ADDITIONAL TOPICS IN INCOME

1
CHAPTER 3
FINANCIAL REPORTING ANALYSIS BY REVSINE
COLLINS JOHNSON 2nd Edition

• ADDITIONAL TOPICS IN INCOME
• DETERMINATION

Slides Authored by Brian Leventhal University
of Illinois at Chicago
2
I. Revenue Recognition Prior to Sale
A. A closer look at the revenue recognition
criteria.

• 1. The critical event---
  (Condition 1 Revenue has
  been earned)
  varies from industry
  to industry.

3
I. Revenue Recognition Prior to Sale
A. A closer look at the revenue recognition
criteria.

• 2. Measurability of Revenue (Condition 2) must
  be based on objective and verifiable
  evidence.

4
I. Revenue Recognition Prior to Sale
B. A closer look at the revenue recognition
criteria.

• 3. In most instances the point of sale is the
  earliest moment in time that the critical
  event(Earned) in the process of earning the
  revenue has taken place.
• The amount that will be collected
  is reasonably assured and is
  measurable with a reasonable
  degree of reliability.
• This is the dominant practice in
  most retail and manufacturing
  industries.

5
Figure 2.2 The Revenue Recognition Process
Industries Recognizing Revenue at Indicated Phases
Revenues may also be recognized at other times
besides the point of sale.
6
I. Revenue Recognition Prior to Sale
A. A closer look at the revenue recognition
criteria.

• 1. Under the percentage-of-completion method
  Conditions 1 and 2 are satisfied prior to the
  point of sale (i.e., transfer of title).
• a. Condition 1 - (critical event Revenue is
  EARNED) is satisfied over time as the project
  progresses.
• b. Condition 2 (Revenue is measurable) is
  satisfied since a firm contract with a known
  buyer at a set price exists.

7
I. Revenue Recognition Prior to Sale
A. A closer look at the revenue recognition
criteria.

•   Normally, once gross revenues for the period
  are determined, the next step in determining
  income is to accumulate and record the costs
  associated with generating those revenues.
• However, under the
  percentage-of-completion method,
  it is the recognition of expenses
  that drives the recognition
  of revenues.

8
I. Revenue Recognition Prior to Sale

• 1. Percentage-of-completion method recognizes
  revenue, cost, and
  thus gross profit
• as progress toward completion
  is made and is used
  primarily for long-term
  construction
  contracts.

9
I. Revenue Recognition Prior to Sale
1. Percentage-of-completion method
recognizes revenue, cost, and thus gross profit
as progress toward completion is made and is used
primarily for long-term construction contracts.

• a. This method
  requires fairly good
  estimates
  of progress.

10
I. Revenue Recognition Prior to Sale
1. Percentage-of-completion method
recognizes revenue, cost, and thus gross profit
as progress toward completion is made and is used
primarily for long-term construction contracts.

• b. Cost-to-cost ratio
  

complete costs incurred to date
estimate of total costs
11
I. Revenue Recognition Prior to Sale
1. Percentage-of-completion method
recognizes revenue, cost, and thus gross profit
as progress toward completion is made and is used
primarily for long-term construction contracts.

c. Calculation Gross Profit Gross Profit ?
complete - Gross Profit recognized in
previous years Gross Profit recognized in
Current Year
12
I. Revenue Recognition Prior to Sale
1. Percentage-of-completion method
recognizes revenue, cost, and thus gross profit
as progress toward completion is made and is used
primarily for long-term construction contracts.

• d. A change in cost estimate is accounted for in
  a cumulative catch-up manner,
• i.e., accounted for such that the balance sheet
  is as it would have been if the revised estimate
  had been the original estimate.

13
I. Revenue Recognition Prior to Sale
1. Percentage-of-completion method
recognizes revenue, cost, and thus gross profit
as progress toward completion is made and is used
primarily for long-term construction contracts.

• e. A current asset
  results when total
  costs and recognized
  profit exceed billings.

This will make more sense after going over
example.
14
I. Revenue Recognition Prior to Sale
1. Percentage-of-completion method
recognizes revenue, cost, and thus gross profit
as progress toward completion is made and is used
primarily for long-term construction contracts.

• f. A current liability
  results when billings exceed
  total costs and
  recognized profit.

This will make more sense after going over
example.
15
Authors Note
   Consulting firms use the percentage-of-completi
on method for fixed price, fixed period
contracts. The
Information Technology Professional Services
sector, for example, uses this method to record
approximately 30 percent of its revenues.
16
      
I. Revenue Recognition Prior to Sale
Lets look At an Example
17
I. Revenue Recognition Prior to Sale
Percentage of Completion Example

• Solid Construction Corp. signs a contract with
  the City of Springfield on JAN 1st 2001 to build
  a highway bridge over Stony Creek.
• The contract price is 1,000,000
• Construction costs are estimated to be 800,000
• The project is scheduled to be completed by DEC.
  31st , 2003.
• Periodic cash payments are to be made by the City
  of Springfield as construction progresses.

18
I. Revenue Recognition Prior to Sale
Percentage of Completion Example
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date 280,000
650,000 1,000,000 Cash collections to
date 210,000 600,000 1,000,000
19
Percentage of Completion Example
Step 1 Compute the Complete ratio for Year 1
complete costs incurred to date
estimate of total costs
complete costs incurred to date
estimate of total costs
240,000

30
800,000
240,000 560,000
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000
20
Percentage of Completion Example
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Contract Price
1,000,000
Step 2 Determine the estimated total profit on
the contract for ALL YEARS.
Estimated Total Contract Price Estimated
Total Costs profit
Estimated Total Contract Price Estimated
Total Costs profit
1,000,000
240,000 560,000
800,000

200,000
21
Step 3 Compute the estimated total gross profit
earned for the contract for Year 1.
Calculation of Gross Profit complete ?
estimated Gross Profit - Gross Profit
recognized in previous years Gross Profit for
year 1 recognized
Calculation of Gross Profit complete ?
estimated Gross Profit - Gross Profit
recognized in previous years Gross Profit for
year 1 recognized
30
200,000
0
60,000
22
Step 3 Or instead Compute the estimated total
revenue earned for the contract for Year 1.
Calculation of Revenue complete ? Total
Revenue - Revenue recognized in previous
years Revenue for year 1 recognized
Calculation of Revenue complete ? Total
Revenue - Revenue recognized in previous
years Revenue for year 1 recognized
30
300,000
1,000,000
0
300,000
Now lets figure out how this information appears
on the Financial Statements!
23
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Contract Price
1,000,000 Gross Profit Recognized 60,000
Percentage of Completion Example
Step 1 Record Customer Billings for Year 1
Dr. Accounts Receivable Cr. Billings
280,000
280,000
Accounts Receivable
Billings
280,000
280,000
24
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Contract Price
1,000,000 Gross Profit Recognized 60,000
Percentage of Completion Example
Step 1 Record Customer Billings for Year 1
What type of account is Billings and why?
Billings is really a deferred revenue account (
Liability) because you dont know the
revenue recognized until the end of the period
using an adjusting entry!
Dr. Accounts Receivable Cr. Billings
280,000
280,000
Accounts Receivable
Billings
Usually for financial reporting purposes, it is
reclassified As a Contra-Asset to
Inventory Construction in Progress. But its
meaning has not changed!
????
280,000
280,000
25
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Contract Price
1,000,000 Gross Profit Recognized 60,000
Percentage of Completion Example
Step 2 Record Construction costs Year 1
Dr. Inventory Construction in Progress Cr. Acco
unts Payable, Cash, Etc,
240,000
240,000
Inventory Construction in Progress
Accounts Payable, Cash, Etc.
240,000
240,000
26
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Contract Price
1,000,000 Gross Profit Recognized 60,000
Percentage of Completion Example
Step 3 Record gross profit recognized for Year
1
Dr. Inventory Construction in Progress Cr. Inco
me on long-term construction K
60,000
60,000
Inventory Construction in Progress
Income on long-term construction K
Costs Yr 1 240,000
60,000
60,000
27
Why is this Gross Profit also being recorded to
InventoryConstruction in Progress?
Percentage of Completion Example
This entry makes sense because we defer all
billings as Unearned Revenue but it is
reclassified as a Contra-Asset to
InventoryConstruction in Progress. So whats
really happening is you are reducing your
deferred revenue when you realize Revenue! This
is done instead of reducing Billings directly,
but it has the same effect!
Step 3 Record gross profit recognized for Year
1
Dr. Inventory Construction in Progress Cr. Inco
me on long-term construction K
60,000
60,000
Income on long-term construction K
InventoryConstruction in Progress
240,000
60,000
????
60,000
28
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Contract Price
1,000,000 Gross Profit Recognized 60,000
Percentage of Completion Example
Notice how the Income Statement will look after
this entry Income on long-term construction K
60,000 This is the Net Method of recording
REVENUES!
Step 3 Record gross profit recognized for Year
1
Dr. Inventory Construction in Progress Cr. Inco
me on long-term construction K
60,000
60,000
Inventory Construction in Progress
Income on long-term construction K
240,000
60,000
60,000
29
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Gross Profit
60,000 Revenue Recognized 300,000
Percentage of Completion Example
Step 3 Or Record Revenue recognized for Year 1
Dr. Inventory Construction in Progress Dr. Const
ruction Expense Cr. Income on long-term
construction K
60,000
240,000
300,000
Revenue on long-term construction K
Inventory Construction in Progress
Construction Expense
240,000
300,000
240,000
60,000
30
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Gross Profit
60,000 Revenue Recognized 300,000
Notice how the Income Statement will look after
this entry Revenues 300,000 Less Construc
tion Expenses 240,000 Gross Profit
60,000 This is the Gross Method of recording
REVENUES!
Percentage of Completion Example
Step 3 Or Record Revenue recognized for Year 1
Dr. Inventory Construction in Progress Dr. Const
ruction Expense Cr. Income on long-term
construction K
60,000
240,000
300,000
Revenue on long-term construction K
Inventory Construction in Progress
Construction Expense
240,000
300,000
240,000
60,000
31
Gross Method
Percentage of Completion Example
Net Method
Either way you do it , it still means the same
thing!
32
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Contract Price
1,000,000 Revenue Recognized 300,000
Percentage of Completion Example
Step 4 Record Cash Received for Year 1
Dr. Cash Cr. Accounts Receivable
210,000
210,000
Accounts Receivable
Cash
210,000
210,000
Billings Yr 1 280,000
End Yr 1 70,000
33
Percentage of Completion Example
Lets see how the Balance Sheet would look for
2001 Year 1
Current Assets
Inventory Construction in Progress
Net Asset Carrying Value

Less
Billings
240,000 Costs Yr 1
60,000 GP Yr1
Yr 1 280,000
20,000

300,000
34
Percentage of Completion Example
Lets see how the Balance Sheet would look for
2001 Year 1
Current Assets
Since theoretically more work has been performed
than Billed, you have a Asset.
Inventory Construction in Progress
Net Asset Carrying Value

Less
Billings
20,000
300,000
280,000
35
Percentage of Completion Example
Lets see how the Balance Sheet would look for
2001 Year 1
Current Assets
Since theoretically more work has been performed
than Billed, you have an Asset.
Ending Unearned Revenues
Heres another way to see the 20,000
Inventory Construction in Progress
Net Asset Carrying Value

Less
Billings
Beg. Unearned Revenues
Realized Revenues
280,000
Costs
60,000
20,000

220,000
240,000
36
Percentage of Completion Example
Step 1 Compute the Complete ratio for Year 2
complete costs incurred to date
estimate of total costs
complete costs incurred to date
estimate of total costs
544,000

64
544,000 306,000
850,000
Notice Total Estimated Costs has changed from
Yr 1 (800,000) So the new reflects the updated
information.
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000 600,000
37
Percentage of Completion Example
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000
600,000 Contract Price 1,000,000
Step 2 Determine the estimated total profit on
the contract for ALL YEARS.
Estimated Total Contract Price Estimated
Total Costs profit
Estimated Total Contract Price Estimated
Total Costs profit
1,000,000
544,000 306,000
850,000

150,000
Noticed Profit has changed from 1st Year of
200,000!
38
Percentage of Completion Example
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000
600,000 Contract Price 1,000,000
Since the profit has changed the new estimate
will be used to update the information in the
records.
Step 2 Determine the estimated total profit on
the contract for ALL YEARS.
Estimated Total Contract Price Estimated
Total Costs profit
Estimated Total Contract Price Estimated
Total Costs profit
1,000,000
544,000 306,000
850,000

150,000
Noticed Profit has changed from 1st Year
200,000!
39
Step 3 Compute the estimated total gross profit
earned for the contract for Year 2.
Calculation of Gross Profit complete
?Gross Profit - Gross Profit recognized in
previous years Gross Profit for year 2
recognized
New estimate used
Total using new estimate
Calculation of Gross Profit complete ?
estimated Gross Profit - Gross Profit
recognized in previous years Gross Profit for
year 2 recognized
64
150,000
96,000
Old estimate
(60,000)
36,000
Updated estimate
40
Step 3 Or instead Compute the estimated total
revenue earned for the contract for Year 2.
Calculation of Revenue complete ? Total
Revenue - Revenue recognized in previous
years Revenue for year 2 recognized
Calculation of Revenue complete ? Total
Revenue - Revenue recognized in previous
years Revenue for year 2 recognized
64
1,000,000
640,000

(300,000)
340,000
Now lets figure out how this information appears
on the Financial Statements!
41
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000
600,000 Contract Price 1,000,000
Percentage of Completion Example
Step 1 Record Customer Billings for Year 2
Dr. Accounts Receivable Cr. Billings
370,000
370,000
Accounts Receivable
Billings
Yr 1 280,000
210,000 Yr1
280,000 Yr 1
370,000 Yr 2
End Yr 1 70,000
650,000 End Yr 2
Yr 2 370,000
42
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000
600,000 Contract Price 1,000,000
Percentage of Completion Example
Step 2 Record Construction costs Year 2
Dr. Inventory Construction in Progress Cr. Acco
unts Payable, Cash, Etc,
304,000
304,000
Accounts Payable, Cash, Etc.
Inventory Construction in Progress
Costs Yr 1 240,000
304,000
GP Yr 1 60,000
End Yr 1 300,000
Costs Yr2 304,000
43
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000
600,000 Gross Profit 60,000
36,000
Percentage of Completion Example
Step 3 Record gross profit recognized for Year 2
Dr. Inventory Construction in Progress Cr. Inco
me on long-term construction K
36,000
36,000
Inventory Construction in Progress
Income on long-term construction K
Costs Yr 1 240,000
GP Yr 1 60,000
36,000
End Yr 1 300,000
Costs Yr 2 304,000
GP Yr 2 36,000
End Yr 2 640,000
44
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000
600,000 Gross Profit 60,000
36,000
Percentage of Completion Example
Notice how the Income Statement will look after
this entry Income on long-term construction K
36,000 This is the Net Method of recording
REVENUES!
Step 3 Record gross profit recognized for Year 2
Dr. Inventory Construction in Progress Cr. Inco
me on long-term construction K
36,000
36,000
Inventory Construction in Progress
Income on long-term construction K
Costs Yr 1 240,000
Gr Prt Yr 1 60,000
36,000
End Yr 1 300,000
Costs Yr 2 304,000
Gr Prt Yr 2 36,000
End Yr 2 640,000
45
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Gross Profit 60,000
36,000 Revenue 300,000 340,000
Percentage of Completion Example
Step 3 Or Record Revenue recognized for Year 2
Dr. Inventory Construction in Progress Dr. Const
ruction Expense Cr. Income on long-term
construction K
36,000
304,000
340,000
Revenue on long-term construction K
Inventory Construction in Progress
Construction Expense
340,000
304,000
300,000 End Yr 1
304,000 Costs Yr 2
36,000 Gr Prt Yr 2
640,000 End Yr 2
46
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Gross Profit 60,000
36,000 Revenue 300,000 340,000
Notice how the Income Statement Year 2 will look
after this entry Revenues
340,000 Less Construction Expenses
304,000 Gross Profit 36,000 This is the
Gross Method of recording REVENUES!
Percentage of Completion Example
Step 3 Or Record Revenue recognized for Year 2
Dr. Inventory Construction in Progress Dr. Const
ruction Expense Cr. Income on long-term
construction K
36,000
304,000
340,000
Revenue on long-term construction K
Inventory Construction in Progress
Construction Expense
340,000
304,000
300,000 End Yr 1
304,000 Costs Yr 2
36,000 Gr Prt Yr 2
640,000 End Yr 2
47
Gross Method
Percentage of Completion Example
Net Method
Either way you do it , it still means the same
thing!
48
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000
600,000 Gross Profit 60,000
36,000
Percentage of Completion Example
Step 4 Record Cash Received for Year 2
Dr. Cash Cr. Accounts Receivable
390,000
390,000
Accounts Receivable
Cash
390,000
End Yr 1 70,000
Billings Yr 2 370,000
390,000
End Yr 2 50,000
49
Percentage of Completion Example
Lets see how the Balance Sheet would look for
2002 Year 2
Current Assets
Net Liability Carrying Value
Current Liabilities
Inventory Construction in Progress
Billings
Less

Costs Yr 1 240,000
Yr 1 280,000
Gr Prt Yr 1 60,000
Yr 2 370,000
End Yr 1 300,000
Costs Yr 2 304,000
Gr Prt Yr 2 36,000
-

10,000
End Yr 2 640,000
End Yr 2 650,000
50
Percentage of Completion Example
Lets see how the Balance Sheet would look for
2002 Year 2
Current Assets
Since theoretically less work has been performed
than Billed, you have a Liability.
Net Liability Carrying Value
Current Liabilities
Inventory Construction in Progress
Billings
Less

Costs Yr 1 240,000
Yr 1 280,000
Gr Prt Yr 1 60,000
Yr 2 370,000
End Yr 1 300,000
Costs Yr 2 304,000
Gr Prt Yr 2 36,000
-

10,000
End Yr 2 640,000
End Yr 2 650,000
51
Percentage of Completion Example
Lets see how the Balance Sheet would look for
2001 Year 2
Heres another way to see the 10,000
Current Assets
Since theoretically less work has been performed
than Billed, you have a Liability.
Ending Unearned Revenues
Current Liabilities
Costs
Inventory Construction in Progress
Net Liability Carrying Value

Less
Billings
Beg. Unearned Revenues
220,000
240,000
Realized Revenues
36,000
304,000
370,000
544,000
10,000

554,000
52
Percentage of Completion Example
Step 1 Compute the Complete ratio for Year 3
complete costs incurred to date
estimate of total costs
complete costs incurred to date
estimate of total costs
850,000
100

544,000 306,000
850,000
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000 1,000,000 Cash
collections to date 210,000 600,000
1,000,000
53
Percentage of Completion Example
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000 1,000,000 Cash
collections to date 210,000 600,000
1,000,000
Step 2 Determine the estimated total profit on
the contract for ALL YEARS.
Estimated Total Contract Price Estimated
Total Costs profit
Estimated Total Contract Price Estimated
Total Costs profit
1,000,000
544,000 306,000
850,000

150,000
Noticed Profit has not changed from 2nd Year
54
Step 3 Compute the estimated total gross profit
earned for the contract for Year 3.
Calculation of Gross Profit complete
?Gross Profit - Gross Profit recognized in
previous years Gross Profit for year 3
recognized
Calculation of Gross Profit complete ?
estimated Gross Profit - Gross Profit
recognized in previous years Gross Profit for
year 3 recognized
100
150,000
150,000
60,000 36,000
(96,000)
54,000
55
Step 3 Or instead Compute the estimated total
revenue earned for the contract for Year 3.
Calculation of Revenue complete ? Total
Revenue - Revenue recognized in previous
years Revenue for year 3 recognized
Calculation of Revenue complete ? Total
Revenue - Revenue recognized in previous
years Revenue for year 3 recognized
100
1,000,000
1,000,000
300,000 340,000
(640,000)
360,000
Now lets figure out how this information appears
on the Financial Statements!
56
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000 1,000,000 Cash
collections to date 210,000 600,000
1,000,000
Percentage of Completion Example
Step 1 Record Customer Billings for Year 3
Dr. Accounts Receivable Cr. Billings
350,000
350,000
Accounts Receivable
Billings
280,000 Yr 1
End Yr 2 50,000
370,000 Yr 2
Yr 3 350,000
650,000 End Yr 2
350,000
1,000,000 End Yr 3
57
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000 1,000,000 Cash
collections to date 210,000 600,000
1,000,000
Percentage of Completion Example
Step 2 Record Construction costs Year 3
Dr. Inventory Construction in Progress Cr. Acco
unts Payable, Cash, Etc,
306,000
306,000
Inventory Construction in Progress
Accounts Payable, Cash, Etc.
Costs Yr 1 240,000
GP Yr 1 60,000
306,000
End Yr 1 300,000
Costs Yr 2 304,000
GP Yr 2 36,000
End Yr 2 640,000
Costs Yr 3 306,000
58
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000
1,000,000 Gross Profit Recognized 60,000
36,000 54,000
Percentage of Completion Example
Step 3 Record gross profit recognized for Year 3
Dr. Inventory Construction in Progress Cr. Inco
me on long-term construction K
54,000
54,000
Inventory Construction in Progress
Costs Yr 1 240,000
Income on long-term construction K
GP Yr 1 60,000
End Yr 1 300,000
Costs Yr 2 304,000
54,000
GP Yr 2 36,000
End Yr 2 640,000
Costs Yr 3 306,000
GP Yr 3 54,000
End Yr 2 1,000,000
59
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000
1,000,000 Gross Profit Recognized 60,000
36,000 54,000
Percentage of Completion Example
Notice how the Income Statement will look after
this entry Income on long-term construction K
54,000 This is the Net Method of recording
REVENUES!
Step 3 Record gross profit recognized for Year 3
Dr. Inventory Construction in Progress Cr. Inco
me on long-term construction K
54,000
54,000
Inventory Construction in Progress
Costs Yr 1 240,000
Income on long-term construction K
GP Yr 1 60,000
End Yr 1 300,000
Costs Yr 2 304,000
54,000
GP Yr 2 36,000
End Yr 2 640,000
Costs Yr 3 306,000
GP Yr 3 54,000
End Yr 3 1,000,000
60
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Revenue
300,000 340,000 360,000 Gross
Profit Recognized 60,000 36,000
54,000
Percentage of Completion Example
Step 3 Or Record Revenue recognized for Year 3
Dr. Inventory Construction in Progress Dr. Const
ruction Expense Cr. Income on long-term
construction K
54,000
306,000
360,000
InventoryConstruction in Progress
Costs Yr 1 240,000
GP Yr 1 60,000
Revenue on long-term construction K
Construction Expense
End Yr 1 300,000
Costs Yr 2 304,000
360,000
306,000
GP Yr 2 36,000
End Yr 2 640,000
Costs Yr 3 306,000
GP Yr 3 54,000
End Yr 3 1,000,000
61
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Revenue
300,000 340,000 360,000 Gross
Profit Recognized 60,000 36,000
54,000
Notice how the Income Statement Year 3 will look
after this entry Revenues
360,000 Less Construction Expenses
306,000 Gross Profit 54,000 This is the
Gross Method of recording REVENUES!
Percentage of Completion Example
Step 3 Or Record Revenue recognized for Year 3
Dr. Inventory Construction in Progress Dr. Const
ruction Expense Cr. Income on long-term
construction K
54,000
306,000
360,000
InventoryConstruction in Progress
Costs Yr 1 240,000
GP Yr 1 60,000
Revenue on long-term construction K
Construction Expense
End Yr 1 300,000
Costs Yr 2 304,000
360,000
306,000
GP Yr 2 36,000
End Yr 2 640,000
Costs Yr 3 306,000
GP Yr 3 54,000
End Yr 3 1,000,000
62
Gross Method
Percentage of Completion Example
Net Method
Either way you do it , it still means the same
thing!
63
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000 1,000,000 Cash
collections to date 210,000 600,000
1,000,000
Percentage of Completion Example
Step 4 Record Cash Received for Year 3
Dr. Cash Cr. Accounts Receivable
400,000
400,000
Accounts Receivable
Cash
End Yr 2 50,000
400,000
Billings 350,000
400,000
End Yr 3 0
64
Percentage of Completion Example
Step 5 Record Completion of Project
Dr. Billings Cr. Inventory Construction in
Progress
1,000,000
1,000,000
Inventory Construction in Progress
Billings
Costs Yr 1 240,000
280,000 End Yr 1
Notice how the Inventory Billings Account equal
the Contract Price.
GP Yr 1 60,000
370,000 Yr 2
End Yr 1 300,000
Costs Yr 2 304,000
650,000 End Yr 2
GP Yr 2 36,000
350,000 Yr 3
End Yr 2 640,000
Costs Yr 3 306,000
1,000,000 End Yr3
1,000,000
GP Yr 3 54,000
0
1,000,000
End Yr 3 1,000,000
0
65
I. Revenue Recognition Prior to Sale

• 2. Completed Contract Method is used
  when interim estimates of progress cannot be
  made.
• a. Therefore, NO interim
  revenue, costs, or gross profit
  are recorded.
• b. These items are accumulated
  on the balance sheet, but
  not reflected on the
  income statement until
  the project is completed.

66
      
I. Revenue Recognition Prior to Sale
Lets look at an Example of Completed
Contract Method
67
I. Revenue Recognition Prior to Sale
Completed Contract Method Example

• Solid Construction Corp. signs a contract with
  the City of Springfield on JAN 1st 2001 to build
  a highway bridge over Stony Creek.
• The contract price is 1,000,000
• Construction costs are estimated to be 800,000
• The project is scheduled to be completed by DEC.
  31st , 2003.
• Periodic cash payments are to be made by the City
  of Springfield as construction progresses.

68
I. Revenue Recognition Prior to Sale
Completed Contract Method Example
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date 280,000
650,000 1,000,000 Cash collections to
date 210,000 600,000 1,000,000
69
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Contract Price
1,000,000
Completed Contract Method Example
Step 1 Record Customer Billings for Year 1
Dr. Accounts Receivable Cr. Billings
280,000
280,000
Accounts Receivable
Billings
280,000
280,000
Same as Percentage of Completion Method
70
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Contract Price
1,000,000
Completed Contract Method Example
Step 2 Record Construction costs Year 1
Dr. Inventory Construction in Progress Cr. Acco
unts Payable, Cash, Etc,
240,000
240,000
Inventory Construction in Progress
Accounts Payable, Cash, Etc.
240,000
240,000
Same as Percentage of Completion Method
71
Actual experience on the project as of DEC 31st
2001 Costs incurred to date
240,000 Estimated future costs 560,000
Billings to date 280,000 Cash
collections to date 210,000 Contract Price
1,000,000
Completed Contract Method Example
Step 3 Record Cash Received for Year 1
Dr. Cash Cr. Accounts Receivable
210,000
210,000
Same as Percentage of Completion Method
Accounts Receivable
Cash
210,000
210,000
Billings Yr 1 280,000
End Yr 1 70,000
72
Completed Contract Method Example
Lets see how the Balance Sheet would look for
2001 Year 1
Current Assets
Current Liability
Inventory Construction in Progress
Net Liability Carrying Value

Less
Billings
240,000 Costs Yr 1
240,000
Yr 1 280,000
40,000

73
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000
600,000 Contract Price 1,000,000
Completed Contract Method Example
Step 1 Record Customer Billings for Year 2
Dr. Accounts Receivable Cr. Billings
370,000
370,000
Accounts Receivable
Billings
Yr 1 280,000
210,000 Yr1
280,000 Yr 1
370,000 Yr 2
End Yr 1 70,000
Same as Percentage of Completion Method
650,000 End Yr 2
Yr 2 370,000
74
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000
600,000 Contract Price 1,000,000
Completed Contract Method Example
Step 2 Record Construction costs Year 2
Dr. Inventory Construction in Progress Cr. Acco
unts Payable, Cash, Etc,
304,000
304,000
Accounts Payable, Cash, Etc.
Inventory Construction in Progress
Costs Yr 1 240,000
304,000
Same as Percentage of Completion Method
Costs Yr2 304,000
Costs End Yr2 304,000
75
Actual experience on the project as of DEC 31st
2001 2002 Costs incurred to date
240,000 544,000 Estimated future
costs 560,000 306,000 Billings to
date 280,000 650,000
Cash collections to date 210,000 600,000
Completed Contract Method Example
Step 3 Record Cash Received for Year 2
Dr. Cash Cr. Accounts Receivable
390,000
390,000
Same as Percentage of Completion Method
Accounts Receivable
Cash
390,000
End Yr 1 70,000
Billings Yr 2 370,000
390,000
End Yr 2 50,000
76
Completed Contract Method Example
Lets see how the Balance Sheet would look for
2002 Year 2
Current Assets
Net Liability Carrying Value
Current Liabilities
Inventory Construction in Progress
Billings
Less

Costs Yr 1 240,000
Yr 1 280,000
Costs Yr 2 304,000
Yr 2 370,000
End Yr 2 544,000
106,000
End Yr 2 650,000

77
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000 1,000,000 Cash
collections to date 210,000 600,000
1,000,000
Completed Contract Method Example
Step 1 Record Customer Billings for Year 3
Dr. Accounts Receivable Cr. Billings
350,000
350,000
Accounts Receivable
Billings
280,000 Yr 1
End Yr 2 50,000
370,000 Yr 2
Same as Percentage of Completion Method
Yr 3 350,000
650,000 End Yr 2
350,000
1,000,000 End Yr 3
78
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000 1,000,000 Cash
collections to date 210,000 600,000
1,000,000
Completed Contract Method Example
Step 2 Record Construction costs Year 3
Dr. Inventory Construction in Progress Cr. Acco
unts Payable, Cash, Etc,
306,000
306,000
Inventory Construction in Progress
Accounts Payable, Cash, Etc.
Costs Yr 1 240,000
Costs Yr 2 304,000
Same as Percentage of Completion Method
306,000
Costs Yr 3 306,000
Costs End Yr 3 850,000
79
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000 1,000,000 Cash
collections to date 210,000 600,000
1,000,000
Completed Contract Method Example
Step 3 Record Cash Received for Year 3
Dr. Cash Cr. Accounts Receivable
400,000
400,000
Same as Percentage of Completion Method
Accounts Receivable
Cash
End Yr 2 50,000
400,000
Billings 350,000
400,000
End Yr 3 0
80
Completed Contract Method Example
Actual experience on the project as of DEC 31st
2001 2002 2003 Costs incurred
to date 240,000 544,000
850,000 Estimated future costs 560,000
306,000 ------ Billings to date
280,000 650,000 1,000,000 Cash
collections to date 210,000 600,000
1,000,000
Step 4 Determine the Actual total profit on
the contract for ALL YEARS.
Actual Total Contract Price Actual Total
Costs profit
Actual Total Contract Price Actual Total
Costs profit
850,000
1,000,000

150,000
81
Completed Contract Example
Notice how the Income Statement Year 3 will look
after this entry Revenues
1,000,000 Less Construction Expenses
850,000 Gross Profit 150,000
Step 3 Record Completion of Project
Dr. Billings Cr. Inventory Construction in
Progress Cr. Income on long-term
construction
1,000,000
850,000
150,000
Inventory Construction in Progress
Billings
Costs Yr 1 240,000
280,000 End Yr 1
Costs Yr 2 304,000
370,000 Yr 2
Costs Yr 3 306,000
650,000 End Yr 2
End Yr 3 850,000
850,000
350,000 Yr 3
1,000,000 End Yr3
1,000,000
0
Income on long-term construction
0
150,000
82
Yearly Income Comparison on 2 Long-Term Contract
Actg Methods

• Completed of
• K Completion
• Year Method Method
• 2001 - 0- 60,000
• 2002 - 0- 36,000
• 2003 150,000 54,000
• Total Income 150,000 150,000

83
I. Revenue Recognition Prior to Sale

• 3. Long-term contract losses
• a. Cost increases require current period
  adjustment of excess gross profit recognized in
  earlier periods.(We saw this in the completion
  example)
• b. With unprofitable contracts, the entire
  expected loss must be recognized in the current
  period (as well as the recovery of previously
  recognized revenue and gross profit).

Follows Conservatism Principle
84
I. Revenue Recognition Prior to Sale

• 4. Revenue recognition on commodities
• a. The completed-transaction method recognizes
  income when the commodities are sold.
• b. The market price method
  recognizes income when the
  agricultural commodities are
  harvested or when the natural
  resources are extracted.

85
I. Revenue Recognition Prior to Sale

• 4. Revenue recognition on commodities
• Market Price Method

• i. This alternative assumes that well-organized
  markets exist for the commodities.
• ii. Changes in the market value
  of the commodities while they are
  held in storage are reflected
  on both the balance
  sheet and income statement.

86
I. Revenue Recognition Prior to Sale

• 4. Revenue recognition on commodities
• Market Price Method Completed Transaction
• c. Comparisons of these two methods
• i. The completed transaction method merges the
  results of speculative and operating activity and
  does not reflect the separate results of either.
• ii. The market price method has the advantage of
  explicitly recognizing the separate results
  arising from operating and speculative
  activities.

87
I. Revenue Recognition Prior to Sale

• B. Revenue recognition Subsequent to Sale
• Conditions 1 (earned) and
  2 (measurable)
  are both satisfied after to
  the time of the sale.

88
I. Revenue Recognition Prior to Sale
B. Revenue recognition Subsequent to
Sale

• 1. This treatment is acceptable only under highly
  unusual circumstances.
  
• For
  example, when a lengthy collection period
  considerably increases the risk
  of
  nonpayment.

89
I. Revenue Recognition Prior to Sale
B. Revenue recognition Subsequent to
Sale

• 2. Installment Sales Method recognizes Revenue
  and Income proportionately as Cash is collected
  based on the
• Installment sales gross profit
  and
• The amount of Cash collected.

90
I. Revenue Recognition Prior to Sale
B. Revenue recognition Subsequent to
Sale

• 2. Installment Sales Method recognizes
  Revenue and Income proportionately as Cash is
  collected.

• a. Installment accounts receivable are shown
  typically shown on the balance sheet as a current
  asset, even amounts that will be collected beyond
  the next 12 months.
• b. Industry practice typically classifies the
  deferred gross profit account as a contra-asset.
• c. Selling, general, administrative costs of
  installment sales are treated as period costs. 

91
      
B. Revenue recognition Subsequent to
Sale
Lets look at an Example of the Installment Sale
s Method
92
B. Revenue recognition Subsequent to
Sale
Installment Sales Method Example
Actual experience on the project as of DEC 31st
2001 2002 Installment Sales
1,200,000 1,300,000 Cost of
installment goods sold 840,000
884,000 Gross Profit
360,000 416,000 Gross Profit
30 32 Cash Collections On 2001
installment sales 300,000
600,000 On 2002 installment sales
340,000
93
Installment Sales Method Example
Step 1 Compute the Gross Profit for Year 1
Gross Profit Gross Profit
Installment Sales
Gross Profit Gross Profit
Installment Sales
360,000

30
1,200,000
Actual experience on the project as of DEC 31st
2001 Installment Sales
1,200,000 Cost of installment goods sold
840,000 Gross Profit
360,000 Gross Profit
30 Cash Collections On 2001 installment
sales 300,000
94
Actual experience on the project as of DEC 31st
2001 Installment Sales
1,200,000 Cost of installment goods sold
840,000 Gross Profit
360,000 Gross Profit
30 Cash Collections On 2001 installment
sales 300,000
Installment Sales Method Example
Step 2 Determine the Gross Profit recognized on
installment sales for Year 1.
Gross Cash Collected Gross Profit Year
1 profit
Gross Cash Collected Gross Profit Year
1 profit
300,000
30

90,000
95
Step 3 Compute the Gross Profit deferred for
Year 1.
Calculation of Deferred Gross Profit Total
Yearly Installment Gross Profit -
Installment Gross Profit recognized Year 1
Installment Gross Profit deferred Year 1
Calculation of Deferred Gross Profit Total
Yearly Installment Gross Profit -
Installment Gross Profit recognized Year 1
Installment Gross Profit deferred Year 1
360,000
90,000
270,000
Lets see how this information looks on the
Financial Statements!
96
Actual experience on the project as of DEC 31st
2001 Installment Sales
1,200,000 Cost of installment goods
sold 840,000 Gross Profit
360,000 Gross Profit
30 Cash Collections On 2001 installment
sales 300,000 Gross Profit Recognized
90,000 Gross Profit Deferred 270,000
Installment Sales Method Example
Step 1 Record Installment Sales for Year 1
Dr.Accounts Receivable- 2001 Installment
Sales Cr. Installment Sales Revenue
1,200,000
1,200,000
Accounts Receivable
Installment Sales Revenue
1,200,000
1,200,000
97
Actual experience on the project as of DEC 31st
2001 Installment Sales
1,200,000 Cost of installment goods
sold 840,000 Gross Profit
360,000 Gross Profit
30 Cash Collections On 2001 installment
sales 300,000 Gross Profit Recognized
90,000 Gross Profit Deferred 270,000
Installment Sales Method Example
Step 2 Record Installment Cost of Good Sold for
Year 1
Dr. Cost of Installment Goods Sold Cr. Inventory

840,000
840,000
Cost of Installment Goods Sold
Inventory
840,000
840,000
98
Actual experience on the project as of DEC 31st
2001 Installment Sales
1,200,000 Cost of installment goods
sold 840,000 Gross Profit
360,000 Gross Profit
30 Cash Collections On 2001 installment
sales 300,000 Gross Profit Recognized
90,000 Gross Profit Deferred 270,000
Installment Sales Method Example
Step 3 Record Cash Collections for Year 1
Dr. Cash Cr. Accounts Receivable
300,000
300,000
Accounts Receivable
Cash
300,000
300,000
Yr 2001 1,200,000
End Yr 2001 900,000
99
Actual experience on the project as of DEC 31st
2001 Installment Sales
1,200,000 Cost of installment goods
sold 840,000 Gross Profit
360,000 Gross Profit
30 Cash Collections On 2001 installment
sales 300,000 Gross Profit Recognized
90,000 Gross Profit Deferred 270,000
Installment Sales Method Example
Step 3 Record Deferred gross profit for Year 1
Dr. Deferred Gross Profit on Income
Statement Cr. Deferred Gross Profit- Adj. To A/R
270,000
270,000
Deferred Gross Profit on Income Statement
Deferred Gross Profit- Adj. To A/R
Gross Profit on I/S
1,200,000
270,000
Notice the I/S now shows 90,000 Gross Profit!
840,000
270,000
360,000
100
Actual experience on the project as of DEC 31st
2001 Installment Sales
1,200,000 Cost of installment goods
sold 840,000 Gross Profit
360,000 Gross Profit
30 Cash Collections On 2001 installment
sales 300,000 Gross Profit Recognized
90,000 Gross Profit Deferred 270,000
Notice how the Income Statement will look after
this entry Installment Sales
1,200,000 Cost of Installment Goods Sold
(840,000) Gross Profit
360,000 Less Deferred GP on Installment Sales
of current year (270,000) Total Gross Profit
recognized this year 90,000
Installment Sales Method Example
Step 3 Record Deferred gross profit for Year 1
Dr. Deferred Gross Profit on Income
Statement Cr. Deferred Gross Profit- Adj. To A/R
270,000
270,000
Deferred Gross Profit on Income Statement
Deferred Gross Profit- Adj. To A/R
Gross Profit on I/S
1,200,000
270,000
Notice the I/S now shows 90,000 Gross Profit!
840,000
270,000
360,000
101
Installment Sales Method Example
What type of account is Deferred GP Adj. To
A/R really?
It is is really a deferred revenue account (
Liability) because you dont know the
revenue recognized until the cash is collected
using an adjusting entry!
Current Assets
Deferred Gross Profit- Adj. To A/R
Usually for financial reporting purposes, it is
reclassified As a Contra-Asset to
Accounts Receivable. But its meaning has not
changed!
????
270,000
102
Actual experience on the project as of DEC 31st
2001 Installment Sales
1,200,000 Cost of installment goods
sold 840,000 Gross Profit
360,000 Gross Profit
30 Cash Collections On 2001 installment
sales 300,000 Gross Profit Recognized
90,000 Gross Profit Deferred 270,000
Installment Sales Method Example
How would this information look on the Balance
Sheet?
Current Assets
Accounts Receivable-2001 Installment Sales
Deferred Gross Profit- Adj. To A/R
-
300,000
Yr 2001 1,200,000
270,000

630,000
End Yr 900,000 2001
103
Installment Sales Method Example
Step 1 Compute the Gross Profit for Year 2
Gross Profit Gross Profit
Installment Sales
Gross Profit Gross Profit
Installment Sales
416,000

32
1,300,000
Actual experience on the project as of DEC 31st
2001 2002 Installment
Sales 1,200,000
1,300,000 Cost of installment goods sold
840,000 884,000 Gross Profit
360,000
416,000 Gross Profit 30
32 Cash Collections On 2001 installment sales
300,000 600,000 On 2002
installment sales
340,000
104
Actual experience on the project as of DEC 31st
2001 2002 Installment
Sales 1,200,000
1,300,000 Cost of installment goods sold
840,000 884,000 Gross Profit
360,000
416,000 Gross Profit 30
32 Cash Collections On 2001 installment sales
300,000 600,000 On 2002
installment sales
340,000
Installment Sales Method Example
Step 2 Determine the Gross Profit recognized on
installment sales from Year 1 collected in Year 2.
Gross Cash Collected GP Year
1 Profit in Yr 2 from 2001 Sales
Gross Cash Collected GP Year
1 Profit in Yr 2 from 2001 Sales
600,000
30

180,000
105
Actual experience on the project as of DEC 31st
2001 2002 Installment
Sales 1,200,000
1,300,000 Cost of installment goods sold
840,000 884,000 Gross Profit
360,000
416,000 Gross Profit 30
32 Cash Collections On 2001 installment sales
300,000 600,000 On 2002
installment sales
340,000 Gross Profit recognized in 2002 from
2001 Sales 180,000
Installment Sales Method Example
Step 3 Determine the Gross Profit recognized on
installment sales from Year 2 collected in Year 2.
Gross Cash Collected GP Year
2 Profit in Yr 2 from 2002 Sales
Gross Cash Collected GP Year
2 Profit in Yr 2 from 2002 Sales
340,000
32

108,800
106
Step 4 Compute the Gross Profit deferred for
Year 2.
Calculation of Deferred Gross Profit Total
Yearly Installment Gross Profit -
Installment Gross Profit recognized Year 2