Revenue Recognition

1
Revenue Recognition

• Chapter 19

2
Basic Conepts

• One of the most difficult problems facing
  accountants. Problem of developing guidelines
  applicable to all situations
• Recognition principle- Revenue is recognized when
  it is
• Realized or realizable (converted into cash or
  claims to cash)
• Earned (entity has substantially performed
  required acts)

3
Revenue Transactions

• Revenue from selling products is recorded at date
  of sale, usually date of delivery
• Revenue from services rendered recognized when
  services have been performed and are billable
• Revenue from permitting others to use assets
  recognized as time passes or as assets are used

4
Revenue Transactions

• Revenue from disposing of assets other than
  products is recognized at date of sale

5
Sales Transactions

• Revenue recognition at point of sale
• Cash sales versus credit sales
• Sales with buyback agreements not sales if a
  repurchase agreement exists which covers all
  costs
• Problems when a high ratio of returned
  merchandise to sales exists. Recognize sale only
  if all six following conditions met

6
Six Conditions

• Sellers price fixed or determinable at date of
  sale
• Buyer has paid seller, or is obligated to do so
  without any contingencies
• Buyers obligation to pay is not affected by
  theft, destruction, or damage of product.

7
Six Conditions

• Buyer has economic substance apart from that
  provided by the seller
• Seller is not obligated to bring about resale of
  the product for the buyer
• Amount of future returns can be reasonably
  estimated.

8
Trade Loading Channel Stuffing

• Undesirable managerial and marketing policy
  decisions and actions that distort operating
  results are discouraged

9
Revenue Recognition Before Delivery

• Revenue recognition during production-long term
  construction contracts
• Percentage-of-completion method
• Gross product recognized periodically, based on
  the percentage of job complete, rather than at
  completion
• Method used when estimates of costs and extent of
  completion are reasonably estimable.
• Extent of completion measured by cost-to-cost
  ratio

10
Revenue Recognition Before Delivery

• Completed-contract method-gross profit not
  recognized until contract is completed

11
Losses on Long-term Contracts

• Accounting for losses on long-term contracts
• Recognize a loss in the current period when costs
  increase to the extent that gross profit in prior
  periods must be eliminated. Only applies to
  percentage-of-completion method
• When estimates indicate that the entire contract
  will be unprofitable, entire loss recognized
  immediately under both methods.

12
Revenue Recognition Before Delivery

• Financial statement disclosures

13
Recognition at Completion of Production

• Agricultural products
• Precious metals

14
Recognition After Delivery

• Installment sales method
• Cost recovery method

15
Installment Sales Method

• Emphasizes collection rather than sale
• Cost of goods sold deferred proportional to
  deferred sales by deferring gross profit
• Used for tax accounting
• Not acceptable for financial accounting except
  under special circumstances because not in
  accordance with accrual accounting

16
Installment Sales Method

• More relevant due to recent increased emphasis on
  cash flows
• Separate calculations for interest on installment
  contracts uncollectible accounts, and defaults
  and repossessions.
• Financial statement presentation

17
Cost Recovery Method

• No profit recognized until cash payments by buyer
  exceed sellers cost of merchandise sold.

18
Deposit Method

• Cash received from buyer before transfer of
  goods. No revenue or income recognized until
  sale is complete
• Seller records cash received as a liability and
  continues to report goods as an asset
• Once transfer of property occurs, revenue should
  be recognized