 Hello and welcome to the session in which we would look at the revenue recognition principle or what I call it the new revenue recognition. It's not relatively new, it has been new since 2014 but every time I teach this revenue recognition because I switched from the old in quote to the new so I would always call it the new revenue recognition. This revenue recognition is covered in your accounting courses, intermediate accounting as well as the important CPA exam. Now if you're studying for your CPA exam you need to be very familiar with the revenue recognition. Maybe you went to school long time ago and you learned the old rules or maybe your college did not teach you the material properly or you learn it but you forgot it. Here's what I can offer you on foreheadlectures.com. I don't replace your CPA course whether you are taken backer, Roger, Glyme or Wiley. What I can do is I can be an addition, I can be a supplement like a vitamin to your CPA course and I can increase your score by 10 to 15 points so you can put the exam behind you and live your life and focus on your career. And I suggest you check out my website if not for anything is just to check how well is your university doing on the CPA exam. I have scores by overall average. I have score by section as well. If you're an accounting students I have plenty of accounting courses on my website that's gonna help you supplement and compliment your courses. Please check out, not check out, please connect with me on LinkedIn. This way we are connected. Like my this recording and subscribe to my YouTube. I upload on regular basis. This way you will get a notification every time I upload. Follow me on Instagram and like my Facebook page. So first let's just have an overview. Why did we have to learn about this new rule? Why did they change the rule? So just need to know that recently FASB and the IASB issued a converged standard on revenue recognition entitled revenue from contract with customers. So the new term that you need to start to get familiar with is you have to have some sort of a contract before you can recognize revenue. And the reason for this converged standard is because FASB had too many standards for revenue recognitions. So what happened is at some transaction would have been revenue under FASB, not revenue under IFRS or revenue under IFRS but not revenue under FASB. And because of the global economy and companies are operating globally, revenue is an important figure. Revenue is as important as cash. So what happened is they decided to kind of have one revenue recognition. So all companies would follow this revenue recognition the principle and this way revenue is recognized basically on the same playing field across the globe. So it's to address the inconsistencies and weaknesses of the previous approach. The previous approach was earned, revenue is earned, realized or realizable. Now we're gonna be using a different standard. So a comprehensive revenue recognition standard now applies to a wide range of transaction and industries. Now revenue from contract with customers adopts an asset liability approach. So what they're gonna be looking at now is the change. So let me just put the change. So they're gonna look at when they want to determine revenue, they're gonna look at the change in asset. What happened to the change in net asset for each party and the change in net liability. So account for revenue based on asset or liability arising from the contract with customers. So we're gonna look at the contract and determine what assets and liabilities will change. So we are required to analyze contract with customers. And in this session specifically, we're gonna be focusing on contract. We're gonna break this revenue recognition into steps and this is the recording that we focus on contract. So the contract indicate terms and measurement of consideration. Measurement of consideration is the dollar amount. Terms is what are we gonna be delivering and the dollar amount. What dollar amount do we record on the box? So simply put without a contract, what we're saying, companies cannot know whether a promises will be met. So without a contract, in theory there should be no revenue. Now a contract can be oral or written or implied, but if there's no contract, supposedly there is no revenue because the contract is the foundation. The contract will identify what are your rights, what are your obligation and we'll assume that the contract obviously is enforceable, but if there's no contract, there's no revenue. And this is basically a summary of what we're gonna be doing throughout the session, but this is a good summary. So the key objective is to recognize revenue to depict the transfer of goods or services to customer and an amount that reflect the consideration that the company receives or expect to receive in exchange for those goods or services. Of course, we're gonna record revenues based on what we're gonna be receiving or expect to receive. There's a five-step process for revenue recognition. So this is basically the new thing, the five-step process. So step one, which we're gonna be covering in this session today is identify the contract with customer. And this is basically, in a sense, this is the foundation. The foundation step. What is the, basically what is a contract? We're gonna determine what is considered a contract, what does a contract exist? Then we're gonna identify the separate performance obligation and the contract. This is gonna be a separate recording. We're gonna determine the transaction price and we'll talk about how to determine the transaction price. Do we need a specific price? Not a specific price, enough information to determine the price. We'll talk about this later. Then we're gonna allocate the transaction price to the separate performance obligation, assuming we have separate performance obligation as in step two. Then recognize revenue when each performance obligation that we identified in two and allocated an amount to in step four is satisfied. So revenue recognition don't take place until you, still you have to perform your obligation in order to satisfy the revenue recognition. So revenue recognized, recognize revenue in the accounting period when the performance obligation is satisfied. It's pretty straightforward. This is the revenue recognition. You recognize your revenue when you perform, when you perform, pretty straightforward. So let's take a look at a quick example that illustrate the five steps, basically very simple, just to kind of get you used to this idea of contract. So assume Boeing, a company, assume Boeing corporation signs a contract to sell airplanes to Delta Airlines for 100 million. Pretty straightforward contract. Identify the contract with customers. First, yes, there is a contract. Identify the contract with customer. A contract, what is a contract? It's an agreement between two parties and we have here in agreement that create enforceable rights or obligations. In this case, Boeing has signed a contract to deliver airplanes to Delta, okay? They have an obligation to deliver airplanes to Delta. Identify the separate performance obligation in the contract step two. We have only one performance, one obligation to deliver airplanes to Delta. Pretty straightforward. Now, if Boeing agrees, agreed to maintain the planes, a separate performance obligation is recorded for that promise. So if there's another promise to maintain those planes, then that's a separate performance. But here we only have one performance, basically selling the plane. Step three, determine the transaction price and this transaction, pretty straightforward. The transaction price is the amount of consideration that a company expect to receive from a customer in exchange for transferring goods or services. Well, 100 million, we're done. Allocate the price to the separate performance obligation. We only have one performance obligation in this contract. In this case, we only have one, the obligation to deliver the airplane. And step five, when do they recognize revenue? Recognize revenue of 100 million when you satisfy the performance obligation and how do you satisfy the performance obligation in this example, delivery. Deliver the airplanes and you have a performance obligation satisfied, okay? But step five is when. Basically, this is when to recognize revenue, when to recognize revenue. Here, you have to deliver the airplane, okay? Sometime you might have to do it throughout the process. We'll see, each contract will be different. That's what we have to look at. Now we're gonna look at understand and apply the five-step revenue recognition process. We're only gonna look at one step and that's contract. So what is a contract? So let's start with contract. Contract is, as I said, it's the foundation, okay? So the first thing is does a contract exist and what is a contract? Well, a contract is an agreement between two or more parties that create enforceable rights or obligation. The contract doesn't have to be written. It can be written, it can be oral or it can be implied from customary business practice. Written obviously, you have a contract on a piece of paper, oral basically you agreed and implied basically based on business practices, that's what we do. For example, if you go into a supermarket, you pick up an item, you walk to do those self-check and you self-check yourself and you leave, basically this is a contract, there was a contract. When you paid, that's an implied contract from the customary business practice. You did not sign a paper, you did not talk to anyone but that's a contract, okay? So it doesn't have to be written, keep that in mind. But if there is no contract, if there is no contract, if there is no contract of any sort, it means there is no revenue. So when do we recognize the revenue? At this point, wait until we perform. That's when we recognize the revenue, okay? So to have a valid contract, okay? Company applies the revenue guidance for a contract according to the following criteria. So for the contract to be a valid contract, it has to have five criteria and those are the five criteria which we'll talk about, kind of illustrate a little bit further. The contract has to have commercial substance and maybe you learn about commercial substance and when you do a non-monetary exchange, does the exchange has a commercial substance or not a commercial substance? Basically, the contract cannot be a shame transaction, okay? So this is basically, this is considered a protective clause and protective clause against what? Against inflating revenue. Oops, let's go back here. Against inflating revenue. So basically what we're saying when a company goes into a contract with another company but basically it's a backdoor deal. I'm gonna sell my product to you this quarter to inflate my revenue, the next quarter I will buy it back or you buy my product. Well, that's, there is no really commercial substance in the contract, okay? So basically this is to kind of avoid, that's also called round-trip transaction. I sell it then I'll buy it back. So the contract has to have commercial substance. Basically, in other words, it has to be an armed land. There's a valid business reason for it. This is what a commercial substance is, okay? The other thing is the parties has approved the contract. In other words, once they approve the contract, they made a commitment. Then the contract is legally, if you think about it, once you make a commitment, legally enforceable, okay? So because think about it, unapproved contract, okay? Unapproved contract is not really a contract. If there's a contract, but it hasn't been approved by both parties because remember a contract has to be approved it's between two parties. So both parties have to approve the contract. So unapproved contract is not legally enforceable. It's not a valid contract, okay? Identifications of the right of the parties is established. Now, this may sound stupid, but you need to know what are your rights? What is the service? What goods or service you will be providing? You need to identify this, identify the rights of the parties. Now also, the parties have approved contract to number two. Just wanna go back and that include the approved contract. Also the approved contract, what we need to look at too, if there's any termination clause. What is the termination clause? Termination clause is, what if one party can cancel the contract with no penalties whatsoever? They can walk away from the contract. Then really the contract is not enforceable, okay? Because if you can walk away with no consequences, then it's not really a contract, okay? So identify the rights. Basically, you need to know what is the right of each party. Payment terms are identified. Notice they are identified. Basically, you don't have to know exactly. They don't have to be not fixed. So you don't have to know exactly how much you're gonna be getting, but as long as you have enough information to basically determine the price. To determine the price. So as long as you can determine or estimate, estimate the price, then you have enough information to estimate the price, then that's good enough. Then you have a price. Because a contract without a price, it's not possible. It is possible, but it's not really a valid. It's not a contract because you don't know how much you're gonna be getting. So what amount you're gonna record on the books? You don't know. You don't have to know exactly, but you should have enough information that you can estimate or you can determine the price of the contract, okay? And the fifth criteria, then it's probable that the consideration will be collected. That's important. Think about it. If you don't think you're gonna be collecting the money, you don't think you're gonna be collecting the money. There's no contract whatsoever, okay? Because why would you sell something or provide a service? But there is no chance of collecting the money. This isn't called a charity, okay? If that's what you are trying to do. But the point is, when do you determine that you're not gonna be able to collect the money? Now, if you can determine upfront, if you provide a service and you know upfront that this customer, there's really good chance that they're not going to pay you. Then you don't recognize revenue until cash is received. So you would use the cash basis. But the problem is, when do you determine this? Sometimes you don't know, okay? But you have to determine if it's probable that the consideration will be collected. If it's probable, then it's okay. Then we can move on and it's a valid contract, okay? But if it's not probable, then we have some sort of an issue here. We have to determine if this is revenue or we have to wait until we receive the cash. So those are the criteria for cash. I'm sorry, for a valid contract to be a valid company. This is step one. So identifying the contract with customer. And let's work an example just to see how it works. Let's assume March 1st, Margo Company enters into a contract to transfer product to soon-une on July 31st. So this is when they enter into the contract to deliver on July 31st. The contract is structured such that soon-une is required to pay the full amount on August. So they signed the contract in March. They will deliver the product in July. They will be paid in August. The cost of the goods transferred is 3,000. And Margo delivered the product on July 31st. So we have an enforceable contract as March 31st. Let's assume that's the case. Excellent. So if we go through the five steps, we have an enforceable contract. We assume it's an enforceable contract. We assume it's a valid contract. We have a price. We know what we need to determine. But we don't recognize revenue until when? Until, let's go back here. We don't recognize revenue until we deliver the product. So revenue is recognized right here when the performance obligation is satisfied. When do I satisfy my performance obligation? I didn't have a contract. I didn't know my performance. I didn't determine the price. That's only one obligation. Then step five, I recognize the revenue. So I recognize the revenue when I perform, which is July 31st. I debit AR 5,000 credit sales revenue. Debit cost of goods sold credit inventory. Now, a month later, they'll pay me the cash. I debit cash, credit account receivable. And this is basically a quick example of you have a contract, a valid contract, and this is how you go through the process. Okay? The next step, let's see, maybe let's work maybe just kind of one or two multiple choice question or some sort of a true false. Just to kind of, let's take a look at those true false. Maybe we'll go through, let's go through those multiple choice questions. So this way, kind of just to kind of reinforce what we just learned because it's a new topic. So as a student, you would need to know, just start to get your head wraps around this. So the new standard revenue from contract with customers adopts an expense liability approach on the, as the basis for revenue recognition. No, it's an asset liability approach. So this is false. The revenue recognition principle states that revenue is recognized when the performance obligation is satisfied, excellent. Yes, that's exactly when you recognize revenue. The first step, the first step of the five step revenue recognition model is to identify the contract. Of course, this is the foundation step, contract with customer. When a customer gives cash for a shirt at a retail store and takes the shirt from the store after paying, revenue is recognized at that point in time because the performance obligation by the store has been satisfied. Absolutely, they gave you the shirt, you paid them the money, we're all good to go. We're all good to go. Let's see if we can maybe also work a few multiple choice just to see. Let's work those three. So the converge standard of on revenue recognition entitled revenue from contract with customer was developed because, because what? Gap had only one basic standard now. Gap had too many. Gap had numerous related standard, yes. That's potential, good answer. IFRS had numerous inconsistent standard now, that's Gap. Gap had more of a principal base now, had rule base, not principal base, so be. The new standard recognizes revenue based on, again, asset liability approach, which of the following best described the current revenue recognition principle? Identify separate performance obligation in the contract, that's part of it, but that's not, that's not the revenue recognition principle. Recognize revenue in the accounting period when cash is received, now this is the cash basis. Recognize revenue when earned, no, that's the old, that's the old one. Recognize revenue in the accounting period when the performance obligation is satisfied, yes, that's the answer. 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