Revenue Revenue RecognitionRecognition

RecognizeRecognizeRevenue whenRevenue when(1) Realized or(1) Realized orRealizable & Realizable &

(2) Earned(2) Earned

• At the Point of Sale:At the Point of Sale:

Transaction approachTransaction approach

• Before DeliveryBefore Delivery: : – Percentage-of-CompletionPercentage-of-Completion

– Completed-Contracts Method Completed-Contracts Method

– Net Realizable ValueNet Realizable Value

• After Delivery: Cash Collection After Delivery: Cash Collection BasisBasis: : – Installment Sales MethodInstallment Sales Method

– Cost Recovery MethodsCost Recovery Methods

– Deposit MethodDeposit Method

• Revenues are Revenues are realizedrealized when goods and when goods and

services are exchanged for cash or claims to services are exchanged for cash or claims to cash (receivables)cash (receivables)

• Revenues are Revenues are realizablerealizable when assets received when assets received

in exchange are readily convertible to known in exchange are readily convertible to known amounts of cash or claims to cashamounts of cash or claims to cash

• Revenues are Revenues are earnedearned when the earnings when the earnings

process is complete or virtually complete -- that process is complete or virtually complete -- that is, when the entity has substantially is, when the entity has substantially accomplished what it must do to be entited to accomplished what it must do to be entited to the benefits represented by the revenuesthe benefits represented by the revenues

Income Determination: recognition basisIncome Determination: recognition basis

• At the Point of SaleAt the Point of Sale -- --

Transaction approachTransaction approach– an exchange has taken place & an exchange has taken place & – the earnings process is (virtually) completethe earnings process is (virtually) complete

Income Determination: recognition basisIncome Determination: recognition basis

• During the production processDuring the production process -- --

Percentage-of-CompletionPercentage-of-Completion– Long-term construction, property or service contractsLong-term construction, property or service contracts

– Have a dependable estimate of the progress and cost to completeHave a dependable estimate of the progress and cost to complete

– Have reasonable assurance of collectibility of contract priceHave reasonable assurance of collectibility of contract price• Provides a better measure of periodic income Provides a better measure of periodic income

• Avoids the fluctuations in revenues, expenses & incomeAvoids the fluctuations in revenues, expenses & income

Income Determination: recognition basisIncome Determination: recognition basis

• Completion-of-Production BasisCompletion-of-Production Basis -- --

Completed-Contract MethodCompleted-Contract Method– Revenue & gross profit from long-term construction are Revenue & gross profit from long-term construction are

recognized only when the contract is completed. Construction recognized only when the contract is completed. Construction costs are accumulated in an inventory account and progress costs are accumulated in an inventory account and progress billings are accumulated in a contra inventory accountbillings are accumulated in a contra inventory account

Net Realizable ValueNet Realizable Value– Immediate marketabilityImmediate marketability

– Unit interchangeabilityUnit interchangeability

– Difficulty determining costDifficulty determining cost• Known or determinable revenuesKnown or determinable revenues

• Inability to determine costs and therefore defer expense Inability to determine costs and therefore defer expense recognition until salerecognition until sale

Income Determination: recognition basisIncome Determination: recognition basis

• Cash Collection BasisCash Collection Basis -- --

Installment & Cost Recovery MethodsInstallment & Cost Recovery Methods– Absence of a reasonable basis for estimating Absence of a reasonable basis for estimating

degree of collectibilitydegree of collectibility• Level of uncertainty with respect to collection of the Level of uncertainty with respect to collection of the

receivable precludes recognition of gross profit receivable precludes recognition of gross profit before cash is receivedbefore cash is received

Recognizing “a sale in the ordinary course of business”:Recognizing “a sale in the ordinary course of business”:Sales Basis CriteriaSales Basis Criteria

• Sale with a right of returnSale with a right of return

• Product financing arrangementProduct financing arrangement

• Real estate saleReal estate sale

• Sales-type leaseSales-type lease

• Sale of receivables with recourseSale of receivables with recourse

• Nonmonetary exchangeNonmonetary exchange

• Sale-leaseback transactionSale-leaseback transaction

Factors to Consider to recognize revenueFactors to Consider to recognize revenue

Conditions that delay recognitionConditions that delay recognition

Sale with a right of returnSale with a right of returnFactors to Consider to recognize revenueFactors to Consider to recognize revenue

– Is the economic substance is a sale or financing arrangement?Is the economic substance is a sale or financing arrangement?

– Is the sales price determined?Is the sales price determined?

– Is the collection of the sales price probable?Is the collection of the sales price probable?

– What are the seller’s future obligations?What are the seller’s future obligations?

– Are returns predictable?Are returns predictable?

Conditions that delay recognitionConditions that delay recognition• Sales price is not fixed or deteminableSales price is not fixed or deteminable

• Payment is excused until product is soldPayment is excused until product is sold

• Payment is excused if product is stolen or damagedPayment is excused if product is stolen or damaged

• Buyer does not have a separate economic substanceBuyer does not have a separate economic substance

• Seller is obligated to bring about a resale of the propertySeller is obligated to bring about a resale of the property

• Future returns are not predictableFuture returns are not predictable

Product Financing ArrangementProduct Financing Arrangement

Factors to Consider to recognize revenueFactors to Consider to recognize revenue– Are risks & rewards of ownership transferred?Are risks & rewards of ownership transferred?

Conditions that delay recognitionConditions that delay recognition– Agreement requires repurchase at specified prices Agreement requires repurchase at specified prices

or provides compensation for lossesor provides compensation for losses

Real Estate SaleReal Estate Sale

Factors to Consider to recognize revenueFactors to Consider to recognize revenue– Probability of collectionProbability of collection

– Seller continued involvementSeller continued involvement

– Whether economic substance of the transaction is a sale Whether economic substance of the transaction is a sale of real estate or another type of transaction such as a of real estate or another type of transaction such as a service contractservice contract

Conditions that delay recognitionConditions that delay recognition– Inadequate buyer investment in the propertyInadequate buyer investment in the property

– Seller’s continuing obligations, such as participation in Seller’s continuing obligations, such as participation in future losses, responsibility to obtain financing, construct future losses, responsibility to obtain financing, construct buildings, or initiate or support operationsbuildings, or initiate or support operations

Sales-type leaseSales-type lease

Factors to Consider to recognize revenueFactors to Consider to recognize revenue– Transfer of benefits and risks of ownershipTransfer of benefits and risks of ownership

– Probability of collectionProbability of collection

– Predictability of future unreimbursable costsPredictability of future unreimbursable costs

Conditions that delay recognitionConditions that delay recognition– Inability to meet the conditions for real estate salesInability to meet the conditions for real estate sales

– Inability to meet specified conditions (4 criteria) Inability to meet specified conditions (4 criteria) indicating transfer of benefits and risks of ownershipindicating transfer of benefits and risks of ownership

– Collection not predictableCollection not predictable

– Uncertainty about future unreimbursable costsUncertainty about future unreimbursable costs

Sale of receivables with recourseSale of receivables with recourse

Factors to Consider to recognize revenueFactors to Consider to recognize revenue– Isolation of transferred assetsIsolation of transferred assets

– Right to pledge or exchange transferred assetsRight to pledge or exchange transferred assets

– Control of receivablesControl of receivables

Conditions that delay recognitionConditions that delay recognition– Transferred assets can be reached by transferor or its Transferred assets can be reached by transferor or its

creditorscreditors

– TransfereeTransferee

– S inability to pledge or exchange transferred assetsS inability to pledge or exchange transferred assets

– Control of receivables not surrendered due to Control of receivables not surrendered due to repurchase or redemption agreementrepurchase or redemption agreement

Nonmonetary exchangeNonmonetary exchange

Factors to Consider to recognize revenueFactors to Consider to recognize revenue• Completion of the earnings processCompletion of the earnings process

Conditions that delay recognitionConditions that delay recognition• Exchanges of similar inventory or productive assetsExchanges of similar inventory or productive assets

Sale-leaseback TransactionsSale-leaseback Transactions

Factors to Consider to recognize revenueFactors to Consider to recognize revenue• Substance of the transactionSubstance of the transaction

• Portion of property leased backPortion of property leased back

• Length of leaseback periodLength of leaseback period

Conditions that delay recognitionConditions that delay recognition• All sale-leaseback transactions are financing All sale-leaseback transactions are financing

transactions and not sales transactions unless transactions and not sales transactions unless leaseback covers only a small part of the property leaseback covers only a small part of the property or is for a short period of timeor is for a short period of time