VLCPA logo

Recent Tweets

Articles

Revenue Recognition Applied: Manufacturing & Distribution

11/18/19 – Beth Vice & Kristin Leadingham

LinkedIn
Share Article


Accounting for Revenue from Contracts with Customers

ASC 606 Revenue from Contracts with Customers introduced a five-step-approach to recognizing revenue from contracts with customers. The approach includes the following actions:

1)    Identify the contract with the customer.

2)    Identify the performance obligations in the contract.

3)    Determine the transaction price.

4)    Allocate the transaction price to the performance obligations in the contract.

5)    Recognize revenue when (or as) the entity satisfies a performance obligation.

Once these steps have been completed, you must next determine what the accounting looks like.  This article observes the perspective of a distributor applying the five-step-approach in a real-world situation.

Background

At the beginning of the year, a Distributor obtains a signed purchase order from a Customer to ship Product A for $100 per unit. If the Customer purchases more than 1,000 units in a calendar year, the price is retrospectively reduced to $90 per unit.

In this example, the contract is the signed purchase order. The performance obligations required under the contract is the shipment of Product A, with the transaction price based on variable consideration. The Distributor will ship Product A for $100 per unit unless more than 1,000 units are sold in the calendar year. If more than 1,000 units are sold, the Distributor is committed to ship Product A for $90 per unit. The transaction price will be allocated to each performance obligation (or unit of Product A shipped) at the price per unit. Finally, revenue will be recognized at the point in time when Product A is shipped and control transfers to the Customer, as it does not meet the criteria to be satisfied over time.

1st Quarter

In the first quarter, the Distributor sells 75 units of Product A to the Customer. As a result, the Distributor is estimating that the Customer will not exceed the 1,000 unit threshold. Therefore, the transaction price is estimated at $100 per unit of Product A. As 75 units were sold in the first quarter, the Distributor will recognize revenue of $7,500 (75 units shipped x $100 per unit). As there are no other conditions required for Distributor to receive the consideration for the exchange, a receivable will be recorded. 

The journal entry as of March 31, 20XX is as follows: 

Accounts Receivable                    $7,500
Revenue                                       $7,500

(To recognize revenue for 75 units of Product A shipped.)

When the payment is received from the Customer, the following entry is made:

Cash                                            $7,500
Accounts Receivable                   $7,500

(To recognize cash received for invoice.)

2nd Quarter

In the second quarter, the Customer acquires another company and has the Distributor ship another 500 units of Product A. The Distributor now estimates that the Customer will exceed the 1,000 unit threshold, and the transaction price is retrospectively reduced to $90 per unit. At this point, the revenue is adjusted in the second quarter for the updated transaction price on the units sold in the first and second quarter. The Distributor will recognize $44,250 [(500 units shipped in second quarter x $90 per unit) – (75 units shipped in first quarter x $10 reduction in price per unit)] in revenue as of June 30, 20XX.

The journal as of June 30, 20XX is as follows:

Accounts Receivable              $44,250
Revenue                                 $44,250

(To recognize revenue for 500 units of Product A shipped and to adjust for variable consideration related to 1st quarter.)

When the payment is received from the Customer, the following entry is made:

Cash                                       $44,250
Accounts Receivable               $44,250

(To recognize cash received for invoice.)            

Additionally, the Customer pays a deposit of $45,000 for another 500 units of Product A to be shipped in the third quarter. As a result, the Distributor prepares the following journal entry as of June 30, 20XX:

Cash                                     $45,000
Contract Liability                   $45,000

(To record deposit on 500 units of Product A.)

3rd Quarter

In the third quarter, the Distributor ships the additional 500 units of Product A. Once the units are shipped, the Distributor recognizes revenue of $45,000 (500 units shipped in the third quarter x $90 per unit).


The journal entry as of September 30, 20XX is as follows:

Contract Liability                     $45,000
Revenue                                 $45,000

(To recognize revenue for 500 units of Product A shipped.)

New Terms

Two new terms came out of the revenue standard, contract asset and contract liability.

A contract asset is the entity’s right to consideration in exchange for goods or services the entity has transferred to a customer. There is a distinction between a contract asset and a receivable. A receivable is an entity’s right to consideration that is unconditional. Unconditional is defined as the passage of time required before payment of the consideration is due. For instance, if an entity enters into a contract to deliver multiple products to a customer and, the customer is not required to pay until 60 days after both products are delivered, a contract asset would be recorded for each performance obligation satisfied until the last product is delivered. Once the last product is delivered, the contract asset is reclassified to a receivable.

A contract liability is an entity’s obligation to transfer goods or services to a customer for which the entity has received consideration (or an amount is due) from the customer. This would apply if the customer pays a deposit or if an invoice is created for an amount owed as a result of the payment terms, but the goods and services have not transferred.

Contract assets and contract liabilities are to be presented net as a single line item of either net contract asset or net contract liability on the face of the financial statements.

For more information regarding the changes in Revenue Recognition standards, visit vlcpa.com and download our recent presentation Revenue Recognition Update for Manufacturing and Distribution Entities