Revenue 18

18-1
PREVIEW OF CHAPTER 18
Intermediate Accounting
16th Edition
Kieso ● Weygandt ● Warfield
18-2
18 Revenue Recognition
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Understand the fundamental 3 Apply the five-step process to
concepts related to revenue major revenue recognition
recognition and measurement. issues.
2 Understand and apply the 4 Describe presentation and
five-step revenue recognition disclosure regarding revenue.
process.
18-3 LO 1
FUNDAMENTALS OF REVENUE
RECOGNITION
Recently, the FASB and IASB issued a converged standard
on revenue recognition entitled Revenue from Contracts
with Customers (IFRS15).
To address the inconsistencies and weaknesses of the
previous approaches, a comprehensive revenue recognition
standard now applies to a wide
range of transactions and
industries.
18-4 LO 1
New Revenue Recognition Standard
Revenue from Contracts with Customers adopts an

asset-liability approach. Companies:
◆ Account for revenue based on the asset or liability arising
from contracts with customers.
◆ Are required to analyze contracts with customers
Contracts indicate terms and measurement of

consideration.
Without contracts, companies cannot know whether

promises will be met.
18-5 LO 1
New Revenue Recognition Standard
ILLUSTRATION 18-1 Key Concepts of Revenue Recognition
18-6
Performance Obligation is Satisfied LO 1
The Five-Step Process—Boeing Example
Assume that Boeing Corporation signs a contract to sell airplanes to
Delta Air Lines for $100 million.
ILLUSTRATION 18-2
Five Steps of Revenue Recognition
A contract is an agreement between two parties

Step 1: Identify the
that creates enforceable rights or obligations. In
contract
this case, Boeing has signed a contract to deliver
with customers.
airplanes to Delta.
Step 2: Identify the Boeing has only one performance obligation—to

separate performance deliver airplanes to Delta. If Boeing also agreed to
obligations in the maintain the planes, a separate performance
contract. obligation is recorded for this promise.
18-7 LO 1
The Five-Step Process
ILLUSTRATION 18-2 Five Steps of Revenue Recognition
Transaction price is the amount of consideration

Step 3: Determine that a company expects to receive from a
the transaction customer in exchange for transferring a good or
price. service. In this case, the transaction price is
straightforward—it is $100 million.
Step 4: Allocate the

transaction price to
In this case, Boeing has only one performance
the separate
obligation—to deliver airplanes to Delta.
performance
obligations.
18-8 LO 1
The Five-Step Process
ILLUSTRATION 18-2 Five Steps of Revenue Recognition
Step 5: Recognize
Boeing recognizes revenue of $100 million for the
revenue when
sale of the airplanes to Delta when it satisfies its
each performance
performance obligation—the delivery of the
obligation
airplanes to Delta.
is satisfied.
18-9 LO 1
LEARNING OBJECTIVES
process.
18-10 LO 2
Identifying Contract with
Customers—Step 1
Contract:
◆ Agreement between two or more parties that creates
enforceable rights or obligations.
◆ Can be
written,
oral, or
implied from customary business practice.
18-11 LO 2
Identifying Contract with
Customers—Step 1
Company applies the revenue guidance to a contract
according to the following criteria:
1. The contract has commercial substance.
2. The parties have approved the contract
3. Identification of the rights of the parties is established
4. Payment terms are identified
5. It is probable that the consideration will be collected.
18-12 LO 2
Identifying Contract—Step 1 ILLUSTRATION 18-3
Basic Revenue Transaction
CONTRACTS AND RECOGNITION

Facts: On March 1, 2017, Margo Company enters into a contract to transfer a
product to Soon Yoon on July 31, 2017. The contract is structured such that
Soon Yoon is required to pay the full contract price of $5,000 on August 31,
2017.The cost of the goods transferred is $3,000. Margo delivers the product to
Soon Yoon on July 31, 2017.
Question: What journal entries should Margo Company make in regards to
this contract in 2017?
The journal entry to record the sale and related cost of goods sold is as follows.
July 31, 2017
Accounts Receivable 5,000
Sales Revenue 5,000
Cost of Goods Sold 3,000
Inventory 3,000
18-13 LO 2
Identifying Contract—Step 1 ILLUSTRATION 18-3
Basic Revenue Transaction
CONTRACTS AND RECOGNITION

Facts: On March 1, 2017, Margo Company enters into a contract to transfer a
product to Soon Yoon on July 31, 2017. The contract is structured such that
Soon Yoon is required to pay the full contract price of $5,000 on August 31,
2017.The cost of the goods transferred is $3,000. Margo delivers the product to
Soon Yoon on July 31, 2017.
Question: What journal entries should Margo Company make in regards to
this contract in 2017?
Margo makes the following entry to record the receipt of cash on August 31, 2017.
August 31, 2017
Cash 5,000
18-14 LO 2
Separate Performance Obligations—Step
2
A performance obligation is a promise to provide a distinct
product or service to a customer.
A product or service is distinct when a customer is able to
◆ benefit from a good or service on its own or
◆ together with other readily available resources.
The objective is to determine whether the nature of a

company’s promise is to transfer individual goods and services
to the customer or to transfer a combined item (or items) for
which individual goods or services are inputs.
18-15 LO 2
2
ILLUSTRATION
Assume that General Motors sells an automobile to Marquart Auto

Dealers at a price that includes six months of telematics services such as
navigation and remote diagnostics. These telematics services are
regularly sold on a standalone basis by General Motors for a monthly
fee. After the six-month period, the consumer can renew these services
on a fee basis with General Motors. The question is whether General
Motors sold one or two products.
If we look at General Motors’ objective, it appears that it is to sell two
goods, the automobile and the telematic services. Both are distinct
(they can be sold separately) and are not interdependent.
18-16 LO 2
2
ILLUSTRATION
SoftTech Inc. licenses customer-relationship software to Lopez

Company. In addition to providing the software itself, SoftTech promises
to provide consulting services by extensively customizing the software to
Lopez’s information technology environment, for a total consideration of
$600,000. In this case, SoftTech is providing a significant service by
integrating the goods and services (the license and the consulting
service) into one combined item for which Lopez has contracted. In
addition, the software is significantly customized by SoftTech in
accordance with specifications negotiated by Lopez. Do these facts
describe a single or separate performance obligation?
The license and the consulting services are distinct but interdependent,
and therefore should be accounted for as one performance obligation.
18-17 LO 2
Determining the Transaction Price—Step
3
Transaction price
◆ Amount of consideration that company expects to receive
from a customer.
◆ In a contract is often easily determined because

customer agrees to pay a fixed amount.
◆ Other contracts, companies must consider:

Variable consideration
Time value of money
Noncash consideration
Consideration paid or payable to the customer
18-18 LO 2
3
Variable Consideration
◆ Price dependent on future events.
Might include discounts, rebates, credits, performance
bonuses, or royalties.
◆ Companies estimate amount of revenue to recognize.

Expected value
Most likely amount
18-19 LO 2
3
ILLUSTRATION 18-4 Estimating Variable Consideration
Expected Value: Probability-weighted amount in a range of possible

consideration amounts.
▪ May be appropriate if a company has a large number of contracts with
similar characteristics.
▪ Can be based on a limited number of discrete outcomes and probabilities.
Most Likely Amount: The single most likely amount in a range of possible
consideration outcomes.
▪ May be appropriate if the contract has only two possible outcomes.
18-20 LO 2
Variable Consideration ILLUSTRATION 18-5
Transaction Price
ESTIMATING VARIABLE CONSIDERATION

Facts: Peabody Construction Company enters into a contract with a
customer to build a warehouse for $100,000, with a performance bonus of
$50,000 that will be paid based on the timing of completion. The amount of
the performance bonus decreases by 10% per week for every week beyond
the agreed-upon completion date. The contract requirements are similar to
contracts that Peabody has performed previously, and management believes
that such experience is predictive for this contract. Management estimates
that there is a 60% probability that the contract will be completed by the
agreed-upon completion date, a 30% probability that it will be completed 1
week late, and only a 10% probability that it will be completed 2 weeks late.
Question: How should Peabody account for this revenue arrangement?
18-21 LO 2
Variable Consideration ILLUSTRATION 18-5
Transaction Price
Question: How should Peabody account for this revenue arrangement?

Management has concluded that the probability-weighted method is the
most predictive approach:
60% chance of $150,000 = $ 90,000
30% chance of $145,000 = 43,500
10% chance of $140,000 = 14,000
$147,500
Most likely outcome, if management believes they will meet the deadline
and receive the $50,000 bonus, the total transaction price would be?
$150,000 (the outcome with 60% probability)
18-22 LO 2
Variable Consideration
◆ Only allocate variable consideration if it is reasonably
assured that it will be entitled to the amount.
◆ Companies only recognizes variable consideration if
1. they have experience with similar contracts and are

able to estimate the cumulative amount of revenue,
and
2. based on experience, they do not expect a significant

reversal of revenue previously recognized.
If these criteria are not met, revenue recognition is

constrained.
18-23 LO 2
3
Time Value of Money
◆ When contract (sales transaction) involves a significant
financing component.
Interest accrued on consideration to be paid over

time.
Fair value determined either by measuring the

consideration received or by discounting the payment
using an imputed interest rate.
Company reports as interest expense or interest

revenue.
18-24 LO 2
Time Value of Money ILLUSTRATION 18-7
Transaction Price
-Extended Payment Terms
EXTENDED PAYMENT TERMS

Facts: On July 1, 2017, SEK Company sold goods to Grant Company for $900,000
in exchange for a 4-year, zero-interest-bearing note with a face amount of
$1,416,163. The goods have an inventory cost on SEK’s books of $590,000.
Questions: (a) How much revenue should SEK Company record on July 1,
2017? (b) How much revenue should it report related to this transaction on
December 31, 2017?
Entry to record SEK’s sale to Grant Company on July 1, 2017, is as follows.

Notes Receivable 1,416,163
Sales Revenue 900,000
Discount on Notes Receivable 516,163
Inventory 590,000
18-25 LO 2
Time Value of Money ILLUSTRATION 18-7
Transaction Price
-Extended Payment Terms
EXTENDED PAYMENT TERMS

Facts: On July 1, 2017, SEK Company sold goods to Grant Company for $900,000
in exchange for a 4-year, zero-interest-bearing note with a face amount of
$1,416,163. The goods have an inventory cost on SEK’s books of $590,000.
Questions: (a) How much revenue should SEK Company record on July 1,
2017? (b) How much revenue should it report related to this transaction on
December 31, 2017?
Entry to record interest revenue (imputed rate12%) at the end of the year,
December 31, 2017.
Discount on Notes Receivable 54,000
Interest Revenue (12% x ½ x $900,000) 54,000

Companies are not required to reflect the time value of money if the time period
for payment is less than a year.
18-26 LO 2
3
Noncash Consideration
Goods, services, or other noncash consideration.
◆ Companies sometimes receive contributions (e.g.,
donations and gifts).
◆ Customers sometimes contribute goods or services, such

as equipment or labor, as consideration for goods
provided or services performed.
◆ Companies generally recognize revenue on the basis of

the fair value of what is received.
18-27 LO 2
3
Consideration Paid or Payable to Customers
◆ May include discounts, volume rebates, coupons, free
products, or services.
◆ In general, these elements reduce the consideration

received and the revenue to be recognized.
18-28 LO 2
Consideration Paid or Payable ILLUSTRATION 18-8
Transaction Price –
Volume Discount
VOLUME DISCOUNT
Facts: Sansung Company offers its customers a 3% volume discount if they
purchase at least $2 million of its product during the calendar year. On March 31,
2017, Sansung has made sales of $700,000 to Artic Co. In the previous 2 years,
Sansung sold over $3,000,000 to Artic in the period April 1 to December 31.
Questions: How much revenue should Sansung recognize for the first 3
months of 2017?
Sansung makes the following entry on March 31, 2017.

Sansung should reduce its revenue by $21,000 ($700,000 x 3%) because it is

probable that it will provide this rebate.
18-29 LO 2
Consideration Paid or Payable ILLUSTRATION 18-8
Transaction Price –
Volume Discount
Questions: How much revenue should Sansung recognize for the first 3
months of 2017?
Assuming Sansung’s customer meets the discount threshold, Sansung makes

the following entry.
Cash 679,000
If Sansung’s customer fails to meet the discount threshold, Sansung makes the
following entry upon payment.
Cash 700,000
Sales Discounts Forfeited 21,000
18-30 LO 2
Allocating Transaction Price to Separate
Performance Obligations—Step 4
◆ Based on their relative fair values.
◆ Best measure of fair value is what the company could

sell the good or service for on a standalone basis.
◆ If not available, companies should use their best

estimate of what the good or service might sell for as a
standalone unit.
18-31 LO 2
Allocating Transaction Price to Separate
Performance Obligations—Step 4 ILLUSTRATION 18-9
Transaction Price
Allocation
18-32 LO 2
ILLUSTRATION 18-12
Allocating Transaction Price Multiple Performance
Obligations—Product,
Installation, and Service
MULTIPLE PERFORMANCE OBLIGATIONS
Facts: Sansung Handler Company is an established manufacturer of

equipment used in the construction industry. Handler’s products range
from small to large individual pieces of automated machinery to complex
systems containing numerous components. Unit selling prices range
from $600,000 to $4,000,000 and are quoted inclusive of installation and
training. The installation process does not involve changes to the
features of the equipment and does not require proprietary information
about the equipment in order for the installed equipment to perform to
specifications.
18-33 (continued) LO 2
ILLUSTRATION 18-12
Handler has the following arrangement with Chai Company.

• Chai purchases equipment from Handler for a price of $2,000,000
and chooses Handler to do the installation. Handler charges the same
price for the equipment irrespective of whether it does the installation
or not. (Some companies do the installation themselves because they
either prefer their own employees to do the work or because of
relationships with other customers.) The installation service included
in the arrangement is estimated to have a standalone selling price of
$20,000.
ILLUSTRATION 18-12
Handler has the following arrangement with Chai Company.

• The standalone selling price of the training sessions is estimated at
$50,000. Other companies can also perform these training services.
• Chai is obligated to pay Handler the $2,000,000 upon the delivery
and installation of the equipment.
• Handler delivers the equipment on September 1, 2017, and
completes the installation of the equipment on November 1, 2017
(transfer of control is complete). Training related to the equipment
starts once the installation is completed and lasts for 1 year. The
equipment has a useful life of 10 years.
ILLUSTRATION 18-12
Question: (a) What are the performance obligations for purposes

of accounting for the sale of the equipment?
Handler’s primary objective is to sell equipment. The other services

(installation and training) can be performed by other parties if necessary.
As a result, the equipment, installation, and training are three separate
products or services. Each of these items has a standalone selling price
and is not interdependent.
ILLUSTRATION 18-12
Question: (b) If there is more than one performance obligation,

how should the payment of $2,000,000 be allocated to various
components?
The total revenue of $2,000,000 should be allocated to the three

components based on their relative standalone selling prices. In this
case, the standalone selling price of the equipment is $2,000,000, the
installation fee is $20,000, and the training is $50,000. The total
standalone selling price therefore is $2,070,000 ($2,000,000 + $20,000 +
$50,000). The allocation is as follows.
Equipment $1,932,367 [($2,000,000 ÷ $2,070,000) × $2,000,000]
Installation $19,324 [($20,000 ÷ $2,070,000) × $2,000,000]
Training $48,309 [($50,000 ÷ $2,070,000) × $2,000,000]
ILLUSTRATION 18-12

components?
Handler makes the following entry on November 1, 2017, to record both

sales revenue and service revenue on the installation, as well as
unearned service revenue.
November 1, 2017
Cash 2,000,000
Service Revenue (installation) 19,324
Unearned Service Revenue 48,309
Sales Revenue 1,932,367
ILLUSTRATION 18-12

components?
Assuming the cost of the equipment is $1,500,000, the entry to record

cost of goods sold is as follows.
November 1, 2017
Cost of Goods Sold 1,500,000
Inventory 1,500,000
As indicated by these entries, Handler recognizes revenue from the sale

of the equipment once the installation is completed on November 1,
2017. In addition, it recognizes revenue for the installation fee because
these services have been performed.
ILLUSTRATION 18-12

components?
Handler recognizes the training revenues on a straight-line basis starting

on November 1, 2017, or $4,026 ($48,309 ÷ 12) per month for 1 year
(unless a more appropriate method such as the
percentage-of-completion method—discussed in the next section—is
warranted). The journal entry to recognize the training revenue for 2
months in 2017 is as follows.
December 31, 2017
Service Revenue (training) ($4,026 × 2) 8,052
ILLUSTRATION 18-12

components?
Therefore, Handler recognizes revenue at December 31, 2017, in the

amount of $1,959,743 ($1,932,367 + $19,324 + $8,052). Handler makes
the following journal entry to recognize the remaining training revenue in
2018, assuming adjusting entries are made at year-end.
December 31, 2018

Service Revenue (training) ($48,309 − $8,052) 40,257
18-41 LO 2
Recognizing Revenue When (or as) Each
Performance Obligation Is Satisfied—Step
5
Company satisfies its performance obligation when the
customer obtains control of the good or service.
Change in Control Indicators

1. Company has a right to payment for asset.
2. Company has transferred legal title to asset.
3. Company has transferred physical possession of asset.
4. Customer has significant risks and rewards of ownership.
5. Customer has accepted the asset.
18-42 LO 2
5
Recognizing revenue from a performance obligation over
time
► Measure progress toward completion
Method for measuring progress should depict transfer

of control from company to customer.
Objective of methods is to measure extent of progress

in terms of costs, units, or value added.
18-43 LO 2
5Step in Process Description Implementation
1. Identify the A contract is an A company applies the revenue

contract with agreement that creates guidance to contracts with
customers. enforceable rights or customers.
obligations.
ILLUSTRATION 18-15
Summary of the
Five-Step Revenue
Recognition Process
18-44 LO 2
2. Identify the A performance obligation A contract may be comprised of

separate is a promise in a contract multiple performance
performance to provide a product or obligations.
obligations service to a customer. Accounting is based on
in the A performance obligation evaluation of whether the
contract exists if the customer can product or service is distinct
benefit from the good or within the contract.
service on its own or If each of the goods or services
together with other readily is distinct, but is interdependent
available resources. and interrelated, these goods
and services are combined and
ILLUSTRATION 18-15
Summary of the reported as one performance
Five-Step Revenue obligation.
Recognition Process
18-45 LO 2
3. Determine Transaction price is the In determining the transaction

the amount of consideration price, companies must consider
transaction that a company expects to the following factors:
price. receive from a customer 1. variable consideration,
in exchange for
2. time value of money,
transferring goods and
services. 3. noncash consideration, and
4. consideration paid or
payable to customer.
ILLUSTRATION 18-15
Summary of the
Five-Step Revenue
Recognition Process
18-46 LO 2
4. Allocate the If more than one The best measure of fair value
transaction performance obligation is what the good service could
price to the exists, allocate the be sold for on a standalone
separate transaction price based basis (standalone selling price).
performance on relative fair values. Estimates of standalone selling
obligation. price can be based on
1. adjusted market
assessment,
2. expected cost plus a margin
approach, or
ILLUSTRATION 18-15 3. a residual approach.
Summary of the
Five-Step Revenue
Recognition Process
18-47 LO 2
5. Recognize A company satisfies its Companies satisfy performance

revenue performance obligation obligations either at a point in
when each when the customer time or over a period of time.
performance obtains control of the Companies recognize revenue
obligation is good or service. over a period of time if one of
satisfied. following criteria are met:
1. the customer receives and
consumes the benefits as
the seller performs,
2. the customer controls the
asset as it is created,
ILLUSTRATION 18-15 3. the company does not have
Summary of the
Five-Step Revenue
an alternative use for the
Recognition Process asset.
18-48 LO 2
LEARNING OBJECTIVES
process.
18-49 LO 3
ACCOUNTING FOR REVENUE
RECOGNITION ISSUES
◆ Sales returns and allowances
◆ Repurchase agreements
◆ Bill and hold
◆ Principal-agent relationships
◆ Consignments
◆ Warranties
◆ Nonrefundable upfront fees
18-50 LO 3
Sales Returns and Allowances
◆ Right of return is granted for product for various
reasons (e.g., dissatisfaction with product).
◆ Company returning the product receives any

combination of the following.
1. Full or partial refund of any consideration paid.
2. Credit that can be applied against amounts owed,

or that will be owed, to the seller.
3. Another product in exchange.
18-51 LO 3
Credit Sales with Returns and
Allowances
Illustration: On January 12, 2017, Venden Company sells 100
cameras for $100 each on account to Amaya Inc. Venden allows
Amaya to return any unused cameras within 45 days of purchase.
The cost of each product is $60. Venden estimates that:
1. Three products will be returned.
2. The costs of recovering the products will be immaterial.
3. The returned products are expected to be resold at a profit.
On January 24, Amaya returns two of the cameras because they
were the wrong color. On January 31, Venden prepares financial
statements and determines that it is likely that only one more camera
will be returned. Venden makes the following entries related to these
transactions.
18-52 LO 3
Allowances
The cost of each product is $60. Venden makes the following entries
To record the sale of the cameras and related cost of goods
sold on January 12, 2017.

Sales Revenue (100 × $100) 10,000
Inventory (100 × $60) 6,000
18-53 LO 3
Allowances
The cost of each product is $60. Venden makes the following entries
To record the return of the two cameras on January 24, 2017.
Sales Returns and Allowances 200

Accounts Receivable (2 × $100) 200
Returned Inventory 120
Cost of Goods Sold (2 × $60) 120
18-54 LO 3
Allowances
Illustration: On January 31, 2017, Venden prepares financial
statements. As indicated earlier, Venden originally estimated that the
most likely outcome was that three cameras would be returned.
Venden believes the original estimate is correct and makes the
following adjusting entries to account for expected returns at January
31, 2017.
Sales Returns and Allowances (1 × $100) 100

Allowance for Sales Returns and Allowances 100
Estimated Inventory Returns 60
18-55 LO 3
Allowances
Venden’s income statement for the month ending of January 31,
2017.
ILLUSTRATION 18-16
Venden’s balance sheet as of January 31, 2017.
ILLUSTRATION 18-17
18-56 LO 3
Cash Sales with Returns and Allowances
Illustration: Assume now that Venden sold the cameras to Amaya

for cash instead of on account. In this situation, Venden makes the
following entries related to these transactions.
To record the sale of the cameras and related cost of goods
sold on January 12, 2017.
Cash 10,000
Sales Revenue (100 × $100) 10,000
Inventory (100 × $60) 6,000
18-57 LO 3
Illustration: Assuming that Venden did not pay cash at the time of
the return of the two cameras to Amaya on January 24, 2017, the
entries to record the return of the two cameras and related cost of
goods sold are as follows.

Accounts Payable (2 × $100) 200
Returned Inventory 120
18-58 LO 3
Illustration: On January 31, 2017, Venden prepares financial

statements. As indicated earlier, Venden estimates that the most
likely outcome is that one more camera will be returned. Venden
therefore makes the following adjusting entries.

Accounts Payable (1 × $100) 100
Estimated Inventory Returns 60
18-59 LO 3
Venden’s income statement for the month ending of January 31,

2017.
ILLUSTRATION 18-18
Venden’s balance sheet as of January 31, 2017.
ILLUSTRATION 18-19
18-60 LO 3
Repurchase Agreements
◆ Allows company to transfer an asset to a customer but
have an unconditional (forward) obligation or
unconditional right (call option) to repurchase the asset
at a later date.
◆ If obligation or right to repurchase is for an amount

greater than or equal to selling price, then
transaction is a financing transaction.
18-61 LO 3
Repurchase Agreements ILLUSTRATION 18-20
Recognition—Repurchase
Agreement
REPURCHASE AGREEMENT
Facts: Morgan Inc., an equipment dealer, sells equipment on January 1,
2017, to Lane Company for $100,000. It agrees to repurchase this
equipment on December 31, 2018, for a price of $121,000.
Question: Should Morgan Inc. record this transaction?

Assuming an interest rate of 10 percent is imputed from the agreement,
Morgan makes the following entry to record the financing on January 1, 2017.
Cash 100,000
Liability to Lane Company 100,000
18-62 LO 3
Repurchase Agreements ILLUSTRATION 18-20
Recognition—Repurchase
Agreement
Question: Should Morgan Inc. record this transaction?

Morgan Inc. records interest on December 31, 2017, as follows.
Interest Expense 10,000

Liability to Lane Company ($100,000 x 10%) 10,000
Morgan Inc. records interest and retirement of its liability to Lane Company
on December 31, 2018, as follows.
Interest Expense 11,000

Liability to Lane Company ($110,000 x 10%) 11,000
Liability to Lane Company 121,000

Cash ($100,000 + $10,000 + $11,000) 121,000
18-63 LO 3
Bill-and-Hold Arrangements
◆ Contract under which an entity bills a customer for a
product but the entity retains physical possession of
the product until a point in time in the future.
◆ Result when buyer is not yet ready to take delivery but

does take title and accepts billing.
18-64 LO 3
Bill-and-Hold Arrangements ILLUSTRATION 18-21
Recognition—Bill and Hold
BILL AND HOLD

Facts: Butler Company sells $450,000 (cost $280,000) of fireplaces on
March 1, 2017, to a local coffee shop, Baristo, which is planning to expand
its locations around the city. Under the agreement, Baristo asks Butler to
retain these fireplaces in its warehouses until the new coffee shops that will
house the fireplaces are ready. Title passes to Baristo at the time the
agreement is signed.
Question: When should Butler recognize the revenue from this

bill-and-hold arrangement?
Butler determines when it has satisfied its performance obligation to transfer a
product by evaluating when Baristo obtains control of that product.
18-65 LO 3

For Baristo to have obtained control of a product in a bill-and-hold

arrangement, all of the following criteria should be met:
(a) The reason for the bill-and-hold arrangement must be substantive.
(b) The product must be identified separately as belonging to Baristo.
(c) The product currently must be ready for physical transfer to Baristo.
(d) Butler cannot have the ability to use the product or to direct it to another
customer.
In this case, it appears that the above criteria were met, and therefore
revenue recognition should be permitted at the time the contract is signed.
18-66 LO 3

Butler makes the following entry to record the sale.

Accounts receivable 450,000
Butler makes an entry to record the related cost of goods sold as follows.
Inventory 280,000
18-67 LO 3
Principle-Agent Relationships
◆ Agent’s performance obligation is to arrange for principal
to provide goods or services to a customer.
◆ Examples:
Travel Company (agent) facilitates booking of cruise
for Cruise Company (principal).
Priceline (agent) facilitates sale of various services
such as car rentals at Hertz (principal).
◆ Amounts collected on behalf of the principal are not

revenue of the agent.
Revenue for agent is amount of commission received.
18-68 LO 3
Consignments
◆ Manufacturers (or wholesalers) deliver goods but
retain title to the goods until they are sold.
◆ Consignor (manufacturer or wholesaler) ships

merchandise to the consignee (dealer), who is to act
as an agent for the consignor in selling the
merchandise.
◆ Consignor makes a profit on the sale.

Carries merchandise as inventory.
◆ Consignee makes a commission on the sale.
18-69 LO 3
Consignments ILLUSTRATION 18-23
Recognition—Sales on
Consignment
18-70 LO 3
Consignments ILLUSTRATION 18-23
Recognition—Sales on
Consignment
18-71 LO 3
WHAT DO THE NUMBERS MEAN? GROSSED
WHAT’S OUT
YOUR PRINCIPLE
As you learned in Chapter 4, many corporate executives obsess over the bottom
line. However, analysts on the outside look at the big picture, which includes
examination of both the top line and the important subtotals in the income
statement, such as gross profit. Not too long ago, the top line caused some
concern, with nearly all companies in the S&P 500 reporting a 2 percent decline in
the bottom line while the top line saw revenue decline by 1 percent. This was
troubling because it was the first decline in revenues since we crawled out of the
recession following the financial crisis. McDonald’s gave an ominous preview—it
saw its first monthly sales decline in nine years. And the United States, rather than
foreign markets, led the drop. What about income subtotals like gross margin?
These metrics too have been under pressure. There is concern that struggling
companies may employ a number of manipulations to mask the impact of gross
margin declines on the bottom line. In fact, Rite Aid prepares an income statement
that omits the gross margin subtotal. Rite Aid has used a number of suspect
accounting adjustments related to tax allowances and inventory gains to offset its
weak gross margin. Or, consider the classic case of Priceline.com, the company
made famous by William Shatner’s ads about “naming your own price” for airline
tickets and hotel rooms. In one quarter, Priceline reported that it earned
WHAT DO THE NUMBERS MEAN? GROSSED
WHAT’S OUT
YOUR PRINCIPLE
$152 million in revenues. But, that included the full amount customers paid for
tickets, hotel rooms, and rental cars. Traditional travel agencies call that amount
“gross bookings,” not revenues. And, much like regular travel agencies, Priceline
keeps only a small portion of gross bookings—namely, the spread between the
customers’ accepted bids and the price it paid for the merchandise. The rest, which
Priceline calls “product costs,” it pays to the airlines and hotels that supply the
tickets and rooms. However, Priceline’s product costs came to $134 million, leaving
Priceline just $18 million of what it calls “gross profit” and what most other
companies would call revenues. And that’s before all of Priceline’s other costs—like
advertising and salaries—which netted out to a loss of $102 million. The difference
isn’t academic. Priceline shares traded at about 23 times its reported revenues but
at a mind-boggling 214 times its “gross profit.” This and other aggressive
recognition practices explain the stricter revenue recognition guidance, indicating
that if a company performs as an agent or broker without assuming the risks and
rewards of ownership of the goods, the company should report sales on a net (fee)
basis.
Sources: Jeremy Kahn, “Presto Chango! Sales Are Huge,” Fortune (March 20, 2000), p. 44; A. Catanach and E. Ketz,
“RITE AID: Is Management Selling Drugs or Using Them?” Grumpy Old Accountants (August 22, 2011); and S. Jakab,
“Weak Revenue Is New Worry for Investors,” Wall Street Journal (November 25, 2012).
18-73 LO 3
Warranties
Two types of warranties to customers:

1. Product meets agreed-upon specifications in contract at
time product is sold.
◆ Warranty is included in sales price (assurance-type

warranty).
2. Not included in sales price of product (service-type

warranty).
◆ Recorded as a separate performance obligation.
18-74 LO 3
Warranties ILLUSTRATION 18-24
Performance Obligations
and Warranties
WARRANTIES
Facts: Maverick Company sold 1,000 Rollomatics on October 1, 2017, at
total price of $6,000,000, with a warranty guarantee that the product was
free of defects. The cost of the Rollomatics is $4,000,000. The term of this
assurance warranty is 2 years, with an estimated cost of $80,000. In
addition, Maverick sold extended warranties related to 400 Rollomatics for 3
years beyond the 2-year period for $18,000. On November 22, 2017,
Maverick incurred labor costs of $3,000 and part costs of $25,000 related to
the assurance warranties. Maverick prepares financial statements on
December 31, 2017. It estimates that its future assurance warranty costs will
total $44,000 at December 31, 2017.
Question: What are the journal entries that Maverick should make
in 2017 related to the sale and the assurance and extended
warranties?
18-75 LO 3
and Warranties
Question: What are the journal entries that Maverick Company

should make in 2017 related to the sale and the related warranties?
To record the sale of the Rollomatics and the related extended warranties on
October 1, 2017:
Cash ($6,000,000 + $18,000) 6,018,000
Sales Revenue 6,000,000
Unearned Warranty Revenue 18,000
To reduce inventory and recognize cost of goods sold:
Cost of Goods Sold 4,000,000

Inventory 4,000,000
18-76 LO 3
and Warranties
Question: What are the journal entries that Maverick Company

should make in 2017 related to the sale and the related warranties?
To record the warranty costs incurred on November 22, 2017:
Warranty Expense 28,000

Salaries and Wages Payable 3,000
Inventory (parts) 25,000
To record the adjusting entry related to its assurance warranty at the end of
the year, December 31, 2017:
Warranty Expense 44,000

Warranty Liability 44,000
18-77 LO 3
Nonrefundable Upfront Fees
◆ Payments from customers before
Delivery of a product
Performance of a service
◆ Generally relate to initiation, activation, or setup of a

good or service to be provided or performed in the
future.
◆ Most cases, upfront payments are nonrefundable.

Examples include:
▪ Membership fee in a health club
▪ Activation fees for phone, Internet, or cable
18-78 LO 3
LEARNING OBJECTIVES
process.
18-79 LO 4
PRESENTATION AND DISCLOSURE
Presentation
Contract Assets and Liabilities
◆ Contract assets are of two types:
1. Unconditional rights to receive consideration
because company has satisfied its performance
obligation.
2. Conditional rights to receive consideration

because company has satisfied one performance
obligation but must satisfy another performance
obligation before it can bill the customer.
18-80 LO 4
Presentation ILLUSTRATION 18-27
Contract Asset Recognition
and Presentation
CONTRACT ASSET
Facts: On January 1, 2017, Finn Company enters into a contract to transfer
Product A and Product B to Obermine Co. for $100,000. The contract
specifies that payment of Product A will not occur until Product B is also
delivered. In other words, payment will not occur until both Product A and
Product B are transferred to Obermine. Finn determines that standalone
prices are $30,000 for Product A and $70,000 for Product B. Finn delivers
Product A to Obermine on February 1, 2017. On March 1, 2017, Finn
delivers Product B to Obermine.
Question: What journal entries should Finn Company make in

regards to this contract in 2017?
18-81 LO 4
Contract Asset Recognition
and Presentation
Question: What journal entries should Finn Company make in

regards to this contract in 2017?
On February 1, 2017, Finn records the following entry:

Contract Asset 30,000
On February 1, Finn does not record an accounts receivable because it does

not have an unconditional right to receive the $100,000 unless it also
transfers Product B to Obermine. When Finn transfers Product B on March
1, 2017, it makes the following entry.

Contract Asset 30,000
18-82 LO 4
Contract Liability Recognition
and Presentation
CONTRACT LIABILITY
Facts: On March 1, 2017, Henly Company enters into a contract to transfer
a product to Propel Inc. on July 31, 2017. It is agreed that Propel will pay the
full price of $10,000 in advance on April 15, 2017. Henly delivers the product
on July 31, 2017. The cost of the product is $7,500.
Question: What journal entries are required in 2017?
No entry is required on March 1, 2017:

Neither party has performed on the contract.
18-83 LO 4
Contract Liability Recognition
and Presentation
Question: What journal entries are required in 2017?
Henly should make the following entry on April 15, 2017.

Cash 10,000
Unearned Sales Revenue 10,000
On satisfying the performance obligation on July 31, 2017, Henly records the
following entries to record the sale.
Unearned Sales Revenue 10,000

Inventory 7,500
18-84 LO 4
Contract Modifications
◆ Change in contract terms while it is ongoing.
◆ Companies determine
whether a new contract (and performance
obligations) results or
whether it is a modification of the existing contract.
18-85 LO 4
Separate Performance Obligation

◆ Accounts for as a new contract if both of the following
conditions are satisfied:
Promised goods or services are distinct (i.e.,
company sells them separately and they are not
interdependent with other goods and services), and
The company has the right to receive an amount of

consideration that reflects the standalone selling
price of the promised goods or services.
18-86 LO 4
Separate Performance Obligation
For example, Crandall Co. has a contract to sell 100 products to a
customer for $10,000 ($100 per product) at various points in time
over a six-month period. After 60 products have been delivered,
Crandall modifies the contract by promising to deliver 20 more
products for an additional $1,900, or $95 per product (which is the
standalone selling price of the products at the time of the contract
modification). Crandall regularly sells the products separately.
Given a new contract, Crandall recognizes an additional:
Original contract [(100 units - 60 units) x $100] =$4,000

New product (20 units x $95) = 1,900
Total revenue $5,900
18-87 LO 4
Prospective Modification
◆ Company should
Account for effect of change in period of change as
well as future periods if change affects both.
Not change previously reported results.
18-88 LO 4
For Crandall, the amount recognized as revenue for each of the
remaining products would be a blended price of $98.33, computed
as shown in below.
Products not delivered under original contract
($100 x 40) = $4,000

Products to be delivered under contract
modification ($95 x 20) = 1,900
Total remaining revenue $5,900
Revenue per remaining unit ($5,900 ÷ 60) = $98.33
18-89 LO 4
Under the prospective approach, a blended price ($98.33) is used
for sales in the periods after the modification.
ILLUSTRATION 18-30
Comparison of Contract Modification Approaches
18-90 LO 4
Presentation
Costs to Fulfill a Contract

◆ Companies divide fulfillment costs (contract acquisition
costs) into two categories:
1. Those that give rise to an asset.
2. Those that are expensed as incurred.
18-91 LO 4
Presentation
Collectibility
◆ Credit risk that a customer will be unable to pay in
accordance with the contract.
Whether a company will get paid is not a
consideration in determining revenue recognition.
Amount recognized as revenue is not adjusted for

customer credit risk.
18-92 LO 4
Disclosure
Companies disclose qualitative and quantitative

information about the following:
◆ Contracts with customers.
◆ Significant judgments.
◆ Assets recognized from costs incurred to fulfill a

contract.
18-93 LO 4
Disclosure
Companies provide a range of disclosures:

◆ Disaggregation of revenue
◆ Reconciliation of contract balances
◆ Remaining performance obligations
◆ Cost to obtain or fulfill contracts
◆ Other qualitative disclosures
Significant judgments and changes in them
Minimum revenue not subject to variable

consideration constraint
18-94 LO 4
COPYRIGHT
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Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
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errors, omissions, or damages, caused by the use of these programs
or from the use of the information contained herein.”
18-95

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18-1

Revenue from Contracts with Customers adopts an

◆ Are required to analyze contracts with customers

Contracts indicate terms and measurement of

Without contracts, companies cannot know whether

ILLUSTRATION 18-1 Key Concepts of Revenue Recognition

A contract is an agreement between two parties

Step 2: Identify the Boeing has only one performance obligation—to

ILLUSTRATION 18-2 Five Steps of Revenue Recognition

Transaction price is the amount of consideration

Step 4: Allocate the

ILLUSTRATION 18-2 Five Steps of Revenue Recognition

1. The contract has commercial substance.

2. The parties have approved the contract

3. Identiﬁcation of the rights of the parties is established

4. Payment terms are identiﬁed

5. It is probable that the consideration will be collected.

CONTRACTS AND RECOGNITION

CONTRACTS AND RECOGNITION

A product or service is distinct when a customer is able to

◆ benefit from a good or service on its own or

◆ together with other readily available resources.

The objective is to determine whether the nature of a

Assume that General Motors sells an automobile to Marquart Auto

SoftTech Inc. licenses customer-relationship software to Lopez

◆ In a contract is often easily determined because

◆ Other contracts, companies must consider:

◆ Companies estimate amount of revenue to recognize.

Expected Value: Probability-weighted amount in a range of possible

ESTIMATING VARIABLE CONSIDERATION

Question: How should Peabody account for this revenue arrangement?

Question: How should Peabody account for this revenue arrangement?

$150,000 (the outcome with 60% probability)

◆ Companies only recognizes variable consideration if

1. they have experience with similar contracts and are

2. based on experience, they do not expect a significant

If these criteria are not met, revenue recognition is

Interest accrued on consideration to be paid over

Fair value determined either by measuring the

Company reports as interest expense or interest

EXTENDED PAYMENT TERMS

Entry to record SEK’s sale to Grant Company on July 1, 2017, is as follows.

EXTENDED PAYMENT TERMS

Discount on Notes Receivable 54,000

Interest Revenue (12% x ½ x $900,000) 54,000

◆ Customers sometimes contribute goods or services, such

◆ Companies generally recognize revenue on the basis of

◆ In general, these elements reduce the consideration

Sansung makes the following entry on March 31, 2017.

Accounts Receivable 679,000

Sansung should reduce its revenue by $21,000 ($700,000 x 3%) because it is

Assuming Sansung’s customer meets the discount threshold, Sansung makes

◆ Best measure of fair value is what the company could

◆ If not available, companies should use their best

MULTIPLE PERFORMANCE OBLIGATIONS

Facts: Sansung Handler Company is an established manufacturer of

MULTIPLE PERFORMANCE OBLIGATIONS

Handler has the following arrangement with Chai Company.

MULTIPLE PERFORMANCE OBLIGATIONS

Handler has the following arrangement with Chai Company.

Question: (a) What are the performance obligations for purposes

Handler’s primary objective is to sell equipment. The other services

Question: (b) If there is more than one performance obligation,