Rev. Recog

7/30/2019 Rev. Recog

1/55

Rev. Recog - 1

REVENUE AND EXPENSE

RECOGNITION


2/55

Rev. Recog - 2

LEARNING OBJECTIVES

Understand the revenue and matchingprinciples

Familiarize yourself with applications of therevenue principle with special attention to:

Installment and cost recovery methodsAccounting for long-term contracts

Completed contract method

Percentage of completion method

Right of return method Product financing arrangements

Franchising agreements

Obtain overall understanding of matching

principle


3/55

Rev. Recog - 3

DEFINITIONS

Revenues Inflows of assets or settlements of liabilities during

a period from delivering or producing goods orservices.

Expenses Outflows of assets or incurrence of liabilities

during a period from delivering or producinggoods or services.

Incurred in an attempt to produce revenues


4/55

Rev. Recog - 4

REVENUE PRINCIPLE

Revenue should be recognized in thefinancial statement when . . .

It is earned, and

It is realized or realizable

(Measurable)


5/55

Rev. Recog - 5

REVENUE PRINCIPLE

Revenue is earned when the earnings processis completed or virtually completed.

Revenue is realized when cash is received.

Revenue is realizable when claims to cash arereceived that can be converted into a knownamount of cash.


6/55

Rev. Recog - 6

REVENUE PRINCIPLE

Revenue is typically recognized:

At delivery (point of sale)

After delivery

Before delivery

of product or service


7/55

Rev. Recog - 7

REVENUE RECOGNITION POINTS

Design and production,

construction in progress,

minerals discovered

Goods completed

and ready for sale,

contract complete

Delivery of

product or

service

Cash collected

for goods or

services

Right of

return expires

Recognition

before delivery

Recognition

after delivery

Recognition

at delivery

Percentage-of

completion method

Production

method

Completed

contract

method

Pointof sale

methodInstallment

method

Cost

recovery

method

Right of

return

expiration

method

RELEVANCE RELIABILITY


8/55

Rev. Recog - 8

Revenue is earned and realized at thepoint of sale.

The product or service has beendelivered to the customer and cash has

been received or is receivable.

This method is sometimes called the

sales method, or delivery method.

REVENUE RECOGNITIONPoint of Sale


9/55

Rev. Recog - 9

Uncertainties about collectibility orfuture performance by seller.

Sale with right of return.

Product-financing arrangements.

REVENUE RECOGNITION

After Delivery


10/55

Rev. Recog - 10

INSTALLMENT SALES

When we are uncertain about the collectibilityof the sales revenue or the ability of the sellerto deliver futures services, we should deferrevenue recognition.

Two commonly used accounting methods are

the . . . Installment sales method. Cost recovery method.


11/55

Rev. Recog - 11

INSTALLMENT SALES

Installment Sales Method

Sale and cost of sale recorded as usual.

Compute gross margin rate on theinstallment sales.

Recognize gross margin as cash is

received. Gross margin not realized is deferred until

a future period.


12/55

Rev. Recog - 12

INSTALLMENT SALESExample

Sams Appliances made sales of $200,000 in 19X5that qualified for the installment sales method of

accounting. The items sold have a cost to Samsof $130,000. During 19X5, Sams collected cash

from installment customers of $90,000. Theremaining amount will be collected in 19X6.

Prepare the journal entries to record theinstallment sales transactions during 19X5.


13/55

Rev. Recog - 13

INSTALLMENT SALES

Example

Sam's Appliances

Installment Sales

Dollars PercentInstallment sales revenue 200,000$ 100%

Cost of goods sold 130,000 65%

Gross margin 70,000$ 35%

R R 14


14/55

Rev. Recog - 14


GENERAL JOURNAL Page 34

Date Description

Post.

Ref. Debit Credit

Installment Accounts Receivable 200,000

Installment Revenue 200,000

R R 15


15/55

Rev. Recog - 15



Date Description

Post.

Ref. Debit Credit



Cost of Installment Sales 130,000

Inventory 130,000

R R 16


16/55

Rev. Recog - 16



Date Description

Post.

Ref. Debit Credit

Cash 90,000


Re Re o 17


17/55

Rev. Recog - 17



Date Description

Post.

Ref. Debit Credit


Cost of Installment Sales 130,000Deferred Gross Margin 70,000

Rev Recog 18


18/55

Rev. Recog - 18



Date Description

Post.

Ref. Debit Credit



Deferred Gross Margin 31,500

Realized Gross Margin 31,500

Rev Recog 19


19/55

Rev. Recog - 19


Date Description

Post.

Ref. Debit Credit




Realized Gross Margin 31,500


Cash collection in 19X5 $90,000Gross margin percentage 35%Gross profit to recognize $31,500

Rev Recog 20


20/55

Rev. Recog - 20


Installment accounts receivable 110,000$

Less: Deferred gross margin 38,500

Net Installment accounts receivable 71,500$

Balance Sheet

Rev Recog - 21


21/55

Rev. Recog - 21



Less: Deferred gross margin 38,500



Less: Cash collections (90,000)


Deferred gross margin 70,000$

Less: Gross margin recognized (31,500)

Deferred gross margin 38,500$

Balance Sheet

Rev Recog - 22


22/55

Rev. Recog - 22

COST RECOVERY METHOD

Like the installment sales method, costrecovery is used when we are uncertain

about the collectibility of the sales revenue orthe ability of the seller to complete futureperformance.

UNCERTAINTY IS GREATER! No profit is recognized until cost of item soldis fully recovered.

Rev Recog - 23


23/55

Rev. Recog - 23

COST RECOVERYExample

Sams Appliances made sales of $200,000 in19X5 that qualified for the cost recovery

method of accounting. The items sold have

a cost to Sams of $130,000. During 19X5,Sams collected cash from installmentcustomers of $90,000. The remaining

amount will be collected in 19X6.

Prepare the journal entries to record theinstallment sales transactions during 19X5.

Rev Recog - 24


24/55

Rev. Recog 24



Date Description

Post.

Ref. Debit Credit




25/55

Rev. Recog - 26


26/55

Rev. Recog 26



Date Description

Post.

Ref. Debit Credit


Cost of Installment Sales 130,000


Rev. Recog - 27


27/55

Rev. Recog 27



Date Description

Post.

Ref. Debit Credit

Cash 90,000


No profit is recognized in 19X5 because the cost of theitem sold ($130,000) has not been recovered in the

form of cash receipts. Once we collect $130,000 incash, profit recognition begins.

Rev. Recog - 28


28/55

Rev. Recog 28



Less: Deferred gross margin (70,000)


All gross profit has been deferred until we recover the$130,000 cost of the item sold.

Balance Sheet

Rev. Recog - 29


29/55

og

RIGHT OF RETURN

In some industries it is commonpractice that the sales terms allow

customers the right to return goodsunder specified conditions and over

long periods of time.

Book Publishing EquipmentManufacturing

Rev. Recog - 30


30/55

g

RIGHT OF RETURN

Recognize revenue at point of sale if,

Selling price is fixed or determinable. Buyer is obligated to pay the seller and payment is not

contingent upon resale of the product. Buyer is obligated even in case of theft or physical

destruction. Buyer has economic substance apart from that

provided by the seller. Seller has no obligation for future performance. Future returns can be estimated.

Rev. Recog - 31


31/55

g

PRODUCT-FINANCINGARRANGEMENTS

An agreement in which a sponsoringcompany sells a product to another

company and in a related transactionagrees to repurchase the product.

The sponsoring company

Records a liability when the proceeds arereceived. No sale is recorded and inventory is not

adjusted.

Wait for a sale to outside party.

Rev. Recog - 32


32/55

g

REVENUE RECOGNITIONBefore Delivery

Accounting for long-term constructioncontracts

Completed-Contract Method Percentage-of-Completion Method

Rev. Recog - 33


33/55

REVENUE RECOGNITION

Before Delivery Percentage-of-completion method is

appropriate when . . .

Contract specifies the amount ofconsideration to be exchanged and theterms of settlement.

Buyer is expected to satisfy the obligation.

Contractor can perform according to theterms of the contract.

Rev. Recog - 34


34/55

MEASURING PROGRESS TOWARD

COMPLETION

Input Measures

Effort devoted to project compared to totaleffort expected (cost incurred to datecompared to total estimated costs)

Output Measures

Results to date compared to total results

Rev. Recog - 35


35/55


COMPLETION

Cost-to-Cost Method

Total costs incurred to datePercent complete =

Most recent estimate of total

costs of the project

Rev. Recog - 36


36/55


COMPLETION Cost-to-Cost Method

Current Period Revenue

Total Revenue from Contract

Percent Complete

Total Revenue to Recognize

- Revenue Recognized in Prior Periods

= Revenue Recognized in Current Period

Rev. Recog - 37


37/55

LONG-TERM CONTRACTS

Example

During 19X6, West, Inc. enters into a

contract with Putnam County to build abridge over Cane River. The project willtake 3 years to complete and has a fixedprice of $4,500,000. Wests engineers

estimate the total cost of the bridge to be$3,000,000. At the end of 19X6, the

information on the next page was gathered

by Wests accountant.

Rev. Recog - 38


38/55

LONG-TERM CONTRACTSExample

Project costs incurred during 19X6 750,000$Estimated cost to complete the bridge 2,250,000

Amounts billed to Putnam Co. in 19X6 800,000

Cash collections from Putnam Co. 790,000

West uses the percentage-of-completionmethod to account for all long-term

construction projects.

Prepare the necessary 19X6 journal entriesfor this project.

Rev. Recog - 39


39/55



Date Description

Post.

Ref. Debit Credit

Construction-In-Process 750,000

Cash, Payables, etc. 750,000

Rev. Recog - 40


40/55



Date Description

Post.

Ref. Debit Credit



Accounts Receivable 800,000

Billings on Contracts 800,000

Rev. Recog - 41


41/55



Date Description

Post.

Ref. Debit Credit



Accounts Receivable 800,000

Billings on Contracts 800,000

Cash 790,000Accounts Receivable 790,000

Rev. Recog - 42


42/55



Date Description

Post.

Ref. Debit Credit


Cost of Construction 750,000

Construction Revenue 1,125,000

750,000$ 3,000,000$ = 25% complete4,500,000$ 25% = 1,125,000$ revenue

1,500,000$ 25% = 375,000$ profit

Rev. Recog - 43


43/55



Date Description

Post.

Ref. Debit Credit


Cost of Construction 750,000

Construction Revenue 1,125,000

If West uses the Completed-Contract method, norevenue is recognized during 19X6. All

revenue and profit is recognized at theend of the contract when delivery of the bridge to

Putnam County is made.

Rev. Recog - 44


44/55

REVENUE RECOGNITION

Before Delivery Completion of Production

Accretion Basis

Discovery Basis

Rev. Recog - 45


45/55

REVENUE RECOGNITIONService Sales

Specific Performance Method

Proportional Performance Method

Completed Performance Method

Collection

Rev. Recog - 46


46/55

SPECIFIC PERFORMANCE

Used to account for revenue that isearned by performing a single act.

Franchise revenue (SFAS No. 45)

BobsBurgers

Rev. Recog - 47


47/55

PROPORTIONAL PERFORMANCE

Used to recognize service revenue thatis earned by more than a single act and

when the service is rendered in morethan one accounting period. Similar performance acts - equal amount

for each act

Dissimilar performance acts - in proportionto direct costs of each act

Similar acts with a fixed period for

performance

Rev. Recog - 48


48/55

COMPLETED PERFORMANCE

Used when revenue is earned byperforming a series of acts, and the last

act is so important that revenue is onlyconsidered earned if it is performed.

Rev. Recog - 49


49/55

COLLECTION

Used to account for service revenuewhen the uncertainty of collection is

very high. Revenue recognized when cash is

received.

Rev. Recog - 50


50/55

EXPENSE RECOGNITION

Expenses are outflows of assets orincurrences of liabilities during a period

from delivery or producing goods orrendering services.

Rev. Recog - 51


51/55

MATCHING

Once revenues are determined, theexpenses incurred in generating the

revenue should be recognized.

As revenues are earned, certain assets

are consumed and services are used.

Rev. Recog - 52


52/55

EXPENSES

Recognition Methods

Direct

Period

Allocated

Rev. Recog - 53


53/55

GAINS AND LOSSES

Gains and losses result from peripheral or

incidentaltransactions, events, or

circumstances.

Most gains and losses are recognized whenthe transaction is completed.

Estimated losses are recognized before

realization if they are probable and can be

reasonably estimated. Rev. Recog - 54

ETHICAL CONSIDERATIONS


54/55

ETHICAL CONSIDERATIONS

Im sorry we shipped yourorder on Dec. 28 instead ofon the delivery date of Jan.

10. But the important thing isthat you have the products

you need...Right?

Rev. Recog - 55


55/55

Ready to Move On?

Midterm

Exam

Documents

Rev. Recog