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Chapter 6

Management and Organizational Studies 3360A/B Chapter Notes - Chapter 6: Revenue Recognition, Fide, Financial Statement


Department
Management and Organizational Studies
Course Code
MOS 3360A/B
Professor
Stacey Hann
Chapter
6

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Chapter 6 Revenue Recognition
UNDERSTANDING THE NATURE OF SALES TRANSACTION FROM A BUSINESS
PERSPECTIVE
Economics of Sale Transactions
Fundamentals of Understanding Sales Transactions
o Selling transactions involves an entity transferring goods or services to its
customers the goods are often referred to as deliverables
o Control of goods
Entity has access to the benefits provided by the asset while others do not
There has been a transfer of risks and rewards (possession and legal title)
o Services are intangible assets, so the concept of possession and legal title are
irrelevant
Reciprocal Nature
o Most businesses are reciprocal where the entity gives something up and receives
something in return
o Arm’s length means transaction between two unrelated parties
We can generally assume that transactions are at arm’s length and
reciprocal
o Sales agreements normally specific what is being given up and what is being
acquired
Acquired: considerations or rights to the consideration
Given up: goods and/or services
o Barter/non-monetary transactions transactions where a few or no monetary
assets are received as consideration when goods or services are sold
o Bona fide purchase and sale that the entity has entered into the transaction for
business purposes, exchanging one type of asset or service for a different type of
asset or service
Concessionary terms terms negotiated by a party to a contract that are more
favourable than normal
Legalities of Sale Transactions
Contract Law
o When an entity sells something, both the entity and the customer enter into a
contract
o Contract may be written or verbal
o An agreement that creates enforceable obligations and establishes the terms of the
deal
o There is a promissor (the seller) and a promissee (the customer)
o Establishes the point in time when the legal title passes
FOB shipping point title passes at the point of shipment
FOB destination title passes when the asset is delivered to the customer
Constructive obligation a type of performance obligation not stated in a contract that
is created through a past practice or by signaling something to potential customers
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Information for Decision Making
Bias reporting is both under principles-based accounting and rules based accounting
Revenue recognition is one of the main areas of misrepresentation in financial statements
RECOGNITION AND MEASUREMENT
Two approaches to recognizing revenues: (I) the asset-liability approach and (II) the
earnings approach
The new IFRS standard, IFRS 15 Revenue from Contracts with Customers, adopts an
asset-liability approach as the basis for revenue recognition
ASPE still follows the earnings approach
Asset-Liability Approach
Companies account for revenue based on the asset or liability arising from contracts with
customers
Contracts indicate the terms of transactions, provide measurement of the consideration,
and specify the promises that must be met by each party
Key objective: recognize revenue to depict the transfer of goods or services to customers
in an amount that reflects that consideration that the company receives, or expects to
receive, in exchange for these goods
Five Step Revenue Recognition Process
1. Identify the contract with customers
2. Identify the separate performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the separate performance obligations
5. Recognize revenue when each performance obligation is satisfied
Identifying the Contract with Customers
Contract an agreement between two or more parties that creates enforceable rights or
obligations
Sometimes there are multiple contracts related to the transaction
On entering into a contract with a customer, a company obtains the rights to receive
consideration from the customer and assumes obligations to transfer goods or services to
the customer
A company does not recognize contract assets or liabilities until one or both parties to the
contract perform
Contract modifications changes to the contract terms while the contract is ongoing
o When this occurs, companies determine whether a new contract results or whether
it is a modification of the existing contract
Company accounts for a contract modification as a new contract if both of the following
conditions are satisfied:
1. The promised good or services are distinct
2. The price increases by an amount of consideration that reflects the stand-alone
selling price of the promised goods or services
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