Revenue Recognition<br />Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the <br />Sale of goods<br />Rendering of services and<br />Use by others, of enterprise resources, yielding interest, royalties and dividends<br />Recognition - Process of recording and reporting an item as an element of financial statement <br />
Principles<br /> The revenue recognition principle provides that revenue is recognized:<br />when it is earned, and<br />when it is realized or realizable<br />Revenue is earned when the earnings process is substantially complete<br />Revenue is realized when goods and services are exchanged for cash or claims to cash<br />Revenue is realizable when assets received are convertible into a known amount of cash<br />
Four Types of Revenue Transactions<br />Revenue from selling products is recognized at the date of sale (date of delivery).<br />Revenue from services is recognized when services are performed and are billable.<br />Revenue from the use of enterprise’s assets by others is recognized as time passes or as the assets are used up.<br />Revenue from disposal of assets (other than inventory) is recognized at the point of sale as gain or loss.<br />
Revenue Recognition Classified by Nature of Transaction<br />
Revenue Recognition at Point of Sale<br /> Revenues from manufacturing and selling are commonly recognized at point of sale<br /> Exceptions:<br />Sales with buyback agreements<br />Sales when right of return exists (high rates that are not reliably estimable)<br />Trade loading/channel stuffing<br />
Revenue Recognition Before Delivery<br /> Revenue may be recognized before delivery under certain circumstances<br />Long-term construction contracts are a notable example<br /> Two methods available are :<br />The percentage-of-completion method, and<br />The completed contract method<br />
Percentage-of-Completion<br />Method<br />Completed Contract<br />Method<br />1) Terms of contract must<br /> be certain, enforceable<br />2) Certainty of performance<br /> by both parties<br />3) Estimates of completion<br /> can be made reliably<br />1) To be used only when <br /> the percentage method is <br /> inapplicable [uncertain]<br />2) For short-term contracts<br />Revenue Recognition Before Delivery<br />Long-Term Construction<br />Accounting Methods<br />
1<br /> Costs incurred to date = Percent complete<br />Most recent estimated total costs <br />2<br />Estimated total revenue x Percent complete<br /> = Revenue to be recognized to date<br />3<br />Total revenue to be recognized to date less Revenue <br /> recognized in PRIOR periods = Current period revenue<br />Current Period Revenue less current costs = Gross profit<br />4<br />Percentage-of-Completion: Steps<br />
Percentage-of-Completion: Example<br />Data: Contract price: $4,500,000 Estimated cost: $4,000,000<br /> Start date: July, 2003 Finish: October, 2005<br /> Balance sheet date: Dec. 31<br />Given: 200320042005<br />Costs to date $1,000,000 $2,916,000 $4,050,000<br />Estimated costs to complete $3,000,000 $1,134,000 $ -0-<br />Progress Billings during year $900,000 $2,400,000 $1,200,000<br />Cash collected during year $750,000 $1,750,000 $2,000,000<br />What is the percent complete, revenue and gross profit recognized each year?<br />
Revenue Recognition After Delivery<br /> Revenue recognition is deferred when collection of sales price is not reasonably assured and no reliable estimates can be made<br /> The two methods that are used are:<br />the installment sales method<br />the cost recovery method<br /> If cash is received prior to delivery, the method used is the deposit method<br />
The Installment Sales Method<br />This method emphasizes income recognition in periods of collection rather than at point of sale<br />Title does not pass to the buyer until all cash payments have been made to the seller<br />Both sales and cost of sales are deferred to the periods of collection<br />Other expenses, selling and administrative, are not deferred<br />
The Cost Recovery Method<br /><ul><li>Seller recognizes no profit until cash payments by buyer exceed seller’s cost of merchandise.
After recovering all costs, seller includes additional cash collections in income.
This method is to be used where there is no reasonable basis for estimating collectibility as in franchises and real estate.
The income statement reports the amount of gross profit recognized and the amount deferred.</li></li></ul><li>The Deposit Method<br />Seller receives cash from buyer before transfer of goods or performance<br />The seller has no claim against the purchaser.<br />There is insufficient transfer of risks to buyer to warrant recording a sale by seller<br />In the case of such incomplete transactions, the deposit method is used<br />The deposit method thus defers sale recognition until a sale has occurred for accounting purposes<br />