The focus of this chapter is revenue recognition. We first discuss the general circumstance in which revenue is recognized when a good or service is delivered. Then we discuss circumstances in which revenue should be deferred until after delivery or should be recognized prior to delivery.
Chapter INCOME MEASUREMENT AND PROFITABILITY ANALYSIS © 2013 The McGraw-Hill Companies, Inc Revenue Recognition IFRS Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants Record Recordrevenue revenuewhen: when: Revenue and costs can be measured reliably Probable that economic benefits will flow to seller Seller has transferred the risks and rewards of ownership and doesn’t effectively manage or control the goods The stage of completion can be measured reliably (for services) 52 U.S GAAP Realization Principle Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations Record Recordrevenue revenuewhen: when: the earnings process is complete or virtually complete AND there is reasonable certainty as to the collectibility of the asset to be received (usually cash) 53 SEC Staff Accounting Bulletin No. 101 and 104 Additional Additionalcriteria criteriafor forjudging judgingwhether whetheror ornot not the the realization realizationprinciple principleis is satisfied: satisfied: 1 Persuasive Persuasiveevidence evidenceof ofan anarrangement arrangementexists exists 2 Delivery Deliveryhas hasoccurred occurred or or services serviceshave havebeen been performed performed 3 The Theseller’s seller’sprice priceto tothe thebuyer buyeris isfixed fixed or or determinable determinable 4 Collectibility Collectibilityis isreasonably reasonablyassured assured In addition to these four criteria, the SABs also pose a number of revenue recognition questions relating to each of the criteria 54 Revenue Recognition Revenue recognition is often tied to delivery of the product from the seller to the buyer 55 Revenue Recognition at Delivery Recognize Recognize Revenue Revenue Revenue Revenue is is recognized recognized at at one one specific specific point point in in time time when when all all the the revenue revenue recognition recognition criteria criteria are are satisfied satisfied 56 Is the Seller a Principal or Agent? Principal Agent Has primary responsibility for delivering product or service and is vulnerable to risks associated with delivery and collection Does not have primary responsibility for delivering product or service but acts as a facilitator that earns a commission Recognizes as revenue the gross (total) amount received from a customer Recognizes as revenue the net commission it receives for facilitating the sale 57 Revenue Recognition after Delivery Recognizing Recognizing revenue revenue when when goods goods and and services services are are delivered delivered as as described described in in the the previous previous section section assumes assumes we we are are able able to to make make reliable reliable estimates estimates of of amounts amounts due due from from customers customers that that might might potentially potentially be be uncollectible uncollectible Under UnderIFRS, IFRS,when whenthere thereis issignificant significant uncertainty uncertaintyregarding regardingcollectibility, collectibility,revenue revenue and andexpense expenserecognition recognitionshould shouldbe bedelayed delayed until untilthe therecognition recognitioncriteria criteriacan canbe besatisfied satisfied Under UnderU.S U.S.GAAP, GAAP,when whenthere thereis isexceptional exceptional uncertainty: uncertainty: 1.Installment 1.InstallmentSales SalesMethod Method 2.Profit 2.ProfitDeferral DeferralMethod Method 58 Installment Sales On November 1, 2013, the Belmont Corporation, a real estate developer, sold a tract of land for $800,000 The sales agreement requires the customer to make four equal annual payments of $200,000 plus interest on each November 1, beginning November 1, 2013 The land cost $560,000 to develop The company’s financial year ends on December 31 59 Installment Sales 510 Appendix 5A: Interim Reporting • • • • • • • • • • • • Disclosures Recognition and reversal of impairment loss and write-downs Purchase and disposal of property, plant, and equipment Litigation settlements Changes in accounting policies, accounting estimates, and correction of errors Related party transactions Changes in the classification of financial assets Changes in contingent liabilities or contingent assets Seasonal revenues, costs, and expenses Issuance of debt and equity securities Dividends paid Changes in corporate structure such as business combinations, gain or loss of control of investments, restructurings, and discontinued operations Unusual or infrequent items 541 Revenue Recognition: A Chapter Supplement Core Revenue Recognition Principle A company must recognize revenue when goods or services are transferred to customers in an amount that reflects the consideration the company expects to receive in exchange for those goods or services Key Steps in Applying the Principle 1.Identify a contract with a customer 2.Identify the performance obligation(s) in the contract 3.Determine the transaction price 4.Allocate the transaction price to the performance obligations 5.Recognize revenue when each performance obligation is satisfied 542 Step 1: Identify the Contract Under the proposed standard, we recognize revenue associated with contracts that are legally enforceable 543 Step 2: Identify the Performance Obligation(s) Performance obligations are promises to transfer goods or services to the buyer and are accounted for separately if they are distinct A performance obligation is accounted for separately from other performance obligations if it is distinct, which is the case if either: 1.The seller regularly sells the good or service separately, or 2.A buyer could use the good or service on its own or in combination with goods or services the buyer could obtain elsewhere 544 Step 2: Identify the Performance Obligation(s) If a seller integrates goods and services into one asset, they are viewed as providing an integration service that qualifies as a single performance obligation A bundle of goods or services is viewed as a single performance obligation if both of the following are true: 1.The goods or services in the bundle are highly interrelated and the seller provides a significant service of integrating them into a combined item 2.The bundle is significantly modified or customized for the customer 545 Step 3: Determine the Transaction Price Determining the transaction price is simple if the buyer pays a fixed amount immediately or in the near future Complications in Determining Transaction Price 546 Accounting for Variable Consideration When it Can be Reasonably Estimated 547 Accounting for Variable Consideration When it Can be Reasonably Estimated 548 The Time Value of Money If the time value of money is significant, a sales transaction is viewed as including two parts: a delivery component and a financing component 549 The Time Value of Money 550 Step 4: Allocate the Transaction Price to the Performance Obligations If an arrangement has more than one distinct performance obligation, the seller allocates the transaction price to the separate performance obligations in proportion to the standalone selling price of the goods or services underlying those performance obligations 551 Step 4: Allocate the Transaction Price to the Performance Obligations 552 Step 5: Recognize Revenue When Each Performance Obligation Is Satisfied In general, a seller recognizes revenue allocated to each performance obligation when it satisfies the performance obligation 553 Step 5: Recognize Revenue When Each Performance Obligation Is Satisfied If a performance obligation is not satisfied over time, it is satisfied at a single point in time, when the seller transfers control of goods to the buyer Often transfer of control is obvious and coincides with delivery In other circumstances, though, transfer of control is not as clear 554 End of Chapter 5 555 ... related to the contract is as follows: 519 Accounting for the Cost of Construction and Accounts Receivable Under the percentage-of-completion, cost recovery, and completed contract methods, all costs... the eventual customer 517 Revenue Recognition Prior to Delivery Long-term Long-term Contracts Contracts Percentage-ofPercentage-ofCompletion Completion Method Method Completed Completed Contract... to close out the billings on construction contract and construction in progress accounts under the percentage-of-completion, cost recovery, and completed contract methods 522 Timing of Gross Profit Recognition Under the