1. Chapter 18. Revenue Recognition I. The Five Step Process
II. Long-term Contract (Very difficult but important! Read the textbook!)
III. Other Issues

2. Overview of Revenue Recognition
New Revenue Recognition Standard
In May 2013, the FASB and IASB issued a converged standard on revenue recognition entitled Revenue from Contracts with Customers
Revenue from Contracts with Customers, adopts an asset-liability approach. Companies:
Are required to analyze contracts with customers
Contracts indicate terms and measurement of consideration.
Without contracts, companies cannot know whether promises will be met.
Account for revenue based on the asset (right) and liability (obligation) arising from contracts with customers.

3. New Revenue Recognition Standard
Performance Obligation is Satisfied

4. The Five-Step Process
Boeing Co. signs a contract to sell airplanes to Delta Air Lines for $100 million.
Step 1: Identify the contract with customers.
Boeing has signed a contract to deliver
airplanes to Delta.
Step 2: Identify the separate performance obligations in the contract.
Boeing has only one performance obligation—to deliver airplanes to Delta.
Step 3: Determine the transaction price.
The transaction price is $100 million.
Step 4: Allocate the transaction price to the separate
performance obligations.
Boeing allocates $100 million to delivering airplanes to Delta.
Boeing recognizes revenue of $100 million for the sale of the airplanes to Delta when the delivery is made.
Step 5: Recognize revenue when
each performance obligation
is satisfied.

5. Step 1: Indentify Contract with Customers
Description
A contract is an agreement that creates enforceable rights or obligations.
Implementation
A company applies the revenue guidance to contracts with customers
A company must determine if new performance obligations are created by a contract modification.

6. Contract with Customers
Contract: Agreement between two or more parties that creates enforceable rights or obligations
- Can be written, oral, or implied from customary business practice
Revenue cannot be recognized until a contract exists.
- Company obtains rights to receive consideration and assumes obligations to transfer goods or services.
- Rights and performance obligations gives rise to an (net) asset or (net) liability.
Contract asset = Rights received > Performance obligation
Contract liability = Rights received < Performance obligation
However, a company does not recognize contract assets or liabilities until one or both parties to the contract perform.

7. Contract Criteria for Revenue Guidance
Company applies the revenue guidance to a contract according to the criteria in the following Illustration
Apply Revenue Guidance to Contracts If:
Disregard Revenue Guidance to Contracts If:
Contract Criteria for Revenue Guidance
The contract has commercial substance;
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 transferred; and
The company can identify the payment terms for the goods and services to be transferred.
The contract is wholly unperformed, and
Each party can unilaterally terminate the contract without compensation.
A company applies the revenue guidance to a contract if
a.The contract has commercial substance.
b.The parties to the contract have approved the contract and are committed to perform their respective obligations.
c.The company can identify each party’s rights regarding the goods or services to be provided, and
d.The company can identify the payment terms for the goods and services to be transferred.
A company disregards the revenue guidance if the contract is wholly unperformed and each party can unilaterally terminate the contract without compensation.

8. Contract Modifications
“Change in contract terms while it is ongoing”.
Companies determine
– whether a new contract (and performance obligations)
is created by a contract modification or
– whether it is a modification of the existing contract.

9. Contract Modifications, cont’d
Separate Performance Obligation
Accounts for as a new contract if both of the following conditions are satisfied:
1) Promised goods or services are distinct (i.e., company sells them separately and they are not interdependent with other goods and services), and
2) The company has the right to receive an amount of consideration that reflects the “standalone” selling price of the promised goods or services.
Prospective Modification
If Additions are not a Separate Performance Obligation
i.e.,) If neither or both of the above conditions are not met,
Account for effect of change in period of change as well as future periods if change affects both.
A contract modification is treated as a new contract if both of the following conditions are met:
 a. The promised goods or services are distinct, and
 b.The company has the right to receive an amount of consideration that reflects the standalone selling price of the promised goods or services.
If neither or both of the above conditions are not met, then companies account for the modification using a prospective approach. Under this approach, companies should account for effect of change in period of change as well as future periods if change affects both. And companies should not change previously reported results.

10. Separate Performance Obligation
Crandall Co. has a contract to sell 100 products to a customer for $10,000 ($100 per product) at various points in time over a six-month period. After 60 products have been delivered, Crandall modifies the contract by promising to additionally deliver 20 more products at $95 per product (which is the standalone selling price of the products at the time of the contract modification). Crandall regularly sells the products separately.
Given a new contract, Crandall recognizes an additional:
In this situation, the contract modification for the additional 20 products is, in effect, a new and separate contract because it meets both the conditions. That is it does not affect the accounting for the original contract.
Original contract [(100 units - 60 units) x $100] = $4,000
New product (20 units x $95) = 1,900
Total revenue recognized after modification = $5,900

11. Prospective Modification
If Additions are not a Separate Performance Obligation, they are recognized as revenue for each of the remaining products would be a “blended price” of $98.33.
Products not delivered under original contract:
($100 x $40) = $4,000
Products to be delivered under contract modification:
($95 x 20) = 1,900
Total remaining revenue $5,900
Revenue per remaining unit ($5,900 ÷ 60) = $98.33
Revenue recognized after modification $5,900 = $98.33*60

12. Comparison of Contract Modification Approaches
Under the separate performance obligation approach
$5,900 = 40* *$95
Under the prospective modification approach
$5,900 = $98.33*60

13. Step 2: Identify Separate Performance Obligations
Description
A performance obligation is a promise in a contract to provide a product or service to a customer.
A performance obligation exists if the customer can benefit from the good or service on its own or together with other readily available resources.
Implementation
A contract may be comprised of multiple performance obligations.
If each of the goods or services is distinct, but is interdependent and interrelated, these goods and services are combined and reported as one performance obligation.

14. Separate Performance Obligations
Determine whether a company has to account for multiple (i.e., more than one) performance obligations
If performance obligation is not highly dependent on or interrelated with other promises in the contract, then each performance obligation should be accounted for separately.
If each of these services is interdependent and interrelated, these services are combined and reported as one performance obligation.

15. Separate Performance Obligations: Examples
Com. A licenses customer-relationship software to Com. B. In addition, Com. A promises to provide consulting services by extensively customizing the software to Com. B’s information technology environment, for a total consideration of $600,000:
Com. A’s license and the consulting services are distinct but interdependent, and therefore should be accounted for as
 One single performance obligation
Com. A manufactures and sells computers that include a warranty to make good on any defect for 120 days (often referred to as an assurance warranty). In addition, it sells separately an extended warranty, which provides protection from defects for 3 years beyond the 120 days (often referred to as a service warranty):
Com. A’s sale of the computer and related assurance warranty are interdependent and interrelated with each other
But, the extended warranty is separately sold and not interdependent.  Separate performance obligation

16. Step 3: Determine Transaction Price
Description
Transaction price is “the amount of consideration that a company expects to receive from a customer” in exchange for transferring goods and services.
Implementation
1. In a contract, transaction price is often easily determined because customer agrees to pay a fixed amount.
2. In other contracts, companies must consider:
variable consideration,
time value of money,
noncash consideration, and
consideration paid or payable to customer.

17. Variable Consideration: “Price dependent on future events”
Companies estimate amount of revenue to recognize.
1. Expected value: Probability-weighted amount in a range of possible consideration amounts
May be appropriate if a company has a large number of contracts with similar characteristics.
Can be based on a limited number of discrete outcomes and probabilities.
2. Most likely amount: The single most likely amount in a range of possible consideration outcomes
May be appropriate if the contract has only “two” possible outcomes.
Variable consideration: A word of caution
Only allocate variable consideration if it is reasonably assured that it will be entitled to the amount.
Companies only recognizes variable consideration if
they have experience with similar contracts and are able to estimate the cumulative amount of revenue, and
based on experience, they do not expect a significant reversal of revenue previously recognized.
 If these two criteria are not met, revenue recognition is constrained.

18. Variable Consideration: Example
Peabody Construction Co. enters into a contract with a customer to build a warehouse for $100,000, with a performance bonus of $50,000 that will be paid based on the timing of completion. The amount of the performance bonus decreases by 10% per week for every week beyond the agreed-upon completion date. The contract requirements are similar to contracts that Peabody has performed previously, and management believes that such experience is predictive for this contract. Management estimates that there is a 60% probability that the contract will be completed by the agreed-upon completion date, a 30% probability that it will be completed 1 week late, and only a 10% probability that it will be completed 2 weeks late.
Question: How should Peabody account for this revenue arrangement?

19. Variable Consideration : Example, cont’d
1. Management has concluded that the probability-weighted method is the most predictive approach:
60% chance of $150,000 = $ 90,000
30% chance of $145,000 = 43,500
10% chance of $140,000 = 14,000
$147,500
2. Most likely outcome, if management believes they will meet the deadline and receive the $50,000 bonus, the total transaction price would be?
$150,000 (the outcome with 60% probability)

20. Other issues Time Value of Money Noncash Consideration
- When contract (sales transaction) involves a significant financing component.
Fair value determined either by measuring the consideration received or by discounting the payment using an imputed interest rate.
Company reports interest expense or interest revenue.
Noncash Consideration
- Companies generally recognize revenue on the basis of the fair value of what is received (transactions with commercial substance).
If that cannot be determined, the selling price of what was given up.
- Receive Donation: Contribution Revenue
Consideration Paid or Payable to Customers
- May include discounts, volume rebates, coupons, or free products.
- In general, these elements reduce the consideration received and the revenue to be recognized.
If a company receives a form of noncash consideration in exchange for the sale of their goods/services, revenue should be measured using the fair value of what was received. If that cannot be determined, the selling price of what was given up should be estimated and used to measure the revenue.
Consideration paid or payable may include discounts, volume rebates, coupons, free products or services. In general, such items will reduce the consideration received and the revenue recognized.

21. Volume Discount: Example
Minjun Company offers its customers a 3% volume discount if they purchase at least $2 million of its product during the calendar year. On March 31, 2014, Minjun has made sales of $700,000 to Artic Co. In the previous 2 years, Minjun sold over $3,000,000 to Artic in the period April 1 to December 31.
Q: How much revenue should Minjun recognize for the first 3 months of 2014?
March 31, 2014:
Accounts Receivable 679,000
Sales Revenue 679,000
Reduced by $21,000(=$700,000x3%) because it is probable that the rebate will be provided.
Cash Receipt:
Assuming Minjun’s customer meets the discount threshold,
Cash 679,000
Accounts Receivable 679,000
If Minjun’s customer fails to meet the discount threshold, Minjun makes the following entry upon payment.
Cash 700,000
Accounts Receivable 679,000
Sales Discounts Forfeited 21,000

22. Step 4: Allocate Transaction Price to Separate Performance Obligations
Description
If more than one performance obligation exists, allocate the transaction price based on relative fair values.
Implementation
The best measure of fair value is what the good service could be sold for on a standalone basis (standalone selling price).
Estimates of standalone selling price can be based on
1) adjusted market assessment,
2) expected cost plus a margin approach, or
3) a residual approach.

23. Allocating Transaction Price to Separate Performance Obligations
1. Best measure of fair value is what the company could sell the good or service for on a standalone basis.
2. If not available, companies should use their best estimate of what the good or service might sell for as a standalone unit.
 Three allocation approach
1) adjusted market assessment,
2) expected cost plus a margin approach, or
3) a residual approach
If more than one performance obligation exists in a contract, the allocation should be based on their relative fair values (Illustration 18-16, Example 2 on Textbook p. 1054)

24. Step 5: Recognize Revenue When
Each Performance Obligation Is Satisfied
Description
A company satisfies its performance obligation when the customer obtains control of the good or service.
Implementation
Companies satisfy performance obligations either at a point in time or over a period of time.
Companies recognize revenue over a period of time if (1) or (2) (i) and (ii) either (a) or (b)
 Next slide
Change in Control Indicators
Company has a right to payment for asset.
Company has transferred legal title to asset.
Company has transferred physical possession of asset.
Customer has significant risks and rewards of ownership.
Customer has accepted the asset.

25. Recognizing Revenue When Each Performance Obligation is Satisfied
Recognize revenue over a period of time (in a more rigorous manner) if:
(1) The customer controls the asset as it is created or enhanced or
(2) (i) the company does not have an alternative use for the asset created or enhanced and
(ii) either (a) the customer receives benefits as the company performs and therefore the task would not need to be re-performed, or (b) the company has a right to payment and this right is enforceable
Recognizes revenue over time by measuring the progress toward completion
Method for measuring progress should depict transfer of control from company to customer
The most common method is the cost-to-cost method
percentage-of-completion method
Performance obligations may be satisfied at a point in time or over a period of time.
Recognize revenue over a period of time if The customer receives and consumes the benefits as the seller performs And, one of the following two criteria is met
The customer controls the asset as it is created or enhanced
the company does not have an alternative use for the asset created or enhanced and either (a) the customer receives benefits as the company performs and therefore the task would not need to be re-performed, or (b) the company has a right to payment and this right is enforceable.
The Company recognizes revenue from a performance obligation over time by measuring the progress toward completion. The method selected should depict transfer of control from company to customer. The most common method is the cost-to-cost method, or percentage-of-completion method. Under this basis, company measures the percentage of completion by comparing costs incurred to date with the most recent estimate of the total costs required to complete the contract. We’ll talk about this method in detail later.

26. Revenue Recognition Situations: Typical cases
Sale of product
from inventory
Rendering a service
Permitting use of an asset
Sale of asset other than inventory
Type of Transaction
Revenue from sales
Revenue from fees or services
Revenue from interest, rents, and royalties
Gain or loss on disposition
Description of Revenue
Timing of Revenue Recognition
Date of sale (date of delivery)
Services performed and billable
As time passes or assets are used
Date of sale or trade-in

27. Most Product Sales: Revenue Recognition at Point of Delivery
On March 1, 2014, Margo Company enters into a contract to transfer a product to Soon Yoon on July 31, The contract is structured such that Soon Yoon is required to pay the full contract price of $5,000 on August 31, 2014.The cost of the goods transferred is $3,000. Margo delivers the product to Soon Yoon on July 31, 2014.
Question: Assuming Margo uses perpetual inventory method, what journal entries should Margo Company make in regards to this contract in 2014?
July 31, 2014
Accounts Receivable 5,000
Sales Revenue 5,000
Cost of Goods Sold 3,000
Inventory 3,000
August 31, 2014
Cash 5,000
Accounts Receivable 5,000

28. Long-term contract
Revenue may be recognized before delivery under certain circumstances
Long-term construction contracts using the percentage-of-completion method, are a notable example
The percentage-of-completion method recognizes revenues at various points in the project based on the percentage of work done.

29. Percentage-of-Completion vs. Completed-Contract method
Long-Term Construction
Accounting Methods
Percentage-of-Completion
Method
Completed-Contract
Method
: Rev. is recognized according to
percentage of completion
(before delivery)
: To be used if
-Terms of contract must
be certain, enforceable and
expected to be performed
by both parties
: Rev. is recognized only when
contract is completed
(at the point of delivery)
: To be used only when the
percentage method is
inapplicable (uncertain)

30. Percentage-of-Completion: How to get gross profit for each yr?
Costs Incurred to Date = Percent Complete
Most Recent Estimated Total Costs 1
Percent Complete x Estimated Total Revenue
= Revenue (to Be Recognized) to Date 2
Revenue to Date – Prior Revenues =Current Period Revenue
Cost to Date – Prior costs =Current Period Cost
So,
Revenue of the year – Costs of the year = Gross Profit 3 OR
Revenue to date - Cost to Date = Gross profit to date
So,
Gross profit to date – prior gross profits = Gross Profit 3

31. An Example Calculate gross profit for each year.
Data: Contract price: $4,500,000
Start date: July, Finish: Oct, 2012
Balance sheet date: December 31st
Given:
Progress billings during year $ 900,000 $2,400,000 $1,200,000
Cash collected during year $ 750,000 $1,750,000 $2,000,000
Costs to date $1,000,000 $2,916,000 $4,050,000
Estimated costs to complete $3,000,000 $1,134,000 $
Calculate gross profit for each year.

32. Percentage-of-Completion: Percent complete?
$4,500, $4,500, $4,500,000
Contract Price
1,000, ,916, ,050,000
+3,000, ,134,
4,000, ,050, ,050,000
Costs To Date
Est. Cost to Complete
Est. Total Costs
1,000, ,916, ,050,000
4,000, ,050, ,050,000
= 25% = 72% = 100%
Percent Complete

33. Percentage-of-Completion: current year gross profit?
1,000, ,916, ,050,000
4,000, ,050, ,050,000
=25% =72% =100%
Percent Complete
$4,500, $4,500, $4,500,000
Contract Price
$1,125, $3,240, $4,500,000
,125, ,240,000
$1,125, $ 2,115, $1,260,000
Revenue to date
- Prior years’ Revenues
Current year revenue
$1,000, $ 2,916, $ 4,050,000
,000, ,916,000
$1,000, $1,916, $ 1,134,000
Cost to date
- Prior years’ costs
Current year cost
Current year Revenue
Current year Cost
Current year gross profit
$ 1,125, $ 2,115, $ 1,260,000
-1,000, ,916, ,134,000
$ , $ , $ 126,000

34. Percentage-of-Completion: current year gross profit? Alternative way
1,000, ,916, ,050,000
4,000, ,050, ,050,000
=25% =72% =100%
Percent Complete
$4,500, $4,500, $4,500,000
Contract Price
$1,125, $3,240, $4,500,000
- 1,000, ,916, ,050,000
$ 125, $ 324, $ 450,000
Revenue to date
Cost to date
Gross Profit to date
$ 125, $ , $ 450,000
, ,000
$ 125, $ 199, $ 126,000
Gross profit to date
Prior Gross profits
Current year gross profit

35. Percentage-of-Completion: F/S Representation

36. Completed-Contract Method
Companies recognize revenue and gross profit only at point of sale (Delivery) —that is, when the contract is completed.
Under this method, companies accumulate costs of long-term contracts in process, but they make no interim charges or credits to income statement accounts for revenues, costs, or gross profit.
Gross Profit in the example:  0;
2011  0;
2012  450,000 (= $4,500,000 - $4,050,000)

37. Completed-Contract Method: F/S Representation

38. Comparison of Results (Gross Profit Recognition)
Year
Percentage-of- Completion
Completed- Contract
2010
$125,000 $
2011
199,000
2012
126,000
450,000
Total
$450,000

39. Another Example
Prior Example
$1,134,000
Data as previously given, except for the 2012 cost estimate
$4,500, $4,500, $4,500,000
Contract Price
1,000, ,916, ,384,962
+3,000, ,468,
4,000, ,384, ,384,962
Costs To Date
Est. Cost to Complete
Est. Total Costs
1,000, ,916, ,384,962
4,000, ,384, ,384,962
= 25% = 66.5% = 100%
Percent Complete
Percentage-of-completion method for 2010,
gross profit (125,000) is the same as that of prior example.

40. Another Example: Gross profit for the 2011?
Percentage-of-completion method (2011)
Revenue to 2011 (= $4,500,000 x 66.5%) $2,992,500
Less: Revenue to ,125,000
Revenue recognized in $1,867,500
Less: Actual costs incurred in ,916,000
Gross Profit (Loss) recognized in (48,500) OR
Revenue to 2011 (= $4,500,000 x 66.5%) $2,992,500
Less: Cost to ,916,000
Gross profit to $ ,500
Less: Gross profit to ,000
Gross profit (Loss) in (48,500)

41. Another Example: Gross profit for the 2012?
Percentage-of-completion method (2012)
Revenue (2012) = 4,500,000 – 2,992,500
= 1,507,500
Cost (2012) = 4,384,962 – 2,916,000
= 1,468,962
Gross profit (2012) = 1,507, ,468,962
= 38,538

42. Another Example: Completed-contract method
Gross profit:
2010  0;
2011  0;
2012  115,038 (= $4,500,000 - $4,384,962)
As the contract is overall profitable, no loss is
recognized in 2011

43. Estimated Overall Loss Contract: Different Approach
A long-term contract may produce 
an estimated overall loss for the project
 Loss should be immediately recognized in the expected year.
- Under the percentage-of-completion method, overall estimated losses are immediately recognized after considering accumulated gross profits to the last year
- Under the completed-contract method, overall estimated losses are immediately recognized

44. Estimated Overall Loss Contract
Prior examples:
$1,134,000 & $1,468,962
Data as previously given, except for the 2011 cost estimate
$4,500, $4,500, $4,500,000
Contract Price
1,000, ,916, ,556,250
+3,000, ,640,
4,000, ,586, ,556,250
Costs To Date
Est. Cost to Complete
Est. Total Costs
1,125, Anticipated total
-) 1,000, Loss is $86,250
125, ,000
So,
-$86,250
= 125,000 + X
X= -$211,250
Gross profit for each yr
In the scenario II, it becomes obvious in 2005 that the contract is going to result in a loss, as the contract revenue, which is $4.5million, is not going to cover the overall costs, which is more than 4.5m (being $4,556,250). As the result, the loss should be recognized under both POC method and the CC method. But you should be very careful here, when the contract is an overall loss, the ways to determine the amount of loss to be recognized and the accounting journal entries to be used under the POC method and the CC method are totally different.

45. Estimated Overall Loss Contract
Gross profit (Losses) recognized in POC CC
gross profit recognized in $125, $ N/A
Losses (Gross profit) recognized in POC CC
Cumulated gross profit recognized to 2010 $125, $ N/A
Expected loss on unprofitable contract (total) ($86,250) ($86,250)
Total loss to be recognized in ($211,250) ($86,250)
In the scenario II, it becomes obvious in 2005 that the contract is going to result in a loss, as the contract revenue, which is $4.5million, is not going to cover the overall costs, which is more than 4.5m (being $4,556,250). As the result, the loss should be recognized under both POC method and the CC method. But you should be very careful here, when the contract is an overall loss, the ways to determine the amount of loss to be recognized and the accounting journal entries to be used under the POC method and the CC method are totally different.
Gross profit recognized in POC CC
Cumulated gross profit recognized to ($86,250) ($86,250)
Actual gross profit on the contract (total) ($86,250) ($86,250)
Total gross profit to be recognized in 2012 $ $

46. Summary (A long-term contract)
First, Check if there is
an estimated overall loss for the project (each year)
1) If No (i.e., total Revenue ≥ total estimated costs),
 Normal method
2) If Yes (i.e., total Revenue < total estimated costs),
 Total loss should be immediately recognized in the expected year. 46

47. Other Revenue Recognition Issues
Right of return
Repurchase agreements
Bill and hold
Warranties
Principal-agent relationships
e.g., Consignment sales

48. Right of Return
Right of return is granted for product for various reasons (e.g., dissatisfaction with product).
When sales are made with a right of return, the seller should recognize revenue adjusted for the products expected to be returned, a refund liability, and
an asset for the right to recover the product.
an asset account: Estimated Inventory Returns
corresponding adjustment to cost of goods sold
Right of return is granted for product for various reasons (e.g., dissatisfaction with product). Company returning the product receives full or partial refund of any consideration paid or credit that can be applied against amounts owed, or that will be owed, to the seller. When sales are made with a right of return, the seller should recognize (a) revenue adjusted for the products expected to be returned, (b) a refund liability, and (c) an asset called estimated inventory returns for the right to recover the product, and adjust corresponding cost of goods sold,

49. Right of Return: Example
Venden Company sells 100 products for $100 each to Amaya Inc. for cash. Venden allows Amaya to return any unused product within 30 days and receive a full refund. The cost of each product is $60. To determine the transaction price, Venden decides that the approach that is most predictive of the amount of consideration to which it will be entitled is the most likely amount. Using the most likely amount, Venden estimates that:
1. Three products will be returned.
2. The costs of recovering the products will be immaterial.
3. The returned products are expected to be resold at a profit.
Question: How should Venden record this sale?

50. Right of Return: Example, Cont’d
Venden records the sale as follows with the expectation that 3 products will be returned:
Cash 10,000
Sales Revenue [$9,700 (= $100 x 97)] 9,700
Refund Liability ($100 x 3) 300
Cost of Goods Sold 5,820
Estimated Inventory Returns ($60 x 3) 180
Inventory 6,000
When a return of 2 products actually occurs later: …
When a return occurs, the company should reduce the refund liability and estimated inventory returns accounts. In addition, the company recognizes the returned inventory in a returned inventory account.
Refund Liability (2 x $100) 200
Accounts Payable (Cash) 200
Returned Inventory (2 x $60) 120
Estimated Inventory Returns 120
Companies record the returned asset in a separate account from inventory to provide transparency.

51. Repurchase Agreement
Transfer control of (sell) an asset to a customer but have an obligation or right to repurchase the asset at a later date.
If obligation or right to repurchase is for an amount greater than or equal to selling price, then the transaction is a financing transaction.
Not a sale
In repurchase agreements, the company transfer control of an asset to a customer but have an obligation or right to repurchase the asset at a later date. In these situations, the question is whether the company sold the asset. If the repurchase price is equal to, or greater than, the selling price, then the transaction is a financing transaction and not a sale.

52. Repurchase Agreement, Example
Morgan Inc., an equipment dealer, sells equipment on January 1, 2014, to Lane Company for $100,000. It agrees to repurchase this equipment on December 31, 2015, for a price of $121,000.
Question: How should Morgan record this transaction?
Assuming an interest rate of 10% is imputed from the agreement, Morgan makes the following entry to record the financing on January 1, 2014.
Cash 100,000
Liability to Lane Company 100,000
Morgan Inc. records interest on December 31, 2014, as follows.
Interest Expense 10,000
Liability to Lane Company ($100,000 x 10%) 10,000
Morgan Inc. records interest and retirement of its liability to Lane Company on December 31, 2015, as follows.
Interest Expense 11,000
Liability to Lane Company ($110,000 x 10%) 11,000
Liability to Lane Company 121,000
Cash ($100,000 + $10,000 + $11,000) 121,000

53. Bill-and-Hold Arrangements
Contract under which an entity bills a customer for a product but the entity retains physical possession of the product until a point in time in the future.
- Result when buyer is not yet ready to take delivery but does take title and accepts billing.
Recognize revenue, depending on when the buyer obtains control of the product.
- all of the following 4 criteria should be met:
1. The reason for the bill-and-hold arrangement must be substantive.
2. The product must be identified separately as belonging to the buyer.
3. The product currently must be ready for physical transfer to the buyer.
4. The buyer cannot have the ability to use the product or to direct it to another customer.
Contract under which an entity bills a customer for a product but the entity retains physical possession of the product until a point in time in the future. In a bill and hold arrangement, the buyer is not yet ready to take delivery but does take title and accept billing. For example, a customer may request a company to enter into such an arrangement because of lack of available space for the product, or more than sufficient inventory in tis distribution channel. Revenue is recognized depending on when the buyer obtains control of the product. For a buyer to obtain control of the product, all of the following criteria should be met:…

54. Bill-and-Hold Arrangements: Example
Butler Company sells $450,000 (cost $280,000) of fireplaces on March 1, 2014 to a local coffee shop, Baristo, which is planning to expand its locations. Under the agreement, Baristo asks Butler to retain these fireplaces in its warehouses until the new coffee shops that will house the fireplaces are ready. Title passes to Baristo at the time the agreement is signed.
Q: When should Butler recognize the revenue from this bill-and-hold arrangement?
In this case, it appears that the 4 criteria were met, and therefore revenue recognition should be permitted at the time the contract is signed.
Butler makes the following entry to record the sale.
Accounts receivable 450,000
Sales Revenue 450,000
Butler makes an entry to record the related cost of goods sold as follows.
Cost of Goods Sold 280,000
Inventory 280,000
…In this case, it appears that the four criteria were met, Baristo obtains control of that product, and therefore revenue recognition should be permitted at the time the contract is signed.

55. Warranties Two types of warranties to customers:
1. Assurance-type warranty
Product meets agreed-upon specifications in contract at the time the product is sold.
Warranty is included in sales price.
Expensed at the point of the sale
Record a warranty liability
estimated costs that will occur after sale due to the correction of defects or deficiencies required under the warranty provisions.
2. Service-type warranty
Provides an additional service beyond the assurance-type warranty
Represent a separate service and are an additional performance obligation
Not included in sales price of the product
Recorded as a separate performance obligation.
The company recognizes revenue in the period that the service-type warranty is in effect.
Companies often provide two types of warranties to customers, assurance-type or service-type.
Assurance-type warranty is for the product that meets agreed-upon specifications in contract at the time the product is sold. This type of warranty is included in the sales price. This type of warranty is nothing more than a quality guarantee that the good or service is free from defects at the point of sale. These type of obligations should be expensed in the period the goods are provided or services performed, that is at the point of sale. In addition, the company should record warranty liability. The estimated amount of the liability includes all costs that will occur after sale due to the correction of defects or deficiencies required under the warranty provisions.
Service-type warranty provides an additional service beyond the assurance-type warranty. This warranty presents a separate service and are an additional performance obligation, not included in the sales price of the product. The company allocates a portion of the transaction price to it and record it as a separate performance obligation. The company recognizes revenue in the period that the service-type warranty is in effect.

56. Warranties: Example
Maverick Company sold 1,000 Rollomatics during 2014 at a total price of $6,000,000, with a warranty guarantee that the product was free of any defects. The cost of Rollomatics sold is $4,000,000. The term of the assurance warranty is two years, with an estimated cost of $30,000. In addition, Maverick sold extended warranties related to 400 Rollomatics for 3 years beyond the 2-year period for $12,000.
Question: What are the journal entries that Maverick Company should make in 2014 related to the sale and the related warranties?
Cash ($6,000,000 + $12,000) 6,012,000
Warranty Expense 30,000
Warranty Liability 30,000
Unearned Warranty Revenue 12,000
Sales Revenue 6,000,000
Cost of Goods Sold 4,000,000
Inventory 4,000,000

57. Principal-Agent Relationships, e.g., Consignment Sales
Principal’s performance obligation is to provide goods/services to a customer, while agent’s performance obligation is to arrange for principal to provide goods or services to a customer.
Examples:
Travel Company (agent) facilitates booking of cruise for Cruise Company (principal).
Priceline (agent) facilitates sale of various services such as car rentals at Hertz (principal).
The principal recognizes revenue when the goods/services are sold to a customer.
The agent recognizes revenue in the amount of the commission that it receives
Amounts collected on behalf of the principal are not revenue of the agent.
In principal-agent relationships, the principal’s performance obligation is to provide goods/services to a customer. The agent’s performance obligation is to arrange for the principal to provide these goods/services to a customer… Examples of principal-agent relationships are…
The principal recognizes revenue when the goods/services are sold to a customer. The agent recognizes revenue in the amount of the commission that it receives. Amounts collected on behalf of the principal are not revenue of the agent.

58. Consignment Sales
Consignments: A type of principal-agent relationships
Consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer), who is to act as an agent for the consignor in selling the merchandise.
Consignment sales
One party (consignor) ships goods to another party (consignee) for sale
Consignor (e.g., manufacturer or wholesaler) earns a profit on consignment sales
Consignee (e.g., dealer) earns a commission on consignment sales.
Possession has transferred; however legal title remains with the consignor
 Question: Goods on consignment should be reported as inventory
by the consignor or consignee? Consignor
Consignments are a type of principal-agent relationships. In a consignment, the consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer), who is to act as an agent for the consignor in selling the merchandise. Note that Manufacturers (or wholesalers) deliver goods but retain title to the goods until they are sold. Consignor carries merchandise as inventory throughout the consignment, separately classified as Inventory (consignments). The consignor makes a profit on the sale and recognizes revenue only after receiving notification of sale and the cash remittance from the consignee.
Consignee makes a commission on the sale. The consignee does not record the merchandise as an asset on its books. Upon sale of the merchandise, the consignee has a liability for the net amount due the consignor. The consignee remits to the consignor cash received from customers, after deducting a sales commission and any chargeable expense.

59. Revenue Recognition for Consignment Sales
Consignor carries goods to consignee and makes a profit on the sale.
Separately classified as Inventory (consignments)
The consignor recognizes revenue only after receiving notification of sale and the cash remittance from the consignee.
Consignee sells goods for consignor and makes a sales commission.
The consignee does not record the product as an asset.
The consignee remits to the consignor cash received from customers, after deducting a sales commission and any chargeable expense: recognizes commission revenue while notifying sales and remitting cash to consignor.

60. Consignment Sales: Example
Dec 10: ABC Co. shipped $200 of merchandise on consignment to XYZ Co. and ABC paid freight cost of $10 in cash.
Dec 15: XYZ paid $20 for local advertising, which is reimbursable from ABC. XYZ hasn’t notified ABC this fact yet.
Dec 28: all merchandise has been sold for $300 in cash.
Dec 31: XYZ notified ABC, retained a 10% as sales commission, and remitted cash due ABC.
Prepare relevant journal entries for both parties

61. Consignment Sales: Example
Consignor’s Books
Consignee’s Books
Goods shipped to Consignee (Dec10)
Inventory on Consignment
Finished Goods Inventory
Payment of Freight (Dec 10)
Inventory on Consignment 10
Cash
Payment of ad by consignee (Dec15)
No entry until notified
Sale of merchandise (Dec 28)
Sales notice and cash remittance (Dec31)
Cash
Advertising Expense
Commission Expense
Consignment Sales Rev
Cost of Goods Sold
Inventory on Consignment
Goods shipped to Consignee (Dec10)
No entry
Payment of Freight (Dec 10)
Payment of ad by consignee (Dec15)
Receivable from Consignor 20
Cash
Sale of merchandise (Dec 28)
Cash
Payable to consignor
Sales notice and cash remittance (Dec31)
Payable to consignor
Commission Revenue
Receivable from consignor 20
Cash

62. Revenue Recognition- Summary
Probably the most difficult single issue in accounting – complex modern business activities makes the issue challenging
What have been examined in class are conceptual guidelines. Real world revenue recognition requires a great deal of professional judgment and involves many accounting estimates.
Revenue recognition is a CASE BY CASE approach.
A relatively small change in revenue recognition can have a major impact on net income
An area where firms use questionable and sometimes improper accounting procedures (Earnings management)
Private firms often have tax minimization as objective, while public firms often have profit maximization as objective
With deliberate attempts to mislead users

63. Ch18 Homework
E18-3, E18-5, E18-10, E18-11, E18-14, E18-16, E18-17, E18-19, E18-26 (a & c), E18-29 (a & b) P18-10, P18-11, P18-12 You must work on these problems for the quiz and exam!