type of variable consideration

c) Identifying whether the seller is acting as a principal or an agent

d)  Time value of money

e)  Payments by the seller to the customer

Variable consideration

Portion of a transaction price depends on the outcome of future events

– Examples:

• Construction—Incentive payments

• Entertainment and media—Royalties

• Health care—Medicare and Medicaid reimbursements

• Manufacturing—Volume discounts and product returns

• Telecommunications—Rebates

– Methods of estimation:

• Expected value

• Most likely amount

If there are several possible outcomes, the expected value will be more appropriate. On the other hand, if only two outcomes are possible, the most likely amount might be the best indication of the amount the seller will likely receive.