Transcript Chapter 18A
Chapter 18
Revenue Recognition
ACCT-3030
1
1. Revenue Recognition Basic Concepts
Revenue recognition
◦ most difficult issue facing accounting
◦ most prevalent reason for accounting
restatements
◦ most common way financial statements are
fraudulently presented
◦ revenue is one of most important measures used
by inventors to assess a company’s performance
◦ revenue recognition is the cornerstone of accrual
accounting
ACCT-3030
2
1. Revenue Recognition Basic Concepts
Definition of revenue (SFAC 6)
◦ Inflows or other enhancements of assets or
settlement of liabilities during a period from delivering
or producing goods, rendering services, or other
activities that constitute the entity’s ongoing major or
central operations.
General recognition criteria (SFAC 5)
◦
◦
◦
◦
meets definition of an element
measurability
relevance
faithful representation
ACCT-3030
3
1a. Revenue Recognition Basic Concepts
APB Statement 4
◦ Revenue is recognized when
the earnings process is complete or virtually complete
an exchange has taken place
Realization principle (SFAC 5)
◦ Revenue is recognized when
the earnings process is judged to be complete or
virtually complete
there is reasonable certainty as to the collectability of
the asset to be received
ACCT-3030
4
1a. Revenue Recognition Basic Concepts
SEC SAB No. 101
◦ persuasive evidence of an arrangement exists
◦ delivery has occurred or services have been
rendered
◦ the seller’s price to the buyer is fixed or
determinable
◦ collectability is reasonably assured
ACCT-3030
5
1b. Revenue from Contracts with Customers
New standard adopted by FASB and IASB
◦ issued May 28, 2014
◦ entities required to apply the new standard for reporting
periods beginning on or after Jan. 1, 2017
◦ the issuing boards agreed that this unusual length of time is
appropriate because of the impact of this project
◦ this gives entities time to update their software systems and
processes in order to capture data for comparatives
◦ the boards tentatively stated that entities could use an
alternative transition method that would recognize the
cumulative effect of initially applying the new standard
ACCT-3030
6
1b. Revenue from Contracts with Customers
New standard adopts an asset-liability
approach to revenue recognition
◦ companies account for revenue based on the asset or
liability arising from contracts with customers
New revenue recognition principle:
◦ revenue is recognized when the performance
obligation is satisfied
Follows a five-step process
ACCT-3030
7
1b. Revenue from Contracts with Customers
The five steps of revenue recognition are:
1. Identify the contract with customers.
2. Identify the separate performance obligations in the
contract.
3. Determine the transaction price.
4. Allocate the transaction price to the separate
performance obligations.
5. Recognize revenue when each performance
obligation is satisfied.
ACCT-3030
8
1b. Revenue from Contracts with Customers
1.
Identifying the Contract with Customers
◦ a contract is an agreement between two or more
parties that creates enforceable rights or obligations
◦ requirements for a contract
the contract has commercial substance (future cash flows change
as a result of the contract)
the parties to the contract have approved the contract and
are committed to perform their respective obligations.
the company can identify each party’s rights regarding the
goods or services to be provided, and
the company can identify the payment terms for the goods
and services to be transferred.
ACCT-3030
9
1b. Revenue from Contracts with Customers
1.
Identifying the Contract with Customers
◦ Revenue from a contract with a customer
cannot be recognized until a contract exists.
◦ Do not recognize contract assets or liabilities
until one or both parties to the contract
perform.
ACCT-3030
10
1b. Revenue from Contracts with Customers
1.
Identifying the Contract with Customers
◦ Contract modification - determine if a new contract
and performance obligation results or whether it is a
modification of the existing contract
Treated as a new contract if both of the following
conditions are met:
the promised goods or services are distinct, and
the company has the right to receive an amount of
consideration that reflects the standalone selling price of the
promised goods or services
If either or both of the above conditions not met,
account for modification using a prospective approach
under this approach, revenue is recognized using a blended price
ACCT-3030
11
1b. Revenue from Contracts with Customers
Identify the separate performance obligations in the contract.
2.
A company must provide a distinct product or service for a
performance obligation to exist.
If a single product or service is provided there is only one
performance obligation.
If multiple products/services are provided and they are
interdependent and interrelated, they are combined and
reported as a single performance obligation.
If the products/services are not highly dependent or interrelated
with other promises, then each performance obligation should
be accounted for separately.
ACCT-3030
12
1b. Revenue from Contracts with Customers
3.
Determine the transaction price.
◦ Transaction price is amount company expects to receive from a
customer in exchange for transferring goods/services
◦ In some contracts, may need to consider:
variable consideration (such as discounts, rebates, bonuses, royalties)
use expected value (if more than two possible outcomes) or,
most likely amount (if only two possible outcomes)
time value of money
m/b used if contract has significant financing component and time period greater than
one year
noncash consideration
measure as fair value of what received
consideration paid or payable to the customer
items that will reduce the consideration received (e.g., free products, volume discounts)
ACCT-3030
13
1b. Revenue from Contracts with Customers
4.
Allocate the transaction price to the separate
performance obligations.
◦ If more than one performance obligation exists, an
allocation of the transaction price should be based on
the relative fair values of the various performance
obligations
◦ When a bundle of goods/services is sold, the bundle’s
selling price may be less than the sum of the individual
standalone prices. If so
the discount should be allocated to the product(s) causing the
discount, not to the entire bundle
ACCT-3030
14
1b. Revenue from Contracts with Customers
5.
Recognize revenue when each performance
obligation is satisfied.
◦ A company satisfies its performance obligation when
the customer obtains control of the good/service.
◦ Performance obligations may be satisfied at a point in
time or over a period of time.
◦ Companies recognize revenue over a period of time
if:
the customer controls the asset as it is created or the
company does not have an alternative use for the asset, and
the company has a right to payment.
ACCT-3030
15
2. General Rule
When applying Revenue from Contracts with Customers,
revenue usually recognized at the point of sale
Activity
Revenue recognized when
Selling products
Point of sale (date of delivery;
when title passes)
Providing services
Services have been performed
and amounts are billable
Permitting others to use the
firm’s assets
As time passes
Disposing of assets
Date of sale
ACCT-3030
16
3. Possible Points to Recognize Revenue
Most significant event
Recognition before point of sale
◦ prior to starting production
customer advances
◦ during production
long-term construction contracts
◦ at completion of production
precious metals, ag products
Recognition at point of sale
◦ but if right of return exists or sale with buyback
Recognition after point of sale
◦ cash collection methods
installment sales, cost recovery basis
◦ consignments
ACCT-3030
17
4. Expense Recognition
Expense – expired economic benefits
Outflows or other using up of assets or incurrence of liabilities
during a period from delivering or producing goods, rendering
services, or other activities that constitute the entity’s ongoing
major or central operations. (SFAC 6)
Expenses to be recognized can be identified
by
◦ matching
◦ direct expensing (period costs)
◦ systematic allocation
ACCT-3030
18
5. Revenue Frauds
Obvious accounting violations
◦ Fictitious sales or fake customers
◦ Premature recording of sales
◦ Inflated sales
Transactions sometimes lacking integrity
◦
◦
◦
◦
◦
◦
Roundtrip transactions
Channel stuffing and trade loading
Bill and hold transactions
Repurchase agreements
Related party transactions
Principle-agent (grossing up revenue)
Contracts, agreements and side letters
ACCT-3030
19
6. Long-term Construction Contracts
Percentage of completion method
◦ revenue recognized each period based on
progress of construction
◦ this method required if
company’s performance creates or enhances an asset
that the customer controls, or
company’s performance does not create an asset with
an alternate use, and
costs to complete and extent of progress toward
completion are reasonably dependable
If criteria not met use completed contract
method
ACCT-3030
20
6a. Long-term Construction Contracts
Methods to estimate percentage of
completion
◦ cost-to-cost method (input method)
costs to date ÷ total estimated costs to complete
most common method
◦
◦
◦
◦
machine hours or labor hours (input measure)
project milestones (output method)
units of production (output method)
engineer’s or architect’s estimates
ACCT-3030
21
6b. Long-term Construction Contracts
Revenue and GP recognized per period
◦ percentage completed this period x total
revenue or GP
◦ new accounts
construction in progress (inventory account)
progress billings (contra acct to CIP)
◦ financial statement presentation
net both accounts – could be debit or credit balance
◦ example
ACCT-3030
22
7. Completed contract method
Revenues and gross profit recognized when
project finished
Entries
◦ same entries to record costs and billings
◦ do not recognize revenue and gross profit each
year
The two methods are not acceptable
alternatives
Example
ACCT-3030
23
8. Right of Return
Only recognize revenue if all of following are met
sellers price is fixed
◦ buyer has paid or is obligated to pay
◦ buyer’s obligation would not be changed by the theft
or destruction of the product
◦ buyer has economic substance apart from that
provided by the seller
◦ seller doesn’t have future significant obligations
◦ amount of future returns can be reasonably estimated
ACCT-3030
24