Chapter 30 Flashcards
5 Step model for Rev Recg:
Rev Disclosure Requirements
When is rev recg?
Rev is recognized in period which it is earned, this doesn’t mean it got the cash from the customer if it was bought on credit.
Rev: Money from credit, what is it and where on fin statements?
Money from credit is an asset, A/R, and is created on BS
Rev on IS
On Incomes statement:
Rev is reported as net (after) of any returns and allowances (the amt of AR you wont get from customers who owe money to you).
Unearned Rev
- When you get payment before you transfer goods or services
- Liability
- Unearned rev is created until you get cash. (offsetting the increase in the asset cash)
- Rev is recognized when you transfer goods to buyer, like subscription purchase for magazine.
o When the subscription is purchased, an unearned revenue liability is created, and as magazine issues are delivered, revenue is recorded and the liability is decreased.
performance obligation
A performance obligation is a promise to deliver a distinct good or service.
“distinct good or service” for performance obligation criteria:
A distinct good or service is one that meets the following criteria:
- The customer can benefit from the good or service on its own or combined with other resources that are readily available.
- The promise to transfer the good or service can be identified separately from any other promises.
- Firm recognizes rev when performance obligation is satisfied by transferring the control of goods or services from seller to buyer.
o Control is :
physical position by customer,
accepting good or services,
customer taking on risk of ownership,
customer holding legal title,
seller having a right of pmt.
Control of goods means:
*Firm reconizes rev when performance obligation is satisfied by transferring the control of goods or services from seller to buyer.
o Control is :
physical position by customer,
accepting good or services,
customer taking on risk of ownership,
customer holding legal title,
seller having a right of pmt.
transaction price
A transaction price is the amount a firm expects to receive from a customer in exchange for transferring a good or service to the customer. A transaction price is usually a fixed amount, but it can also be variable (e.g., if it includes a bonus for early delivery).
LT contracts, when is rev recg?
Input vs Output
Long-Term Contracts:
- rev is recognized based on firms progress towards completing a performance obligation over a period of time.
o Progress toward completion can be measured from the input side (e.g., using the percentage of completion costs incurred as of the statement date).
o Progress can also be measured from the output side, using engineering milestones or the percentage of total output delivered to date.
A performance obligation is satisfied over a period of time if any of the following three criteria are met:
- The customer receives and benefits from the good or service over time as the supplier meets the obligations of the contract (e.g., service and maintenance contracts).
- The supplier enhances an existing asset or creates a new asset that the customer controls over the period in which the asset is created or enhanced.
- The asset has no alternative use for the supplier, and the supplier has the right to enforce payment for work completed to date (e.g., constructing equipment specific to the needs of a single customer).
Cost to secure LT contracts must be CAP or Expensed?
The costs to secure a long-term contract, such as sales commissions, must be capitalized; that is, the expense for these costs is spread over the life of the contract.
Capitalized
Cap is spreading the asset costs over multi periods, creating a BS asset.
Cap is where expenditure doesn’t hit IS, instead u recg cost of asset on BS (you bought it and recg in BS) and you gradually expense in IS for the asset life.
So you start off in BALANCE SHEET, and gradually reduce the asset and move the expenditure/cost to INCOME STATEMENT.
Capitalized costs are items of property, plant, and equipment.
For example, if a company buys a machine, building, or computer, the cost would not be expensed but would be capitalized as a fixed asset on the BALANCE SHEET.
Gross Profit Margins
Gross Profit/Rev
Franchising and Licensing Rev Disaggregated into what?
Rev from Company-owned restaurants
Franchise royalties and fees
Rev from supplies to franchises (the main co. will sell items to franchise like materials, ovens, etc. The main co. sell it to francise and when the company sells it its a rev.)
Purchase of licenses has what two options under IFRS
Example: Revenue recognition
Contractor agrees to build warehouse for:
- Price: 10 mil
- Total cost of construction: 8 mil
Year 1:
- Builder incurs 4 mil cost (50% of 8 mil)
- Builder recognizes 5 mil (50% of 10mil) for revenue
Year 2:
-Builder incurred additional 2 mil in cost
Question:
(1) Pct of total cost for Y1 and Y2
(2) Tot Rev
(3) Y2 Rev
(1) % of total cost for Y1 and Y2:
($4 million + $2 million) / $8 mil= 75%.
(2) Tot Rev: 0.75 × $10 million = $7.5 million (tot rev recg for Y1 & Y2)
(3) Y2 rev = $2.5 million (= $7.5 million – $5 million) (year 1 we recognized 5 mil)
Rev Recg - AGENT Example
Example Question:
Contractor agrees to build a bridge.
Total Price = 10 Mil
Time to COMPL = 4 years
Tot Cost = 6.5 Mil
After Y1 cost of 2.5 mil is incurred
In Y2, a further 1 mil cost is incurred.
Client pays 2 mil each for first two years.
The amt of rev the contractor should recg in Y2 is:
In Year 1, the contractor has incurred:
Expected tot cost: 38.5%
($2.5 mil cost incurred in Y1/ $6.5 mil tot cost)
Should recognize 38.5% of total revenue:
($10 mil tot price × 38.5% expected tot cost = $3.85 million).
By the end of Year 2,
Tot cost incurred: $3.5 Mil
(Cost incurred both years = 2.5 mil +1 mil = 3.5 mil)
Expected Tot Cost:
53.8% of expected total costs. (3.5 mil of tot cost incurred /6.5 mil tot cost)
Cumulatively, by the end of Year 2,
total revenue of 53.8% (expected cost) × $10 mil (tot price)= $5.38 million should have been recognized,
This leaves:
$1.53 million =
$5.38 mil (Y2 tot Rev) - $3.85 mil (Y1 tot rev) to be recognized in Year 2.
The amount paid by the client does not affect revenue.
Answer: 1.53 Mil
Example:
Realtor sells home for 1.4 Mil.
Commission 3%
Cost to realtor associated with sale 15K
What is realtors GP for this transaction?
The realtor is acting as an agent, and so should recognize only the commission as revenue.
Revenue should therefore be: ($1.4 million × 3%) = $42,000.
Gross profit will be $42,000 - $15,000 = $27,000.
Expense Recognition
Expenses are subtracted from revenue to calculate net income.
Expense recognition is in the period in which the economic benefits of the expenditure are consumed.
Expense is taking an assets cost as an expense on the IS in the CURRENT PERIOD.
Expense definition from IASB
According to the IASB, expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets, or incurrence of liabilities that result in decreases in equity other than those relating to distributions to equity participants.
Three Methods for Expenses:
(1) the matching principle,
- expenses to generate rev are recg in same period as rev (Ex inventory)
- If you buy inventory in Q4 but don’t sell it until Q1 next year, the rev is at Q1 and that is when cost should affect IS, even tho you bought it in Q4.
(2) capitalization.
-To capitalize is to record a cost or expense on the balance sheet then expensed using depreciation or amortization, to the income statement over the assets life as benefits are consumed.
-Typical examples of corporate capitalized costs are items of property, plant, and equipment. For example, if a company buys a machine, building, or computer, the cost would not be expensed but would be capitalized as a fixed asset on the balance sheet.
(3) Period Costs
Expenditures that less directly match the timing of rev (e.g. admin cost)
Subsequent expenditures, when is it cap and when is it expensed?
Subs exp that provide benefit beyond one year:
- you have to replace roof that last more than one year, you CAP it.
Sub Ex do not provide benefit beyond one year you EXPENSE it
- You get warehouse and you hire maids to clean it… it doesn’t cover a year.
An expenditure that is capitalized is initially recorded as an asset on the balance sheet at cost…
what is the formula and exceptions?
An expenditure that is capitalized is initially recorded as an asset on the balance sheet at cost,
This is fair value at acquisition + any cost to prep the asset for use.
Exceptions:
o Land
o Intangible assets with indefinite lives (like goodwill).
o Cost of these are in income statement for life of asset as :
Depreciation (tangible assets)
Depletion (natural resources)
Amortization expense (for intangible assets with finite lives)
Depreciation, depletion, and amortization reduce WHAT?
Depreciation, depletion, and amortization reduce the carrying value (net book value) of the asset in the balance sheet, and the expense reduces net income in the income statement.
Expenditures that are immediately expensed reduce what?
if an expenditure is immediately expensed, current-period pretax income is reduced by the amount of the expenditure.
Do you CAP or EXPENSE?
Cap vs Expense
Financial Statement Effects for:
Asset and Equity
NI (first year)
NI (other years)
Income Variability
Cap vs Expense
Financial Statement Effects for:
ROA&ROE (First year)
ROA&ROE (Other years)
Debt Ratio & Debt-to-Eq
CFO
CFI
DEBT:
- We assume expense or cap, it has no impact on debt or how much you owe people.
- Assets will be higher if you cap
- Equity will be higher if you cap.
Interest Cap Example
Internally developed intangibles, are they expensed or cap?
what are the exceptions?
Example of items that are unusual or infrequent.
Where are they included from?
Where are they on fin. statement?
UUnusual or infrequent items are included in income from continuing operations and are reported before tax.
Unusual infrequent items are reported BEFORE NET INCOME and PRETAX from continuing operations (above the line).
Account Changes
retrospective application
prospective application
prior-period adjustment
Scope Changes
When is exchange rates applicable?
EPS (basic) Formula
Profitability measure.
Common stock div are NOT subtracted from net income for basic EPS.
Diluted EPS Formula
Diluted EPS with convertible Debt Formula
A quick way to calculate the net increase in common shares from the potential exercise of stock options or warrants when the exercise price is less than the average market price is:
LOS 30.d
Checking for dilution:
Which one is used in calc of D-EPS?
Three questions to ask to see if its dilutive.
