Learning Objectives
LO5–1 State the core revenue recognition principle and the five key steps in applying it.
LO5–2 Explain when it is appropriate to recognize revenue at a single point in time.
LO5–3 Explain when it is appropriate to recognize revenue over a period of time.
LO5–4 Allocate a contract’s transaction price to multiple performance obligations.
LO5–5 Determine whether a contract exists, and whether some frequently encountered features of contracts qualify as performance obligations.
LO5–6 Understand how variable consideration and other aspects of contracts affect the calculation and allocation of the transaction price.
LO5–7 Determine the timing of revenue recognition with respect to licenses, franchises, and other common arrangements.
LO5–8 Understand the disclosures required for revenue recognition, accounts receivable, contract assets, and contract liabilities.
LO5–9 Demonstrate revenue recognition for long-term contracts, both at a point in time when the contract is completed and over a period of time according to the percentage completed.
LO5–10 Identify and calculate the common ratios used to assess profitability.

Revenues
• Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations
• Recognizing Revenue (Measuring and reporting revenue) is a critical aspect of financial reporting
How much?
Revenue recognition
When?

Revenue Recognition
• Recognizing Revenue (Measuring and reporting revenue) is a critical aspect of financial reporting
How much?
Revenue recognition
When?
Revenue recognition criteria ensure appropriateness of the timing and amount of revenue reported

LO5-1
Revenue Recognition
• New revenue recognition standard by FASB: ASC 606:
• Accounting Standards Update (ASU) No. 2014–09:
“Revenue from Contracts with Customers”
• Core Principle :
Companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods and services.
• When : upon transfer to customers
• How much : amount the seller is entitled to receive

LO5-1
Revenue Recognition
•
•
• Key concept:
• The seller has one or more performance obligations .
• Performance obligations are promises to transfer goods or services to the customer.
• Revenue recognition is tied to satisfaction of performance obligations.

LO5-1
Five Steps to Revenue Recognition
Five Steps to Recognizing Revenue
1. Identify the contract
2. Identify the performance obligation(s)
3. Determine the transaction price
4. Allocate the transaction price
5. Recognize revenue when (or as) each performance obligation is satisfied
Transactions: Single/Multiple POs*
Legal rights of seller and customer established
Performance obligation
Single Multiple
Amount seller is entitled to receive from customer
No allocation required
Amount seller is entitled to receive from customer
Allocate a portion to each performance obligation
At a point in time
Over a period of time
At whatever time is appropriate for each performance obligation
POs* - Performance Obligations

Recognizing Revenue at a Single Point in Time
LO5-2
• Indicators are used to determine when control has transferred from the seller to the customer
• Control means that the customer has direct influence over the use of the good or service and obtains its benefits
• A customer is more likely to control a good or service if the customer has:
• An obligation to pay the seller
• Legal title to the asset
• Physical possession of the asset
• Assumed the risks and rewards of ownership
• Accepted the asset

Example:
Recognizing Revenue at a Single Point in Time
LO5-2
TrueTech Industries sells the Tri-Box, a gaming console that allows users to play video games individually or in multiplayer environments over the Internet. A Tri-
Box is only a gaming module and includes no other goods or services. When should TrueTech recognize revenue for the following sale of 1,000 Tri-Boxes to
CompStores?
• December 20, 2015: CompStores orders 1,000 Tri-
Boxes at a price of $240 each, promising payment within 30 days after delivery.
No entry

Example:
Recognizing Revenue at a Single Point in Time
(continued)
LO5-2
• January 1, 2016: TrueTech delivers 1,000 Tri-Boxes to CompStores, and title to the Tri-Boxes transfers to
CompStores.
Journal Entry
Accounts receivable ($240 × 1,000)
Sales revenue
Debit
240,000
Credit
240,000

Example:
Recognizing Revenue at a Single Point in Time
(continued)
LO5-2
• January 25, 2016: TrueTech receives $240,000 from
CompStores.
Journal Entry
Cash
Accounts receivable
Debit
240,000
Credit
240,000

LO5-3
Recognizing Revenue over a Period of Time
• Revenue is recognized over a period of time if one of the following three conditions hold:
• The customer consumes the benefit of the seller’s work as it is performed.
Example: when a company provides internet services to a customer for a period of time .
• The customer controls the asset as it is created
Example: a building extension.
• The seller is creating an asset that has no alternative use to the seller and the seller has the legal right to receive payment for progress to date even if the contract is cancelled
Example: An order of jets customized for the U.S. Air
Force.
• If a seller can’t recognize revenue over time, it recognizes revenue at a point in time.

LO5-3
Example:
Recognizing Revenue over a Period of Time
TrueTech Industries sells one-year subscriptions to the
Tri-Net multi-user platform of Internet-based games.
TrueTech sells 1,000 subscriptions for $60 each on
January 1, 2016.
Journal Entry at contract inception Debit Credit
Cash ($60 × 1,000)
Deferred revenue
60,000
60,000

LO5-3
Example:
Recognizing Revenue over a Period of Time
(cont.)
At the end of each of the 12 months following the sale, TrueTech would record the following entry to recognize Tri-Net subscription revenue:
Journal Entry each month
Deferred revenue ($60,000 ÷ 12)
Service revenue
Debit
5,000
Credit
5,000
60,000

LO5-3
Estimating Progress Toward Completion
• To recognize revenue over time, a seller needs to estimate progress towards completion
• Output-based estimate
• Measured as the proportion of the goods or services transferred to date.
• Examples include the passage of time and the amount of finished product delivered.
• Input-based estimate
• Measured as the proportion of effort expended thus far relative to the total effort expected (cost-to-cost basis) to satisfy the performance obligation.
Example: Long-term Construction contracts

Recognizing Revenue for Contracts that
Contain Multiple Performance Obligations
• If we suspect a contract has multiple performance obligations, steps 2 and 4 of the revenue recognition process come into play.
• Step 1: Identify the contract
• Step 2: Identify the performance obligation(s)
• Step 3: Determine the transaction price
• Step 4: Allocate the transaction price to each performance obligation
• Step 5: Recognize revenue when (or as) each performance obligation is satisfied
LO5-4

Recognizing Revenue for Contracts that
Contain Multiple Performance Obligations
Separate complex contracts into parts that can be viewed on a stand-alone basis. Steps 2 and 4 are critical to this process.
Step 2: Identify the performance obligation(s) in the contract:
A promise to provide a good or service is a performance obligation if the good or service is distinct from other goods and services in the contract.
• A good or service is distinct if it is both:
Capable of being distinct ->Separately identifiable from other goods or services in the contract.
-The customer could use the good or service on its own or in combination
with other goods and services it could obtain elsewhere.
Step 4: Allocate the transaction price to each performance obligation.
-Allocate based on relative stand-alone selling prices.
-If stand-alone selling prices aren’t observable, estimate them.
-Then treat each performance obligation separately, recognizing revenue when appropriate for that performance obligation .

Example: Recognizing Revenue for Contracts LO5-4 that Contain Multiple Performance Obligations
TrueTech Industries manufactures the Tri-Box System, a multiplayer gaming system allowing players to compete with each other over the Internet.
• The Tri-Box System includes the physical Tri-Box module as well as a oneyear subscription to the Tri-Net multiuser platform of Internet-based games and other applications.
• TrueTech sells individual one-year subscriptions to the Tri-Net platform for $60.
• TrueTech sells individual Tri-Box modules for $240.
• As a package deal, TrueTech sells the Tri-Box System (module plus subscription) for $250.
On January 1, 2016, TrueTech delivers 1,000 Tri-Box Systems to
CompStores at a price of $250 per system. TrueTech receives $250,000 from CompStores on January 25, 2016.
Required: How much revenue TrueTech can recognize on:
01/01/2016: ______
01/25/2016: ______
01/31/2016: ______

Example: Recognizing Revenue for Contracts
LO5-4 that Contain Multiple Performance Obligations
• Step 1: Identify the contract: Yes
• Step 2: Identify the performance obligation(s)
• A good or service is distinct if it is both:
• Capable of being distinct
• Separately identifiable from other goods or services in the contract
• A Tri-Box System contains two distinct goods and services:
• Tri-Box module
• Tri-Net subscription
• Therefore, a Tri-Box System includes two performance obligations .

Example: Recognizing Revenue for Contracts
LO5-4 that Contain Multiple Performance Obligations
(continued)
• Step 1: Identify the contract: Yes
• Step 2: Identify the performance obligation(s):
(1) Tri-Box module and (2) Tri-net subscription
• Step 3: Determine the transaction price: $250,000
• Step 4: Allocate the transaction price to each performance obligation (stand-alone selling prices)
Tri-Box modules:
$240 ÷ ($240 + $60) = 80%
80%
$250
Transaction Price
20%
Tri-Net subscriptions:
$60 ÷ ($240 + $60) = 20%
$200 $50
Tri-Box Module Tri-Net Subscriptions

Example: Recognizing Revenue for Contracts LO5-4 that Contain Multiple Performance Obligations
(continued)
• Step 5: Recognize revenue when (or as) each performance obligation is satisfied
On January 1, 2016, TrueTech records the revenue from the
Tri-Box modules (that performance obligation is satisfied) but defers revenue for the Tri-Net subscriptions.
Journal Entry
Accounts Receivable
Sales Revenue ($250,000 × 80%)
Deferred Revenue ($250,000 × 20%)
Debit
250,000
Credit
200,000
50,000
Tri-Box modules
Tri-Net subscriptions

Example: Recognizing Revenue for Contracts LO5-4 that Contain Multiple Performance Obligations
(continued)
• Step 5: Recognize revenue when (or as) each performance obligation is satisfied
In each of the 12 months following the sale, TrueTech records the following entry to recognize Tri-Net subscription revenues.
Journal Entry
Deferred Revenue ($50,000 ÷ 12)
Service Revenue
Debit
4,167
Credit
4,167
50,000

Problem: Recognizing Revenue for Contracts that Contain Multiple Performance Obligations

Summary of Fundamental Issues
Related to Recognizing Revenue
(Illustration 5-11)
LO5-4

Spiceland Part B: Special Issues
Step 1: Specific requirements for contract existence
Step 2: Prepayments, warranties, customer options
Step 3: Variable consideration, right of return, principal versus agent, time value of money, payments by seller
Step 4: Various approaches to estimating standalone selling prices
Step 5: Licenses, franchises, bill-and-hold arrangements, consignment arrangements, gift cards
LO5-6

Special Issues for Step 1:
Identify the Contract
• Contracts can be explicit or implicit, oral or written
• A contract only exists if it:
• has commercial substance
• has been approved by the seller and customer
• specifies the rights of the seller and customer
• specifies payment terms
• is probable that the seller will collect the amount it is entitled to receive under the contract
• A contract does not exist if:
• neither the seller nor the customer has performed any obligations under the contract, and
• both the seller and the customer can terminate the contract without penalty
LO5-5

LO5-5
Special Issues for Step 2:
Identify the Performance Obligation(s)
Not performance obligations :
• Prepayments (part of the transaction price)
• Quality-assurance warranties (part of the performance obligation to deliver goods and services that are free of defects)
• Right of return (part of the performance obligation to deliver acceptable goods and services)
Performance obligations :
• Extended warranties. A warranty is an extended warranty if either
• the customer has the option to purchase the warranty separately, or
• the warranty provides a service to the customer beyond quality assurance
• Options that provide a material right (a material right is something the customer wouldn’t get otherwise, so the seller is obligated to provide it)

Special Issues for Step 2:
Identify the Performance Obligation(s)
LO5-5
Not performance obligations : Prepayments (part of the transaction price)
Non-refundable up-front fees. Examples:
-Up-front Registration Fees for Gym membership: Bally Total Fitness Club;
-Up-front Activation Fees for Phone Lines: AT&T
Customers DO NOT RECEIVE Anything of Value!
Therefore, Such prepayments are NOT performance obligations because they are not a promise to transfer a product or service to a customer.
Instead, Prepayments (up-front fees) are advance payment by the customer for future products or services.
Therefore,
-Prepayments should be included in the transaction price ,
Allocated to the various performance obligations in the contract,
Initially recorded as deferred revenue, and
-Later recognized as revenue when (or as) each performance obligation is satisfied.

Problem for Step 2: Identify the Performance
Obligation(s): PREPAYMENTS

Special Issues for Step 2:
Identify the Performance Obligation(s)
Quality-assurance warranties:
Sometimes called warranty is not a performance obligation.
Rather, it is a cost of satisfying the performance obligation to deliver products of acceptable quality.
Warranty:
Seller’s obligation to replace or correct a product (or service) that fails to perform as expected within a specified period .
Part of the performance obligation to deliver goods and services that are free of defects!
To conform with the matching principle, the seller
ESTIMATES expected warranty (contingent) liability and warranty expense in the period when revenue from the
sale is reported.

Warranty Liabilities
A dealer sells a car for $32,000, on December 1, 2009, with a warranty for parts and labor for 12 months, or 12,000 miles. The dealership experiences an average warranty cost of 3% of the selling price of each car.
Dec 1. Accounts receivable
Sales revenue
32,000
32,000
Dec. 1 Warranty Expense
Estimated Warranty Liability
960
960
On February 15, 2010, parts of $200 and labor of $250 covered under warranty were incurred.
Feb. 15 Estimated Warranty Liability
Auto Parts Inventory
Salaries Payable
To record warranty costs
DR CR
450
200
250
9-31

LO5-5
Special Issues for Step 2:
Identify the Performance Obligation(s)
Performance obligations :
Options for additional goods or services are considered performance obligations if they provide a material right to the customer that the customer would not receive otherwise.
Example:
A shoe seller normally discounts its products by 5%.
But customers who purchase a pair of shoes receive a 20% discount off the next pair of shoes purchased at the same store.
The extra discount of 15%= (20% - 5%) is a material right, as it is a discount customers would not receive otherwise.

Example: Special Issues for Step 2: (OPTIONs)
Identify the Performance Obligation(s)
LO5-5
As a promotion, TrueTech Industries offers a 50% coupon for a gaming headset with the purchase of a Tri-Box for its normal price of $240.
The headset costs $120 without a coupon (and $60 with a coupon), and the coupon must be exercised within one year of the Tri-Box purchase.
TrueTech estimates that 80% of customers will take advantage of the coupon.
The coupon provides a material right to the customer, because it provides a discount of $120 x 50% x $60, so it is a performance obligation.
Therefore, TrueTech must allocate the $240 transaction price to two performance obligations: the Tri-Box and the coupon.
How would TrueTech account for the cash sale of 100 Tri-Boxes sold under this promotion on January 1, 2016?
Estimated stand-alone selling price of the coupon (Material Right):
Discount = $120 × 50% = $60
Estimated stand-alone selling price = $60 × 80% = $48

LO5-5
Example: Special Issues for Step 2:
Identify the Performance Obligation(s)
Estimated stand-alone selling price of the coupon:
Discount = $120 × 50% = $60
Estimated stand-alone selling price = $60 × 80% = $48
Each coupon saves a customer $60, but on average
TrueTech will only have to provide discounts of $48, so $48 is its estimate of the average stand-alone value of its performance obligation.

LO5-5
Special Issues for Step 2:
Identify the Performance Obligation(s)
Total of stand-alone selling prices = $240 + $48 = $288
Tri-Box:
$240/$288 = 83.33% = (5/6) × $240 × 100 = $20,000
Coupon:
$48/$288 = 16.67% = (1/6) × $240 × 100 = $4,000
Journal Entry
Cash ($240 × 100)
Sales revenue
Deferred revenue—coupons
Debit
24,000
Credit
20,000
4,000

Special Issues for Step 2:
Identify the Performance Obligation(s)
Assume that by December 31, 70 (70%) of the coupons are redeemed.
Provide the necessary Journal Entries for 12/31/2016:
Cash ($60 * 70)
Deferred Revenue -coupons ($40 *70)
Sales revenue
4,200
2,800
7,000
Deferred Revenue (4,000 – 2,800)
Forfeiture Revenue –Coupons
1,200
1,200

LO5-6
Special Issues for Step 3:
Determine the Transaction Price
Estimating the transaction price involves a variety of considerations, including:
• Estimating variable consideration.
• Identifying whether the seller is acting as a principal or an agent
• Considering the time value of money
• Accounting for payments by the seller to the customer

LO5-6
Special Issues for Step 3: Determine the Transaction Price
Variable Consideration:
Part of the transaction price depends on the outcome of some future event.
Example:
TrueTech enters into a contract with ProSport Gaming to add
ProSport’s online games to the Tri-Net network.
ProSport offers popular games like Brawl of Bands, and wants those games offered on the Tri-Net so ProSport can sell gems, weapons, health potions, and other game features that allow players to advance more quickly in a game.
The terms of the contract are:
• On January 1, 2016, ProSport pays TrueTech an up-front fixed fee of $300,000 for six months of featured access.
• ProSport also will pay TrueTech a bonus of $180,000 if Tri-Net users access ProSport games for at least 15,000 hours during the six-month period.

Special Issues for Step 3: Determine the Transaction Price
Variable Consideration:
Other Examples:
• Entertainment and media Royalties
• Health care Medicare and Medicaid reimbursements
• Manufacturing Volume discounts and product returns
• Construction Incentive payments
• Telecommunications – Rebates
LO5-6
When an amount to be received depends on some uncertain future event, the seller still should include the uncertain amount in the transaction price by estimating it.
Methods of estimation:
• Expected value;
• Most likely amount.

Special Issues for Step 3: Determine the Transaction Price LO5-6
Variable Consideration:
Methods of estimation:
• Expected value:
Value ($) is calculated as the sum of each possible amount multiplied by its probability;
• Most likely amount:
Amount ($) associated with the best of two possible outcome.
RULE: Seller should choose the method that better predicts the amount the seller will receive in future.
If there are several possible outcomes , the expected value will be more appropriate.
On the other hand, if only two outcomes are possible , the most likely amount might be the best indication of the amount the seller will likely receive.

LO5-6
Example: Special Issues for Step 3: Determine the Transaction Price
TrueTech enters into a contract with ProSport Gaming to add
ProSport’s online games to the Tri-Net network. ProSport offers popular games like Brawl of Bands, and wants those games offered on the Tri-Net so ProSport can sell gems, weapons, health potions, and other game features that allow players to advance more quickly in a game.
The terms of the contract are:
• On January 1, 2016, ProSport pays TrueTech an up-front fixed fee of $300,000 for six months of featured access.
• ProSport also will pay TrueTech a bonus of $180,000 if Tri-Net users access ProSport games for at least 15,000 hours during the six-month period.
TrueTech estimates a 75% chance that it will achieve the usage target and receive the $180,000 bonus.

LO5-6
Example: Special Issues for Step 3: Determine the Transaction Price
TrueTech would record the following entry for the receipt of the cash on January 1, 2016:
Journal Entry at Inception
Cash
Deferred revenue (fixed fee)
Debit
300,000
Credit
300,000
Subsequent entries to recognize revenue depend on whether TrueTech estimates the transaction price as the expected value or the most likely amount .

LO5-6
Example: Special Issues for Step 3: Determine the Transaction Price
Alternative 1: Expected Value
Possible Amounts
$480,000
($300,000 + $180,000 )
Probabilities
× 75%
(fixed fee + bonus )
$300,000
($300,000 + $0 )
× 25%
Expected Amounts
= $360,000
= 75,000

LO5-6
Example: Special Issues for Step 3: Determine the Transaction Price
Journal Entry at inception
Cash
Deferred revenue
Debit
300,000
Credit
300,000
Alternative 1: Expected Value
Possible Amounts
$480,000
$300,000
Probabilities
× 75%
× 25%
Expected value of contract price at inception
Expected Amounts
= $360,000
= 75,000
$435,000

Example: Special Issues for Step 3:
Determine the Transaction Price
Alternative 2: Most Likely Amount
Because there is a greater chance of qualifying for the bonus than of not qualifying for the bonus , a transaction price based on the most likely amount would be $300,000
+ $180,000 = $480,000.
Let’s assume that TrueTech bases the estimate on the most likely amount, $480,000.
In each successive month TrueTech would recognize one month’s revenue based on a total transaction price of
$480,000.
Because it previously recorded $300,000 as deferred revenue , at the end of each month TrueTech would reduce deferred revenue by one-sixth of the $300,000 as well as recognizing a bonus receivable for one-sixth of the
$180,000 bonus it expects to receive:

Example: Special Issues for Step 3:
Determine the Transaction Price
Alternative 2: Most Likely Amount
Journal Entry each month
Deferred revenue
Bonus receivable
Service revenue
$480,000 = $300,000 + $180,000
$480,000 ÷ 6 months = $80,000
$300,000 ÷ 6 months = $50,000
$180,000 ÷ 6 months = $30,000
Debit
50,000
30,000
Credit
80,000
LO5-6

Example: Special Issues for Step 3:
Determine the Transaction Price
• After six months, TrueTech’s deferred revenue account would have been reduced to a zero balance, and the bonus receivable account would have a balance of $180,000 =($30,000 x 6).
• At that point, TrueTech would know if the usage of
ProSport products had reached the bonus threshold and would record one of the following two journal entries:

Example: Special Issues for Step 3:
Determine the Transaction Price
(continued)
If TrueTech receives the bonus:
Journal Entry Debit Credit
Cash
Bonus receivable
180,000
180,000
If TrueTech does not receive the bonus :
Journal Entry Debit
Service revenue 180,000
Bonus receivable
Credit
180,000
LO5-6

LO5-6
Example: Changes in Estimated Variable Consideration
Now, assume that after three months TrueTech concludes that, due to low usage of ProSport’s games, the most likely outcome is that it will not receive the $180,000 bonus.
TrueTech would record the following entry in April to reduce its bonus receivable to zero and reflect the adjustment in revenue:
Journal Entry at start of April
Service revenue
Bonus receivable
Debit
90,000
Credit
90,000

Example:
Changes in Estimated Variable Consideration
(continued)
LO5-6
In the remaining three months, TrueTech will recognize revenue associated with the fixed portion of the contract, and will not accrue bonus revenue.
Journal Entry months 4-6
Deferred revenue
Service revenue
Debit
50,000
Credit
50,000

LO5-6
Special Issues for Step 3:
Determine the Transaction Price
Constraint on Recognizing Variable Consideration: Sellers only include an estimate of variable consideration in the transaction price to the extent it is probable that a
significant revenue reversal will not occur when the uncertainty associated with the variable consideration is resolved.
• Indicators that a significant revenue reversal could occur include:
• Poor (limited) evidence on which to base an estimate
• Dependence of the estimate on factors outside the seller’s control
• A history of the seller changing payment terms on similar contracts
• A broad range of outcomes that could occur
• A long delay before uncertainty resolves

Example: Constraint on Recognizing Variable
LO5-6
Consideration
Assume that TrueTech initially concludes that it is not probable that a significant revenue reversal will not occur in the future.
Journal Entry each month
Deferred revenue
Service revenue
Debit
50,000
Credit
50,000
TrueTech is constrained from recognizing revenue associated with variable consideration. So, it bases revenue on the fixed contract price.

Example: Constraint on Recognizing Variable
LO5-6
Consideration -- Change in Estimate
Now assume that , on March 31, after three months of the contract have passed, TrueTech concludes it now can make an accurate enough bonus estimate for it to be probable that a significant revenue reversal will not occur.
TrueTech still estimates a 75% likelihood it will receive the bonus.
Since on March 31 the contract is one-half finished (3 of the 6 months have passed), TrueTech records a bonus receivable and service revenue for $90,000 = $180,000 x 3/6 , the amount that would have been recognized over the first three months of the contract if an estimate of variable consideration had been included in the transaction price to begin with:
Bonus receivable ($180,000 × 3⁄6)
Service revenue
90,000
90,000

Example: Constraint on Recognizing Variable
LO5-6
Consideration -- Change in Estimate
In the final three months of the contract, TrueTech recognizes the remaining revenue assuming a transaction price of
$480,000, exactly as if it had included an estimate of variable consideration in the transaction price all along:
Journal Entry Debit
Deferred revenue ($300,000 ÷ 6 months)
Bonus receivable ($180,000 ÷ 6 months)
Service revenue ($480,000 ÷ 6 months)
50,000
30,000
Credit
80,000

Special Issues for Step 3:
Determine the Transaction Price
LO5-6
One type of variable consideration is provided by a right of return
• Exists when the customer can return the good if not satisfied or unable to resell it;
• The right to return merchandise does not create a performance obligation for the seller.
• Instead, it represents a potential failure to satisfy the original performance obligation to provide goods that the customer wants to keep.
• We discuss these and other aspects of accounting for returns in more detail in Chapter 7.

Special Issues for Step 3:
Determine the Transaction Price
-Is the Seller a Principal or Agent?
-Time Value of Money:
I f a contract includes a significant financing component.
-Payments by the Seller to the Customer
If the seller purchases distinct goods or services from the customer.
LO5-6

LO5-6
Special Issues for Step 4: Allocate the Transaction
Price to the Performance Obligations
Various approaches available to estimate stand-alone selling prices:
• Adjusted market assessment approach (Covered Before)
• Price if the product or services were sold in the market
=> Stand Alone Price.
• Expected cost plus margin approach (Not Covered)
• Estimate the costs of satisfying a performance obligation and then add an appropriate profit margin
• Residual approach (Covered Here)
• Subtract the sum of the known or estimated stand-alone selling prices of other goods and services in the contract from the total transaction price of the contract

Example: Special Issues for Step 4: Allocate the
LO5-6
Transaction Price to the Performance Obligations
Assume TrueTech sells 1,000 TriBoxes with one-year
Tri-Net subscription at $250. The stand-alone selling price of the one-year subscription is highly uncertain because TrueTech hasn’t sold that service previously and hasn’t established a price for it.
Under the residual approach:
Total price of Tri-Box with Tri-Net subscription
Stand-alone price of Tri-Box
Estimated stand-alone price of Tri-Net subscription
$250,000
240,000
$ 10,000

LO5-6
Example: Special Issues for Step 4: Allocate the
Transaction Price to the Performance Obligations
Under the residual approach the Journal Entry would be as follows:
Journal Entry
Accounts receivable
Sales revenue
Deferred revenue
Debit
250,000
Credit
240,000
10,000

Special Issues for Step 5: Recognize Revenue
When (Or As) Each Performance Obligation Is
Satisfied (NOT COVERED)
LO5-7
Some common arrangements can have complicated revenue recognition timing:
• Licenses
• Franchises
• Bill-and-hold arrangements
• Consignment arrangements
• Gift cards

Disclosures (NOT COVERED)
• Income statement disclosure
• Bad debt expense
• Interest revenue/expense
• Balance sheet disclosure
• Contract liabilities
• Contract assets
• Accounts receivable
• Disclosure notes
• Nature, amount, timing, and uncertainty of revenue and cash flows
• Outstanding performance obligations, discuss how performance obligations typically are satisfied, and describe important contractual provisions like payment terms and policies for refunds, returns, and warranties
LO5-8

Summary of Fundamental and Special Issues
Related to Recognizing Revenue

Accounting for Long-Term Contracts
Steps 2 and 5 are critical for long-term contracts.
• Step 2: Identify the performance obligations
• Usually have a single performance obligation, because don’t meet the “separately identifiable” criterion necessary for goods and services to be viewed as distinct.
• Step 5: Recognize revenue when (or as) each performance obligation is satisfied
• Recognizing revenue over time according to the progress toward completion
• Long-term contracts often qualify
• Recognizing revenue upon contract completion
LO5-9

LO5-9
Accounting for a Profitable Long-Term Contract

Accounting for the Cost of Construction and
Accounts Receivable
LO5-9

Revenue Recognition — General Approach
LO5-9
Revenue Recognized:
2016
2017
2018
Total Revenue
Revenue Recognition:
Over time Upon completion
$2,000,000
1,125,000
1,875,000
$5,000,000
-0-
-0-
$5,000,000
$5,000,000

Revenue Recognition Upon the Completion of the Contract
LO5-9

Recognizing Revenue Over Time According to
LO5-9
Percentage of Completion
Revenue recognized this period
=
Total
( estimated revenue
×
Percentage completed
) to date
-
Revenue recognized in prior periods
Cumulative revenue to be recognized to date

Recognizing Revenue Over Time According to
LO5-9
Percentage of Completion

Recognizing Revenue Over Time According to
LO5-9
Percentage of Completion

Balance Sheet Recognition
LO5-9

Long-Term Contract Losses
We worry about two types of contract losses:
• A periodic loss that occurs for a project that is projected to be profitable overall, and
• An overall loss projected to occur for the entire project
• Sellers must update their estimates and recognize losses as necessary, but the specifics depend on the timing of revenue recognition.
LO5-9

Periodic Loss Occurs for Profitable Project:
Revenue Recognized over Time
LO5-9
Percentage complete as of 2017 = 2,760 ÷ 4,600 = 60%
2017 revenue = ($5,000,000 × 60%) - $2,000,000 = $1,000,000
Journal Entry
Cost of construction
Revenue from long-term contracts
Construction in progress
Debit
1,260,000
Credit
1,000,000
260,000

LO5-9
Periodic Loss Occurs for Profitable Project:
Revenue Recognized Upon Project Completion
Percentage complete as of 2017 = 2,760 ÷ 4,600 = 60%
2017 revenue = ($5,000,000 × 60%) - $2,000,000 = $1,000,000
No Entry

Loss Projected on the Entire Project
LO5-9

Loss Projected on the Entire Project:
Revenue Recognized Over Time
LO5-9
$2,760,000 ÷ $5,100,000

Loss Projected on the Entire Project:
Revenue Recognized Over Time
LO5-9

Loss Projected on the Entire Project:
Revenue Recognized Over Time
LO5-9
Recognizing revenue over time:

LO5-9
Loss Projected on the Entire Project:
Revenue Recognized Upon Project Completion
When the contract does not qualify for recognizing revenue over time:

PART C: Profitability Analysis (Not Covered)
LO5-10