254 SECTION 1 The Role of Accounting as an Information System GIFT CARDS Let’s assume you received an iTunes gift card that allows you to download songs or audiobooks later. When your friend bought that gift card, Apple recorded a deferred revenue liability in anticipation of recording revenue when you used your gift card to get songs. But, what if you lose the card or fail to redeem it for some other reason? Sellers like Apple, Target, Amazon, and others will recognize revenue at the point when they have concluded based on past experience that there is only a “remote likelihood” that customers will use the cards. 22 We discuss accounting for gift card liabilities further in Chapter 13. Disclosures INCOME STATEMENT DISCLOSURE. Of course, a seller reports revenue in its income statement. In addition, that seller is required to either include in its income statement or disclosure notes any bad debt expense and any interest revenue or interest expense associated with significant financing components of long-term contracts. BALANCE SHEET DISCLOSURE. A seller reports accounts receivable, “contract liabilities,” and “contract assets” on separate lines of its balance sheet. We discuss each in turn. If a customer pays the seller before the seller has satisfied a performance obligation, we saw earlier that the seller records deferred revenue. For example, we recorded deferred revenue in Illustration 5–6 when TrueTech received payment for Tri-Net subscriptions prior to providing that service. A contract liability is a label we give to deferred revenue (or unearned revenue) accounts. On the other hand, if the seller satisfies a performance obligation before the customer has paid for it, the seller records either a contract asset or accounts receivable. The seller recognizes an account receivable if the seller has an unconditional right to receive payment, which is the case if only the passage of time is required before the payment is due. In other words, the seller has satisfied all of its performance obligations and is just waiting to be paid. If, instead, the seller satisfies a performance obligation but payment depends on something other than the passage of time, the seller recognizes a contract asset. For example, construction companies sometimes complete a significant amount of work prior to when the construction contract indicates they can bill their clients for progress payments. As we will see in Part C of this chapter, a construction company in that situation reports a contract asset called “construction-in-progress in excess of billings” to reflect that the company will be able to bill its client in the future for the work that has been completed. DISCLOSURE NOTES. Several important aspects of revenue recognition must be disclosed in the notes to the financial statements. For example, sellers must separate their revenue into categories that help investors understand the nature, amount, timing, and uncertainty of revenue and cash flows. Categories might include product lines, geographic regions, types of customers, or types of contracts. Sellers also must disclose amounts included in revenue that were previously recognized as deferred revenue or that resulted from changes in transaction prices. Sellers also must describe their outstanding performance obligations, discuss how performance obligations typically are satisfied, and describe important contractual provisions like payment terms and policies for refunds, returns, and warranties. They also must disclose any significant judgments used to estimate transaction prices, to allocate transaction prices to performance obligations, and to determine when performance obligations have been satisfied. Sellers also must explain significant changes in contract assets and contract liabilities that occurred during the period. The objective of these disclosures is to help users of financial statements understand the revenue and cash flows arising from contracts with customers. Of course, the downside of these disclosures is that sellers also are providing information to competitors, suppliers, and customers. Illustration 5–22 provides a summary of both Parts A and Parts B of this chapter to provide a comprehensive review of revenue recognition. Sales of gift cards are recognized as deferred revenue. 22 This is sometimes referred to as “breakage” of the gift card. ● LO5–8 The seller recognizes contract liabilities , contract assets , and accounts receivable on separate lines of its balance sheet. Companies provide detailed disclosures about revenues.
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