ACCT 301 - Chapter 6 Notes

Revenues

Inflows or other enhancements of assets or settlements of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying other activities.

Performance obligations

Promises to transfer goods and services to a customer; they are satisfied when the seller transfers control of goods or services to the customer.

Control

The customer has direct influence over the use of the good or service and obtains its benefits.

Core revenue recognition principle

Companies recognize revenues 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 service.

Five steps used to apply the revenue recognition principle

1. Identify the contract with a customer. 2. Identify the performance obligation(s) in the contract, 3. Determine the transaction price. 4. Allocate the transaction price to each performance obligation. 5. Recognize revenue when (or as) each performance obligation is satisfied.

When there is a single performance obligation in allocating the transaction price

No allocation required.

When there are multiple performance obligations in allocating the transaction price

Allocate a portion to each performance obligation.

When there is a single performance obligation in recognizing revenue when each performance obligation is satisfied

Recognize at a point in time over a period of time.

When there are multiple performance obligation in recognizing revenue when each performance obligation is satisfied

At whatever time is appropriate for each performance obligation.

The 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, and accepted the asset.

Revenue is recognized over time if either

The customer consumes the benefit of the seller’s work as it is performed or the customer controls the asset as it is created, or the seller is creating an asset that has no alternative use to the seller, and the seller has the legal right to receive payment for progress to date.

If one-third of a service has been performed

One-third of the performance obligation has been satisfied, so one-third of the revenue should be recognized.

If revenue is recognized over time, sellers need a way to estimate progress toward completion, they can use

Output-based or input-based estimates.

Output-based estimate

Measures progress toward completion as the proportion of the goods or services transferred to date if revenue is recognized over time by the seller.

Input-based estimate

Measures progress toward completion as the proportion of effort expended thus far relative to the total effort expected to satisfy the performance obligation.

Distinct

Sellers account for a promise to provide a good or service as a performance obligation if the good or service is ___ from other goods or services in the contract. The idea is to separate contracts into parts that can be viewed on a stand-alone basis.

Single performance obligation

Goods or services that are distinct are combined and treated as a ____.

A good or service is distinct if it is

Separately identifiable from other goods or services in the contract and capable of being distinct.

Context of the contract; individually; combined

The promises to transfer goods and services are distinct in the ___, because the seller is promising to provide goods and services ___ as opposed to promising to provide a ___ good or service for which the individual goods or services are inputs.

Transaction price

The amount the seller expects to be entitled to receive from the customer in exchange for providing goods and services.

Stand-alone selling price

The amount at which the good or service is sold separately under similar circumstances.

Contract

Establishes the legal rights and obligations of the seller and customer with respect to one or more performance obligations. Can be explicit or implicit.

The seller allocates the transaction price to performance obligations based on the

Relative stand-alone selling prices of the goods or services in each performance obligation.

The seller recognizes revenue at a single point in time when

Control passes to the customer.

The seller recognizes revenue over a period in time if either the

Customer consumes the benefit of seller’s work as it is performed, customer controls assets as it’s created, or seller is creating an asset that has no alternative use to the seller and the seller has a legal right to receive payment for work completed.

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.

Prepayments/deferrals

The cash flow precedes either expense or revenue recognition.

Quality-assurance warranty

An obligation by the seller to make repairs or replace products that are later demonstrated to be defective for some period of time after the sale.

Extended warranties

Additional, extended service that covers new problems arising after the buyer takes control of the product.

You have an extended warranty if either

The customer has the option to purchase the warranty separately from the seller or the warranty provides a service to the customer beyond only assuring that the seller delivered a product or service that was free from defects.

Option

Feature of a contract that allows the customer to receive additional goods or services at no cost or discount.

Options discounts

Software upgrades, customer loyalty programs, discounts on future goods or services, and contract renewal options.

Material right

Options for additional goods or services are considered performance obligations if they provide a ___ to the customer that the customer would not receive otherwise.

Step 1 of the revenue recognition principle

Identify the contract.

Step 2 of the revenue recognition principle

Identify the performance obligation(s).

Step 3 of the revenue recognition principle

Determine the transaction price.

Specific situations affecting the transaction price

Variable consideration and the constraint on its recognition, sales with a right return, identifying whether the seller is acting as a principal or an agent, the time value of money, and the payments by the seller to the customer.

Variable consideration

The portion of a transaction price that depends on the outcome of future events.

Contracts that include variable consideration

Construction (incentive payments), entertainment and media (royalities), health care (Medicare and Medicaid reimbursements), manufacturing (volume discounts and product returns), and telecommunications (rebates).

A seller can estimate variable consideration using

The expected value (sum of each possible amount multiplied by its probability) or the most likely amount.

Indicators that a significant revenue reversal could occur include

Poor evidence on which to base an estimate, dependence of the estimate on factors outside the seller’s control, a history of the seller changing payment terms on similar contracts, a broad range of outcomes that could occur, and a long delay before uncertainty resolves.

Right of return

Customers’ right to return merchandise to retailers if they are not satisfied.

Principal

Controls goods or services and is responsible for providing them to the customer.

Agent

Facilitates transfer of goods and services between sellers and customers.

If the time value of money is a significant part of the contract, the seller should view the transaction price as consisting of two components

A delivery component (equal to the cash price) and a financing component (interest considered paid to the customer or to the seller).

Step 4 of the revenue recognition principle

Allocate the transaction price to the performance bliggations.

Estimating stand-alone selling prices examples

Adjusted market assessment approach, expected cost plus margin approach, and residual approach.

Adjusted market assessment approach

The seller considers what it could sell the products or services for in the market in which it normally conducts business, perhaps referencing prices charged by competitors.

Expected cost plus margin approach

The seller estimates its costs of satisfying a performance obligation and then adds an appropriate profit margin.

Residual approach

The seller estimates an unknown stand-alone selling price by subtracting the sum of the known or estimated stand-alone selling prices of other goods or services in the contract from the total transaction price of the contract. Allowed only if the stand-alone selling price is highly uncertain.

Step 5 of the revenue recognition principle

Recognize revenue when (or as) each performance obligation is satisfied.

Licenses

Allow the customer to access the seller’s intellectual property.

Functional intellectual property

Has significant stand-alone functionality, such that the intellectual property can perform a function or task, be played, or be aired over various types of media; the seller typically recognizes revenue at the point in time the customer can start using functional intellectual property.

Functional intellectual property examples

Software, drug formulas, and media content like books, music, and movies.

Symbolic intellectual property

Has usefulness to the customer that depends on the seller’s ongoing activities, so it transfers a right of access; the seller recognizes revenue over the period of time the customer accesses the IP.

Symbolic intellectual property examples

Trademarks, logos, brand names, and franchise rights.

Franchise

Contractual arrangement under which the franchisor grants the franchisee the exclusive right to use the franchisor’s trademark or tradename within a geographical area, usually for a specified period of time.

Bill-and-hold

Occurs when a customer purchases goods but requests that the seller retain physical possession of the goods until a later date.

Sellers can recognize revenue prior to delivery only if

They conclude that the customer controls the product, there is a good reason for the bill-and-hold agreement, and the product is specifically identified as belonging to the customer and is ready for shipment.

Consignment

A selling arrangement whereby the consignor transfers goods to another company (“consignee”) to sell, while retaining legal title to those goods.

Gift card

Transferable prepayments for a specified dollar value of goods or services to be delivered at a future date. ___ give rise to deferred revenue liabilities until they are redeemed or viewed as not going to be redeemed (broken).

Contract liability

A label given if the seller received payment prior to satisfying a performance obligation.

The seller satisfies a performance obligation before the customer has paid for it

The seller records either a contract asset or accounts receivable.

Account receivable

The seller recognizes an ___ if the seller has an unconditional right to receive payment, which is the case if only the passage of time is required before the payment is due. Satisfied all of its performance obligations and is just waiting to be paid.

Contract asset

Asset recognizing that a seller has a conditional right to receive payment after satisfying a performance obligation.

Construction in process

Asset account equivalent to the asset work-in process inventory in a manufacturing company.

Billings on construction contract

Contra account to the asset construction in progress, recognizing that a customer has been billed for work performed; subtracted from construction in progress to determine balance sheet presentation.

Revenue recognized this period equals

(Total estimated revenue X percentage completed to date) minus revenue recognized in prior periods.