measurement

how to find the amount to recognise:

1. Find the transaction price

2. Allocate transaction price to performance allocations
3. Find the amount of revenue earned

Clarification

transaction price- what is it?

 It is the consideration that an entity can expect to receive when it completes its
performance under the contract, taken into account of any expectation over variable
component(s)

How to allocate transaction price to performance obligations?

 should be done on a pro-rate basis with the weight of each performance obligation being its
standalone price

How to find the amount to recognise for performance of obligation that is completed over a period
of time?

o That depends on how much progress is made, and that can be measured in 2 ways:

o Input method- by cost incurred as a proportion of total estimated cost

o Output method- by number of units produced as a proportion of total number

Issue regarding transaction price

how to find transaction price (and cost of revenue) when there is variable component to it

o Ther are 2 possible methods to use

o Most likely amount method, to be used when there are only 2 possible outcomes
o Expected value method, to be used when there are more than 2 possible outcomes
o Both expense should be determined on same basis as transaction price

how to determine the value of a variable component based on expected value approach

o For each outcome, find the odds and the value

o find the overall expected value by calculator, do not compute in head

What if there are 2 variable components, there are 4 outcomes identified for one component, and 2
outcomes identified for the other?

 Adopt expected value approach for first component, most likely outcome approach for the
other
What if estimation about variable component to transaction price changes midway through the
contract?

 Find the new transaction price

 Find the difference between new and old estimated transaction price

 Find out how much of that difference should be recognised given the amount of progress
made
i) To recognise the change: e.g. for decrease in estimate=> revenue-, AR-

A company contracts to sell 1000 units. There is a return policy and that it expects the customer to
return a total of 100 units before the return period ends.

What should be the transaction price be based on?

 It should be based on the 1000 units

 However, revenue recognised initially should be adjusted for such expectation. i.e. it will be
lower and there will be a refund liability

ACE Company, a construction company, enters into a contract to construct a commercial building for
SKY Company on customer-owned land. It has limited experience on similar types of contracts
previously. The promised consideration is $1 million and a bonus of $500,000 if the building is
completed within 24 months. Besides, ACE Company accounts for the promised bundle of goods and
services as single performance obligation satisfied over time. The expected costs of construction are
$700,000.
What is the amount of expected profit at the inception of the contract?

 There is no indication that ACE is likely to earn the bonus, so it should not be included in the
transaction price
 Profit= 1M- 700K= 300K

Issue regarding allocation of transaction price to obligations

What if the standalone price of a performance obligation is not available?

o The standalone price should be estimated based on 1 of the following methods

o Market approach- estimate the price a customer would be willing to pay
o Cost plus margin approach- estimate the cost to completing the obligation and add a margin
o Residual approach- transaction price less standalone prices of other obligation

Issues regarding recognition of revenue over a period

how much progress is made by input method

 8.8/ 22= 40%

How much progress is made by output method

 12.25/ 35= 35%

a marketing firm has entered into a contract to advise a client on their marketing strategy. The
contract has a duration of 8 months, and the client promises to pay 60000 at the beginning of each
month. What should be the accounting treatment regarding this 60k?

 at the beginning of each month, the firm will receive 60K, so debit cash by 60K. But because
the firm not been completed the work for this month's revenue, so credit DR by 60K
 At the end of the month, the firm should have provided its work. Therefore, revenue should
be recognised (a credit of 60K) and deferred revenue will be debited with 60K.

How to recognise bonus received at end of contract?

 That depends on whether bonus has already been fully recognised

 If yea: cash+, AR-
 If no: cash+, AR-, Revenue+

Issues regarding determining the amount of revenue earned

suppose I need to find progress based on input method, but the total estimated cost is not available,
how can I find a) progress and b) amount to revenue to recognise in a year?

 Find the cumulative % completed at end of previous year

 Find the cumulative % completed at end of current period
 Find the difference between these 2 figures, which is the % completed this year
 Apply this percentage to find proportion of transaction price that should be recognised for
current period

cumulative % completed by end of a year=

 cumulative cost incurred/ (cumulative cost incurred+ estimated cost to complete)

Issues regarding return policy

What transactions have to be recognised for a sales with return policy scenario

1. Initial sales
2. Returns
3. End of return period

Initial sales

What accounts will be affected

Debit ($) Credit($)

DR Cash/ AR A
CR sales Revenue B
 CR Refund Liability C

o The amount of revenue to recognise should take into account of estimated return
o The amount of refund liability reflects the estimated value of returns

Regarding the cost of goods sold

Debit ($) Credit($)

DR Cost of sales A
DR inventory recoverable B
CR Inventory C

o A should take into account of estimated return

o B reflects the value of estimated return
o C reflects the value of all goods sold in beginning

returns (within estimate)

what accounts will be affected

Reporting day Debit ($) Credit($)

DR Refund Liability A
CR Account receivable B

Reporting day Debit ($) Credit($)

DR inventory A
CR inventory recoverable B

Returns (beyond estimate)/ end of period change to estimate

Reporting day Debit ($) Credit($)

DR Refund Liability A
CR Account receivable B
CR Revenue C

Reporting day Debit ($) Credit($)

DR inventory A
DR cost of sales B
CR inventory recoverable C
Issues regarding warranty

Warranty- what are the 2 kinds

o assurance-type warranty: Warranties that the product meets agreed-upon specifications in

the contract at the time the product is sold; the price of the warranty is included in the sales
price of the product.

o Service-type warranty: a warranty provide an additional service beyond the assurance-type

warranty. This warranty is not included in the sales price of the product, instead it is sold
separately

Do these warranties constitute separate performance obligation

o Assurance-type warranty cannot constitute a separate performance obligation.

o Service-type warranty is not included in price and can be sold separately, can constitute a
separate performance obligation.

How to deal with the sales of product sold with service-type warranty?

Stage 1: sales of product

o Because the warranty is sold separately, therefore the AR will be higher

o Revenue in respect of the warranty is not earned at this point, so there will instead be an
increase to unearned revenue.

Stage 2: recognition of revenue

o Revenue is recognised on a straight line basis over the period to which it applies.
o The costs associated with the service-type warranty are expensed as incurred

Issue regarding discount over bulk purchase

ACE Company enters into a contract with SKY on 1 January 20X5 to transfer DVDs to Jacky
Company (J Company) for $150 per DVD. If J Company purchases more than 1 million DVDs in a
calendar year, the contract indicates that the price per disc is retrospectively reduced to $100 per disc.
The consideration is due when control of the DVDs are transferred to J Company. Upon the first
shipment to J Company of 100 DVDs, ACE Company estimates that J Company is a highly probably
in meeting the 1 million DVD threshold in the year.
What accounting journal entries should ACE Company make for the above transaction?
 When 100 discs are given to J, debit 100,000 to account receivable, credit 100,000 to revenue

 in the event the J fails to purchase a million DVDs, then the price of each DVD will be 150. As
such the revenue to ACE should increase. so the adjusting entry will involve credit to sales
revenue and debit to account receivable.

Billings during the year is a term=

to the amount of money that a contractor or a company invoices its clients for the work
completed in a certain period of time, usually a year.
o It is a measure of how much cash the contractor or the company expects to receive from

its clients for the services rendered.

o Billings during the year can be different from the revenue recognized in the same period,

depending on the accounting method used