The assignmentis titled practice questions. I've attached my classnotes (ASC 606) and the codification access(must copy and paste hyperlink in order to access the site)
Revenue Recognition Revenue From Contracts With Customers I. Background: A. Revenue is the top line on the income statement. It is essential that managers understand the complexities involved in recognizing revenue. B. Revenue recognition is concerned with two things: · The timing issue (the when issue) · The amount to be recognized (the how much issue) C. ASC Topic 606: Provides a five-step model for evaluating how and when revenue should be recognized, rather than providing detailed industry-by-industry standards. Is far more principles oriented than the existing standards, which tended to be more rules based. Focuses on when control of goods and services is transferred to the customer, rather than when the firm has earned the consideration to which it is entitled. Core Principle: Companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods and services · When: upon transfer to customers · How much: amount the seller is entitled to receive D. ASC 605 vs. ASC 606 (i.e. old standard vs. new standard) · ASC 605: Revenue is recognized when it is earned and realized or realizable. · ASC 606: Revenue from Contracts With Customers 1. Identify the contract with the customer 2. Identify the separate performance obligations in the contract. 3. Determine the transaction price 4. Allocate the transaction price to the separate performance obligations 5. Recognize revenue when each performance obligation is satisfied. E. Current status of revenue recognition-related literature 1. ASU 2014-09, Revenue from Contracts with Customers was issued in May 2014. 2. The content of ASU 2014-09 created Topic 606 in the Codification and details a complete change in revenue recognition guidance – see Codification 3. IASB issued IFRS 15 in May 2014 at the same time ASU 2014-09 was issued by the FASB 4. ASU 2014-09 supersedes all existing revenue recognition guidance in US GAAP (Topic 605) including industry guides. 5. Effective Date: FASB issued ASU 2015-14 in August, 2015 that postponed the effective date of ASU 2014-09 for public companies one year to fiscal years beginning after December 15, 2017. Early adoption is permitted but only for annual reporting periods beginning after December 15, 2016 F. The AICPA has formed a series of industry task forced to help develop non-authoritative guidance. G. The guidance in ASU 2014-09 applies to both public and non-public entities. Our focus will be on the former. IFRS 15 does not apply to non-public entities. H. The SEC’s stance 1. The SEC has issued SAB 116 to “conform its existing staff guidance to the new revenue recognition standard that takes effect for public companies at the end of the year.” 2. The SEC went on to say that “Topic 13 is no longer applicable when a registrant adopts ASC Topic 606.” · Effective date for IFRS 15 is for “annual reporting periods beginning on or after 1 January 2018. Earlier application is permitted”. IFRS 15 states that its objective is to “develop a common revenue standard for IFRS and US GAAP.” I. Transition to New Standard: Both US GAAP and IFRS identify two adoption approached. Entities are given a choice for transitioning to the new standard. 1. Retrospective Approach: · Each period presented is restated to what the financial statements would have been had the standard always been in place. · There are three practical expedients permitted: · Contracts that begin and complete in the same year need not be restated. · Firms may use the transaction price as of the date on which the contract was completed. · Firms need not disclose the amount of the transaction price allocated to the remaining performance obligations or explain when the firm expects to recognize that amount for the restated periods. 2. Cumulative Effect (Modified Retrospective) Approach: · The firm determines how the balance sheet would differ as of the first day of the year the new standard is adopted. · It makes an adjustment in the statement of shareholders’ equity to the opening balance at the beginning of that year. · All other balance sheet accounts are adjusted, as of the first day of the year, to what they would have been had the new standard always been applied. · Then, the firm accounts for new transactions under the new standard. · No prior period financial statements are restated. J. Objective and Scope 1. According to the FASB, the objective of the new guidance “is to establish principles that an entity shall apply to report useful information to users of financial statements about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a contract with a customer.” (ASC 606-10-10-1) 2. The guidance applies to most contracts with customers with few exceptions (e.g., leases and insurance contracts). 3. ASC 606-10-15-3 defines a customer as “a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities.” 4. The underlying principle associated with revenue recognition under the new guidance is that an entity “should recognize revenue in an amount that reflects the consideration that the entity expects to be entitled to in exchange for goods and services.” (EY Foundation) 5. To apply this principle, Topic 606 presents a five-step procedure to guide the revenue recognition process: · Identify the contract(s) with the customer · Identify the performance obligations in the contract · Determine the transaction price · Allocate the transaction price to the performance obligations · Recognize revenue when (or as) each performance obligation is satisfied 1. Performance Obligations: promises to transfer goods or services to a customer. 2. Performance Obligations are satisfied when the seller transfers control of the goods or services to the customer. 3. Transfer: has occurred when the customer has control of the good or service. 4. Control: Means the customer has direct influence over the use of the good or service. II. Step 1: Identify the contract(s) with the customer: A. ASC 606-10-25-2 defines a contract as “… an agreement between two or more parties that creates enforceable rights and obligations.” The literature also says that both written and oral agreements are considered contracts. In addition, contracts can also be implied based on the seller’s normal or customary business practices. B. Customer: A party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration. C. ASC 606-10-25-1 indicates that five criteria must be met before an entity has a “contract with a customer”: 1. The parties to the contract have approved the contract … and are committed to perform their respective obligations. 2. The entity can identify each party’s rights regarding the goods or services to be transferred. 3. The entity can identify the payment terms for the goods or services to be transferred. 4. The contract must have commercial substance 5. It is probable that the entity will collect … all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. D. A contract does not exist if: · Neither the seller nor the customer has performed any obligations under the contract, and · The entity has not received, or is not entitled to receive any consideration in exchange for promised goods or services. D. Special Issues: Issue 1: According to GAAP, “probable” is defined “as likely to occur” (75%) while in IFRS, “probable” means “more likely than not.” (>50%). It appears as if the probability of collectability is a bit higher in GAAP. Issue 2: Failure to Meet Contract Criteria: If a seller doesn’t satisfy all of the five Step 1 criteria, then it should recognize revenue when either: 1. The seller has no remaining obligations to transfer goods or services and substantially all (or all) of the consideration has been received by the seller and is nonrefundable 2. The contract has been terminated and any consideration already received from the customer is nonrefundable Issue 3: Combining Contracts: What happens if two or more contracts are entered into around the same time? ASC 606-10-25-9 allows contracts “entered into at or near the same time with the same customer” to be accounted for as a “single contract” if one of three criteria are met: 1. The contracts are “negotiated as a package with a single commercial objective.” 2. The amount of consideration in one contract depends on the price or performance in the other contract. 3. The goods or services promised in the contracts are a single performance obligation. Issue 4: Contract Modifications: · “A contract modification is a change in the scope or price (or both) of a contract that is approved by the parties to the contract. A contract modification exists when the parties to a contract approve a modification that either creates new or changes existing enforceable rights and obligations of the parties to the contract.” (ASC 606-10-25-10) · “A contract modification should be accounted for as a separate contract if additional distinct goods or services are promised and the price increases by the standalone selling price of these additional goods or services. · If a contract modification does not meet the criteria to be accounted for as a separate contract (see above), then the remaining goods or services to be transferred should be accounted for in one of the following manners: 1. If the remaining goods or services to be transferred are distinct from those previously delivered, then the contract modification should be handled as a termination of an existing contract and the origination of a new contract. 2. If the remaining goods or services are not distinct, then the contract modification should be accounted for as part of the existing contract. Issue 5: Enforceability & Termination Rights · Contracts do not have to be written, but they do have to be legally enforceable. · Oral contracts or implied contracts, if they are enforceable, are considered contracts. · In addition, if neither party has yet performed under the contract and both parties have the right to cancel the contract without penalty, then for purposes of the revenue recognition standard, no contract exists. Issue 6: Collectibility vs. Price Concessions If a firm believes it will not ultimately receive the full, stated contract price, judgment may be necessary to determine if the shortfall is due to a collectibility problem or a price concession. For example: · A