8 Pages

Accounting & Financial Management
Course Code
AFM 291
Kareen Brown

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CHAPTER 6 REVENUE RECOGNITION 1. Apply the revenue recognition principle • Revenue is recognized when performance is substantially complete and when collection is reasonably assured o Performance occurs when the entity can measure the revenue and when the earnings process must be complete or substantially complete  Persuasive evidence of an arrangement exists (following factors to be considered) o Customary business practice—refers to how and when the entity considers that the terms of the arrangement are finalized o Side arrangements—sometimes an entity enters into additional agreements with the customer which may modify the original transactions o Economic substance—transaction may be a consignment or financing type of transaction, in which case no revenue will be recognized, initially  Delivery has occurred; seller’s price to the buyer is fixed and determinable • Revenues recognized: o Performance is achieved which means  Risks and rewards are transferred and/or the earnings process is substantially complete, and  Measurability is reasonably assured o Collectability is reasonably assured 2. Describe the accounting issues associated with revenue recognition for sales of goods • Earnings process refers to the actions that a company takes to add value • Often, there is one main act or critical event in the earnings process that signals substantial completion or performance o In business that sell goods, it’s normally at point of delivery o Discrete earnings process is referred to as if the earnings process has a critical event, whether a sale has occurred at the point of delivery, it’s important to look at who has possession of the goods and who has legal title • Risks and rewards of ownership o In determining who has the risks and rewards of ownership  FOB shipping point—legal title belongs to the buyer when the goods leave the shipping docks  FOB destination—legal title does not pass until the goods reach the customer’s location o Sales with buyback  if company sells inventory in one period and agrees to buy it back in the next accounting period, has the company sold the products, then 100% return  when there’s a repurchase agreement at a set price and this price covers all costs of the inventory plus related holding costs, the inventory and related liability remain on the seller’s books since the seller retains the price risk o Bill and hold transactions  Sometimes a company will sell inventory to a customer but not ship it  Why? Perhaps the customer doesn’t have room in its warehouse in the short-term, or perhaps the customer’s receiving department is on strike  EIC 141 requires that certain additional analysis be completed before recognizing revenues in this situation: • the customer must be the one who requests it; • there must be a fixed commitment (written or electronic) including a delivery schedule; • goods must be segregated from other inventory in the warehouse and be ready to ship o Transactions with customer acceptance provisions  Customer has the right to accept or reject the inventory  Types: trial or evaluation basis; right of return based on subjective criteria; right of return based on seller’s or customer’s objective spcifications o Disposition of assets other than inventory  Applies to items that are disposed of through sales that are not part of the normal earnings process—e.g. sales of income-producing or capital assets  If the purchaser does not pay, legal title to the asset may return to the vendor at little or no loss to the purchaser 3. Explain the accounting for consignment sales • The risks and rewards remain with the seller in this case, and thus, a real sale does not occur until the goods are sold to a third party • Special accounts separate inventory on consignment • Under this arrangement, the consignor (e.g., manufacturer) ships merchandise to the consignee (e.g., a dealer), who acts as an agent for the consignor in selling the merchandise o Consignor make a profit or develop a market, consignee to make a commission on the sales o The company selling the goods will often use this type of distribution mechanism to encourage consignees to take their goods and sell them • Non-refundable fees—fees that are paid up front shouldn’t be recognized as revenues unless the earnings process is substantially complete, that it, unless the company has earned them • Continuing managerial involvement—the vendor retains some involvement in the product sold, such as the responsibility to fix the product if it breaks or to provide ongoing product support to the customer • Completion of production—revenue recognized when the sales price is reasonably assured, the units are interchangeable, and no significant costs are involved in distributing the product 4. Describe the accounting issues related to revenue recognition for services and long-term contracts • When services are provided, the focus is on performance of the service, and the earnings process often has numerous significant events instead of just one critical event or discrete act • The earnings process = ongoing or continuing earnings process • Businesses that provide services that are different from businesses that sell goods, since the customer is usually identified before the services are performed • Two different accounting methods for long-term construction contracts are recognized: o Percentage-of-completion method—revenues and gross profit are recognized each period based on the construction progress  Used when there is a continuous earnings process o Completed-contract method—revenues and gross profit are recognized only when the contract is completed  Used when there’s a discrete earnings process or a continuous earnings process but the revenues are not measurable o Debit inventory account (construction in process) and credit contra inventory account (billings on construction in process) 5. Apply the percentage-of-completion method for long-term contracts • Its method recognizes revenues, costs, and gross profit as progress is made toward completion on a long-term contract • Measuring process toward completion requires significant judgment o In
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