Week 4 - Revenue Recognition Flashcards
(31 cards)
Why does contract costs exist when a company is trying to gain the contract?
Its something they have to pay in order to recieve the contract
What are some examples of contract costs?
○ They have to pay for things such as cost to prepare bid documents, legal fees, etc)
How and when do we recognize the cost of ‘contract costs’?
IFRS recommends these costs are recgonized these costs are incremental (meaning: they only happen because they won the contract)
When a company won a contract how are these costs recorded as?
They are recorded as an assset
What happens if these costs are not due to the contract but were to happen with or without the contract?
Then those costs cannot be capitalized — they have to be recorded as an expense right away.
What counts as an incremental cost?
Costs that only happen when the contract is obtained
What are non-incremental costs?
- Costs that would have been incurred anyway, even if the company didn’t win.
What is an onerous contract
An onerous contract is a long-term contract where the company knows it will lose money on the job.
What happens in accounting when a contract becomes onerous?
As soon as the company realizes that it will lose money, it must:
Recognize the full expected loss immediately in the financial statements
Even if the project is only partially done (e.g., 20% finished), the company must record 100% of the expected loss now
What are long-term contracts
Projects that take TIMEEE to finish like building a house or building
What does rev rec say for long term contracts
Use the percentage of completion method if you’re recognizing revenue over time.
What is the POC method?
Its a method that recognizes part of the revenue and costs each period, based on how much of the work is done.
What are two types of long-term contracts?
1) Fixed - price contract
2) Cost-plus contract
What is a fixed price contract?
These are contracts that the contractor agrees to a price before the performance (the contract starts)
What is a cost plus contract?
The buyer agrees to pay whatever the actual cost is, plus an additional profit margin for the contractor.
Who bears the risk in a fixed-price contract?
The contractor — if costs go up, they still have to finish the work at the agreed price.
Who bears the risk in a cost-plus contract?
The buyer — they pay more if costs increase.
How to compute the percentage of completion method?
1) We figure out how much of the project was completed each year (measured by % completion).
2) We apply that % to the total contract price to calculate revenue recognized.
Helps us compute the amout of revenue to be recongized
Percentage complete*contract price - revenue previously recgonized
Does he percentage of completetion allocation revenue and expenses?
The percentage of completion method allocates revenue, not expenses in the fixed price contract method.
Instead, you record actual costs incurred when they happen.
What is another way to estimate the percentage of completion?
Cost-to-cost approach
What is the cost-to cost approach?
based on how much costs have been incurred/ total estimated cost
Equation for revenue under percentage of completion method using the cost-to-cost approach:
Revenue=( Estimatedtotalcost/ Costincurredtodate )×Contractrevenue−Revenuepreviouslyrecognized
Equation for gross profit under percentage of completion method using the cost-to-cost approach:
Grossprofit=( Estimatedtotalcost/ Costincurredtodate)×Estimatedgrossprofit−Grossprofitpreviouslyrecognized
What is the five accounting entries for a long term contract?
1) Incurring costs on the project
2) Billing the client
3) Receiving payments from the client
4) Accruing revenue and any other adjustments for the accounting period
5) Closing the accounts at the end of the contract
