Question

QUESTION 4

1. Part IV:
   
   Background       
   On January 10, KH sold a mixer it purchased from MU for $80 cash and delivered it to a customer. KH has a 45-day return policy under which a customer can exchange a product for another product of the same type, quality, condition and price. The exchange policy requires that all returned products must be like new. Based on extensive historical experience, KH estimates that 2% of its products will be exchanged by customers for another product of the same price, condition, quality and type. KH estimates the cost of recovering any products will be insignificant. KH does not record any potential volume discounts until they are earned.  
   Requirements
   ►      Prepare a detailed explanation of each of the five steps of revenue recognition. Record all initial accounting entries for MU for January 10 based on guidance on revenue recognition in ASC 606. Include references to the guidance to support your proposed accounting. Show any calculations you make to support your journal entries.
   

Answer 1

Firstly Understand ''What Is Revenue as per ASC - 606''

Inflows or other enhancements of assets of an entity or settlement of liabilities from delivering or producing goods, rendering services or other activities that constitutes the entity ongoing major or central operations.

Now what is the core principles of ASC 606 - Recognize revenue to depict the transfer of promised goods or services to customer in an amount that reflect the consideration to which entity expects to be entitled in exchange for those goods or services.

Following steps are followed to apply the above principles:

• Identify the contract with the customer

Firstly Understand what is the contract - An agreement between two or more parties that creates a enforceable rights and obligations. Further establishment of contract is not sufficient following five condition also need to be satisfied :

• Approvals have been obtained and commitment to perform exists on both the party
• Rights of both the parities are identifiable
• Payment terms are identifiable
• Commercial substance exist
• Collection against transfer of goods or services is likely to occur or probable

• Identify the Performance obligation in the contract

Firstly Identify that what are the entity promises to provide goods or services in the contract. and secondly determine whether promises to provide goods or services should be treated as performance obligations and accounted for separately.

• Determine the Transaction price

Transaction Price is “the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes).”

This guidance does not apply to - product exchanges, provided the products are of the same type, quality, condition and price (which have no accounting effect) or product exchanges due to defects (which are accounted for as warranties).

• Allocate the transaction price to the performance obligation

In thsi steps , Entity should allocate the transaction price as per the no. of performance obligation exist in the contract , if obligation is related to two septate activity like firstly transfer the goods and thereafter services then allocates according to this .

• Preconization revenue when each performance obligation is satisfied.

Revenue is recognized when - a performance obligation is satisfied, which is the transfer of underlying good or service to the customer. The amount of revenue recognized upon satisfaction of a performance obligation is the transaction price allocated to it. Such is related with the transfer of Control , Transfer of control means that when the customer has the ability to direct the use of the asset and receive substantially all of the related remaining benefits, which includes the customer being able to stop others from directing the use of the asset and receiving substantially all of the related remaining benefits. Here benefits are considered in terms of the potential cash flows the customer can obtain or save (directly or indirectly) as a result of having control of the asset. Following indicators must be considered to assess whether control of an assets has transferred to the customers.

• Customer is presently obligated to pay the entity for the transferred asset
• Customer has legal title to the transferred asset
• Customer has physical possession of the transferred asset
• Customer has the significant risks and rewards of owning the asset
• Customer has accepted the asset

Journal Entry as on 10th

Cash A/C .....Dr.      $ 80

TO Revenue ... Cr.   $ 80

( Revenue should be booked at the time of sale and no liability is required to be booked or revenue to be booked less because here in the obligation is to exchange the goods not return and refund. So in case of exchange of goods this guidance ASC 606 is not applicable)

If return and refund case then following entry is required to be pass:

Cash ...... Dr.    

To Revenue   Cr.

To Liability towards Refund Cr..