1. Chapter 8
Revenue Recognition
ACCT-3030

2. 1. Revenue Recognition Basic Concepts
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

3. 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

4. 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)
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

5. 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

6. 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 (now 2018)
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

7. 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

8. 1b. Revenue from Contracts with Customers
The five steps of revenue recognition are:
Identify the contract with customers.
Identify the separate performance obligations in the contract.
Determine the transaction price.
Allocate the transaction price to the separate performance obligations.
Recognize revenue when each performance obligation is satisfied.
ACCT-3030

9. 1b. Revenue from Contracts with Customers
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

10. 1b. Revenue from Contracts with Customers
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

11. 1b. Revenue from Contracts with Customers
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

12. 1b. Revenue from Contracts with Customers
Identify the separate performance obligations in the contract.
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

13. 1b. Revenue from Contracts with Customers
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

14. 1b. Revenue from Contracts with Customers
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

15. 1b. Revenue from Contracts with Customers
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

16. Revenue recognized when
2. General Rule
When applying Revenue from Contracts with Customers, revenue is 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

17. 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

18. 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

19. 5. Revenue Frauds Contracts, agreements and side letters
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

20. 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

21. 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

22. 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

23. 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

24. 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