Complexities of Revenue Recognition. 2 Identify the primary criteria for revenue recognition. ...

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2

Identify the primary criteria for revenue recognition.

Explain when revenue is appropriately recognized prior to delivery of goods or services through percentage-of-completion accounting.

Record journal entries for long-term construction-type contracts using percentage-of-completion and completed-contract methods.

Learning Objectives

3

Record journal entries for long-term service contracts using the proportional performance method.

Explain when revenue is recognized after delivery of goods or services through installment sales, cost recovery, and cash methods.

Learning Objectives

4

Learning Objectives

Describe accounting for the transfer of assets prior to the recognition of revenue with the deposit method and consignment sales.

EXPANDED MATERIAL:

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Revenue Recognition Criteria

They are realized or realizable, andThey have been earned through

substantial completion of the activities involved in the earnings process.

FASB’s two criteria for recognizing revenues and gains:

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Revenue Recognition Criteria

Both of these criteria generally are met at

the point of sale.

Both of these criteria generally are met at

the point of sale.

This most often occurs when goods are

delivered or when services are rendered.

This most often occurs when goods are

delivered or when services are rendered.

7Revenue Recognition--Exceptions

• A product or service was provided without receiving a valid promise of payment from customer.

• The company has not provided the product or service.

• A product or service was provided without receiving a valid promise of payment from customer.

• The company has not provided the product or service.

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Revenue Recognition--IAS 18

The significant risks and rewards of ownership of the goods have been transferred to the buyer and the selling company retains no effective control over what happens to the goods,

Both the amount of the revenue and of the costs associated with the transaction can be reliably measured, and

It is probable that the economic benefits of the sale will flow to the selling company.

A company should recognize revenue from the SALE OF GOODS when all of the following conditions have been satisfied:

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Revenue Recognition--IAS 18

The total amount of the revenue, the total amount of the costs, and the stage of completion of the transaction can be reliably measured, and

It is probable that the economic benefits of the transaction will flow to the company rendering the services.

A company should recognize revenue from the RENDERING OF SERVICES when both of the following conditions have been satisfied:

10Revenue Recognition--Exceptional Cases

• Long-Term Contracts• Uncertain Collections• Deposit Method• Consignment Sales

• Long-Term Contracts• Uncertain Collections• Deposit Method• Consignment Sales

11Long-Term Contracts--Recognition Choices

• Completed-Contract Method: recognize all income when project is completed.

• Percentage-of-Completion Method: recognize revenue throughout the term of the contract.

• Completed-Contract Method: recognize all income when project is completed.

• Percentage-of-Completion Method: recognize revenue throughout the term of the contract.

GAAP requires percentage-of-completion method unless certain

criteria are not met.

GAAP requires percentage-of-completion method unless certain

criteria are not met.

12Percentage-of-Completion Criteria

Dependable estimates of:– revenues.

– costs.

– progress toward completion.

Contract clearly specifies:– enforceable rights of the parties.

– consideration to be exchanged.

– manner and terms of settlement.

Dependable estimates of:– revenues.

– costs.

– progress toward completion.

Contract clearly specifies:– enforceable rights of the parties.

– consideration to be exchanged.

– manner and terms of settlement.

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The buyer can be expected to satisfy obligations under the contract.

Contractor can be expected to perform the contractual obligation.

The buyer can be expected to satisfy obligations under the contract.

Contractor can be expected to perform the contractual obligation.

Percentage-of-Completion Criteria

14Percentage-of-Completion--General Concepts

• Recognize revenue throughout life of the contract.

• Revenue recognized is a function of how complete the project is.

• Costs are charged to an inventory account: Construction in Process (CIP).

• Profits are charged to CIP.• CIP is valued at net realizable value.• Any anticipated loss is booked for the full

amount of the loss when it becomes measurable.

• Recognize revenue throughout life of the contract.

• Revenue recognized is a function of how complete the project is.

• Costs are charged to an inventory account: Construction in Process (CIP).

• Profits are charged to CIP.• CIP is valued at net realizable value.• Any anticipated loss is booked for the full

amount of the loss when it becomes measurable.

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Percentage-of-Completion

• Input measures: Cost-to-cost method where the degree of completion is determined by comparing costs already incurred with the most recent estimates of total expected costs to complete the project.

• Input measures: Cost-to-cost method where the degree of completion is determined by comparing costs already incurred with the most recent estimates of total expected costs to complete the project.

Engineers are often called in to help provide estimates.

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At the beginning of the contract, At the beginning of the contract, costs are expected to be incurred costs are expected to be incurred

each year as shown.each year as shown.

At the beginning of the contract, At the beginning of the contract, costs are expected to be incurred costs are expected to be incurred

each year as shown.each year as shown.

2001 __ 2002 2003 Costs incurred to date $ 72,000 $192,000 $240,000

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Total cost of the project at completion is Total cost of the project at completion is expected to be $240,000. The difference expected to be $240,000. The difference between the costs incurred to date and the between the costs incurred to date and the

total estimated costs at completion is total estimated costs at completion is defined as the estimated costs remaining to defined as the estimated costs remaining to

complete the project.complete the project.

Total cost of the project at completion is Total cost of the project at completion is expected to be $240,000. The difference expected to be $240,000. The difference between the costs incurred to date and the between the costs incurred to date and the

total estimated costs at completion is total estimated costs at completion is defined as the estimated costs remaining to defined as the estimated costs remaining to

complete the project.complete the project.

Costs incurred to date $ 72,000 $192,000 $240,000

Total estimated costs $240,000 $240,000 $240,000

Estimated costs to complete 168,000 48,000 0


2001 _ 2002 2003

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Percentage complete is the ratio Percentage complete is the ratio of costs incurred to date to total of costs incurred to date to total estimated costs at completion.estimated costs at completion.

Percentage complete is the ratio Percentage complete is the ratio of costs incurred to date to total of costs incurred to date to total estimated costs at completion.estimated costs at completion.



Percentage complete 30% 80% 100%



2001 2002 2003

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Estimated total income is the difference between the Estimated total income is the difference between the contract price and total expected costs. Assume the contract price and total expected costs. Assume the

contract price in this example is $300,000.contract price in this example is $300,000.

Estimated total income is the difference between the Estimated total income is the difference between the contract price and total expected costs. Assume the contract price and total expected costs. Assume the

contract price in this example is $300,000.contract price in this example is $300,000.




Estimated total income $ 60,000 $ 60,000 $ 60,000



2001 2002 2003

Total Contract $300,000

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Estimated total income to date is computed Estimated total income to date is computed based on the cumulative percentage complete.based on the cumulative percentage complete.Estimated total income to date is computed Estimated total income to date is computed

based on the cumulative percentage complete.based on the cumulative percentage complete.







2001 2002 2003

Estimated total income to date $ 18,000 $ 48,000 $ 60,000

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Less:Iincome previously recognized 18,000 48,000

Income recognized this period $ 18,000 $ 30,000 $ 12,000


0


2001 2002 2003

Income recognized in the current period is the Income recognized in the current period is the difference between total income to date and difference between total income to date and

income previously recognized.income previously recognized.

Income recognized in the current period is the Income recognized in the current period is the difference between total income to date and difference between total income to date and

income previously recognized.income previously recognized.

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Less: Income previously recognized 18,000 48,000

Income recognized this period $ 18,000 $ 30,000 $ 12,000


0


2001 2002 2003

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Construction in Progress…………. 72,000Materials, Cash, etc…………... 72,000

To record costs incurred.

Accounts Receivable…………….. 100,000Progress Billings on Construction Contracts……… 100,000

To record billings (amount assumed).

Cash………………………………. 90,000Accounts Receivable………….. 90,000 To record cash collections (amount assumed).

2001200120012001

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Construction in Progress………… 120,000Materials, Cash, etc………….. 120,000


Accounts Receivable……………. 140,000Progress Billings on Construction Contracts……... 140,000


Cash……………………………… 125,000Accounts Receivable………… 125,000

To record cash collections (amount assumed).

2002200220022002

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2003200320032003

Construction in Progress…………. 48,000Materials, Cash, etc…………... 48,000


Accounts Receivable…………….. 60,000Progress Billings on Construction Contracts……… 60,000


Cash………………………………. 85,000Accounts Receivable………….. 85,000

To record cash collections (amount assumed).


• Long-Term Contracts

• Uncertain Collections• Deposit Method• Consignment Sales

• Long-Term Contracts

• Uncertain Collections• Deposit Method• Consignment Sales

27Uncertain Collections--Recognition Alternatives

Installment Sales Method: Recognizes revenues and related expenses as cash is received (used when collection is somewhat uncertain).

Cost Recovery Method: No income is recognized on sale until the cost of the item sold is recovered through cash receipts (used when collection is very uncertain).

Cash Method: Recognizes all expenses immediately as incurred and all revenues only when cash is collected.

28Uncertain Collections--Comparison of Recognition Methods

Full Accrual At point of sale Revenue at point of sale

Installment Sales

At collection of cash (portion of receipt)

Defer and matchagainst revenue ascash is collected

Cost Recovery

At collection of cash(after all costs havebeen recovered)

Defer and matchagainst cashreceipts

Cash At collection of cash Charge to expenseas incurred

MethodTiming of Revenue

RecognitionTreatmentof Costs

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Installment Sales Method

The installment sales method is used most

commonly in cases of real estate sales.

The installment sales method is used most

commonly in cases of real estate sales.

30Example:Installment Sales Method

George sells merchandise on the installment basis.

Uncertainty of collection makes use of the installment method necessary. Use the

accompanying data to prepare George’s journal entries.

George sells merchandise on the installment basis.

Uncertainty of collection makes use of the installment method necessary. Use the

accompanying data to prepare George’s journal entries.


SalesCost of SalesGross ProfitGross Profit Percentage

2001 2002$150 $200 100 140$ 50 $ 60

33.33% 30%

Cash Collection 2001 Sales $ 30 $ 75 2002 Sales $ 70


2001:Accounts Receivable--2001……... 150

Installment Sales………………. 150Cost of Installment Sales………... 100

Inventory………………………. 100

Cash……………………………… 30Accounts Receivable--2001…... 30


2001:Installment Sales…………………. 150

Cost of Installment Sales………. 100Deferred Gross Profit--2001…... 50

Deferred Gross Profit--2001……... 10Realized Income……………….. 10

($30 x 33.33%)


2002:Accounts Receivable--2002……….. 200

Installment Sales…………………200Cost of Installment Sales………….. 140

Inventory………………………… 140

Cash………………………………... 145Accounts Receivable--2001……... 75Accounts Receivable--2002……... 70


2002:Installment Sales…………………... 200

Cost of Installment Sales………...140

Deferred Gross Profit--2002…….. 60

Deferred Gross Profit--2001………. 25Deferred Gross Profit--2002………. 21

Realized Gross Profit on Installment Sales……………….. 46

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Example: Cost Recovery Method

Assume George has to use the cost recovery method, but all sales

and collections remain the same.

Assume George has to use the cost recovery method, but all sales

and collections remain the same.

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Example: Cost Recovery Method

2002:

All entries are the same except do not book the entry to gross profit.Deferred Gross Profit--2001……….. 5

Realized Gross Profit on Installment Sales……………….. 5


• Long-Term Contracts• Uncertain Collections

• Deposit Method• Consignment Sales

• Long-Term Contracts• Uncertain Collections

• Deposit Method• Consignment Sales

39Deposit Method--General Requirement

Used when cash is received before a sale is completed.

All revenue is initially deferred.Seller retains property sold as a

recognized asset until sale is completed.Revenue is recognized when sale is

completed.

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Deposit Method and Franchises

Relates primarily to initial franchise fees.Franchiser defers initial fee at time cash is

received.Franchiser recognizes initial fee revenue when

“substantial performance” of services is achieved.

Franchiser may use any appropriate recognition method once substantial performance is achieved.

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Example: Franchise

Mary sells Bob a franchise for $1,000 cash on June 1.

Substantial performance is agreed upon that Mary will

complete $700 of renovation on Bob’s restaurant (which occurs on July 10). Prepare

Mary’s journal entries.

Mary sells Bob a franchise for $1,000 cash on June 1.

Substantial performance is agreed upon that Mary will

complete $700 of renovation on Bob’s restaurant (which occurs on July 10). Prepare

Mary’s journal entries.

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June 1Cash……………………………... 1,000

Deposit on Franchise (orUnearned Franchise Fee)…... 1,000

Example: Franchise

July 10Cost of Franchise Fee Revenue…. 700

Cash…………………………. 700Deposit on Franchise (or

Unearned Franchise Fee)……… 1,000Franchise Fee Revenue……... 1,000


• Long-Term Contracts• Uncertain Collections• Deposit Method

• Consignment Sales

• Long-Term Contracts• Uncertain Collections• Deposit Method

• Consignment Sales

44Consignment Sales--General Principles

• Definitions:– Consignee: Title holder/seller of merchandise.– Consignor: Merchandise selling agent.

• Consignor does not recognize revenue upon shipment to consignee.

• Consignor accounts for consigned goods in separate Inventory on Consignment account.

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• Consignee does not recognize consigned goods as inventory.

• Consignor records all pre-sale expenses as Inventory on Consignment.

• Consignor recognizes revenue when informed of a sale by consignee.

• Consignee recognizes revenue only for consignment commission.

Consignment Sales--General Principles

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Example: Consignment Sales

Bob agrees to consign goods worth $1,000 to Lucy. Lucy agrees to sell the goods at her store for a 5 percent of net

sales consignment commission and reimbursement of selling expenses.

Bob agrees to consign goods worth $1,000 to Lucy. Lucy agrees to sell the goods at her store for a 5 percent of net

sales consignment commission and reimbursement of selling expenses.The next several slides demonstrate the transactions and journal entries for Bob and Lucy throughout the consignment

cycle. (All numbers are assumed.)

The next several slides demonstrate the transactions and journal entries for Bob and Lucy throughout the consignment

cycle. (All numbers are assumed.)

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Transaction: Shipment of Goods


Entry in Bob’s (consignor’s) books:

Inventory on Consignment…… 1,000

Finished Goods Inventory….. 1,000Entry in Lucy’s (consignee’s) books:

None--memorandum inventory control record.

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Transaction: Incurrence of $200 of selling expenses by Lucy.


Entry in Bob’s books:Inventory on Consignment…. 200

Consignee Payable……….. 200Entry in Lucy’s books:Consignor Receivable………. 200

Cash………………………. 200

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Transaction: Sale of merchandise for $2,000.


Entry in Bob’s books:

None.Entry in Lucy’s books:

Cash……………………… 2,000

Consignor Payable…….. 2,000

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Transaction: Lucy notifies Bob of the sale and sends him net cash proceeds.


Entry in Bob’s books:Commission Expense…………... 100Cash…………………………….. 1,700Consignee Payable……………... 200Cost of Goods Sold…………….. 1,000

Consignment Sales Revenue…. 2,000Inventory on Consignment…… 1,000

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Entry in Lucy’s books:Consignor Payable…………. 2,000

Cash……………………….1,700

Commission Revenue…….. 100

Consignor Receivable…….. 200


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Complexities of Revenue Recognition. 2 Identify the primary criteria for revenue recognition. ...

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