Question

Which of the following 5 conditions must be met for a firm to account for a contract with a customer?

1. All parties to the contract have approved the contract and are legally obligated to perform their obligations under the contract.
2. Each party’s rights regarding the goods or services being exchanged can be identified.
3. Payment terms can be identified.
4. The contract has commercial substance.
5. Collection is probable.

A. 1, 2 & 3.

B. 1 & 2.

C. 1, 3 & 5.

D. All of the above 5 conditions must be met for a firm to account for a contract with a customer

Answer 1

Solution:-

D. All of the above 5 conditions must be met for a firm to account for a contract with a customer

Explanation:-

The new revenue guidance defines a contract as an agreement between two or more parties that creates enforceable rights and obligations. Standard setters identified the attributes below as essential parts of a contract:

• All parties have approved the agreement. This criterion addresses the fact that a contract is usually only enforceable once all parties have approved it. Contracts may be written, oral, or implied by the entity’s normal business practices. Since contract enforceability is a matter of law, an entity should consider the legal jurisdiction in which it operates as the rules for contract enforceability may differ (e.g., some jurisdictions may require written contracts).
• All parties are committed to fulfilling their obligations. Termination clauses must be evaluated when addressing this criterion. The standard states that if each party has the unilateral right to terminate a wholly unperformed obligation, then no contract exists.
• Each party’s rights are identifiable. The arrangement must clearly identify the goods or services to be provided. If the performance obligations cannot be identified, then it is impossible to determine when the transfer of control has occurred, which is prerequisite for recognizing revenue.
• Payment terms are identified. As long as there is an enforceable right to receive payment in exchange for goods or services, the transaction price does not need to be expressly stated in the contract. The contract does need to include sufficient detail that the price can be reasonably estimated. When determining if payment terms are identified, the entity should consider if there are any laws or legal precedents that the customer could use to override the contractual obligation to pay.
• The contract has commercial substance. A contract only exists if the risk, timing, or amount of cash flows to an entity are expected to change as a direct result of the contract.
• Collectibility is probable. The new standard requires vendors to evaluate a customer’s credit risk at contract inception. Consistent with current guidance, a vendor can only recognize revenue when payment is likely to be received. For more information, see our article on Collectibility.