ACCO 310 Lecture Notes - Lecture 6: No Entry, Finished Good, Current Asset

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7 Feb 2016
Department
Course
Professor
ACCO 310 Financial Reporting I
Prof. Rucsandra Moldovan
Chapter 6. Revenue Recognition
How does the company make money?
Understand the business model of the entity in order to account for transactions properly:
-when to recognize a transaction
-how to measure it
-how to present it
Revenues vs. Gains
-revenues – inflow of economic benefits arising from ordinary activities (e.g., sale of inventory to customers)
-gains inflow of economic benefits arising from peripheral activities, sales that are not part of the normal
earnings process (e.g., sale of PPE or investments)
What is being sold?
-sales transactions often involve transfer of goods (tangible assets), services, or both (in a word,
deliverables)
-When are they transferred? Accounting is different depending on what is being sold:
-sale of goods – generally record the sale when legal title and possession have transferred (definite
point in time)
-sale of services – legal title and possession are irrelevant (could span several periods)
-sale of goods and/or services combinations must try to measure each component of bundled
sales or multiple deliverables
What is being received?
-reciprocal nature – give up smth and receive smth of same value in return
-consideration being received for goods and/or services sold is either:
-monetary (cash or cash-like)
-non-monetary (barter transactions; receive another good/service in return)
-generally assume that the transaction is at arm’s length (i.e., between unrelated parties) such that:
Value of deliverables sold = Value of consideration received
Concessionary terms
-selling/marketing strategies must be accounted for!
-discounts,
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ACCO 310 Financial Reporting I
Prof. Rucsandra Moldovan
-lenient return/payment policy,
-loose credit policy,
-“bill and hold”,
-goods shipped subject to customer acceptance conditions,
-ongoing/additional services,
-seller continues to have some involvement etc.
-additional recognition and measurement uncertainty, which could translate into:
prohibit revenue recognition if the risks and rewards (control) have not yet passed to the
customer
Require recording contra-assets, expenses, or liabilities along with revenue
-essential question: Is this the normal course of business? If so, then not concessionary terms!
Recognition and measurement
-realization = process of converting non-cash resources/rights into money
-recognition – based on persuasive evidence of the sales arrangement (invoice, contract, other documents)
REVENUE RECOGNITION FOR GOODS
-revenue for sale of goods and related costs are recognized when:
- the risks and rewards of ownership are transferred to the customer
- the entity has no continuing involvement in, nor effective control over, the goods sold
- the amount of revenue and costs incurred can be measured reliably
- it is probable that the economic benefits associated with the transaction will flow to the entity
(collectability)
Risks and rewards
-two indicators of whether the risks and rewards were transferred from seller to buyer:
Who has the legal title to the goods sold?
Who has the possession of the goods sold?
-exceptions: in some situations, revenue is recognized even before there is a specific customer, for
example, in forestry and agricultural industries when some products have assured prices and available
markets; in this case, revenue is recognized over time as the assets mature (as they appreciate in value)
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ACCO 310 Financial Reporting I
Prof. Rucsandra Moldovan
Measurability
-sales are generally measured at fair value
-if credit/repayment terms extend over a long period of time, revenues need to reflect the time value of
money under IFRS, the discount rate is (1) the rate for a similar note receivable OR (2) imputed rate that
discounts the cash flows to the current cash selling price of the item sold
-measurement uncertainty generally arises when:
-cannot reasonably estimate the consideration
-cannot reasonably estimate the related costs
-cannot reasonably estimate the outcome of the transaction itself (i.e., it is contingent on future
events, terms of the contract not solidified etc.)
-two main options for revenue recognition under measurement uncertainty:
1) Do not recognize revenue until measurement uncertainty is resolved (i.e., do not record the sale)
2) [PREFERRED] Recognize revenue (i.e., record the sale), but attempt to measure and accrue an
amount relating to the uncertainty as a cost or reduced revenue (e.g., sales returns and allowances) use
measurement models to help quantify risk and uncertainties
-measurability is more complex when the sale involves multiple deliverables (e.g., phone + monthly phone
service + monthly data service + warranty) need to measure parts of a sale:
-separate each deliverable, if possible, and allocate the price using
Relative fair value method determine the stand-alone FV of each item and allocate
price based on the relative FVs
OR
Residual value method - the FV of the undelivered item is subtracted from the overall
purchase price; the residual value is then used to value the delivered item.
-if components cannot be measured individually, then revenue recognition criteria are applied to
the bundled sale as a whole
-accounting for bundled sales is highly complex and involves lots of judgment!
Collectability
-in order to recognize revenues at the time of sale, it is necessary to establish ultimate collectability (i.e.,
that eventually cash will be received and from whom); use historical data
-if collectability cannot be reasonably assured, then revenues cannot be recognized at the time of sale
because, in substance, no real sale has been made (revenue will be recognized at the time cash is
received accounting treatment defaults to cash basis)
-only an issue with sales on credit
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