Chapter 16 Investments/ Chapter 17 Revenue Recognition

Investments

• Debt Inv: Bonds

• Equity: Stock

We are going to be the people lending the money

Motivations for Investing

• To earn a high rate of return

• To secure certain operating or financing arrangements with another company

IN class:

• Business Investing: Not only to make return, but also to make business connection. Ex. Customer company Invests in suppler company. This way you can have a say in management, also get cheaper price of RM

Debt Securities

• Management Intent

  • Can either be No plans to sell or Plan to sell

• Valuation Approach

  • Amortized Cost= the last column of the amortization table

  • Fair value= when the incentive is plan to sell

• Examples

  • Us government securities— municipal securities

  • Corporate bonds

  • convertible debt

Equity Securities

• Management Intent

  • Plan to sell

  • Exercise some control

• Valuation Approach

  • Fair Value

  • Equity Method

Debit Securities Accounting Category

• Held to Maturity

• Trading: Waiting for a good price to sell

• Available for Sale (AFS): don’t know what to do yet exactly yet.

Held to Maturity

• Valuation

  • Amortized Cost

• Unrealized Gain or Loss

  • Not recognized

• Other Income effects

  • Interest when earned; gains and losses from sale

Trading

• Valuation

  • Fair Value

• Unrealized Gain or Loss

  • recognized in Net income

• Other Income effects

  • Waiting for a good price to sell

Available For Sale (AFS)

• Valuation

  • Fair Value

• Unrealized Gain or Loss

  • recognized as other Comprehensive Income and as a separate componet of equity

• Other Income effects

  • Don’t know what to do yet exactly. If not held to m or trading it is gonna be AFS

Sale of Debt Securities

If a company sells bond before maturity date:

• It must make entries to remove the debt investments account and the amortized cost of bonds sold

• Any realized Gain or Loss on sale is reported in the “other” section of the income statement

Investments in Equity Securities

Represents Ownership of capital stock

Cost Includes:

• Price of the security, PLUS

• broker’s commissions and fees related to purchase

The degree to which one corp (investor) acquires an interest in common stock of another corporation (investee) generally determines the accounting treatment for the investment subsquent to acquisition

Equity Securities Accounting Category

• Holding Less than 20%

• Holding between 20%—50%

• Holding between more than 50%

Holding Less than 20%

• Valuation

  • Fair Value

• Unrealized Gain or Loss

  • recognized gains or Loss in Net income

• Other Income effects

  • Dividends declared; gains and losses from sale

Holding Between 20-50%

• Valuation

  • Equity Method

• Unrealized Gain or Loss

  • NOT recognized

• Other Income effects

  • Proportionate share of investor’s net income

Holding More than 50%

• Valuation

  • Consolidation

• Unrealized Gain or Loss

  • NOT recognized

• Other Income effects

  • Not applicable

Five Steps of Revenue Recognition

1. Identifying contract with customers

2. Separate Performance Obligations

3. Determining the Transaction Price

4. Allocating Transaction Price to Separate Performance Obligations

5. Recognizing Revenue when Each Performance Obligation is Satisified

Identifying contract with customers

Contract: agreement between the two parties or more that creates enforceable rights or obligations

• Can be: written, oral, or implied from customary business practice

Company applies the revenue guidance to a contract according to the following criteria:

1. The Contract has commercial substance (impact on CF— Dollar amount, timing, risk)

2. The parties have approved the contract

3. Identification of the rights of the parties is established

4. Payment terms are identified

5. It is probable that the consideration will be collected

2. Separate Performance Obligations

A ___ is a promise to provide a distinct product or service to a customer

• A product or service is distinct when a customer is able to:

  • Benefit from good or service on its own OR

  • together with other readily available resources

3. Determining the Transaction Price

Amount of consideration that company expects to receive from a customer

Companies must consider:

• Variable Consideration:

  • Amt received depends on something in the future

  • If you Buy $100 amount of stuff, with 20% discount. the Transaction price is 80

• Time Value of Money

  • Longer than 1 year. Notes payable

• Non cash consideration

  • doesn’t always have to receive cash

  • FV the more reliable number

• Consideration Paid or Payable to the Customer

  • Ex. Rebates. If you buy $100 stuff, I will give 20. Then transaction price is 80 if used . You have to estimate

  • e.g. discounts, volume rebates, coupons, free products

  • reduce consideration received and the revenue to be recognized

Variable Consideration

• Price dependent on future events

  • might include discounts, rebates, credits, performance bonus, or royalties

• Companies estimate amount of revenue to recognize

  • Expected value (probability-weighted)

  • most likely amount

• Expected Value:

  • Probability-weighted amount in a range of possible consideration amounts

  • may be appropriate if a company has large number of contracts with similar characteristics

  • can be based on a limited number of discrete outcomes and probabilities

• Most likely Amount:

  • The single most likely amount in a range of possible consideration outcomes

  • may be appropriate if the contract has two possible outcomes.

4. Allocating Transaction Price to Separate Performance Obligations

• Based on their relative fair values

• Best measure of fair value is what company could sell the good or service for on a stand alone basis

• If not available, companies should use their best estimate of what the good or service might sell for as a standalone unit.

Allocation Approach

1. Adjusted Market Assessment Approach: Proportional Method

2. Expected cost plus margin approach: Not gonna use FV, gonna find different matches cost ( cost + margin)

3. Residual Approach: Incremental Method

5. Recognizing Revenue When Each Performance Obligation is Satisfied

Company satisfies its performance obligation when the customer obtains control of the good or service.

Change in control Indicators:

1. Company has a right to payment for asset

2. Company has transferred to legal title to asset

3. Company has transferred physical possession of asset

4. Customer has significant risks and rewards ownership

5. Customer has accepted the asset

Recognizing Revenue from a performance Obligation over time

• Measure progress towards completion

  • method for measuring progress should depict transfer of control from company to customer

  • objective of methods is to measure extent of progress in terms of costs, units, or value added

    • Ex. Long-term construction (over 1 year)

Revenue Recognition Issues

1. Sales Return (example on handout); Know JEs

2. Repurchase agreement

3. Bill and hold agreement

4. Principal-agent arrangement.

5. Consignment (ex on handout); Know JEs

6. Warranties

7. Nonrefundable upfront fees

Revenue Recognition Over time

A company satisfies a performance obligation and recognizes revenue over time if at least one of the following 3 criteria is met:

1. The customer simultaneously receives and consumes the benefits of the seller’s performance as the seller performs

2. The company’s performance creates on enhance an assets (for example, work in progress) that the customer controls as the asset is created or enhanced; OR

3. The company’s performance does not create an asset with an alternative use.

Methods for Accounting Revenue Recognition

1. Percentage-of-completion Method ( if we meet at least one of 3 requirements).

• Recognize revenue and gross profit each period based upon the progress of the construction

• buyer and seller have enforceable rights

2. Completed-Contract Method/Cost Recovery

• Recognize revenues and gross profit only when the contract is completed

Consignment

Owner of products give products to store to sell for commission

Reimbursable

usually means receivable for consignee

Long-Term Contract Losses

• Contract Price < cost of project

1. Loss in current on a Profitable contract

• Percentage-of-completion method only, the estimated cost increase requires a current-period adjustment of gross profit recognized in prior periods

• Still profitable upon completion