ch07 [EDocFind.com]

8/7/2019 ch07 [EDocFind.com]

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Chapter7-1


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Chapter7-3

1. Apply the revenue recognition principle.

2. Describe accounting issues involved with revenuerecognition at point of sale.

3. Apply the percentage-of-completion method for long-term contracts.

4. Apply the completed-contract method for long-termcontracts.

5. Describe the installment-sales and cost-recoverymethods of accounting.

Learning ObjectivesLearning Objectives


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Chapter7-5

One study noted restatements of revenue:

Result in larger drops in market capitalization

than other types of restatement.

Caused eight of the top ten market value losses

in a recent year.

Of the ten companies, the leading three lost

$20 billion in market value in just three days

following disclosure.

Revenue recognition has been the largest source of

public company restatements over the past decade.

The Current EnvironmentThe Current Environment


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Chapter7-6

The revenuerecognition principle provides that

companies should recognize revenue

Guidelines forRevenueRecognition


LO 1 Apply therevenuerecognition principle.LO 1 Apply therevenuerecognition principle.

(1) when it is realized or realizable and

(2) when it is earned.


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Chapter7-8

Earlierrecognition is appropriate if there is a high

degree of certainty about the amount of revenue

earned.

Delayed recognition is appropriate if the

degree of uncertainty concerning the amount of

revenue or costs is sufficiently high or sale does not represent substantial completion

of the earnings process.

Departures from theSale Basis


LO 1 Apply therevenuerecognition principle.LO 1 Apply therevenuerecognition principle.


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Chapter7-9

RevenueRecognitionAlternatives


LO 1 Apply therevenuerecognitionprinciple.LO 1 Apply therevenuerecognitionprinciple.

Illustration 7-2


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Chapter7-10

FASBs ConceptsStatement No. 5, companies

usually meet the two conditions for recognizing

revenue by the time they deliver products or renderservices to customers.

Departures from theSale Basis

RevenueRecognitionat Pointof Sale (Delivery)RevenueRecognitionat Pointof Sale (Delivery)

LO 2Describeaccounting issues forrevenuerecognitionat pointof sale.LO 2Describeaccounting issues forrevenuerecognitionat pointof sale.

Implementation problems,

Sales with buyback agreements Sales when right of return exists

Trade loading and channel stuffing


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Chapter7-11

When a repurchase agreement exists at a set price

and this price covers all cost of the inventory plus

related holding costs, the inventory and relatedliability remain on the sellers books.* In other

words, no sale.

Sales with BuybackAgreements

RevenueRecognitionat Point of Sale (Delivery)RevenueRecognitionat Point of Sale (Delivery)

LO 2 Describeaccounting issues forrevenuerecognitionatpoint of sale.LO 2 Describeaccounting issues forrevenuerecognitionatpoint of sale.

* Accounting for Product Financing Arrangements, Statement ofFinancial Accounting Standards No. 49 (Stamford, Conn.: FASB, 1981).


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Chapter7-13

Sales WhenRightof ReturnExists


LO 2 Describeaccounting issues forrevenuerecognitionatpointof sale.LO 2 Describeaccounting issues forrevenuerecognitionatpointof sale.

4. The buyer acquiring the product for resale has economicsubstance apart from that provided by the seller.

5. The seller does not have significant obligations for future

performance to directly bring about resale of the product

by the buyer.6. The seller can reasonably estimate the amount of future

returns.

Recognize revenue only if all six of the following

conditions have been met.


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Chapter7-14

Trade loading is a crazy, uneconomic, insidious

practice through which manufacturerstrying to

show sales, profits, and market share they dontactually haveinduce their wholesale customers,

known as the trade, to buy more product than they

can promptly resell.*

Trade Loadingand Channel Stuffing


LO 2 Describeaccounting issues forrevenuerecognitionatpointof sale.LO 2 Describeaccounting issues forrevenuerecognitionatpointof sale.

* The $600 Million Cigarette Scam, Fortune (December 4, 1989), p. 89.


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Chapter7-15

Two Methods:

Percentage-of-Completion Method.

Rationale is that the buyer and seller have

enforceable rights.

Completed-Contract Method.

Most notable example is long-termconstruction

contract accounting.

RevenueRecognition Before DeliveryRevenueRecognition Before Delivery

LO 2 Describe accounting issuesforrevenuerecognition atpointofsale.LO 2 Describe accounting issuesforrevenuerecognition atpointofsale.


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Chapter7-16

Must use Percentage-of-Completion method whenestimates of progress toward completion, revenues, andcosts are reasonably dependable and all of the followingconditions exist:


1. The contract clearly specifies the enforceable rightsregarding goods or services by the parties, theconsideration to be exchanged, and the manner and termsof settlement.

2. The buyer can be expected to satisfy all obligations.

3. The contractor can be expected to perform under thecontract.

LO 2 Describeaccounting issues forrevenuerecognitionat pointof sale.LO 2 Describeaccounting issues forrevenuerecognitionat pointof sale.


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Chapter7-17

Companies should use the Completed-Contractmethodwhen one of the following conditions applies when:


1. Company has primarily short-term contracts, or

2. Company cannot meet the conditions for using thepercentage-of-completion method, or

3. There are inherent hazards in the contract beyond thenormal, recurring business risks.

LO 2 Describeaccounting issuesforrevenuerecognitionat pointof sale.LO 2 Describeaccounting issuesforrevenuerecognitionat pointof sale.


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Chapter7-18

Measuring theProgress toward Completion

Most popular measure is the cost-to-costbasis.

LO 3 Apply thepercentageLO 3 Apply thepercentage--ofof--completionmethodforlongcompletionmethodforlong--termcontracts.termcontracts.

PercentagePercentage--ofof--Completion MethodCompletion Method

The percentage that costs incurred bear to total

estimated costs, can be applied to the totalrevenue or the estimated total gross profit onthe contract.


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Chapter7-19

2007 2008 2009

Contract price $675,000 $675,000 $675,000

Cost incurred current year 150,000 287,400 170,100Estimated cost to complete

in future years 450,000 170,100 0Billings to customer current year 135,000 360,000 180,000Cash receipts from customer

Current year 112,500 262,500 300,000

A) Prepare the journal entries for2007, 2008, and 2009.

Casper Construction Co.

LO 3 Apply thepercentageLO 3 Apply thepercentage--ofof--completionmethodforlongcompletionmethodforlong--term contracts.term contracts.


Illustration:


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Chapter7-20 LO 3 Apply thepercentageLO 3 Apply thepercentage--ofof--completionmethodforlongcompletionmethodforlong--term contracts.term contracts.


2007 2008 2009

Costs incurred to date 150,000$ 437,400$ 607,500$

Estimated cost to complete 450,000 170,100

Est. total contract costs 600,000 607,500 607,500

Est. percentage complete 25.0% 72.0% 100.0%

Contract price 675,000 675,000 675,000

Revenue recognizable 168,750 486,000 675,000

Rev. recognized prior year (168,750) (486,000)

Rev. recognized currently 168,750 317,250 189,000

Costs incurred currently (150,000) (287,400) (170,100)

Income recognized currently 18,750$ 29,850$ 18,900$

Illustration:


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Chapter7-26

LongLong--Term Contract LossesTerm Contract Losses

LO 3 & 4 Losses onpercentageLO 3 & 4 Losses onpercentage--ofof--completion and completed contractcompletion and completed contract

methods onlongmethods onlong--term contracts.term contracts.

Two Methods:

Loss in the Current Period on a Profitable Contract

Percentage-of-completion method only, the estimated

cost increase requires a current-period adjustmentof gross profit recognized in prior periods.

Loss on an Unprofitable Contract

Under both percentage-of-completion and completed-contract methods, the company must recognize in the

current period the entire expected contract loss.


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Chapter7-28

2007 2008 2009



Est. total contract costs 600,000 652,836 652,836

Est. percentage complete 25.0% 67.0% 100.0%

Contract price 675,000 675,000 675,000


Rev. recognized prior year (168,750) (452,250)Rev. recognized currently 168,750 283,500 222,750

Costs incurred currently (150,000) (287,400) (215,436)

Income recognized currently 18,750$ (3,900)$ 7,314$


Illustration: Loss on Profitable Contract


methods on longmethods on long--term contracts.term contracts.


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Chapter7-29

C str ct pr ress 18 750 7 314

C str ct e pe se 150 000 215 436C str ct re e e 168 750 222 750

C str ct pr ress 3 900

C str ct e pe se 287 400

C str ct re e e 283 500

20092007 2008


Illustration: Loss on Profitable Contract


methods onlongmethods onlong--term contracts.term contracts.


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Chapter

7-30

Illustration: Loss on Unprofitable Contract


2007 2008 2009

Contract price $675,000 $675,000 $675,000

Cost incurred current year 150,000 287,400 246,038Estimated cost to complete

in future years 450,000 246,038 0Billings to customer current year 135,000 360,000 180,000Cash receipts from customer

Current year 112,500 262,500 300,000

c) Prepare the journal entries for 2007, 2008, and 2009 assuming theestimated cost to complete at the end of 2008 was $246,038 instead of$170,100.

Casper Construction Co.

LO 3 & 4 Losses onpercentageLO 3 & 4 Losses onpercentage--ofof--completion and completed contractcompletion and completed contractmethods onlongmethods onlong--term contracts.term contracts.


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Chapter

7-31

2007 2008 2009



Est. total contract costs 600,000 683,438 683,438Est. percentage complete 25.0% 64.0% 100.0%

Contract price 675,000 675,000 675,000


Rev. recognized prior year (168,750) (432,000)

Rev. recognized currently 168,750 263,250 243,000Costs incurred currently (150,000) (290,438) (243,000)

Income recognized currently 18,750$ (27,188)$ -$


$683,438 678,500 = 8,438 cumulative loss


PlugPlug

LO 3 & 4 Losses onpercentageLO 3 & 4 Losses onpercentage--ofof--completion and completed contractcompletion and completed contractmethods on longmethods on long--term contracts.term contracts.


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Chapter

7-33

L tr t tra t 3

C tr t pr re 3

7



For the Completed-Contractmethod, companies wouldrecognize the following loss :

LO 4 Apply thecompleted contractmethod for longLO 4 Apply thecompleted contractmethod for long--termcontracts.termcontracts.


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Chapter

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Construction contractors should disclosure:

the method of recognizing revenue,

the basis used to classify assets and liabilities ascurrent (length of the operating cycle),

the basis for recording inventory,

the effects of any revision of estimates,

the amount of backlog on uncompleted contracts, and

the details about receivables.

Disclosures inFinancial Statements

RevenueRecognition BeforeDeliveryRevenueRecognition BeforeDelivery

LO 4 Apply thecompletedcontractmethodfor longLO 4 Apply thecompletedcontractmethodfor long--termcontracts.termcontracts.


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Chapter

7-35

In certain cases companies recognize revenue at thecompletion of production even though no sale has been

made.

Completion-of-Production Basis


Examples are:

precious metals or

agricultural products.

LO 4 Apply thecompleted contractmethod for longLO 4 Apply thecompleted contractmethod for long--termcontracts.termcontracts.


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Chapter

7-36

When the collection of the sales price is notreasonably assured and revenue recognition isdeferred.

RevenueRecognition After DeliveryRevenueRecognition After Delivery

LO 5 Describe the installmentLO 5 Describe the installment--sales and costsales and cost--recoverymethods of accounting.recoverymethods of accounting.

Methods of deferring revenue:

Installment-sales method

Cost-recovery method

Deposit method

GenerallyGenerallyEmployedEmployed


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Chapter

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Recognizes income in the periods of collection ratherthan in the period of sale.

Recognize both revenues and costs of sales in theperiod of sale, but defer gross profit to periods inwhich cash is collected.

Selling and administrative expenses are not deferred.

Installment-SalesMethod

RevenueRecognitionafter DeliveryRevenueRecognitionafter Delivery

LO 5 Describe the installmentLO 5 Describe the installment--salesand costsalesand cost--recoverymethodsofaccounting.recoverymethodsofaccounting.


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Chapter

7-38

The profession concluded that except in specialcircumstances, the installment method of recognizing

revenue is not acceptable.*The rationale: because the installment method doesnot recognize any income until cash is collected, it isnot in accordance with the accrual concept.

Acceptabilityof theInstallment-SalesMethod

*Omnibus Opinion, Opinions of the Accounting Principles Board No. 10(New York: AICPA, 1966), par. 12.

RevenueRecognitionafter DeliveryRevenueRecognitionafter Delivery

LO 5 Describe the installmentLO 5 Describe the installment--salesand costsalesand cost--recoverymethodsof accounting.recoverymethodsof accounting.


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Chapter

7-39

Recognizes no profit until cash payments by the buyerexceed the cost of the merchandise sold.

APB Opinion No. 10 allows a seller to use the cost-recovery method to account for sales in which there isno reasonable basis for estimating collectibility. Inaddition, FASB Statements No. 45 (franchises) andNo. 66 (real estate) require use of this method wherea high degree of uncertainty exists related to thecollection of receivables.

Cost-RecoveryMethod

RevenueRecognition after DeliveryRevenueRecognition after Delivery

LO 5 Describe the installmentLO 5 Describe the installment--sales and costsales and cost--recoverymethodsof accounting.recoverymethodsof accounting.


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Chapter

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Measuring theProgress toward Completion

Cost-to-costbasis

LO 3 Apply the percentageLO 3 Apply the percentage--ofof--completionmethod for longcompletionmethod for long--termcontracts.termcontracts.

PercentagePercentage--ofof--CompletionMethodCompletionMethod

Illustrations 7-3,4,& 5

Costs incurred to date

Most recent estimate of total costs = Percent complete

Percent complete x Estimated total revenue =Revenue to

be recognizedto date

Revenue tobe recognized

to date

Current-periodRevenue-

Revenuerecognized inprior periods

=


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