Topic 6 & 7 - Accounting For Revenues

TOPIC 6 - 7: ACCOUNTING
FOR REVENUES
18-1
LEARNING OBJECTIVE 1
Fundamentals of Understand the fundamental
concepts related to revenue
Revenue Recognition recognition and measurement.
Background
Both the IASB and the FASB have indicated that the
state of reporting for revenue was unsatisfactory.
Recently, the IASB issued a converged standard on

revenue recognition entitled Revenue from Contracts
with Customers.
18-2 LO 1
Revenue Recognition
New Revenue Recognition Standard

Revenue from Contracts with Customers, adopts an
asset-liability approach.
◆ Companies account for revenue based on the asset or
liability arising from contracts with customers.
◆ Companies analyze contracts with customers because

contracts initiate revenue transactions.
► Contracts indicate terms of the transaction,
► provide the measurement of the consideration, and
► specify the promises that must be met.

18-3 LO 1
New Revenue Recognition Standard
ILLUSTRATION 18.1 Key Concepts of Revenue Recognition
18-4
Performance Obligation is Satisfied LO 1
Overview of the Five-Step Process
Assume that Airbus (FRA) Corporation signs a contract to sell

airplanes to Cathay Pacific Airlines (HKG) for €100 million.
ILLUSTRATION 18.2
Five Steps of Revenue Recognition
A contract is an agreement between two parties

Step 1: Identify the
that creates enforceable rights or obligations. In
contract with
this case, Airbus has signed a contract to deliver
customers.
airplanes to Cathay Pacific.
Airbus has only one performance obligation—to

Step 2: Identify the
deliver airplanes to Cathay Pacific. If Airbus also
separate performance
agreed to maintain the planes, a separate
obligations in the
performance obligation is recorded for this
contract.
promise.
18-5 LO 1
ILLUSTRATION 18.2 Five Steps of Revenue Recognition
Transaction price is the amount of consideration

Step 3: Determine that a company expects to receive from a
the transaction customer in exchange for transferring a good or
price. service. In this case, the transaction price is
straightforward—it is €100 million.
Step 4: Allocate the

transaction price to
In this case, Airbus has only one performance
the separate
obligation—to deliver airplanes to Cathay Pacific.
performance
obligations.
18-6 LO 1
ILLUSTRATION 18.2 Five Steps of Revenue Recognition
Step 5: Recognize
Airbus recognizes revenue of €100 million for the
revenue when
sale of the airplanes to Cathay Pacific when it
each performance
satisfies its performance obligation—the delivery
obligation
of the airplanes to Cathay Pacific.
is satisfied.
18-7 LO 1
Extended Example of Five-Step Process
Identifying the Contract with Customers—Step 1

Assume that Tyler Angler orders a large cup of black coffee costing $3
from BEAN. Tyler gives $3 to a BEAN barista, who pours the coffee
into a large cup and gives it to Tyler.
Question: How much revenue should BEAN recognize on this

transaction?
18-8 LO 1
Step 1: Identify the contract with customers.
1. The contract has commercial substance: Tyler gives cash for the
coffee.
2. The parties have approved the contract: Tyler agrees to purchase
the coffee and BEAN agrees to sell it.
3. Identification of the rights of the parties is established: Tyler
has the right to the coffee and BEAN has the right to receive $3.
4. Payment terms are identified: Tyler agrees to pay $3 for the
coffee.
5. It is probable that the consideration will be collected: BEAN
has received $3 before it delivered the coffee.
18-9 It appears that BEAN and Tyler have a valid contract with one another.
LO 1
Step 2: Identify the separate performance obligations.
BEAN has a performance obligation to provide a large cup of coffee

to Tyler.
BEAN has no other performance obligation for any other good or
service.
Step 3: Determine the transaction price.
The price of the coffee is $3, and no discounts or other adjustments

are available. Therefore, the transaction price is $3.
18-10 LO 1
Step 4: Allocate the transaction price to the separate

performance obligations.
Given that BEAN has only one performance obligation, no allocation

is necessary.
Step 5: Recognize revenue when each performance

obligation is satisfied.
BEAN satisfies its performance obligation when Tyler obtains control

of the coffee.
BEAN should recognize $3 in revenue from this

transaction when Tyler receives the coffee.
18-11 LO 1
Identifying Separate Performance Obligations—Step

2
The following day, Tyler orders another large cup of coffee for $3 and
also purchases two bagels at a price of $5. The barista provides these
products and Tyler pays $8.
Question: How much revenue should BEAN recognize on the

purchase of these two items?
18-12 LO 1
A valid contract exists as it meets the five conditions necessary for a

contract to be enforceable as discussed in the previous example.
BEAN must determine whether the sale of the coffee and the sale of
the two bagels involve one or two performance obligations.
18-13 LO 1
Multiple performance obligations exist when the following two

conditions are satisfied:
1. BEAN must provide a distinct product or service.
2. BEAN’s products are distinct within the contract. If the performance
obligation is
► not highly dependent on,
► or interrelated with,
other promises in the contract, then each performance obligation
should be accounted for separately.
BEAN has two performance obligations.

18-14 LO 1
The transaction price is $8 ($3 + $5).

BEAN has two performance obligations.

► Each obligation is distinct and not interrelated (and priced
separately); no allocation of the transaction price is necessary.
► The coffee sale is recorded at $3 and the sale of the bagels is
priced at $5.
18-15 LO 1

BEAN has satisfied both performance obligations when the coffee

and bagels are given to Tyler (control of the product has passed to
the customer).
BEAN should recognize $8 ($3 + $5) of revenue

when Tyler receives the coffee and bagels.
18-16 LO 1
Determining the Transaction Price—Step 3

BEAN is interested in stimulating sales of its Smoke Jumper coffee
beans on Tuesdays, a slow business day for the store. Normally,
these beans sell for $10 for a 12-ounce bag, but BEAN decides to cut
the price by $1 when customers buy them on Tuesdays (the
discounted price is now $9 per bag). Tyler has come to the store on a
Tuesday, decides to purchase a bag of Smoke Jumper beans, and
pays BEAN $9.
Question: How much revenue should BEAN recognize on this

transaction?
18-17 LO 1

BEAN has a performance obligation to provide a bag of Smoke

Jumper coffee beans to Tyler.
BEAN has no other performance obligation to provide a product or
service.
18-18 LO 1
The transaction for a bag of Smoke Jumper beans sold to Tyler is

$9, not $10.

There is only one performance obligation, no allocation is necessary.

BEAN has satisfied both performance obligations.
BEAN should recognize $9 of revenue when Tyler receives

the Smoke Jumper coffee beans.
18-19 LO 1
Allocating the Transaction Price to Separate

Performance Obligations—Step 4
Transaction price is allocated to the various performance obligations
based on their relative standalone selling prices.
BEAN offers customers a $2 discount on the purchase of a large cup

of coffee when they buy a bag of its premium Motor Moka beans
(which normally sell for $12) at the same time. As indicated earlier, a
large cup of coffee normally retails for $3 at BEAN.
Question: How much revenue should BEAN recognize on the

purchase of these two items?
18-20 LO 1

The bag of Motor Moka beans and the large cup of coffee are
distinct from one another and are not highly dependent on or highly
interrelated with the other.
18-21 LO 1
The transaction price is $13 ($12 + $1).

BEAN allocates the transaction price to the two performance

obligations based on their relative standalone selling prices as
follows.
18-22 LO 1

BEAN allocates the transaction price to the two performance

obligations based on their relative standalone selling prices as
follows.
Standalone
Product Selling Price Percentage Percentage
Beans (one bag) $12 80% ($12 ÷ $15) $ 10.40 ($13 × 80%)
Large cup of coffee 3 20% ($3 ÷ $15) 2.60 ($13 × 20%)
Total $15 100% $ 13.00
The total transaction price ($13) is allocated $10.40 to the bag of

Motor Moka beans and $2.60 to the large cup of coffee.
18-23 LO 1

BEAN has satisfied both performance obligations as control of the

bag of Motor Moka beans and the large cup of coffee has passed to
Tyler.
BEAN should recognize revenue of $13, comprised of

revenue from the sale of the Motor Moka beans at
$10.40 and the sale of the large cup of coffee at $2.60.
18-24 LO 1

BEAN satisfied its performance obligation(s) when Tyler obtained

control of the product(s).
Indicators that Tyler has obtained control are as follows:
a. BEAN has the right to payment for the coffee.
b. BEAN has transferred legal title to the coffee.
c. BEAN has transferred physical possession of the coffee.
d. Tyler has significant risks and rewards of ownership.
e. Tyler has accepted the asset.
18-25 LO 1
The Five-Step Understand and apply the five-
step revenue recognition
Process Revisited process.
Identifying the Contract with Customers—Step 1

Contract:
◆ Agreement between two or more parties that creates
enforceable rights or obligations.
◆ Can be
► written,
► oral, or
► implied from customary business practice.
18-26 LO 2
Contract with Customers—Step 1
Accounting
◆ Revenue cannot be recognized until a contract exists.
◆ Company obtains rights to receive consideration and

assumes obligations to transfer goods or services.
◆ Rights and performance obligations gives rise to an (net)

asset or (net) liability.
◆ Company does not recognize contract assets or liabilities

until one or both parties perform under the contract.
18-27 LO 2
Contract with Customers—Step 1 ILLUSTRATION 18.3
Basic Revenue
Transaction
CONTRACTS AND RECOGNITION

Facts: On March 1, 2019, Margo Company enters into a contract to transfer a
product to Soon Yoon on July 31, 2019. The contract is structured such that
Soon Yoon is required to pay the full contract price of $5,000 on August 31,
2019.The cost of the goods transferred is $3,000. Margo delivers the product to
Soon Yoon on July 31, 2019.
Question: What journal entries should Margo Company make in regards to
this contract in 2019?
The journal entry to record the sale and related cost of goods sold is as follows.
July 31, 2019
Accounts Receivable 5,000
Sales Revenue 5,000
Cost of Goods Sold 3,000
Inventory 3,000
18-28 LO 2
Contract with Customers—Step 1 ILLUSTRATION 18.3
Basic Revenue
Transaction
CONTRACTS AND RECOGNITION

Facts: On March 1, 2019, Margo Company enters into a contract to transfer a
product to Soon Yoon on July 31, 2019. The contract is structured such that
Soon Yoon is required to pay the full contract price of $5,000 on August 31,
2019.The cost of the goods transferred is $3,000. Margo delivers the product to
Soon Yoon on July 31, 2019.
Question: What journal entries should Margo Company make in regards to
this contract in 2019?
Margo makes the following entry to record the receipt of cash on August 31, 2019.
August 31, 2019
Cash 5,000
18-29 LO 2
Separate Performance Obligations—Step 2
A performance obligation is a promise to provide a distinct

product or service to a customer.
A product or service is distinct when a customer is able to
◆ benefit from a good or service on its own or
◆ together with other readily available resources.
The objective is to determine whether the nature of a

company’s promise is to transfer individual goods and services
to the customer or to transfer a combined item (or items) for
which individual goods or services are inputs.
18-30 LO 2
ILLUSTRATION
Assume that Tata Motors (IND) sells an automobile to Marquart Auto

Dealers at a price that includes six months of telematics services such as
navigation and remote diagnostics. These telematics services are
regularly sold on a standalone basis by Tata Motors for a monthly fee.
After the six-month period, the consumer can renew these services on a
fee basis with Tata Motors. The question is whether Tata Motors sold one
or two products.
If we look at Tata Motors’ objective, it appears that it is to sell two goods,
the automobile and the telematic services. Both are distinct (they can
be sold separately) and are not interdependent.
18-31 LO 2
ILLUSTRATION
SoftTech Inc. licenses customer-relationship software to Lopez

Company. In addition to providing the software itself, SoftTech promises
to provide consulting services by extensively customizing the software to
Lopez’s information technology environment, for a total consideration of
$600,000. In this case, SoftTech is providing a significant service by
integrating the goods and services (the license and the consulting
service) into one combined item for which Lopez has contracted. In
addition, the software is significantly customized by SoftTech in
accordance with specifications negotiated by Lopez. Do these facts
describe a single or separate performance obligation?
The license and the consulting services are distinct but interdependent,
and therefore should be accounted for as one performance obligation.
18-32 LO 2
Determining Transaction Price—Step 3
Transaction price
◆ Amount of consideration that company expects to receive
from a customer.
◆ In a contract is often easily determined because customer

agrees to pay a fixed amount.
◆ Other contracts, companies must consider:

► Variable consideration
► Time value of money
► Non-cash consideration
► Consideration paid or payable to customers
18-33 LO 2
Variable Consideration
◆ Price dependent on future events.
► May include price increases, volume discounts,
rebates, credits, performance bonuses, or royalties.
◆ Companies estimate amount of revenue to recognize.

► Expected value
► Most likely amount
18-34 LO 2
ILLUSTRATION 18.4 Estimating Variable Consideration
Expected Value: Probability-weighted amount in a range of possible

consideration amounts.
▪ May be appropriate if a company has a large number of contracts with
similar characteristics.
▪ Can be based on a limited number of discrete outcomes and probabilities.
Most Likely Amount: The single most likely amount in a range of possible
consideration outcomes.
▪ May be appropriate if the contract has only two possible outcomes.
18-35 LO 2
Variable Consideration ILLUSTRATION 18.5
Transaction Price
ESTIMATING VARIABLE CONSIDERATION

Facts: Peabody Construction Company enters into a contract with a
customer to build a warehouse for $100,000, with a performance bonus of
$50,000 that will be paid based on the timing of completion. The amount of
the performance bonus decreases by 10% per week for every week beyond
the agreed-upon completion date. The contract requirements are similar to
contracts that Peabody has performed previously, and management
believes that such experience is predictive for this contract. Management
estimates that there is a 60% probability that the contract will be completed
by the agreed-upon completion date, a 30% probability that it will be
completed 1 week late, and only a 10% probability that it will be completed 2
weeks late.
Question: How should Peabody account for this revenue arrangement?
18-36 LO 2
Variable Consideration ILLUSTRATION 18.5
Transaction Price
Question: How should Peabody account for this revenue arrangement?
Management has concluded that the probability-weighted method is the

most predictive approach:
On time: 60% chance of $150,000 = $ 90,000
1 week late: 30% chance of $145,000 = 43,500
2 weeks late: 10% chance of $140,000 = 14,000
$147,500
Most likely outcome, if management believes they will meet the deadline
and receive the $50,000 bonus, the total transaction price would be?
$150,000 (the outcome with 60% probability)
18-37 LO 2
Variable Consideration
◆ Companies only allocate variable consideration if it is

reasonably assured that it will be entitled to the
amount.
◆ Companies only recognize variable consideration if
1. they have experience with similar contracts and are

able to estimate the cumulative amount of revenue,
and
2. based on experience, they do not expect a significant

reversal of revenue previously recognized.
If these criteria are not met, revenue recognition is

constrained.
18-38 LO 2
Time Value of Money

◆ When contract (sales transaction) involves a significant
financing component.
► Interest accrued on consideration to be paid over

time.
► Fair value determined either by measuring the

consideration received or by discounting the payment
using an imputed interest rate.
► Company reports as interest expense or interest

revenue.
18-39 LO 2
ILLUSTRATION 18.7
Time Value of Money Transaction Price -
Extended Payment Terms
EXTENDED PAYMENT TERMS

Facts: On July 1, 2019, SEK Company sold goods to Grant Company for
R$900,000 in exchange for a 4-year, zero-interest-bearing note with a face
amount of R$1,416,163. The goods have a cost on SEK’s books of R$590,000.
Questions: (a) How much revenue should SEK Company record on July 1,
2019? (b) How much revenue should it report related to this transaction on
December 31, 2019?
Entry to record SEK’s sale to Grant Company on July 1, 2019, is as follows.

Notes Receivable 900,000
Sales Revenue 900,000
Cost of Goods Sold 590,000
Inventory 590,000
18-40 LO 2
ILLUSTRATION 18.12
Time Value of Money Transaction Price -
Extended Payment Terms
EXTENDED PAYMENT TERMS

Facts: On July 1, 2019, SEK Company sold goods to Grant Company for
R$900,000 in exchange for a 4-year, zero-interest-bearing note with a face
amount of R$1,416,163. The goods have a cost on SEK’s books of R$590,000.
Questions: (a) How much revenue should SEK Company record on July 1,
2019? (b) How much revenue should it report related to this transaction on
December 31, 2019?
Entry to record interest revenue at the end of the year, December 31, 2019.
Notes Receivable 54,000
Interest Revenue (12% x ½ x R$900,000) 54,000
Companies are not required to reflect the time value of money if the time period
for payment is less than a year.
18-41 LO 2
Non-Cash Consideration
Goods, services, or other non-cash consideration.
◆ Companies sometimes receive contributions (e.g.,
donations and gifts).
◆ Customers sometimes contribute goods or services,

such as equipment or labor, as consideration for goods
provided or services performed.
◆ Companies generally recognize revenue on the basis

of the fair value of what is received.
18-42 LO 2
Consideration Paid or Payable to Customers

◆ May include discounts, volume rebates, coupons, free
products, or services.
◆ In general, these elements reduce the consideration

received and the revenue to be recognized.
18-43 LO 2
ILLUSTRATION 18.8
Consideration Paid or Payable Transaction Price –
Volume Discount
VOLUME DISCOUNT
Facts: Sansung Company offers its customers a 3% volume discount if they
purchase at least ¥2 million of its product during the calendar year. On March 31,
2019, Sansung has made sales of ¥700,000 to Artic Co. In the previous 2 years,
Sansung sold over ¥3,000,000 to Artic in the period April 1 to December 31.
Questions: How much revenue should Sansung recognize for the first 3
months of 2019?
Sansung makes the following entry on March 31, 2019.

Sales Revenue 679,000
Sansung should reduce its revenue by ¥21,000 (¥700,000 x 3%) because it is

probable that it will provide this rebate.
18-44 LO 2
ILLUSTRATION 18.8
Consideration Paid or Payable Transaction Price –
Volume Discount
Questions: How much revenue should Sansung recognize for the first 3
months of 2019?
Assuming Sansung’s customer meets the discount threshold, Sansung makes

the following entry.
Cash 679,000
If Sansung’s customer fails to meet the discount threshold, Sansung makes the
following entry upon payment.
Cash 700,000
Sales Discounts Forfeited 21,000
18-45 LO 2
Allocating Transaction Price to Separate
Performance Obligations—Step 4
◆ Based on their relative fair values.
◆ Best measure of fair value is what the company could

sell the good or service for on a standalone basis.
◆ If not available, companies should use their best

estimate of what the good or service might sell for as a
standalone unit.
18-46 LO 2
Allocating Transaction Price to Separate
Performance Obligations—Step 4 ILLUSTRATION 18.9
Transaction Price—
Allocation
18-47 LO 2
ILLUSTRATION 18.12
Allocating Transaction Price Multiple Performance
Obligations—Product,
Installation, and Service
MULTIPLE PERFORMANCE OBLIGATIONS
Facts: Handler Company is an established manufacturer of equipment

used in the construction industry. Handler’s products range from small to
large individual pieces of automated machinery to complex systems
containing numerous components. Unit selling prices range from
$600,000 to $4,000,000 and are quoted inclusive of installation and
training. The installation process does not involve changes to the
features of the equipment and does not require proprietary information
about the equipment in order for the installed equipment to perform to
specifications.
18-48 (continued) LO 2
ILLUSTRATION 18.12
Handler has the following arrangement with Chai Company.

• Chai purchases equipment from Handler for a price of $2,000,000
and chooses Handler to do the installation. Handler charges the same
price for the equipment irrespective of whether it does the installation
or not. (Some companies do the installation themselves because they
either prefer their own employees to do the work or because of
relationships with other customers.) The installation service included
in the arrangement is estimated to have a standalone selling price of
$20,000.
ILLUSTRATION 18.12
Handler has the following arrangement with Chai Company.

• The standalone selling price of the training sessions is estimated at
$50,000. Other companies can also perform these training services.
• Chai is obligated to pay Handler the $2,000,000 upon the delivery
and installation of the equipment.
• Handler delivers the equipment on September 1, 2019, and
completes the installation of the equipment on November 1, 2019
(transfer of control is complete). Training related to the equipment
starts once the installation is completed and lasts for 1 year. The
equipment has a useful life of 10 years.
ILLUSTRATION 18.12
Question: (a) What are the performance obligations for

purposes of accounting for the sale of the equipment?
Handler’s primary objective is to sell equipment. The other services

(installation and training) can be performed by other parties if necessary.
As a result, the equipment, installation, and training are three separate
products or services. Each of these items has a standalone selling price
and is not interdependent.
ILLUSTRATION 18.12
Question: (b) If there is more than one performance obligation,

how should the payment of $2,000,000 be allocated to various
components?
The total revenue of $2,000,000 should be allocated to the three

components based on their relative standalone selling prices. In this
case, the standalone selling price of the equipment is $2,000,000, the
installation fee is $20,000, and the training is $50,000. The total
standalone selling price therefore is $2,070,000 ($2,000,000 + $20,000 +
$50,000). The allocation is as follows.
Equipment $1,932,367 [($2,000,000 ÷ $2,070,000) × $2,000,000]
Installation $19,324 [($20,000 ÷ $2,070,000) × $2,000,000]
Training $48,309 [($50,000 ÷ $2,070,000) × $2,000,000]
ILLUSTRATION 18.12

components?
Handler makes the following entry on November 1, 2019, to record both

sales revenue and service revenue on the installation, as well as
unearned service revenue.
November 1, 2019
Cash 2,000,000
Service Revenue (installation) 19,324
Unearned Service Revenue 48,309
Sales Revenue 1,932,367
ILLUSTRATION 18.12

components?
Assuming the cost of the equipment is $1,500,000, the entry to record

cost of goods sold is as follows.
November 1, 2019
Cost of Goods Sold 1,500,000
Inventory 1,500,000
Handler recognizes revenue from the sale of the equipment once the
installation is completed on November 1, 2019. In addition, it recognizes
revenue for the installation fee because these services have been
performed.
ILLUSTRATION 18-12

components?
Handler recognizes the training revenues on a straight-line basis starting

on November 1, 2019, or $4,026 ($48,309 ÷ 12) per month for 1 year
(unless a more appropriate method such as the percentage-of-
completion method—discussed in the next section—is warranted). The
journal entry to recognize the training revenue for 2 months in 2019 is as
follows.
December 31, 2019
Service Revenue (training) ($4,026 × 2) 8,052
ILLUSTRATION 18-12

components?
Therefore, Handler recognizes revenue at December 31, 2019, in the

amount of $1,959,743 ($1,932,367 + $19,324 + $8,052). Handler makes
the following journal entry to recognize the remaining training revenue in
2020, assuming adjusting entries are made at year-end.
December 31, 2020

Service Revenue (training) ($48,309 − $8,052) 40,257
18-56 LO 2
Recognizing Revenue When (or as) Each
Performance Obligation Is Satisfied—Step 5
Company satisfies its performance obligation when the

customer obtains control of the good or service.
Change in Control Indicators

1. Company has a right to payment for asset.
2. Company has transferred legal title to asset.
3. Company has transferred physical possession of asset.
4. Customer has significant risks and rewards of ownership.
5. Customer has accepted the asset.
18-57 LO 2
Recognizing revenue from a performance obligation over

time
◆ Measure progress toward completion
► Method for measuring progress should depict transfer
of control from company to customer.
► Most common are cost-to-cost and units-of-delivery

methods.
► Objective of methods is to measure extent of progress

in terms of costs, units, or value added.
18-58 LO 2
Step in Process Description Implementation
1. Identify the A contract is an A company applies the revenue

contract with agreement that creates guidance to contracts.
customers. enforceable rights or
obligations.
ILLUSTRATION 18.15
Summary of the
Five-Step Revenue
Recognition Process
18-59 LO 2
2. Identify the A performance obligation A contract may be comprised of

separate is a promise in a contract multiple performance
performance to provide a product or obligations.
obligations service to a customer. Accounting is based on
in the A performance obligation evaluation of whether the
contract exists if the customer can product or service is distinct
benefit from the good or within the contract.
service on its own or If each of the goods or services
together with other readily is distinct, but is interdependent
available resources. and interrelated, these goods
and services are combined and
ILLUSTRATION 18.15
Summary of the reported as one performance
Five-Step Revenue obligation.
Recognition Process
18-60 LO 2
Performance Obligation Is Satisfied—Step
5Step in Process Description Implementation
3. Determine Transaction price is the In determining the transaction

the amount of consideration price, companies must consider
transaction that a company expects to the following factors:
price. receive from a customer 1. variable consideration,
in exchange for
2. time value of money,
transferring goods and
services. 3. non-cash consideration, and
4. consideration paid or
payable to customer.
ILLUSTRATION 18.15
Summary of the
Five-Step Revenue
Recognition Process
18-61 LO 2
4. Allocate the If more than one The best measure of fair value
transaction performance obligation is what the good service could
price to the exists, allocate the be sold for on a standalone
separate transaction price based basis (standalone selling price).
performance on relative fair values. Estimates of standalone selling
obligation. price can be based on
1. adjusted market
assessment,
2. expected cost-plus a margin
approach, or
ILLUSTRATION 18.15 3. a residual approach.
Summary of the
Five-Step Revenue
Recognition Process
18-62 LO 2
5. Recognize A company satisfies its Companies satisfy performance

revenue performance obligation obligations either at a point in
when each when the customer time or over a period of time.
performance obtains control of the Companies recognize revenue
obligation is good or service. over a period of time if one of
satisfied. the following criteria is met:
1. customer receives and
consumes the benefits as
the seller performs,
2. customer controls the asset
as it is created, or
ILLUSTRATION 18.15
Summary of the 3. company does not have an
Five-Step Revenue
Recognition Process alternative use for the asset.
18-63 LO 2
Accounting for Revenue Apply the five-step process to
major revenue recognition
Recognition Issues issues.
◆ Sales returns and allowances
◆ Repurchase agreements
◆ Bill and hold
◆ Principal-agent relationships
◆ Consignments
◆ Warranties
◆ Non-refundable upfront fees
18-64 LO 3
Sales Returns and Allowances
◆ Right of return is granted for product for various

reasons (e.g., dissatisfaction with product).
◆ Company returning the product receives any

combination of the following.
1. Full or partial refund of any consideration paid.
2. Credit that can be applied against amounts owed,

or that will be owed, to the seller.
3. Another product in exchange.
18-65 LO 3
Repurchase Agreements
◆ Allows company to transfer an asset to a customer but

have an unconditional (forward) obligation or
unconditional right (call option) to repurchase the asset
at a later date.
◆ If the obligation or right to repurchase is for an amount

greater than or equal to selling price, then
transaction is a financing transaction.
18-66 LO 3
Bill-and-Hold Arrangements
◆ Contract under which an entity bills a customer for a

product but the entity retains physical possession of
the product until a point in time in the future.
◆ Result when buyer is not yet ready to take delivery but

does take title and accepts billing.
18-67 LO 3
Principal-Agent Relationships
◆ Principal’s performance obligation is to provide goods or
perform services for a customer.
◆ Agent’s performance obligation is to arrange for principal to

provide goods or services to a customer.
◆ Examples:
► Preferred Travel Company (agent) facilitates the booking
of cruise excursions by finding customers for Regency
Cruise Company (principal).
► Priceline (USA) (agent) facilitates the sale of various
services such as car rentals at Hertz (USA) (principal).
◆ Revenue for agent is amount of commission received.
18-68 LO 3
Consignments
◆ Manufacturers (or wholesalers) deliver goods but retain

title to the goods until they are sold.
◆ Consignor (manufacturer or wholesaler) ships

merchandise to the consignee (dealer), who is to act as
an agent for the consignor in selling the merchandise.
◆ Consignor makes a profit on the sale.
► Carries merchandise as inventory.
◆ Consignee makes a commission on the sale.
18-69 LO 3
Warranties
Two types of warranties to customers:

1. Product meets agreed-upon specifications in contract at
time product is sold.
a. Warranty is included in sales price (assurance-type

warranty).
2. Not included in sales price of product (service-type

warranty).
a. Recorded as a separate performance obligation.
18-70 LO 3
Non-Refundable Upfront Fees
◆ Payments from customers before

► Delivery of a product.
► Performance of a service.
◆ Generally relate to initiation, activation, or setup of a
good or service to be provided or performed in the
future.
◆ Most cases, upfront payments are nonrefundable.
► Examples include:
▪ Membership fee in a health club.
▪ Activation fees for phone, Internet, or cable.
18-71 LO 3
APPENDIX 18A Long-Term Construction Contracts
Apply the percentage-of-completion method for long-term contracts.
Revenue Recognition Over Time

Under certain circumstances companies recognize revenue
over time.
The most notable context in which revenue may be

recognized over time is long-term construction contract
accounting.
18-72 LO 5
Long-term contracts frequently provide that seller (builder)

may bill purchaser at intervals.
► Examples:
▪ Development of military and commercial aircraft
▪ Weapons-delivery systems
▪ Space exploration hardware
18-73 LO 5
A company satisfies a performance obligation and

recognizes revenue over time if at least one of the following
three criteria is met:
1. Customer simultaneously receives and consumes the
benefits of the seller’s performance as the seller performs.
2. Company’s performance creates or enhances an asset (for

example, work in process) that the customer controls as the
asset is created or enhanced; or
3. Company’s performance does not create an asset with an

alternative use. In addition to this alternative use element,
at least one of the following criteria must be met:
18-74 LO 5
In addition to this alternative use element, at least one of the

following criteria must be met:
a. Another company would not need to substantially re-perform
the work the company has completed to date if that other
company were to fulfill the remaining obligation to the
customer.
b. The company has a right to payment for its performance

completed to date, and it expects to fulfill the contract as
promised.
18-75 LO 5
If criterion 1, 2 or 3 is met, then a company recognizes

revenue over time if it can reasonably estimate its
progress toward satisfaction of the performance
obligations.
◆ Company recognizes revenues and gross profits each
period based upon the progress of the construction—
referred to as the percentage-of-completion method.
◆ If criteria are not met, the company recognizes revenues

and gross profit when the contract is completed, referred
to as the cost-recovery (zero-profit) method.
18-76 LO 5
Percentage-of-Completion Method
Measuring the Progress Toward Completion
Most popular input measure used to determine the progress
toward completion is the cost-to-cost basis.
18-77 LO 5
Revenue to be Recognized on Cost-to-Cost Basis

ILLUSTRATION 18A.1
ILLUSTRATION 18A.2
ILLUSTRATION 18A.3
18-78 LO 5
Illustration: Hardhat Construction Company has a contract to

construct a £4,500,000 bridge at an estimated cost of
£4,000,000. The contract is to start in July 2019, and the bridge
is to be completed in October 2021. The following data pertain to
the construction period.
2019 2020 2021
18-79 LO 5
2019 2020 2021
2019 2020 2021
ILLUSTRATION 18A.4
Application of Percentage-of-
Completion Method, Cost-to-
18-80 Cost Basis LO 5
2019 2020 2021
ILLUSTRATION 18A.5 2019 2020 2021
18-81 LO 5
Illustration: Percentage-of-Completion Revenue, Costs, and

Gross Profit by Year
ILLUSTRATION 18A.6
2019
2020
2021
18-82 LO 5
ILLUSTRATION 18A.6
Percentage-of- 2019
Completion
Method 2020
2021
ILLUSTRATION 18A.7 2019 2020 2021
18-83 LO 5
Illustration: Content of Construction in Process Account—

ILLUSTRATION 18A.8
18-84 LO 5
Financial Statement Presentation—Percentage-

of-Completion
Computation of Unbilled Contract Price at 12/31/19
ILLUSTRATION 18A.9
18-85 LO 5

of-Completion (2019)
ILLUSTRATION 18A.10
18-86

ILLUSTRATION 18A.11
18-87

ILLUSTRATION 18A.12
18-88 LO 5
Cost-Recovery (Zero-Profit) Method

Apply the cost-recovery method for long-term contracts.
This method recognizes revenue only to the extent of costs

incurred that are expected to be recoverable.
Only after all costs are incurred is gross profit recognized.
18-89 LO 6
Cost-Recovery (Zero-Profit) Method
Illustration: Hardhat Construction would report the following

revenues and costs for 2019–2021. ILLUSTRATION 18A.14
2019
2020
2021
18-90 LO 6
ILLUSTRATION 18A.14
Cost-Recovery Method Revenue,
Costs, and Gross Profit by Year
2019 2020 2021
ILLUSTRATION 18A.15
Journal Entries—Cost-Recovery Method
18-91 LO 6
ILLUSTRATION 18A.14
Cost-Recovery Method Revenue,
Costs, and Gross Profit by Year
ILLUSTRATION 18A.16
Comparison of Gross Profit Recognized under Different Methods
18-92 LO 6
ILLUSTRATION 18A.17
Financial Statement Presentation—Cost- Recovery Method
18-93 LO 6
Long-Term Contract Losses

Identify the proper accounting for losses on long-term contracts.
1. Loss in Current Period on a Profitable Contract

► Percentage-of-completion method only, the estimated
cost increase requires a current-period adjustment of
excess gross profit recognized in prior periods.
2. Loss on an Unprofitable Contract
► Under both percentage-of-completion and cost-
recovery methods, the company must recognize in the
current period the entire expected contract loss.
18-94 LO 7
Loss in Current Period

2018 2019 2020
Contract price $675,000 $675,000 $675,000
Cost incurred current year 150,000 287,400 215,436
Estimated cost to complete
in future years 450,000 215,436 0
Billings to customer current year 135,000 360,000 180,000
Cash receipts from customer
Current year 112,500 262,500 300,000
Prepare the journal entries to record revenue and expense for 2018, 2019, and
2020 assuming the estimated cost to complete at the end of 2019 was
$215,436.
18-95 LO 7
2018
2014 2019
2015 2020
2016
Costs incurred to date $ 150,000 $ 437,400 $ 652,836
Estimated cost to complete 450,000 215,436
Est. total contract costs 600,000 652,836 652,836
Est. percentage complete 25.0% 67.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 452,250 675,000
Rev. recognized prior year (168,750) (452,250)
Rev. recognized currently 168,750 283,500 222,750
Costs incurred currently (150,000) (287,400) (215,436)
Gross profit recognized $ 18,750 $ (3,900) $ 7,314
18-96 LO 7
2018 2019 2020
Construction in Process 18,750 7,314

Construction Expenses 150,000 215,436
Revenue from LT Contracts 168,750 222,750
Construction in Process 3,900

Construction Expenses 287,400
Revenue from LT Contracts 283,500
18-97 LO 7
Loss on Unprofitable Contract

2018 2019 2020
Contract price
Casper Construction Co. $675,000 $675,000 $675,000
Cost incurred current year 150,000 287,400 246,038
Estimated cost to complete
in future years 450,000 246,038 0
Billings to customer current year 135,000 360,000 180,000
Cash receipts from customer
Current year 112,500 262,500 300,000
Prepare the journal entries for 2018, 2019, and 2020 assuming the estimated
cost to complete at the end of 2019 was $246,038 instead of $170,100.
18-98 LO 7
2014
2018 2015
2019 2016
2020
Costs incurred to date $ 150,000 $ 437,400 $ 683,438
Estimated cost to complete 450,000 246,038
Est. total contract costs 600,000 683,438 683,438
Est. percentage complete 25.0% 64.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 432,000 675,000
Rev. recognized prior year (168,750) (432,000)
Rev. recognized currently 168,750 263,250 243,000
Costs incurred currently (150,000) (290,438) (243,000)
Gross profit recognized $ 18,750 $ (27,188) $ -
$675,000 – 683,438 = (8,438) cumulative loss

18-99 LO 7
2018 2019 2020
Construction in Process 18,750 -

Construction Expenses 150,000 243,000
Revenue from LT Contracts 168,750 243,000
Construction Expenses 290,438

Revenue from LT Contracts 263,250
18-100 LO 7
For the Cost-Recovery method, companies would recognize the

following loss :
2018 2019 2020
Loss on LT Contracts 8,438

18-101 LO 7

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TOPIC 6 - 7: ACCOUNTING

Recently, the IASB issued a converged standard on

New Revenue Recognition Standard

◆ Companies analyze contracts with customers because

► provide the measurement of the consideration, and

► specify the promises that must be met.

ILLUSTRATION 18.1 Key Concepts of Revenue Recognition

Assume that Airbus (FRA) Corporation signs a contract to sell

A contract is an agreement between two parties

Airbus has only one performance obligation—to

ILLUSTRATION 18.2 Five Steps of Revenue Recognition

Transaction price is the amount of consideration

Step 4: Allocate the

ILLUSTRATION 18.2 Five Steps of Revenue Recognition

Identifying the Contract with Customers—Step 1

Question: How much revenue should BEAN recognize on this

Step 1: Identify the contract with customers.

Step 2: Identify the separate performance obligations.

BEAN has a performance obligation to provide a large cup of coffee

Step 3: Determine the transaction price.

The price of the coffee is $3, and no discounts or other adjustments

Step 4: Allocate the transaction price to the separate

Given that BEAN has only one performance obligation, no allocation

Step 5: Recognize revenue when each performance

BEAN satisfies its performance obligation when Tyler obtains control

BEAN should recognize $3 in revenue from this

Identifying Separate Performance Obligations—Step

Question: How much revenue should BEAN recognize on the

Step 1: Identify the contract with customers.

A valid contract exists as it meets the five conditions necessary for a

Step 2: Identify the separate performance obligations.

Step 2: Identify the separate performance obligations.

Multiple performance obligations exist when the following two

BEAN has two performance obligations.

Step 3: Determine the transaction price.

The transaction price is $8 ($3 + $5).

Step 4: Allocate the transaction price to the separate

BEAN has two performance obligations.

Step 5: Recognize revenue when each performance

BEAN has satisfied both performance obligations when the coffee

BEAN should recognize $8 ($3 + $5) of revenue

Determining the Transaction Price—Step 3

Question: How much revenue should BEAN recognize on this

Step 1: Identify the contract with customers.

A valid contract exists as it meets the five conditions necessary for a

Step 2: Identify the separate performance obligations.

BEAN has a performance obligation to provide a bag of Smoke

The transaction for a bag of Smoke Jumper beans sold to Tyler is

Step 4: Allocate the transaction price to the separate

There is only one performance obligation, no allocation is necessary.

Step 5: Recognize revenue when each performance

BEAN has satisfied both performance obligations.

BEAN should recognize $9 of revenue when Tyler receives

Allocating the Transaction Price to Separate

BEAN offers customers a $2 discount on the purchase of a large cup

Question: How much revenue should BEAN recognize on the

Step 1: Identify the contract with customers.