Revenue Recognition

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Transcript of Revenue Recognition

  • 1. Chapter 18: Revenue Recognition

2.

  • Issues
    • Largest single source of public company FS restatements
    • Required to be considered fraud risk under SAS #99
    • Can occur in any industry

Revenue Recognition 3.

  • Revenue recognition principleprovides that revenue is recognized:
    • when it isearnedAND
    • when it isrealized orrealizable
  • Revenue is
    • Earnedwhen earnings process is substantially complete
    • Realizedwhen goods & services exchanged for cash or claims to cash
    • Realizable when assets received are convertible into a known amount of cash

Guidelines for Revenue Recognition 4.

  • Revenue fromselling products
    • Recognized at the date of sale (date of delivery)
  • Revenue fromservices
    • Recognized when services are performed & are billable
  • Revenue from theuse of enterprises assetsby others
    • Recognized as time passes or as the assets are used up
  • Revenue fromdisposal of assets(other than inventory)
    • Recognized at the point of sale as gain or loss

Four Types of Revenue Transactions 5. Revenue Recognition Classified by Nature of Transaction 6.

  • Point of sale (delivery)
  • Before delivery
  • After delivery
  • Special transactions
    • Franchises
    • Consignments
  • Comparative matrix of bases page 909

Revenue Recognition 7.

  • Revenues from manufacturing & selling
    • Realized/realizable
    • Earned

Revenue Recognition at Point of Sale 8.

  • Exceptions:
    • Sales withbuyback agreements
    • Sales whenright of returnexists
      • High rates that are not reliably estimable continued risk of ownership
      • Criteria to meet
        • Page 910
    • Trade loading&channel stuffing

Revenue Recognition at Point of Sale 9.

  • Revenue may berecognized before deliveryunder certain circumstances
    • Long-term construction contracts are a notable example
      • Revenue recognition methods
        • Percentage-of-completion method
        • Completed contractmethod

Revenue Recognition Before Delivery 10. Long-Term Construction Accounting Methods Revenue Recognition Before Delivery 1)Terms of contract must be certain, enforceable 2) Certainty of performance by both parties 3) Estimates of completion can be made reliably 1) To be used only whenpercentage method inapplicable (uncertain) 2) For short-term contracts Percentage-of-Completion Method Completed Contract Method 11. Percentage-of-Completion: Steps Costs incurred to date=Percent complete Most recent estimated total costs 1 Estimated total revenuexPercent complete =Revenue to be recognized to date 2 Total revenue to be recognized to datelessRevenuerecognized in PRIOR periods=Current period revenue 3 Current Period Revenuelesscurrent costs =Gross profit 4 12.

  • Cost of construction:
    • Construction in process (CIP)
    • Materials, cash, payables, etc .
  • Progress billings:
    • Accounts receivable
    • Billings on CIP
  • Collections:
    • Cash
    • Accounts receivable

Percentage-of-Completion: Entries 13.

  • To recognize revenue and gross profit:
    • Construction in process (gross profit)
    • Construction expenses
    • Revenue
  • To record completion of project:
    • Billings on CIP
    • Construction in process

Percentage-of-Completion: Entries 14. Data :Contract price: $4,500,000Estimated cost: $4 mil Start date:July, 20X3Finish: October, 20X5 Balance sheet date:Dec. 31 Given: 20X3 20X4 20X5 Costs to date $1,000,000$2,916,000$4,050,000 Est costs to complete$3,000,000$1,134,000$-0- Progress Billings during yr$900,000$2,400,000$1,200,000 Cash collected during year$750,000$1,750,000$2,000,000 What is the percent complete, revenue and gross profit recognized each year? Percentage-of-Completion: Example 15. 20X3 20X4 20X5 Percentage-of-Completion: Example % completeto-date 1,000,000= 25%2,916,000 = 72%100 % 4,000,000 4,050,000 Revenuerecognized 4,500,000 * 25%4,500,000 * 72%4,500,000 = 1,125,000 less 1,125,000less 3,240,000 = 2,115,000 = 1,260,000 1,125,000 less 2,115,000 less1,260,000 1,000,0001,916,000less 1,134,000 =125,000 = 199,000 = 126,000 Gross Profit recognized 16.

  • All revenue & GP recognized only at point of sale (when contract completed)
    • Revenue is actual vs. estimate
    • Does not reflect current performance when extends beyond one accounting period

Completed Contract 17.

  • A long-term contract may produce :
    • Interim loss& overall profit OR
    • Overall lossfor the project
  • Percentage-of-completionmethod
    • Losses in any case recognized immediately
    • Examples page 920-921
  • Completed contractmethod
    • Losses recognized immediately only when overall losses indicated
    • Example page 921

Recognizing Current & Overall Losses on Long-Term Contracts 18. Current Losson an otherwise overall profitable contract Loss on an overall unprofitable contract Recognizing Current & Overall Losses on Long-Term Contracts Completed method : No adjustment needed. Percentage Method :Recognize loss currently. Percentage Method :Recognize entire loss now. Completed method :Recognize loss currently. 19.

  • Method of revenue recognition
  • Basis to classify A&L as current
  • Inventory basis
  • Effects of estimate revisions
  • Backlog on uncompleted contracts
  • Details re: receivables
    • Billed, unbilled, interest rate, retainage, concentrations of credit risk

Financial Statement Disclosures Contractors 20.

  • Revenue recognitiondeferred
    • Collection of sales price not reasonably assured AND
    • No reliable estimates can be made
  • Revenue recognition methods
    • Installment sales method
    • Cost recovery method
  • Cash receivedpriorto delivery
    • Usedeposit method

Revenue Recognition After Delivery 21.

  • Emphasizes revenue recognition in periods ofcollectionrather than point of sale
  • Title does not pass to buyer until all cash payments made to seller
  • Sales & cost of salesdeferredto periods of collection
  • Other expenses, selling & administrative, arenot deferred

The Installment Sales Method 22.

  • Installment salesmust be kept separate
  • Gross profitmust be determinable
  • Amount of cash collected from installment accounts must be known
  • Cash collected from current year & prior years accounts must be known
  • Provision must be made to carry forwarddeferred gross profit

The Installment Sales Method: Issues 23.

  • For installment sales in any year
  • For installment sales made in prior years (realized gross profit)
  • Determinerate of gross profiton installment sales
  • Apply rate to cash collections of current year installment sales to yieldrealized gross profit
  • Gross profit not realized isdeferred
  • Applyrelevant rateto cash collections of prior year installment sales

The Installment Sales Method: Steps 24.

  • Given: 20X3 20X4 20X5
  • Installment sales $200,000 $250,000 $240,000
  • Cost of sales $150,000 $190,000 $168,000
  • Gross Profit $ 50,000 $ 60,000$ 72,000
  • Cash received in:
  • from 20X3 sales $60,000 $100,000 $40,000
  • from 20X4 sales $-0-$100,000 $125,000
  • from 20X5 sales $-0- $-0- $80,000
  • Determine the realized