Accounting Notes - Revenue Recognition

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

1) Can the customer benefit from the goods/services on its own?

a. By using it, consuming it, selling it on its own

b. EX: a cellphone provider can sell a phone with a plan, but they can be available on their own as well

2) Is the promise to transfer the good/service separately identifiable from other promises in the contract?

a. 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:

1) Variable consideration

2) Constraining estimates of variable consideration

3) Significant financing components

4) Non-cash consideration

5) 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

o Usually considered the appropriate approach when there are multiple outcomes

• Most likely – takes the one outcome that is the most likely

o 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

o Amount of consideration is highly susceptible to factors outside the entity’s influence (volatility in market, judgement of third parties, weather)

o Uncertainty in amount of consideration is not expected to be resolved for a very long time

o 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