Generally Accepted Accounting Principles; Revenue Recognition · Generally Accepted Accounting...

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Copyright © 1997 McGraw-Hill Ryerson Limited.Slide 1

Generally AcceptedAccounting Principles;Revenue Recognition

Chapter 6

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GAAPObjectives of financial reporting Useful, meaningful information for investing

and credit decisionsInformation on future cash flows

Qualitative characteristics ofaccounting information

Understandability, relevance, reliability,comparability

Elements of financial statements Assets, liabilities, equity/net assetsRevenues, expenses, gains, losses

Recognition and measurement criteria

Asset/liability measurement � historical cost,fair value basis

Revenue/expense recognition � cash basis,accrual method

Assumptions Entity concept, periodic concept, going concern

Principles Unit of measure, matching, consistency,disclosure

Constraints Materiality, conservatism, industry practices,cost/benefit

Specific accounting policies, procedures and rules

CICA Handbook

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Revenue Recognition

❖ When may acompany recognizerevenue from atransaction?

❖ Three questions:

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Revenue Recognition


❖ Three questions:➊ Have we transferred

to the buyersubstantially all of therisks and rewardsassociated with theproduct sold orservice provided?

Why did I buythis thing?

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Revenue Recognition

❖ When may acompanyrecognize revenuefrom atransaction?

❖ Three questions:➋ Have we earned the

right to proceedsfrom the salebecause wecompleted ourshare of thetransaction?

The brochuresaid this wouldbe a LUXURY

cruise!

I amnot

payingfor

this!

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Revenue Recognition


❖ Three questions:➌ Is the collectibility of

proceeds from thesale assured with areasonable degree ofcertainty?

Don�t worry,Chester! I�ll pay

up eventually.

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Revenues vs. Cash Receipts

Customerselectsgoods.

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Customerdoes not have

the cash topay now . . .

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Selleragrees to

deliver now,and receivecash later.

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Usually, 30days later,

sellerreceives

cash.

Selleragrees to

deliver now,and receivecash later.

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Revenue Recognition Methods

Percentage-of-completion method

Completed-contract method

Completion-of-production method

Point-of-sale method

Instalment sales method

Cost recovery method

Before Sale(During/End

of Production) Time of SaleAfter Sale

(Cash Collection)

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Expense Recognition

❖ When may acompany recognizean expense?

❖ Three questions:

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Expense Recognition


❖ Three questions:➊ Have we included in

our income statementall of the costs andexpenses associatedwith the benefits(revenues) we realizedduring the year?

TheTheMatchingMatchingPrinciplePrinciple

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Expense Recognition


❖ Three questions:➋ As we prepared these

financial statements,have our judgmentsand estimates beenappropriatelyconservative?

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Expense Recognition


❖ Three questions:➌ Do all of our assets

still have thepotential to earnfuture cash flowsequal to their currentcosts?

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Matching Principle

Current Period Costs

Commissions expenseAdvertising expenseOperating expensesInterest expense

Prior Period Costs

Cost of goods sold(inventory)Insurance expenseAmortization expense

Future PeriodCosts

Warranty expenseBad debts expense

Revenues(sales)

generated arematched by

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How Conservative/AggressiveShould I Be with My Estimates?

Our employees hadcomputer trainingclasses before we

opened the business.

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Should we be conservativeand expense the training

costs or be aggressive andrecord the costs as an asset

with future value?


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The conservatism principleadvocates selecting the

method that will not createsurprises in the future.


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Do All Assets Have the Potential to EarnCash Equal to Their Carrying Value?

GAAP requires that assetshaving no future cash-

earning benefit be chargedoff as an expense.

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Income StatementClassification

❖ Income statementformat:● List all revenues.

● Deduct variouscategories ofexpenses.

● Compute net income.

SERVICE CompanyIncome Statement

For the Period Ending MM-DD-YY

Revenues $ XXX

Operating Expenses Expense #1 $ XXX Expense #2 XXX Expense #3 XXX

Total Operating Exp. XXX

Net Income fromContinuing Operations $ XXX

SERVICE CompanyIncome Statement


Revenues $ XXX




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❖ Income statementformat:● List all revenues.

● Deduct variouscategories ofexpenses.

● Compute net income.

MERCHANDISE CompanyIncome Statement


Revenues $ XXXCost of Goods Sold XXXGross Margin $ XXX




MERCHANDISE CompanyIncome Statement


Revenues $ XXXCost of Goods Sold XXXGross Margin $ XXX




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Terminology and Concepts

Gains &Losses

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Gains andlosses result

from sales notin the ordinary

course ofbusiness.

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If proceeds greaterthan carrying value

Gain

If proceeds less thancarrying value

Loss

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Gain and Loss: Example

❖ Bob�s Boats, Inc. sellsfishing boats. On April5, Bob�s Boats sold landthe company owned inanother county to EveDevelopment Corp. for$20,000.

❖ The land has a carryingvalue on Bob�s books of$16,000.

Should the $20,000 receivedfrom Eve Development be

recorded as revenue?



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No. The sale of land by Bob'sBoats is not a sale in the

ordinary course of business.

The gain/loss on the transactionshould be computed andand reported separately.



No. The sale of land by Bob'sBoats is not a sale in the

ordinary course of business.

The gain/loss on the transactionshould be computed andand reported separately.



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W hat is the gain or loss onthe sa le tha t should be

recognized by Bob's Boats?



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Proceeds 20,000$

Carrying Va lue 16,000

Ga in on Sa leof Land 4,000$



Proceeds 20,000$

Carrying Va lue 16,000

Ga in on Sa leof Land 4,000$



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❖ DiscontinuedOperations

● Shows income/loss relatedto major segments of thebusiness that have beendiscontinued.

❖ Extraordinary Items● Defined by GAAP as a gain

or loss that is both unusualin nature and infrequent inoccurrence.

I hate it whena factory

burns down!!!

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❖ Changes in Accounting Policies● GAAP requires consistent application of principles from one

period to the next.

● When a change in principle occurs, special accounting andreporting of the effect of the change is required.

❖ Subsequent Events● An event that occurred after the financial statement date

that might influence a reader of the financial statements.

● If relates to conditions that existing at the financialstatement date, the statements should be adjusted.

● If relates to conditions after the financial statement date,the event should be disclosed in a footnote.

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End of Chapter 6

We�recruisin�

now,dude!

Generally Accepted Accounting Principles; Revenue Recognition · Generally Accepted Accounting...

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