FRA

FRASessions 6-7Revenue and Monetary AssetsIn boxWhen should revenue be recognized?

How much revenue should be recognized?

How to measure monetary assets ?Operating CycleCash-to-cashPurchase materials/services & pay cashConvert materials/services to salable productInspect the product/serviceStore productReceive order from the customerShip the product and send the invoice Acknowledgement of receipt of product by customerReceive cash from customerRevenue recognition: When? (Timing) At one point in revenue cycle (objectivity) Criteria:When Earned? (Conservatism)Normally, goods shippedService performed

Basic Revenue Recognition criteriaSubstantial Performance

2. Reliable Measurement

3. Conversion into cash or claims for cash

According to FASBRevenue should not be recognized untilIt isRealized or realizable and earnedCan you recognize Revenue?WhenSales orders are receivedDeposit or advance payment is receivedGoods are manufacturedGoods are stored after the production processGoods shipped or services rendered/ performedCustomer pays dues/ARs

Revenue recognition: How much? (Amount)How much Realized or realizable (Realization)?Already collected or collectible Amount can be measured reliablyTiming of Revenue RecognitionIllustration 5-2 [Event-Time of RR-Method of RR]Sales order receivedDeposit or advance payment receivedGoods producedProduction completed & goods storedGoods delivered or services performedCustomer pays accounts receivable

IFRS vs GAAP on RRRR on the transfer of risks and rewards of ownership IFRSRR when it is earned GAAP

But accounting for Revenue transaction would be the same under both GAAP & IFRSConditions for RR under IFRS[ all need to be satisfied]Transfer of significant risks and rewards of ownership of goods by seller to the buyerNo managerial involvement and control in the goods sold by the sellerReliable measurement of revenue amountEconomic benefits of the transaction go to the sellerReliable measurement of the costs of the transactionCommon types of fraudulent RR practicesFictitious revenueSwaps , round-tripping & Barter arrangementsSales transactions billed but not shippedRR from transactions with unresolved contingenciesImproper accounting for or failure to establish appropriate reserves for rights to refund or exchange , liberal cancellation or refusal rights or liberal or unconditional rights of return granted through undisclosed oral or written agreementsRR without delivery or customer acceptanceChannel stuffing Channel stuffing is legal whenAll the GAAP requirements for RR are met andDisclosure of channel stuffing to investorsSEC : Criteria forRevenue Realized & Earned[SAB 101] Persuasive evidence of an orderDelivery occurred or services performed[ customers place of business, no uncertainty exists, substantial performance, license term begins]Fixed or determinable selling priceReasonably assured collectabilityDelivery MethodRecognize revenue when goods or services are deliveredFor goods: when title transfers shipping point (when goods are given to carrier)Examples:Order is received for INR 5000. Sales entry?Goods are produced. Sales entry?Goods are shipped. Sales entry?Consignment TransactionsNo RR until the goods are sold by the consignee- till that time, the consignee does not assume the risks and rewards of ownershipConsignment of goods- treated as mere movement of goodsConsignment MethodConsignor ships goods to consignee.Inventory on consignment A/c DR1,000To Merchandise inventory A/c1,000Consignor retains title until goods are sold to customer. At sale:Accounts receivableA/c Dr1,400To Sales revenueA/c1,400

COGS A/c Dr1,000To Inventory on consignment A/c 1,000

Problem 5-5Problem 5-5In the books of Green LawnWhen goods were sent on consignmentInventory on Consignment A/C Dr $8,400To Finished Goods Inventory A/c $8,400-When goods are sold by the consignee [ Carson]A/R A/c Dr To Sales A/c $ 5,040CGS A/c Dr to Inventory on Consignment A/c 3,360Problem 5-5In the books of CarsonWhen goods are received on consignmentNo entry- neither own the goods nor owe to Green Lawn for the goodsWhen goods received on consignment are soldCash or A/R A/c Dr To Sales Revenue A/c $6,720CGS A/c Dr to Accounts Payable A/c $5,040Franchise RevenueRecognize:When earned/ services renderedNot necessarily when agreement signed or fee receivedNormally after the commencement of operations by franchiseeFranchise Revenue - Example Mcdonalds charges a franchise fee primarily for identifying the site, designing the store, training management and staff, and otherwise helping to get the franchise started in business. Assume the initial fee is INR10,00,000. When should this 10,00,000 be recorded as revenue?Franchise Revenue -ExampleHudson.Agro receives INR60,000 from a franchisee for the right to use its trademark for ARUN ICECREAM for a period of 5 years. When should the INR60,000 be recognized as revenue?

Percentage-of-Completion MethodDesign/development and construction/production projects that extends over several yearsCustomer pays either on fixed price or cost reimbursement contract methodReasonable assurance of profit margin and ultimate realizationRevenue recognized based on total percentage of project work performed during period

Problem 5-6Problem 5-6Particulars200420052006Revenue[ in $]9,80,00014,70,00022,05,000- Expenses [ in $]7,21,00011,90,00017,15,000Income [ in $]2,59,0002,80,0004,90,000Completed Contract MethodWhen Amount of income to be earned on contract cannot reasonably be determinedAlternative is completed contract methodCosts incurred are an asset/inventory (Contract Work in Progress) until revenue is recognizedIllustration 5-3 [page no.114]Completed Contract vs Percentage of Completion MethodFixed Price contracts require milestonesCost-reimbursement contract requires the formulae for RRCustomer payments are irrelevant in computing revenue under completed or percentage of completion methodProblem 5-2Problem 5-2Particulars]Completed Contract Current yearCompleted Contract- Next Year% completion current year% completion- Next YearIncome excluding Motel[$000]1,2501,2501,2501,250Income from motel project[$000]

0 750450300EBT[$000]

1,2502,0001,7001,550Production MethodApplies to agricultural and mining companiesCriteria:Clear market determined pricePerformance substantially completed[harvest]Fluctuating prices of mining productsPermitted but not required by GAAPInstallment MethodCustomer pays a certain amount per periodInstallment payment is recognized as revenue and a proportional part of cost of sales is recorded- Pure Installment methodUnder cost recovery method, cost is recorded equal to installment payment until total cost of sales is coveredExample [ page no.115]Problem 5-1Problem 5-1Sales MethodJanFebMarAprMayJuneSales12,0008,00013,00011,0009,00013,500CGS 7,8005,2008,4507,1505,8508,775Gross Profit4,2002,8004,5503,8503,1504,725Installment methodSales11,00010,00011,50010,50010,5009,500CGS7,1506,5007,4256,8256,8256,175Gross Profit3,8503,5004,0253,6753,6753,325Real Estate SalesDeveloper often finances over many yearsUncertainty of income due to uncertainty of receipt of future paymentsConditions required for revenue recognition:Period allowing cancellation and refund to buyer has expiredCumulative payments equal to 10% of purchase priceSeller has completed or is clearly capable of completing required improvementReal Estate SalesIf seller completes the improvement- delivery methodIf the improvement is semi complete or in process- % completion methodIf receipt of proceeds is uncertain- Installment methodIf any of the 3 conditions not fulfilled- then the amount received from customer shown as Deposits on land sales in the liability side of B/SSimilar treatment for commercial sale of land Amount of Revenue Recognized- ARNet realizable value (amount reasonably estimated to be collected)2 approaches for Bad debtsDirect write-off method[ requires identification of specific uncollectable accounts]Allowance method% of sales or % of ARBad DebtsDirect Write-Off MethodWrite-off when specific account that is uncollectible is identifiedBad debts expense A/c DrTo A/R A/c

Why is this not acceptable under GAAP?

Allowance MethodEstimate amount of current period credit sales that will not be collectedHistorical % of sales tempered by judgment.Historical % of aged receivables (+ judgment)Adjusting entry at end of periodWhen an uncollectible account is identified, it is written off Bad Debt -Example Amount of revenue recognized:Sales for the year were INR2,000 for cash and INR 6,000 on creditHistorically we dont collect about 5% of our credit sales due to customer bankruptcies or unable to locate customerA customer, The XYZ Company went bankrupt. They owed us 175Entry for revenue?Entry for bad debts - direct write-off (not-GAAP)?Entries for bad debts (allowance method)? Bad Debt- ExampleBalances in AccountsAccounts receivable dr 3,000Consisting of 2,000 current and 1,000 overdueAllowance for doubtful accounts cr 50Estimated amount of accounts that are uncollectible: 2% for current and 10% for non-current accountsWhat entry do we make at the end of the year to accrue for bad debts?Aging ScheduleCategories: Current, o/s less than 30 days, 30-60 days, 61-90 days, 91-180, above 180 daysAmount O/SEstimated % of uncollectibleAllowance for DDAllowance Method Allowance is a contra-asset accountCollection of a bad debt that was written-off:Cash A/c DrTo Allowance for Doubtful Accounts- In B/S , AR is shown net of allowance for doubtful accounts

If certainty exists about the non payment of a customerAllowance for Doubtful Accounts DrTo A/R A/cIn B/S both the allowance and A/R is reduced by this amountIf that customer repays the amount, thenCash A/c DrTo Allowance for Doubtful AccountsProblem 5-3Problem 5-3Under Direct Write off MethodTo record the write offBad debt expense A/c Dr $3,000To Accounts Receivable A/C $3,000-To record the partial paymentCash A/c Dr $950To Bad debts recovered A/c $950Problem 5-3Under the Allowance methodTo record the write-offAllowance for Doubtful A/c Dr $ 3,000To Accounts Receivable A/c $ 3,000To record the partial amountCash A/c Dr $ 950To Allowance for Doubtful A/c $950Problem 5-4Problem 5-4- Allowance for Doubtful accountsDays Account O/SAmount [ in $]Expected % uncollectibleEstimated Uncollectible[in $]0-15 days4,50,0000.014,50016-30 days1,50,0000.069,00031-45 days 75,0000.2015,00046-60 days 45,0000.3515,75061-75 days 15,0000.50 7,500Balance for Allowance for Doubtful Accounts51,750Problem 5-4- Allowance for Doubtful accounts & Net A/RAccounts O/S over 75 days[ $ 15,000] have zero probability of collection and would be written off immediately and not considered for calculation of allowanceNet Accounts ReceivableA/R = $ 7,35,000[ i.e 7,50,000- 15,000]Less: Allowance for doubtful accounts $51,750Net A/R = $6,83,250Problem 5-4- Allowance for Doubtful accounts& Net IncomeAmount to be entered in IS[ debit side] = New allowance + Bad Debts written off Old Allowance otherwise known as N+B-O = 51,750+15,000-37,500 = 29,250