Chp 5: Revenue Recognition And Profitability Analysis(Key Concepts)

Front 1

Performance Obligation

Back 1

Are promises by the seller to transfer goods or services to a customer.

Seller recognizes revenue when it satisfies a performance obligation by transferring the promised good or service.

Front 2

Distinct

Back 2

*Goods or services provided by sellers require this quality to be treated as a performance obligation.

1. Capable of being distinct

2. Separately identifiable from other goods or services in the contract

Front 3

Transaction Price

Back 3

Is the amount the seller expects to be entitled to receive from the customer in exchange for providing goods and service

Front 4

Stand-alone Selling Prices

Back 4

Is the amount at which the good or service is sold separately under similar circumstances.

Front 5

Contract

Back 5

Is an agreement that creates legally enforceable rights and obligations.

Can be explicit, oral, or written

Front 6

Quality-Assurance Warranties

Back 6

A warranty that is sold with most products, which obligates the seller to make repairs or replace products that later are found to be defective or unsatisfactory.

1. Not sold separately

2. Can be stated explicitly or implicitly

3. not a performance obligation

4. Rather, the cost of satisfying a performance obligation to deliver products of acceptable quality

Front 7

Extended Warranties

Back 7

Offered as an additional service that covers new problems arising after the customer takes control of the product.

1. Provides protection beyond the manufacturer's quality-assurance warranty.

2. constitutes a performance obligation

3. can be viewed as a separate transaction

Front 8

Variable Consideration

Back 8

*When a transaction price is uncertain because some of the price depends on the outcome of future events

Ex:

1. Construction(incentive payments)

2.Entertainment and media(royalties)

3.Health care( Medicare and Medicaid reimbursements)

4. Manufacturing(volume discounts and product returns)

5. Telecommunications(rebates)

Front 9

Right of Return

Back 9

Right to return granted to customers for merchandise when customers are not satisfied or unable to sell the merchandise.

1. Not a performance obligation

2. Represents a potential failure to satisfy the original performance obligation to provide goods that the customer wants to keep.

3. Sellers estimate returns by creating contra sales revenue account and liability

4. Sales Returns is a contra revenue account

5. Seller also reduces COGS and records an asset, "inventory--estimated returns

6. at the end of each reporting period, make adjustments to sales return and refund liability

Front 10

Principal

Back 10

when a company is providing the good or service to the customer.

1. Controls goods or services before they're transferred to customers. Is evident if:

• Principal has primary responsibility for delivering a product or service
• vulnerable to risks associated with holding inventory, delivering the product, and collecting payment from customer.
  

2. Performance obligation is to deliver goods and services.

3. Records revenue equal to the total sales price paid by customers as well as COGS equal to the cost of the item to the company.

Front 11

Agent

Back 11

Arranging for another company to provide the good or service.

1. Performance obligation is to facilitate a transaction between a principal and customer

2. Facilitator that receives commission for helping sellers provide goods and services to buyers

3. Records as revenue only the commission it receives on the transaction

Front 12

Licenses

Back 12

Allow the customer to use the seller's intellectual property by paying a licensing fee.

1. Right of use

2. Right of access

3. sometimes isn't distinct from other promised goods or services.

Front 13

Franchisor

Back 13

Grants a franchisee the right to sell its products and use its name for a specified period of time.

1. Provides initial start-up services

2. provides ongoing product and services

Front 14

Franchisee

Back 14

Quite often an individual that is granted a license to use a franchisor's name and sell its products for a specified period of time.

Front 15

Bill-and-hold arrangement

Back 15

Exists when a customer purchases a good but requests that the seller not ship the product until a later date

1.Revenue recognition usually occurs at delivery for this type of arrangement.

2. Can recognize revenue prior to deliver only if:

• customers can be concluded to control the product
  
• there is a good reason for the bill-and-hold arrangement
• the product is specifically identified as belonging to the customer and is ready for shipment

Front 16

Consignment

Back 16

1. Consignor physically transfers the goods to the consignee, but the consignor retains legal title.

2. If buyer is found, consignee remits the selling price less commission and approved expenses to the consignor.

3. If the consignee can't find a buyer within an agreed-upon time, then the consignee returns the goods to the consignor.

4. Revenue Recognition occurs upon sale to an end customer in a consignment arrangement

Front 17

Contract Liability

Back 17

label given to deferred revenue or unearned revenue accounts

Front 18

Accounts Receivable

Back 18

1. Recognized 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).

2.Recognized as well as a contract asset when a seller satisfies a performance obligation before the customer has paid for it.

Front 19

Contract asset

Back 19

Seller satisfies performance obligation, but payment depends on something other than the passage of time.

Front 20

Construction in Progess(CIP)

Back 20

Asset account equivalent to work-in-process inventory for a manufacturer.

Front 21

Billings on Construction contract

Back 21

A contra account to the CIP asset, which is where periodic billings are credited to.

Front 22

Asset turnover ratio

Back 22

Net sales/avg total assets

indication of how efficiently a company uses its assets to generate revenue

Front 23

Receivables turnover ratio

Back 23

Net sales/avg a/r(net)

indication of a company's efficiency in collecting receivables

shows the number of times the average a/r is collected.

A decline in the ratio could be an indication of customer dissatisfaction or that the firm is granting extended(too lenient) credit terms in order to maintain customers.

Front 24

Average Collection Period

Back 24

365/Receivables turnover ratio

number of days average a/r balance is outstanding

Front 25

Inventory Turnover Ratio

Back 25

1.number of times the average inventory balance is sold during a period.

2. Indicates how quickly inventory is sold

3. COGS/avg inventory

4. High ratio could indicate a superior sales force or a successful advertisement campaign; also a relatively low inventory level, which indicates either efficient inventory management or stockouts and lost sales in the future.

5. low ratio indicates that too much capital may be tied up in inventory; overstocking, obsolete items, poor marketing and sales efforts

6. The more a company turns over its inventory, the lower the investment it has to have in inventory for a given level of sales.

Front 26

average days in inventory

Back 26

365/inventory turnover ratio

number of days it normally takes to sell inventory

Front 27

Profit Margin on sales

Back 27

1. Net income/net sales

2. indicates the portion of each dollar of revenue that is available after all expenses have been covered

3. offers a measure of the company's ability to withstand either higher expenses or lower revenues

4. A low profit margin can be compensated for by a high asset turnover rate and vice versa

Front 28

Return on Assets(ROA)

Back 28

1. Net income/average total assets

2. Because total assets are partially financed with debt and partially by equity, this is an inclusive way of measuring earning power that ignores specific sources of financing.

3. PM*TAT=ROA; profitability

4. PM High and TAT low in some industries such as manufacturer of specialized equipment

5. PM low and TAT high in some industries, such as grocery stores

Front 29

Return on Shareholder's Equity

Back 29

1. net income/shareholder's equity

2. PM*TAT*EM

3. ROA*EM

Front 30

DuPoint framework

Back 30

Breaks ROE into three key components:

1. Profitability; measured by profit margin

2. Activity; measured by asset turnover

3. Financial leverage; measured by equity multiplier

ROE= Profit margin*asset turnover*equity multiplier