5.7 Chapter Summary

LO 1: Describe the criteria for recognizing revenue and determine if a company has earned revenue in a business transaction.

Under IFRS, revenue is recognized using a five-step process: 1) identify the contract, 2) identify the performance obligations, 3) determine the transaction price, 4) allocate the transaction price to the performance obligations, and 5) recognize revenue when a performance obligation is satisfied. Performance obligations must relate to distinct goods or services. Performance obligations can be satisfied over time or at a point in time. The amount of revenue to be recognized from a performance obligation will depend on whether the entity is acting as a principal or an agent. Incremental costs incurred to obtain or fulfill a contract should be capitalized and amortized over the life of the contract. For long-term contracts, a rational method of recognizing revenue will need to be applied, based on some method of measuring progress.

LO 2: Discuss the problem of measurement uncertainty and alternative accounting treatments for these situations.

Measurement uncertainty can occur when the contract includes variable consideration, an implied financing component, non-cash consideration, or a discount on a bundle of goods and services. The accounting treatment will depend on the nature of the measurement problem. Where sales are bundled, the consideration will normally be allocated based on the relative stand-alone selling prices of each component. Variable consideration should be measured at the expected value or most likely amount. Interest, even if not explicitly stated in the contract, should be identified as a separate performance obligation, unless the contract period is less than one year. Non-cash consideration should be reported at its fair value.

LO 3: Prepare journal entries for a number of different types of sales transactions.

For bundled sales, consideration should be allocated proportionally, based on the stand- alone selling price of each component. The residual value approach would only be appropriate if the stand-alone selling price of a component was not determinable. For consignment sales, inventory first needs to be reclassified. Revenue from consignment sales should not be recorded until the consignee actually sells the goods to a third party. Costs of the transaction also need to be recorded. For sales with a right of return, an accrual of the estimated amount of the refund liability needs to be recorded, along with an estimate of the amount of refund assets expected to be received from customers. For bill-and-hold arrangements, revenue should only be recognized if control has been transferred to the customer. Additional criteria will need to be evaluated in making this determination. For non-monetary exchanges, revenue should be recorded based on the fair value of the goods or services received.

LO 4: Apply revenue recognition concepts to the determination of profit from long-term construction contracts.

For a long-term construction contract, profits should be recognized in some rational manner over the life of the project. To do this, reliable estimates of progress are required. Input or output measures may be used. Many construction companies prefer to use the cost-to-cost method, which measures progress in terms of the dollar value of inputs. If progress cannot be reliably measured, then profits should be reported using the zero- margin method.

LO 5: Prepare journal entries for long-term construction contracts.

Costs are accumulated a construction-in-progress account. When profit is estimated at the end of the year using the percentage-of-completion method, the revenue and related expense will be recorded, with the net profit being added to the construction-in-progress account. Also, journal entries will record billings to customers and collections of those billings. At the end of the construction contract, the construction-in-progress account will be zeroed out against the billings account. The terms “contract asset” and “contract liability” may also be used in place of the construction-in-progress and billings accounts.

LO 6: Apply revenue recognition concepts to unprofitable long-term construction contracts.

When a construction contract is predicted to be unprofitable, resulting in an onerous contract, the entire projected loss on the contract needs to be recognized immediately. Once the project is completed, this amount will be adjusted so that the actual amount of the project loss is reported. This approach results in inconsistent amounts of profit being reported in each year of the project, but the total profit will be correct over the life of the project.

LO 7: Describe presentation and disclosure requirements for revenue-related accounts.

Contract assets and liabilities should be presented separately from contract receivables on the balance sheet. IFRS 15 contains detailed qualitative and quantitative disclosure requirements, including disaggregation of revenue categories, descriptions and reconciliations of performance obligations, and discussions of methods and judgments applied in determining revenue.

LO 8: Discuss the earnings approach to revenue recognition, and compare it to current IFRS requirements.

The earnings approach is used in ASPE and includes four criteria for revenue recognition: 1) the seller has transferred the risks and rewards of ownership to the buyer, 2) the seller does not maintain any continuing managerial involvement or control over the goods, 3) there is reasonable assurance regarding measurement of the consideration to be received and the amount of goods that may be returned, and 4) collection of consideration is reasonable assured. In many instances, the earnings approach will arrive at similar results as the contract-based approach of IFRS 15. In some cases, however, the results may be different. With long-term construction contracts, the earnings approach allows for the completed contract method to be used if there is no reasonable way to estimate progress or performance of the contract consists of a single act.