FAR 3C - Revenue Flashcards
(40 cards)
When and how should an entity test capitalized contract costs for impairment?
🕵️♂️ When to test:
When there is an indicator of impairment (e.g., contract cancellation, significant modification, change in expected cash flows).
🧮 How to test:
Compare the carrying amount of the asset to:
💲 The remaining consideration expected to be received,
➖ Minus: Directly related costs to fulfill the remaining performance obligations (that haven’t yet been expensed).
📉 If carrying amount > recoverable amount → recognize an impairment loss in profit or loss
What should be included in the estimate of expected consideration when testing capitalized contract costs for impairment?
🔍 Expected consideration should include:
💰 The amount already received but not yet recognized as revenue
📆 The amount expected to be received in the future
🔁 Expected contract renewals or extensions, if likely
⚠️ Adjustments for customer credit risk
📊 Determined using the transaction price principles from ASC 606
What does “expected consideration” mean?
💡 the amount of payment an entity expects to receive from a customer under a contract, including:
💰 Payments already received but not yet recognized as revenue
📆 Future expected payments
🔁 Contract renewals/extensions (if probable)
⚠️ Adjustments for customer credit risk
📉 Adjustments for variable consideration (e.g., bonuses, returns, discounts)
📘 It is calculated using transaction price principles from ASC 606 and is used to test the recoverability of capitalized contract costs.
What are the two methods an entity may use to estimate variable consideration?
📊 Expected Value – Sum of probability-weighted possible outcomes.
🎯 Most Likely Amount – The single most probable amount in the range.
🔁 The chosen method must be applied consistently throughout the contract.
When is it appropriate to use the expected value method vs. the most likely amount method?
📊 Expected Value is appropriate when:
There are many contracts with similar characteristics
Multiple outcomes are reasonably possible
🎯 Most Likely Amount is appropriate when:
The outcome is binary (e.g., bonus received or not)
Only two outcomes are likely
When does a customer option create a separate performance obligation?
🟢 if it provides a material right the customer would not receive without entering the contract
What are examples of customer options that do and do not provide a material right?
✅Examples of options that provide a material right (separate performance obligation):
🎁 Free item offered only with a qualifying purchase
💸 50% discount on future purchases not available to the general public
🔁 Exclusive renewal pricing offered only to contract customers
❌Examples of options not providing a material right (no separate obligation):
🧾 20% coupon given to all customers
🔄 Return policy offering full refund within 30 days
📢 General online ad for an upcoming sale
What are the 5 criteria that must be met before recognizing a contract with a customer?
✅ Contract approved and both parties are committed to perform
🔍 Each party’s rights regarding goods/services are identifiable
💵 Payment terms are identifiable
💼 Contract has commercial substance (affects cash flows)
🤝 Probable that consideration will be collected
What is the matching principle in accounting, and how does it affect income measurement?
⚖️ The matching principle requires that:
Expenses be recognized in the same period as the revenues they help generate.
🎯 This ensures that income or loss is determined by associating realized revenues with the necessary related expenses, providing a more accurate measure of profitability for the period.
📘 A core concept in accrual accounting, used to match costs like COGS, commissions, and warranty expenses to the period when related revenue is earned.
What costs can be capitalized as costs to fulfill a contract?
✅ Costs may be capitalized if they:
- Relate directly to a specific contract or anticipated contract
- Generate/enhance resources to fulfill the contract
- Are expected to be recovered
Examples include:
🧱 Direct materials
👷 Direct labor
📊 Allocations of related costs (e.g., depreciation)
🧾 Explicitly chargeable costs to the customer
🤝 Costs incurred only because of the contract (e.g., subcontractor fees)
How should royalty advances be accounted for under a trademark or license agreement?
💰 Advance royalties received (e.g., minimum guarantees) should be recorded as unearned revenue (a liability) when received.
📆 As royalty revenue is earned (e.g., based on sales), the entity should:
- Recognize the earned portion as revenue
- Reduce the unearned revenue balance accordingly
🧾 If actual royalties in a period are less than the advance, defer the difference until future periods.
📘 This matches revenue with performance and complies with accrual accounting
Which types of gains or losses are reported separately as a component of income from continuing operations?
🧾 Reported separately (but still in continuing operations):
- Items that are unusual in nature or infrequent in occurrence
- Must be material and not part of normal operations
❌ Do NOT report separately if:
- The event is recurring or part of regular business activity
- E.g., regular early bond retirements or repeated weather-related losses
🚫 Discontinued operations (e.g., sale of a business segment) are excluded from continuing operations and shown below it on the income statement.
How does an entity determine if it is a principal or an agent?
🔍 An entity determines its role based on control:
- 🧩 The entity is a principal if it controls the good or service before transferring it to the customer.
- 🤝 The entity is an agent if it arranges for another party to provide the good or service.
How is revenue recognized differently for a principal vs. an agent?
💰 Principal:
- Recognize gross revenue (full amount received from customer)
Also recognize corresponding cost of goods sold
💼 Agent:
Recognize net revenue (only the fee or commission retained)
No cost of goods sold recognized for the third-party service/product
How does an entity determine if it is a principal or an agent?
An entity determines its role based on control:
✅ The entity is a principal if it controls the good or service before transferring it to the customer.
🤝 The entity is an agent if it arranges for another party to provide the good or service.
Consider indicators such as:
📦 Inventory risk
💲 Discretion in setting prices
🧾 Responsibility for fulfilling the performance obligation
How is revenue recognized differently for a principal vs. an agent?
Principal:
💰 Recognize gross revenue (full amount billed to the customer)
📉 Also recognize cost of goods sold or fulfillment costs
Agent:
💼 Recognize net revenue (only the fee or commission earned)
🚫 Do not record the gross sale or the related cost of the good/service
What are the overall objectives of ASC Topic 606 (Revenue from Contracts with Customers)?
What are the overall objectives of ASC Topic 606 (Revenue from Contracts with Customers)?
ASC 606 aims to:
🔄 Remove inconsistencies and weaknesses in previous revenue guidance
🧱 Provide a more robust framework for addressing revenue recognition issues
🌍 Improve comparability across entities, industries, jurisdictions, and capital markets
📊 Provide more useful information to users of financial statements
🧾 Simplify the preparation of financial statements by reducing the number of required sources
These objectives reflect the joint effort by FASB and IASB to unify revenue recognition principles.
What are common guidelines under ASC 606 for identifying separate performance obligations in a contract?
A promised good or service is a separate performance obligation if it is distinct — meaning:
1) The customer can benefit from it on its own or with other resources
2) It is separately identifiable within the contract
What are examples of separate performance obligations in a contract?
📦 Goods (e.g., equipment, software)
🛠️ Installation services that do not significantly modify the good and are sold separately
🔧 Service-type warranties (e.g., extended coverage)
🧾 Customer options that provide a material right (e.g., exclusive discounts)
🧑🏫 Training or onboarding sold separately
📡 Software updates or technical support subscriptions
Not separate obligations:
🛡️ Assurance-type warranties (e.g., required by law)
🔁 Routine return policies
💬 Marketing offers or general discounts available to all customers
🧩 The good and the installation are highly interdependent or interrelated, such that they function only together as a combined output
🚫 The customer cannot benefit from the good without the installation service
📦 The installation is not sold separately and not available from third parties
What is the collectibility threshold under ASC 606, and when can nonrefundable consideration be recognized if it’s not met?
📌 Revenue can only be recognized if it’s probable the customer will pay.
❌ If collectibility is not probable, nonrefundable consideration can be recognized only if:
✅ The entity has no remaining obligations, and has received substantially all of the nonrefundable amount, or
🛑 The contract is terminated, and the amount is nonrefundable
🛡️ This prevents recognizing revenue from contracts that lack substance.
When does an entity recognize revenue under ASC 606, and how is control defined?
📆 Revenue is recognized when (or as) a performance obligation is satisfied.
📦 A performance obligation is satisfied when the customer obtains control of the promised good or service, which may occur:
– 🕒 Over time (e.g., ongoing service, construction)
– 📍 At a point in time (e.g., delivery of goods)
🎮 Control means:
– The ability to direct the use of the asset
– The ability to obtain substantially all benefits from the asset
– The ability to prevent others from using or benefiting from the asset (defensive control)
How do revenues differ from gains, and how can changes in assets or liabilities result in revenue?
📘 Revenue is:
– Inflows of assets or settlements (decreases) of liabilities
– From the entity’s primary, ongoing operations (e.g., selling products, providing services)
📈 Gains are:
– Increases in net assets from incidental or peripheral activities (e.g., selling equipment)
📦 Revenue may result from:
– An increase in assets (e.g., cash or A/R from sales)
– A decrease in liabilities (e.g., fulfilling deferred revenue)
❌ Revenue is not generated from:
– Asset increases or liability changes related to incidental transactions
– Borrowings or investments unrelated to core operations
What does “incidental” mean and how are incidental transactions reported?
🔹 Incidental refers to transactions that are not part of an entity’s core or primary operations.
These are peripheral or secondary activities, and their results are reported as gains or losses, not revenues or expenses.
📊 Examples:
– Selling used equipment or office furniture
– Earning interest on idle cash
– Receiving insurance proceeds
– Foreign currency gains/losses (if not central to the business)
📘 Revenue and expenses come from main operations; gains and losses come from incidental activities.
What additional factors determine whether a good or service is separately identifiable (distinct)?
🧩 Not distinct if:
1️⃣ The entity provides a significant integration service (bundling into one output)
2️⃣ One good/service significantly modifies another
3️⃣ Goods/services are highly interdependent or interrelated
