Efficient Tests of Balances Series--No. 35: More Revenue Recognition Accounting Standards

Sales of Product when Right of Return Exists


605-15-25-1:  If an entity sells its product but gives the buyer the right to return the product, revenue for the sales transaction shall be recognized at time of sale only if all the following conditions are met:


  1. The seller’s price to the buyer is substantially fixed or determinable at the date of sale.
  2. The buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product.
  3. The buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product.
  4. The buyer acquiring the product for resale has economic substance apart from that provided by the seller.
  5. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer.
  6. The amount of the returns can be reasonably estimated.


Multiple-Element Arrangements


A multiple-element arrangement exists when an entity becomes party to an agreement to perform multiple activities that generate revenue.  All elements in such an arrangement must be evaluated to determine if separate accounting is required.


605-25-25-5:  In an arrangement with multiple deliverables, the delivered item or items shall be considered a separate unit of accounting if all the following criteria are met:


  1. The delivered item or items have value to the customer on a standalone basis.  The item or items have value on a standalone basis if they are sold separately by any vendor or the customer could resell the delivered item(s) on a standalone basis.
  2. There is objective and reliable evidence of the fair value of the undelivered item(s).
  3. If the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item or items is considered probable and substantially in the control of the vendor.


Extended Warranty and Product Maintenance Contracts


604-20-25-3:  Sellers of extended warranty or product maintenance contracts have an obligation to the buyer to perform services throughout the period of the contract and, therefore, revenue shall be recognized in income over the period in which the seller is obligated to perform.  That is, revenue from separately priced extended warranty and product maintenance contracts shall be deferred and recognized in income on a straight-line basis over the contract period except in the circumstances in which sufficient historical evidence indicates that the costs of performing services under the contract are incurred on other that a straight-line basis.  In those circumstances, revenue shall be recognized over the contract period in proportion to the costs expected to be incurred in performing services under the contract.


Principal vs. Agent


Companies that conduct business as agents rather than as principals sometimes face a dilemma as to how to record revenues, gross amount of billings or net amounts of commissions.  Judgment based on facts and circumstances should guide resolution.


Indicators of gross revenue reporting include whether the entity:

  • Is the primary obligor in the arrangement.
  • Has general inventory risk.
  • Has latitude in establishing price.
  • Changes the product or performs part of the service.
  • Has discretion in supplier selection.
  • Is involved in the determination of product or service specifications.
  • Has physical loss inventory risk.
  • Has credit risk.

Indicators of net commission reporting include:

  • The supplier, not the entity, is the primary obligor in the arrangement.
  • The amount the company earns is fixed.
  • The supplier has credit risk.


Some Disclosure Checklist Questions


The following questions are illustrative of common disclosure requirements for revenues.


1.  Are major categories of income reported separately in the income statement?


2.  Are sales discounts and allowances netted against sales?


3.  Are unusual and infrequent transactions presented as separate line items or as extraordinary transactions?


4.  Are items of comprehensive income presented in a statement of comprehensive income (ASU 2011-05)?


5.  Has the method of accounting and, specifically, recognizing revenues been disclosed in Note A?


6.  Have special disclosures for revenue recognition of sales of software, construction contract revenues, bartering revenues and non-monetary exchanges been included in the footnotes?


7.  Has the net income and comprehensive income of non-controlling interests of consolidated entities been disclosed on the applicable statement or in a footnote?


8.  Are gains or losses resulting from fair value accounting adjustments appropriately disclosed in the financial statements or footnotes?

Efficient substantive procedures auditing revenues and other account classifications resulting from cost-beneficial audit strategies are discussed in my live and on-demand webcasts which can be accessed by clicking the applicable box on the left side of my home page, www.cpafirmsupport.com

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by Larry Perry, CPA, CPA Firm Support Services, LLC - Larry has over 40 years experience as a CPA practitioner, author of accounting and auditing manuals, author and presenter of live staff training seminars and author of webcast and self-study CPE programs.  He is co-founder of CPA Firm Support Services, LLC (www.cpafirmsupport.com), an organization providing resources, training and consulting to smaller CPA firms.  Larry writes a weekly blog on AccountingWEB.com focusing on small audits, reviews and compilations.  He is currently developing documentation manuals and handbooks for small audits, reviews and compilations and related electronic practice aids.

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