Chp 1-7(Additional Concepts)

Front 1

Objective

Back 1

To provide decision useful information to capital providers such as the amount, timing, and uncertainty of a company's future cash flows. (PG 21–22)

Front 2

Qualitative Characteristics

Back 2

FUNDAMENTAL:
Relevance
1. Predictive value
2. Confirmatory value
3. Materiality

Faithful Representation
1. Completeness
2. Neutrality
3. Free from error

ENHANCING
1. Comparability(including consistency)
2. Verifiability
3. Timeliness
4. Understandability

(PG 21)

Front 3

Elements

Back 3

1. Assets
2. Liabilities
3. Equity
4. Investments by owners
5. Distribution to owners
6. Revenues
7. Expenses
8. Gains
9. Losses
10. Comprehensive Income
(PG 21)

Front 4

Recognition, Measurement, and Disclosure Concepts

Back 4

ASSUMPTIONS
1. Economic Entity
2. Going Concern
3. Periodicity
4. Monetary Unit

PRINCIPLES
1. Revenue recognition
2. Expense recognition
3. Mixed–attribute measurement
4. Full disclosure
(PG 21)

Front 5

Financial Statements

Back 5

1. Balance sheet
2. Income statement
3. Statement of comprehensive income
4. Statement of cash flows
5. Statement of shareholders' equity
6. Related disclosures(notes)
(PG 21)

Front 6

Assets

Back 6

Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. (PG 25)

Front 7

Liabilities

Back 7

Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. (PG 25)

Front 8

Equity(net assets)

Back 8

Called shareholders' equity or stockholders' equity for a corporation, it is the residual interest in the assets of an entity that remains after deducting its liabilities. (PG 25)

Front 9

Investments by owners

Back 9

Increases in equity of a particular enterprise resulting from transfers to it from other entities of something of value to obtain or increase ownership interests in it. (PG 25)

Front 10

Distributions to owners

Back 10

Decreases in equity of a particular enterprise resulting from transfers to owners. (PG 25)

Front 11

Comprehensive Income

Back 11

The change in equity of a business enterprise during a period from transactions and other events and circumstances from non–owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. (PG 25)

Front 12

Revenues

Back 12

Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing central operations. (PG 25)

Front 13

Expenses

Back 13

Outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing central operations. (PG 25)

Front 14

Gains

Back 14

Increases in equity from incidental or peripheral transactions of an entity. (PG 25)

Front 15

Losses

Back 15

Represent decreases in equity resulting from peripheral or incidental transactions of an entity. (PG 25)

Front 16

General Recognition Criteria

Back 16

1.Definition:The item meets the definition of an element of financial statements.

2.Measurability: The item has a relevant attribute measurable with sufficient reliability.

3.Relevance: The information about it is capable of making a difference in user decisions


4.Reliability: The information is representationally faithful, verifiable, and neutral

(PG 27)

Front 17

Revenue Recognition

Back 17

Revenue is recognized when goods or services are transferred to customers(Performance obligation) for the amount the company expects to be entitled to receive for transferring those goods and services. Revenue is recognized over a period of time or a point in time, depending on when goods or services are transferred to customers. (PG 28)

Front 18

Expense Recognition

Back 18

Often matches revenues and expenses that arise from the same transactions or other events.



Based on four different approaches:


1. An exact cause–and–effect relationship; ex– sale of merchandise and COGS



2. By associating an expense with the revenues recognized in a specific time period; ex– employee salary costs indirectly related to revenues earned in a period


3. By a systematic and rational allocation to specific time periods; ex– depreciation, amortization, depletion


4. In the period incurred, without regard to related revenues; ex– advertisement expenses



(PG 28–29)

Front 19

5 Measurement Attributes of Mixed Attribute Model

Back 19

1. Historical cost
2. Net realizable value
3. Current cost
4. Present(or discounted) value of future cash flows
5. Fair value
(PG 29)

Front 20

Historical Cost Principle

Back 20

Measuring assets and liabilities based on their original transaction value.


(PG 29)

Front 21

Net Realizable Value

Back 21

The amount of cash into which an asset is expected to be converted in the ordinary course of business.


(PG 30)

Front 22

Current Cost

Back 22

The cost that would be incurred to purchase or reproduce the asset. (PG 30)

Front 23

Fair Value

Back 23

Current market value; the price that would be received to sell assets or paid to transfer a liability between market participants at the measurement date. (PG 30)

Front 24

3 Valuation Techniques to Measure Fair Value

Back 24

1. Market approaches; base valuation on market information


2. Income approaches; discount future amounts to find present value


3. Cost approaches; estimate amount that would be required to buy or construct an asset of similar quality and condition (PG 30)

Front 25

Expected Rate of Return

Back 25

Dividends+share price appreciation/initial investment

Front 26

Accounting Standards Update(ASU)

Back 26

Any new standard issued by FASB

Front 27

Norwalk Agreement

Back 27

Signed in 2002 by FASB and IASB, which was a pledge to remove existing differences between their standards and to coordinate their future standard–setting agendas.

Front 28

Roadmap

Back 28

Issued by the SEC that listed necessary conditions to be achieved before the U.S. will shift to requiring use of IFRS by public companies.

Front 29

FASB Standard Setting Process

Back 29

1. Board identifies issue
2. Decides whether to add project to technical agenda
3. Deliberation at public meetings
4. Board issues exposure draft
5. Roundtable meeting held
6. Staff analyzes gathered information
7. Board issues an accounting standards update

Front 30

Model for ethical decisions

Back 30

1. Facts of situation
2. ethical issue
3. related values
4. alternative courses of action
5. Evaluation
6. Identify consequences
7. Make your decision

Front 31

Big Bath Accounting

Back 31

Involves the inclusion of recurring operating expenses in "special charge" categories such as restructuring costs.

Front 32

Income Statement Classification

Back 32

The most common form of income statement classification is sometimes called "big bath" accounting.

Front 33

Channel Stuffing

Back 33

Accelerates revenue recognition by persuading distributors to purchase more of your product than necessary near the end of a reporting period.

Front 34

Income Shifting

Back 34

Is achieved by accelerating or delaying the recognition of revenues or expenses, which could be done through a practice called channel stuffing.

Front 35

The Two Ways Managers Manipulate Income

Back 35

1. Income shifting
2. Income statement classification

Front 36

Other Income(expense)

Back 36

Often is the classification used by companies in the income statement for nonoperating items.

Front 37

Transitory Earnings

Back 37

Result from transactions or events that are not likely to occur again in the foreseeable future or that are likely to have a different impact on earnings in the future.

Front 38

Should Restructuring Costs be considered part of a company's permanent earnings stream

Back 38

A financial statement user must interpret restructuring charges with consideration of the company's past history.

Front 39

Some Unusual Items that warrant Additional Scrutiny

Back 39

1. Restructuring Costs
2. Goodwill impairments
3. Asset impairments
4. Loss from write down of inventory
5. Loss from natural disasters
6. Gain or loss from litigation settlements



These items require investigation to determine their permanent or transitory nature.

Front 40

Revenue Issues related to Unusual Items and Earnings Quality

Back 40

1. Company loses a major customer that can't be replaced
2. Timing of revenue recognition in which pressure to meet certain earnings expectations may lead to premature revenue recognition.

Front 41

Intraperiod Income Tax Allocation

Back 41

The fact that discontinued operations is reported net of tax and separately from continuing operations.

Front 42

When the component has been sold

Back 42

Reported income effects of discontinued operations will include two elements:


1. Income or loss from operations of the component from the beginning of the reporting period to the disposal date
2. Gain or loss on disposal of component's assets

Front 43

When the component is considered held for sale

Back 43

Reported income effects of discontinued operation:


1. Income or loss from operations of the component from the beginning of the reporting period to the end of the reporting period.
2. An "impairment loss" if the book value of the assets of the component is more than fair value less cost to sell.

Front 44

Discontinued Operations Disclosure Note

Back 44

Provides additional details about the discontinued component, including its identity, its major classes of assets and liabilities, the major revenues and expenses constituting pretax income or loss from operations, the reason for the discontinuance, and the expected manner of disposition if held for sale.

Front 45

Interim Reports

Back 45

Financial statements covering periods of less than a year.


Benefits:



1. Enhance timeliness of financial information
2. Provide external users with additional insight on seasonality of business operations


Disadvantages:

1. Relative unreliability because of issues with estimation and allocation
2. Should smaller companies use lower tax rates in earlier quarters and higher rates in later quarters.
3. Should unusual material gains and losses be allocated over the entire year?

Front 46

Reporting Revenues and Expenses

Back 46

1. Under GAAP, interim reports are viewed as integral part of annual statements.
2. Most expenses are recognized in interim periods as incurred, but when they clearly benefit more than just one period, the expenses must be allocated among the periods through the use of accruals and deferrals.
3. Income tax expense at each interim period should be based on estimates of the effective tax rate for the whole year.

Front 47

Interim Reporting Unusual Items

Back 47

Discontinued operations and unusual items are reported entirely within the interim period in which they occur, which is more consistent with the discrete view rather than the integral view.

Front 48

EPS

Back 48

Follow same procedures as annual calculations; treated in manner consistent with the discrete view

Front 49

Retrospectively

Back 49

To recast prior years' financial statements when those statements are reported again in comparative form; those statements are made to appear as if the newly adopted accounting method had been used in those prior years.

Front 50

Reporting accounting changes

Back 50

Changes affecting: IFCO, NI, and related per share amounts for the postchange interim period are disclosed.

Front 51

Minimum Disclosures

Back 51

Complete financial statements not required, but certain minimum disclosures are required:


1. Sales, Income taxes, and net income
2. Earnings per share
3. Seasonal revenues, costs, and expenses
4. Significant changes in estimates for income taxes
5. Discontinued operations and unusual items
6. contingencies
7. Changes in accounting principles and estimates
8. Information about fair value of financial instruments and the methods and assumptions used to estimate fair values
9. Significant changes in accounting position

Front 52

OCI Items

Back 52

1. Foreign currency translation adjustments
2. Unrealized gains/losses on securities(AFS)
3. Minimum pension liabilities
4. Gain or loss from cash flow hedge

Front 53

Problems with realization principle

Back 53

1. placed more emphasis on earnings approach when FASB conceptual framework puts emphasis on balance sheet approach(assets and liabilities)
2. Earnings focus led to similar transactions being treated differently in different industries
3. Was difficult to apply to complex arrangements

Front 54

ASU No. 2014–09, "Revenue from Contracts with Customers"

Back 54

1. Replaces more than 200 different pieces of specialized guidance that had developed over time in U.S. GAAP for revenue recognition under various industries and circumstances

2. Provides a unified approach for revenue recognition
3. Applies to companies issuing reports after Dec 15, 2016.

Front 55

2 Options for Adopting ASU No. 2014–09

Back 55

1. They can restate prior years presented in comparative financial statements to appear as if the company had always accounted for revenue under the ASU.
2. They can leave prior year financial statements unchanged and in the beginning of 2017 record the adjustments necessary to convert to the ASU.

Front 56

Core Revenue Recognition Principle

Back 56

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.

Front 57

Five Steps to Apply Core Revenue Recognition Principle

Back 57

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

Front 58

Control

Back 58

The customer has direct influence over the use of the good or service and obtains its benefits.

Front 59

Transfer

Back 59

Occurs when when the customer has control of the good or service

Front 60

Multiple Performance Obligations

Back 60

Step 4(Transaction Price): Allocate a portion to each performance obligation
Step 5(Revenue recognition): At whatever time is appropriate for each performance obligation

Front 61

Single Performance Obligation

Back 61

Step 4(Transaction Price): No allocation required
Step 5(Revenue Recognition: At a point in time or over a period of time

Front 62

5 key indicators to decide whether control has passed from seller to customer

Back 62

The customer is more likely to control a good or service if the customer has:


1. An obligation(unconditional) to pay the seller
2. Legal title to the asset
3. Physical possession of the asset
4. Assumed the risks and rewards of ownership

5. Accepted the Asset

Front 63

Criteria for recognizing revenue over time

Back 63

1. Customer consumes the benefit of the seller's work as it is performed, as when a company provides cleaning services to a customer for a period of time

2. The customer controls the asset as it is created, as when a contractor builds an extension onto a customer's existing building

3. The seller creating an asset has no alternative use to the seller, and the seller has the legal rights to receive payment for progress to date.


*If at least one of the three criteria is met, then revenue is recognized in proportion to the amount of performance obligation that has been satisfied

Front 64

Determining Progress Towards Completion

Back 64

1. Output–based estimate

2. Input–based estimate

Front 65

Output–based estimate

Back 65

Measured as the proportion of the goods or services transferred to date; output measured by passage of time

Front 66

Input–based estimate

Back 66

measured as the proportion of effort expended thus far relative to the total effort expected to satisfy the performance obligation.

Front 67

Capable of being distinct

Back 67

Customer could use the good or service on its own or in combination with other goods and services it could obtain elsewhere

Front 68

Separately identifiable from other goods or services in the contract

Back 68

Good or service is distinct in the context of the contract because it is not highly interrelated with other goods and services

Front 69

Step 1: Identify the Contract with customer

Back 69

A contract establishes the legal rights and obligations of the seller and customer with respect to one or more performance obligations.

Front 70

Step 2: Identify the performance obligations

Back 70

A performance obligation is a promise to transfer a good or service that is distinct, which is the case if the good or service is both: capable of being distinct and separately identifiable

Front 71

Step 3: Determine the Transaction Price

Back 71

The transaction price is the amount the seller is entitled to receive from the customer

Front 72

Step 4: Allocate the transaction price

Back 72

The seller allocates the transaction price to performance obligations based on the relative stand alone selling prices of the goods or services in each performance obligation.

Front 73

Step 5:Recognize Revenue When(or as) each performance obligation is satisfied

Back 73

Seller recognizes revenue at a single point of time when control passes to the customer, which is more likely if the customer has:


1. Obligation to pay the seller
2. Legal title to the asset
3. Possession of the asset
4. Assumed the risks and rewards of ownership
5. Accepted the asset


Seller recognizes revenue over a period of time if:


1. Customer consumes benefits as work performed
2. Customer controls assets as it's created
3. Seller is creating an asset that has no alternative use and the seller has right to receive payment for work completed

Front 74

Existence of Contracts(Special Issues for step 1: to identify contracts)

Back 74

Contract only exists if it:


1. has commercial substance
2. has been approved by the seller and customer
3. specifies the rights of the seller and customer
4. specifies payment terms
5. if the seller believes it's probable that it will collect the amount it's entitled to receive under the contract.



A contract does not exist if:


1. Neither the seller nor the customer has performed any obligations under the contract
2. Both the seller and the customer can terminate the contract without penalty

Front 75

Contract Modifications

Back 75

1. Just a separate new contract.
2. Adds a distinct performance obligation, but that new performance obligation isn't priced at its stand–alone selling price
3. performance obligation that is being satisfied over time is modified in which assessment of progress toward completion is updated.

Front 76

Special Issues for step 2: Identifying performance obligations

Back 76

Not Performance obligations:
1. Prepayment

2. Quality–Assurance Warranties
3. Right of Return


Performance obligations:
1. Customer options
2. Extended warranties

Front 77

Prepayments

Back 77

Such as upfront fees, which is an advance payment by the customer for future products or services and should be included in the transaction price, allocated to the various performance obligations in the contract.


Initially recorded as deferred revenue, and recognized as revenue when(or as) each performance obligation is satisfied.

Front 78

Warranties

Back 78

Include: Quality assurance and Extended warranties


Should be treated as extended warranty when:


1. A customer has the option to purchase the warranty separately from the seller
2. The warranty provides a service to the customer beyond only assuring that the seller delivered a product or service that was free from defects.

Front 79

Customer Options for Additional Goods or Services

Back 79

1. Are considered performance obligations if they provide a material right to the customer that customer would not receive otherwise

2. Granted by seller to customer to receive additional goods or services at no cost or at a discount.
3. Ex: Software upgrades, coupons, customer loyalty programs, discounts on future goods or services, and contract renewal options

Front 80

Considerations affecting Transaction Price(Step 3)

Back 80

1. Variable consideration and constraint on its recognition
2. Sales with a right of return
3. Identifying whether the seller is acting as a principal or agent
4. Time value of money
5. Payments by the seller to the customer

Front 81

Estimating Variable Consideration

Back 81

1. Seller should include uncertain amount in transaction price through estimation

2. Seller estimates variable consideration through expected value or the most likely amount

3. Expected value is better when there are several possible outcomes

4. most likely amount is better if there are only two possible outcomes.

Front 82

Constraint on Recognizing Variable Consideration

Back 82

1. Sellers are limited to recognizing variable consideration to the extent that it is probable that a significant revenue reversal will not occur in the future.

2. Concerns include:

Seller might overestimate variable consideration
Recognize revenue based on transaction price that is too high, and later have to reverse that revenue to correct the estimate

Front 83

Indicators that a significant revenue reversal could occur

Back 83

1. Poor evidence on which to base an estimate
2. Dependence of the estimate on factors outside the seller's control
3. history of the seller changing payment terms on similar contracts
4. broad range of outcomes that could occur
5. long delay before uncertainty resolves(not a short delay)

Front 84

Allowance for sales return

Back 84

Contra asset account credited that reduces book value of accounts receivable

Front 85

Time Value of Money

Back 85

If TVM is significant, the seller views the transaction price as consisting of:


1. Cash price of the good or service
2. A financing component representing the interest for the time between the sale and the cash payment
3. Seller adjusts transaction price to remove financing component
4. Seller separately accounts for financing component of the contract by recognizing interest revenue or interest expense

5. TVM is not significant when payment and delivery are relatively close each other, which is usually less than a year.

Front 86

Payments by the Seller to the Customer

Back 86

1. Is payment by seller to buyer for purchase of goods or services a refund of some of the price paid by the buyer to purchase seller's products?


2. If seller purchases distinct goods or services from customer at fair value, then purchase is accounted for in a separate transaction


3. If seller purchases goods or services from customer at an amount greater than fair value, then excess payments are viewed as a refund.


4. Subtracted from transaction price.

Front 87

Various approaches to estimate stand–alone selling prices

Back 87

1. Adjusted market assessment approach
2. Expected cost plus margin approach
3. residual approach

Front 88

Adjusted market assessment approach

Back 88

Seller considers what it could sell the products or services for in the market in which it normally conducts business, perhaps referencing prices charged by competitors.

Front 89

Expected Cost plus margin approach

Back 89

Seller estimates its costs of satisfying a performance obligation and than adds an appropriate profit margin

Front 90

Residual Approach

Back 90

Seller estimates an unknown(or highly uncertain) stand–alone selling price by subtracting the sum of the known or estimated stand–alone selling prices of other goods and services in the contract from the total transaction price of the contract.

Front 91

Right of Use

Back 91

When license transfers right of use, revenue is recognized at the point in time the right is transferred or at the start of the license period(software, CDs, music)

Front 92

Right of Access

Back 92

If a seller's activities during the time period are expected to affect the intellectual property being licensed to the customer, revenue is recognized over the license period(trademark; brands)

Front 93

Variable consideration and licenses

Back 93

Sales–based or usage–based royalties on licenses are only included in the transaction price when they're no longer variable.

Front 94

Franchise

Back 94

1. Involves a license to use the franchisor's intellectual property


2.involves initial sales of products and services



3. ongoing sales of products and services

Front 95

Gift Cards

Back 95

1. Sales of gift cards are recognized as deferred revenues.



2. Sellers recognize revenue from gift cards at the point when they have concluded based on past experience that there is only a remote likelihood that customers will use the cards.

Front 96

Income Statement Disclosure

Back 96

Company needs to include in income statement or disclosure notes any bad debt expense and any interest revenue or interest expense related to significant financing components of long–term contracts.

Front 97

Balance Sheet Disclosure

Back 97

1. Contract liability; deferred revenues, billings in excess of CIP

2. A/R
3. Contract asset; CIP in excess of billings

Front 98

Disclosure notes

Back 98

*Objective is to help users of financial statements understand the revenue and cash flows arising from contracts with customers.

Sellers must:

1. 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.

2. disclose amounts included in revenue that were once recognized as deferred revenue or that resulted from changes in transaction prices


3. describe outstanding performance obligations


4. discuss how performance obligations are typically satisfied


5. describe important contractual provisions such as refund policies, returns, and warranties



6. Disclose any significant judgements used to estimate transaction prices, to allocate transaction prices to performance obligations, and to determine when performance obligations have been satisfied.


7. Explain significant changes in contract assets and contract liabilities that occurred during a period.

Front 99

Accounting For Long–term Contracts(Intro)

Back 99

1. Long term contracts typically include a lot of items that could be considered separate performance obligations, but are treated as a single performance obligation because they are not separately identifiable, such as in one building with many distinct components.


2. Since only recognizing revenue at a point in time on long–term contracts may lead to lower quality financial reporting due to delayed revenue recognition, long–term contracts generally qualify for revenue recognition over time.


3. Often the customer owns the seller's work in process, such that the seller is creating an asset that the customer controls as it is completed.


4. The seller is creating a asset which the seller has no use for, meaning the seller has the right to paid for progress even if the customer cancels the contract.


5. Long–term contracts used to account for percentage–of–completion method and the completed contract method.


6. ASU No. 2014–09 removes the terms percentage of completion method and completed contract method from the Accounting Standards Codification and changes the criteria that determine whether revenue should be recognized over a period of time or at a point in time.


7. Still use the same journal entries as they were under percentage–of–completion method and completed contract method.

Front 100

Percentage of Completion method

Back 100

For long–term contracts that qualified for revenue recognition over time, which recognized revenue in each year of the contract according to the progress toward completion that occurred during that year.

Front 101

Completed contract method

Back 101

Long–term contracts that didn't qualify for revenue recognition over time were accounted for using this approach; because all revenue was recognized at a single point in time––upon completion of the contract.

Front 102

Accounting for Profitable Long–term contract

Back 102

1. Whether we recognize revenue at a point in time or over time, the same amount of revenue and profit is recognized over the life of the contract, but the timing is different.

Front 103

Accounting for the cost of construction and accounts receivable

Back 103

1. At the end of each period, balance between CIP asset and contra CIP asset account, billings on construction contract, are compared; if the net amount is a debit, then a contract asset is reported on the balance sheet; if it's a credit, then a contract liability is reported on the balance sheet.

2. Financial asset and physical asset cannot be on the balance sheet at the same time because of double counting.

3. The billings account, which reduces the total CIP account, is used to prevent double counting by allowing the A/R account(financial) balance to increase and the physical account(CIP) balance to decrease.


4. Construction company will report an A/R for amounts it has billed to the customer and not yet been paid and will report a contract asset(CIP–billings) for the remaining amount of work completed(which will eventually be paid once it is able to bill the client).

Front 104

Revenue Recognition General Approach

Back 104

1. the same amount of revenue, cost, and gross profit are recognized whether it's over the term of the contract or only upon completion with the difference being the timing.


2. Gross profit is added to CIP asset because CIP asset is on the seller's balance sheet until delivery to the customer.



3. Gross profit also updates the CIP asset to reflect the total value(Cost+Gross profit=sales price)


4. At the end of the contract, CIP account and contra CIP billings account will offset each other to create a net value of zero.

Front 105

Revenue Recognition upon the completion of the contract

Back 105

1. If a contract doesn't qualify for revenue recognition over time, revenue is recognized at the point in time that control transfers from the seller to the buyer, which typically occurs when the contract has been completed.


2. If revenue is recognized upon completion of the contract, CIP is updated to include gross profit at that point in time.

Front 106

Recognizing revenue over time according to percentage of completion

Back 106

1. If a contract qualifies for revenue recognition over time, revenue is recognized over time as the project is completed.


2. Can measure progress towards completion with output based measures, but they have shortcomings:
a. may provide a distorted view of actual progress to date
b. information they require may be costly to obtain


3. Can also use seller's input of effort


4. Most common approach is cost–to–cost ratio, which compares total cost incurred to date with the total estimated cost to complete the project; costs that don't reflect progress toward completion must be excluded


5. When recognizing revenue over the term of the contract, CIP is updated each period to include gross profit

Front 107

Amount of Revenue Recognized each period formula

Back 107

Revenue Recognized this period= Total estimated revenue*Percentage completed to date – Revenue recognized in prior periods

Total estimated revenue*percentage completed to date= Cumulative revenue to be recognized to date

Front 108

Cost to Cost Ratio

Back 108

Percentage of completion=Actual Costs to date/ Total Cost(Est.+ actual)

Front 109

Completion of the Contract

Back 109

We record the same journal entry to close out the billings and CIP accounts regardless of whether revenue is recognized over time or upon completion.

Front 110

Income Recognition

Back 110

1. Timing of revenue recognition does not affect the total amount of profit or loss recognized.


2. Recognizing revenue over the term of the project provides a better measure of the company's economic activity and progress over the three–year term.

Front 111

Balance Sheet Recognition

Back 111

1. When revenue is recognized over the term of the contract, CIP contains cost and gross profit


2. If revenue is recognized upon the completion of the contract, CIP typically only contains costs.



3. It's not unusual to see both contract assets and contract liabilities on a balance sheet because a company may have some contracts with a net asset position or net liability position


4. CIP in excess of billings is treated as a contract asset


5. Once seller has made progress sufficient to bill customer, it will debit the A/R and credit billings, which will reduce CIP in excess of billings


6. Billings in excess of CIP are treated as a contract liability


7. Reflects that the seller has billed the customer for more work than it actually has done

Front 112

Long–term Contract losses

Back 112

1. Losses sometimes occur on long–term contracts.


2. As facts change, sellers must update their estimates and recognize losses if necessary to properly account for the amount of revenue that should have been recognized to date.


3. How we treat losses in any one period depends on whether the contract is profitable overall.

Front 113

Periodic loss occurs for profitable project

Back 113

1. Due to a change in gross profit recognized to date, a change in accounting estimate is required prospectively.

2. Recognized losses on long–term contracts reduce CIP account

Front 114

Loss is projected on the entire project

Back 114

1. An estimated loss on a long–term contract is fully recognized in the first period the loss is anticipated, regardless of whether revenue is recognized over time or upon completion


2. If loss is not recognized in first period the loss is anticipated, then CIP would be valued at an amount greater than the company expects to realize from the contract


3. Equivalent to lower of cost or market concept


4. In situations where a loss is expected on the entire project, cost of construction for the period will no longer be equal to cost incurred during the period.


5. Compute cost of construction by adding the amount of loss recognized to the amount of revenue recognized.



6. When the contract only recognizes revenue upon completion, no revenue or cost of construction is recognized until the contract is complete; however, a loss on long–term contract is recognized.

Front 115

Activity Ratios

Back 115

Ratios to evaluate a company's effectiveness in managing its assets; key to profitability



1. Asset turnover over ratio
2. Receivables turnover ratio
3. Inventory turnover ratio

Front 116

Profitability ratios

Back 116

Attempt to measure a company's ability to earn an adequate return relative to sales or resources devoted to operations.

Resources devoted to operations can be defined as total assets or only those assets provided by owners

1. Profit margin on sales
2. Return on Assets
3. Return on Shareholder's equity

To enhance predictive value, analysts often adjust these ratios to separate a company's transitory earnings effects from its permanent earnings.

They begin with income from continuing operations, then adjust for any unusual, one–time gains or losses included in income from continuing operations.

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Additional consideration to ROA

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ROA=Net income+ interest expense(1–tax rate)/ Average total assets

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Financial leverage

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1. Measured by equity multiplier.


2. A high equity multiplier indicates that relatively more of the company's assets have been financed with debt.
3. leverage can provide additional return to the company's equity holders
4. At some point the benefits of a higher equity multiplier are offset by a lower profit margin because creditors will start to charge more interest, which decreases net income.

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Special Issues for step 5: Recognizing revenue when(or as) each performance obligation is satisfied

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1. Licenses
2. Franchise
3. bill–and–hold arrangement
4. gift cards
5. consignment arrangements

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Additional Consideration: Transitioning to ASU No. 2014–09

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1. Retroactive restatement: restates prior years as if the ASU had been used all along


2. Prospective: applies the ASU only to new contracts and to contracts that have not been completed as of the date the ASU is initially adopted by the company; adjusts opening balance of retained earnings for cumulative effect on net income from ASU.

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Key Concept Underlying revenue recognition(old GAAP)

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The realization principle–– recognize revenue when both the earnings process is complete and there is reasonable certainty as to collectibility of the assets to be received

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Role of collectibility in determining whether revenue is recognized(old GAAP)

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Defer revenue recognition if cash collection is not reasonably certain. Use installment method or cost–recovery method to tie revenue recognition to subsequent cash collection

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Criteria for recognizing revenue over time(old GAAP)

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Depends on the earning process. For long–term contracts, recognizing revenue over time is generally required unless reliable estimates can't be made.

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Accounting for multiple performance obligations(old GAAP)

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Depends on the industry. Sometimes performance obligations are ignored("free" smartphones in cell phone contracts); sometimes revenue recognition is constrained(software for which there is no sufficient evidence of stand–alone prices).

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Key Concept Underlying revenue recognition(New GAAP)

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The core revenue recognition principle: 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.

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Role of collectibility in determining whether revenue is recognized(New GAAP)

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Defer revenue recognition until cash collection is probable. Installment and cost recovery methods eliminated.

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Criteria for recognizing revenue over time(new GAAP)

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Depends on characteristics of the contract and of the performance obligations being satisfied

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Accounting for multiple performance obligations(new GAAP)

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Regardless of the industry, apply criteria for determining whether goods and services are distinct to identity performance obligations, allocate transaction price to performance obligations, and recognize revenue when each performance obligation is satisfied.

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Treatment of customer options for additional goods or services(old GAAP)

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Depends on the industry. Sometimes treated as a separate deliverable(software upgrades), other times ignored.

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Treatment of customer options for additional goods or services(new GAAP)

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Regardless of industry, treat an option as separate performance obligation if it provides a material right to the customer that the customer would not otherwise have.

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Treatment of variable consideration(old GAAP)

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Typically only recognize revenue associated with variable consideration when uncertainty has been resolved.

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Treatment of variable consideration(new GAAP)

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Include estimated variable consideration in the transaction price, but only to the extent that it is probable that a significant revenue reversal will not occur in the future.

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Treatment of time value of money(old GAAP)

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Interest revenue recognized for long–term receivables but interest expense typically not recognized for long–term customer prepayments

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Treatment of time value of money(new GAAP)

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Interest revenue or expense is recognized for both long–term receivables and long–term customer prepayments if amount is significant.

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Realization principle

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Bases revenue recognition on completion of the earnings process and reasonable certainty about collectibility.

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IAS No. 18

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Prior to IFRS version of ASU No. 2014–09, IFRS No.15.


Allowed revenue to be recognized when the following conditions were met:

1. amount of revenue and costs associated with the transaction can be measured reliably
2. it is probable that economic benefits associated with the transactions will flow to the seller
3. the seller has transferred to the buyer the risk s and rewards of ownership, and doesn't effectively manage or control the goods
4. The stage of completion can be measured reliably.

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Installment Sales

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The installment sales and cost recovery methods are only used when extreme uncertainty exists regarding future cash collections

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Installment sales method

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recognizes revenue and costs only when cash payments are received


2 components:
1. a partial recovery of the cost of the item sold
2. a gross profit component


recognizes gross profit by applying the gross profit percentage on the sale to the amount of cash actually received


Used because a company can't reliably estimate bad debts.

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Deferred gross profit

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contra installment receivables account, which will be reduced as collections are received

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Cost recovery method

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An even more conservative approach than installment sales method


Defers all gross profit recognition until cash equal to the cost of the item sold has been received.

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Software and other multiple element arrangements

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1. Prior to ASU No. 2014–09, revenue associated with a software contract that included multiple elements was allocated to the elements based on vendor specific objective evidence(VSOE) of fair values of the individual elements.

2. VSOE of fair values are the sales price of the elements when sold separately by that vendor.

3. if VSOE didn't exist, revenue recognition was deferred until VSOE became available or until all the elements of the contract had been delivered.

4. Emerging Issues Task Force(EITF) issued guidance to broaden the application of this basic perspective to other arrangements that involve "multiple deliverables."

5. New guidance required that sellers allocate total revenue to the various parts of a multiple deliverable agreement on the basis of the relative stand–alone selling prices of the parts.

6. Sellers had to defer revenue recognition for parts that don't have stand–alone value, or whose value was contingent on other undelivered parts.

7. Sellers offering other multi–deliverable contracts were allowed to estimate selling prices when they lacked VSOE from stand–alone selling prices.

8. Using estimated selling prices allowed for earlier revenue recognition

9. ASU requires a similar process as was used to account for revenue on contracts that include multiple deliverables.

10. Sellers allocate a contract's transaction price to the contract's performance obligations based on the stand–alone selling prices of those performance obligations

11. Key differences are that the ASU provides much more guidance concerning how to identify performance obligations and eliminates the need for VSOE for software contracts.

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Franchise Sales

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1. The fees to be paid by the Franchisee to the franchisor usually comprise:

a. an initial franchise fee
b. continuing franchise fees

2. Initial franchise fee compensates franchisor for right to use its name and sell its products.

3. initial franchise fee is usually a fixed amount that is payable installments

4. GAAP was modified to require that substantially all of the initial services of the franchisor required by the franchise agreement be performed before the initial franchise fee could be recognized as revenue.

5. If the initial franchise fee was collectible in installments and if a reasonable estimate of bad debts could not be made, the installment of sales or cost recovery methods were required.

6. Continuing franchise fees compensate the franchisor for ongoing rights and services provided over the life of the franchise agreement

7. sometimes are a fixed annual or monthly amount, a percentage of the volume of business done by the franchise, or a combination of both.

8. Present no accounting problems

9. Previous GAAP required that they be recognized by the franchisor as revenue over time in the period the services are performed by the franchisor.

10. Accounting for franchise revenue under ASU. No. 2014–09 is similar to previous GAAP.

11. To the extent that the services underling initial franchise fees comprise separate performance obligations, revenue associated with those fees is recognized when those services have been performed.

12. to the extent that continuing franchise fees constitute payments for services that are provided over time, revenue recognition over time is appropriate

13. Justification for the amount and timing of revenue recognition is based on the ASU, rather than on special guidance provided for franchise arrangements.


14. ASU includes new guidance for recognizing license revenue

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Long–term construction contracts(difference between IFRS and GAAP prior to ASU No. 2014–09 )

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When reliable estimates could not be made, under IAS No.11 required the use of the cost recovery method, rather than the completed contract method under US GAAP.

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Multiple Deliverable Arrangements

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.1. IFRS contained very little guidance about multi–deliverable arrangements


2. No requirement to focus on VSOE


3. particular contractual traits like contingencies mattered less under IFRS than they do under US GAAP.