Concept Review Solutions
CHAPTER 6: REVENUE RECOGNITION
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1. Revenues arise from increases in the businesses assets from activities that constitute a business operation over a period of time. Gains result from activities that are peripheral transactions or from measurement or revaluation events relating to the businesses principal lines.
2. The following criteria must be satisfied before revenue for a sale can be recognized:
The seller’s performance is complete and the seller has transferred the significant risks and rewards of ownership.
The seller can reliably measure all costs relating to the transaction, past and future.
The amount of revenue can be measured reliably and collection is reasonably assured.
The economic benefits from the transaction most probably flow to the seller.
The seller retains no continuing managerial involvement or control over the goods sold.
3. When revenue is recognized, all costs, both past and present, must be measurable. If the seller cannot reliably measure after-sale costs, revenue recognition must be delayed until the costs are known or measurable, whichever comes first. In addition, the amount of revenue must be measured reliably. For example, there should be no revenue that is contingent on future events or performance, and the collectability of amounts owing must be reasonably assured.
Page 281
1. If the quantity of returns is reasonably predictable, the company can recognize revenue at delivery for the estimated volume of goods that will not be returned. An allowance for sales returns representing the amount expected to be refunded on return must also be recorded at the time of the sale. If returns are not predictable, revenue is deferred until the return situation is known.
2. Cost deferral -Accrue the (reliably) estimated costs of the vendor’s warranty obligation as a provision and an expense when revenue is recognized; future costs are charged to the warranty provision as they are incurred.
Revenue Deferral- A proportionate part of the sales revenue is deferred as unearned revenue; the deferred revenue is recognized over time until the warranty or service agreement expires. Warranty or servicing costs are charged to expense as incurred.
3. Transfer of risks and rewards (control) of the units’ shifts to the buyer when the buyer takes title and all of the following conditions are met:
• The buyer has acknowledged the deferred delivery instructions;
• Delivery is probable;
• The buyer’s inventory is separately identified as belonging to the buyer (i.e., held apart from the seller’s other inventory);
• The inventory is ready to be delivered; and
• The customary payment terms apply to the invoice.
Only in these special situations can the seller recognize the revenue prior to the delivery of the product.
4. The consignee does not purchase the goods but assumes responsibility only for their care and resale. With a sale with the right of return the purchaser takes title to the goods but can return the goods at a future date.
5. Recognize revenue over time. In other cases, the license grants the buyer limited access to the seller’s intellectual property for only a fixed period of time. In this case, the revenue would be recognized over the period of time covered by the license, five years.
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6. Under the instalment sales method, both revenue and profit are recorded when cash is received. Under the cost recovery method, the seller recognizes profit only after sufficient cash has been received to offset all the related costs incurred.
Page 287
1. Long-term service contracts and construction contracts are types of revenue transactions where performance is completed over time rather than at a specific point in time. Revenue is also measured over time.
2. Two methods can be used to measure progress over time:
1. Output methods recognize revenue based on the value of the work performed to date.
Examples of this would be units produced or milestones achieved. Basically, the question is, “What has been finished?” Results to date are compared with expected total results when the contract is completed. Output measures also include the basic passage of time—the customer has the service provided for the time promised.
2. Input methods recognize the revenue based on value of the effort performed to date.
The effort devoted to a project to date is compared with the total effort expected to be required to complete the project. Examples are (1) costs incurred to date compared with total estimated costs for the project and (2) labour hours worked compared with total estimated labour hours required to complete the project.
3. Some contracts spread the cash payments to be made by the buyer in future periods. A $10 million contract may be payable in five years. If interest is charged over and above the $10 million then this separate interest revenue is recognized as time passes. However, if the contract appears to be interest free, the accounting treatment must recognize substance over form and acknowledge that there is no real economic truth to an interest-free contract. Interest is included in the $10 million price and must be accounted for separately. This means that the amount of revenue is the present value of the discounted cash flows.
4. A contract has multiple deliverables if it includes a bundle of goods and/or services in a single contract. Examples of different goods and/or services, which constitute multiple deliverables, are:
• Delivery of goods;
• Provision of a service;
· Granting licenses for the use of intangible property; and
• Granting options to the customer to receive additional goods or services at discounted prices.
5. The residual value method, where the fair value of the initial component is reliably measurable while the values of subsequent components are not. In such a case, the residual method can be used. Under this approach, the fair value of the initial component is recognized, and the remaining (i.e., “residual”) revenue is allocated to the remaining component or components and treated as a single component.
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1. Often input methods can be easier to apply than output methods because measuring inputs is straightforward. In fact, if costs are incurred evenly over the contract, revenue can be recognized on a straight-line basis. The difficulty with this method is that costs incurred might not be linear with real progress.
2. Estimates required in order to use the percentage-of-completion method include estimates of revenues, estimated total costs, estimated costs to complete, and costs estimated to be incurred in the current period.
3. A contracted performance obligation is an onerous contract when the consideration yet to be received is less than the lowest cost of settling the obligation. This lowest cost is determined to be the lower of:
1. The costs required to satisfy and complete the obligation; and
2. The amount the company would have to pay to cancel and exit the contract, if this is allowed.
Page 298
1. Biological assets are living animals or plants (including trees, such as orchards and timberlands). Agricultural produce is the harvested product of a company’s biological assets (e.g., wheat, fruit, milk, timber). After harvest these plants or animals become inventory.
2. At each reporting date, the biological assets are measured at their fair value less costs to sell.
3. The change in value during the reporting period is recognized in earnings for the year.
Page 304
1. Commercial substance means that the transaction has economic consequence to the company. This results when there is a change in the amount, nature or timing of cash flows before and after the transaction. A transaction must have economic substance – that is commercial substance – in order for it to be recognized at fair value; when a transaction is recorded at fair value, a gain/loss can be recognized. In the absence of commercial substance, the transaction will be recorded at book value –no gain/loss can be recognized.
2. The book value approach should be used for recording asset exchanges when:
§ There is no commercial substance to the transaction;
§ the transaction is in the normal course of business facilitate a sale to a third party;
§ Fair values cannot be reliably determined; or
§ The exchange is a distribution/spin off to shareholder
Concept Review Solutions Intermediate Accounting, 6e, Volume 1
© 2014 McGraw-Hill Ryerson, Ltd.