Flashcards in Revenue Recognition Deck (33)
What 3 conditions must be met for revenue to be considered realized?
1. the earnings process is complete
2. an exchange as taken place
If these conditions are met, the realization should be evidenced by the recognition of revenue in the income statement
In most situations, when is revenue recognized?
At the point of sale because it is generally felt that the sale transaction provides evidence that realization (i.e. earning) is complete or virtually complete.
Prior to the point of sale, significant uncertainties may exist concerning realization. What 6 pertinent questions should be considered?
1. will the product being held or manufactured be completed?
2. what will the total cost of manufactured inventory be?
3. will existing inventory be sold?
4. at what price will the inventory sell?
5. will the sales price be collectible (in the case of a credit sale)?
6. will costs arise after the sale (e,g, warranties) and if so, how much?
What 3 types of allowance must be considered in revenue recognition to complete the matching process for the income statement?
1. Uncollectible receivables
2. warranty costs
3. merchandise returns
These estimates are base on prior experience with similar items
What are the methods for accounting for revenues under a long-term contracts and when is it used?
1. percentage of completion
2. completed-contracts method
Occurs when revenue recognition spans two or more accounting periods
What is the percentage of completion method for long term contracts?
Partial revenue is recognized on an estimated basis in each period covered by the contract
Under what circumstances is the percentage of completion method appropriate?
when reliable estimates of the degree of completion can be made based on costs incurred to date or other bases
What is the completed contracts method for long term contracts?
All revenue is deferred and recognized in the period when the contract is completed.
Under what circumstances is the completed contracts method appropriate?
when reliable estimates of the degree of completion cannot be made at intermediate points in the contract period
Disclosure of the long term contracts should be made in what section of the financial statements?
in the summary of significant accounting policies
What should a long term contract include?
It should include clear, enforceable rights and duties of both parties and the manner and terms of settlement
When is a loss on a long term contract recognized?
Under both methods, the estimated total loss on the contract is recognized in the period in which the loss becomes apparent and estimable
When is revenue recognized under installments sales?
Revenue recognition is deferred beyond the point of sale and is associated with the subsequent collection of payments. The rationale underlying the method is that the length of the installment contract and the nature of the contract itself impose degrees of uncertainty concerning collection such that reasonable dependable estimates of uncollectible are not possible. When these conditions exist, the seller typically retains the right to repossess the property.
When is gross profit on sales recognized under the installment sales method?
The gross profit on sales is deferred and recognized as cash is actually collected. Each payment is divided into a recover cost and a recognition of gross profit. Since gross profit margins may vary from period to period, it is necessary to identify receivables and deferred gross profit account by year.
When a buyer defaults on an installment contract, what entries must be made?
Repossessed inventory (debit)
Deferred gross profit (debit)
Installment AR (credit)
The repossessed inventory is debited for the fair value of the asset received. It will be necessary to recognize a gain/loss on repossession if the FV of the asset is greater or less than the excess of the receivable balance over the deferred gross profit on the deferred contract at the time of repossession.
What is the cost recovery method of installment sales?
It is an even more conservative approach in that the early payments are considered entirely a recovery of cost, and not until the cost is completely recovered is any gross profit recognized. This method is rarely encountered in practice.
Under GAAP, when is installment sales acceptable in the preparation of general-purpose financial statements?
Profit is deemed to be realized at the point of sale unless circumstances are such that the collection of the sales price is not reasonably assured. Only in exceptional cases, where receivable are collectible over an extended period of time and because of the terms of the transaction or other uncertainties, there is no reasonable basis for estimating the degree of collectability, are the installment sales and cost recover methods acceptable
What is a consignment arrangement?
The consignor (owner) transfers merchandise to the consignee, who attempt to sell the merchandise for the consignor.
Who owns the inventory under a consignment arrangement?
Typically, the consignor retains ownership of the property and reimburses the consignee for costs of selling, including a commission on the sale
When is Franchise fee revenue recognized?
It is recognized when all material services or conditions relating to the sale have been substantially performed or satisfied by the franchisor. In addition, an appropriate provision is made for estimated uncollectible amounts.
What does substantial performance mean?
It mean that the franchisor has no remaining obligations, virtually all services required of the franchisor have been performed and no other material obligations of the franchisor remain.
If a portion of the initial franchise fee is designated to compensate the franchisor for continuing services, how should this be recognized?
a portion of the fee is deferred and recognized over the franchise period
If the conditions necessary for recognition of franchise fee revenue are not met, how are direct costs related to franchise sales recognized?
They are deferred until the related revenue is recognized. Any costs deferred in this manner should not exceed anticipated revenue less estimated additional related costs to be incurred
What 4 disclosures should be made in the financial statements and related notes concerning franchises?
1. the nature of all significant commitments and obligations from franchises
2. the details of deferred franchise fees
3. the separation of initial franchise fees from other franchise fee revenues
4. revenues and costs related to franchise-owned outlets, separate from revenues and costs related to franchise outlet, if practicable
When the right of return exists, what 6 conditions must be met for revenue to be recognized by the seller?
1. the seller's price is substantially fixed or determinable at the date of the sale
2. the buyer has paid the seller; or the buyer is obligated to pay the seller and this obligation is not contingent on the resale of the products
3. the buyer's obligation is not changed in the event of theft or destruction of the products
4. the buyer has economic substance apart from the seller
5. the seller does not have significant obligations for future performance to directly bring about the resale of the products
6. the amount of future returns can be estimated
Product financing arrangements include agreements in which a sponsor (the enterprise seeking to finance a product, pending future resale or use) does the following 3 things.
1. sells the product to another entity and in a related transaction agrees to repurchase the product
2. arranges for another entity to purchase the product on the sponsor's behalf and, in a related transaction, agrees to purchase the product from the other entity
3. controls the disposition of the product that has been purchased by another entity in accordance with either of the arrangements described previously
How are financing arrangement accounted for by the sponsor?
1. if a sponsor sells a product to another entity, agreeing to repurchase the product in the future, the sponsor records a liability at the time the proceeds are received. The sponsor does not record a sale and does not remove the product from its balance sheet
2. if the sponsor is a party to an arrangement whereby another entity purchases a product on the sponsor's behalf, the sponsor records the asset and the related liability when the product is purchased by the other entity.
Profit is recognized in full when real estate is sold provided what 2 things are present?
1. the profit is determinable (i.e. collectability is reasonably assured or the amount that will not be collectible can be estimated) and
2. the earnings process is virtually complete (i.e. the seller has no further obligations to earn the profit)
Profit on real estate sale transactions is not recognized until what 4 criteria are met?
1. a sale is consummated
2. the buyer's initial and continuing investments are adequate to demonstrate a commitment to pay for the property
3. the seller's receivable is not subject to future subordination
4. the seller has transferred to the buyer the usual risks and rewards of ownership in a transaction that is in substance a sale, and the seller does not have a substantial continuing involvement with the property