Intermediate Accounting Volume 1, 11th Canadian Edition By Bruce J. McConomy – Test Bank
CHAPTER STUDY OBJECTIVES
1. Understand the economics and legalities of selling transactions from a business perspective. It is critical to understand a transaction from a business perspective before attempting to account for it. The analysis should begin with what is being sold to the customer (goods or services) and note also the nature and amount of the consideration. When one party is in a better bargaining position than the other, it may be able to negotiate concessions such as more lenient payment terms. These concessions often complicate the accounting as they introduce measurement uncertainty in many cases.
Selling transactions are based on contractual arrangements between a buyer and a seller. Contracts create rights and obligations under law that must be considered when accounting for the transactions. In addition to contractual law, rights and obligations may exist under other forms of the law, such as common law or contract law. These should also be considered.
2. Identify the five steps in the revenue recognition process. The five steps in the revenue recognition process are (1) identify the contract with customers, (2) identify the separate performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the separate performance obligations, and (5) recognize revenue when each performance obligation is satisfied.
3. Identify the contract with customers. A contract is an agreement that creates enforceable rights or obligations. A company applies the revenue guidance to contracts with customers and must determine if new performance obligations are created by a contract modification.
4. Identify the separate performance obligations in the contract. A performance obligation is a promise in a contract to provide a product or service to a customer. A contract may be composed of multiple performance obligations. The accounting for multiple performance obligations is based on evaluation of whether the product or service is distinct within the contract. If each of the goods or services is distinct, but is interdependent and interrelated, these goods and services are combined and reported as one performance obligation.
5. Determine the transaction price. The transaction price is the amount of consideration that a company expects to receive from a customer in exchange for transferring goods and services. In determining the transaction price, companies must consider the following factors: (1) variable consideration, (2) time value of money, (3) noncash consideration, and (4) consideration paid or payable to a customer.
6. Allocate the transaction price to the separate performance obligations. If more than one performance obligation exists in a contract, allocate the transaction price based on relative fair values. The best measure of fair value is what the good or service could be sold for on a stand-alone basis (stand-alone selling price). Estimates of stand-alone selling price can be based on (1) adjusted market assessment, (2) expected cost plus a margin approach, or (3) a residual approach.