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Terms in this set (36)

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. When the time lapse between payment and delivery is more than one year, entities are required to separate the revenue generated from the contract from the financing component if the financing component is significant at the individual contract level.

The rationale is that the seller should recognize revenue at the amount that properly reflects the price that buyer would pay, if payment occurred on the same date as delivery. In determining whether a significant financing component exists, the entity considers three factors:
1. The difference between the contract price and the cash selling price of the goods or services
2. The length of time between delivery and payment
3. The prevailing interest rate in the market

Once an entity concludes that there is a significant financing component, it determines the transaction price by using the time value of money:

If the delivery occurs BEFORE payment, the entity discounts the promised consideration amount back to the present value, using the same discount rate it would use if it entered into a separate financing arrangement.

If the delivery occurs AFTER the payment, the entity determines the future value of the payment, using the same discount rate it would use if it entered into a separate financing arrangement.

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 before delivery.
While 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.

1. Adjusted market assessment approach - Evaluate the market and estimate the price that it believes customers would pay. (Might include using prices from the seller's competitors and adjusting those prices as necessary)

2. Expected-cost-plus-a-margin approach - focuses on internal factors by forecasting the costs associated with providing the goods or services and adding an appropriate profit margin.

3. Residual approach - allows an entity to estimate one or more, but not all, of the standalone selling prices, and then allocate the remainder of the transaction price, or the residual amount, to the goods and services for which it does not have a standalone selling price estimate.

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 prices of each performance obligation to the sum of the standalone selling price of all of the performance obligations in the contract.
While the general rule is that the transaction price should be allocated based on the relative standalone selling prices, there are two possible exceptions.
1. When the contract includes variable consideration
2. When the discount is not related to all of the contract's performance obligations

The seller should allocate variable consideration to one or more, but not all performance obligations if 2 criteria are met:

1. The terms of the variable amount relate to one or more, but not all, of the specific performance obligations.
2. 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.

2nd exception: discount is not related to all of the contract's performance obligations

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 only allocate the discount to the performance obligations to which it relates. Specifically, if the following three criteria are met, then the seller should allocate the discount to one or more, but not all, of the performance obligations.

1. The entity regularly sells the goods/services in the contract on a standalone basis.
2. The entity regularly sells a bundle of some of those goods/services at a discount to the sum of the standalone selling prices of the separate goods/services
3. The discount in the bundle of goods/services described in (2) is basically the same as the discount in this contract
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.

Goods or services are transferred over time if the seller meets any one of the following 3 criteria:

1. The customer receives and consumes the benefits of the goods or services simultaneously (ex. health club memberships, and magazine subscriptions)
2. The customer controls the asset as the seller creates it or enhances it over time (ex. software updates)
3. The asset the seller is creating does not have an alternative use to the seller, and the seller has an enforceable right to payment for the performance completed to date.

If a good or service is transferred over time, then the seller recognizes revenue over that same time period, based on the progress that is has made toward completion. However, if the seller does not have a reasonable way to measure its progress toward completion, then it should not recognize ANY revenue until it can reasonably estimate progress.

Progress towards 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.
Percentage-of-Completion Method Accounting Procedures:
1. Accumulate construction costs by debiting an asset (inventory) account called construction in progress (CIP)
The CIP account is an asset account because, as project costs are incurred, the contractor has the right to bill the buyer.
2. When the contractor sends bills to the customer throughout the project, increase accounts receivable with a debit and credit an account called billings on construction in progress, a contra account to the construction in progress account that reduces the net carrying value of the asset, CIP. In effect, this transaction replaces the physical asset(inventory) with a financial asset (accounts receivable). Using the contra account avoids double counting the total asset value.
3. When the contractor receives cash from the customer, increase cash with a debit and decrease accounts receivable
4. Recognize the revenue and the associated costs each year, basing the amount of gross profit in a given year on the progress to date (that is, the percentage of the project that has been completed). Credit revenue from long-term contracts, debit the construction costs, and debit the difference between the revenue and the cost of construction (the gross profit) to the CIP account
5. At the end of the project, remove the CIP account from the books with a credit and remove the billings on construction in progress account with a debit.

At the end of each year, the firm reports accounts receivable and costs and recognized profits in excess of billings on the balance sheet. If CIP is larger than the billings account, the net amount is called costs and recognized profits in excess of billings, and is reported as an asset on the balance sheet. If, however, the billings account is larger than the CIP account, then the firm reports the net of the two accounts, billings in excess of costs and recognized profits, as a liability on the balance sheet.

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 the 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, it 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.
A consignment sale is an arrangement where a seller (referred to as the consignor) delivers goods to a third party (the consignee), who sells the goods to the customer. A consignment sale is an example of a principal-agent arrangement (where one party (the agent) acts on behalf of another party (the principal).) In this case, the consignor is the principal and the consignee is the agent.

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 consignment basis.

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. If not, then it qualifies as a consignment arrangement.

3 indicators that an arrangement is a consignment arrangement:
1. The seller controls the product until a specified event occurs, such as the sale to the ultimate consumer.
2. The seller can require that the product be returned to it or sent to another third party
3. The third party does not have an unconditional obligation to pay for the product.

The parties must use judgement to determine whether control has passed based on these indicators. 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 while the consignee makes not 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