Intermediate Accounting

Chapter 18
Revenue Recognition
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Learning Objective 1
Discuss the Fundamental Concepts
Related to Revenue Recognition and
Measurement
2
 (Thảo luận các khái niệm cơ bản liên
quan đến ghi nhận và đo lường doanh
thu)

Fundamentals of Revenue Recognition (Nguyên

tắc cơ bản của việc ghi nhận doanh thu)

Recently, the FASB and IASB issued a converged standard on revenue

recognition entitled Revenue from Contracts with Customers.
LO 1 3
(Gần đây, FASB và IASB đã ban hành một tiêu chuẩn thống nhất về ghi
nhận doanh thu mang tên Doanh thu từ hợp đồng với khách hàng)

To address the inconsistencies (ko thống nhất) and weaknesses of the

previous approaches, a comprehensive revenue recognition standard
now applies to a wide range of transactions and industries.

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
4
 o Contracts indicate terms (điều khoản) and
measurement of consideration.
o Without contracts, companies cannot know whether
promises will be met.

LO 1 5
 New Revenue Recognition Standard
Key Concepts of Revenue Recognition
Key Objective
Recognize revenue to depict the transfer of goods or services to customers in an amount that reflects
the consideration that the company receives, or expects to receive, in exchange for these goods or
services.
Five-Step Process for Revenue Recognition
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.
5. Recognize revenue when each performance obligation is satisfied.

Revenue Recognition Principle

Recognize revenue in the accounting period when the performance obligation is satisfied.
Performance Obligation is Satisfied
LO 1 6
 The Five-Step Process—Boeing Example
Assume that Boeing Corporation signs a contract to sell
airplanes to Delta Air Lines for $100 million.

LO 1 7
Boeing Example Step 3 and Step 4

8
 Boeing Example Step 5

LO 1 9
Extended Five-Step Example
Assume coffee and wine business called BEAN. BEAN is
located in the Midwest and serves gourmet coffee, espresso,
lattes, teas, and smoothies. It also sells various pastries, coffee
beans, other food products, wine, and beer.

Identifying the Contract with Customers—Step 1

Assume that Tyler Angler orders a large cup of black coffee
costing $3 from BEAN. Tyler gives $3 to a BEAN barista, who
pours the coffee into a large cup and gives it to Tyler.
Question: How much revenue should BEAN recognize on this
transaction?

10
Extended Five-Step Example – Step 1
Step 1 We first must determine whether a valid (hợp lệ) contract exists between
BEAN and Tyler. Here are the components of a valid contract and how it affects
BEAN and Tyler.
1. The contract has commercial substance: Tyler gives cash for the coffee.

2. The parties have approved (thống nhất) the contract: Tyler agrees to purchase
the coffee and BEAN agrees to sell it.
3. Identification of the rights of the parties is established: Tyler has the right to
the coffee and BEAN has the right to receive $3.
4. Payment terms are identified: Tyler agrees to pay $3 for the coffee.
5. It is probable that the consideration will be collected: BEAN has received $3
before it delivered the coffee.
From this information, it appears that BEAN and Tyler have a valid contract with
one another.
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Extended Five-Step Example – Step 2
Identifying Separate Performance Obligations—Step 2
The following day, Tyler orders another large cup of coffee for
$3 and also purchases two bagels at a price of $5. The barista
provides these products and Tyler pays $8.

Question: How much revenue should BEAN recognize on the

purchase of these two items?

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Extended Five-Step Example – Step 2
Identifying Separate Performance Obligations
Step 2 BEAN must determine whether the sale of the coffee and the sale of the two bagels involve
one or two performance obligations. In the previous transaction between BEAN and Tyler, this
determination was straightforward because BEAN provided a single distinct product (a large cup of
coffee) and therefore only one performance obligation existed. However, an arrangement to
purchase coffee and bagels may have more than one performance obligation. Multiple performance
obligations exist when the following two conditions are satisfied:
1. BEAN must provide a distinct product or service. In other words, BEAN must be able to sell the
coffee and the bagels separately from one another.
2. BEAN’s products are distinct within the contract. In other words, if the performance obligation is
not highly dependent on, or interrelated with (liên quan đến), other promises in the contract, then
each performance obligation should be accounted for separately. Conversely, if each of these
products is interdependent and interrelated, these products are combined and reported as one
performance obligation.
The large cup of coffee and the two bagels appear to be distinct from one another and are not highly
dependent or interrelated. That is, BEAN can sell the coffee and the two bagels separately, and Tyler
benefits separately from the coffee and the bagels. BEAN should therefore record two performance
obligations—one for the sale of the coffee and one for the sale of the bagels.

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Extended Five-Step Example – Step 3
Determining the Transaction Price—Step 3
BEAN decides to provide an additional incentive (ưu đãi) to its
customers to shop at its store. BEAN roasts its own coffee beans
and sells the beans wholesale to grocery stores, restaurants, and
other commercial companies. In addition, it sells the coffee
beans at its retail location. BEAN is interested in stimulating
(thức đẩy) sales of its Smoke Jumper coffee beans on Tuesdays, a
slow business day for the store. Normally, these beans sell for
$10 for a 12-ounce bag, but BEAN decides to cut the price by $1
when customers buy them on Tuesdays (the discounted price is
now $9 per bag). Tyler has come to the store on a Tuesday,
decides to purchase a bag of Smoke Jumper beans, and pays
BEAN $9.
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Extended Five-Step Example – Step 3
Determining the Transaction Price
Question: How much revenue should BEAN recognize on this
transaction?
Step 3 The transaction price for a bag of Smoke Jumper beans sold
to Tyler is $9, not $10. The transaction price is the amount that a
company expects to receive from a customer in exchange for
transferring goods and services. The transaction price in a contract
is often easily determined because the customer agrees to pay a
fixed amount to the company over a short period of time. In other
contracts, companies must consider adjustments such as when they
make payments or provide some other consideration to their
customers (e.g., a coupon) as part of a revenue arrangement.
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Extended Five-Step Example – Step 4
Allocating the Transaction Price to Separate Performance
Obligations—Step 4
BEAN wants to provide even more incentive for customers to buy its
coffee beans, as well as purchase a cup of coffee. BEAN therefore
offers customers a $2 discount on the purchase of a large cup of
coffee when they buy a bag of its premium Motor Moka beans
(which normally sell for $12) at the same time. Tyler decides this
offer is too good to pass up and buys a bag of Motor Moka beans
for $12 and a large cup of coffee for $1. As indicated earlier, a large
cup of coffee normally retails for $3 at BEAN.

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Extended Five-Step Example – Step 4
Allocating the Transaction Price to Separate Performance
Obligations
Question: How much revenue should BEAN recognize on
the purchase of these two items?

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Extended Five-Step Example – Step 5
Recognizing Revenue When (or as) Each Performance
Obligation Is Satisfied
BEAN has satisfied both performance obligations as control of the
bag of Motor Moka beans and the large cup of coffee has passed to
Tyler.

Solution: BEAN should recognize revenue of $13, comprised of

revenue from the sale of the Motor Moka beans at $10.40 and
the sale of the large cup of coffee at $2.60.

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 Learning Objective 2
Explain and Apply the Five-Step
Revenue Recognition Process

LO 2 19
Identifying Contract with Customers—
Step 1
Contract:
• Agreement between two or more parties that
creates enforceable rights or obligations.
(Thỏa thuận giữa hai hoặc nhiều bên tạo ra các
quyền hoặc nghĩa vụ có hiệu lực thi hành)
• Can be written, oral, or implied from customary
business practice (Có thể bằng văn bản, bằng
miệng hoặc ngụ ý từ thông lệ kinh doanh thông
thường)
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 Identifying Contract—Step 1
Contracts and Recognition
Facts: On March 1, 2020, Margo Company enters into a contract to transfer a product to
Soon Yoon on July 31, 2020. The contract is structured such that Soon Yoon is required to
pay the full contract price of $5,000 on August 31, 2020.The cost of the goods transferred is
$3,000. Margo delivers the product to Soon Yoon on July 31, 2020.
Question: What journal entries should Margo Company make in regards to this contract
in 2020?
The journal entry to record the sale and related cost of goods sold is as follows.
July 31, 2020
Accounts Receivable 5,000
Sales Revenue 5,000
Cost of Goods Sold 3,000
Inventory 3,000

LO 2 21
Identifying Contract—Step 1
Contracts and Recognition
Facts: On March 1, 2020, Margo Company enters into a contract to transfer a
product to Soon Yoon on July 31, 2020. The contract is structured such that Soon
Yoon is required to pay the full contract price of $5,000 on August 31, 2020.The
cost of the goods transferred is $3,000. Margo delivers the product to Soon Yoon
on July 31, 2020.

Question: What journal entries should Margo Company make in regards to this
contract in 2020?
Margo makes the following entry to record the receipt of cash on August 31, 2020.
August 31, 2020
Cash 5,000
Accounts Receivable 5,000
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 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.

LO 2 23
 Separate Performance Obligations
General Motors 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.

LO 2 24
 Separate Performance Obligations
SoftTech Inc. Illustration
SoftTech Inc. licenses (cấp phép) customer-relationship software to Lopez
Company. In addition to providing the software itself, SoftTech promises
to provide consulting (tư vấn) 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 (điều
chỉnh) 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.

LO 2 25
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:
o Variable consideration
o Time value of money
o Noncash consideration
o Consideration paid or payable to the customer

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 Determining the Transaction Price
Variable Consideration
• Price dependent on future events.
o Might include discounts, rebates, credits, performance
bonuses, or royalties.
• Companies estimate amount of revenue to recognize.
o Expected value
o Most likely amount

LO 2 27
Determining the Transaction Price
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.

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Variable Consideration
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?

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Variable Consideration
Estimating Variable Consideration
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
Blank $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)
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Variable Consideration
Estimating
• 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 (hạn chế).
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Determining the Transaction Price
Time Value of Money
• When contract (sales transaction) involves a significant
financing component.
o Interest accrued on consideration to be paid over time.
o Fair value determined either by measuring the
consideration received or by discounting the payment
using an imputed interest rate.
o Company reports as interest expense or interest revenue.

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Time Value of Money
Extended Payment Terms
Facts: On July 1, 2020, 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, 2020?
(b) How much revenue should it report related to this transaction on
December 31, 2020?

Entry to record SEK’s sale to Grant Company on July 1, 2020, is as follows.

Notes Receivable 1,416,163
Sales Revenue 900,000
Discount on Notes Receivable 516,163
Cost of Goods Sold 590,000
Inventory 590,000
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Time Value of Money
Extended Payment Terms
Facts: On July 1, 2020, 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, 2020? (b) How
much revenue should it report related to this transaction on December 31, 2020?
Entry to record interest revenue (12%) at the end of the year, December 31, 2020.
Discount on Notes Receivable 54,000
Interest Revenue (12% x 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.

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Determining the Transaction Price
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.

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Determining the Transaction Price—Step 3
(6 of 6)
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.

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Consideration Paid or Payable
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, 2020, 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
2020?

Sansung makes the following entry on March 31, 2020.

Accounts Receivable 679,000
Sales Revenue 679,000

Sansung should reduce its revenue by $21,000 ($700,000 × 3%) because it is probable
that it will provide this rebate (là khoản giảm giá cho khách hàng khi mua sản phẩm với
một số lượng nhất định)
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Consideration Paid or Payable
Volume Discount
Questions: How much revenue should Sansung recognize for the first 3 months
of 2020?
Assuming Sansung’s customer meets the discount threshold (ngưỡng chiết
khấu), Sansung makes the following entry.
Cash 679,000
Accounts Receivable 679,000

If Sansung’s customer fails to meet the discount threshold, Sansung makes the
following entry upon payment.

Cash 700,000
Accounts Receivable 679,000
Sales Discounts Forfeited 21,000
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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 (độc lập)
basis.
• If not available, companies should use their best
estimate of what the good or service might sell for as a
standalone unit.

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Transaction Price Allocation
Allocation Approach Implementation
Evaluate the market in which it sells goods or services and
estimate the price that customers in that market are willing to
Adjusted market pay for those goods or services. That approach also might
assessment approach include referring to prices from the company's competitors for
similar goods or services and adjusting those prices as
necessary to reflect the company's costs and margins.
Expected cost plus a Forecast expected costs of satisfying a performance obligation
margin approach and then add an appropriate margin for that good or service.
If the standalone selling price of a good or service is highly
variable or uncertain, then a company may estimate the
Residual approach standalone selling price by reference to the total transaction
price less the sum of the observable standalone selling prices
of other goods or services promised in the contract.

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Allocating Transaction Price
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 (lắp đặt) and training. The installation process does
not involve changes to the features of the equipment and does not
require proprietary (độc quyền) information about the equipment
in order for the installed equipment to perform to specifications.

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Allocating Transaction Price
Multiple Performance Obligations
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.

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Allocating Transaction Price
Multiple Performance Obligations-Additional Facts
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, 2020, and
completes the installation of the equipment on November 1,
2020 (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.
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Allocating Transaction Price
Question (a)
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.

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Allocating Transaction Price
Question (b)
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]

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 Allocating Transaction Price
Question (b) Sale
Question: (b) If there is more than one performance obligation,
how should the payment of $2,000,000 be allocated to various
components?
Handler makes the following entry on November 1, 2020, to record both
sales revenue and service revenue on the installation, as well as
unearned service revenue.
November 1, 2020
Cash 2,000,000
Service Revenue (installation) 19,324
Unearned Service Revenue 48,309
Sales Revenue 1,932,367
LO 2 46
Allocating Transaction Price
Question (b) Cost of Goods Sold
Question: (b) If there is more than one performance obligation, how should
the payment of $2,000,000 be allocated to various components?
Assuming the cost of the equipment is $1,500,000, the entry to record cost of
goods sold is as follows.
November 1, 2020

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, 2020. In addition,
it recognizes revenue for the installation fee because these services have been
performed.

47
 Allocating Transaction Price
Question (b) Revenue Recognition 2020
Question: (b) If there is more than one performance obligation, how should
the payment of $2,000,000 be allocated to various components?
Handler recognizes the training revenues on a straight-line basis starting on
November 1, 2020, 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 2020 is as follows.
December 31, 2020

Unearned Service Revenue 8,052

Service Revenue (training) ($4,026 × 2) 8,052

LO 2 48
Allocating Transaction Price
Question (b) Revenue Recognition 2021
Question: (b) If there is more than one performance obligation,
how should the payment of $2,000,000 be allocated to various
components?
Therefore, Handler recognizes revenue at December 31, 2020, 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 2021, assuming adjusting entries are made at year-end.

December 31, 2021

Unearned Service Revenue 40,257

Service Revenue (training) ($48,309 − $8,052) 40,257
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 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.

LO 2 50
Performance Obligation Satisfied
Recognizing revenue from a performance obligation over
time
• Measure progress toward completion o Method
for measuring progress should depict transfer of
control from company to customer.
o Objective of methods is to measure extent of
progress in terms of costs, units, or value added.
Summary-Step 1
Step in Process Description Implementation
1. Identify the contract A contract is an agreement A company applies the
51
 with customers. that creates enforceable revenue guidance to
rights or obligations. contracts with customers.

LO 2 52
 Summary-Step 2
Step in Process Description Implementation
2. Identify the separate A performance obligation is A contract may be
performance a promise in a contract to comprised of multiple
obligations in the provide a product or service performance obligations.
contract to a customer. Accounting is based on
A performance obligation evaluation of whether the
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
together with other readily services is distinct, but is
available resources. interdependent and
interrelated, these goods
and services are combined
and reported as one

LO 2 53
 performance obligation.

Summary-Step 3
Step in Process Description Implementation
3. Determine the Transaction price is the In determining the
transaction price. amount of consideration transaction price, companies
that a company expects to must consider the following
receive from a customer in factors:
exchange for transferring 1. variable consideration,
goods and services. 2. time value of money,
3. noncash consideration,
and
4. consideration paid or
payable to customer.

LO 2 54
Summary-Step 4
Step in Process Description Implementation
4. Allocate the transaction If more than one The best measure of fair
price to the separate performance obligation value is what the good
performance obligation. exists, allocate the service could be sold for on a
transaction price based on standalone basis
relative fair values. (standalone selling price).
Estimates of standalone
selling price can be based on
1. adjusted market
assessment,
2. expected cost plus a
margin approach, or
3. a residual approach.

55
 Summary-Step 5
Step in Process Description Implementation
5. Recognize revenue A company satisfies Companies satisfy performance
when each its performance obligations either at a point in time
performance obligation obligation when the or over a period of time. Companies
is satisfied. customer obtains recognize revenue over a period of
time if one of following criteria are
control of the good
met:
or service.
1. the customer receives and
consumes the benefits as the
seller performs,
2. the customer controls the asset
as it is created,
3. the company does not have an
alternative use for the asset.

LO 2 56
 Learning Objective 3
Apply the Five-Step Process to Major
Revenue Recognition Issues
Accounting for Revenue Recognition
Issues
• Sales returns and allowances
• Repurchase agreements
• Bill and hold
• Principal-agent relationships
LO 3 57
 • Consignments
• Warranties
• Nonrefundable upfront fees

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.
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 2. Credit that can be applied against amounts owed, or
that will be owed, to the seller.
3. Another product in exchange.
Credit Sales with Returns and
Allowances Illustration
On January 12, 2020, 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.
LO 3 59
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.

Credit Sales with Returns and

Allowances-January 12, 2020
Illustration: On January 12, 2020, 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 makes the following entries To record the sale of the
cameras and related cost of goods sold on January 12, 2020.

Accounts Receivable 10,000

60
 Sales Revenue (100 × $100) 10,000

Cost of Goods Sold 6,000

Inventory (100 × $60) 6,000

LO 3 61
 Credit Sales with Returns and
Allowances-January 24, 2020
Illustration: On January 12, 2020, 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 makes the following entries To record the return of the two
cameras on January 24, 2020.

Sales Returns and Allowances 200

Accounts Receivable (2 × $100) 200

Returned Inventory 120

LO 3 62
 Cost of Goods Sold (2 × $60) 120

Credit Sales with Returns and

Allowances-January 31, 2020
Illustration: On January 31, 2020, 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, 2020.

Sales Returns and Allowances 100

Allowance for Sales Returns and Allowances (1 × $100) 100

LO 3 63
 Estimated Inventory Returns 60
Cost of Goods Sold (1 × $60) 60

Credit Sales with Returns and

Allowances-Financial Statements
Venden’s income statement for the month ending of January 31, 2020.

Venden’s balance sheet as of January 31, 2020.

LO 3 64
LO 3 65
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, 2020.

Cash 10,000
Sales Revenue (100 × $100) 10,000

Cost of Goods Sold 6,000

Inventory (100 × $60) 6,000
66
Cash Sales with Returns and
Allowances – January 24, 2020
Illustration: Assuming that Venden did not pay cash at the time of the
return of the two cameras to Amaya on January 24, 2020, the entries to
record the return of the two cameras and related cost of goods sold are
as follows.

Sales Returns and Allowances 200

Accounts Payable (2 × $100) 200

Returned Inventory 120

Cost of Goods Sold (2 × $60) 120

67
LO 3

Cash Sales with Returns and

Allowances – January 31, 2020
Illustration: On January 31, 2020, 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.

Sales Returns and Allowances 100

Accounts Payable (1 × $100) 100

Estimated Inventory Returns 60

Cost of Goods Sold (1 × $60) 60
68
LO 3

Cash Sales with Returns and

Allowances-Financial Statements
Venden’s income statement for the month ending of January 31, 2020.

Venden’s balance sheet as of January 31, 2020.

69
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.

70
LO 3

Repurchase Agreements
Illustration
Facts: Morgan Inc., an equipment dealer, sells equipment on January 1, 2020, to
Lane Company for $100,000. It agrees to repurchase this equipment on
December 31, 2021, 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, 2020.

Cash 100,000

Liability to Lane Company 100,000

71
LO 3

Repurchase Agreements
Should Morgan Inc. record this transaction?
Morgan Inc. records interest on December 31, 2020, as follows.
Interest Expense 10,000
Liability to Lane Company ($100,000 ×10%) 10,000

Morgan Inc. records interest and retirement of its liability to Lane Company on
December 31, 2021, as follows.

Interest Expense 11,000

Liability to Lane Company ($110,000 × 10%) 11,000 Liability to Lane
Company 121,000
Cash ($100,000 + $10,000 + $11,000) 121,000
72
 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.

LO 3

73
Bill-and-Hold Arrangements
Illustration
Facts: Butler Company sells $450,000 (cost $280,000) of fireplaces on March 1,
2020, 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.

74
LO 3

Bill-and-Hold Arrangements
Question: When should Butler recognize the revenue
from this bill-and-hold arrangement?
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.

75
Bill-and-Hold Arrangements
When should Butler recognize the revenue from this
billand-hold arrangement?
Butler makes the following entry to record the sale on March 1, 2020.

Accounts receivable 450,000

Sales Revenue 450,000

Butler makes an entry to record the related cost of goods sold on March 2, 2020,
as follows.

Cost of Goods Sold 280,000

Inventory 280,000

76
LO 3

Principle-Agent Relationships
• Agent’s performance obligation is to arrange for principal to
provide goods or services to a customer.
• Examples:
o Travel Company (agent) facilitates booking of cruise for
Cruise Company (principal).
o 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. o Revenue for agent is amount of
commission received.

77
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.
o Carries merchandise as inventory.
• Consignee makes a commission on the sale.

78
Consignments Illustration

79
LO 3

Consignments Illustration Continued

80
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.

81
Warranties
Illustration
Facts: Maverick Company sold 1,000 Rollomatics on October 1, 2020, 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, 2020,
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, 2020. It estimates that its future assurance warranty costs
will total $44,000 at December 31, 2020.

82
 Question: What are the journal entries that Maverick should make in
2020 related to the sale and the assurance and extended warranties?

LO 3

Warranties
Question: What are the journal entries that Maverick Company
should make in 2020 related to the sale and the related
warranties?
To record the sale of the Rollomatics and the related extended warranties on
October 1, 2020:

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:
83
 Cost of Goods Sold 4,000,000
Inventory 4,000,000

LO 3

Warranties
Additional Journal Entries
To record the warranty costs incurred on November 22, 2020:

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, 2020:

84
 Warranty Expense 44,000
Warranty Liability 44,000

Nonrefundable Upfront Fees

• Payments from customers before o Delivery of a
product o 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.
o Examples include:
• Membership fee in a health club

85
 • Activation fees for phone, Internet, or cable
LO 3

Learning Objective 4
Describe Presentation and Disclosure
Regarding Revenue

LO 4

86
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.
87
 Presentation
Contract Asset
Facts: On January 1, 2020, 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, 2020. On March 1, 2020, Finn delivers
Product B to Obermine.

Question: What journal entries should Finn Company make in

regards to this contract in 2020?
LO 4 88
Presentation
Contract Asset
Question: What journal entries should Finn Company make in regards to this
contract in 2020?

On February 1, 2020, Finn records the following entry:

Contract Asset 30,000
Sales Revenue 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, 2020, it
makes the following entry.
Accounts Receivable 100,000

89
 Contract Asset 30,000
Sales Revenue 70,000

LO 4 90
 Presentation
Contract Liability
Facts: On March 1, 2020, Henly Company enters into a contract to transfer a
product to Propel Inc. on July 31, 2020. It is agreed that Propel will pay the full
price of $10,000 in advance on April 15, 2020. Henly delivers the product on July
31, 2020. The cost of the product is $7,500.

Question: What journal entries are required in 2020?

No entry is required on March 1, 2020:

• Neither party has performed on the contract.

LO 4 91
 Presentation
Question: What journal entries are required in 2020?
Henly should make the following entry on April 15, 2020.

Sales Revenue 10,000

Cost of Goods Sold 7,500
Inventory 7,500
Cash 10,000
Unearned Sales Revenue 10,000

On satisfying the performance obligation on July 31, 2020, Henly records the
following entries to record the sale.

LO 4 92
 Unearned Sales Revenue 10,000

Contract Modifications
• Change in contract terms while it is ongoing.
• Companies determine o whether a new contract (and
performance obligations) results or o whether it is a
modification of the existing contract.

LO 4 93
Contract Modifications
Separate Performance Obligation
• Accounts for as a new contract if both of the following
conditions are satisfied:
o Promised goods or services are distinct (i.e.,
company sells them separately and they are not
interdependent with other goods and services), and
o The company has the right to receive an amount of
consideration that reflects the standalone selling
price of the promised goods or services.

94
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) × $100] = $4,000

New product (20 units × $95) = 1,900

Total revenue $5,900

95
LO 4

Contract Modifications
Prospective Modification
• Company should
o Account for effect of change in period of change
as well as future periods if change affects both. o
Not change previously reported results.

96
LO 4

Prospective Modification
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 × 40) = $4,000

Products to be delivered under contract modification ($95 × 20) 1,900 =

Total remaining revenue $5,900

Revenue per remaining unit ($5,900 ÷ 60) = $98.33

97
Prospective Modification
Comparison of Contract Modification Approaches
Under the prospective approach, a blended price ($98.33) is used
for sales in the periods after the modification.
Blank Revenue
Revenue Recognized Recognized After Total Revenue
Prior to Modification Modification Recognized
Separate $6,000 $5,900 $11,900
performance
obligation
No separate $6,000 $5,900 $11,900
performance
obligation —
prospectively
98
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.

99
LO 4

Presentation
Collectibility
• Credit risk that a customer will be unable to pay in
accordance with the contract.
o Whether a company will get paid is not a
consideration in determining revenue recognition. o
Amount recognized as revenue is not adjusted for
customer credit risk.
Disclosure
Companies disclose qualitative and quantitative
information about the following:
100
 • Contracts with customers.
• Significant judgments.
• Assets recognized from costs incurred to fulfill a
contract.

LO 4

Disclosure
Companies provide a range of disclosures:
101
 • Disaggregation of revenue
• Reconciliation of contract balances
• Remaining performance obligations
• Cost to obtain or fulfill contracts
• Other qualitative disclosures o Significant judgments and
changes in them
o Minimum revenue not subject to variable consideration
constraint

LO 4

102
 Learning Objective 5
Apply the Percentage-of-Completion
Method for Long-Term Contracts

LO 5

103
Appendix 18A: Long-Term Construction
Contracts
Revenue Recognition Over Time
A company satisfies a performance obligation and recognizes
revenue over time if at least one of the following three criteria is
met:
1. The customer simultaneously receives and consumes the
benefits of the seller’s performance as the seller performs.
2. The company’s performance creates or enhances an asset (for
example, work in process) that the customer controls as the
asset is created or enhanced; or
3. The company’s performance does not create an asset with an
alternative use.
104
LO 5

Long-Term Construction Contracts

Revenue Recognition Over Time
Two Methods of accounting:
• Percentage-of-Completion Method o Recognize
revenues and gross profits each period based upon the
progress of the construction
o Buyer and seller have enforceable rights
• Completed-Contract Method o Recognize revenues
and gross profit only when the contract is completed

105
Long-Term Construction Contracts
Percentage-of-Completion Method
Revenue to Recognized Cost-to-Cost Basis

106
LO 5

107
Long-Term Construction Contracts
Illustration
Blank 2020 2021 2022

Costs to date $1,000,000 $2,916,000 $4,050,000

Estimated costs to complete 3,000,000 1,134,000 -
Progress billings during the
900,000 2,400,000 1,200,000
year
Cash collected during the
year 750,000 1,750,000 2,000,000
Hardhat Construction Company has a contract to construct a
$4,500,000 bridge at an estimated cost of $4,000,000. The
contract is to start in July 2020, and the bridge is to be

108
 completed in October 2022. The following data pertain to
the construction period.

LO 5 109
Long-Term Construction Contracts
Application of Percentage-of-Completion Method, Cost-
to-Cost Basis

110
 Long-Term Construction Contracts
Journal Entries—Percentage-of-Completion Method,
Cost-to-Cost Basis

LO 5 111
 Long-Term Construction Contracts
Percentage-of-Completion Revenue, Costs, and Gross
Profit by Year

LO 5 112
 Long-Term Construction Contracts
Journal Entries to Recognize Revenue and Gross Profit and to

LO 5 113
Record Contract Completion—Percentage-of-Completion
Method, Cost-to-Cost Basis

Long-Term Construction Contracts

Content of Construction in Process Account—
Percentage-of-Completion Method
114
 Financial Statement Presentation—
Percentage-of-Completion
Computation of Unbilled Contract Price at 12/31/20

LO 5 115
 Financial Statement Presentation—
Percentage-of-Completion (2020)
LO 5

116
 Learning Objective 6
Apply the Completed-Contract Method
for Long-Term Contracts.

LO 6

117
Completed-Contract Method
Companies recognize revenue and gross profit only at
point of sale—that is, when the contract is completed.
Under this method, companies accumulate costs of
longterm contracts in process, but they make no interim
charges or credits to income statement accounts for
revenues, costs, or gross profit.

118
LO 6

Completed-Contract Method
Illustration
Under the completed-contract method for the bridge project
previously illustrated, Hardhat Construction Company would
make the following entries in 2022 to recognize revenue and
costs and to close out the inventory and billing accounts.

Billings on Construction in Process 4,500,000

Revenue from Long-Term Contracts 4,500,000 Costs of
Construction 4,050,000
Construction in Process 4,050,000
119
Completed-Contract Method
Comparison of Gross Profit Recognized under Different
Methods

120
LO 6

121
Completed-Contract Method
Financial Statement Presentation

122
 Learning Objective 7
Identify the Proper Accounting for
Losses on Long-Term Contracts
Long-Term Contract Losses
1. Loss in Current Period on a Profitable Contract
• Percentage-of-completion method only, the estimated
cost increase requires a current-period adjustment of
gross profit recognized in prior periods.

LO 7 123
 2. Loss on an Unprofitable Contract
• Under both percentage-of-completion and
completed-contract methods, the company must
recognize in the current period the entire expected
contract loss.
Loss in Current Period
Assume that on December 31, 2021, Hardhat estimates the costs to
complete the bridge contract at $1,468,962 instead of $1,134,000.
Assuming all other data are the same as before, Hardhat would
compute the percent complete and recognize the loss as shown in
the following illustration.

LO 7 124
 Loss in Current Period
Journal Entry
Hardhat Construction would record the loss in 2021 as follows.

Construction in Process 1,916,000

LO 7 125
 Construction in Process (loss) 48,500
Revenue from Long-Term Contracts 1,867,500

Hardhat will report the loss of $48,500 on the 2021 income

statement as the difference between the reported revenue of
$1,867,500 and the costs of $1,916,000.

LO 7 126
Loss on an Unprofitable Contract
Assume that at December 31, 2021, Hardhat Construction
Company estimates the costs to complete the bridge contract at
$1,640,250 instead of $1,134,000. Revised estimates for the bridge
contract are as follows.

127
 Loss on an Unprofitable Contract
Under the Percentage-of-Completion Method
Hardhat recognized $125,000 of gross profit in 2020. This amount
must be offset in 2021 because it is no longer expected to be
realized. In addition, since losses must be recognized as soon as
estimable, the company must recognize the total estimated loss of
$56,250 in 2021. Therefore, Hardhat must recognize a total loss of
$181,250 ($125,000 + $56,250) in 2021.

LO 7 128
 Loss on an Unprofitable Contract
Computation of Revenue Recognizable, 2021—
Unprofitable Contract

LO 7 129
LO 7 130
 Loss on an Unprofitable Contract
Computation of Construction Expense, 2021—
Unprofitable Contract
To compute the construction costs to be expensed in 2021, Hardhat
adds the total loss to be recognized in 2021 ($125,000 + $56,250)
to the revenue to be recognized in 2021.

LO 7 131
 Loss on an Unprofitable Contract
Journal Entry, 2021—Unprofitable Contract
Hardhat Construction would record the long-term contract
revenues, expenses, and loss in 2021 as follows.

Construction Expense 1,936,250

Construction in Process (loss) 181,250 Revenue from Long-Term
Contracts 1,755,000

LO 7 132
Loss on an Unprofitable Contract
Content of Construction in Process Account at End of
2021—Unprofitable Contract
At the end of 2021, Construction in Process has a balance of
$2,859,750 as shown.

133
Loss on an Unprofitable Contract
Under the Completed-Contract Method
Hardhat also would recognize the contract loss of $56,250 through
the following entry in 2021 (the year in which the loss first became
evident).
Loss on Long-Term Contracts 56,250
Construction in Process (loss) 56,250

134
LO 7

Learning Objective 8
Explain the Revenue Recognition for
Franchises

LO 8

135
 Appendix 18B: Revenue Recognition for
Franchises
Franchises
Four types of franchising arrangements have evolved:
1. Manufacturer-retailer
2. Manufacturer-wholesaler
3. Service sponsor-retailer
4. Wholesaler-retailer

LO 8 136
Revenue Recognition for Franchises
Franchises
Fastest-growing category is service sponsor-retailer:
• Soft ice cream/frozen yogurt stores (Tastee Freeze, TCBY,
Dairy Queen)
• Food drive-ins (McDonald’s, KFC, Burger King)
• Restaurants (TGI Friday’s, Pizza Hut, Denny’s)
• Motels (Holiday Inn, Marriott, Best Western)
• Auto rentals (Avis, Hertz, National)
• Others (H & R Block, Meineke Mufflers, 7-Eleven Stores)

137
 Revenue Recognition for Franchises
Two Sources of Revenue
1. Sale of initial franchises and related assets or services, and
2. Continuing fees based on the operations of franchises.

LO 8 138
Revenue Recognition for Franchises
Franchises
The franchisor normally provides the franchisee with:
1. Assistance in site selection
2. Evaluation of potential income
3. Supervision of construction activity
4. Assistance in the acquisition of signs, fixtures, and equipment
5. Bookkeeping and advisory services
6. Employee and management training
7. Quality control

139
 8. Advertising and promotion

Appendix 18B: Revenue Recognition for

Franchises (5 of 14)
Franchise Accounting
Performance obligations relate to:
• Right to open a business
• Use of trade name or other intellectual property of the
franchisor
• Continuing services, such as marketing help, training, and in
some cases supplying inventory and inventory management

LO 8 140
 Revenue Recognition for Franchises
Franchise Accounting
Franchisors commonly charge an initial franchise fee and
continuing franchise fees:
• Initial franchise fee (payment for establishing the relationship
and providing some initial services)
• Continuing franchise fees received o In return for continuing
rights granted by the agreement o For providing
management training, advertising and promotion, legal
assistance, and other support

Franchises Accounting
Facts: Tum’s Pizza Inc. enters into a franchise agreement on December 31,
LO 8 141
 2020, giving Food Fight Corp. the right to operate as a franchisee of Tum’s
Pizza for 5 years. Tum’s charges Food Fight an initial franchise fee of $50,000
for the right to operate as a franchisee. Of this amount, $20,000 is payable
when Food Fight signs the agreement, and the note balance is payable in
five annual payments of $6,000 each on December 31. As part of the
arrangement, Tum’s helps locate the site, negotiate the lease or purchase of
the site, supervise the construction activity, and provide employee training
and the equipment necessary to be a distributor of its products. Similar
training services and equipment are sold separately. Food Fight also
promises to pay ongoing royalty payments of 1% of its annual sales (payable
each January 31 of the following year) and is obliged to purchase products
from Tum’s at its current standalone selling prices at the time of purchase.
The credit rating of Food Fight indicates that money can be borrowed at 8%.
The present value of an ordinary annuity of five annual receipts of $6,000
each discounted at 8% is $23,957. The discount of $6,043 represents the
interest revenue to be accrued by Tum’s over the payment period.

LO 8 142
 Franchises Accounting
What are the performance obligations in this
arrangement and the point in time at which the
performance obligations for Tum’s are satisfied and
revenue is recognized?
Rights to the trade name, market area, and proprietary know-how for 5
years are not individually distinct.
• Each one is not sold separately and cannot be used with other goods
or services that are readily available to the franchisee.
• Combined rights give rise to a single performance obligation.
• Tum’s satisfies performance obligation at point in time when Food
Fight obtains control of the rights.

LO 8 143
Franchises Accounting
What are the performance obligations in this
arrangement and the point in time at which the
performance obligations for Tum’s are satisfied and
revenue is recognized? (continued)
Training services and equipment are distinct because similar services and
equipment are sold separately.
• Tum’s satisfies those performance obligations when it transfers the
services and equipment to Food Fight.
Tum’s cannot recognize revenue for the royalty payments because it is
not reasonably assured to be entitled to those royalty amounts.
• Tum’s recognizes revenue for the royalties when (or as) the uncertainty
is resolved.
144
Franchises Accounting
Allocation of Transaction Price at December 31, 2020.

Training is completed January 2021, the equipment is installed in

January 2021, and Food Fight holds a grand opening on February 2,
2021.

145
LO 8

Franchises Accounting
Franchise Entry—Inception
Tum’s signs the agreement and receives upfront payment and note
on December 31, 2020

Cash 20,000
Notes Receivable 30,000
Discount on Notes Receivable 6,043
Unearned Franchise Revenue 20,000
Unearned Service Revenue (training) 9,957
Unearned Sales Revenue (equipment) 14,000
146
LO 8

Franchises Accounting
Franchise Entries—Commencement of Operations
On February 2, 2021, franchise opens. Tum’s satisfies the performance
obligations related to the franchise rights, training, and equipment.
Unearned Franchise Revenue 20,000
Franchise Revenue 20,000
Unearned Service Revenue (training) 9,957
Service Revenue (training) 9,957
Unearned Sales Revenue (equipment) 14,000
Sales Revenue 14,000
Cost of Goods Sold 10,000
Inventory 10,000
147
Franchises Accounting
Franchise Entries—First Year of Franchise Operations
During 2021, Food Fight does well, recording $525,000 of sales in its first
year of operations. Tum’s records continuing franchise fees on December
31, 2021 as follows.
Accounts Receivable ($525,000 × 1%) 5,250
Franchise Revenue 5,250
To record payment received and interest revenue on note on December
31, 2021.
Cash 6,000
Notes Receivable 6,000
Discount on Notes Receivable 1,917
148
 Interest Revenue ($23,957 × 8%) 10,000
LO 8

149
Appendix 18B: Revenue Recognition for
Franchises (14 of 14)
Recognition of Franchise Rights Revenue Over Time
Depending on the economic substance of the rights, the
franchisor may be providing access to the right rather
than transferring control of the franchise rights.
In this case, the franchise revenue is recognized over
time, rather than at a point in time.
Franchise Revenue Over Time
Facts: Tech Solvers Corp. is a franchisor and provides a range of
computing services (hardware/software installation, repairs, data
backup, device syncing, and network solutions) on popular Apple and

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 PC devices. Each franchise agreement gives a franchisee the right to
open a Tech Solvers store and sell Tech Solvers’ products and services
in the area for 5 years. Under the contract, Tech Solvers also provides
the franchisee with a number of services to support and enhance the
franchise brand, including
a) advising and consulting on the operations of the store;
b) communicating new hardware and software developments, and
service techniques;
c) providing business and training manuals; and
d) advertising programs and training.

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Franchise Revenue Over Time
Additional Facts
Facts: As an almost entirely service operation (all parts and other
supplies are purchased as needed by customers), Tech Solvers
provides few upfront services to franchisees. Instead, the franchisee
recruits service technicians, who are given Tech Solvers’ training
materials (online manuals and tutorials), which are updated for
technology changes, on a monthly basis at a minimum. Tech Solvers
enters into a franchise agreement on December 15, 2020, giving a
franchisee the rights to operate a Tech Solvers franchise in eastern
Indiana for 5 years. Tech Solvers charges an initial franchise fee of
$5,000 for the right to operate as a franchisee, payable upon signing
the contract. Tech Solvers also receives ongoing royalty payments of
7% of the franchisee’s annual sales (payable each January 15 of the

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 following year). The franchise began operations in January 2021 and
recognized $85,000 of revenue in 2021.

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 Franchise Revenue Over Time
What are the performance obligations in this
arrangement and the point in time at which the
performance obligations will be satisfied and revenue
will be recognized?
Rights to the trade name, market area, and proprietary know-how for 5
years are not individually distinct.
• Each one is not sold separately and cannot be used with other goods or
services that are readily available to the franchisee.
• Licensed rights and the ongoing training materials are a single
performance obligation.

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 • Tech Solvers is providing access to the rights and must continue (over
time) to perform updates and services.

Franchise Revenue Over Time

What are the performance obligations in this
arrangement and the point in time at which the
performance obligations will be satisfied and revenue
will be recognized? (continued)
Tech Solvers cannot recognize revenue for the royalty payments
• Not reasonably assured to be entitled to those revenue-based royalty
amounts.
• Payments represent variable consideration.
• Recognize revenue for royalties when (or as) uncertainty is resolved.
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 Franchise Revenue Over Time
Franchise Entries—Revenue Recognized over Time
Franchise agreement signed and receipt of upfront payment and note,
December 15, 2020:
Cash 5,000
Unearned Franchise Revenue 5,000
Franchise begins operations in January 2021 and records $85,000 of
revenue for the year ended December 31, 2021.
Unearned Franchise Revenue 1,000
Franchise Revenue ($5,000 ÷ 5) 1,000 Accounts Receivable 5,950
Franchise Revenue ($85,000 × 7%) 5,950

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Copyright
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