Chapter 6

Question 1

revenues

Answer 1

inflows or other enhancements of assets (of an entity or settlements of its liabilities or both)

from delivering g/s, from business main ops

important not only know how much rev to recognize (record) but WHEN

Question 2

five steps to rev recognition

Answer 2

1) identify the contract

2) identify the performance obligations

3) determine the transaction price

4) allocate the transaction price

5) recognize rev when (or as) each performance obligation is satisfied

Question 3

1) identify the legal contract

Answer 3

legal rights of seller and customer

contract establishes the legal rights and obligations of the s/c with respect to one or more performance obligations

Question 4

2) identify the performance obligations

Answer 4

can be single or multiple

it is a promise to transfer a g/s that is distinct (which if g/s is capable of being distinct and separately identifiable)

Question 5

3) determine the transaction price

Answer 5

the amount seller is entitled to receive from customer (for both single and multiple)

Question 6

4) allocate the transaction price

Answer 6

if single - no allocation required

if multiple - allocate a portion to each performance obligation

seller allocates the transaction price to performance obligations based on the relative stand alone selling prices of the g/s in each performance obligation

Question 7

5) recognize rev when (or as) each performance obligation is satisfied

Answer 7

if single - at one point in time or over a period of time (refer back to reasons)

if multiple - at whatever time is appropriate for each performance obligation (over a period to time) –> because of three things (refer back to slide)

Question 8

recognizing rev at a single point in time BREAK DOWN (5 things)

Answer 8

indicators are used to determine when control has transferred from seller to customer

customer more likely to control a g/s if customer has

• an obligation to pay the seller
• legal title to the asset
• physical possession of the asset
• assumed the risks/rewards of ownership
• accepted the asset

Question 9

example for recognizing rev at a single point in time

Answer 9

Corp A sells stuff to Corp B

when should Corp A recognize revenue?

1) Dec 20, 2023 Corp A sells 1,000 things at price of 240 each promising payment in 30 days
- NOOOO

2) Jan 1, 2024 Corp A delivers 1,000 things at 240 each to Corp B
- YESSSS

Journal entry
Debit: AR 240,000
Credit: Sales Rev 240,000

Question 10

for recognizing rev at a single point in time example, what would Corp journal entry be once receive payment from Corp B

Answer 10

Debit: cash
Credit: AR

Question 11

recognizing rev over a period of time

Answer 11

1) the customer consumes the benefit of the seller’s work as it is performed
ex: cleaning service

2) the customer controls the asset as it is created
ex: constructing a building extension

3) 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
ex: order of jets customized for US Air Force

NOTE: recv is recognized in proportion to amt of performance obligation that has been satisfied

Question 12

recognizing rev over a period of time

Answer 12

example: TrueTech Industries sells one year subscriptions to the Tri Net multisuer platform of Internet based games

TrueTech sells 1,000 subscriptions for $60 each on Jan 1, 2024

Journal entry: Jan 1, 2024
Debit: Cash 60,000
Credit: Deferred Rev 60,000

at the end of each 12 months what will be the journal entry

Journal entry each month
Debit: Deferred Rev 5,000
Credit: SR 5,000

5,000 –> 60,000/12

Question 13

Recognizing Rev when the three criteria do not apply when recognizing a revenue over a point in time

Answer 13

if a performance obligation does not meet any three of the criteria for recognizing rev over time then…

• revenue must be recognized at the point in time when the performance obligation has been completely satisfied
• usually occurs at the end of contract

Question 14

determining progress towards completion

Answer 14

to recognize rev over time the seller needs to estimate progress towards completion

1) out-based estimate
- measured as the proportion of the g/s transferred to date

2) input-based estimate
- measured as the proportion of effort expended thus far relative to the total effort expected to satisfy the performance obligation

Question 15

recognizing rev for contracts that contain multiple performance obligations

Answer 15

steps 2 and 4 are VERY important

step 1: identify the contract

step 2: identify the performance obligation(s)

step 3: determine the transaction price

step 4: allocate the transaction price to each performance obligation

step 5: recognize rev when (or as) each performance obligation is satisfied

Question 16

BREAKDOWN of step 2 for recognizing rev for contracts that contain multiple performance obligations

Answer 16

step 2: identify the performance obligation(s)

sellers account for a promise to provide a good or service as a performance obligation if the good/service is distinct from other g/s in the contract

Question 17

in step 2, what makes something distinct

Answer 17

1) capable of being distinct
2) seperately identifiable from other g/s in the contract

Question 18

special issues in revenue recognition (steps)

Answer 18

step one: specific requirements for contract existence

step 2: prepayments, warranties, customer options for additional g/s

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: lots of it

Question 19

special issues for step 1: identify the contract (5 things must happen) and what is NOT supported

Answer 19

can be explicit, implicit, oral and written

contract can only exist if:
- has commercial substance (meaningful change in co. finances)
- has been approved by the s/c
- specifies the rights of the s/c
- specifies payment terms
- is probable that the seller will collect the amount it is entitled to receive under the contract

a contract does NOT exist if:
- neither the s/c has performed any obligations under the contract
- s/c can terminate the contract without penalty

Question 20

determining whether a contract exsits for rev recognition purposes

Answer 20

CompStores orders 1,000 TriBox systems on Dec 20, 2023 at price of $250 per unit

assume CompStores and TrueTech can cancel order wihtout penalty prior to delivery

TrueTech made delivery on Jan 1, 2024 and received $250,000 on Jan 25, 2024

When does True Tech’s arrangement with CompStores qualify as a contract for purposes of rev recognition?

A: Jan 1 2024

Question 21

special issues for step 2: identify things that are NOT performance obligations

Answer 21

prepayments:
part of the transaction price (paid in advance, not a distinct promise, not going to be purchased separately)

quality assurance warranties:
part of performance obligation to deliver products of acceptable quality
(NOTE: extended warranty is part of PO)

right of return:
represents a potential failure to satisfy original performance obligation to provide goods that the customer wants to keep

Question 22

special issues for step 2: identify things that are performance obligations

Answer 22

1) extended warranties:
warranty is an extended if:
- customer has option to purchase the warranty separately
- the warranty provides a service to customer beyond quality assurance

2) options provide a material right (is something the customer would not receive otherwise, so the seller is obligated to provide it)
- a discount is a type of option

Question 23

special issues for step 3: determine the transaction price

Answer 23

1) variable consideration and the constraint on its recognition

2) sales with a right of return (a particular type of variable consideration)

3) identifying whether the seller is acting as a principal or an agent

4) time value of money

5) payments by the seller to the customer

Question 24

step 3 special issues

Answer 24

variable consideration: portion of 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)

Question 25

variable consideration

Answer 25

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

Question 26

what are two methods of estimation for determining the transaction price

Answer 26

- expected value: used in situations where contracts contains large number of possible outcomes - most likely amount: used where a contract has only two possible outcomes (outcome you believe has highest liklehood of occuring) these methods are based on ability to best predict the amount the seller will receive

Question 27

expected value - determining the transaction price

Answer 27

journal entry for receipt of cash: Debit: Cash or AR Credit: Deferred Rev so if have 300,000 up front fixed fee for 6m, 180,000 bonus, 75% chance possible amounts: 480,000 probabilities: 75% Expected Amounts: 360,000 possible amounts: 300,000 probabilties: 25% expected amounts: 75,000 expected amounts = 435,000 so every 6ms: debit: DR 50,000 Debit: BR 22,500 Service Revenue 72,500 135,000/6 = 22,500 435,000/6 = 72,500

Question 28

special amounts for step 3: alternative 2 --> most likely amount

Answer 28

journal entry each month: Debit: DR 50,000 Debit: BR 30,000 Credit: SR 80,000 300,000 + 180,000 = 480,000 480,000/6 = 80,000 300,000/6 = 50,000 180,000/6 = 30,000 at the end of month: will need to Debit: Cash Credit: BR (is this supposed to be AR) Debit: Service Rev Credit: BR NOTE: after three months (NOT receive 180,000 bonus) Debit: SR 90,000 Credit: BR 90,000 NOTE: Debit: DR 50,000 Credit: SR 50,000

Question 29

special issues for step 3: constraint on recognizing variable considerations

Answer 29

sellers only include an estimate variable consideration in the transaction price to the extent it is "probably" that a significant revenue reversal will not occur when the uncertainty associated with the variable consideration is resolved --> they are only estimating if slight uncertainty --> there are factors/indicators of poor uncertainty for revenue reversal

Question 30

what are indicators that a significant revenue reversal could occur include:

Answer 30

- poor evidence on which to base an estimate - dependence of estimate on factors outside the seller's control - history of the seller changing payment terms on similar contracts - broad range of outcomes that could occur - long delay before uncertainty resolves

Question 31

slide 60-61 --> constraint on recognizing variable consideration

Answer 31

Journal entry every months 4-6 Debit: DR 50,000 Credit: SR 50,000 company constrained from recognizing revenue associated with variable consideration --> company includes only the up-front fixed payment of 300,000 in the transaction price and recognizes revenue of 50,000 each month 300,000/6 = 50,000 (going back and recognizing the BR and the revenue that would be recognized in Jan-Mar, that you would have recognized, but then have to estimate it) now assume April 1st, after three months of the contract passed, company concludes it now can make an accurate enough bonus estimate for it to be probable that a significant revenue reversal will not occur: assume 75% likelihood will receive bonus Debt: Bonus R 90,000 Credit: SR 90,000 Debit DR: 50,000 Debit: BR 30,000 Credit: 80,000 (the second part of the entry is recognizing the DR of 50,000 for the month of April + BR, gives you a total of 80,000

Question 32

special issues for step 3: right of return

Answer 32

right of return exists when the customer can return the good if not satisfied or unable to resell it viewed as a failure to satisfy the original performance obligation sellers report net sales revenue in the income statement, equal to gross sales revenue less actual and estimated returns

Question 33

example of right of return

Answer 33

assume company sold 1,000 for $240 each; estimates will 5% will be returned Debit: estimated returns 12,000 Credit: Return or Refund Liability 12,000 income statement presentation: Sales Rev (240x1000) 240,000 Less: estimated returns (5%) (12000) Net Sales rev 228,000

Question 34

special issues: is the seller principal or agent (performance obligation)

Answer 34

performance obligation: Principal: to provide g/s (so is vulnerable to risks associated with holding inventory) Agent: to facilitate a transaction between a principal and a customer

Question 35

special issues: is the seller principal or agent (recording revenue)

Answer 35

principal: total sales price paid by customers; also recognizes cost of goods sold agent: recognizes only the commission it receives on the transaction

Question 36

special issues for step 3: time value of money

Answer 36

if time value of money is a significant part of the contract, seller should view the transaction price as consisting of two components: 1) delivery component: equal to the cash price of the g/s 2) financing component: interest considered paid to the customer (in case of prepayment) or to the seller (in the case of a receivable) sellers can assume the financing component is NOT significant if the period between delivery and payment is less than a year

Question 37

journal entries for time value of money PREPAYMENT

Answer 37

when gives price in beginning this is FV journal entry when issued: Debit: Cash Credit: DR subsequent delivery Debit: Interest Exp (PV x i) Debit: DR Credit: Sales Revenue

Question 38

journal entries for special issues for step 3 - time value of money RECEIVABLES

Answer 38

value given is FV entry on delivery: Debit: NR 1,056 Credit: Discount on NR 96 Credit: Sales Revenue 960 when subsequent collection occurs: Debit: cash 1056 Debit: disct on NR 96 Credit: Interest Rev 96 Credit: Notes Receivable 1,056

Question 39

special issues for step 3: payments by the seller to the customer

Answer 39

if the seller purchases distinct goods/services from the customer - at the fair value of those g/s, seller accounts for that purchase as a separate transaction - pays more than the fair value of those g/s, thos excess payments are viewed as a refund (subtracted from the amount the seller is entitled to receive when calculating the transaction price to the sale of the customer

Question 40

special issues for step 4: allocate the transaction rice to the performance obligations

Answer 40

estimating the stand alone selling prices: 1) adjusted market assessment approach: price if product or services were sold in the market 2) expected cost plus margin approach: estimate the costs of satisfying a performance obligation and then add an appropriate profit margin 3) residual approach: subtract the sum of the known or estimated stand-alone selling prices of others goods and services in the contract from the total transaction price of the contract

Question 41

residual approach for step 4 (special issues)

Answer 41

total price stand alone (______) estimated stand alone JE: Debit: AR 250,000 Credit: SR 240,000 Credit: SR 10,000

Question 42

special issues for step 5: recognize revenue when each performance obligation is satisfied

Answer 42

licenses franchises bill-and-hold arrangements consignment arrangements gift cards

Question 43

licenses

Answer 43

allow the customer to access the seller's intellectual property (IP) - licenses of functional intellectual property transfer a right of use, so sellers typically recognize revenue at a point in time (1) has a significant stand-alone functionality (can perform a task, or be played or aired) (2) the benefit the customer receives from the license isn't affected by the seller's ongoing activity (3) therefore viewed as transferring a right of use (ex: a music download) (4) revenue is recognized at the point in time that the customer can start using the IP

Question 44

symbolic IP

Answer 44

transfer seller's IP with the understanding that the seller will undertake ongoing activities (1) lacks significant stand-alone functionality (2) the benefit the customer receives from the license affected by the seller's ongoing activity (3) license transfers a right of access to the seller's IP (example: trademarks, logos, brand names, franchise rights)

Question 45

what is the exception for licenses

Answer 45

- functional IP: viewed as transferring a right of access (and requiring revenue recognition over time) if both (1) the seller is expected to change the functionality over time (2) the customer is required to use the updated version example: virus protection software

Question 46

franchises

Answer 46

franchisor grants to the franchisee right to sell the franchisor's products and use its name for a specified time period franchises often include a license to use intellectual property, as well as initial sales of products and services transferred at the start of the franchise as well as on going sales over the life of the franchise franchisor must evaluate each part of the franchise agreement to identify the performance obligations

Question 47

bill-and-hold arrangement

Answer 47

exists when customer purchases goods but requests that the seller retain physical possession of the goods until a later date since the customer does not have physical possession of the asset until the seller has delivered it, transfer of control has not occured, so revenue typically should not be recognized until actual delivery to the customer occurs

Question 48

consignment arrangements

Answer 48

"consignor" physically transfers the goods to the other company (the consignee) but the consignor retains the legal title if a buyer is found, the consignee remits the selling price (less commission and approved expenses) to the consignor if the consignee cannot find a buyer within an agreed upon time, the consignee returns the goods to the consignor given that the consignor retains the risk of ownership, it postpones revenue recognition until sale to a third party occurs

Question 49

gift cards

Answer 49

sales of gift cards are recognized as DR liability rev is recognized when a gift card is redeemed or the likelihood of redemption is viewed as remote