Revenue Recognition

Erica Pimentel PhD, CPA, CA

COMM 311
September 20, 25 & 27, 2024
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Understanding the Nature of Sales
Transactions from a Business Perspective

• Much of the complexity of accounting for revenues

comes from the way sales transactions are structured
• In most selling transactions, an entity gives up one
asset in exchange for another
• Recording the transaction—on the SFP and income
statement—involves deciding when to recognize it,
how to measure it, and how to present it
• To account for transactions properly, it is important to
understand the business an entity is engaged in
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Example: Economic substance of a business
transaction

Rainn Summers is the owner of Rainn’s Umbrellas (RU). In

order to secure product placement at a national retailer, RU
offers a deep discount on the price and favourable payment
terms. In addition, RU packages each umbrella with a special
pouch, specially crafted in the retailer’s colors. Each
umbrella is sold to the retailer for $49 (including the pouch).
A similar pouch would normally be sold to a retailer for $5
each.

Purpose: Determine the deliverables of the transaction.

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The Physical Nature of Sales Transactions

• Sales transactions involve the transfer of goods, services, or both
(known as deliverables)
• Sales of goods and sales of services are different
Sales of Goods Sales of Service
Tangible assets Not tangible assets
Definite point when control Possession, legal title are
passes—indicated by irrelevant—depends on when
transfer of legal title and the service is rendered
possession
Usually viewed as “one-time” Often spans more than one
period
• Transactions that involve both goods and services add complexity—
how/when to recognize revenue; goods may be transferred before the
service is rendered
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Reciprocal Nature of Sales Transactions

• Most business transactions are reciprocal: some consideration is
provided in exchange for goods or services
• Monetary—cash or cash-like
• Non-monetary—another good or service
• When the transaction is at arm’s length (between unrelated parties)
and reciprocal, usually the
Value of what is given up = Value of what
is received
• Sales agreements that specify the transaction parameters aid in
revenue recognition and measurement
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Other Elements of Reciprocal Transactions

• There is an element of credit risk involved—especially if the
exchange involves extending credit
• Bartering or if only nonmonetary consideration is exchanged—
should it be recorded as a sale? How should it be measured?
• The transaction must have commercial substance, (meaning it
is a legitimate sale) to be recognized
• Exchanging similar assets (e.g., swapping inventory) would not
be considered a sale
• There is the risk that the price of the asset will change, which
is called price risk
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Legalities of Sales Transactions—
Constructive Obligation

• Contractual obligations that arise without the existence

of a contract or having been explicitly noted in a
contract
• May be created through past practice (raising
expectations) or by signalling something to potential
customers
• They Any enforceable promise that results from a sale
are enforceable under law
(whether implicit or explicit) may create a
performance obligation that needs to be recognized
in the statement of financial position.

EXAMPLE: Sam’s Sofas offers a “100% lifetime satisfaction guarantee or

your money back” in their ads. Does this represent a constructive
obligation?
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Revenue Recognition: An Overview

• There are two approaches to recognizing revenue:

o The asset-liability approach (or contracts-based
approach) as adopted by IFRS (IFRS 15)
 Accounts for revenue based on the asset or liability arising
from contracts with customers or changes to assets and
liabilities
o The earnings approach as followed under ASPE
 Recognizes and measures revenue based on whether it
has been earned
 The performance obligation is satisfied when there is a
change in control from the seller to the customer
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Key Concepts of Revenue Recognition

KEY OBJECTIVE
Recognize revenue to depict the transfer of goods or services to customers in an
amount that reflects the consideration that the company receives, or expects to
receive, in PROCESS
FIVE-STEP exchange for
FORthese goods or
REVENUE services.
RECOGNITION
1. Identify the contract with customers.
2. Identify the separate performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the separate performance obligations.
5. Recognize revenue when each performance obligation is satisfied.

REVENUE RECOGNITION PRINCIPLE

Recognize revenue in the accounting period when the performance obligation is
satisfied.
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Identifying the Contract with Customers –
Step 1

• A contract is an agreement between two or more parties that

creates enforceable rights or obligations
• The combination of the rights and performance obligations set
out in a contract gives rise to a (net) asset or (net) liability
• A company does not recognize contract assets or liabilities,
nor is a journal entry prepared, until one or both parties
perform their contracted obligations
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Illustrative example
On January 1, 2023, Electric Autos signs an agreement to deliver 500 electric cars
to Larry’s Limos. The terms of the sale are as follows:
• The 500 electric cars will be delivered on March 1, 2023. Each car cost Electric
Auto $20,000 and is being sold to Larry’s Limos for $40,000.
• Electric Autos is responsible for delivering the cars to Larry’s Limos lot. Electric
Autos must cover all costs relating to shipping and transportation. The Controller
of Electric Autos expects the transport to cost $500 per vehicle
• As a perk in order to make the sale, Electric Autos agrees to provide discounted
winter tires for all the vehicles. The tires have a retail price of $150 each (they
normally retail for $250 each) and a cost of $100. The tires will be delivered on
October 1, 2023.

REQUIRED: Determine how to recognize the revenue under IFRS 15 for this
transaction.
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Identifying the Contract and Contract Modifications

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Illustrative Example:

Let’s say that on February 1, 2023, Larry’s Limos

decides that it wants 50 additional cars for its fleet for
$41,000 each. How do we account for this contract
modification?
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Identifying Separate Performance Obligations – Step
2

• Performance obligation is a promise to provide a product

or service to the customer
o Promise may be explicit, implicit or possibly based on
customary business practice
o The product or service must be distinct (the customer can
separately benefit from it)
• If a performance obligation in a multi-obligation contract
is distinct within the contract, then it should be
accounted for separately
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Multiple Goods and Services—
Multiple Performance Obligations

In our example:
On January 1, 2023, Electric Autos signs an agreement to
deliver 500 electric cars to Larry’s Limos. The terms of the
sale are that the cars will be delivered on March 1 and the
tires will be delivered on October 1, 2023

What are the deliverables in this contract?

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Multiple Goods and Services—
One Performance Obligation

Example:
Oscar’s Ovens sells high-end bakery equipment. On March 4,
2023, they sell an oven for $35,000. The price of the oven
includes delivery and installation, as well as customizing the unit
to the specific needs of the buyer.

What are the deliverables in this contract?

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Material Rights

• Sometimes a sale includes an option to acquire a future good

or service (e.g., loyalty points, coupons) for free or at a reduced
price
• Material Right: a right that the customer would not otherwise
have been entitled to
• Should be considered as two separate performance obligations:
the current sale and the future sale
• Revenue related to the option is deferred
• Unredeemed amounts are called breakage
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Multiple Goods and Services—

Customer Loyalty Programs

Example: An airline offers 1,000 points on a prepaid flight for $1,000.

Redemption is estimated to be 90%. The stand-alone value of the
points is $50 (taking into account breakage) and the value for the
flight is $980.

Question: What are the separate performance obligations in this

transaction?
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Warranties

• Companies often provide two types of

warranties:
Warranty Type Description Accounting Treatment
Assurance Provides assurance that the Represents a cost of
product meets agreed-upon selling the product
specifications in the contract at Recognize a warranty
the time the product is sold liability for after-sale
(quality guarantee) expenses
Service Provides an additional service Represents a separate
beyond the assurance-type performance obligation
warranty Recognizes revenue in
the period the warranty
is in effect
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Multiple Goods and Services—Warranties

On January 1, 2023, Electric Autos signs an agreement to deliver 500 electric cars to Larry’s Limos. The terms of
the sale are as follows:
• The 500 electric cars will be delivered on March 1, 2023. Each car cost Electric Auto $20,000 and is being sold
to Larry’s Limos for $40,000.
• Electric Autos is responsible for delivering the cars to Larry’s Limos lot. Electric Autos must cover all costs
relating to shipping and transportation. The Controller of Electric Autos expects the transport to cost $500 per
vehicle
• Electric Autos offers an 80,000 km warranty on the sale of vehicles to Larry’s Limos. This any normal upkeep or
major technical malfunctions in the car resulting from faulty manufacturing. The estimated cost of servicing this
warranty is $60,000.
• Electric Autos also offers an extended warranty at a price of $2,500 per car which will extend the protection for
an addition 40,000 km. Larry purchases 500 such extended warranties.

Question: What are the separate performance obligations in this transaction?

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Upfront Fees

• Upfront fees are payments received before a product is

delivered or a service is performed (e.g., a membership fee
that provides a significant discount on future annual fees)
• Theoretically, this is a material right to future benefits and
would be considered a separate obligation
• Under IFRS 15, treated as one performance obligation—
because it is difficult to determine the stand-alone value of
the future benefit
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Multiple Goods and Services—Initiation Fees
as One Performance Obligation

Example:
Evercrest Golf Club sells memberships to its club. Initiation fees
are $20,000 and annual dues are $5,000. Members normally
remain with the club for 20 years before cancelling their
membership.

Question: What are the separate performance obligations in this

transaction?
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Determining the Transaction Price—Step 3

• Transaction price is the amount of consideration that a

company expects to receive from a customer in
exchange for transferring goods or services
o Transaction price is usually stated within the contract
o In other contracts consider
• variable consideration
• time value of money
• non-cash consideration
• consideration paid or payable to customers
o Factors addressed in I FRS; little guidance from A SPE
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Variable Consideration

• Sometimes the transaction price is dependent on future events

• Companies estimate the amount of consideration to determine the
revenue to record—called variable consideration—using two methods

Expected value Most likely amount

Probability-weighted amount The single most likely amount
in a range of possible in a range of possible
amounts outcomes
Use with a large volume of May be appropriate if there
contracts that are similar are only two outcomes
Based on a limited number of
discrete
outcomes/possibilities
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Transaction Price—Variable Consideration

Example: Red’s Roofing provides roofing services and charges a peak season
surcharge for services providing during its busiest months. The price for a single
roofing job is $20,000 with a 10% premium for jobs performed in June, a 15%
premium for job completed in July and a 20% premium for jobs completed in
August.

Red’s Roofing is writing a quote for a new job. Management estimates a 20%
probability the job will be completed in June, a 40% probability the job will be
completed in July, a 30% probability the job will be completed in August and a 10%
probability that the job will be complete outside the busy season (therefore, no
busy season premium)

QUESTION: What is the transaction price?

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Variable Consideration: Right of Return

• Right of return obligates the seller to allow the customer

to return goods for a refund, a credit or an exchange
• Seller must recognize
o Revenue from the sale of the product (considering the
possibility of future returns)
o A refund liability
o An asset (and adjustment to cost of sales) to recognize
recovery to inventory
• Accounting treatment differs between I FRS and ASPE
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Transaction Price—Right of Return

Example: Feather Furniture (FF) sells 50 office chairs for $200 each to
Carl’s Computers (CC) payable in 60 days. FF allows CC to return any
unused product within 60 days and receive a full refund. The cost of
each product is $100. Based on past experience, FF estimates five
products will be returned.
The amounts used are the same under IFRS and ASPE
• Revenue: $9,000 ($200 x 45)—products that will not be returned
• Cost of sales: $4,500 ($100 x 45)—cost of the products that will
not be returned
• Refund liability: $1,000 ($200 x 5)—products expected to be
returned
• An asset: $500 ($100 x 5)—products that will be recovered and
returned to inventory
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Transaction Price—Right of Return Journal
Entries (IFRS)
To recognize revenue:

AR 10,000
Sales Revenue 9,000
Refund Liability 1,000

COGS 4,500
Estimated Inventory Returns 500
Inventory 5,000
To an actual return of three items:

Refund Liability 600 Whether we credit AP or AR will depend on

AP or AP whether
600 the customer has paid yet!

Returned inventory 300 (Your book usually the customer has already
Estimated Inventory Returns 300 paid)
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Transaction Price—Right of Return Journal
Entries (ASPE)
To recognize revenue:

AR 10,000
Sales Revenue 10,000
Sales Returns and Allowances 1,000
Allowance for Sales Returns and Allowances 1,000

COGS 4,500
Estimated Inventory Returns 500
Inventory 5,000

To an actual return of three items:

Allowance for Sales Returns and Allowances 600

AP or AP 600

Returned inventory 300

Estimated Inventory Returns 300
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Variable Consideration: Volume Discounts

• Some customers may be given a volume discount when

buying large amounts
• Revenues should be reduced if it is probable the
discount will be provided
IFRS ASPE
When the Dr. Revenue Dr. Sales Returns and Allowances
discount is Cr. Contracts Liability Cr. Allowance for Sales Returns and
probable Allowances
When the Dr. Contracts Liability Dr. Allowance for Sales Returns and
discount is Cr. Accounts Receivable Allowances
provided Cr. Accounts Receivable
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Variable Consideration: Volume Discounts

Example:
Red Bird Ice Cream offers its customers a 2% volume discount if they purchase at
least $1 million of its products during the calendar year. On February 15, 2023, Red
Bird Ice Cream has made sales of $500,000 to Daisy’s Diner. In the previous two
years, Red Bird sold over $5 million to Daisy’s per year.

Question:
How much revenue should Red Bird Ice Cream recognize under IFRS and ASPE?
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Non-cash Consideration

• When companies receive consideration in the form of

goods, services, or other non-cash consideration, they will
recognize revenue based on the fair value of what is
received
• If customers contribute goods or services to fulfil a
contract, it should be treated as a non-cash consideration
and included in the transaction price, as long as control
Example:
has passed to the company
Red Bird Ice Cream received catering services from Daisy’s Diners in exchange
for ice cream. Red Bird follows IFRS. How should the sale of ice cream be
measured?
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Consideration Paid or Payable

• Consideration paid or payable covers items like vouchers,

coupons or gift cards
• The impact is to reduce the consideration received and the
revenue to be recognized
• E.g., gift cards: At the time of the sale, the company sets
up a contract liability for the value
• To account for breakage, when the gift card is used,
revenue is increased by a factor based on past redemption
experience
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Gift Cards - Example

Custom T-Shirts sells a $100 gift card to a customer on

January 1, with no expiry date. Based on past gift card
sales, 95% of gift cards are redeemed and 5% are
unexercised. Custom feels this information has good
predictive value and estimates that 5% of the gift card
value will remain unredeemed. On October 11, the
customer makes one purchase of $85 using the gift card.

Question: How should Custom T-Shirts account for the

sale?
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In-class exercise
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Allocating the Transaction Price to Separate
Performance Obligations – Step 4

• Transaction prices are allocated to more than one

performance obligation in a contract based on their
relative fair values
o The best measure of fair value is what the company could sell the good
or service for on a stand-alone basis (stand-alone selling price)
o If this information is not available, best estimates are used
o All information that is available (like market conditions and type of
customer) should be used; in particular, observable information
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Estimating Stand-Alone Selling Price

• How to calculate stand-alone prices (in preferred order

of use)
Allocation Approach Implementation
Adjusted market assessment Estimate the price that customers purchasing the
approach goods or services will pay. The company might also
look at competitor prices for similar goods or services.
Expected cost plus a margin Forecast expected costs and add a reasonable profit
margin.
Residual approach Use where the selling price is highly variable or
uncertain. Estimate the stand-alone selling price by
starting with the total price for the contract and
deducting the observable selling prices of other items
being sold.
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Allocation of Transaction Price—Bundled Sale
(1)

• When the sum of the value of each good/service in a

bundle is greater than the transaction price …
o the total revenue (transaction price) should be
allocated to the separate performance obligations
based on their relative value
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Bundled Sale: Example
Evergreen Computers is an experienced manufacturer of computer systems. Selling prices range from
$500,000 to $3 million and are quoted inclusive of installation and training.
The installation process does not involve changes to the computer system’s features and does not require
proprietary information about the computer for the installed equipment to perform to specifications.
Evergreen has the following arrangement with Sunshine Corporation:
• Sunshine purchases a computer system from Evergreen for $750,000 and chooses Evergreen to do the
installation and training. Evergreen charges $750,000 for the computer system whether it does the
installation or not. If sold separately, the installation service is estimated to have a fair value of $20,000.
This equipment cost Evergreen $500,000
• The fair value of the training sessions is estimated at $10,000. Other companies could also perform these
training services, but Sunshine chooses to use Evergreen for its training so it does not have to pay extra to
another company.
• Sunshine is obligated to pay Evergreen the $750,000 upon the delivery and installation of the computers.
Evergreen delivers the computers and completes the installation on November 1, 2023.
• Training related to the computers starts once the installation is completed and lasts for six months.

QUESTION:
a) What are the performance obligations pertaining to this contract?
b) How should the $750,000 payment be allocated to the performance obligations?
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Allocation of Transaction Price—Bundled Sale
(2)

• When the selling price of a bundle is less than the

individual stand-alone prices due to a specific component
…
o the discount should be allocated to the performance obligation that is
causing the discount, and not to the entire bundle
Example:

Rosie’s Bakery sells a new baker’s fit: this includes a one-hour introductory
baking class, a set of bowls and a set of mixing spoons for $125. The company
also sells the mixing bowl and spoons as a set for $50.

The standalone price of the items is: How would the discount be
Baking class $75 allocated in this arrangement?
Bowls $40
Spoon $20
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Recognizing Revenue when (or As) Each
Performance Obligation is Satisfied—Step 5

• A company satisfies its performance obligation

when the customer obtains control of the good or
service
• Indicators of control:
o The company has a right to payment for the asset
o The company has transferred legal title to the asset
o The company has transferred physical possession of the asset
o The customer has significant risks and rewards of ownership
o The customer has accepted the asset
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When to Recognize Revenue

• Companies satisfy performance obligations either at a

point in time or over a period of time
• (IFRS) Companies recognize revenue over a period of
time if one or more of the following criteria are met:
o The customer receives and consumes the benefits as the
seller performs
o The customer controls the asset as it is being created or
enhanced
o The company does not have an alternative use for the
asset created or enhanced, and the amount is collectible
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Recognizing Revenue—Progress Towards
Completion

• A company recognizes revenue from a performance

obligation over time by measuring the progress towards
completion
• Method should depict the transfer of control
• Objective is to measure the extent of progress of costs,
units or value added
• Input measures: efforts devoted to a contract
• Output measures: track results
• Most popular input measure is cost-to-cost basis
• Comparing costs incurred to date with the most recent
estimate of total contract costs
Recognition— 45
Satisfying a Performance Obligation over
Time

Example:

Optimal Security provides mall security to several shopping centers in the Kingston area.
Optimal finds that in the summer months, there are higher numbers of incidents but the
services are essentially the same each month.

On February 1, Optimal signs a contract with Kingston Realty. Optimal receives $12,000
upfront and collects $5,000 per month.

Question:
How should Optimal Security record revenue on this contract for the month of February
2023?
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Group exercise: IFRS 15
WizKidz Tech Group has been contracted by the government to build a brand new application (software program)
to facilitate the booking, reservation, and payment of fees for camp sites in the province. The old system was very
manual and needed to be completely replaced. A contract was signed on July 1, 2023 by WizKidz and the Minister
responsible for technology in the government. As per the agreement, WizKidz is charging the government
$2,000,000 to build the program (to be completed within 1 year), host the application on its servers and provide
the associated storage, and service the system over the next four years. WizKids would change $2M whether it did
the support and hosting or not.
The service portion of the contract promises 50 hours of technical support per year over the next four years. The
average cost of a technical support staff is $45 per hr. It is also expected that the server/storage costs are $55.10
per TB each year and that the government will need about 500 TB of storage.

WizKidz uses IFRS to prepare its annual financial statements.

Instructions
a) Use the above to illustrate the 5 steps of the revenue recognition process.
b) If WizKidz reports its financial results on a quarterly basis, what revenue recognition method would be
most appropriate related to the transaction price allocated for the software program?
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Other Revenue Recognition Issues

• There are several situations where revenue

recognition issues arise
o repurchase agreements
o bill and hold
o principal-agent relationships
o consignments
• This discussion is based on I FRS 15 as ASPE
has little specific guidance in these areas
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Repurchase Agreements

Issue Description Implementation

Repurchase Seller has an Generally, if the company has an
agreements obligation or right obligation to repurchase the asset for
to repurchase the an amount greater than its selling price,
asset at a later then the transaction is a financing
date transaction
• Raises the question, “Did the company actually sell the
asset?”; Was there a transfer of control?
• Likely control stays with the company if it intends to
repurchase
• Generally reported as a financing transaction (borrowing)
using a Contract Liability account
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Example: Repurchase Agreements

Wheelhouse Wagons (WW) is a manufacturer of tractors and
farm equipment. WW sells equipment on January 1, 2023, to
Bovine Industries for $500,000.

WW agrees to repurchase this equipment from Bovine

Industries on December 31, 2024, for $551,250. Assume that
WW continues to have control over the asset during the
period.

Question: How should WW account for this transaction?

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Bill-and-Hold Arrangements

Issue Description Implementation

Bill and Results when the buyer is Revenue is recognized
hold not yet ready to take depending on when the
delivery but takes title and customer obtains control of
accepts billing that product
• To establish transfer of control, and therefore
recognize revenue, all of these criteria have to be
met
a. The reason to hold the inventory must be substantive.
b. The product must be identified separately and belong to
the customer.
c. The product must be ready to ship.
d. The company cannot use the product nor sell it to another
customer.
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Example: Bill and hold arrangements

Cold River sells energy drinks to major retailers across Ontario. On December 29, 2023,
Cold River sells 100 cases of Cold Buzz, its best-selling drink, to a local beverage
distributor, Delicious Drinks.

Due to a flood at their warehouse, Delicious Drinks tells Cold River to hold onto the
merchandise until after year-end. Cold River packages the order and stores it in a
separate location in the shipping bay. The bundle of 100 cases is clearly labelled
“Destined for Delicious Drinks”.

On December 31, 2023, Cold River receives a rush order from another local vendor,
Sensational Spritzes, for 100 cases of Cold Buzz. To fill the order quickly, the shipping
manager takes the label off the merchandise destined for Delicious Drinks and ships it to
Sensational Spritzes. He makes a mental note to replace the merchandise destined for
Delicious Drinks.
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Bill and Hold:
Fraud Risks
 53

Principal-Agent Relationships
• Performance obligations in a principal-agent relationship
Principal Agent
To provide goods or perform To arrange for the principal
services for a customer to provide goods or perform
e.g., an airline services for a customer
e.g., travel agency

• Amounts collected on behalf of the principal are not revenue

of the agent; revenue for the agent is the amount of
commission it receives
• The principal recognizes revenue when the goods and services
are sold to a third party
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Example: Gross versus net

Ticket Suite is an online sporting event ticket reseller.

Resellers post their tickets on Ticket Suite’s website and
Ticket Suit provides a platform to match resellers with
buyers. Ticket Suite collects payment for the ticket sale from
customers which it remits to resellers.

Ticket Suite earns a 5% commission on each sale.

QUESTION: Should Ticket Suite recognize revenue on a

gross or net basis?
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Consignment Sales

• Manufacturers or wholesalers (consignors) deliver goods to the

dealer (consignee) but retain title until the goods are sold
• Accounting for consignment sales
o The consignee does not record the merchandise as an asset on its
books; inventory is carried on books of consignor
o Once the merchandise is sold, consignee has a liability for the net
amount due
o Consignee remits proceeds from sales to consignor after deducting
commission and chargeable expenses
o Consignor recognizes revenue when the remittance from the
consignee is received
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Example: Consignment sales

Harry’s Handbags is a reseller of pre-owned luxury handbags. Harry’s
primary sales channel is consignment sales at luxury department stores
across the country.

Harry’s delivers pre-owned luxury handbags to Holt Renfrew on December

1, 2023, on consignment. The delivered merchandise has a cost of $30,000.
On December 31, 2023, Holt Renfrew notifies Harry’s that all of the
handbags have sold for a retail price of $50,000. Holt Renfrew takes a 10%
commission on the sale and remits the rest to Harry’s

QUESTION: How should Harry’s Handbags and Holt Renfrew account for
the transaction?
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In-class exercise
 58

Contract accounting
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Long-term Contracts
• Long-term contracts have some unique features
o They can span several reporting periods
o They can allow for progress billings
• Some long-term contracts can be viewed as a series of distinct
performance obligations
• Therefore, revenue can be recognized over time as each
performance obligation is satisfied
• Or revenue can be recognized each period based on
performance up to that point
• Recognize revenue and gross profit each period based on
progress: percentage-of-completion method
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Revenue Recognition Criteria

• (IFRS) A company can recognize revenue over time if at least one of
the following criteria is met
• The customer receives and consumes the benefit as it is performed
• The customer controls the asset
• The company does not have an alternative use for the asset and has a
right to payment for its performance
• And the company can reasonably estimate its progress towards
completion of the performance obligations
• If one of the criteria is not met, revenue is recognized at a point in
time
• (ASPE) Criteria are more general; revenue should reflect work
accomplished
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Long-term Contracts: Treatment under I FRS
15

Long-Term Contract Accounting under IFRS When to Recognize Revenue

Many distinct performance Treat as many As each performance
obligations within one performance obligations obligation is completed
contract
One performance obligation; Treat as one When the performance
does not meet criteria performance obligation obligation is satisfied
One performance obligation; Treat as one Recognize revenue over time
meets criteria performance obligation (percentage-of-completion or
zero-profit methods)
Many distinct performance Treat as one Recognize revenue over time
obligations—each is performance obligation (percentage-of-completion
substantially the same with method or a time-based
same pattern of delivery method)
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Revenue Recognition Methods

• Percentage-of-completion
• Revenue recognized based on progression—accumulated costs or
units delivered
• Buyer and seller have enforceable rights
• Buyer: legal right to specific performance
• Seller: right to progress payments
• If criteria is met; but an estimate cannot be made
• Zero-profit method (IFRS): company records recoverable revenues
equal to costs
• Completed-contract method (ASPE): recognizes revenue at the
end of the contract
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Measuring the Progress Toward Completion—
Percentage of Completion

• Objective is to measure the extent of progress toward

completion in terms of costs, units, or value added
• Measures classified as
• Input measures—efforts devoted to a contract
• Based on established relationship between a unit of input and
productivity—subject to inefficiencies
• Skewed by significant upfront costs at the beginning
• Most common is the cost-to-cost method
• Output measures—units of delivery
• Used for tracking results
• Inaccurate if units are not comparable
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Percentage-of-Completion, Cost-to-Cost Basis
Formulas

Determine the percentage completed:

Apply percentage to total revenue and estimated gross profit on

the contract:

To determine current-period revenue (or gross profit):

 65

Long-term contracts
worksheet
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Percentage-of-Completion: Financial
Statement Presentation

• The Contract Asset/Liability account is reported net

• Debit balance: reported as an asset (Accounts Receivable:
revenue recognized > amount billed)
• Credit balance: reported as a liability (Unearned revenue:
amount billed > revenue recognized)
• When reporting contract accounts on the financial statements,
they are classified as follows:
• Contract Asset/Liability is current (as long as the related
revenues will be earned in the following year)
• Accounts Receivable are current (assuming they will be
received within the following year)
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Zero-Profit Method

• Under IFRS, if a company is uncertain about the outcome of

a contract, they must recognize revenue using the zero-
profit method
• With this method, recoverable revenues = costs, until the
uncertainty is resolved
• The company must be confident it will recover costs
incurred in order to use the zero-profit method
 71

Let’s come back to our

example
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Completed-Contract Method

• Under ASPE, and the completed-contract method, companies

recognize revenue and gross profit when the contract is
completed
• This method is used where performance consists of a single
act or the company is unable to estimate progress toward
completion
• Advantage--no estimates are required
• Disadvantage—does not reflect current performance
• Journal entries are the same as percentage-of-completion; but
no recognition of revenue or construction expenses until the
final year
 76

Let’s come back to our

example
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Losses on Long-Term Contracts

• Two types of losses can occur under long-term contracts

• Loss in current period on a profitable contract
• significant increase in costs but they do not fully eliminate the profit to
date
• Applies to percentage-of-completion only
• Adjust current period for excess gross profit
• Recorded as a loss in the current period
• Loss on an unprofitable contract
• Entire expected loss recognized in the current period
 80

Example: Losses on a profitable contract

• Pinewood Construction is a real estate development firm. Pinewood signs a non-cancellable
agreement to construct a shopping mall for Kingston Realties for $10,000,000 at an estimated
cost of $8,000,000. The contract is set to start in May 2023 with delivery of the shopping mall
in August 2025. Assume that progress billing are non-refundable and that Pinewood uses the
% of completion method of revenue recognition under IFRS.

• The Controller of Pinewood provides the following information:

2023 2024 2025
Costs to date $4,000,000 $4,400,000* $8,400,000
Estimated costs to $4,000,000 $4,000,000* $0**
complete (as at year-
end)
Progress billings $3,000,000 $4,000,000 $3,000,000
during the year
Cash collected during $2,500,000 $5,000,000 $2,500,000
the year
Under the completed-contract and zero-profit methods, no loss is recognized in 2024, because 81 the
contract is still expected to result in a profit that will be recognized in the year of completion.

Notice now, the total costs to complete has changed so the % complete in 2024 has changed. The
contract is still profitable overall, except that now:

Costs to date 4,400,000

Estimated costs to complete (revised) 4,000,000
Estimated total costs 8,400,000
% complete 52%

Revenue recognized In 2024

10M x 52% 5,000K 200K
Costs incurred in 2024 400K
Net loss (200K)

Entry:
Construction expense 400,000
Construction revenue 200K
Contract liability 200K
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Loss on an Unprofitable Contract

• A contract becomes onerous when the total estimated

costs exceed the total revenues
• Under the percentage-of-completion method, revenues
recognized in previous periods must be reversed, and
the total estimated loss must be recognized in the
current period
• Under the zero-profit and completed-contract methods,
because no revenue has been recognized, nothing has
to be reversed; but the total estimated loss has to be
recognized in the current period
 83

Example: Losses on an unprofitable contract

• Pinewood Construction is a real estate development firm. Pinewood signs a non-cancellable
agreement to construct a shopping mall for Kingston Realties for $10,000,000 at an estimated
cost of $9,000,000. The contract is set to start in May 2023 with delivery of the shopping mall
in August 2025. Assume that progress billing are non-refundable and that Pinewood uses the
% of completion method of revenue recognition under IFRS.

• The Controller of Pinewood provides the following information:

2023 2024 2025
Costs to date $4,000,000 $5,000,000* $10,400,000
Estimated costs to $9,000,000 $6,000,000 $0**
complete (as at year-
end)
Progress billings $3,000,000 $4,000,000 $3,000,000
during the year
Cash collected during $2,500,000 $5,000,000 $2,500,000
the year
Under the % complete method, Pinewood would have recognized 44% of the total gross profit or 440K 84
of gross profit in 2023. This amount needs to be offset in 2024 because it is no longer expected to be
realized. In addition, since losses must be recognized as soon as estimable, the company must
recognize the total estimated loss of $400,000 in 2024.

Therefore, Pinewood must recognize a total loss of 840K ($440K + 400K) in 2024:

Revenue recognized in 2024:

Contract price 10M
Percentage complete 48%
Journal entry:
(based on costs to date / total estimated costs) =
Construction expense 1240K
50000/10400
Contract asset/liability 840K
Revenue from LT contracts
Revenue recognizable to date 4,800,000
400K
Revenue recognized to date 4,400,000
Revenue to recognize in 2024 400,000
Under the zero profit and completed contract
methods, also would need to recognize
contract loss as soon as evident:
Total loss recognized in 2024:
Reversal of profit from 2023: 440K
Loss on long-term contract 400K
Total estimated contract loss 400K 840K
Contract asset/ liability 400K
(amount limited to expected loss on
Construction cost expense in 2024 1240K
contract)