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Chapter 18: Q18-2CA (page 1042)

Question: CA18-2 (Satisfying Performance Obligations) Judy Schaeffer is getting up to speed on the new guidance on revenue recognition. She is trying to understand the revenue recognition principle as it relates to the five-step revenue recognition process.

Instructions

(a) Describe the revenue recognition principle.

(b) Briefly discuss how the revenue recognition principle relates to the definitions of assets and liabilities. What is the importance of control?

(c) Judy recalls that previous revenue recognition guidance required that revenue not be recognized unless the revenue was realized or realizable (also referred to as collectibility). Is collectibility a consideration in the recognition of revenue? Explain.

Short Answer

Expert verified

Answer

  1. The principle stating thatrevenue must be recognized as the performance obligations are satisfied is known as the revenue recognition principle.
  2. Business entity recognizes asset and liability depending upon satisfaction of performance obligation is made by seller or buyer.
  3. The business entity must recognize the revenue after adjusting the customer鈥檚 credit risk.

Step by step solution

01

Definition of Accrual Accounting

The accounting method of reporting all the financial transactions of the business entity without considering the cash receipt and payment is known as accrual accounting

02

Revenue recognition principle

One of the principles that provide information regarding the situations under which the revenue must be recognized is the revenue recognition principle. This principle is applied under the accrual accounting method and states that revenue must be recognized as the service or product is sold, or it must be recognized as it is earned.

03

Relation of revenue recognition principle with assets and liabilities

Companies use assets and liabilities to recognize revenue in the following way:

  1. When the company satisfies a performance obligation by providing goods or services to the customer, then the company is eligible to receive consideration. Therefore, the company will recognize the contract asset.
  2. If the customer satisfies the performance obligation by prepaying the amount of consideration, then the company will recognize contract liability.
  3. Both of them must be reported on the balance sheet of the company.
04

Collectibility as consideration in recognition of revenue

Collectibility refers to the risk attached to collecting payment from the customer to whom product or services are provided. The seller generally does not report revenue after adjusting the credit risk. Instead, it is reported on the gross amount, and then the provision is created for uncollectible accounts. This provision is reported as an expense in the income statement.

If there exists doubt regarding the collection of payment from a customer, then it can be said that parties to the contract are not committed toward their obligations, and the terms and conditions of the contract are not met.

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Most popular questions from this chapter

In September 2017, Gaertner Corp. commits to selling 150 of its iPhone-compatible docking stations to Better Buy Co. for \(15,000 (\)100 per product). The stations are delivered to Better Buy over the next 6 months. After 90 stations are delivered, the contract is modified and Gaertner promises to deliver an additional 45 products for an additional \(4,275 (\)95 per station). All sales are cash on delivery.

Instructions

(a) Prepare the journal entry for Gaertner for the sale of the first 90 stations. The cost of each station is $54.

(b) Prepare the journal entry for the sale of 10 more stations after the contract modification, assuming that the price for the additional stations reflects the standalone selling price at the time of the contract modification. In addition, the additional stations are distinct from the original products as Gaertner regularly sells the products separately.

(c) Prepare the journal entry for the sale of 10 more stations (as in (b)), assuming that the pricing for the additional products does not reflect the standalone selling price of the additional products and the prospective method is used.

Franchise Fee, Initial Down Payment) On January 1, 2017, Lesley Benjamin signed an agreement, covering 5 years, to operate as a franchisee of Campbell Inc. for an initial franchise fee of \(50,000. The amount of \)10,000 was paid when the agreement was signed, and the balance is payable in five annual payments of \(8,000 each, beginning January 1, 2018. The agreement provides that the down payment is nonrefundable and that no future services are required of the franchisor once the franchise commences operations on April 1, 2017. Lesley Benjamin鈥檚 credit rating indicates that she can borrow money at 11% for a loan of this type.

Instructions

(a) Prepare journal entries for Campbell for 2017-related revenue for this franchise arrangement.

(b) Prepare journal entries for Campbell for 2017-related revenue for this franchise arrangement, assuming that in addition to the franchise rights, Campbell also provides 1 year of operational consulting and training services, beginning on the signing date. These services have a value of \)3,600.

(c) Repeat the requirements for part (a), assuming that Campbell must provide services to Benjamin throughout the franchise period to maintain the franchise value.

How do companies recognize revenue from a performance obligation over time?

Tablet Tailors sells tablet PCs combined with Internet service, which permits the tablet to connect to the Internet anywhere and set up a Wi-Fi hot spot. It offers two bundles with the following terms.

1. Tablet Bundle A sells a tablet with 3 years of Internet service. The price for the tablet and a 3-year Internet connection service contract is \(500. The standalone selling price of the tablet is \)250 (the cost to Tablet Tailors is \(175). Tablet Tailors sells the Internet access service independently for an upfront payment of \)300. On January 2, 2017, Tablet Tailors signed 100 contracts, receiving a total of \(50,000 in cash.

2. Tablet Bundle B includes the tablet and Internet service plus a service plan for the tablet PC (for any repairs or upgrades to the tablet or the Internet connections) during the 3-year contract period. That product bundle sells for \)600. Tablet Tailors provides the 3-year tablet service plan as a separate product with a standalone selling price of \(150. Tablet Tailors signed 200 contracts for Tablet Bundle B on July 1, 2017, receiving a total of \)120,000 in cash.

Instructions

(b) Prepare any journal entries to record the revenue arrangement for Tablet Bundle B on July 1, 2017, and December 31, 2017.

Explain the reporting for (a) costs to fulfill a contract and (b) collectibility.
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