Intermediate accounting 17e by kieso ch18

Preview of Chapter 18Revenue Recognition Fundamentals of Revenue Recognition • New revenue recognition standard • Overview of five-step process: Boeing example • Extended example of five

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Learning Objectives

After studying this chapter, you should be able to:

1 Discuss the fundamental concepts related to revenue recognition and measurement.

2 Explain and apply the five-step revenue recognition process.

3 Apply the five-step process to major revenue recognition issues.

4 Describe presentation and disclosure regarding revenue.

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Preview of Chapter 18

Revenue Recognition

Fundamentals of Revenue Recognition

• New revenue recognition standard

• Overview of five-step process: Boeing example

• Extended example of five-step process: BEAN

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• Identifying the contract with customers

• Identifying separate performance obligations

• Determining the transaction price

• Allocating the transaction price

• Satisfying performance obligations

The Five-Step Process Revisited

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• Sales returns and allowances

Revenue Recognition Issues

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• Presentation

• Disclosure

Presentation and Disclosure

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Learning Objective 1

Discuss the Fundamental Concepts Related to Revenue Recognition and Measurement

LO 1

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Fundamentals of Revenue Recognition

Recently, the FASB and IASB issued a converged standard on revenue recognition entitled Revenue from Contracts with Customers.

To address the inconsistencies and weaknesses of the previous approaches, a comprehensive

revenue recognition standard now applies to a wide range of transactions and industries

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New Revenue Recognition Standard

Revenue from Contracts with Customers adopts an asset-liability approach Companies:

• Account for revenue based on the asset or liability arising from contracts with customers

• Are required to analyze contracts with customers

o Contracts indicate terms and measurement of consideration

o Without contracts, companies cannot know whether promises will be met.

LO 1

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Key Objective

Recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that the company receives, or expects to receive, in exchange for these goods or services.

Five-Step Process for Revenue Recognition

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.

Revenue Recognition Principle

Recognize revenue in the accounting period when the performance obligation is satisfied.

Performance Obligation is Satisfied

New Revenue Recognition Standard

Key Concepts of Revenue Recognition

LO 1

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The Five-Step Process—Boeing Example

Assume that Boeing Corporation signs a contract to sell airplanes to Delta Air Lines for $100 million.

LO 1

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Boeing Example Step 3 and Step 4

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Boeing Example Step 5

LO 1

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Extended Five-Step Example

Assume coffee and wine business called BEAN BEAN is located in the Midwest and serves gourmet coffee, espresso, lattes, teas, and smoothies It also sells various pastries, coffee beans, other food products, wine, and beer.

Identifying the Contract with Customers—Step 1

Assume that Tyler Angler orders a large cup of black coffee costing $3 from BEAN Tyler gives $3 to a BEAN barista, who pours the coffee into a large cup and gives it to Tyler.

Question: How much revenue should BEAN recognize on this transaction?

LO 1

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Extended Five-Step Example – Step 1

Step 1 We first must determine whether a valid contract exists between BEAN and Tyler Here are the components of a valid contract and how it affects BEAN and Tyler.

1 The contract has commercial substance: Tyler gives cash for the coffee.

2 The parties have approved the contract: Tyler agrees to purchase the coffee and BEAN agrees to sell it.

3 Identification of the rights of the parties is established: Tyler has the right to the coffee and BEAN has the right to

receive $3.

4 Payment terms are identified: Tyler agrees to pay $3 for the coffee.

5 It is probable that the consideration will be collected: BEAN has received $3 before it delivered the coffee.

From this information, it appears that BEAN and Tyler have a valid contract with one another.

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Identifying Separate Performance Obligations—Step 2

The following day, Tyler orders another large cup of coffee for $3 and also purchases two bagels at a price

of $5 The barista provides these products and Tyler pays $8.

Question: How much revenue should BEAN recognize on the purchase of these two items?

LO 1

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Identifying Separate Performance Obligations

Step 2 BEAN must determine whether the sale of the coffee and the sale of the two bagels involve one or two performance obligations In the previous transaction between

BEAN and Tyler, this determination was straightforward because BEAN provided a single distinct product (a large cup of coffee) and therefore only one performance obligation existed However, an arrangement to purchase coffee and bagels may have more than one performance obligation Multiple performance obligations exist when the following two conditions are satisfied:

1 BEAN must provide a distinct product or service In other words, BEAN must be able to sell the coffee and the bagels separately from one another.

2 BEAN’s products are distinct within the contract In other words, if the performance obligation is not highly dependent on, or interrelated with, other promises in the

contract, then each performance obligation should be accounted for separately Conversely, if each of these products is interdependent and interrelated, these products are combined and reported as one performance obligation.

The large cup of coffee and the two bagels appear to be distinct from one another and are not highly dependent or interrelated That is, BEAN can sell the coffee and the two bagels separately, and Tyler benefits separately from the coffee and the bagels BEAN should therefore record two performance obligations—one for the sale of the coffee and one for the sale of the bagels.

LO 1

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Determining the Transaction Price—Step 3

BEAN decides to provide an additional incentive to its customers to shop at its store BEAN roasts its own coffee beans and sells the beans wholesale to grocery stores, restaurants, and other commercial companies In

addition, it sells the coffee beans at its retail location BEAN is interested in stimulating sales of its Smoke

Jumper coffee beans on Tuesdays, a slow business day for the store Normally, these beans sell for $10 for a ounce bag, but BEAN decides to cut the price by $1 when customers buy them on Tuesdays (the discounted price is now $9 per bag) Tyler has come to the store on a Tuesday, decides to purchase a bag of Smoke Jumper beans, and pays BEAN $9.

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12-Extended Five-Step Example – Step 3

Determining the Transaction Price

Question: How much revenue should BEAN recognize on this transaction?

Step 3 The transaction price for a bag of Smoke Jumper beans sold to Tyler is $9, not $10 The transaction price is the

amount that a company expects to receive from a customer in exchange for transferring goods and services The transaction price in a contract is often easily determined because the customer agrees to pay a fixed amount to the company over a short period of time In other contracts, companies must consider adjustments such as when they make payments or provide some other consideration to their customers (e.g., a coupon) as part of a revenue

arrangement

LO 1

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Allocating the Transaction Price to Separate Performance Obligations—Step 4

BEAN wants to provide even more incentive for customers to buy its coffee beans, as well as purchase a cup of

coffee BEAN therefore offers customers a $2 discount on the purchase of a large cup of coffee when they buy a bag

of its premium Motor Moka beans (which normally sell for $12) at the same time Tyler decides this offer is too good

to pass up and buys a bag of Motor Moka beans for $12 and a large cup of coffee for $1 As indicated earlier, a large cup of coffee normally retails for $3 at BEAN

LO 1

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Allocating the Transaction Price to Separate Performance Obligations

Question: How much revenue should BEAN recognize on the purchase of these two items?

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Recognizing Revenue When (or as) Each Performance Obligation Is Satisfied

BEAN has satisfied both performance obligations as control of the bag of Motor Moka beans and the large cup of coffee has passed to Tyler

Solution: BEAN should recognize revenue of $13, comprised of revenue from the sale of the

Motor Moka beans

at $10.40 and the sale of the large cup of coffee at $2.60

LO 1

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Learning Objective 2

Explain and Apply the Five-Step Revenue Recognition Process

LO 2

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Identifying Contract with Customers—Step 1

LO 2

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Identifying Contract—Step 1

Contracts and Recognition

Facts: On March 1, 2020, Margo Company enters into a contract to transfer a product to Soon Yoon on July 31, 2020 The contract is structured such that Soon Yoon is required to pay the full contract price of $5,000 on August 31, 2020.The cost of the goods transferred is

$3,000 Margo delivers the product to Soon Yoon on July 31, 2020.

Question: What journal entries should Margo Company make in regards to this contract in 2020?

The journal entry to record the sale and related cost of goods sold is as follows.

LO 2

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Identifying Contract—Step 1

Contracts and Recognition

Question: What journal entries should Margo Company make in regards to this contract in 2020?

Margo makes the following entry to record the receipt of cash on August 31, 2020.

August 31, 2020

Facts: On March 1, 2020, Margo Company enters into a contract to transfer a product to Soon Yoon on July 31, 2020 The contract is structured such that Soon Yoon is required to pay the full contract price of $5,000 on August 31, 2020.The cost of the goods transferred is

$3,000 Margo delivers the product to Soon Yoon on July 31, 2020.

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Separate Performance Obligations—Step 2

A performance obligation is a promise to provide a distinct product or service to a customer.

A product or service is distinct when a customer is able to

The objective is to determine whether the nature of a company’s promise is to transfer individual goods and services to the customer or to transfer a combined item (or items) for which individual goods or

services are inputs.

LO 2

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Assume that General Motors sells an automobile to Marquart Auto Dealers at a price that includes six months of telematics services such as navigation and remote diagnostics These telematics services are regularly sold on a standalone basis by General Motors for a monthly fee After the six-month period, the consumer can renew these services on a fee basis with General Motors The question is whether General Motors sold one or two products

If we look at General Motors’ objective, it appears that it is to sell two goods, the automobile and the telematic

services Both are distinct (they can be sold separately) and are not interdependent.

Separate Performance Obligations

General Motors Illustration

LO 2

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SoftTech Inc licenses customer-relationship software to Lopez Company In addition to providing the software itself, SoftTech promises to provide consulting services by extensively customizing the software to Lopez’s information

technology environment, for a total consideration of $600,000 In this case, SoftTech is providing a significant service by integrating the goods and services (the license and the consulting service) into one combined item for which Lopez has contracted In addition, the software is significantly customized by SoftTech in accordance with specifications negotiated

by Lopez Do these facts describe a single or separate performance obligation?

The license and the consulting services are distinct but interdependent, and therefore should be accounted for as one

performance obligation.

Separate Performance Obligations

SoftTech Inc Illustration

LO 2

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Determining the Transaction Price—Step 3

Transaction price

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Variable Consideration

LO 2

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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

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

LO 2

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Estimating Variable Consideration

Facts: Peabody Construction Company 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?

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Estimating Variable Consideration

Question: How should Peabody account for this revenue arrangement?

Management has concluded that the probability-weighted method is the most predictive approach:

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)

LO 2

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• Only allocate variable consideration if it is reasonably assured that it will be entitled to the amount.

revenue, and

If these criteria are not met, revenue recognition is constrained.

Estimating

LO 2

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Time Value of Money

payment using an imputed interest rate.

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Extended Payment Terms

Facts: On July 1, 2020, S E K Company sold goods to Grant Company for $900,000 in exchange for a 4-year, zero-interest-bearing note with

a face amount of $1,416,163 The goods have an inventory cost on S E K’s books of $590,000.

Questions: (a) How much revenue should SEK Company record on July 1, 2020? (b) How much revenue should it report related to this transaction on December 31, 2020?

Entry to record S E K’s sale to Grant Company on July 1, 2020, is as follows.

LO 2

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Extended Payment Terms

Facts: On July 1, 2020, S E K Company sold goods to Grant Company for $900,000 in exchange for a 4-year, zero-interest-bearing note with

a face amount of $1,416,163 The goods have an inventory cost on S E K’s books of $590,000.

Questions: (a) How much revenue should SEK Company record on July 1, 2020? (b) How much revenue should it report related to this transaction on December 31, 2020?

Entry to record interest revenue (12%) at the end of the year, December 31, 2020.

54,000

Companies are not required to reflect the time value of money if the time period for payment is less than a year.

LO 2

1 12%

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Goods, services, or other noncash consideration.

• Companies sometimes receive contributions (e.g., donations and gifts).

• Customers sometimes contribute goods or services, such as equipment or labor, as

consideration for goods provided or services performed.

• Companies generally recognize revenue on the basis of the fair value of what is received.

Noncash Consideration

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Determining the Transaction Price—Step 3 (6 of 6)

Consideration Paid or Payable to Customers

• May include discounts, volume rebates, coupons, free products, or services

• In general, these elements reduce the consideration received and the revenue to be recognized.

LO 2

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