#1:If this PowerPoint presentation contains mathematical equations, you may need to check that your computer has the following installed:
1) MathType Plugin
2) Math Player (free versions available)
3) NVDA Reader (free versions available)
#6:Revenue recognition involves issues dealing with both timing (i.e., when revenue is recognized) and measurement (i.e., how much revenue is recognized). With regard to timing, the fundamental principle of revenue recognition is that a company should recognize revenue when it transfers control of an asset (either a good or service) to the customer. With regard to measurement, the fundamental principle is that a company should recognize the amount of revenue that it expects to be entitled to receive in exchange for the goods or services. Finally, the company recognizes revenue as it satisfies each performance obligation.
#7:The seller must meet the Step 1 requirement, to identify the contract, in order to continue with the revenue recognition process. Once the contract is identified, the seller must identify both the separate performance obligations (Step 2) and the transaction price (Step 3) in order to continue with Step 4. Step 4 takes the transaction price that is determined in Step 3 and allocates it to the separate performance obligations that are identified in Step 2. Once the seller has identified the separate performance obligations and has a price attached to each, it determines the appropriate timing for the recognition of revenue for each performance obligation separately.
Example 8.1 provides a simplified illustration of the five-step approach to provide a conceptual understanding of the steps.
#8:The revenue recognition standards discussed in this chapter are new and are effective for public companies with fiscal years beginning after December 15, 2017. They are not completely aligned with the conceptual framework. That is, the revenue recognition standards indicate that the overarching principle of revenue recognition is the notion of the transfer of control of the goods or services. In contrast, the current conceptual framework does not mention transfer of control but rather states that a company recognizes revenue when it meets two conditions:
1. The revenue has been earned, and
2. The revenue is realized or realizable.
Although transfer of control often occurs simultaneously with the culmination of the earning process, there are scenarios in which they do not happen at the same time. How then can the standards and the conceptual framework that both come from the FASB conflict? As we discussed in Chapter 2, the FASB is currently in the process of rewriting the conceptual framework. We expect that the FASB will align the conceptual framework with the new standard when it rewrites the framework.
#9:Answer:
A company should recognize revenue when it transfers control of an asset (either a good or service) to the customer.
#11:Contract criteria:
All parties to the contract have agreed to the contract and are committed to performing under the contract. The approval by the parties can be in writing, provided orally, or implied by an entity’s customary business practices.
Each party’s rights with respect to the goods or services that are being transferred are identifiable.
The payment terms for the goods or services that are being transferred are identifiable.
The contract has commercial substance, meaning that the risk, timing, or amount of the entity’s future cash flows is expected to change as a result of the contract.
It is probable that the seller will collect the consideration to which it is entitled in exchange for the goods or services. To assess the probability of collection, the seller considers the customer’s ability and intention to pay this specific amount of consideration when it is due.
For purposes of the fifth criterion, U.S. GAAP defines probable as “likely to occur.” The seller assesses collectability on the expected consideration (the estimated transaction price), not the contract price. For example, if the seller intends to offer a price concession, which is a reduction in the contract price, then the estimated transaction price will be less than the contract price.
#12:If the seller receives cash before the appropriate time to recognize revenue, it should report the consideration as a liability. In addition, the entity should not remove the inventory from its balance sheet.
#13:It is not uncommon for vendors to enter into multiple contracts with the same customer. Under the circumstances described on the slide, the seller should combine these contracts and account for them as a single contract.
#14:When identifying a contract with a customer, IFRS differs from U.S. GAAP in two ways. The first way is in the definition of “probable,” as explained on this slide.
For example, Turro Company makes a sale to Milano Corporation, and Turro determines the probability of collection is 55%. Under IFRS, the 55% probability suggests that it is “more likely than not” that Turro will collect from Milano. Under U.S. GAAP, a probability of 55% does not meet the “likely to occur” threshold. Therefore, the collectability criterion will be met under IFRS but not U.S. GAAP.
The difference is because the FASB and IASB decided to set the threshold at a level consistent with their previous revenue recognition standards and based on the interpretations of “probable” under each set of standards.
#15:The second difference is in determining when to recognize revenue when the five criteria for a contract are not met. IFRS does not explicitly include the third condition that the seller has transferred control of the goods or services, is no longer transferring the goods or services, has no obligation to transfer additional goods or services, and the consideration received is nonrefundable. The FASB added this condition to clarify when to recognize revenue. The IASB did not believe this clarification was needed because the first two conditions should cover these cases. The IASB noted that contracts often specify that a company has the right to terminate a contract if a customer is not paying. However, for any goods or services already transferred, the company has a right to collect payment.
#16:Answer:
A contract is an agreement between two or more parties that creates enforceable rights and obligations.
#18:A seller needs to identify the various performance obligations in a contract to allocate the transaction price to these different performance obligations and to recognize revenue when or as it satisfies each individual one. Conceptually, a performance obligation is a promise to transfer a good or service that is distinct.
#19:As shown in Exhibit 8.3, a performance obligation is either:
A promise to transfer a good or service, or a bundle of goods or services, that is distinct, or
A promise to transfer a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer
#20:It is often clear that a customer can benefit from a product or service on its own (or in conjunction with other assets). At other times, this determination requires more judgment. If the good or service can be used, consumed, or sold for a nontrivial amount, then it passes the test of being distinct.
#21:As an example of a readily available resource, consider a set of earbuds packaged with a mobile phone. Because the earbuds can be sold separately and can be used with other electronic devices, the earbuds are a readily available resource.
Judgment may be involved in the determination of whether the promise to deliver the good or service is separate from other promises. Generally, if a promise to deliver is separable from other promises in the contract, then the two promises are not highly dependent or interrelated.
Example of a “free” good or service: The telecommunications industry may offer free mobile phones with a service agreement.
Also, the promised good or service does not have to be explicitly identified in the contract. If the customer has a valid expectation that the seller will provide the good or service, then this item should also be assessed as a possible performance obligation.
An entity should aggregate the goods or services promised in a contract until it identifies a bundle of goods or services that is distinct and thus defined as a separate performance obligation. There may be only one performance obligation identifiable in a contract.
#22:Answer:
Conceptually, a performance obligation is a promise to transfer a good or service that is distinct.
#24:The third step in the revenue recognition process is to determine the transaction price . The transaction price is the amount of consideration that the entity expects to be entitled to as a result of providing goods or services to the customer. The transaction price is not necessarily the price stated in the contract—rather, it is the amount the seller expects to receive. The transaction price does not include amounts collected that will be remitted to third parties (such as sales tax).
#25:Measuring the transaction price can be quite simple in some cases. For example, assume that a customer shopping at a retail store selects and pays $100 cash for a new dress. The transaction price is $100. However, with complex transactions, determining the transaction price is involved.
#26:For example, a discount for early payment typically offered by a seller is considered an element of variable consideration, even though it may not be specified explicitly in the contract.
#27:If variable consideration is included in the contract, then the entity must estimate the consideration that it expects to receive using one of two acceptable approaches: the expected-value approach or the most-likely-amount approach. The entity should use the approach that provides the best estimate of the amount of consideration it will receive.
#29:Example 8.7 illustrates estimating variable consideration under the most-likely-amount approach.
#30:“Probable” is generally interpreted as 70% to 75%. This assessment requires the use of a cumulative probability level to determine if the definition of “probable” (likely to occur) is met. Example 8.8 provides a case with a constraining estimate of variable consideration.
#31:In estimating the constraint on variable consideration, U.S. GAAP uses the term “probable,” whereas IFRS uses the term “highly probable.” The definitions of “probable” under U.S. GAAP and “highly probable” under IFRS are essentially the same.
#32:In contracts when delivery of the goods or services occurs in advance of the payment, the seller is providing financing to the buyer. Alternatively, in contracts when delivery occurs well after payment, the buyer is providing financing to the seller.
#33:In determining whether a significant financing component exists, the entity considers the three factors on this slide.
#34:The entity ultimately recognizes the transaction price as sales or service revenue and records the difference between the total contract price and the present or future value as interest revenue if the payment occurs after delivery or interest expense if the payment occurs before delivery.
An example of a contract with a significant financing component is presented in Example 8.9. Example 8.10 provides an illustration of a scenario in which the delivery occurs after the payment.
#35:Example 8.11 demonstrates accounting for noncash consideration.
#36:Example 8.12 demonstrates accounting when consideration is payable to a customer.
#37:Exhibit 8.4 summarizes the process of determining the transaction price.
#38:Answer:
The transaction price is the amount of consideration that an entity expects to be entitled to as a result of providing goods or services to the customer.
#40:The next step in the revenue recognition process is allocating the transaction price determined in Step 3 to the performance obligations determined in Step 2. If the determination from Step 2 is that there is only one performance obligation, then Step 4 is not required.
To allocate the transaction price, the entity first determines the standalone selling price of the goods or services related to each performance obligation. Then, if the sum of the standalone selling prices is higher than the transaction price, the seller typically allocates the discount to separate performance obligations on the basis of the relative standalone selling prices.
The standalone selling price of each performance obligation is the price the seller would charge for the same goods or services if it sold them on a standalone basis to similar customers under similar circumstances. Companies can often determine the standalone selling price using this method because they typically sell their goods or services on a standalone basis.
However, in practice, the seller sometimes does not sell the same goods or services separately. In this case, the seller must estimate the standalone selling price. The authoritative literature does not stipulate an exact method but states that the company should use a method that maximizes the use of observable inputs. Whatever method the entity chooses for estimating the standalone selling price, it should use the same method consistently in similar circumstances.
#41:Although the authoritative literature does not specify a particular method, it does provide three suggestions suitable to determine a standalone selling price specific to a good or service: the adjusted market assessment approach, the expected-cost-plus-a-margin approach, and the residual approach.
Specifically, when using the residual approach, the entity estimates the residual standalone selling price by subtracting the standalone selling prices of the goods or services that underlie the other performance obligations from the total transaction price.
Once the entity has estimated all of the standalone selling prices, it allocates any discount (that is, any amount by which the sum of the standalone selling prices is greater than the transaction price) to separate performance obligations on the basis of relative standalone selling prices. In other words, the entity allocates the transaction price to each separate performance obligation based on the proportion of the standalone selling price of each performance obligation to the sum of the standalone selling prices of all of the performance obligations in the contract.
Example 8.13 illustrates the three approaches.
#42:While the general rule is that the transaction price should be allocated based on the relative standalone selling prices, there are two possible exceptions:
When the contract includes variable consideration
When the discount is not related to all of the contract’s performance obligations
#43:Related to the first exception, the seller should allocate variable consideration to one or more, but not all, performance obligations if two criteria are met:
The terms of the variable amount relate to one or more, but not all, of the specific performance obligations.
Allocating the variable amount entirely to one or more, but not all, of the specific performance obligations is consistent with the objective of performing the allocation in a way that reflects a reasonable allocation of the transaction price on the basis of the standalone selling prices.
Example 8.14 demonstrates a situation in which variable consideration is allocated entirely to one performance obligation. Example 8.15 illustrates a contract whose variable consideration cannot be allocated to just one performance obligation.
#44:The second exception to the relative standalone selling price allocation method involves the allocation of a discount measured as the difference between the sum of the standalone selling prices and the transaction price. Typically, any discount should be allocated proportionately to the performance obligations based on the relative standalone selling prices. However, if an entity determines that the discount is not related to all of the performance obligations, it should allocate only the discount to the performance obligations to which it relates.
#45:Example 8.16 provides an illustration of a discount that is not proportionally allocated to the performance obligations (that is, the discount does not relate to all performance obligations).
#46:Exhibit 8.5 provides a summary of allocating the transaction price.
#47:Answer:
The standalone selling price of each performance obligation is the price the seller would charge for the same goods or services if it sold them on a standalone basis to similar customers under similar circumstances.
#49:Companies determine when to recognize revenue in Step 5 based on when the goods or services are transferred to the customer. A good or service is transferred when the customer obtains control. A customer has control of the asset if it has the ability to direct the use of the asset and receives all (or substantially all) of the remaining benefits of owning the asset.
#50:Goods and services may be transferred to the customer over time or at a point in time. If the goods or services are transferred over time, then the seller recognizes revenue over that time period. However, if the goods or services are transferred to the customer at a point in time, then the seller recognizes the revenue at that point in time. Companies must determine whether the goods/services are transferred over time or as of a point in time at the inception of the contract.
#51:Progress toward completion can be measured using either output methods or input methods. Examples of output methods include units produced or delivered, progress such as floors or miles completed, and time elapsed. Examples of input methods include labor hours expended, machine hours used, and costs incurred.
Example 8.17 illustrates transferring services over time because the customer receives and consumes the benefit simultaneously. Example 8.18 illustrates a scenario in which the seller recognizes revenue over the service period and the contract meets the second criterion to recognize revenue.
#52:If the seller does not meet the three criteria to recognize revenue over time, then she assumes that the goods or services are transferred at a point in time. It is often straightforward to determine when control is transferred. For example, consider a retailer that sells computers. Control is transferred when a customer purchases a computer at the retailer, takes delivery at the register, and pays for a computer at the point of sale. However, other times it is more difficult to make this determination. In these cases, the entity should consider the five indicators of the transfer of control to the customer listed on this slide.
These five conditions indicate that control may have transferred, but any one of them does not determine whether control has actually passed to the customer. The entity should consider all of the facts and circumstances to make this determination. Example 8.19 provides an illustration of goods transferred at a point in time.
#53:Exhibit 8.6 summarizes the process of determining when to recognize revenue.
#54:Exhibit 8.7 presents a summary of the revenue recognition process in graphical form as a guide for analysis.
#55:Companies use extensive judgment when implementing the five steps in the revenue recognition process. When identifying the contract, companies make judgments as to whether it is probable that they will collect the consideration. This may be particularly challenging when an entity may expect to receive partial payment. Is the difference between full payment and the partial payment simply a price concession that affects the transaction price? Or does the lack of a full payment indicate that the transaction price is not collectable? In addition, the determination of whether contracts should be combined may be a matter of judgment.
With regard to the second step, entities may need to exercise judgment to determine if goods or services are distinct. Will a customer benefit from the product or service on a standalone basis? In addition, there may also be judgment involved in determining whether the promise to deliver the good or service is separate from other promises.
#56:In the third step, the amount of variable consideration is often an estimate. Using either the expected-value approach or most-likely-amount approach, entities must estimate their anticipated probabilities. Measuring the financing component also involves estimation of an appropriate discount rate.
The allocation of the transaction price to the performance obligation often requires the seller to estimate a standalone selling price. Finally, depending on the circumstances, the determination of whether the performance obligation is satisfied at a point in time or over time can require judgment.
#57:Answer:
A customer has control of an asset if it has the ability to direct the use of the asset and receives all (or substantially all) of the remaining benefits of owning the asset.
#59:Long-term contracts are prevalent in industries such as communications, homebuilding, software development, aircraft, shipbuilding, and construction. Consider a company that enters into a contract to manufacture or build a product for the customer when the manufacturing process will take a period of time substantially longer than a year. If the firm recognized revenue at a point of time, it would not recognize the revenue (and associated gross profit) attributable to the long-term contract until it completed the product and delivered it to the customer. However, as we discuss next, this approach may not provide the most accurate presentation of the company’s financial position and economic performance.
#60:An entity should use the percentage-of-completion method when it meets one of the three criteria for goods and services transferred over time (discussed earlier for transfer of control to the customer) and it can reasonably measure its progress toward completion. If these conditions are met, the financial statements are more accurately presented under the percentage-of-completion method because the entity’s economic activities are reported on the income statement. If the contract does not meet any of the three criteria or if the entity cannot reasonably measure progress toward completion, then it uses the completed-contract method.
#61:Assume that a company is engaged in a 10-year project for which it does not recognize any revenues or costs until completion. Waiting until completion to recognize any revenue could be misleading because the income statement will not report any activity for the first nine years.
Now consider the case where Boeing needs five years to develop a new passenger jet. Using point-of-sale accounting would delay revenue and expense recognition until Boeing manufactures and delivers the jet to the customer. If this were Boeing’s only project in process, the income statement would show no activity in the first four years and recognize the full amount of the transaction in the fifth year. The resulting volatile trend in earnings would distort operating results and not faithfully represent the underlying economic event.
#62:In this section, we discuss accounting for contracts under the percentage-of-completion method. We begin with a discussion of estimating the percentage of completion of a long-term contract. Then, we explain the accounting procedures and introduce accounts specific to accounting for long-term contracts.
Firms can estimate the degree of completion by using input measures (for example, costs incurred and direct labor hours used), output measures (for example, miles of highway and the number of cell towers installed), or engineering estimates.
The estimated total cost of the project equals the total actual costs incurred to date plus the estimated costs to complete the project. The estimated total cost of the project is likely to change throughout the contract period. This does not create a problem because the ratio is computed each period using the current costs to date and estimated total cost.
#63:Under the percentage-of-completion method, firms recognize revenues based on the project’s stage of completion.
If the reported costs exceed the reported revenues in a given year for an otherwise profitable contract, then the gross profit is negative. In this case, the firm credits construction in progress in the journal entry made to record revenues, costs, and gross profit.
Example 8.21 illustrates the computation of revenue and gross profit under the cost-to-cost approach.
#64:Example 8.22 illustrates the use of an output measure to estimate the percent completed.
#65:As a company constructs an asset, it accumulates resources used in construction such as raw materials in an inventory account called construction in progress (CIP). Long-term construction contracts usually allow a company, also called a contractor, to bill the customer periodically over the contract term. When a company bills the customer, it increases accounts receivable with a debit. The credit is to an account called billings on construction in progress. Billings on construction in progress is a contra account to the construction-in-progress account and reduces the net carrying value of the asset, CIP. In effect, this entry offsets the physical asset in the CIP (inventory) with a financial asset in billings on CIP (accounts receivable). Using the contra account avoids double counting the total asset value.
As discussed, revenue is based on the progress to date (that is, the percentage of the project that has been completed). Unique to accounting for long-term construction contracts, revenue from long-term contracts is credited, the construction costs account is debited, and the debit to the CIP account is the difference between the revenue and the construction cost (the gross profit). At the end of the project, the company removes the CIP account from the books with a credit and removes the billings on construction in progress account with a debit.
The measurement of the net asset or net liability position of each contract has implications for financial statement users:
If the company reports a net asset position, the contract has unbilled receivables. That is, the contractor has an asset, giving the firm the right to bill the buyer for work performed.
If the company reports a significant amount of unbilled receivables, the buyer may have little capital at risk and can easily abandon the project.
If the company reports a significant net liability position, this implies that the contractor has received cash in advance and has the obligation to perform on the contract. However, if the contractor expends cash received for alternative uses, there may be insufficient resources to complete the project.
#66:This slide summarizes the first three accounting procedures of the percentage-of-completion method.
#67:This slide summarizes the fourth and fifth accounting procedures of the percentage-of-completion method.
Example 8.22 illustrates the percentage-of-completion method showing all journal entries.
#68:The timing of revenue and gross profit recognition is the key the completed-contract and percentage-of-completion methods.
#69:This slide summarizes the first three accounting procedures of the completed-contract method. The completed-contract method accounting procedures in Steps 1, 2, and 3 are the same as the percentage-of-completion method.
#70:This slide summarizes the fourth and fifth accounting procedures of the completed-contract method.
The timing of revenue and gross profit recognition in Step 4 is the key difference between the completed-contract and percentage-of-completion methods. Step 5 is the same as the percentage-of-completion method.
Example 8.23 illustrates the completed-contract method.
#71:Answer:
The differences between the two approaches are in the timing of revenue and gross profit recognition on the contract:
The percentage-of-completion method recognizes gross profit over the production period.
The completed-contract method only recognizes gross profit at the end of the contract.
#73:When a company makes a right-to-return sale, it is providing customers with the ability to return a product that has been transferred to them. The seller is obligated to accept the returned product if the buyer chooses to return it. The right of return does not represent a separate performance obligation but rather is a component of variable consideration affecting the transaction price. The entity recognizes the amount of expected returns as a refund liability, which represents its obligation to the customer to stand ready to receive the returned product and refund the customer’s consideration (or provide the customer with a credit or a different product).
#74:The seller does not recognize revenue for the amount of expected returns until the amounts are no longer subject to the constraint, such as at the end of the return period. In addition to recording a refund liability, the seller must reduce the cost of goods sold by the amount of costs attributable to the products that it expects will be returned. However, the seller should continue to reduce the inventory by the full amount of the cost of sales. The seller recognizes the offset as an asset that it records separately from inventory.
Example 8.24 illustrates accounting for a sale with the right of return.
#75:Consignment sales—for goods such as books, furniture, musical instruments, toys, automobiles, and sporting goods—are quite common in practice. For example, a retailer of musical instruments can hold a piano from a manufacturer that it will sell on a consignment basis. eBay drop-off sites make use of consignment sales.
#76:Determining whether a particular arrangement is a consignment arrangement is based on whether the seller passes control to the other party. If so, then it is a normal sale.
The parties must use judgment to determine whether control has passed based on these indicators.
#77:If an arrangement is classified as a consignment arrangement, the consignee does not record the inventory on its books, and the consignor does not record revenue when the goods are delivered. Rather, on the delivery date, the consignor credits inventory and debits inventory on consignment, and the consignee makes no entry. The consignor records revenue, along with the commission expense and receivable or cash, upon notification that the consignee has sold the inventory. The consignor will also record cost of goods sold and remove the inventory on consignment from its books. When the consignee sells the inventory, it records commissions revenue and an amount that is due to the consignor for the sale.
Example 8.25 illustrates recording consignment sales.
#78:Other common principal-agent transactions—such as travel agency transactions, transactions related to advertisements and mailing lists, and auction transactions—require special accounting.
#79:For example, Priceline.com Incorporated, the online travel company, uses both methods depending on the types of transactions. For transactions where Priceline is the seller of record—that is, it selects suppliers and determines the price it will accept from the customer—it uses the gross revenue reporting approach. In transactions where customers purchase hotel room reservations or rental car reservations directly from suppliers at disclosed contractual rates, Priceline recognizes revenue using the net revenue reporting approach.
If gross profit is the same under the gross and net methods, is the approach used important to the financial statement user? Because companies are often evaluated, at least partially, on their revenues, the implications of the two different approaches can be significant, as illustrated in Example 8.26.
#80:Bill-and-hold arrangements are transactions in which a buyer accepts title and billings but delays the physical receipt of the goods. The buyer may request a delay in delivery for several reasons: a temporary shortage of warehouse space, current excess inventory levels, a significant backlog in the production cycle, or the construction of a new facility.
#81:If the seller has transferred control of the goods to the buyer (i.e., meets all four of the conditions on the slide), then the seller can recognize revenue at the point of sale. Otherwise, the seller must wait until it meets the conditions or it delivers the goods to the buyer.
If the seller has transferred control of the goods to the buyer, then the seller can recognize revenue at the point of sale. The seller determines if it has transferred control by considering the normal indicators of control discussed earlier in the chapter.
#82:Companies often engage in channel stuffing: selling practices designed to accelerate revenue recognition.
#83:For example, in 2015, Diageo PLC, a large U.K. beverage company, was investigated for shipping excess inventory to distributors to increase sales to boost the company’s results. Channel stuffing caused a buildup of the customers’ inventory levels that posed risks to the company’s future sales and earnings.
#84:Answer:
A consignment sale is an arrangement in which a seller (referred to as the consignor) delivers goods to a third party (the consignee), who sells the goods to the customer.
#86:Companies provide extensive revenue recognition disclosures for financial statement users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
#87:Companies are permitted to choose the approach for disaggregating revenues based on the information about revenue they have presented for other purposes, including earnings releases, annual reports, or investor presentations. Companies should also consider presenting information consistent with what managers regularly review to evaluate the performance of operating segments.
#88:Quantitative information includes the beginning and ending balances of receivables and unearned revenue from contracts with customers, and significant changes in these accounts. Any revenue recognized in the period that was included in the beginning unearned revenue balance should be reported. Further, companies should disclose revenue recognized in the period from performance obligations satisfied (or previously satisfied) in previous periods, such as changes in transaction price.
#89:Companies must explain how the timing of satisfaction of their performance obligations relates to the typical timing of payment. In turn, companies should discuss how the timing of satisfaction of their performance obligations affects the contract asset and contract liability balances.
#90:Companies provide information about performance obligations in contracts with customers, including descriptions of:
When the company typically satisfies its performance obligations (for example, upon shipment, upon delivery, or as services are rendered, including when performance obligations are satisfied in a bill-and-hold arrangement).
The significant payment terms, when payment is due, whether there is variable consideration, and, if it is constrained, whether there is a significant financing component.
#91:Companies provide information about performance obligations in contracts with customers, including descriptions of:
The nature of goods or services that the entity has promised to transfer, highlighting any performance obligations to arrange for another party to transfer goods or services (an entity or acting as an agent).
Obligations for return, refunds, or similar obligations.
Types of warranties and related obligations.
#92:Companies disclose the total amount of transaction prices related to any performance obligations that are unsatisfied (or partially satisfied) at the end of the period. Companies also explain when they expect to recognize the amount as revenue. As a practical matter, companies need not provide disclosure if the performance obligation is part of a contract that has an original expected duration of one year or less or there is a right to consideration based on the value of performance to date.
Example 8.27 illustrates disclosure of the transaction price allocated to the remaining performance obligations.
#93:Companies disclose the judgment and changes in judgments made in applying the revenue recognition guidance. Companies provide a description of the timing of satisfaction of performance obligations, including the methods used to recognize revenue and an explanation of why the methods provide a faithful depiction of the transfer of goods or service.
#94:Companies also disclose information about the transaction price and the amounts allocated to performance obligations based on:
Determining the transaction price, including estimating variable consideration, adjustments for time value of money, and measuring noncash consideration
Assessing whether an estimate of variable consideration is constrained
Allocating the transaction price, including standalone selling prices and variable consideration
Measuring obligations for returns, refunds, or other similar obligations
#95:Answer:
Companies provide both qualitative and quantitative information in two main areas:
Contracts with customers
Significant judgments made, and changes in judgments in applying, the revenue recognition standards
#96:In this section, we highlight the financial statement effects of the percentage-of-completion versus the completed-contract methods. The primary criticism of the completed-contract method is that it does not properly measure economic activity. This criticism is avoided under the percentage-of-completion method.
#97:Under both methods, the total gross profit recognized is the same. Only the timing of recognition differs.
#98:Failure to recognize gross profit under the completed-contract method overstates the net liability or understates the net asset. Therefore, financial statement ratios using amounts such as revenue, net income, total assets, liabilities, and equity differ between the two methods.
#99:Because the percentage-of-completion method recognizes gross profit over the production process, revenues and net income will typically be higher in early years than under the completed-contract method. Therefore, the profit margin ratio will be higher under the percentage-of-completion method. Under the percentage-of-completion method, assets are generally higher (and liabilities are lower) because the asset construction-in-progress includes a portion of the estimated profits. Equity is also higher under the percentage-of-completion method because profit is recognized. Therefore, the debt-to-equity ratio will generally be lower under the percentage-of-completion method.
Exhibit 8.8 summarizes these effects on common ratios.
