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Chapter 6

RSM220H1 Chapter Notes - Chapter 6: Fide, Consignor, Barter


Department
Rotman Commerce
Course Code
RSM220H1
Professor
Gus De Franco
Chapter
6

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REVENUE RECOGNITION
NATURE OF SALES TRANSACTIONS FROM BUSINESS PERSPECTIVE
ECONOMICS OF BUSINESS TRANSACTIONS
Goods are tangible assets and there is a definite point in time when control over the goods passes to buyer
Control of asset means that the entity has access to the benefits provided to the asset while others don’t
Multiple deliverables or bundled sales – contracts involving both goods and services
Consideration – what the entity receives in return for the provision of goods or services
Arm’s length – transactions are between unrelated parties
oCan assume that the value of what’s given up usually approximates the value of what is received
in the transaction
Assuming transactions are at arm’s length and reciprocal
oDoing this allows us to better capture and measure the economics of transactions in the statements
Sales agreements normally specify what is being given up and what is being acquired
Credit risk – if the entity sells on credit there is a risk that the customer will not pay
Barter or nonmonetary transactions are transactions where few or no monetary assets are received as
consideration when goods/services are sold
A barter transaction is seen as a sale if the transaction has commercial substance – the transaction is a
bona fide (or legitimate) purchase and sale and that the entity has entered into the transaction for business
purposes, exchanging one type of asset/service for a different type of asset/service
The company’s future cash flows will change as a result of the transaction in terms of timing, amount,
and/or riskiness
When reciprocal transaction occurs, the entity’s risk profile changes
Price risk – the risk that the price of an asset will change
The representational faithfulness concept supports full disclosure of risks and changes in risk, as they affect
the entity’s ability to generate future cash flows
Concessionary terms – terms negotiated by a party to the contract that are more favourable than normal
oEx. the selling price is deeply discounted
oEx. the entity agrees to a more lenient return or payment policy
oEx. the entity loosens its credit policy
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oEx. entity transfers legal title but allows the customer to take delivery at a later date (bill and hold)
oEx. the goods are shipped subject to customer acceptance conditions (extended trials)
oEx. the entity agrees to provide ongoing or additional services beyond the main goods/services
agreed to in order to make the sale
oEx. the seller continues to have some involvement
Concessionary or abnormal terms may create additional obligations or may reflect the fact that the risks and
rewards or control has not yet passed to the customer
oCreate additional recognition and measurement uncertainty
LEGALITIES
Any promise that is enforceable under law and any obligation that is imposed by law should be included in
the statements under the full disclosure and transparency principles assuming that they are material
Contract law:
oContract with customers is an agreement that creates enforceable obligations and establishes the
terms of the deal
oContract establishes the point in time when legal title – entitlement and ownership under law –
passes
oWhen customer has physical possession of the goods straight away, legal title would normally
pass at this point
oFOB shipping point: title passes at the point of shipment
oFOB destination: title passes when the asset reaches the customer
Constructive obligation:
oConstructive obligation – having an implied obligation even if it is not explicitly noted in a
selling contract
oCreated through past practice or by signaling something to potential customers
oEnforceable under common or other law
oAny enforceable promise that results from the sale may create a performance obligation that needs
to be recognized in the BS
RECOGNITION AND MEASUREMENT
EARNINGS PROCESS
Earnings approach – focuses on the earnings process and how a company adds value for its customers
In place under ASPE and IFRS
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Aka income statement approach for revenues
Revenues for sale of goods and related costs are recognized when:
oThe risks and rewards of ownership are transferred to the customer;
oThe vendor has no continuing involvement in, nor effective control over, the goods sold;
oCosts and revenues can be measured reliably; and
oCollectability is probable
The related costs must be measurable and recognized at the same time as revenues to help measure net
income appropriately
Earnings process – actions that a company takes to add values
oFocuses on operating activities
oUnique for each company and industry
Selling goods:
oOften one critical event in the earnings process that signals substantial completion or
performance
oSubstantial completion normally occurs at the point of delivery
oIf it has a critical event, it is referred to as a discrete earnings process
oRisks and rewards of ownership helps to establish ownership and to indicate when ownership
passes from one party to another
Selling services:
oThe focus is on performance of the service
oAccounting more complex where the earnings process has numerous significant events
(continuous earnings process)
Long-term contracts:
1. Percentage of completion method: revenue and gross profit are recognized each period based on
progress made to a specific point in time
a. Use if the performance requires many ongoing acts (continuous earnings process) and
the company is able to measure the transaction
2. Completed contract method: revenues and gross profit are recognized only when the contract is
completed (use when there are measurement problems)
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