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Recognizing Revenue                        Recognizing Revenue                Chapter                     18             I...
Revenue Recognition                       Revenue Recognition                          Revenue             Revenue        ...
The Current Environment                  The Current Environment     Revenue recognition has been the largest     source o...
The Current Environment                  The Current Environment    Guidelines for Revenue Recognition          The revenu...
Guidelines for Revenue Recognition  Proper revenue recognition revolves around three    terms:  1. Revenue are realized wh...
The Current Environment                  The Current Environment     Guidelines for Revenue Recognition (IFRS)     Revenue...
Revenue Recognition Classified by Type of Transaction               Chapter 18     Chapter 18 Type of          Sale of    ...
The Current Environment                  The Current Environment     Departures from the Sale Basis          Earlier recog...
The Current Environment          The Current Environment Departures from the Sale BasisChapter 18-9
Revenue Recognition at Point of Sale           Revenue Recognition at Point of Sale     Recognition of Sale Revenue     Re...
Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery)     Departures from the Sal...
Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery)     Sales with Buyback Agre...
Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery)  Sales When Right of Return...
Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery)  Sales When Right of Return...
Revenue Recognition at Point of Sale           Revenue Recognition at Point of Sale     Sales with Right of Return     Two...
Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery)     Trade Loading and Chann...
Revenue Recognition Before Delivery          Revenue Recognition Before Delivery     Most notable example is long-term con...
Long-Term Contracts (Construction)              Long-Term Contracts (Construction)     Two methods (under IFRS) of account...
Revenue Recognition Before Delivery          Revenue Recognition Before Delivery     Must use Percentage-of-Completion met...
Revenue Recognition Before Delivery          Revenue Recognition Before Delivery     Companies should use the Completed-Co...
Percentage-of-Completion Method            Percentage-of-Completion Method     Measuring the Progress toward Completion   ...
Percentage-of-Completion Method             Percentage-of-Completion Method     Measuring the Progress toward Completion  ...
Percentage-of-Completion Method           Percentage-of-Completion Method   Illustration:    Casper Construction Co.      ...
Percentage-of-Completion Method          Percentage-of-Completion Method   Illustration:                    2007          ...
Percentage-of-Completion Method           Percentage-of-Completion Method   Illustration:                                 ...
Percentage-of-Completion Method          Percentage-of-Completion Method   Illustration:    Income Statement              ...
Completed Contract Method             Completed Contract Method     Companies recognize revenue and gross profit only at  ...
Completed Contract Method                  Completed Contract Method   Illustration:                                      ...
Completed Contract Method                Completed Contract Method   Illustration:    Income Statement                2007...
Long-Term Contracts (Construction)          Long-Term Contracts (Construction)     Cost-Recovery Method     Companies reco...
Cost-Recovery Method                      Cost-Recovery Method   Illustration:                                     2010   ...
Cost-Recovery Method                      Cost-Recovery Method   Illustration:          Income Statement              2010...
Long-Term Contract Losses                Long-Term Contract Losses     Two Methods:          Loss in the Current Period on...
Long-Term Contract Losses                 Long-Term Contract Losses   Illustration: Loss on Profitable Contract    Casper ...
Long-Term Contract Losses                   Long-Term Contract Losses   Illustration: Loss on Profitable Contract         ...
Long-Term Contract Losses                 Long-Term Contract Losses   Illustration: Loss on Profitable Contract           ...
Long-Term Contract Losses                 Long-Term Contract Losses   Illustration: Loss on Unprofitable Contract    Caspe...
Long-Term Contract Losses                   Long-Term Contract Losses   Illustration: Loss on Unprofitable Contract       ...
Long-Term Contract Losses                 Long-Term Contract Losses   Illustration: Loss on Unprofitable Contract         ...
Long-Term Contract Losses                 Long-Term Contract Losses   Illustration: Loss on Unprofitable Contract     For ...
Revenue Recognition Before Delivery          Revenue Recognition Before Delivery     Disclosures in Financial Statements  ...
Revenue Recognition Before Delivery          Revenue Recognition Before Delivery     Completion-of-Production Basis     In...
Revenue Recognition After Delivery          Revenue Recognition After Delivery     When the collection of the sales price ...
Revenue Recognition after Delivery          Revenue Recognition after Delivery     Installment-Sales Method     Recognizes...
Revenue Recognition after Delivery          Revenue Recognition after Delivery     Acceptability of the Installment-Sales ...
Revenue Recognition after Delivery          Revenue Recognition after Delivery     Cost-Recovery Method     Recognizes no ...
Revenue Recognition after Delivery          Revenue Recognition after Delivery     Deposit Method     Seller reports the c...
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Slide 4 revenue recognition revisi

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Slide 4 revenue recognition revisi

  1. 1. Recognizing Revenue Recognizing Revenue Chapter 18 Intermediate Accounting 12th Edition Kieso, Weygandt, and WarfieldChapter 18-1
  2. 2. Revenue Recognition Revenue Recognition Revenue Revenue Revenue Current Recognition at the Recognition Recognition after Environment Point of Sale before Delivery Delivery Guidelines for Sales with Percentage-of- Installment-sales revenue buyback completion method recognition agreements method Cost-recovery Departures from Sales when right Completed- method sale basis of return exists contract method Deposit method Trade loading Long-term Summary of and channel contract losses bases stuffing Disclosures Concluding Completion-of- remarks production basisChapter 18-2
  3. 3. The Current Environment The Current Environment Revenue recognition has been the largest source of public company restatements over the past decade. One study noted restatements of revenue: Result in larger drops in market capitalization than other types of restatement. Caused eight of the top ten market value losses in a recent year. Of the ten companies, the leading three lost $20 billion in market value in just three days following disclosure of revenue recognition problems.Chapter (PricewaterhouseCoopers, 2002) 18-3
  4. 4. The Current Environment The Current Environment Guidelines for Revenue Recognition The revenue recognition principle provides that companies should recognize revenue (1) when it is realized or realizable and (2) when it is earned.Chapter 18-4
  5. 5. Guidelines for Revenue Recognition Proper revenue recognition revolves around three terms: 1. Revenue are realized when a company exchange goods and services for cash or claims to cash (receivables) 2. Revenue are realizable when assets a company receives in exchange are readily convertible to known amounts of cash or claims to cash . 3. Revenue are earned when a company has substantially accomplished what it must do to be entitled to the benefits represented by the revenues—that is, when theChapter earnings process is complete or virtually complete. 18-5
  6. 6. The Current Environment The Current Environment Guidelines for Revenue Recognition (IFRS) Revenue recognition principle: Revenue is recognized (1) when it is probable that the economic benefits will flow to the company and (2) when the benefits can be measured reliably.Chapter 18-6 LO 1 Apply the revenue recognition principle.
  7. 7. Revenue Recognition Classified by Type of Transaction Chapter 18 Chapter 18 Type of Sale of Sale of asset Rendering a Permitting useTransaction product from other than service of an asset inventory inventory Description Revenue from Revenue from Gain or loss on Revenue from of Revenue fees or interest, rents, disposition sales services and royalties Timing of Date of sale Services As time passes Date of sale or Revenue (date of performed and or assets are trade-in Recognition delivery) billable usedChapter 18-7
  8. 8. The Current Environment The Current Environment Departures from the Sale Basis Earlier recognition is appropriate if there is a high degree of certainty about the amount of revenue earned. Delayed recognition is appropriate if the  degree of uncertainty concerning the amount of revenue or costs is sufficiently high or  sale does not represent substantial completion of the earnings process.Chapter 18-8
  9. 9. The Current Environment The Current Environment Departures from the Sale BasisChapter 18-9
  10. 10. Revenue Recognition at Point of Sale Revenue Recognition at Point of Sale Recognition of Sale Revenue Revenue from the sale of goods is recognized when all the following conditions are met: 1. Company has transferred to the buyer the significant risks and rewards of ownership of the goods; 2. Company retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; 3. The amount of revenue can be measured reliably; 4. It is probable that the economic benefits will flow to the company; and 5. The costs incurred or to be incurred can be estimated reliably.Chapter 18-10 LO 2
  11. 11. Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery) Departures from the Sale Basis FASB’s Concepts Statement No. 5, companies usually meet the two conditions for recognizing revenue by the time they deliver products or render services to customers. Implementation problems,  Sales with Buyback Agreements  Sales When Right of Return Exists  Trade Loading and Channel StuffingChapter 18-11
  12. 12. Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery) Sales with Buyback Agreements When a repurchase agreement exists at a set price and this price covers all cost of the inventory plus related holding costs, the inventory and related liability remain on the seller’s books.* In other words, no sale. * “Accounting for Product Financing Arrangements,” Statement of Financial Accounting Standards No. 49 (Stamford, Conn.: FASB, 1981).Chapter 18-12
  13. 13. Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery) Sales When Right of Return Exists Recognize revenue only if six conditions have been met. 1. The seller’s price to the buyer is substantially fixed or determinable at the date of sale. 2. The buyer has paid the seller, or the buyer is obligated to pay the seller, and the obligation is not contingent on resale of the product. 3. The buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product.Chapter 18-13
  14. 14. Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery) Sales When Right of Return Exists Recognize revenue only if six conditions have been met. 4. The buyer acquiring the product for resale has economic substance apart from that provided by the seller. 5. The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer. 6. The seller can reasonably estimate the amount of future returns.Chapter 18-14
  15. 15. Revenue Recognition at Point of Sale Revenue Recognition at Point of Sale Sales with Right of Return Two possible revenue recognition methods are available when the right of return exposes the seller to continued risks of ownership: 1. not recording a sale until all return privileges have expired or 2. recording the sale, but reducing sales by an estimate of future returns.Chapter 18-15 LO 2 Describe accounting issues for revenue recognition at point of sale.
  16. 16. Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery) Trade Loading and Channel Stuffing “Trade loading is a crazy, uneconomic, insidious practice through which manufacturers—trying to show sales, profits, and market share they don’t actually have—induce their wholesale customers, known as the trade, to buy more product than they can promptly resell.”* * “The $600 Million Cigarette Scam,” Fortune (December 4, 1989), p. 89.Chapter 18-16
  17. 17. Revenue Recognition Before Delivery Revenue Recognition Before Delivery Most notable example is long-term construction contract accounting. Two Methods: Percentage-of-Completion Method.  Rationale is that the buyer and seller have enforceable rights. Completed-Contract Method.Chapter 18-17
  18. 18. Long-Term Contracts (Construction) Long-Term Contracts (Construction) Two methods (under IFRS) of accounting for long-term construction contracts:  Percentage-of-completion method.  Cost-recovery (zero-profit) method.Chapter 18-18
  19. 19. Revenue Recognition Before Delivery Revenue Recognition Before Delivery Must use Percentage-of-Completion method when estimates of progress toward completion, revenues, and costs are reasonably dependable and all of the following conditions exist: 1. The contract clearly specifies the enforceable rights regarding goods or services by the parties, the consideration to be exchanged, and the manner and terms of settlement. 2. The buyer can be expected to satisfy all obligations. 3. The contractor can be expected to perform under the contract.Chapter 18-19
  20. 20. Revenue Recognition Before Delivery Revenue Recognition Before Delivery Companies should use the Completed-Contract method when one of the following conditions applies when: 1. Company has primarily short-term contracts, or 2. Company cannot meet the conditions for using the percentage-of-completion method, or 3. There are inherent hazards in the contract beyond the normal, recurring business risks.Chapter 18-20
  21. 21. Percentage-of-Completion Method Percentage-of-Completion Method Measuring the Progress toward Completion Most popular measure is the cost-to-cost basis. The percentage that costs incurred bear to total estimated costs, can be applied to the total revenue or the estimated total gross profit on the contract.Chapter 18-21
  22. 22. Percentage-of-Completion Method Percentage-of-Completion Method Measuring the Progress toward Completion Cost-to-cost basis Costs incurred to date = Percent complete Most recent estimate of total costs Revenue to Percent complete x Estimated total revenue = be recognized to date Revenue to Revenue Current-period be recognized - recognized in = Revenue to date prior periodsChapter 18-22 LO 3 Apply the percentage-of-completion method for long-term contracts.
  23. 23. Percentage-of-Completion Method Percentage-of-Completion Method Illustration: Casper Construction Co. 2007 2008 2009 Contract price $675,000 $675,000 $675,000 Cost incurred current year 150,000 287,400 170,100 Estimated cost to complete in future years 450,000 170,100 0 Billings to customer current year 135,000 360,000 180,000 Cash receipts from customer Current year 112,500 262,500 300,000 A) Prepare the journal entries for 2007, 2008, and 2009. A) Prepare the journal entries for 2007, 2008, and 2009.Chapter 18-23
  24. 24. Percentage-of-Completion Method Percentage-of-Completion Method Illustration: 2007 2008 2009 Costs incurred to date $ 150,000 $ 437,400 $ 607,500 Estimated cost to complete 450,000 170,100 Est. total contract costs 600,000 607,500 607,500 Est. percentage complete 25.0% 72.0% 100.0% Contract price 675,000 675,000 675,000 Revenue recognizable 168,750 486,000 675,000 Rev. recognized prior year (168,750) (486,000) Rev. recognized currently 168,750 317,250 189,000 Costs incurred currently (150,000) (287,400) (170,100) Income recognized currently $ 18,750 $ 29,850 $ 18,900Chapter 18-24
  25. 25. Percentage-of-Completion Method Percentage-of-Completion Method Illustration: 2007 2008 2009Construction in progress 150,000 287,400 170,100 Cash 150,000 287,400 170,100Accounts receivable 135,000 360,000 180,000 Billings on contract 135,000 360,000 180,000Cash 112,500 262,500 300,000 Accounts receivable 112,500 262,500 300,000Construction in progress 18,750 29,850 18,900Construction expense 150,000 287,400 170,100 Construction revenue 168,750 317,250 189,000Billings on contract 675,000 Construction in progress 675,000Chapter 18-25
  26. 26. Percentage-of-Completion Method Percentage-of-Completion Method Illustration: Income Statement 2007 2008 2009 Revenue on contracts $ 168,750 $ 317,250 $ 189,000 Cost of construction 150,000 287,400 170,100 Gross profit 18,750 29,850 18,900 Balance Sheet (12/31) Current assets: Accounts receivable 22,500 120,000 - Cost & profits > billings 33,750 Current liabilities: Billings > cost & profits 9,000Chapter 18-26
  27. 27. Completed Contract Method Completed Contract Method Companies recognize revenue and gross profit only at point of sale—that is, when the contract is completed. Under this method, companies accumulate costs of long- term contracts in process, but they make no interim charges or credits to income statement accounts for revenues, costs, or gross profit.Chapter 18-27
  28. 28. Completed Contract Method Completed Contract Method Illustration: 2007 2008 2009Construction in progress 150,000 287,400 170,100 Cash 150,000 287,400 170,100Accounts receivable 135,000 360,000 180,000 Billings on contract 135,000 360,000 180,000Cash 112,500 262,500 300,000 Accounts receivable 112,500 262,500 300,000Construction in progress 67,500Construction expense 607,500 Construction revenue 675,000Billings on contract 675,000 Construction in progress 675,000Chapter 18-28
  29. 29. Completed Contract Method Completed Contract Method Illustration: Income Statement 2007 2008 2009 Revenue on contracts $ - $ - $ 675,000 Cost of construction - - 607,500 Gross profit - - 67,500 Balance Sheet (12/31) Current assets: Accounts receivable 22,500 120,000 - Cost & profits > billings 15,000 Current liabilities: Billings > cost & profits 57,600Chapter 18-29
  30. 30. Long-Term Contracts (Construction) Long-Term Contracts (Construction) Cost-Recovery Method Companies recognize revenue only to the extent of costs incurred that are expected to be recoverable. Only after all costs are incurred is gross profit recognized.Chapter 18-30 LO 4 Apply the cost-recovery method for long-term contracts.
  31. 31. Cost-Recovery Method Cost-Recovery Method Illustration: 2010 2011 2012Construction in progress 150,000 287,400 170,100 Cash 150,000 287,400 170,100Accounts receivable 135,000 360,000 180,000 Billings on contract 135,000 360,000 180,000Cash 112,500 262,500 300,000 Accounts receivable 112,500 262,500 300,000Construction in progress 67,500Construction expense 150,000 287,400 170,100 Construction revenue 150,000 287,400 237,600Billings on contract 675,000 Construction in progress 675,000Chapter 18-31 LO 4 Apply the cost-recovery method for long-term contracts.
  32. 32. Cost-Recovery Method Cost-Recovery Method Illustration: Income Statement 2010 2011 2012 Revenue on contracts €0 €0 € 675,000 Cost of construction - - 607,500 Gross profit - - 67,500 Balance Sheet (12/31) Current assets: Accounts receivable 22,500 120,000 - Cost & profits > billings 15,000 Current liabilities: Billings > cost & profits 57,600Chapter 18-32 LO 4 Apply the cost-recovery method for long-term contracts.
  33. 33. Long-Term Contract Losses Long-Term Contract Losses Two Methods: Loss in the Current Period on a Profitable Contract  Percentage-of-completion method only, the estimated cost increase requires a current-period adjustment of gross profit recognized in prior periods. Loss on an Unprofitable Contract  Under both percentage-of-completion and completed- contract methods, the company must recognize in the current period the entire expected contract loss.Chapter 18-33
  34. 34. Long-Term Contract Losses Long-Term Contract Losses Illustration: Loss on Profitable Contract Casper Construction Co. 2007 2008 2009 Contract price $675,000 $675,000 $675,000 Cost incurred current year 150,000 287,400 215,436 Estimated cost to complete in future years 450,000 215,436 0 Billings to customer current year 135,000 360,000 180,000 Cash receipts from customer Current year 112,500 262,500 300,000 b) Prepare the journal entries for 2007, 2008, and 2009 assuming the b) Prepare the journal entries for 2007, 2008, and 2009 assuming the estimated cost to complete at the end of 2008 was $215,436 instead of estimated cost to complete at the end of 2008 was $215,436 instead of $170,100. $170,100.Chapter 18-34
  35. 35. Long-Term Contract Losses Long-Term Contract Losses Illustration: Loss on Profitable Contract 2007 2008 2009 Costs incurred to date $ 150,000 $ 437,400 $ 652,836 Estimated cost to complete 450,000 215,436 Est. total contract costs 600,000 652,836 652,836 Est. percentage complete 25.0% 67.0% 100.0% Contract price 675,000 675,000 675,000 Revenue recognizable 168,750 452,250 675,000 Rev. recognized prior year (168,750) (452,250) Rev. recognized currently 168,750 283,500 222,750 Costs incurred currently (150,000) (287,400) (215,436) Income recognized currently $ 18,750 $ (3,900) $ 7,314Chapter 18-35
  36. 36. Long-Term Contract Losses Long-Term Contract Losses Illustration: Loss on Profitable Contract 2007 2008 2009Construction in progress 18,750 7,314Construction expense 150,000 215,436 Construction revenue 168,750 222,750 Construction in progress 3,900Construction expense 287,400 Construction revenue 283,500Chapter 18-36
  37. 37. Long-Term Contract Losses Long-Term Contract Losses Illustration: Loss on Unprofitable Contract Casper Construction Co. 2007 2008 2009 Contract price $675,000 $675,000 $675,000 Cost incurred current year 150,000 287,400 246,038 Estimated cost to complete in future years 450,000 246,038 0 Billings to customer current year 135,000 360,000 180,000 Cash receipts from customer Current year 112,500 262,500 300,000 c) Prepare the journal entries for 2007, 2008, and 2009 assuming the c) Prepare the journal entries for 2007, 2008, and 2009 assuming the estimated cost to complete at the end of 2008 was $246,038 instead of estimated cost to complete at the end of 2008 was $246,038 instead of $170,100. $170,100.Chapter 18-37
  38. 38. Long-Term Contract Losses Long-Term Contract Losses Illustration: Loss on Unprofitable Contract 2007 2008 2009 Costs incurred to date $ 150,000 $ 437,400 $ 683,438 Estimated cost to complete 450,000 246,038 Est. total contract costs 600,000 683,438 683,438 Est. percentage complete 25.0% 64.0% 100.0% Contract price 675,000 675,000 675,000 Revenue recognizable 168,750 432,000 675,000 Rev. recognized prior year (168,750) (432,000) Rev. recognized currently 168,750 263,250 243,000 Costs incurred currently (150,000) Plug (290,438) (243,000) Income recognized currently $ 18,750 $ (27,188) $ - $683,438 – 678,500 = 8,438 cumulative lossChapter 18-38
  39. 39. Long-Term Contract Losses Long-Term Contract Losses Illustration: Loss on Unprofitable Contract 2007 2008 2009Construction in progress 18,750 -Construction expense 150,000 243,000 Construction revenue 168,750 243,000 Construction in progress 27,188Construction expense 290,438 Construction revenue 263,250Chapter 18-39
  40. 40. Long-Term Contract Losses Long-Term Contract Losses Illustration: Loss on Unprofitable Contract For the Completed-Contract method, companies would recognize the following loss : 2007 2008 2009Loss on construction contract 8,438 Construction in progress 8,438Chapter 18-40
  41. 41. Revenue Recognition Before Delivery Revenue Recognition Before Delivery Disclosures in Financial Statements Construction contractors should disclosure: the method of recognizing revenue, the basis used to classify assets and liabilities as current (length of the operating cycle), the basis for recording inventory, the effects of any revision of estimates, the amount of backlog on uncompleted contracts, and the details about receivables.Chapter 18-41
  42. 42. Revenue Recognition Before Delivery Revenue Recognition Before Delivery Completion-of-Production Basis In certain cases companies recognize revenue at the completion of production even though no sale has been made. Examples are: precious metals or agricultural products.Chapter 18-42
  43. 43. Revenue Recognition After Delivery Revenue Recognition After Delivery When the collection of the sales price is not reasonably assured and revenue recognition is deferred. Methods of deferring revenue: Installment-sales method Generally Employed Cost-recovery method Deposit methodChapter 18-43
  44. 44. Revenue Recognition after Delivery Revenue Recognition after Delivery Installment-Sales Method Recognizes income in the periods of collection rather than in the period of sale. Recognize both revenues and costs of sales in the period of sale, but defer gross profit to periods in which cash is collected. Selling and administrative expenses are not deferred.Chapter 18-44
  45. 45. Revenue Recognition after Delivery Revenue Recognition after Delivery Acceptability of the Installment-Sales Method The profession concluded that except in special circumstances, “the installment method of recognizing revenue is not acceptable.”* The rationale: because the installment method does not recognize any income until cash is collected, it is not in accordance with the accrual concept. *“Omnibus Opinion,” Opinions of the Accounting Principles Board No. 10 (New York: AICPA, 1966), par. 12.Chapter 18-45
  46. 46. Revenue Recognition after Delivery Revenue Recognition after Delivery Cost-Recovery Method Recognizes no profit until cash payments by the buyer exceed the cost of the merchandise sold. APB Opinion No. 10 allows a seller to use the cost- recovery method to account for sales in which “there is no reasonable basis for estimating collectibility.” In addition, FASB Statements No. 45 (franchises) and No. 66 (real estate) require use of this method where a high degree of uncertainty exists related to the collection of receivables.Chapter 18-46
  47. 47. Revenue Recognition after Delivery Revenue Recognition after Delivery Deposit Method Seller reports the cash received from the buyer as a deposit on the contract and classifies it on the balance sheet as a liability. The seller does not recognize revenue or income until the sale is complete.Chapter 18-47

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