Conceptual Framework and Financial Reporting ModuleNOTES (© Becta sroteeeona| dousaton Corporation all cymes erenceMODULE Standards and Conceptual Framework 1 Financial Accounting Standards 11 Standard Setting Bodies in the United States three oiMerent Dos es of the accounting profession have determined GAaPsince 1934 1.1.1. Securities and Exchange Commission (SEC) The SEC was established by the Securities Exchange Act of 1924 ll companies that issue securities in the United States sre subject to SEC rules and regulations. The SEC has issued jublic company specific sccounting rules and regulations in Regulation S-x, Financial Reporting Releases (FRA), Accounting Series Releases (ASR), Interpretative Releases (IR), Staff Accounting Bulletins (SAB), and EITE Topic D and SEC Gbserver comments. 1.1.2 @pmmittee onf®}countingPjocedure (CAP The Commiee on Accounting Procedure (CAP) was a part-time committee of the American Institute of Certified Public Accountants (AICPA) that promulgated Accounting Research Bulletins (ARB), which determined GAAP from 1929 until 1959 1.1.3 @feounting@finciptes@para (Avs) The Accounting Principles Board (APB} was another part-time committee of the AICPA. It issued Accounting Principles Board Opinions (APEO) and APE Interpretations, which davermined GAAP from 1559 vol 1973 1.1.4. Financial Accounting Standards Board (FASB) (GBD an independent fil-cime organization called the Financial Accounting Standards Board (PaSBhwvos ectablished, and it has determined GAAD since then. Through 2008, che PASE issued ‘Statements of Financial Accounting Standards (SFAS), FASS Interpretations (FIN), FASB Technical Bulletins (FTE), Emerging Issues Task Force Statements (EITF]. FASB Staff Positions, FASB Implementation Guides, and Statements of Financial Accounting Concepts (SFAC). ‘The FASE has seven full-time members, who serve for five-year terms and may be reappointed to one additional five-year term. The Board members must sever connections with firms or institutions before joining the Board. 1.2 U.S. GAAP: FASB Accounting Standards Codification= ‘The vast number of standards issued by the Committee on Accounting Procedures, the Accounting Principles Board, and the Financial Accounting Standards Board. 2s well as additional guidance provided by the S&C and the AICPA, made it difficult for users to access the full body. ofS. GAAP. Effective July 1, 2009, the FASB Accounting Stondards Codification became the single source of suthoricative nonsovernmencal U.S. GAB. Accounting and financial reporting prasticednodincluded in the codification arefnogScandavae an Censepival Srameners FARA 1.2. “Private Company'Council The Financial Accounting Foundation (FAF) crested the Private Company Council (PCC)10 1 vats inthe U.S. ThafGpalet the PCC is te where appropiate £. statements (nore relevant less comples, and gosi-beneficial: Accounting alternatives for private companies are incorporated into the relevant sections of the Accounting Standards Codification (ASC). Proposed FASS amendments to the ASC are issued for public comment in the form of exposure drafts. A majority vote of the Board members is required to apprave an exposure draft for issuance. At the end of the exposure draft public comment period, the FASE staff analyzes and studies 2il comment letters and position papers and then the Board re-deliberstes the issue, When the Board is satisfied that all reasonable alternatives have been adequately considered, the FASE staff prepares an Accounting Standards Update for Beard consideration. A majority vote of the Board members is required to smend the ASC, 2 Conceptual Framework for Financial Reporting ‘hela as scaatag eoncepsual rarrevorfeet forth in prengunsemenss called Stacemenss cr SPAC) that serves asa basis‘or all caS8 oroncuncemenss Baler The SPAC arene out mney provide 2 basis for finenslal accounting concerts for business weagonlng enterprise: and netfor-proft entities, The framework is 2 coherent system of imterrel objectives and concepts that prescribe the nature, function, and limits of fingncial sccoun and reporting that is expected to lead to consimentstandards. 2.1 SFAC No. 8, Conceptual Framework for Financial Reporting— Chapter 1: "The Objective of General Purpose Financial Reporting" ‘The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to the primary users of general purpose financial reports in making ecisions about providing resources to the reporting entity. a1 Cemeslondonneeted Orner parties. including regulators and members of a EE who ‘are not investors, lenders, and other creditors, may also use general purpose financial reports, but are not consideredto be primary users.relevant FAR ‘Scandards and Censepiusl ramewerl To meet the informational needs of these users 2.1.2. Financial Information Provided in"General Purpose Financial Report? Financial information needed by primary users includes information about the resources of ‘ig entity, the claims against the entity, the changes in the resources ang claims, and now efficiently and effectively the entity's mansgement and governing board have discharged their responsibilicies to use the entity's resources. Financial information should be presented using Eig accrual basis of accounting. Accrual sccounting inciuces the effects of transactions im tne Period in which they occur. regardless of the timing of the related cash receipt or payment. This provides a bewer basis fer a financial statement user for assessing past and future perforememer. Existing and potential investors, lenders, and other creditors use financial information zo assess the reporting entity's prospects for future net cash inflows to the entity. Such information may be used to estimate the value of the reporting entity. 2.2 SFAC No. 8, Conceptual Framework for Financial Reporting—Chapter 3: “Qualitative Characteristics of Useful Financial Information” Thelualistive choracteristiccAbf useful financial information are the gharacterisiics that are likely 19 be mast useful to existing and potential investors, lenders, and other creators im Taking decisions sbout the reporting enviry bared on financial information, 2.2.1 GungamentalQualitative Characteristics Relevemt ana faithful (reliable) ‘The fundamental qualitetive characteristics of useful financial information are relevance and faithful representation. Both characteristics must be present for financial information to be useful. = Relevance: Financial information is relevant ifit is capable of making a differencein the ecisions made by users. To be relevant financial information must have pregicrve value and/or confirming value, and must be material © Bedictive Value: Information has predictive value fit can be used by users to predict ‘urure ourcomes © @arirmatary Values intormation nas confirmatory value iit provides feedback azout ‘evelustions previously made by users, © Dteriatity Information is material fan omission or misstatement ofthe information could aflec the decisions made by users based on financial information. Material x Bn entinespectc aspect of relevance The FASS had(Gatnectfied a uniform quantitative Shceateld for materiality and has not specfied whatwould be material spect Seuatons, = Faithful Representation: To be useful, financial information must faithfully represen: the Completely renorzed economic phenomena, Faithful representation requires the financial information neutral is Pree from to be complete. neutral. and free from error. Although perfect faithful representation is generally not achievable, these characteristics must be maximized. © Complete: A complete depiction of financial information includes all information necessary for the user to understand the reported economic event, including and descriptions and explanations. © Neutral: 4 neutral depiction of financial formation is free from bias in selection or presentstign. 2 Free RMP ERE re trom error mesns that there are no errors nthe selection or pplication of the process used to produce reported financial information and that there are ng errors of amissions in the descriptions of economic events. Free fram cron does(vairequire perfect accuracy because, for example, itis difficult to determine the accuracy of estimates. Seeker Botseeans|Eaucate Moguletlls Scandavae an Censepival Srameners FARA 2.22 Steps to Apply the Fundamental Qualitative Characteristics The most efficient and effective process for applying the fundamental characteristics of useful financial information is: 1. Identify the economic event or transaction that has the potential to be useful to the users of a reparting entity's financial information. 2. Identify the type of information about the event or transaction that would be most relevant. 3. Determine whether the information is available and can be faithfully represented, I the information is available and can be faichfully represented, then the fundamental gualitative characteristics nave Deen satisfied. If not, the process is repeated with the mext most relevant type of information. 2.23 [Enfaneinploualitative Characteristics Compare ama verity in Hive te understand Comparability. verifiability, timeliness, snd understandability enhance the usefulness of infermation that is relevant and faithfully represented. These characteristics can be used to determine how sn economic event or transaction should be depicted if wo ways are ‘equally relevant and faithfully represented. The enhancing qualitative characteristics should Bemasimiea: pele vs, MicrosoPt Trend analysis Comparability: Intormation is mare useful ieegy@E compare vith similar information {bout other entities or from other ime periodge€omparabiity enables users i idencty Similarkies and differences among items, Cofestency, which =the use ofthe same methods for me same ime ether fom pevien to period within an enety orn a single period across entices helps co achieve comparabiy = Verifiability: Verifiabilicy means tha: differentknowledgeable and independent observers sgnresch consensus chat 2 particulsr depiction is fsithtully represented. Verifiability does not require complete agreement. Timeliness: Timeliness means that information is gyailable to users in time to be capable of influencing their decisions. = Understandability: Information is understandable if its classified, characterized, and presented clearly and concisely. However, even well-informed and diligent users may need ‘the assistance of advisors to understand complex and difficult transactions. 2.24 The Cost Constraint BeneBit > cost The cost constraint is a pervasive constraint on the information provided in financial reporting The benefits of reporting financial information must be greater than the costs of obtaining land prasenting the information. The FASS considers costs and benefits in relation to financial reporting in general and notat the individual reporting entity level. 2.3 SFAC No. 8, Conceptual Framework for Financial Reporting— iS REGL Chapter 4: “Elements of Financial Statements" BS ALE, 1D, C1 Elements are chfierpereneh bf che Financia! sratements and the definitions below focus on the essential characteristics, Other areas of the conceptual framework focus on recognition and measurement in the financial statements 23.1 @sets nase ia present right of an eniy to or GRR ETETEP ust be present meaning itmust exist at the financial statement date. Fiaé ale? proteseona ausaton c:FAR ‘Scandards and Censepiusl ramewerl 2.3.2 (abilities [A liability is 2 present obligation of an entity to gransfedSpcovide an economic benefitt others 2.3.3 (huity (or Net Assets) A - Le E \ Residual Equity is thelferuaT lereaijn the assets ifthe eft task cernsing after deducting the entity's lablives 2.3.4 (Ihvestments by Gwners - Nok revenue -Net en lS “conbipubed capital” Excluded) nvescrents by owners aro REeanan the eauity of an ent epulting tram wanstering Prom C1 | something velusble to obtain or Merease ownership interests (or equity) in the entity. 2.3.5 Qstributions to Owners - Not expense - Nok on IS - Reduces RE Distributions to owners ar in the equity of an entity from transfers of cash, proper Eewmea 2¢280ices, or che incurrence of s[bity we owners ‘Gaiked 2.3.6 Comprehensive Income eLotMper ist C/V OC | foect bo Comprehensive income includes any change in equisjlother charnvestments by suners@ag) gigtributions to owners (¢.g.. net income plus other comprehensive income). ex 2.3.7 Brenig Operating [Revenues are indus or enhancements of assets, or settlements of liabilities from delivering or producing soodsorsenices Sales of inventory 2.3.8 ©penses COGS, SG&A, Aepr., e&c, Expenses are outflows or uses of assets, or incurrences of liabilities {om delivering or producing goads or services, 3.3.9 G@pins

BV WRV= SP - Casts te sell 2 Nonperating| ins are increases in equity fram trancocions ana oxfet enc, except ase inatrecutrom| sonore ee “oe revenues and investments fram owners. wribedowns, 2.3.10(Dpsses SP ov NRV< BV ete, Losses are decreases in equity from transactions and other events, except those that result from expenses and distributions to-owners. 2.4 SFAC No. 8, Conceptual Framework for Financial Reporting— BS, !S, Cl.CFs, Chapter 7: "Presentation" AE, notes This chapter of the framework describes the(@formanien}o be included in zeneral purpose financial reporting and how presentation can contnbute to achieving the objective oF financial repornng. General purpose financial renorsng iaetineshs a full se o¢inancial satemencs (statement of financial positon Htaterent of Rarnings statersert of garprehensive come. statement of gash flows, and statement of owners equity) and nae to financial statements. Presentation refers to the display of ine Items ofthe financial stareTenes. including czals and subtotals. ST Hiquidity BS 2.4.1 @setsDpbilities, andQjuity - Financial eS Information about an entity’s assets liabilities, equity, and their relstionsMie to tach other ata [Boingin cme)nelps financial statement users to assess items such as liquidity, financial flexibility, TSLcespurees ovetlable- cquabiliy oF gene: ating future ng: cosh flows risk exposures snd the Sntiys ability to meet Sigs tenes obieos PO Treneial obligations. Assets- copacity te produce/sell iw. poration ai mgr Moguletiu IS - Performance = TO x PM = ROA - Operating risk Be = Meamed capital 2.4.2 @pvenues(Efpenses Gpins, ane{[psses—Components of Comprehensive Income Revenues, expenses. gains, and losses provide information about how and to what extent ‘an entity has been gble to increase or decrease overall equity without the consideration of investments from(GndMistributions to owners. Financial statement users can evaluate how ‘ssets and other resources were used and how efficiently the entity financed or supported its activities. é CFO oma We quality 68 eowul 2.4.3. Cash Flows cash . ve BS Information about an envinys cash receipts and payments helps financial statement users to ‘assess the entiy’s financial flexibility and risk, An understanding of the type of transaction causing the inflow or Outflow of cash may help a resource provider to assess the prospects for future net cash flows. i 2.4.4 (jvestments by and@)stributions to Qwners = Ai corbtoubed capa © a O y Ques Pay AVdenAs Investments by and distributions to owners reflects the changes in equity resulting from wransactions with(wnersjand may help a user of the financial statement, in conjunction with ‘other information, to assess the entity's financial flexibility, capacity for future cash flow generation. and risk. 24.5 Comprehensive Income and Net Income - B earned capital = NI + C/AY OCI Comprehensive income summarizes the net effects of all recognized changes in equity during = period, except those resulting from transactions with owners. For entiies without owners, such ss notlor-prafitensties, comprehensive income represents sll changes in net assets Scandavae an Censepival Srameners 2.4.6 Presentation Considerations Financial information must belcondensedknd line items, subtotsis and totals without losing useful imormation about the underlying data. The following are important considerations when determining line-item presentation of individual items: = Cause, activity, and frequency - Opewerting vs. nonepererting = Expected timing ang form ef reslization or settlement - Short-terw vs. long-terwa Response to changes in economic conditions rather factors - Whithedowks/AFMV Methed of measurement = BM, FMV, NRV, PY - vawiety of morys Relationship with other information 2.5 SFAC No. 8, Conceptual Framework for Financial Reporting— Chapter 8: (Notes}to Financial Statements” This chazter gizcusses the surpoce and limitations of the notes te the financial statements and addresses the nature of information that chould be considered for inclusion in tne notes Sef the notes to Financial statements isco supplements or further exolsin rheunfarmsstion on Me tace of che Financisl ststemente. To aenieve tne objective of financial Teporting the notes to Financial statements should include information about the following: = Financial statement line items = Methods, esHimabes = The reportingfentity = Consdlidabed FS © Past events(A current conditions that have nat been recognized(Gaajcan affect the entigy’s eee ae Warket Conditions Flag oale?FAR ‘Scandards and Censepiusl ramewerl + 2.5.1. Limitations on Information in Notes to Financial Statements FACR There are at least four ways in which the requirements to include information in the notes are limited: = @btevance: Only information relevant ro existing ang potential financial statement users ‘Should be required. = Gbst Constraint: The notes are subject to the same cost constraint es financial reporting "and entities should not be required to include information that is generally already available wo users. = Potentialfiverse Consequences: Thé’board/bhould consider the impact of legal ‘competitive, reputational, or other economic consequences when determining whether to require particulsr disclosure. = @iture-orientes information: Generally, cisclosures of expectations and assumptions Sout the future that are ot nputs to current measures in nancial statements oF notes remot required. 2.6 SFAC No.5, Recognition and Measurement in the Financial Statements This statement sets forth the recognition criteria and guidance on what and when information should be incorporated in the financial statements. 2.6.1 Fundamental Recognition Criteria JE Recognition is the process of formally recording or incorporating an item in the financial istements of an entity ang classifying ita asset, lability, equity, revenue or expense. = Defi jons: The item meets the definition of an element of financial statements "= Measurability: The item has a relevant attribute measurable with sufficient reliabilty.~ Awatant m4 Relevance: The information sbout itis capable of making a difference to e francial Predict Clontiewy sigtement user. akeriel > Reliability: The information is represencationallyfrachful] verifiable, and neutral. Cowplebe, neubral, Pron wetberial error 2.6.2 Measurement Attributes for Assets and Liabilities Items reported in the financial statements are currently measured using diferent atributes, including those listed belaw. — = Historical cost PPA = Currenteost Iuventory Net realizable value AR = Current markecvalue Mawkebabble securities = Present value of future cash flows LT ponds, nobes 2.6.3 Monetary Unit Assumption us Iv is assumed that money is an sppropriste basis by which to measure economic activity, The a8sumption is that the manetary unit does not change over timeGhus) the effects of inflation oS flected in the fnencisl ststements poration ai mgr Module tScandavae an Censepival Srameners FARA 2.7 SFAC No. 7, Using Cosh Flow Information and" Present Valuc* in Accounting Measurements SFAC No. 7 provides a framswerk for accountants te employ when using fuuure cash flows as Ameasurement basis for assess and lablliie: especially when the factors to consider in the messurement are complex. Ir also provides a et of principles that govern the use of present value, especially when the timing and/or amount of future cash flows are uncertain 2.7.1 Measurements Based on Future Cash Flows Only SFAC No. 7 applies omly to measurement issues for assets and lisbilities that sre determines using future cash flows only. Asset- wobe rec, 2.7.2 Five Elements of Present Value]Measurement _ Insurance expense 3. Net book value of fixed assets Depreciation expense 4. Unexpired cost of patents ————>_ Patents expense (amortization) 1.2.2 @fBs)Concept (Revenues and Expenses) ~ Norwal/operaating Revenues are reported in the gross amountof consideration to which the entityexpectstobe Gales ‘entiled in exchange for the specified goods or services transferred. Coes fs Expenses (costs tharbenefit only the current period or the allocation of unexpired comstO cog y he current period for the benefit received) are reported at their gross amounts. 1.2.3 Qedconcept iG. = Gains are reported at Sand Losses) Owly, wot SP - NRV cir net amounts (e., proceeds less net book value). A gains the er not in the ordinary course of business (e.g. gains on the he incurrence of an expense (e.g., finding gold on the company’s property) je Losses are reported at their net amounts (i proceeds less net book value). A loss is cost ‘expiration either not in the ordinary course of business (e.g. loss on the sale of investme: assets) or without the generation of revenue (eg., abandonment) = Sale noninventory, write-Aowns, wrike-offsarg Dalense Sheet FARA financial statement effects should be a ca in the focenotes . Ow Ow 2 Income Fi ‘Continuing Operations=£ of Operating + Nonoperating £_Inconye (8 scontaned Qi BEng OS™ * 0F Oreratng © Now Inberest 21 Multiple-Step incom ERE MEnt Dathe fer Friday night ther The multisie-ztep income sttement repore(QSSaeng}ever ues and expenses separately trom ues and expenses and cther gains and losses. TheGgne*Dbf the muuitole-sten Income statement is gqhsoced user information (because the line tems presented often provide the user with readily available data with which 1 calculate various analytical ratios) Why is nit or | of ety Te RTs eed Facts: The following tril balance contains a list of ineame statement accounts for the year enced December 31, Yee Triat Balance: Income Statement Account For the Year Ended December 31, Year 1 in “4000 Sales revenue $220 4950 Sales returns i$ 25 307 PAL Beem | 4960 Sales discounts Returns end discounts $39] “s 350 Net sales - Goods 4100 Service revenue 4200 continuing etna 4200 Rental revenue #100, 650 = Total net sales 00 Score™ puasiness | 5100 Cost of services sold 150 Ald> Tobel cost of sale 5200 Cost of rental income $99 pales 60 "FAO Gross margin 5259 expense* zo soo renee re 5400 cores] eg sergio [2 + $20 = $100 Total selling 5500 Advertising 5 20 + $50 = $10 Tete) Gia 5600 Insurance expense operating | 5000 Cost of goods sold tio 200 Deoreci 25 Floo0 incmesarespene.] Setewate Tine ens <5 Continuing tout | 6900 oteres: cevenus 170 nonoperating G, Ly £200 Qtner revenue ‘Het a1 'bewle, Haus nonoperating 130 8500 Gain on sale of avsfsblevor-ssle securities 50 theres ther | ooo meres eunence 50 7500 Loss on sale of fixed assets 40 7550 Restructuring expense™* 100 Highly regular 8000 Loss enfaiscontinuedpperations Gerona) 25 Sepewately reported abter continuing operations Fide ccense @iDpelates to salaries for galespenals and@Ejrelates to selaries for (Qificers of the company. — relates to an infrequent restructuring of service division. (continued) NewoperatingFAR Income Stetemencans Galance Sheet (continued) Note: The trisl balance does not balance, as the balance sheet accounts are excluded. Required: Prepare s multiple-step income statement prepared from the trial balance information above. Solution: Radon Industries inc. bes Income Statement Net grOSS kor che Year Ended December 31, Year 1 For a period of Hime (in thousands) (Regesles (including goods, services, and rentals), less: discounts and returns ses Cost of sales 1g goods, services, and rentals} (a0) Gross margin $240 Selling expenses $100 General and administrative expenses 70 Depreciation expense EN 250) Income (loss) from operations (10) evenues and gains: 2B Ge evenve 170 Before tou Continuing | Gaon sale of avaliable for-sale securives 50 ‘put Other revenue 130 350 ing Ciiedexpenses and losses: Interest expense 50 einen 40 sgicusturing expense 2 ‘Income before income zaxe Imcome Brow Showm 2x | income tax expense operations, Selon Tae Income from gantiquing operations APher beve vig equine CezamnaaDoperatons ner of 30) Net income (Freight(@)- pout of inventory) Scling expenses include freigh{Ga9 salaries for salespeople, commissions, and adverssin General and administrative expenses include gficers' salaries and insurance [Nonoperat revenues and gains include‘suxiliary activities.” OYnerarg Dalense Sheet FARA 2.2 Single-Step Income Statement I expenses (including income t statement hasa single step. Th feted Bin J Facts: Same as Example 1. Required: Using the trial balance trom Example 1_prepsre a single-step income ststement, Solution: Radon Industries Inc. Income Statement For the Year Ended December 31, Year 1 {in thousands} Revenues and other items: Sales revenue "Wet of veturns and discounts” 320-30 $350 ‘Service revenue 200 Interest revenue 170 Rental revenue 100 Gain on sale of fixed assets 50 Other revenue 130 Less: 51,000 Expenses and other items: Cost of goods sold $ 200 Cost of zenvises sold 150 Cost of genial income 0 Seling expenses 100 General and adriniscrative expenses 70 | I step Interest expense <0 Depreciacion expense % Loss on sale of fixed assets * Loss on sale of availablefor-sale securities 100 Income tax expense 109 5950 Income from continuing operations APher fave 3 50 4p[- Disconsinued operations (net of ta) 25 Netincome £25FAR 3 Balance Sheet - Financial visk "capital structure" Income Stetemencans Galance Sheet Under US. GAAP, entities may present ="Llsssified!bslance sheet that distinguishes current snd nonscurrent assets and liabili ss. When appropri fe, a balance sheet presencation basedon [iguidity is also permissible, The following is an evample of 2 classified balance sheet Company Name Balance Sheet As of December 31, Year 1 Assets Current assets ‘Cash and cash equivalencs ‘Traging securities, 2t fair value Accounts receivable, net of allowance Notes receivable Inventory Prepaid expenses: Investments Available-for-sale securities, at fair value Held-to-maturity securities Property, plant, and equipment Land Building Equipment Less: accumulated depreciation Intangible assets Goodwill Patents, net of amor Other assets Pension and other postretirement benefit assets Deferred income tax ass Total assets Long-term lia! heat C Total stockholders’ equity ui Current liabilities ‘Curremt partion of long-term debt Accounts payable Notes payable Incerest payable Selaries paysble Unearned revenue ies Risk Y Deferred income tax liability Pension ang other postretirement benefit liabilities Bonds payable Total liabilities Stockholders’ equity "ResiAual” inberest| Capital steek Preferred stack. $10 par. 8% cumulative ‘and nonparticipating, 10,000 shares authorized, 5,000 shares issued and outstanding Commen stock, $0.01 par, 600,000,000 shares authorized, 57,598,000 shares issued and 57,178,485 shares ‘outstanding Pald-in capital in excess of par Retained earnings Accumulated@herpmprehensive (Treasury stock at cost] (419,515 shares) ~ Total liabilities and stockholders’ equity AH=L+Enegra Statement ard Eelence Sheet FARA ‘Scott Corporation sold a fixed asset used for operations for greater than its carrying amount. Scott sheuld report the transaction in the income statement using the: 2, Gross concept showing the proceeds as part of revenues and the carrying amount as part of expenses in the continuing operations section. Net concept, showing the total amount as a component of ather comprehensive incame. net of income taxes. Net concept, showing the total gain as part of discontinued aperations, net of income taxes. Net concept, showing the total gain as part of continuing operations, nor net of income taxes. Which of the following should be included in general and administrative expenses? Interest Advertising Yes Yes Yes No No Yes No No Fete boauie2 (© Becta sroteeeona| dousaton Corporation all cymes erenceMODULE Revenue Recognition a 1 Overview and Scope Revenue recognition occurs when an entity satisfies a performance obligation by transferring either @ good or a service to a customer. Revenue should be recognized at an amountthat reflects the expected consideration the entity is entitled te receive in exchange for the good or service provided. All entities (public, private, nov-for-profit) that efther enter inte contracts with custemers to transfer goods, services, or nonfinancial assets (unless gaverned by other standards) are subject to the revenue recognition standard. Certain contracts, such as those covering leases, insurance, non-warranty guarantees, ang financial instruments, are covered under other standards. 2 The e-Step Approach In order to properly apply the revenue recognition standard, an er fvestep approach described below fm Step 1: Identify the contract with the customer should implement the ‘Sm Step 2: Identify the separate performance obligations in the contract “Tm Step3: Determine the fransaction price A= Step-4: dllocste the transaction price to the separate performance obligations Ru Step 5: Recognize revenue when or as the entity satisfies each performance abligation 241 Step 1: Identify the Contract(s) With the Customer (7) STAR 2.1.1 Definitions A contract is defined as an agreement between two or more parties that creates enforceable rights and obligations. Depending on sn entity's typical business practices, contracts can be verbal, written, or implied. A customer is a party that has contracted with an entity to exchange consideration in order to btsin goods or services that are an output of the entity's ordinary activities. 2.1.2. Criteria for Revenue Recognition Revenue is only recognized when 2 contract meets olf of the criteria listed below. The criteria sssessment i performed at contract inception and ifall criteria are met, reassessments should only be needed if significant changes occur. If all of the criteria are not met at inception, regular reassessments should follow: m= All parties have approved the contract and have committed to perform their obligations. tified. The rights of each party regarding contracted goods or services are ide ied. = Paymer erm can be ideBeverue facegncien: Part FARA | The contract has commercial substance, meaning future cash flows (amount risk, and timing) are expected to change as.a result of the contract. = itis probable (based on the customer's intent and ability to pay when due) thatthe entity ‘will collect substantially all of the consideration due under the cantract. Ifthe criteria above are not met but consideration has been paid by the customer. an entity can recognize revenue if the consideration is nonrefundable and either there are no remaining obligations to transfer goods/services or the contract has terminated. If not recognized as revenue, the consideration received is booked as a liability. Pe Facts: On March 1, Year 1, Bulldog Inc. entered into a contract to transfer a product to Kitty Inc. on September 1. Year 1. Kitty will pay the full contract price of $15,000 ta Bulldog by August 1, Year 1. Bulldog transferred the product to Kitty on September 1, Year 1. The cost of the product totaled $9,000. Required: Determine the journal entries that Bulldog will book to account for this transaction. Solutio March 4, Year 1, journal entry: No entry is required because neither party has performed accarding to the contract. August 1, Year 1, journal entry: A contract liability (e£. unesrned ssles revenue) is recognized when the cash is received in advance. Cash $15,000 Larpility << Unearned sales revenue $15,000 ‘September 1, Yeor 1, journal entry: Revenue is recorded when the products transferred from the seller to the buyer. a ee on ee re $15,000 mcome <-— Sales revenue $15,000 Cost of goods sold 3,000 Inventory 3,000 2.1.3. Combination of Contracts When two or more contracts are entered into with the same customer ar with related parties ofthe customer at or near the same time, the contracts should be combined and accounted for 25.8 single contract if either the contracts are negotiated as a package with a single commercial ‘objective, consideration for one contract is tied to the performance or price of another contract, or the goods/services promised representa single performance obligation. Rule of conservatism: Revenue when joo is Ame (earned) Mogules 5 Ssciar Protseeons Eavcaton Corporation al raneFAR Revenue Mecegniciens art 2.1.4 Contract Modification ‘A contract modification represents a change in the price or scope (or both) of @ contract approved by both parvies, When 2 modification eccurs, itis either treated as a new contract gr as a modification of the existing contract. The modification is treated as.a new contract if both the scope increases due to the addition of distinct goods or services and the price increase sppropriately reflects the Hang-slone selling prices of te additonal goods/services. if not accounted for az. new contract the modification is treated az part of the existing contract (for non.cistinct goods and services) with an ‘agjustment to ravenue to reflect che change in the transaction price. 2.2 Step 2: Identify the Separate Performance Obligations 1 @)TAR in the Contract 2.2.1 Performance Obligation Defined A performance obligation is a promise to transfer a good or a service to @ customer. The transfer can be either an individual good or service (or a bundle of goods or services) that is distinct, or 2 series of goods or services thst are substantially the same and sre thereby transferred in the seme manner. If the promise to transfer a good or a service is notdistinct from other goods or services, they will all be combined into a single performance obligation. 2.2.2. A Distinct Good or Service In order to be distinct, bath criteria below must be met 1. The promise to transfer the good or service is separately identifiable from other goods or services in the contract: and 2. The customer can benefit either from the good or service independently or when combined ‘with the customer's available resources. 2.23 Separately Identifiable Avwansfer of good or service is separately idenzifigble if the entity does notintegrate the good or service with other goods or services in the contract: the good or service does not customize ‘or modify another good or service in the contract: or the good or service dogs not depend on or relate te other gooes or services promised in the contract. Factors that indicate two or more promises totransfera good or a service toa customer are) separately identifiable include (but are net limited to) the following m= The goods or services are highly interrelated or interdependent. jes a significant service of integrating the good or service with other goods ‘of services promised in the contract into # bundle of goods or services that represent the ‘Combined output contracted for by the customer. Example: Design ana bulla Seeker Botseeans|Eaucate MoguleZ FeatBeverue facegncien: Part FARA Facts: Tanner Co. is building a mutti-unit residential complex. The entity enters into & contract with a customer for a specific unit that is under construction. The goods and services to be provided in the contract include procurement, construction. piping. wiring, installation of equipment, and finishing. Required: Identify the performance obligations) in this contract. Solution: Although the goods snd services provided by the contractor are capable of being distinct they are not distinct in this contract because the goods and services cannot be separately identified from the promise to construct the unit. The contractor will integrate the goods and services into the unit, so all the goods and services are accounted for as 3 single performance obligation. » No revenue as each is done = Must walt wntil last them TT Bee Facts: A software developer enters into a contract with a customer to transfer a software license, perform installation, and provide sofware updates and technical support tor five years. The developer sells the license, installation, updates, and technical support separately. The entity determines that each good or service is separately idemifiable because the installation does not modify the software and the software is functional without the updates and technical suppore. Required: Identify che performance obligation(s} in this contract. Solution: The software is delivered before the installation, updates, and technical support ‘and is functional withaut the updates and technical suppart. so the customer can benefit from each good or service on its own. The developer has also determined that the software license, installation, updates, and technical support are separately identifiable. On this basis, there are four performance abligations in this contract: 4. Software license 2. Installation service | Recgenize vevenue on ench one 3. Software updares 4. Technical support 2.3 Step 3: Determine the Transaction Price i s@ar 2.3.1. Transaction Price Defined The transaction price represents the amount of consideration that an entity can sxpecs to be gotivied 9 receive in exchange fer transferring promised goods or services to 3 customer. The transaction price should be determined based on considering the effects af variable consideration (and any constraining estimates), significant financing if applicable, noncash considerations, and any consideration payable to the customer (if applicable). Fez ogule3 5 Becher Potseeans Baveate poration a) ogy reeorse| year Discount FAR R gricensParct Probability weighted average = (lets of options) 2.32 Variable Consideration Most likely = Pew 5 The amount of variable consideration should be estimated by taking # range of possible oP amounts and using ether tne expected value (which sums probabiliy-welghted amounts) ar ine ~ PENA most likely amount—whichever is assumed to be the better predictor. Variable consideration * should only be included in the price ift is probable that a significant revenue reversal will not be - Tiyae wah required once any uncertsinty tied to the consideration is resolved. 2.33. Significant Financing Time value of money should be an adjustment to the transaction price if the timing of the payments per the contract provides either the customer or the entity with a significant benefit in regard to financing the transter of goods or services. Revenue should be recognized based on the price that would have been paid in cash by the customer at the time of transfer. ifthe time between the transfer of goods/zervices and the payment by the customer is anticipated to be Jess than one year, discounting the transaction price Pear) 2.3.4 Noncash Consideration Sign today # Noneath consideration should be measured at fai value aCoRDRCTTREEDTON) < Settlement Jan | 2.3.5 Consideration Payable to a Customer Any consideration (cash, credits, vouchers, ett.) that iz payable tes customer should te treated 55.8 (eduction in the transaction orice and revenue recognized by the entity unless the entity is receiving goods or services transferred by the customer. cet Pa Sod Facts: On January 1. Year 5, SOF sold furniture ta a customer for $4,000 with three years’ interest-free credit, The customer took delivery of the furniture on that day. The $4,000 payable to SDF on December 31, Year 7. The applicable discount cate based onthe cusomecsccodiorofie ifs percen) Required: Determine the transaction price for the sale of furniture. ‘Solution: The transaction price i ($4,000 = 1/(1.08)") because the time value of money mustibe considered when determbyjng the transaction price. Note that interest income will alsa be recogngd each year as follows: Year 5: $3,175 x 8% Year 6: ($3,175 + $254) «3% Year 7: ($3.175 + $254 + $274) « 896 2.4 Step 4: Allocate the Transaction Price is7@e to the Performance Obligations in the Contract 2.4.1 Allocation Defined IF there is more than one performance obligation within = contract, the transaction price should be allocated 9 each separate performance obligation based on the amount of consideration that would be expected for satisfying each unique obligation. The stand-alone selling price (and any applicable discount or variable consideration) of each distinct good or service underlying each performance obligation should be determined st contract incention. Proportional basis (FMV)Beverue facegncien: Part FARA 2.4.2 Stand-alone Selling Price The price an entity would sell the promised goad or service to @ customer on a stand-alone basis. Once this price is devermined for each obligation within the contract, the total transaction price should be sllocsted in proportion to the stand-slone selling prices 2.4.3 Discounts A discount exists when the sum of the stand-alone prices for each obligation within a contract exceeds the tocal consideration for the contract. A discount should be allocated proportionally to all obligations within the contact. 2.4.4 Variable Consideration If applicable, variable consideration may be atcributable to the entire contract, individual performance obligations within a contract. or distinct goads or services within a single performance obligation 2.4.5 Transaction Price Changes Ifthe wangaction price changes after contract inception, the change should be allocated to the performance obligations in the contract on the same basis that was used at inception. Changes in stand-alone selling prices sfter inception should not be reallocated. ted eee ead Facts: A software company enters into a $250,000 contract with a customer to transfer ‘a software license, perform installation service, and provide technical support far 3 three-year period. The entity sells the license, installation service, and technicsl support separately. The installation service and technical support could be performed by other ‘entities and the sofware remains functional in the absence of these services. The contract price must be paid on installation of the software, which is planned for March 1, Year 1. Regi red: How should the software company recognize revenue for these transactions? Solution: The entity identifies three performance obligations in the contractfor the following goods and services: 1. Software license 2. Installation service 3. Technical support ‘The stand-alone selling price ean be determined for esch performance obligation. The license is usually sold for $160,000, the installation service is $20,000 and technical support $50,000 urs £20.000.p9t vear. THe fai value of the contracts determined to be $270,000. Based ‘on the relative fair values, the allocation of revenue is as follows: x3 yeews: $90,000 © Softwarelicense —_{$160,000/$270,000) x $250,000] = $142,148 Delivered end earned Installation service _(($20.990/$270,000) x $250,000]= $12,519 Delivered ama eammed Technical support —_{($90.000/$270.000) x $250,000] = $83333 Earned ever3 yeaws (continued) Fie2d bogie 5 Becher Potseeans Baveate poradn. gpsFAR gricensParct (continued) The journal entry t0 record the $250,000 payment made on March 1 appears below. March 4, Year 4 Cash $250,000 License revenue $148,148 Service revenue 18519 Unearned service revenue 33533-<4— Liability Revenue is recorded for the sale of the license and the installation at the time of sale. The technical support will be recognized on a momthly basis as the support is provided December 31. Year 1 Unearned service revenue $23,148 Service revenue $23,148 ‘At year-end, an adjusting entry is made to record 10 months of technical support ($83,232/36 = $2,314.20; $2,314.20 « 10 months = $23,142) through the end of Year 1. ‘The remaining technical support will be recorded in Years 2.3, and 4 2.5 Step 5: Recognize Revenue When (or as)the Entity | sta@®) Satisfies a Performance Obligation 2.5.1 Transfer of Control An entity should recognize revenue when the er Transferring the good or service to the customer, whe thereby abtains control af the asset. Contrel implies the ability to obtain the benefits from and direct the usage of the asset while also preventing other entities from obtaining benefits and directing usage. Performance obligations may be satisfied either over timefonat a point in time. 2.5.2. Satisfied Over Time Revenue is recognized over The entity's performance crestes or enhances sn asset thatthe customer controls. = Aumual services m= The customer receives and consumes the benefits of the entity's performance asthe. SupgevipHen ‘entity performs it (e.g., service contracts, such as a cleaning service or 8 monthly payroll processing service). satisfies @ performance obligation by ime if any one of the criteria below is met: = The emtity’s performance does not create an asset with alternative use to the entity Nok pewic (assessed at inception) and the entity has an enforceable right to receive payment for tyyewbory performance completed to date, In order to recognize revenue, the entity must be able to reasonably measure progress toward completion. Progress can be measured using output and input methods.Beverue facegncien: Part FARA 1. Output Methods = Newspapers By using ourput methods, revenue is recognized based on the value to the customer of the goods or services transferred to dave relative to the remaining goods or services promized Examples of output methods include: units produced or delivered. time elapsed, milestones achieved, surveys of performance complaced to date, and appraisal of results achieved. These methods should only be used when the output selected represents the entity's performance ‘toward complete satisfaction of the performance obligation. When the ourputs used to measure progress are not aveilable or directly observable, an input method may be necessary. 2. Input Methods = CPA fines By using input methods, revenue is recognized based on the entity's efforts or inputs ta the ‘satisfaction of the performance ebligation relative to the total expected inputs. Examples of input methods include: costs incurred relative to total expected costs, resources consumed, Isbor-hours expended, and time elapsed. A disadvantage of input methads is that there may not be s direct relationship between an entity's inputs and the transfer of control of goods and services to a customer. Ifinputsare used evenly throughout the performance period, revenue can be recognized on a straight-line basis. Aheshth club enters into a contract with customer for one year of unlimited health club ‘access for $75 per month. The health club determines that the customer simultaneously receives and consumes the benefits of the club's performance, so the contract is a performance obligation satisfied over time. Because the customer benefits from the club's services evenly throughout the year, the best messure of progress toward complete satisfaction of the performance obligation is a time-based measure. Revenue will be recognized on a straight-line basis throughout the year at $75 per month. In the absence of reliable information used to measure progress. if an entity expects to recover its costs, revenue may be recognized to the extent that costs are recovered until the point at which it can reasonably measure the outcame of the performance obligation. 2.5.3 Satisfied at a Point in Time: Depawtwent store. If the performance obligation is not satisfied over time, then itis satisfied at 3 paint in time, Revenue should be recognized at the point in time when the customer obtains concrol of the asset Control would generally require the following: = The entity has 2 right to payment and the customer has an obligation to pay for an asset = The customer has legal ttle to the asset. The entity has transferred physical possession of the asset . ‘The customer has the significant rewards and risks of ownership ‘The customer has accepted the asset. Fels boaule3 5 Becher Potseeans Baveate poration a) ogy reeorseFAR Revenue Mecegniciens art ay De ec mr Facts: Tanner Co. is building a mutti-unit residential complex. The entity enters into & ‘contract with a customer for a specific unit that is under construction. The contract haz the following terms: © The customer pays 8 nonrefundable security deposit upon entering the contract. = The customer agrees to make progress payments during construction. ‘© Ifthe customer fails to make the progress payments, the entity has the right to all of the consideration in the contract if it completes the unit. © The terms of the contract prevent the entity from directing the unit to another customer. Required: Determine whether this performance obligation is satisfied over time or ats point in time. Solution: This performance obligation is satisfied over time because: ‘© The unit does not have an alternative future use to the entity because it cannot be directed to another customer. © The entity has a right to payment for performance to date because the entity has a right +0 all of the consideration in the contract if ircompletes the uni. ea Dee eee en Facts: Tanner Co. is building a mutti-unit residential complex. The entity enters ince 3 contract with a customer for a specific unit that is under construction. The contract has the following terms: ‘© The customer pays a deposit upon entering the contract that is refundable ifthe entity ‘fails to complete the unit in accordance with the contract. © The remainder of the purchase price is due on completion of the unit. © Ifthe customer defaults on the contract before completion, the entity only has the right to retain the deposit. Required: Determine whether this performance obligation is satisfied over time or at a point in time. Solution: This is a performance obligation satisfied at point in time because itis nots service contract, the customer does not control the unit as it is created. and the entity does nothave an enforceable right to payment for performance completed to date (Le..the entity only has a right to the deposit until the unit is completed). Seeker Botseeans|Eaucate Mogulez I-27 poration. ai ngree reeBeverue facegncien: Part FARA 3 Presentation A.contract assetor liability should be presented in the statement of financial position when either party has performed in a contract. A contract assert reflects the entiry's right to consideration in exchange for goods or services that the entity nas transferred to the customer. Essentisily, the entity nas performed prior to the customer paying or prior to the payment due date. The conditions associated with this right are something other than the passage of ime. Note: If the payment due date is concitioned only by the passage of time, the entity should present this separately as a receivable. A controct liability must be booked when an entity has an obligation to transfer goads or services toa customer. In this situation, the entity has ether already received consideration from the customer or the customer owes consideration and itis unconditional (the customer pays or ‘owes payment before the entity performs). a Petr eon) Facts: On January 1, Anderson Co. enters into a noncancelable contract with Tanner Co. for the sale of an excavator for $380,000. The excavator will be delivered to Tanner on April 1. ‘The contract requires Tanner to nd Tanner makes the paypenton March Required: Prepare the journal entries that would be used by Anderson to accours for this contract. Solutia February 1 journal entry: Anderson recognizes a receivable because ithas an unconditional Fight to the consideration (ie, the contract is noncancelable). Receivable $350,000 Contract liability $350,000 March 1 journal entry: When Tanner makes the payment, Anderson recognizes the cash collection Cash $350,000 Receivable $350,000 April 1 journal entry. Anderson recognizes revenue when the excavator is deli to Tanner. Contract liability $350,000 Revenue $250,000 Ft Module 5 Sccicfroteercnalfaisacor Corporason.al cateFAR Revenue Mecegniciens art ey fee oro Facts: On January 1, Anderson Co. enters into a contract with Tanner Co. for the sale of ‘two excavators for $350,000 each. The contract requires one excavator to be delivered on February 1 and states that the payment for the delivery of the first excavator is conditional Gn the delivery of the second excavator. The second excavator is delivered on June 1. Required: Prepare the journal eniries that would be used by Anderson to account for this contract. Solution: February 3 journo! entry: Anderson recognizes contract asset and revenue when it satisfies the performance obligation to deliver the first excavator. Contract asset $350,000 (Revenue $250,000 Note that a receivable is not recognized on February 1. because Anderson does not have an unconditional right to the consideration until the second excavator is delivered. une 1 journal entry: Anderson recognizes a receivable and revenue when it satisfies the Performance obligation to deliver the second excavator. (EY Recenabie $700,000 For $50 a month, Raw Co. visits its customers’ premises and performs insect control services. If customers experience problems between regularly scheduled visits, Raw! makes service calls at no additional charge. Instead of paying monthly. customers may pay an annual fee of $540 in advance. For a customer who pays the annual fee in advance, Rawl should recognize the related revenue under U.S. GAAP: a, When the cash is collected. b, At the end of the fiscal year. c. At the end of the contrsct yesr after all of the services have been performed, d. Evenly over the contract year as the services are performed. (© Eocigrsroteeeona| Eousavon Corporation all ngresraeance Moguiez —FI-2BBeverue facegncien: Part FARA ‘On April 15, Year 3, Landon Co. signed a contract that entailed providing = piece of scientific ‘equipment tor $215,000 to Jacobs Inc., with delivery expected to occur on August 31, Year 3. Per the terms of the contract, Jscobs will psy Landon for the full amount on July 31. Year 3. Landon's cost to produce the equipment is $175,000. Assuming delivery occurs as expected, ‘the August 21 journal entry for Landon will Involve which of the following debins/eredits? a. Creditto cash of $215,000. b. Debitto invencory of $175,000. © Creditto cost of goods sold of $175,000. d. Debitto unearned sales revenue of $215,000. FIe32oaule3 (© Becta sroteeeona| dousaton Corporation all cymes erenceMODULE Revenue Recognition nea 1 Specific Applications Within Revenue Recognition 1.1 Incremental Costs of Obtaining a Contract ‘of obtaining a contract are costs incurred that would not have been, incurred if the contract had mot been obtained. and are ce 35 srXesse)cspiislized and amortized) if the entity expects that itwill recover these costs. An entity will recognize an. Supense the costs would have been incurred rezsrdiess of whether the contract w3s obtsined. ea eet to ee ad Facts: A sofware developer enters into a contract with a customer to vanster a software Ticense. perform installation, and provide software updates and technical support for three years in exchange for §240,000. In order to win this contract, the developer incurred the following costs: The incremental ct Legal fees for drawing up the contract Travel costs to deliver proposal Commissions to sales employee Total Required: Determine which costs should be recognized ar an asset and which should be expensed. Solution: The travel costs ($20,000) should be expensed because they would have been incurred even if the developer did not get the contrac. The legal fees ($10,000) and sales ‘commissions ($12,000) should be recognized as assets because they are costs of obtaining the contract, assuming that the developer expects to recover the costs 4.2. Costs to Fulfill a Contract | Bb.,] Cavitalizea The costs that are incurred to fulfill a contract that are not within the scope of anather standard will be recognized as an asset if they meet alf of the following crit = Relate di a contract (such a: direct labor marerials allocated cosss and other costs ‘thst are explicitly chargeable to the customer per the contract). They generate or enhance the resources of the entity. They are expected to be recovered, Costs to be@ipensed\ncluce selling senses! and sdministrative cose, wasted labor and materials costs, and costs tied to satisfied performance obligations. oration. FeatReverue facegncien Parc? FARA feed Costs to Fulfill a Contract Facts: A software developer enters into a contract with # customer to transfer a software license, perform installation, and provide software updates and technical support for three years in exchange for $240,000. In order to fulfill the technical support portion of the project, the developer purchases an additional workstation for the technical support team (a. 60 0 d assigns one employee to be primarily responsible for providing the technical support for the customer. This employee also orovides services for other customers. ‘The employee is paid $20,000 annually and is expected to spend 10 pepdnt of his time supportng the customer Required: Determine which costs should be recognized as an asset and which should be expensed. Solution: The additional workstation ($8,000) should be recognized as an asset. The cost of the employee assigned to the contract ($30,000) should be recognized as a payroll expense because, although the costs relate to the contract and are expected to be recovered, the ‘employee was already working for the developer and therefore the costs do not generate er enhance the resources of the developer. — GrOSS VEVENUE 13 Principal vs. agent <0 Whenever an entity uses another party to provide gaods or services to = customer. the entity needs to determine whether it is acting as 3 principal or an agent. = Brincipal: The entity controls the good or service before it is transferred te che customer. When this is the case the gevenue recosnized is equal to the erose consideration an entity ‘expects to receive. = Agene: The entity arranges for the other party to provide the gaod or service to the ‘qustomer. When this is the case, the revenue recognized iz equal to the fee or commission for performing the agent function. Indicators that an entity is an agent and does not control the good or service before itis provided te the customer include: = another party (the principal) is primarily responsible for fulfilling the contract the entity dees not have inventory risk: ana the entity daes not have discretion in establishing prices for the other parny's goods Comect Incorrect ‘DR: Cash $10,000 DR: Cash ‘$10,000 CR: Due te other ce, 1000 CR Revenue $10,000 CR Revenue 1,000 DR: Cost of goods solA $7,000 CR: Due Fe other co, $1,000 Fiea2boauled 5 Becher Potseeans Baveate poradn. gpsFAR Revenue Qacegncen:Pat2 Facts: On January 1, Anderson Co. enters into a contract with Tanner Co. for the sale of ‘an excavator with unique specifications. Anderson and Tanner develop the specifications and Anderson contracts with a construction equipment manufacturer to produce the ‘equipment. The manufacturer will deliver the equipment te Tanner when it is completed. Anderson agrees to pay the manufacturer $250,000 on delivery of the excavator to Tanner. Anderson and Tanner agree to a selling price of $385,000, which will be paid by Tanner to ‘Anderson. Anderson's profit is $35,000. Anderson's contract with Tanner requires Tanner to seek remedies for defects from the manufacturer, but Anderson is responsible for any corrections due to errors in specifications. Required: Determine whether Anderson is acting as principal or agent in its contract with Tanner. ‘Solution: Anderson is acting as principal in the cantract based on the following indicators: © Anderson is responsible for fulfilling the contract because itiz responsible for ensuring ‘that the excavator meets specifications = Anderson has inventory risk because it is responsible for correcting errors in ‘specifications, even though the manufacturer has inventary risk during production. © Anderson has discretion in establishing the selling price. 1.4 Repurchase Agreements right of A repurchase agreament isa contract by which an ghiinedie an ates: ata asa ether promises por has the option to repurchase the asset, The three main forms of repurchase agreements include: an entity's obligation co repurchase the asset (a forward}: an entity's right to repurchase the asset (a call option}; and an entity's obligation to repurchase the asset atthe customer's request (a put option]. 1.4.1. Forward or Call Option The entity's accounting for the contract will be based on whether it must (forward) or can (call) repurchase the asset for either: | less than the original selling erice (it will be 3 less): or | equal to/more than the original price (it will be financing arrangement}, |f the comtrsct is 3 financing srrsngement the entity will recognize the asset, recognize 3 financial liability for any consideration received from the customer, and recognize as interest expense the difference between the amount of consideration received from ihe customer and the amount of consideration talbe paid by the customer. Seeker Botseeans|Eaucate Modules FIABEReverue facegncien Parc? FARA Tey Seen TL) Facts: On January 1, Anderson Co. enters into a contract with Tanner Co. for the sale of an excavator for $250,000. The contract includes a call option that gives Anderson the right to repurchase the excavator for $385,000 on or before December 31. Tanner pays the entity $350,000 on January 1. On December 21, the option lapses unexercised. Required: Explain how Anderson should account for the transaction on January 1, during the year, and an December 31 Solution: Anderson should account for the transaction as a financing arrangement because the repurchase price is greater than the original selling price. ‘On January 1, Anderson recognizes a financial liability of $250,000: Cash $350,000 Financial liability $250,000 During the year, Anderson recognizes interest exnense of $35,000. the difference between the repurchase price of $385,000 and the cash received of $350,000 Interest expense $25,000 Financial liability. $35,000 ‘On December 31, when the option lapses, Anderson derecognizes the liability and records asale: Financial liability $385,000 Revenue $385,000 1.4.2 Put Option \Fthe entigy nas an obligation to repurcnare sne asset at the customer's request ‘odEEEDANe original selling price the entity will account for the contract as either: =— a lease (if the customer has a significant economic incentive te exercise the right): or a gle with = right of retum (if the customer does not have a significant economic incentive 10 exercise the right) Ifthe repurchase price ie{Gaual es or srester thanhhe original selling price, the entity accounts for the contract as either ma financing arrangement {if the repurchase price is more than the expected market value of the asset); or = a sale with a right of retum (if the repurchase price is less than or equal to the expected market value of the asset and the customer does not have a significant economic incentive 10 exercise the right). Fred — boauled 5 Becher Potseeans Baveate poradn. gpsFAR Revenue Qacegncen:Pat2 Facts: On January 1, Anderson Co. enters into contract with Tanner Co. forthe sale of aan excavator for $350,000. The contract includes a put option that obliges Anderson to repurchase the excavator at Tanner's request for $315,000 on or before December 31. The market value is expected to be $275,000 on December 31. Tanner pays Anderson $250,000 on January 1 Required: Determine whether Anderson should ccaunt for this transaction as alesse, 3 financing arrangement, or a sale with a right of return. Solution: The transaction should be accounted for as a leaze because Anderson has an obligation to repurchase the excavator for less tan the orizins| selling price, snd Tanner has. significant economic incentive to exercise the option because the repurchase price is greater than the market value expected on December 31 15 Bill-and-hold arrangements are contracts in which the entity bills a customer for a product thst it has not yet delivered to the customer. Revenue cannot be recosnized in 5 bil-snd-nold sxrengement until the cuscomer obtains control of hs product Generally, control is transferred {othe Eustomer when the preduct is shipped te or delivered te the customer (depending on the terms of the contract]. For a customer to have obtained control of a product in a bill-and-hold arrangement, gil of che following criteria must be mer = There must be a substancive reason for the arrangement (eg. the cuswomer has requested the arrangement because it does nat have space for the product). lI-and-Hold Arrangements ‘The product has been separately identified as belonging to the custemer. The product is cucrentiy ready for transfer to the customer. IB The entitycnnot use the product or direct it to another customer. Seeker Botseeans|Eaucate Vosules BS,Reverue facegncien Parc? FARA Tag P| Facts: On January 1, Anderson Co. enters into a contract with Tanner Co. for the sale of ‘an excavator and spare parts. The manufacturing lead time is 18 months. On July 1 ofthe following year, Tanner pays for the machine and spare parts, but only takes possession of the machine. Tanner inspects and accepts the spare parts, but requests that the parts be stored in Anderson's warehouse because Tanner does not have a place to store the parts and its premises are very close to Anderson's warehouse. Anderson expects to store the spare parts in a separate section of its warehouse for three years. The parts sre gvailsble for immediate delvery to Tanner. Anderson cannot use the: ‘spare parts or transfer them fo another customer. Required: Identify che performance obligation(s) in this contract and determine when revenue is recognized on each performance ebligation. Solution: There are three performance obligations in this contract: 1. Promise to provide the excavator 2. Promise to provide spare parts 3. Custodial services related to the spare parts Tanner obtains control of the spare parts on July 1 because all of the criteria are met (Le, there is a substantive reason for Anderson to hold the spare parts, the parts are separately identified and ready to transfer, and Anderson canmet use the parts or transfer them to another customer). Anderson recognizes revenue for the excavator and spare parts on July 1 when the ‘excavator is transferred to Tanner and Tanner has obtained control of the spare parts. ‘Anderson recognizes revenue on the custodial services over the three years thar the services are provided. 1.6 Consignment Consignment is when the desler or distributor has not obtained cantrol of the praduct. Revenue is cecognized when the dealer or distributer sells the producto a customer, or when the dealer or distributer obtains control of the product (Le.. after a specified period of time expires) Indiestors of s consignment arrangement include: Ja The entity controls the product until a specified event occurs (the sale of the praduct to the ‘customer or @ specific time period expires). l= The desler does not have an unconditional obligation to pay the entity for the produce (although it might be required to pay a deposit) j= The entity can require the return of the praduct er transfer the praduct to another parry. FieBe bogie 5 Becher Potseeans Baveate poradn. gpsFAR Revenue Qacegncen:Pat2 eas Sal Cd Facts: FMC, a large multinational car manufacturer, delivers cars to 3 car dealer on the following terms: © Legal title passes on ssle to the public. © ‘The ear desler must pay for the car when legs! ttle passes. The price to the car desler is determined on the dace FMC delivers the cars to the dealership. © FMC can require the return of the cars and, ifnot sold by the car dealer, can wansfer the cars to another dealer. Required: Determine whether FMC should accaunt for the delivery of the cars te the car desler as a sale or a consignment arrangement. Solution: FMC should account for the delivery of cars to the car dealer ar a consignment arrangement because the desler has not cbtained control of the cars, as evidenced by the fact that FMC can require the return or transfer of the cars and the dealer does not have an unconditional obligation co pay FMC for che cars. Revenue should not be recognized until the dealer sells a car. 1.7 Warranties The accounting for 8 warranty will depend on whether @ customer has the option to purchase the warranty separately. if itcan be purchased separately, the warranty will be considered a distinct service because itis promised to the customer in addition vo the product covered by the cantract. An entity will therefore account for the warranty as.a performance obligation and allocate a portion of the overall transaction price to that obligation. If che warranty cannot be purchased separately, then there is no separate performance obligation. The following factors should be considered when determining whether the warranty represents & service in addition to the assurance that s product is compliant with agreed-upon specifications: sche lw ceauices the warranty his would indicate that i (GBD pectormance obligacion m= The longer the coverage period, the higher the likelihood that itis stan omity muctperform spect teksto provide acaurance regarding product compliance wren eprecd-onae spertanins Sere tats ore ke fGapu pevormance sbigacon formance oblesto Ifa warranty provides a service to 8 custamer thatis beyond the assurance that the product will comply with agreed-upon specifications, the promised service will represent a performance obligation that will require the transaction price be allocated te both the product itself and the service. Seeker Botseeans|Eaucate Modules FIATReverue facegncien Parc? FARA 1.8 Refund Liabilities and the Right to Return An emity should recognize a refund liability if it receives or will receive consideration from customer and anticipates having to refund a portion or all of that consideration. The refund liability represents the amount an entity does not expect to be entitled to receive. For products with a right of return (which may involve the customer receiving a refund, a credit, or another product in exchange for the original product), an entity should recognize: Keep= = Revenue for ransferred products equaling the amount of consideration the entity expects {to be entitled to receive (revenue will not be recognized for products that entities anticipate having to return) Give back == 4 refund Jiabiliny Get pack == An asset related to the subsequent recovery of products when the refund liability is settled Journal entry to record an initial ability an a cash sale of $50,000 where 10 percent of items (purchased tend to be returned Cash $50,000 Refund liabilisy 5,000 Sales revenue (NE) "45,000 Journal entry to record cash paid ta customer who returns $3,09941n gaods purchased: Refund liability $3,000 ash $2,000 Jojo Roasters manufactures and sells coffee bean roasters. Jajo entered into an agreement with Smocth and Bald Coffee Company (S&B) to manufacture five roasters for S&B's new production facility. The roasters were manufactured to S&B's specifications and were completed on September 1, Year 2, Que to delays in the construction of SAB'= new facility, Jojo agreed to maintain the coffee rossters in a separate section of its warehouse until the ‘SEB facility opened on January 10, Year 3. SEE paid for the roasters on October 1, Year 2. ‘On which date can Jojo recognize the revenue from this bill-and-hold arrangement? a, September 1. Year? b. October t, Year 2 December 31. Year 2 @. january 10, Year 3 Fieas boauled 5 Becher Potseeans Baveate poration a) ogy reeorseU.S. GAAP SERS FAR spriiere Part 2 Long-Term Construction Contracts 2.1 Recognizing Revenue Before Delivery In mostinstances, companies recognize revenue atthe point of sale (delivery). Under certain circumstances companies recognize revenue over time. Long-term construction contrarts are an ‘example of this type of revenue recognition. 2.2 Percentage-of-Completion Method = Revenue over Hime 2.21 Requirements When a long-term construction contract meets the criteria for recogni time, syst 4. reasonably est ing revenue over is appropriate to use the percentage-of- completion methed if the entity's accounting wate profitebil 2. provide a reliable mesure of progress coward completion 2.2.2 Determination of Revenues Recognized Income recognized is the percentage of estimated total income either: 4. that incurred costs to date bear t information, or ated costs based on the mast recent cost 2. that may be indicated by such other measure of progress toward completion appropriate to ‘the work performed,serus teregncen Part FARA 2.23 Balance Sheet Presentation Under the percentage-of-completion method, co: earned are accumulated in the construction ‘Sccount). The two accounts are neted against each other for balance sheet repor = Current Asset Accounts * Due on accounss (receivable) cose and ectimatea earnings of uncompleted gonsracis in excess of progress bilings Uke tavenhory (Cometines calles constuction progress) or = Current Liability Account + Excess pilingserogress billings in excess of cost and estimated earnings on uncompleted contracts: - Deposits 2.24 Accounting for the Percentage-of-Completion Method The following are important points to remember in accounting fer contracts under the percentage-of-completion method: = Journal encries and interim balance sheet treatment are the same as the completed contract method (described in the next section), except that the amount of estimated gross profit ‘earned in each period is recorded by charging the construction in progress account and crediting realized gross profit. | Gross profit or loss is recognized in esch periad by the following steps: Step 1 Compute gross profit ef completed contract: Contract price < Estimated total cost > Gross profit Step2 Compute percentage of completior Total cost to date Total estimated cost of contract Step3 Compute gross profit earned (profit to date): ‘Step 1 (Current year-to-date GP =A jon the totel contract is eccenized immediately in the yesr itediscoveres, REVESE However, any previous gross profit or loss reported in pricr years must be adjusted for Previous: ‘when calculating che total estimated loss. profit Vad Pass Key Pay attention te the terminology in long-term construction contract questions. Estimated total costs can be confused with estimated costs to complete. Estimated total costs is the tozal costs for a long-term contract from inception te completion. Estimated costs to complete would be added to costs incurred to date to arrive at estimated total costs.FAR Revenue Qacegncen:Pat2 fT at Tet ge Facts: Year Year2 = Year3 Year Loss Sales price sao00 $4000 f,000)**™5 4.000 Total (estimated) cost of contract 3,000, 3,200, 4200, 4.300, Costs incurred to date 1.500 2.400 3.600 4300 Required: Compute gross profit in Years 1 through 4 under the percentage-W-completion and completed contract methods. Solution: Yeart Year2 Year? |Year4 ‘Step 1 Compute GP of completed contract: Total contract sales price $4000 $4000 $4000 /s 4000 Lene: Total estimated ceetef contact (2,000) (2.200) _(4.200/ _(a.290) Totsl gross profit $4000 $ 800 § (oof § (300) Step 2 Compute percentage of completion: Costs incurred to date $1500 $2400 $3600 § 4300 Tots! escimated cos: of contract $3000 $5200 $4200 $4300 Percentage of completion (Wowk Aeme) ___50% 25% 100% 100% (Loss Rule) Step 3 Compute GP earned to date: Total contract GP $1,000 $ 800 $ (200) $ (300) x Percentage of completion soe 75% __100% __100% GP earned to date (cumulative) ‘Step 4 Compute GP earned each year— percentage of completion: $ Gon) Previously recognized $500 $600 $ (200) Current year gross profit $500 $ 100 $ 4800) § (100) $600, $ (09) Compute GP earned each year—Completed contract metho Computations a (200) 100) (© Eocigrsroteeeona| Eousavon Corporation all ngresraeance Modules Feet