5 Step model for revenue recognition:

1. Identify the contract -> Legal rights of the seller and customer established.
2. Identify performance obligation(s) -> Single or Multiple
3. Determine the transaction price -> Single; Amount seller is entitled to receive from a
customer. Multiple; Amount seller is entitled to receive from customer.
4. Allocate transaction price -> Single: no allocation required. Multiple: allocate a portion
to each performance obligation
5. Recognize revenue when (or as) each performance obligation is satisfied.

Distinct Performance obligations

 Selling arrangements can have multiple performance obligations if contract has distinct
goods.
 Distinct goods are items that can be sold on their own.

Revenue Recognized over time:

 Revenue is recognized over a period if any of these criteria are met:
1. The customer consumes the benefit of the sellers work or it is performed.
2. The customer controls the asset as it is created (example constructing a building
extension
3. The seller is creating an asset that has no alternative use to the seller and the seller
has the legal right to receive the payment for progress made.
 Revenue is recognized in proportion to the amount of performance obligation that has
been satisfied.

Tri box problem for allocating transaction price

 Tribox system is $250.
 Tribox module is $240.
 Trinet subscription is $60.
Equations: tribox module 240 / (240 + 60) = 80%, tribox sub = 60 / (240 + 60) = 20%
On January 1, 2021 true tech will record the revenue for the module (performance obligation is
fulfilled) but will defer the trinet subscription
Journal entry:
Accounts Receivable $250,000
Sales Revenue (250,000 * 80%) 200,000
Deferred Revenue (250000 * 205) 50,000

Recognizing Revenue at a Single Point in Time

 Indicators that determine when control has been transferred:
o An obligation to pay the seller
o Legal title to the asset
o Assumed the risks and rewards of ownership.
o Accepted the asset
*the indicators should be looked at separately and in combination*
 Revenue Recognition over a period
Recording revenue over time is based off the sellers estimate progress towards
completion
- Output based estimate: Measured as the proportion of the goods or services
transferred to date
- Input based estimate: Measured as the proportion of effort expended thus far
relative to the total effort expected to satisfy the performance obligation
Companies should choose the most appropriate method for their business.
Accounting expected sales return
- When accounting for sales returns we create a “contra-revenue’ account. Which has
the effects of reducing revenue
- Involves high degree of estimating
- Sellers report net sales revenue in the income statement, equal to gross sales
revenue less actual and estimated returns

Example of sales return, truetech sold 1000 tri-boxes to compstores for 240 each, true tech
estimates five percent of sales will be returned:
Sales Revenue (240 * 1000) 240000
Less: Estimated returns (5%) (12000)
Net Sales Revenue 228000

Performance obligation of principal: To provide goods and services (so is vulnerable to risks
associated with holding inventory)

Performance obligation of agent: To facilitate a transaction between a principal and customer

Recording revenue of principal: Total sales price paid by customers, also recognizes COGS
Recording revenue of agent: only the commission it receives on the transaction

Licenses: Licenses allow the customner to access the sellers intellectual property (IP)
Licenses of functional IP transfer a right of use, so sellers typically recognize revenue at a point
in time
- Has significant standalone functionality (can perform a function or task, or be played
or aired)
- The benefit the customer receives from the license isn’t affected by the seller’s
ongoing activity
- Therefore, viewed as transferring a right of use (ex. A music download)
So, when should revenue be recognized?
-Revenue is recorded at the time the customer can use the IP
Symbolic IP: transfer sellers IP with the understanding that the seller will undertake ongoing
activities.
- Lacks standalone functionality
- The benefit the customer receives from the license is affected by the sellers ongoing
activity
 - License transfers a right of access, examples include; trademarks, brand names,
logos, franchise rights.
Exception: Functional IP is viewed as transferring a right to access (and requiring revenue
recognition over time) if both
- The seller is expected to change the functionality over time and
- The customer is required to use the updated version
- Example being virus protection software

Consignment Arrangement
- The consignor physically transfers the goods to the other company (the consignee),
but the legal title stays with the consignor.
- If a buyer is found, the consignee remits the selling price (less commission and
approved costs) to the consignor
- If the consignee can’t find a buyer within an agreed upon time, the consignee
returns the goods to the consignor.
- Given that the consignor retains the risks of ownership, it postpones revenue
recognition until the sale to a third party occurs
Gift Cards
- Sales of gift cards are recognized as deferred revenue liability and then
- Revenue is recognized in proportion to the pattern of rights exercised by the
customer
- The amount of the gift card that is not expected to be redeemed is referred to as
“breakage”
- If entity is unable to estimate the breakage amount, revenue for the unused portion
of the gift card is recognized when the likelihood of the customer exercising its rights
becomes remote
Accounting for long term contracts
Steps 2 & 5 are critical for long term contracts
Step 2: identify the performance obligations.
- Usually have a single performance obligation because don’t meet the “separately
identifiable: criterion necessary for goods and services to be viewed distinct
- Step 5: Recognize revenue when (or as) each performance obligation is satisfied.
- Recognizing revenue over time according to the progress toward completion
- i.e. long term contracts often qualify.
- Recognizing revenue upon contract completion
Recognizing revenue over time according to percentage of completion
Revenue recognized this period = (total estimated revenue * percentage completed to date) –
revenue recognized in prior periods
Cash and cash equivalents
Cash: Amounts readily available to pay off debt or to use in operations
Examples: Currency and coins, Balances in checking accounts

Cash Equivalents: Short term, highly liquid investments, readily convertible to cash with
little risk of loss
Have a maturity date no longer than three months from the date of purchase
Examples: Money market funds, treasury bills, and commercial paper

Accounting for Sales returns

Accounts affected: Cash & Sales revenue are debit and credit for a Sales journal entry,
the second part of the entry affects COGS and inventory (COGS Dbt. INV Cdt.)

Accounts affected for a sales return is Sales return and cash, and second part is
inventory and COGS

Accounts for additional sales return: if additional returns occurred, the journal entries
are Refund liability and cash. And Inventory and inventory est. returns

Allowance for bad debt

Accounts affected, bad debt expense and allowance for uncollectable Accts

Receivables turnover ratio and Average collection period are designed to monitor
receivables

Receivables turnover ratio = Net sales / Avg Accounts receivables (net)\

Average collection period = 365 days / receivables turnover ratio

Effective rate = to save $2 on $100 purchase customer must pay $98 20 days earlier
2/10 n/30
Recording revenue using the net method is more conceptually accurate because it more
accurately reflects the amount the seller expects to be entitled to receive