Revenue Recognition

Question 1

When is revenue recognized?

Answer 1

When a performance obligation is satisfied or while it is being satisfied.

Question 2

When is a performance obligation considered satisfied?

Answer 2

When the entity has transferred the promised goods or services to the customer and they have control of those goods or services.

Question 3

When does a customer have control over goods and services (asset)?

Answer 3

1. Ability to direct the use of goods or services;
2. Can prevent others from benefiting from them;
3. Can obtain benefits from the goods or services in the form of cash flows.

Question 4

If control is uncertain, what other factors should be considered?

Answer 4

• Does customer have legal title to goods?
• Does customer have physical possession of goods?
• Are there significant risks and rights associated with ownership of the goods?
• Has the customer accepted the goods?

Question 5

What are the 3 circumstances that indicate whether a performance obligation is being satisfied over time and as a result revenue is recognized while the performance obligation is being satisfied?

Answer 5

1. The customer consumes the goods or services as they are being delivered;
2. The customer has control over the asset while it is being created or enhanced; or
3. The entity has no alternative use for the goods or services and is entitled to payment for performance completed to date.

Question 6

In accounting for costs incurred, how are recoverable incremental costs of obtaining a contract reported on the income statement?

Answer 6

They are capitalized and reported in the same period in which the related revenue is recognized (e.g. rezoning of land).

Question 7

What are the 3 criteria that if met require costs to be capitalized?

Answer 7

1. The costs relate directly to a contract that is in existence or a specific contract that is currently being negotiated;
2. The costs generate or enhance resources that will be used to satisfy a performance obligation in the future; and
3. The costs are expected to be recovered

Question 8

How are costs of obtaining a contract recognized?

Answer 8

Generally, recognized as expenses in the period in which they are incurred.

Question 9

In order to recognize revenues while the performance obligation is being satisfied, what are the two methods used to measure progress toward completion of an obligation?

Answer 9

Two methods:

1. Output method
2. Input method

Question 10

What is the focus of the output method of measuring progress toward satisfaction of a performance obligation?

Answer 10

The focus of the output method is the value the customer can or does derive from the goods or services that have been transferred to the customer up to that point. Could use surveys, such as engineering studies, of the work completed; appraisals of results achieved; milestones reached; time elapsed; or units produced or delivered.

Question 11

What is the focus of the input method of measuring progress toward satisfaction of a performance obligation?

Answer 11

The focus of the input method is the effort put forth by the entity, including amounts spent on raw materials that will be used in deriving a meaningful measurement. Measurement may be based on a wide variety of inputs including resources consumed; labor hours expended; costs incurred; time elapsed; machine hours used.

Question 12

What is an onerous performance obligation?

Answer 12

When the expected cost of satisfying a performance obligation is greater than the amount of revue allocated to that performance obligation. The loss is reported on the financial statements and is recognized immediately.

Question 13

When must a loss be recognized in an onerous performance obligation?

Answer 13

In the earliest period in which it is determined that a loss will be incurred.

Question 14

What is the standalone selling price?

Answer 14

The price the entity sells a good or service for separately in comparable transactions. If sold separately, these is an observable price so we can use that price as best evidence of standalone price. If not, it must be estimated using one of the three approaches.

Question 15

What are the 3 approaches for determining standalone selling price if a good or service is not sold separately?

Answer 15

1. Adjusted market assessment approach
2. Expected Cost plus margin approach
3. Residual value approach

Question 16

How do you determine the standalone selling price using the adjusted market assessment approach?

Answer 16

Evaluate the market, see what a customer might be willing to pay or look at competitors.

Question 17

How do you determine the standalone selling price using the expanded cost plus margin approach?

Answer 17

Forecast expected costs and add an appropriate profit margin for the good or service.

Question 18

When do you use the residual value approach for determining standalone selling price?

Answer 18

When some goods or services are sold for diff amounts to diff customers.
OR
When the good or service not previously sold as a standalone product or service and a price has not yet been set.

Question 19

Name 3 ways revenue is often overstated in fraudulent financial reporting?

Answer 19

1. Fictitious transactions
2. Acceleration of when revenue should be recognized
3. Including cash receipts that are not actually revenues.

Question 20

Why did the FASB and IASB create a joint standard for revenue recognition?

Answer 20

• To reduce the ability of an entity to fraudulently report revenues
• to eliminate the numerous different approaches to revenue recognition being applied by different entities or for different transactions causing a lack of comparability among companies and sometimes a lack of consistency within an entity
• to adopt standards that are similar to those applied in financial statements prepared in accordance with International Financial Reporting Standards

Question 21

Name the two core components of the revenue recognition principle:

Answer 21

1. Revenue is to be recognized upon the transfer of promised goods and services to customers; and
2. The amount of revenue recognized represents the consideration the entity expects to receive in exchange for those goods and services

Question 22

What is the 5-step Revenue Recognition process?

Answer 22

1. Identify contracts with customers
2. Identify all separate performance obligations
3. Determine the total consideration for the contract
4. Allocate the total consideration among the separate performance obligations
5. Recognize revenue either when the entity has satisfied its performance obligation (products) or while the entity is satisfying its performance obligation (services)

Question 23

What is a contract?

Answer 23

an arrangement between two or more parties that creates legally enforceable rights and obligations. If either party can terminate the arrangement without penalty, it is not considered a contract.

Question 24

What are the 4 criteria for a contract?

Answer 24

1. The parties must have approved the provisions and must have committed to perform
2. The rights in the contract and the payment terms can be identified
3. The contract has commercial substance
4. Collection is probably

Question 25

How should amounts received be recognized if an arrangement does not meet the criteria for a contract?

Answer 25

As a liability such as deferred or unearned revenue. The liability will be measured as the amount received.

Question 26

How should amounts received be recognized if an arrangement never meets the criteria for a contract?

Answer 26

The liability is derecognized and treated as revenue

Question 27

When should amounts received be recognized if an arrangement never meets the criteria for a contract?

Answer 27

When the entity has no remaining obligations to the customer; all or substantially all of the consideration has been received by the entity; the amounts received are non refundable. OR The arrangement has been terminated and consideration received is non refundable.

Question 28

When should contracts be combined?

Answer 28

- Contracts negotiated as a single package with a single commercial objective - amount of consideration to be paid in one contract depends on the price or performance of the other contracts (multiple deliverables) - goods or services promised in two or more contracts are a single performance obligation

Question 29

What is an assurance-type warranty?

Answer 29

Protects the customer from obtaining a product that is not capable of performing at the level that the seller indicated that it would. Seller should be able to estimate the frequency with which these products will not perform at an acceptable level and the average cost incurred to repair or replace the product when it does not perform acceptably. Therefore, assurance-type warranties represent a contingent liability that is probable and estimable and should be accrued in the period incurred, generally the period of sale. (warranty expense and estimated warranty liability)

Question 30

What is a service-type warranty?

Answer 30

Generally provides a customer with repairs in the form of parts and labor in additional to making certain that the product performs as was promised. Separately identifiable promise in a contract and is a distinct performance obligation. Recognized while the performance obligation is being satisfied over the term of the contract. (deferred revenue)

Question 31

What is the transaction price?

Answer 31

The amount of consideration an entity expects to be entitled to in exchange for transferring goods or services in a satisfactory manner, excluding amounts to be collected on behalf of others such as sales taxed.

Question 32

How do you recognize revenue when the seller is a principal in the transaction?

Answer 32

Entire amount of revenue will be recognized and amounts paid to third parties will be recognized as expense or as a component of cost of sales

Question 33

How do you recognize revenue when the seller is an agent in the transaction?

Answer 33

One the net amount (the amount of revenue to be retained after paying the principal, is recognized.

Question 34

Responsibilities of the principal in a transaction

Answer 34

Has an obligation to provide goods or services

Question 35

Responsibilities of the agent in a transaction

Answer 35

obligation to arrange for another party, the principal, to provide goods and services

Question 36

How do you determine who is the principal and who is the agent in a transaction?

Answer 36

Determine who has control of the goods or services that are the subject of the contract

Question 37

Indications of who has control of goods or services prior to transfer to the customer include:

Answer 37

- primary responsibility for the goods or services to the customer - risk of loss associated with inventory both before delivery to the customer and after delivery to the customer (such as when a customer returns goods) - authority to set prices for the goods or services that are the subjects of the contract

Question 38

Expected Value Approach

Answer 38

Different amounts that are obtained based on various levels of performance will each be assigned a probability with the total of the probabilities equaling 100% Each amount is multiplied by the probability of achieving it and the total is the expected amount of variable consideration.

Question 39

Two approaches for variable consideration

Answer 39

1. Expected value approach | 2. Most likely amount approach

Question 40

Most like amount approach

Answer 40

Different outcomes are each assigned a probability such that the total of the probabilities equals 100% and the outcome with the greatest probability of occurrence is assumed to be the amount that is to be recognized

Question 41

What are factors that increase the likelihood or the magnitude of a potential reversal?

Answer 41

- market volatility beyond the control of the entity - uncertainties that are not likely resolved for long periods - amounts due cannot be reliably anticipated due to lack of experience - practice of making price concessions or changing terms and conditions - wide range of possible consideration amounts

Question 42

What is realization?

Answer 42

Realization is the conversion of an item or service into cash or a claim to cash as would be the case when equipment is sold for a note receivable. Realization occurs at the time that an entity converts goods or services into accounts receivable, and not necessarily when the receivable is collected.

Question 43

Based on revenue recognition, when is a revenue recognized?

Answer 43

- A binding arrangement exists (a signed contract) - Services rendered or delivery has occurred - Fixed or determinable price exists - Collection is reasonable assured

Question 44

How do recognize revenue when a buyer has the right of return?

Answer 44

- If returns are reasonably estimable, revenue is recognized in the period of sale with an allowance for returns - If returns cannot be reasonably estimated, revenue is not recognized until the right of return has expired