Revenue recognition
Concepts of FS Receivables Inventory Investment PP&E
Balance Sheet
Intangibles Payables Equity
Income Statement
Comprehensive Income Statement
Cash Flow Statement
Revenue
Lease Income Tax
Statement of Owners’ Equity Recognition
Revenue Recognition
and Reporting
study map
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Financial Accounting
2
Revenue Recognition
The revenue recognition principal in FASB concept statement no. 5 states that revenue is recognized
when its is realized or realizable and earned.
Realized : when goods or service have been exchanged for cash or claims to cash.
Realizable : when goods or service have been exchanged for assets that are readily convertible
into cash or claims to cash
Earned : when earning process has been substantially completed and the entity is entitled to
the resulting benefit or revenues
Common sources of Revenue and the point at which recognition typically occurs
Gain disposition
Point of Sale Sale of Product Service & Fees Rent / Interest
of non-inventory
Date of Sale or Service performed With time passing
Revenue Recognition Delivery & billed or Asset Usage
At date of Sale
Point of Sale Recognition Issues
Sale with buyback agreements : A sale that includes an agreement to buy back goods later has
transferred the title legally, but the seller retains the risks of
ownership, so no sale should be recorded.
Sale with right of return : Books, magazine and music publishers provide guarantees
for return of unsold merchandise in order to increase overall
sales. Firms should report sales less allowance for estimated
returns.
Trade loading (Channel stuffing): Is the practice of convincing retailers to buy more wholesale
product than they can sell in a reasonable amount of time to
inflate revenues and profits in the near term. Thus, future
revenues are booked in the current period. Such window-
dressing policies are discouraged.
Recognition of Revenues After Delivery
Recognize profits as cash is collected rather than at the point of sale.
The installment method is only acceptable when
1. Receivable are collectible over an extended period.
Installment 2. No reasonable basis for estimating the degree of collectability
Method Ex: Furniture, Machinery
To protect the seller, agreements may include provisions such as delaying
transfer of title until full payment has been made.
Steps :
1. This Method recognizes the Revenue and Costs of goods sold related to installment sales in the
period of sale.
2. Defers gross profit until the cash is collected
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Revenue Recognition
A TV costing $600 and sold with $1,000 on Nov 1st Year 1 with a down-payment of $100 and the
remainder is due in 9 months on installments of $100
Cash 100
Installment Receivable 900
Installment Sales Revenue 1,000
Sale Entry
Cost of installment sales 600
Inventory 600
Sale Entry
Cash 100
Installment Receivable 100
1st installment Entry
Installment Sales Revenue 1,000
Cost of installment sales 600
Deferred gross profit * 400
End of Year 1 “Deferring Profits Until cash is collected”
Gross Profit Rate = Gross Profit / Sales Revenue
Gross Profit Rate = $ 400 / $ 1,000 = 40%
Deferred gross profit 80
Realized gross profit 80
(200 “Down payment & 1st installment” * 40%) = 80
* Deferred Gross Profit is generally reported as a liability representing Unearned Revenue.
Balance Sheet
Assets
Installment Receivable 800 ($1,000 – $200)
Liabilities
Deferred profit 320 ($400 – $80)
Revenue is recognized only when the cash is received by the seller exceeds the
cost of goods sold.
Cost
Recovery The Cost recovery method is only acceptable when
Method 1. Receivable are collectible over an extended period.
2. No reasonable basis for estimating the degree of collectability
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Revenue Recognition
In year 1, creditor made a $ 100,000 sale. The cost of the item sold was $70,000, and Year 1 collections
equaled $ 50,000 In Year 2, collections equaled $ 25,000, and $ 10,000
Accounts Receivable 100,000
Cost of Sales 70,000
Sales Revenue 100,000
Inventory 70,000
Year 1 Sale Entry
Cash 50,000
Accounts Receivable 50,000
Year 1 Entry Cash Collection
Sales Revenue 100,000
Cost of Sale 70,000
Deferred Gross Profit 30,000
At end of Year 1 “ Cash did not exceed Cost”
Cash 25,000
Receivable 25,000
Year 2 Cash Collection
Deferred Gross Profit 5,000
Realized Gross Profit 5,000
Recognize $5,000 Over Cost
Cash 10,000
Receivable 10,000
Year 2 Cash Collection
Deferred Gross Profit 10,000
Realized Gross Profit 10,000
Recognize $10,000 Over Cost
This method is used when the firm receives a cash advance for goods that
have not yet been transferred to the buyer. No revenue is recognized until
the sale is complete
Deposit
Method Cash xx
Deposit Liability xx
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Revenue Recognition
Recognition of Revenues Before Delivery
GAAP permits revenue recognition before delivery of goods in special cases when there is a high
certainty about the amount of revenue that will be earned.
Firms that produce commodities are permitted to recognize revenues as soon
as units are produced rather than waiting until the units are sold.
Completion Criteria to be met
of production 1. Demand for the commodity is unlimited.
basis
2. The selling price for the commodity is set by the market.
Ex. Agriculture products (Meet, grain, dairy and fruits) and natural resources
(timber, oil, coal)
Percentage of Completion: This accounting treatment permit firms
engaged in long-term construction projects to recognize a portion of total
revenue and gross profit during each year of the project.
Percentage of
Completion Criteria to be met
1. Each party of the contract has enforceable rights.
2. The firm can estimate the extent of job completion.
Estimation of the extent of job completion can be done through input measures such as Cost
Incurred & Labor Hours Used or Output measures such as Stories Completed & Miles of road
completed.
Commonly used measure is Cost-To-Cost Percentage Complete
Costs Incurred to date
Percentage of completion =
Most Recent estimate of total costs
Casper Construction Co.
2007 2008 2009
Contract price $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.
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Revenue Recognition
150,000+287,400 150,000+287,400+170,100
2007 2008 2009
Costs incurred to date $150,000 $437,400 $607,500
Estimated cost to complete $450,000 $170,000 $0
Est. total contract costs $600,000 $607,500 $607,500
Est. percentage complete
25% 72% 100%
Multiply Percentage of Completion to Revenue
2007 2008 2009
Contract Price $675,000 $675,000 $675,000
% of Completion 25% 72% 100%
Total Revenue Recognizable $168,750 $406,000 $675,000
Current Year Revenue $168,750 $317,250 $189,000
406,000-168,750 675,000-168,750-317,250
Cost Incurred $150,000 $287,400 $170,100
Current Year Profit $18,750 $29,850 $18,900
Or you can calculate Gross profit the same way of Revenue as follows
2007 2008 2009
Contract Price $675,000 $675,000 $675,000
Estimated Contract Cost $600,000 $607,500 $607,500
Total Contract Profit $75,000 $67,500 $67,500
% of Completion 25% 72% 100%
Total Profit Recognizable $18,750 $48,600 $67,500
Current Year Profit $18,750 $29,850 $18,900
48,600 – 18,750 67,500–18,750–29,850
2007 2008 2009
Construction in progress 150,000 287,400 170,100
Cash 150,000 287,400 170,100
Both Construction Accounts receivable 135,000 360,000 180,000
in Progress and Billings on contract 135,000 360,000 180,000
Billing on Contracts
are Balance sheet Cash 112,500 262,500 300,000
Accounts. Accounts receivable 112,500 262,500 300,000
Construction in progress 18,750 29,850 18,900
Construction expense 150,000 287,400 170,100
Construction revenue 168,750 317,250 189,000
Billings on contract 675,000
Construction in progress 675,000
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Revenue Recognition
Financial Statement Presentation :
Income Statement 2007 2008 2009
Revenue on contracts $ 168,750 $ 317,250 $ 189,000
Cost of construction 150,000 287,400 170,100
Balance Sheet
Current Assets 135,000 – 112,500 22,500+360,000-262,500 120,000+180,000-300,000
Accounts Receivable 22,500 120,000 0
Construction in Progress 33,750
Current Liabilities 9,000 0
Billing on Contract
150,000+18,750-135,000 33,750+(287,400+29,850)-360,000 -9,000+(170,100+18,900)-180,000
Completed Contract: This method is used when
1. When the entity has mostly short term contracts.
2. When percentage of completion method is inappropriate because
cost estimation can’t be done.
Under the completed contract method, the construction in progress account is used to accumulate
only costs and revenue is not recognized until the contract is completed.
Using the Previous Example.
2007 2008 2009
Construction in progress 150,000 287,400 170,100
Cash 150,000 287,400 170,100
Accounts receivable 135,000 360,000 180,000
Billings on contract 135,000 360,000 180,000
Cash 112,500 262,500 300,000
Accounts receivable 112,500 262,500 300,000
Construction in progress 67,500
Construction expense 607,500
Construction revenue 675,000
Billings on contract 675,000
Construction in progress 675,000
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Revenue Recognition
Losses on Long Term Contracts
1 Losses on Long Term Contracts on a profitable contract
An increase in the estimated cost to complete a long-term project may create a loss in the current
period even through the overall project is expected to be profitable.
The current Period Loss is recorded
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
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
$170,100.
Multiply Percentage of Completion to Revenue
2007 2008 2009
Contract Price $675,000 $675,000 $675,000
% of Completion 25% 67% 100%
Total Revenue Recognizable $168,750 $452,250 $675,000
Current Year Revenue $168,750 $283,500 $222,750
Cost Incurred $150,000 $287,400 $215,436
Current Year Profit $168,750 $(3,900) $7,314
2007 2008 2009
Construction in progress 18,750 7,314
Construction expense 150,000 215,436
Construction revenue 168,750 222,750
Construction in progress 3,900
Construction expense 287,400
Construction revenue 283,500
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Revenue Recognition
2 Losses on Long Term Contracts on a Un-profitable contract
If the estimated costs to complete the project have increased to the point that an overall loss on the
project is expected.
The entire Loss is recorded in the Period
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 450,000 246,038 0
Billings to customer current year 135,000 360,000 180,000
Cash receipts from customer
Current year 112,500 262,500 300,000
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
$170,100.
2007 2008 2009
Contract Price $675,000 $675,000 $675,000
% of Completion 25% 64% 100%
Total Revenue Recognizable $168,750 $432,000 $675,000
Current Year Revenue $168,750 $263,250 $222,750
Cost Incurred $150,000 Plug $290,438 $215,436
Current Year Profit $18,750 $(27,233)
$(24,150) $7,314
Year 2008
Contract Price $675,000
Current Cost Estimation $683,438
8,483
Percentage of Completion 2007 2008 2009
Construction in progress 18,750 -
Construction expense 150,000 243,000
Construction revenue 168,750 243,000
Construction in progress 27,188
Construction expense 290,438
Construction revenue 263,250
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Revenue Recognition
Completed Contract 2007 2008 2009
Loss on construction contract 8,438
Construction in progress 8,438
Disclosures
1. The method of recognizing revenue.
2. The basis used to classify assets and liabilities as current (length of the operating cycle).
3. The basis for recording inventory.
4. The effects of any revision of estimates.
5. The amount of backlog of uncompleted contracts.
6. The details about receivables.
Difference Between IFRS and GAAP
Revenue recognized when risks and Revenue recognized when delivery has
Revenue Recognition occurred, risks and rewards of
Sale of Goods
rewards of ownership have been
transferred, buyer has control of the ownership have been transferred there
goods, revenues can be measured is persuasive evidence of a sale, the fee
reliability, and it is probable that is determinable, and collectability is
economic benefits will flow to the reasonably assured.
company
Considered a financing agreement, so Discounting to present value required
Revenue Recognition only in limited situations.
Deferred Receipts
all future receipts are discounted at an
imputed interest rate.
Percentage of completion method is Percentage-of-completion method is
Revenue Recognition allowed if specific criteria are met,
Construction Contracts
allowed if specific criteria are met,
otherwise, revenue is recognized using otherwise, use completed-contract
recoverable costs incurred. The method.
completed-contract method is
prohibited.
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