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Intermediate I stuff to know
Terms in this set (72)
Present Value Formula
Future Value Formula
Inventory Turnover Ratio
cost of goods sold/average inventory
Days' Sales in Inventory
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 or services.
Prior GAAP rev
had to be recognized when both the earnings process was virtually complete and either cash had been collected or there was reasonable certainty as to its collectability
problems with prior GAAP
1) Revenue recognition was poorly tied to the FASB's conceptual framework.
2) Focusing on the earnings process led to similar transactions being treated differently in different industries.
3)difficult to apply to complex arrangements that involved multiple goods or services.
new standard issued in 2014 and effective jan 2017
-Accounting Standards Update (ASU) No. 2014-09: "Revenue from Contracts with Customers."
-Also known as ASC 606
-closely converged with the IFRS version, IFRS No. 15
Core Revenue Recognition Principle
-companies must 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 or services.
-So, the "when" is upon transfer of goods and services to customers
- the "how much" is the amount the seller is entitled to receive for those goods and services
-determining when transfer occurs and determining the amount the seller is entitled to receive are at the heart of much of the complexity of ASU 2014-09.
5 steps of revenue recognition
1. Identify the contract
2. Identify the performance obligations
3. Determine the transaction price
4. Allocate the transaction price
5. Recognize revenue when (or as) each performance obligation is satisfied
indicators suggesting performance obligation has been satisfied at a single point in time
-customer is more likely to control a good or service if the customer has:
•1) An obligation to pay the seller
2) Legal title to the asset
3) Physical possession of the asset
4) Assumed the risks and rewards of ownership
5) Accepted the asset
Companies recognize revenue over time if either:
(1) the customer consumes the benefit of the seller's work as it is performed (when a company provides cleaning services to a customer for a period of time)
(2) the customer controls the asset as it is created (when a contractor builds an extension onto a customer's existing building), or
(3) 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 (when a company manufactures fighter jets for the U.S. Air Force).
stand-alone selling price
the amount at which the good or service is sold separately under similar circumstances
What are three methods for estimating stand-alone selling prices of goods and services that normally are not sold separately?
1. Adjusted market assessment approach
2. Expected cost plus margin approach
3. Residual approach
Adjusted market Assessment approach
- seller considers what it could sell the product or services for in the market in which it normally conducts business
-perhaps referencing prices charged by competitors
Expected cost plus margin approach
-seller estimates its costs of satisfying a performance obligation and then adds an appropriate profit margin
- seller estimates an unknown (or highly uncertain) stand-alone selling price
-subtracting the sum of the known or estimated stand-alone selling prices of other goods or services in the contract from the total transaction price of the contract.
- residual approach is allowed only if the stand-alone selling price is highly uncertain, either because the seller hasn't previously sold the good or service and hasn't yet determined a price for it, or because the seller provides the same good or service to different customers at substantially different prices
Explain how to account for revenue on a long-term contract over time as opposed to at a point in time. Under what circumstances should revenue be recognized at the point in time a contract is completed?
-same 1-5 steps but
Step 2, "Identify the performance obligation(s) in the contract," is important because long-term contracts typically include many products and services that could be viewed as separate performance obligations. For example, constructing a building requires the builder to deliver many different materials and other products (concrete, lumber, furnace, bathroom fixtures, carpeting) and to provide many different services (surveying, excavating, construction, fixture installation, painting, landscaping). These products and services are capable of being distinct, but they not separately identifiable, because the seller's role is to combine those products and services for purposes of delivering a completed building to the customer.
- it's the bundle of products and services that comprise a single performance obligation.
-Most long-term contracts should be viewed as including a single performance obligation.
step 5- Step 5, "Recognize revenue when (or as) each performance obligation is satisfied," is important because there can be a considerable difference for long-term contracts between recognizing revenue over time and recognizing revenue only when the contract has been completed.
-ie builder who spends years constructing a skyscraper but only gets to recognize revenue at the end of the contract. Such delayed revenue recognition would do a poor job of informing financial statement users about the builder's economic activity.
- most long-term contracts qualify for revenue recognition over time.
-Often the customer owns the seller's work in process, such that the seller is creating an asset that the customer controls as it is completed.
-Also, often the seller is creating an asset that is customized for the customer, so the seller has no other use for the asset and has the right to be paid for progress even if the customer cancels the contract.
-In either of those cases, the seller recognizes revenue over time.
Periodic billings to the customer for a long-term construction contract are recorded as billings on construction contract. How is this account reported in the balance sheet?
Billings on construction contracts are subtracted from CIP to determine balance sheet presentation.
with CIP > Billings viewed as a
contract asset and labeled as "CIP in excess of Billings",
Billings > CIP
viewed as a contract liability and labeled as "Billing in excess of CIP"
-liability reflecting that company has billed its customer for more work than it actually has done.
-similar to the deferred revenue liability that is recorded when a customer pays for a product or service in advance.
-advance is properly shown as a liability that represents the obligation to provide the good or service in the future.
A contract exists for purposes of revenue recognition only 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. Note that this last criterion is somewhat similar to the contract having commercial substance.
A contract does not exist if:
1. neither the seller nor the customer has performed any obligations under the contract
2. both the seller and the customer can terminate the contract without penalty
Not performance obligations
-right of return
Part of the transaction price depends on the outcome of some future event
the average of each possible outcome of a future event, weighted by its probability of occurring
only 2 options
cost incurred + profit recognized
cash collections + A/R
cost to complete
(Actual cost incurred/A)
× (Contract price - A) = Profit recognized
A= Actual cost incurred + Estimated cost to complete
Is restricted cash included in the reconciliation of cash balances on a statement of cash flows?
-Restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period cash balances.
Define a compensating balance
-amount of cash a depositor (debtor) must leave on deposit in an account at a bank (creditor) as security for a loan or a commitment to lend
How are compensating balances reported in financial statements?
-depends on the nature of the restriction and the classification of the related debt
1) restriction is legally binding= cash classified as either current or noncurrent (investments and funds or other assets) depending on the classification of the related debt
- In either case, note disclosure is appropriate
2) compensating balance arrangement is informal and no contractual agreement restricts the use of cash, note disclosure of the arrangement including amounts involved is appropriate, and the compensating balance can be included in the cash and cash equivalents category of current assets
reductions below a list price and are used to establish a final price for a transaction
----reduced price is the starting point for initial valuation of the transaction
reduction, not in the selling price of a good or service, but in the amount to be paid by a credit customer if the receivable is paid within a specified period of time
gross method of accounting for cash discounts
initially records accounts receivable at their gross value, without reducing them for sales discounts, and then reduces sales revenue for discounts taken
The net method of accounting for cash discounts
initially records accounts receivable at their net value, having already reduced them for sales discounts, and then, if collection does not occur in the discount period, increases sales revenue for discounts not taken.
Briefly explain the accounting treatment for sales returns
1) Companies must estimate sales returns and reduce revenue to account for them
a) account for returns as they occur during the period:
reducing revenue and refunding cash as well as reducing cost of goods sold and increasing inventory for the returned items.
b) at the end of the accounting period:
----adjusting entry that debits sales returns, an account that is contra to sales revenue, and credits a refund liability for the amount expected to be refunded when products are returned
----reduce cost of goods sold for estimated returns and recognizes an asset for the right to receive inventory that will be returned.
Explain the typical way companies account for uncollectible accounts receivable (bad debts).
Each period companies estimate the amount of accounts receivable that will be collected, and adjust an allowance for uncollectible accounts (contra to accounts receivable) to show net accounts receivable at that carrying value. The corresponding entry to that adjustment is bad debt expense. ex: if additional accounts are expected to prove uncollectible, the allowance is credited (increasing it) and a corresponding debit increases bad debt expense for the period.
When is it permissible to record bad debt expense only at the time when receivables actually prove uncollectible?
If uncollectible accounts are immaterial, any bad debts that do arise can be written off as bad debt expense at the time they prove uncollectible
Define the CECL model for accounts receivable.
- "Current Expected Credit Loss"
-allows a company to apply any method that reasonably captures its expectation of credit losses, so that the resulting carrying value of net accounts receivable reflects the cash the company expects to collect
On what does CECL base the estimate of the allowance for uncollectible accounts?
the estimate should consider all receivables and be based on all relevant information,
1) historical experience
2) current conditions
3) reasonable and supportable forecasts
(Based on Appendix 7A) In a two-step bank reconciliation, identify the items that might be necessary to adjust the bank balance to the corrected cash balance
The items necessary to adjust the bank balance might include
-deposits outstanding (including undeposited cash)
-any bank errors discovered during the reconciliation process
in a two step bank reconciliation identify the items that might be necessary to adjust the book balance to the corrected cash balance.
The items necessary to adjust the book balance might include
-collections made by the bank on the company's behalf
-service and other charges made by the bank
-NSF (nonsufficient funds) check charges
-any company errors discovered during the reconciliation process
A/R turnover ratio
Sales / Average Accounts Receivable
average days to collect receivables
365/accounts receivable turnover
The process of comparing the bank's account balance with the company's balance, and explaining the differences to make them agree.
bank reconciliation items to adjust bank balance
1) Deposits outstanding
2) outstanding checks
3) bank errors discovered in reconciliation process
bank reconciliation items to adjust book balance
1) collections made by bank on company's behalf
2) service and other charges made by bank
3) NSF check charge
4) company errors discovered during reconciliation process
Describe the three types of inventory of a manufacturing company
(1) raw materials, (2) work in process, and (3) finished goods
represent the cost, primarily purchase price plus freight charges, of goods purchased from suppliers that will become part of the finished product
-products that are not yet complete in the manufacturing process
-cost of work in process includes:
- --cost of raw materials used in productio
---cost of labor that can be directly traced to the goods in process,
---allocated portion of other manufacturing costs, called manufacturing overhead
units of product that have been completed but not yet sold to customers
-when the manufacturing process is completed, these costs that have been accumulated in work in process are transferred to
What is the main difference between a perpetual inventory system and a periodic inventory system? Which system is used more often by major companies?
Beginning inventory plus net purchases for the period equals cost of goods available for sale.
-periodic system allocates cost of goods available for sale to ending inventory and cost of goods sold only at the end of the period. The perpetual system accomplishes this allocation by decreasing inventory and increasing cost of goods sold each time goods are sold.
The perpetual inventory system is used by nearly all major companies.
Perpetual purchase of merchandise
periodic purchase of merchandise
Perpetual sale of merchandise
periodic sale of merchandise
Perpetual return of merchandise
periodic return of merchandise
credit purchase returns
Perpetual payment of freight
periodic payment of freight
debit freight in
shipped f.o.b. shipping point
Inventory shipped f.o.b. shipping point is included in the inventory of the purchaser when the merchandise is given to the delivery company.
Shipped FOB destination
included in the inventory of the seller until it reaches the purchaser's location
What is a consignment arrangement?
A consignment is an arrangement under which goods are physically transferred to another company (the consignee), but the transferor (consignor) retains legal title. If the consignee can't find a buyer, the goods are returned to the consignor.
Explain the accounting treatment of goods held on consignment.
Goods held on consignment are included in the inventory of the consignor until sold by the consignee
purchase discounts gross method
-record the purchase for the full (or gross) amount of the inventory's cost
-Purchase discounts taken are a reduction of inventory at the time the invoice is paid
purchase discounts net method
-record the purchase of inventory for its full amount minus (or net of) the possible discount on that amount
-The presumption by purchaser is that inventory should be recorded for its cost, and because the purchaser expects to pay the invoice within the discount period, the discount should be subtracted at the time of the purchase to reflect the inventory's expected cost
It's common in the electronics industry for unit costs of raw materials inventories to decline over time. In this environment, explain the difference between LIFO and FIFO in terms of the effect on cost of goods sold and ending inventory. Assume that inventory quantities remain the same for the period.
When costs are declining, LIFO will result in a lower cost of goods sold and higher net income than FIFO. This is because LIFO will include in cost of goods sold the most recently purchased lower-cost merchandise. LIFO also will provide a higher ending inventory in the balance sheet when costs are declining because the inventory has units purchased at an earlier date, when costs were higher.
Explain what is meant by the Internal Revenue Service conformity rule with respect to the inventory method choice.
Many companies choose the LIFO inventory method to reduce income taxes in periods when prices are rising. In periods of rising prices, LIFO results in a higher cost of goods sold and therefore a lower net income than the other methods. The companies' income tax returns will report lower taxable incomes using LIFO and lower taxes will be paid currently. If a company uses LIFO to measure its taxable income, IRS regulations require that LIFO also be used to measure income reported to investors and creditors.
Cost of Goods Sold (COGS)
beginning inventory + purchases - ending inventory
inventory accounting in which the most recently acquired items are assumed to be the first sold
- method is supposed to create the lowest ending inventory in a period of rising prices
-Also create a lower taxable income, lower gross profit.
This set is often in folders with...
Intermediate Acct 1 Chapter 1- Accounting Concepts
Intermediate accounting chapter 1
Chapter 6 revenue recognition
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