CMA 2020 Part 1 Lec 5

CMA 2020 Part 1 Lec 5 https://youtu.be/-MPDwgfyRHM

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REVENUE FROM CONTRACTS WITH CUSTOMERS

1.6    REVENUE FROM CONTRACTS WITH CUSTOMERS

1.       Overview

a.       The core principle is that an entity recognizes revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in the exchange.

b.       Below is the five-step model for recognizing revenue from contracts with customers.

Step 1:    Identify the contract(s) with a customer.
Step 2:    Identify the performance obligations in the contract.
Step 3:    Determine the transaction price.
Step 4:	Allocate the transaction price to the performance obligations in the contract.
Step 5:	Recognize revenue when (or as) a performance obligation is satisfied.

2.       Step 1: Identify the Contract with a Customer

a.       A contract is an agreement between two or more parties that creates enforceable rights and obligations.

b.       Revenue is recognized for a contract with a customer if all of the following criteria are met:

1)      The contract was approved by the parties.

2)      The contract has commercial substance.

3)      Each party’s rights regarding (a) goods or services to be transferred and (b) the payment terms can be identified.

4)      It is probable that the entity will collect substantially all of the consideration to which it is entitled according to the contract.

a)      Probable means that the future event is likely to occur.

c.       If the criteria described above are not met (e.g., if collectability cannot be reliably estimated), the consideration received is recognized as a liability, and no revenue is recognized until the criteria are met.

1)      However, even when the criteria described above are not met, revenue in the amount of nonrefundable consideration received from the customer is recognized if at least one of the following has occurred:

a)      The contract has been terminated.

b)      Control over the goods or services was transferred to the customer and the entity has stopped transferring (and has no obligation to transfer) additional goods or services to the customer.

c)       The entity (1) has no obligation to transfer goods or services and (2) has received substantially all consideration from the customer.

d.       A contract modification exists when the parties approve a change in the scope or price of a contract.

1)      It is accounted for as a separate contract if the following conditions are met:

a)      The scope of the contract increases because of the addition of promised goods or services that are distinct, and

b)       The price of the contract increases by a consideration amount that reflects the entity’s standalone selling prices of the additional promised goods or services.

3.       Step 2: Identify the Performance Obligations in the Contract

a.       A performance obligation is a promise in a contract with a customer to transfer to the customer (1) a good or service that is distinct or (2) a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer.

b.       Promised goods or services are distinct if

1)      The customer can benefit from them either on their own or together with other resources that are readily available (capable of being distinct), and

2)      The entity’s promise to transfer them to the customer is separately identifiable from other promises in the contract (distinct within the context of the contract). A separately identifiable good or service

a)      Does not significantly modify or customize another good or service promised in the contract.

b)      Is not highly dependent on, or highly interrelated with, other goods or services promised in the contract.

c.       A contract may include a customer option to acquire additional goods or services for free or at a discount (e.g., coupon, sales incentives, etc.). If the option provides a material right to the customer, the result is a separate performance obligation in the contract.

4.       Step 3: Determine the Transaction Price

a.       The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer.

1)      It excludes amounts collected on behalf of third parties (e.g., sales taxes).

2)      Any consideration payable to the customer, such as coupons, credits, or vouchers, reduces the transaction price.

3)      To determine the transaction price, an entity should consider the effects of the time value of money and variable consideration.

b.       The revenue recognized must reflect the price that a customer would have paid for

the promised goods or services if the cash payment had been made when they were transferred to the customer (i.e., the cash selling price).

1)      Thus, the transaction price is adjusted for the effect of the time value of money when the contract includes a significant financing component.

2)      The following factors should be considered in assessing whether a contract includes a significant financing component:

a)      The difference between (1) the cash selling price of the promised goods or services and (2) the amount of consideration to be received

b)       The combined effect of (1) the expected time between the payment and the delivery of the promised goods or services and (2) market interest rates

c.       The transaction price should not be adjusted for the effect of the time value of money if

1)      The time between the payment and the delivery of the promised goods or services to the customer is 1 year or less

2)      The customer paid in advance and the transfer of goods or services is at the discretion of the customer

a)      An example is a bill-and-hold contract in which the seller provides storage services for goods it sold to the buyer.

3)      A substantial amount of the consideration promised is variable and its amount or timing varies with future circumstances that are not within the control of the entity or the customer

a)      An example is consideration in the form of a sales-based royalty.

d.       Interest income or expense is recognized using the effective interest method.

1)      It must be presented in the income statement separately from revenue from contracts with customers.

EXAMPLE 1-13                   Significant Financing Component

On January 1, Year 1, BIF Co. sold and transferred a machine to a customer for $583,200 that is payable on December 31, Year 2. Other customers pay $500,000 upon delivery of the same machine at contract inception. The cost of the machine to BIF is $400,000. BIF determined that the contract includes a significant

financing component because of the difference between the consideration ($583,200) and the cash selling price ($500,000). The contract includes an implicit interest rate of 8%. The following entries are recorded by BIF:

January 1, Year 1
Accounts receivable	$500,000	Cost of goods sold	$400,000
Revenue	$500,000	Machine inventory	$400,000
December 31, Year 1
Accounts receivable ($500,000 × 8%)	$40,000
Interest income	$40,000
December 31, Year 2
Accounts receivable ($540,000 × 8%)	$43,200	Cash	$583,200
Interest income	$43,200	Accounts receivable	$583,200

EXAMPLE 1-14                   Significant Financing Component -- Advance Payment

On January 1, Year 1, Eva Co. received a payment of $100,000 for delivering a machine to a customer at the end of Year 2. The cost of the machine to Eva is $70,000. Eva determined that (1) the contract includes a significant financing component and (2) a financing rate of 10% is an appropriate discount rate. The following entries are recorded by Eva:

January 1, Year 1		December 31, Year 1
Cash	$100,000	Interest expense ($100,000 × 10%)	$10,000
Contract liability	$100,000	Contract liability	$10,000
December 31, Year 2
Interest expense ($110,000 × 10%)	$11,000	Contract liability	$121,000
Contract liability	$11,000	Revenue	$121,000
Cost of goods sold	70,000
Machine inventory	70,000