Accounting Notes – Revenue Recognition
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Chapter 35 – Revenue Recognition (Wk 1)***
Recognition
Process of including an item in the F/S of an entity (GAAP criteria need to be assessed carefully to ensure that revenue is recognized appropriately)
Revenue from Contracts with Customers (IFRS 15)
Step 1 – Identify the contract
Contract – agreement between two or more parties that creates enforceable rights and obligations
May be written, oral or implied by an entity’s customary business practices
Contract must have the following attributes (5):
Approved by all parties
Rights regarding goods/services to be transferred can be identified
Payment terms can be identified
Contract has commercial substance (future cash flows result from this transaction)
Probable that the entity will collect the consideration to which it is entitled, considering only the customer’s ability and intention to pay
Combination of Contracts
Vendor shall combine two or more contracts entered at or near the same time with the same customer
Account for the contracts as a single contract if one or more of the following criteria is met:
Contracts are negotiated as a package with a single commercial objective
Amount of consideration to be paid in one contract depends on the price or performance
Goods/services promised in the contracts are a single performance obligation
Contract Modifications
Change in the scope and/or price of a contract that is approved by the parties to that contract
Must result in either a new or changing enforceable rights and obligations
Account for contract mod as a separate contract if both criteria are met:
Change in scope is due to addition of distinct goods/services
Price of contract has increased by the amount of the vendor’s standalone selling price
Step 2 – Identify the performance obligation(s)
Promise of goods/services to a customer through a contract
Performance obligation – promise to a customer to transfer one of the following:
Good/service that is DISTINCT
Series of DISTINCT goods/services that are substantially the same and that have the same pattern of transfer to the customer
Distinct Goods/Services
Can the customer benefit from the goods/services on its own?
By using it, consuming it, selling it on its own
EX: a cellphone provider can sell a phone with a plan, but they can be available on their own as well
Is the promise to transfer the good/service separately identifiable from other promises in the contract?
Good 1 must not need good 2 to fulfill each other
Step 3 – Determine the transaction price
Transaction price is the amount of consideration that a vendor expects to be entitled to in exchange for the promised good/service
Can be fixed, variable or both
Following considerations when determining a price:
Variable consideration
Constraining estimates of variable consideration
Significant financing components
Non-cash consideration
Consideration payable to a customer
Variable Consideration – this can be a result from volume discounts, rebates, performance bonus
Standards on VC must apply if there is an uncertainty
Does not account for and is not intended to consider risk
Two methods exist: EXPECTED VALUE AND MOST LIKELY VALUE
Expected value – takes the range of possible outcomes and considers the probability of each
Usually considered the appropriate approach when there are multiple outcomes
Most likely – takes the one outcome that is the most likely
Ex: if a contract will receive a bonus or not
Constraining estimate of VC – Risks that these amounts will not be receive
IFRS 15 puts constraints on the estimates of VC
Amount recognized should be limited to an amount that is highly probably to be received.
Factors that could increase the likelihood of a revenue reversal
Amount of consideration is highly susceptible to factors outside the entity’s influence (volatility in market, judgement of third parties, weather)
Uncertainty in amount of consideration is not expected to be resolved for a very long time
Entity’s experience with contracts is limited
Right of Return – considered a VC when goods can be returned
B/c revenue to be recognized is limited to an amount
If the amount can be estimated for the possible return – revenue is recognized up to the amount that vendor expects to receive
If the amount cannot be estimated for the possible return – revenue is simply NOT recognized, and the money is set up in the deferred revenue account until uncertainty has passed
Significant Financing components