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Q32Q.

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Intermediate Accounting (Kieso)
Found in: Page 1031

Short Answer

Explain the reporting for (a) costs to fulfill a contract and (b) collectibility.

(a) Companies divide fulfillment costs (contract acquisition costs) into two categories: (1) those that result in an asset (2) those that are expensed as they are incurred.

(b) Collectibility: The risk that a customer will be unable to pay the agreed-upon amount of consideration is referred to as collectibility.

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Step by Step Solution

Definition of Collectibility

Collectibility relates to a client's credit risk or the possibility that the customer may be unable to pay the agreed-upon amount of consideration. The revenue amount is not adjusted for customer credit risk under the revenue guideline as long as a contract exists (it is likely that the customer will pay).

Reporting for costs to fulfill a contract 

Companies categorize fulfillment expenses (contract acquisition costs) into two groups: those that result in an asset and those that are expensed as they are spent.

If the extra expenditures are incurred to acquire a contract with a client, the charges are recognized as an asset. In other words, incremental costs are expenses that a firm would not have incurred if the contract had not been awarded (for example, selling commissions).

Other examples include:

(a) direct labor, direct materials, and cost allocation for contract-related expenditures (such as contract management and supervision costs, insurance, and depreciation of tools and equipment).

(b) Costs that produce or increase the company's resources that will be used to meet future performance requirements. Intangible design and engineering costs that will continue to benefit the company in the future are included in the costs. Businesses capitalize direct, incremental, and recoverable expenses (assuming that the contract period is for more than a year).

Reporting for Collectibility

A collectibility problem arises whenever a business sells a product or provides a service on credit. Collectibility refers to the risk that a client will be unable to pay the agreed-upon amount of consideration. The amount recorded as revenue is not adjusted for client credit risk under revenue guidance as long as a contract exists (it is likely that the customer will pay). As a result, organizations report gross revenue(without taking into account credit risk) and then show an allowance for any impairment due to bad debts recognized initially and later in line with the specific bad debt advice). An impairment attributable to bad loans is presented as an operating expenditure in the income statement. A corporation will be compensated for fulfilling a performance obligation that has no impact on revenue recognition.

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