Textbook Notes (290,000)
CA (170,000)
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Chapter 6

RSM220H1 Chapter Notes - Chapter 6: Credit Risk, Measurement Uncertainty, Time Control


Department
Rotman Commerce
Course Code
RSM220H1
Professor
Dragan Stojanovic
Chapter
6

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Chapter 6: Revenue Recognition
Process of capturing info for financial purposes involves deciding when to recognize
the transaction and how to measure and present it; must therefore understand the
business the entity is engaged in (in order to account for transactions properly)
[Economics of Business Transactions]
Basics- Are we selling goods, services, or both? What is the physical nature of the
transaction?
Important to focus on whether goods or services or both are being transferred
(referred to as deliverables)
Why does this matter for accounting purposes?
Sales of goods and of services are different
o Goods are tangible assets; therefore at one point in time control over the
goods or item being sold passes to the buyer (coincides w transfer of
possession and legal title)
o With services, transfer of possession & legal title is irrelevant
Many contracts involve both goods and services (known as multiple
deliverable or bundled sales)
Understanding what the company is selling will help determine when to recognize
revenues
Reciprocal nature- what Is being received?
Most business transactions are reciprocal; the entity gives smth up and receives
smth in return
Consideration is what the entity receives in return for the provision of goods or
services
Why does the reciprocal nature of transactions matter for accounting purposes?
We assume transactions are at arms length (value of what is given up usually
approximates the value of what is received in the transaction) and reciprocal
Sales agreements specify what is being given up and what is being acquired
o Acquired: consideration or rights to them; the amount, nature, and timing
agreed upon
o Given up: goods or services (now or in future); details regarding delivery
(quantities, nature of goods/services, timing, shipping terms) are agreed
upon
If entity sells on credit, there is a risk that customer will not pay (credit risk)
o Consideration that is non monetary (like w barter transactions) presents
challenges for accounting purposes; generally seen as a sale if the transaction
has commercial substance (bona fide purchase and sale and the company
UNDERSTANDING THE NATURE OF SALES TRANSACTIONS FROM A BUSINESS PERSPECTIVE

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entered into it for business purposes- exchanging one asset or service for
another)
The risk that the price of an asset will change: price risk
Concessionary terms- are the terms of sale normal or is this a special deal?
Examples include:
o Selling price discounted
o The entity agrees to a more lenient return or payment policy (paying in
installments or using contingent sales)
o Loosens its credit policy
o Transfers legal title but allows the customer to take delivery at a later date
(bill and hold)
o Goods are shipped subject to customer acceptance conditions
o Agrees to provide ongoing or additional services beyond the main goods or
services agreed to in order to make the sale
o Seller continues to have some involvement, including a guarantee of resale
(or permission to return) or guarantee of profit
Why does this matter for accounting purposes?
Care must be taken to identify concessionary (or abnormal) terms in any deal as
they may complicate accounting
o These terms are more lenient than usual and meant to induce sales
Should also ask if the selling terms are normal business practices for the company
or special/unusual in some way
o Pg 320
[Legalities]
Companies operate within environments governed by law (contract law, common
law, securities law etc)
[Contract Law]
when entity sells smth, both enter into a contract
An agreement that creates enforceable obligations and establishes the terms of the
deal
The two parties have promised to exchange assets and this creates a contract
Therefore entering this creates legal rights and obligations
Contract establishes the point when legal title passes (entitlement/ownership under
law)
o When customer takes physical possession, legal title would pass at this point
o If goods are shipped, point t which legal title passes is by shipping terms:
FOB shipping point- title passes at point of shipment
FOB destination- title passes when the asset reaches the customer
[Constructive Obligation]
Constructive obligation: an entity may have an implicit obligation even if its not
explicitly noted in a selling contract
o Created through past practice or by signaling smth to potential customers

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o If enforceable (under common or other law) it creates an obligation which
needs to be recognized on BS
Information for Decision Making
Trend analysis most important showing changes in revenues from year to year
Biased reporting is possible under principles and rules based accounting standards
Revenue is an inflow of economic benefits and arises from ordinary activities
Revenues are realized when goods and services are exchanged for cash
Realization is the process of converting non cash resources and rights into money
(cash to cash cycle)
How to account for revenues (recognized)
o Earnings approach: focuses on the earning process and how a company adds
value for its customers
Under ASPE and IFRS
Revenues for sale of goods and related costs are recognized when
1. The risks and rewards of ownership are transferred
2. Vendor has no continuing involvement in nor effective control
over the goods sold
3. Costs and revenues can be measured reliably and
4. Collectability is probable
o Contract based approach: focuses on contractual rights and obligations
creates by sales contracts
[Earnings Approach]
General Principle
Earnings approach historically placed under Canadian GAAP and IFRS
Seen as an IS approach to accounting for revenues and focus is on measuring
revenues and costs and recognizing revenues when earned; recognized when
o Performance is substantially complete: can measure the revenue and
costs when it has substantially accomplished what must do to e entitled to
the benefits of the revenue- earnigns process must be complete or sub.
Complete
The risks and rewards are transferred and or the earnings process is
sub. Complete (normally when product delivered or services are
provided)
Measurability is reasonably assured
o Collection is reasonable assured
ACCOUNTING FOR SALES TRANSACTIONS RECOGNITION AND MEASUREMENT
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