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Fin. Accounting I - Session 16. William F. Bentz. Accounting & MIS. Revenue Allocation. - PowerPoint PPT Presentation
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William F. Bentz1
A&MIS 521
Fin. Accounting I - Session 16
William F. Bentz
Accounting & MIS
William F. Bentz2
A&MIS 521
Revenue Allocation
In selected circumstances, revenue is recognized over 2 or more accounting periods. In many such cases, revenue is allocated in a manner that results in either a uniform gross margin, or in a uniform rate of return. We will use both methods.
William F. Bentz3
A&MIS 521
Revenue Allocation
Uniform gross margin method % is used for – construction contracts
– warranty contracts
– software development contracts
– installment sales (limited use)
William F. Bentz4
A&MIS 521
Revenue Allocation
Uniform rate-of-return method are used for – interest income (A&MIS 522,
investments)
– interest method of depreciation (chapter 5)
William F. Bentz5
A&MIS 521
Uniform Gross Margin %
For the gross margin percentage to be truly uniform, revenues and costs must be equal to the amounts forecast.
However, if one is able to forecast the revenues and the associated costs with acceptable accuracy, the intermediate reported results will be informative. The threshold for reasonable accuracy is a matter of professional judgement.
William F. Bentz6
A&MIS 521
Uniform Gross Margin %
This method is implemented by multiplying the total amount of revenue to be allocated by the proportion of the costs incurred to date to the total estimated costs. Consider the warranty problem Bentley’s.
William F. Bentz7
A&MIS 521
Bentley’s
Price of a warranty contract - $2,000 (constant)
Projected warranty costs per contract - $1,200
Projected gross margin - $800 [$2,000 - $1,200]
Term of contract - five years
William F. Bentz8
A&MIS 521
Bentley’s
Forecast of annual costs per contract: Year 1 - $ 100
Year 2 - 150
Year 3 - 250
Year 4 - 300
Year 5 - 400
Total $1,200
William F. Bentz9
A&MIS 521
Proportion of cost incurred:
Cumulative proportion to date:Y1: $100/$1,200 = 0.0833
Y2: [$100 + $150]/$1,200 = 0.2083
Y3: [$100 + 150 + 250]/$1,200 = 0.4167
Y4: [$100 + 150 +250
+ 300]/$1,200 = 0.6667
Y5: $1,200/$1,200 = 1.0
William F. Bentz10
A&MIS 521
Cumulative revenue earned
Cumulative revenue by year:
Y1: 0.0833 × $2,000 = $ 166.67
Y2: 0.2083 × $2,000 = $ 416.67
Y3: 0.4167 × $2,000 = $ 833.33
Y4: 0.6667 × $2,000 = $1,333.33
Y5: 1.0000 × $2,000 = $2,000.00
William F. Bentz11
A&MIS 521
Cumulative revenue earned
Cumulative proportion of revenue earned (CPRE) = cumulative proportion of the cost incurred to the total (forecast) cost
CPRE(0 d) = Total cost incurred to date (0 d)/Total cost forecasted (0 n)for a contract beginning at t = 0 and ending
at t = n
William F. Bentz12
A&MIS 521
0 d n
Total = 1.0
CPRE
William F. Bentz13
A&MIS 521
Annual Revenue
Y1: $ 166.67 - 0 = $ 166.67
Y2: $ 416.67 - 166.67 = 250.00
Y3: $ 833.33 - 416.67 = 416.66
Y4: $1,333.33 - 833.33 = 500.00
Y5: $2,000.00 - 1,333.33 = 667.67
Total $2,000.00
William F. Bentz14
A&MIS 521
Go to Workbook Pages
William F. Bentz15
A&MIS 521
Revenue Recognition - Long-term Contracts
Objective: To recognize revenue period-by-period as the revenue from a long-term contract is earned. The key criteria for revenue recognition are still:– Earning of the revenue– Realization/estimation of doubtful accounts– Reasonably estimable costs
William F. Bentz16
A&MIS 521
Consider the Issue of Collection
Realization is deemed to have occurred if the seller has received a valid claim to a determinable amount of money subject to reasonable payment terms by a buyer that is capable of paying the amount due.
William F. Bentz17
A&MIS 521
Revenue Recognition Methods
Revenue is recognized on long-term projects on one of two bases:– Completed contract method– Percentage-of-completion method
Annual revenues, expenses, income, and asset values are affected by the choice of method.
William F. Bentz18
A&MIS 521
Revenue Recognition Methods
With the completed contract method, project costs are accumulated in a Construction-in-Process account. The cumulative cost is matched against revenues when the contract is completed. The amount of revenue recognized is the final contract price.
William F. Bentz19
A&MIS 521
Revenue Recognition Methods
With the percentage-of-completion method, a portion of the total contract price is recognized each period. That portion is the percentage of the work completed to date, less the revenue already recognized.
William F. Bentz20
A&MIS 521
Percentage-of-completion
To use the percentage-of-completion method, one must have some way of determining the percentage of completion for each project! The percentage of the costs incurred relative to total expected project cost is the measure used.
William F. Bentz21
A&MIS 521
Calculating the Percent
Cumulative cost
Cumulative incurred to date
% complete =
Total Expected
project cost
William F. Bentz22
A&MIS 521
Example Co.
Contract Cumulative Cumulative Annual
Date Price Cost Revenue Revenue
12/00 $70,000 $20,000 $23,333 $23,333
12/01 70,000 40,000 46,666 23,333
12/02 70,000 60,000 70,000 23,334
Total $70,000
William F. Bentz23
A&MIS 521
Example Co. (B)
Cumulative Estimated Cumulative AnnualDate Cost Tot. Cost Revenue* Revenue12/00 $15,000 $60,000 $17,500 $17,50012/01 35,000 60,000 40,833 23,33312/02 59,000 59,000 70,000 29,167Total $70,000*Contract price is $70,000‘98: (15,000/60,000) x $70,000 = 17,500‘99: (35,000/60,000) x $70,000 - $17,500 = $23,333‘00: $70,000 - $17,500 - $23,333 = $29,167
William F. Bentz24
A&MIS 521
Example Co. (B)
Annual Annual Gross Margin
Date Revenue Cons. Cost Margin %
12/98 $17,500 $15,000 $ 2,500 14.3%
12/99 23,333 20,000 3,333 14.3%
12/00 29,167 24,000 5,167 17.7%
Total $70,000 $59,000 $11,000
*Contract price is $70,000
William F. Bentz25
A&MIS 521
Revenue Recognition
For our purposes, the percentage completion method of recognizing revenue is applied the same way regardless of the profitability of the contract, or the timing of the contract billings and cash collections. The method is effort (cost) driven.