Financial Exam 2

Revenue Recognition Steps

1) Identify Contract

2) Identify Performance Obligations

3) Determine Transaction Price

4) Allocate Transaction Price to Performance Obligations

5) Recognize Revenue as Performance Obligations are Met

Variable Consideration Transaction Price Approaches (2)

Expected Value Approach & Most Likely Approach

Principal

The organization that provides a good or service, sets prices, and has inventory risk. Their recognized revenue includes full good/service revenue as well as fees remitted to agents

Agent

The organization that facilitates transactions, usually without inventory risk or price management. Their recognized revenue includes fees to the principal

Expected Value Approach

The sum of each possible outcome: (probability of occurrence x payment)

Most Likely Approach

Payment for the event that is the most likely to occur

Methods of Finding Standalone Selling Price for Performance Obligations

A) Estimate Fair Value (internal company approach)

B) Adjust Market Assessment

C) Expected Cost Plus Margin

D) Residual Approach
These occur before allocating transaction price to performance obligations

Adjust Market Assessment Approach

Take price charged by similar vendors and adjust it. Adjustment might be done by finding their price ratio (compared to total products price) and applying it to a different company’s total products price

Expected Cost Plus Margin Approach

Cost + (cost x profit margin over cost)

Residual Approach

Total transaction price - standalone value of other contract items

When is revenue recognized for functional intellectual property?

When buyers can start using the IP

Bill & Hold Criteria

1) A customer controls the product

2) There’s a valid reason for the bill & hold

3) The product is identified as belonging to the customer & is ready to ship

Contract Asset vs AR vs Contract Liability

Contract Asset: a conditional right to an asset

Accounts Receivable: an unconditional right to an asset

Contract Liability: an obligation, like deferred revenue, to provide an asset

Sales Discounts Journal Entry: Gross Method

1) Recognize full revenue upon purchase

2) Recognize sales discounts as they are taken

Sales Discounts Journal Entry: Net Method

1) Recognize revenue net of full discount

2) Record sales discounts forfeited as a gain at the end of the period

Sales Returns Journal Entry: Actual

Returns x

Cash x

Inventory x

COGS x

Sales Returns Journal Entry: Estimated

Returns x

Refund Liability x

Inventory
(Estimated x
returns)

COGS x

Sales Returns Journal Entry: Future Actual Returns

Refund Liability x

Cash x

Inventory x

Inventory
(Estimated x
Returns)

Sales Returns Journal Entry: Change in Estimate

Refund Liability x

Sales Returns x

COGS x

Inventory
(Estimated x
Returns)

Recording Bad Debt Expense Methods

1) Balance Sheet Approach - AR Aging Schedule

2) Income Statement Approach - % of Net Credit Sales

Perpetual Inventory Method

This is the method you’re used to: inventory gets updated perpetually as transactions occur in real time

Periodic Inventory Method

When inventory is updated at the end of a period. All transactions (like purchases, freight-in, discounts, and returns) go to temporary accounts that are resolved to inventory and COGS.
At the end of a period, ending inventory, returns, and discounts are debited, and beginning inventory, purchases, and freight are credit to find COGS (leftover debit balance)