CHAPTER 5 Revenue Recognition and Profitability Analysis 275 Financial Reporting Case Solution 1. Under what circumstances do companies recognize revenue at a point in time? Over a period of time? (p. 234) A seller recognizes revenue when it satisfies a performance obligation, which happens when the seller transfers control of a good or service to the customer. Indicators that transfer of control has occurred include customer acceptance and physical possession of the good or service as well as the seller having a right to receive payment. Some performance obligations are satisfied at a point in time, when the seller has finished transferring the good or service to the customer. Other performance obligations are satisfied over time. For example, the customer might consume the benefit of the seller’s work as it is performed, or the customer might control an asset as the seller creates it. 2. When do companies break apart a sale and treat its parts differently for purposes of recognizing revenue? (p. 237) Sellers must break apart a contract if the contract contains more than one performance obligation. Goods and services are viewed as performance obligations if they are both capable of being distinct (for example, if the goods and services could be sold separately) and if they are separately identifiable (which isn’t the case if the point of the contract is to combine various goods and services into a completed product, as occurs with construction contracts). To account for contracts with multiple performance obligations, the seller allocates the contract’s transaction price to the performance obligations according to their stand-alone selling prices and then recognizes revenue for each performance obligation when it is satisfied. 3. How do companies account for long-term contracts that qualify for revenue recognition over time? (p. 257) When contracts qualify for revenue recognition over time, the seller recognizes revenue each period as the contract is being fulfilled. The amount recognized is based on progress to date, which usually is estimated as the fraction of the project’s cost incurred to date divided by total estimated costs. To calculate the total amount of revenue that should be recognized up to a given date, the estimated percentage of completion is multiplied by the contract price. To calculate the amount of revenue to be recognized in the current period, the amount of revenue recognized in prior periods is subtracted from the total amount of revenue that should be recognized as of the end of the current period. ● The Bottom Line ● LO5–1 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 or services. That core principle is implemented by (1) identifying a contract with a customer, (2) identifying the performance obligations in the contract, (3) determining the transaction price of the contract, (4) allocating that price to the performance obligations, and (5) recognizing revenue when (or as) each performance obligation is satisfied. (p. 232) ● LO5–2 Revenue should be recognized at a single point in time when control of a good or service is transferred to the customer on a specific date. Indicators that transfer has occurred and that revenue should be recognized include the seller having the right to receive payment, the customer having legal title and physical possession of the asset, the customer formally accepting the asset, and the customer assuming the risks and rewards of ownership. (p. 234) ● LO5–3 Revenue should be recognized over time when a performance obligation is satisfied over time. That occurs if (1) the customer consumes the benefit of the seller’s work as it is performed, (2) the customer controls the asset as the seller creates it, or (3) the asset has no alternative use to the seller and the seller can be paid for its progress even if the customer cancels the contract. (p. 235)
Spiceland_Inter_Accounting8e_Ch05
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