Explain the reporting for (a) costs to fulfill a contract and (b) collectibility.

Short Answer

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(a) Companies divide fulfillment costs (contract acquisition costs) into two categories: (1) those that result in an asset (2) those that are expensed as they are incurred.

(b) Collectibility: The risk that a customer will be unable to pay the agreed-upon amount of consideration is referred to as collectibility.

Step by step solution

01

Definition of Collectibility

Collectibility relates to a client's credit risk or the possibility that the customer may be unable to pay the agreed-upon amount of consideration. The revenue amount is not adjusted for customer credit risk under the revenue guideline as long as a contract exists (it is likely that the customer will pay).

02

Reporting for costs to fulfill a contract 

Companies categorize fulfillment expenses (contract acquisition costs) into two groups: those that result in an asset and those that are expensed as they are spent.

If the extra expenditures are incurred to acquire a contract with a client, the charges are recognized as an asset. In other words, incremental costs are expenses that a firm would not have incurred if the contract had not been awarded (for example, selling commissions).

Other examples include:

(a) direct labor, direct materials, and cost allocation for contract-related expenditures (such as contract management and supervision costs, insurance, and depreciation of tools and equipment).

(b) Costs that produce or increase the company's resources that will be used to meet future performance requirements. Intangible design and engineering costs that will continue to benefit the company in the future are included in the costs. Businesses capitalize direct, incremental, and recoverable expenses (assuming that the contract period is for more than a year).

03

Reporting for Collectibility

A collectibility problem arises whenever a business sells a product or provides a service on credit. Collectibility refers to the risk that a client will be unable to pay the agreed-upon amount of consideration. The amount recorded as revenue is not adjusted for client credit risk under revenue guidance as long as a contract exists (it is likely that the customer will pay). As a result, organizations report gross revenue(without taking into account credit risk) and then show an allowance for any impairment due to bad debts recognized initially and later in line with the specific bad debt advice). An impairment attributable to bad loans is presented as an operating expenditure in the income statement. A corporation will be compensated for fulfilling a performance obligation that has no impact on revenue recognition.

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Most popular questions from this chapter

On May 3, 2017, Eisler Company consigned 80 freezers, costing \(500 each, to Remmers Company. The cost of shipping the freezers amounted to \)840 and was paid by Eisler Company. On December 30, 2017, a report was received from the consignee, indicating that 40 freezers had been sold for \(750 each. Remittance was made by the consignee for the amount due after deducting a commission of 6%, advertising of \)200, and total installation costs of $320 on the freezers sold.

Instructions

(a) Compute the inventory value of the units unsold in the hands of the consignee.

(b) Compute the profit for the consignor for the units sold.

(c) Compute the amount of cash that will be remitted by the consignee.

Explain the importance of a contract in the revenue recognition process.

Describe the critical factor in evaluating whether a performance obligation is satisfied.

Tablet Tailors sells tablet PCs combined with Internet service, which permits the tablet to connect to the Internet anywhere and set up a Wi-Fi hot spot. It offers two bundles with the following terms.

1. Tablet Bundle A sells a tablet with 3 years of Internet service. The price for the tablet and a 3-year Internet connection service contract is \(500. The standalone selling price of the tablet is \)250 (the cost to Tablet Tailors is \(175). Tablet Tailors sells the Internet access service independently for an upfront payment of \)300. On January 2, 2017, Tablet Tailors signed 100 contracts, receiving a total of \(50,000 in cash.

2. Tablet Bundle B includes the tablet and Internet service plus a service plan for the tablet PC (for any repairs or upgrades to the tablet or the Internet connections) during the 3-year contract period. That product bundle sells for \)600. Tablet Tailors provides the 3-year tablet service plan as a separate product with a standalone selling price of \(150. Tablet Tailors signed 200 contracts for Tablet Bundle B on July 1, 2017, receiving a total of \)120,000 in cash.

Instructions

(b) Prepare any journal entries to record the revenue arrangement for Tablet Bundle B on July 1, 2017, and December 31, 2017.

Allee Corp evaluates a revenue arrangement to determine proper revenue recognition. The contract is for the construction of 10 speedboats for a contract price of \(400,000. The customer needs the boats in its showrooms by February 1, 2018, for the boat purchase season; the customer provides a bonus payment of \)21,000 if all ships are delivered by the February 1 deadline. The bonus is reduced by $7,000 each week that the boats are delivered after the deadline until no compensation is paid if the ships are provided after February 15, 2018. Allee frequently includes such bonus terms in its contracts and thus has good historical data for estimating the probabilities of completion at different dates. It calculates an equal likelihood (25%) for each delivery outcome. What approach should Allee use to determine the transaction price for this contract? Explain.

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