09. Other Topics in Revenue Recognition

This section addresses nuanced revenue recognition situations under ASC 606, including contract modifications, returns, repurchase agreements, and bill-and-hold arrangements. These topics are frequently tested on the USCPA FAR exam due to their complexity and practical relevance.

🔁 Contract Modifications

Definition

A contract modification is a change in the scope or price (or both) of a contract that is approved by both parties.

Accounting Treatment

Evaluate whether the modification should be:

Treated as a separate(New) contract
- Criteria:
  - Adds distinct goods/services, and
  - Price increase reflects standalone selling price
Part of the existing contract (i.e., cumulative catch-up or prospective approach)
- If the remaining goods/services are not distinct, use the cumulative catch-up method.
- If distinct but not separately priced, use the prospective approach.

📌 Example

Scenario:
Stellar Tech has a contract to sell 500 ergonomic chairs to Office Solutions Inc. over a one-year period for a price of $300 per chair. The cost for Stellar Tech to produce each chair is $180. After Stellar Tech has successfully delivered 300 chairs, the two companies modify the contract. The modification adds an additional 100 chairs to the order.

First, let's record the journal entries for the initial 300 chairs delivered before the modification.

Cash/Accounts Receivable      90,000
    Sales Revenue                         90,000
(To record sale of 300 chairs × $300)

Cost of Goods Sold            54,000
    Inventory                             54,000
(To record cost of 300 chairs × $180)

Case 1: Modification as a Separate Contract

Instruction: Prepare the journal entry for the sale of the next 50 chairs after the contract modification. Assume the price for the additional 100 chairs is set at $310 per chair, which represents the standalone selling price at the time of the modification. The chairs are distinct, and Stellar Tech sells them separately.

When the additional goods are distinct and priced at their standalone selling price, the modification is treated as a new, separate contract. The original contract accounting is unaffected.

Journal Entry:

Cash/Accounts Receivable      15,500
    Sales Revenue                         15,500
(To record sale of 50 chairs × $310)

Cost of Goods Sold             9,000
    Inventory                              9,000
(To record cost of 50 chairs × $180)

Case 2: Prospective Modification

Instruction: Prepare the journal entry for the sale of the next 50 chairs after the contract modification. Now, assume the price for the additional 100 chairs is set at $270 per chair, which does not reflect the standalone selling price at the time of modification. This modification will be accounted for prospectively.

When the additional goods are distinct but the price is not the standalone selling price, the modification is treated as a termination of the old contract and the creation of a new one. The revenue for all remaining goods (both from the original contract and the modification) is recognized prospectively using a blended price.

Calculation of Blended Price:

Calculate the value of remaining goods under the original contract:
- Remaining units: 500 - 300 = 200 chairs
- Price: $300 per chair
- Remaining contract value: 200 × $300 = $60,000
Calculate the value of goods from the modification:
- New units: 100 chairs
- Price: $270 per chair
- Modification value: 100 × $270 = $27,000
Calculate the blended price per unit:
- Total remaining consideration: $60,000 + $27,000 = $87,000
- Total remaining units: 200 + 100 = 300 chairs
- Blended price: $87,000 ÷ 300 chairs = $290 per chair

Journal Entry:

Cash/Accounts Receivable      14,500
    Sales Revenue                         14,500
(To record sale of 50 chairs × $290 blended price)

Cost of Goods Sold             9,000
    Inventory                              9,000
(To record cost of 50 chairs × $180)

🔄 Sales with a Right of Return

Overview

If customers have the right to return goods, revenue should only be recognized to the extent it is probable a significant reversal will not occur.

Journal Entry at Sale

Recognize revenue for expected sales (net of returns)
Create a refund liability
Record a return asset for the expected goods to be returned

📌 Example

Scenario:
On May 5, Year 3, Delta Tech sold 1,000 units of wireless keyboards to Echo Retailers on account for $40 each. The cost of each keyboard to Delta is $25. Echo Retailers has the right to return any unused units within 30 days of sale.

On May 12, Echo returned 20 units.
As of May 31, when Delta Tech prepared its interim financial statements, it estimated that another 15 units are likely to be returned.

Journal entries - Delta Tech record on May 5, 12, 31

✅ Solution & Explanation (ASC 606 Standard)

The accounting treatment under ASC 606 requires recognizing revenue net of expected returns from the very beginning. The entries should be as follows, reflecting all information known as of the reporting date.

Step 1: Journal Entry for the Initial Sale on May 5

On the date of sale, the company must estimate the returns and recognize revenue only for the portion it expects to keep. All known information (including the estimate from May 31) is used to make the entry.

Total Expected Returns: 20 (actual) + 15 (estimated) = 35 units
Net Sale: 1,000 - 35 = 965 units

// To record the sale on May 5, net of expected returns
Dr. Accounts Receivable       $40,000
    Cr. Sales Revenue             $38,600  // (For 965 units expected to be kept)
    Cr. Refund Liability          $1,400   // (For 35 units expected to be returned)

// To record the cost side of the sale
Dr. Cost of Goods Sold        $24,125  // (Cost for 965 units)
Dr. Inventory - Return Asset    $875     // (Cost for 35 units to be recovered)
    Cr. Inventory                 $25,000  // (Total cost of inventory shipped)

Step 2: Actual return on May 12 (20 units)

When a customer returns goods, the company settles a portion of the refund liability and physically receives the inventory. The "Return Asset" (a right to recover) is converted into actual "Inventory".

Return Amount: 20 units × $40 =$ 800 Cost of Returned Goods: 20 units × $25 =$ 500

// To record the settlement of the liability for the returned goods
Dr. Refund Liability            $800
    Cr. Accounts Receivable         $800

// To record the receipt of inventory from the customer
Dr. Inventory                   $500
    Cr. Inventory - Return Asset    $500

Step 3: Estimated return on May 31 (15 units)

No additional entry is required. The initial entry on May 5, guided by the information available on May 31, already accounted for the total estimate of 35 returned units. The balances in the "Refund Liability" ($1,400 - $800 = $600) and "Inventory - Return Asset" ($875 - $500 = $375) accounts already reflect the correct amounts for the remaining 15 units expected to be returned. An adjusting entry would only be needed if the estimate itself changed on this date.

🎯 CPA Tip: Don’t forget to reduce COGS based on expected returns.

🔁 Repurchase Agreements

🔎 Definition

A repurchase agreement is a contractual arrangement where the seller retains control of the asset by agreeing to or being obligated to repurchase the asset in the future. Despite appearing to be a sale, these are often financing arrangements under ASC 606.

🔄 Types of Repurchase Agreements

Forward Contract
- The seller has an obligation to repurchase the asset.
- This structure almost always points towards a financing arrangement, especially if the repurchase price is greater than the original selling price.
Call Option
- The seller has the right (but not obligation) to repurchase the asset.
- The accounting treatment depends on whether the seller has a significant economic incentive to exercise this right (e.g., the repurchase price is well below the asset's expected future market value).
Put Option
- The buyer has the right to require the seller to repurchase the asset.
- The accounting treatment hinges on whether the buyer has a significant economic incentive to exercise this option. This is the most complex scenario and can result in a financing arrangement, a lease, or a sale with a right of return.

📘 Accounting for Repurchase Agreements

The accounting treatment depends on which party holds the power (via obligation or incentive) and the relationship between the selling price (SP) and repurchase price (RP).

A. Financing Arrangement

This treatment applies if:

It's a Forward or Call Option where RP ≥ SP.
It's a Put Option where the buyer has a significant economic incentive to exercise, and RP ≥ SP.

Accounting:

The seller does not derecognize the asset (inventory).
The cash received is recorded as a Financial Liability.
The difference between the cash received (SP) and the repurchase price (RP) is recognized as Interest Expense over the life of the agreement.

Example Journal Entries:

Scenario: Sold asset for $10,000, obligated to repurchase for $12,000 in one year.

// To record the initial cash receipt
Dr. Cash                  $10,000
    Cr. Financial Liability     $10,000

// To accrue interest over the year
Dr. Interest Expense      $2,000
    Cr. Financial Liability     $2,000

B. Lease

This treatment applies if:

It's a Call Option where RP < SP.
It's a Put Option where the buyer has a significant economic incentive to exercise, and RP < SP.

Accounting:

The seller does not derecognize the asset and continues to record depreciation.
The cash received is treated similarly to a lease payment, and a lease liability is recognized.

C. Sale with a Right of Return

This treatment applies if:

It's a Put Option, but the buyer has NO significant economic incentive to exercise (e.g., the RP is at or below the expected future market value).

Accounting:

The transaction is treated as a regular sale.
The seller recognizes revenue, COGS, and a receivable.
Based on the probability of the option being exercised, the seller must also account for potential returns by recording a Refund Liability and a Return Asset.

3. Summary Table

Type	Condition	Accounting Treatment
Forward	Obligation to repurchase (RP ≥ SP)	Financing Arrangement
Call Option	Right to repurchase (RP ≥ SP)	Financing Arrangement
	Right to repurchase (RP < SP)	Lease
Put Option	Buyer has significant incentive (RP ≥ SP)	Financing Arrangement
	Buyer has significant incentive (RP < SP)	Lease
	Buyer has NO significant incentive	Sale with Right of Return

📦 Bill-and-Hold Arrangements

Definition

A revenue recognition situation where goods are billed to the customer but not yet delivered.

Criteria for Revenue Recognition

All must be met:

Customer requested the arrangement.
Product must be separately identified as belonging to the customer.
Product must be ready for physical transfer.
Seller cannot use or redirect the product.

⚠️ Common Error: Recognizing revenue too early when delivery has not occurred and criteria are unmet.

📝 Summary Table

Topic	Key Rule or Consideration
Contract Modification	Separate contract vs. cumulative catch-up
Sales Return	Record refund liability and return asset
Repurchase Agreement	Often results in financing, not sale
Bill-and-Hold	Must meet all 4 criteria to recognize revenue

🧠 CPA Exam Tip

Expect scenario-based MCQs and SIMs that test your ability to apply ASC 606 principles. Especially focus on:

Identifying distinct goods/services in modifications
Proper journal entries for returns
Economic substance of repurchase arrangements
Legal title vs. control in bill-and-hold