Gabriela H Schneider CMA Grant MacEwan College INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO WEYGANDT WARFIELD IRVINE SILVESTER YOUNG WIECEK C H A P T E R 6 Revenue Recognition ID: 159739
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Slide1
Prepared by:Gabriela H. Schneider, CMA; Grant MacEwan College
INTERMEDIATE
ACCOUNTING
Sixth Canadian Edition
KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEKSlide2
C H A P T E R
6
Revenue RecognitionSlide3
Learning Objectives
1. Apply the revenue recognition principle.
2. Describe accounting issues involved with revenue recognition for sale of goods.
3. Explain accounting for consignment sales.
4. Describe accounting issues involved with revenue recognition for services and long-term contracts.Slide4
Learning Objectives
5. Apply the
percentage-of-completion method
for long-term contracts.
6. Apply the
completed-contract method
for long-term contracts.
7. Identify the proper accounting for losses on long-term contracts.
8. Discuss how to deal with measurement uncertainty.Slide5
Learning Objectives
9. Discuss how to deal with collection uncertainty.
10.Explain and apply the
instalment sales method of
accounting.
11.Explain and apply the
cost recovery method
of accounting.Slide6
Revenue Recognition
Current Environment
Revenue recognition criteria
Measurement Uncertainty
Sales with buy-back
Sales when right of return exists
Trade loading and channel stuffing
Earnings Process
Sale of goods
Risks and rewards
Disposition of assets other than inventory
Consignment sales
Continuing managerial involvement
Completion of production
Rendering of services and long-term contracts
% of completion method
Completed contract method
Long-term contract losses
Disclosures
Uncertainty Associated with Collectibility
Instalment sales
Instalment method
Cost recovery methodSlide7
Guidelines for Revenue RecognitionRevenue is recognized based on two criteria:
PerformanceCollectibility
Revenue is earned when the
earnings process
is substantially complete
Earnings Process: actions taken to add value
Substantial Performance
: when little or no uncertainty exists as to the completion of the product or service (at this point revenue is recognized)
Revenue is realized when goods and services are
exchanged for cash or claims to cashSlide8
Four Types of Revenue TransactionsRevenue from selling products is recognized at the date of sale (date of delivery)
Revenue from services
is recognized when services are performed and are billable
Revenue from the
use of enterprise’s assets
by others
is recognized as time passes or as the assets are used up
Revenue from
disposal of assets
is recognized at the point of saleSlide9
Risks and RewardsRisks and rewards (benefits) of ownership:Who has possession of the goods?Who has legal title?When the risks and rewards of ownership have transferred
Determines when a sale has occurredSlide10
Revenue Recognition at Point of SaleRevenues from manufacturing and selling are commonly recognized at point of sale
Revenues from sales with buyback agreements are not recognized (not sales)
Revenues from sales
where rights of return
exist are not generally recognized
Certain trade practices such as
trade loading
and
channel stuffing
do not result in recognizable sales revenuesSlide11
Consignment SalesPossession has transferred; however legal title remains with the sellerRisks and rewards have not transferred
Seller acts as an agentGoods are held by seller as Merchandise on Consignment
Not held as inventory on consignee’s booksSlide12
Consignment Sales
Goods shipped to ConsigneeInventory on Consignment $$$
Finished Goods Inventory $$$
Payment of Freight
Inventory on Consignment $$
Cash $$
Notification of Sale
Accounts Receivable $$$
Relevant Expenses $$
Revenue $$$
Receipt of Cash from Sale
Cash $$$
Accounts Receivable $$$
Cost of Goods Sold $$$
Inventory on Consignment $$$
(Note: cost includes freight)
No Entry
No Entry
Notification/Payment of Sale
Cash $$$
Payable to Consignor $$$
Consignor’s Books
Consignee’s BooksSlide13
Revenue Recognition Before DeliveryRevenue may be recognized before delivery under certain circumstances
Long-term construction contracts (percentage of completion method), are a notable example
The percentage method permits
periodic billing
at various points in the project
The completed contract method
is used only when the percentage method is inapplicableSlide14
Contract Accounting
Long-Term ConstructionAccounting Methods
Percentage of Completion
Method
Completed Contract
Method
Terms of contract must
be certain, enforceable
Certainty of performance
by both parties
To be used only when
the percentage method is
inapplicable [uncertain]
For short-term contractsSlide15
Percentage Completion: ConceptPercentage completion method permits periodic billing
The amount of gross profit recognized depends upon the
percent of work done
Application of percentage completion method requires a basis for measuring the progress toward completion at interim dates
See the
specific steps
for determining gross profit (next slide)Slide16
Percentage Completion: Steps
Costs incurred to date
= Percent complete
Most recent estimated total costs
1
Percent complete X Estimated total revenue =
Revenue to be recognized to date
2
Revenue to be recognized to date
–
Revenue recognized in prior periods =
Current period revenue
3
Current Period Revenue
–
Current costs = Gross Profit
4Slide17
Percentage Completion: Cost-to-Cost Basis
Data: Contract price: $4,500,000 Estimated cost: $4,000,000
Start date: July, 2001 Finish: October, 2003
Balance sheet date: December 31
st
Given:
2001
2002
2003
Costs to date $1,000,000 $2,916,000 $4,050,000
Estimated costs to complete $3,000,000 $1,134,000 $ -0-
Progress billings during year $ 900,000 $2,400,000 $1,200,000
Cash collected during year $ 750,000 $1,750,000 $2,000,000Slide18
Percentage Completion: Cost-to-Cost Basis
2001 2002 2003
$4,500,000 $4,500,000 $4,500,000
Contract Price
1,000,000
2,916,000 4,050,000
3,000,000
1,134,000
-0-
4,000,000
4,050,000
4,050,000
Estimated Costs:
To Date
Est. Cost to Complete
Est. Total Costs
25% 72% 100%
1,000,000
2,916,000
4,050,000
4,000,000
4,050,000 4,050,000
Percent Complete
$ 500,000 $ 450,000 $ 450,000
Estimated Total Gross
ProfitSlide19
Percentage Completion: Cost-to-Cost Basis
2001 2002 2003
$4,500,000 $4,500,000 $4,500,000
Contract Price
25% 72% 100%
Percent Complete
$1,125,000 $3,240,000 $4,500,000
-0-
1,125,000
3,240,000
$1,125,000 $2,115,000 $1,260,000
Revenue Recognized:
Current Year
Less: Prior Year
= Revenue
$ 125,000 $ 324,000 $ 450,000
-0-
125,000
324,000
$ 125,000 $ 199,000 $ 126,000
Gross Profit Recognized:
Current Year
Less: Prior Year
= RevenueSlide20
Completed-Contract MethodRevenue and gross profit recognized on completion of contractAdvantage: reported revenue is based on actual results, not estimates
Disadvantage: does not reflect current performance; creates distortion of earningsProgress billings are reported contra
to ‘Construction in Progress’ account on the Balance Sheet
Construction in Progress used to accumulate contract costsSlide21
Long-Term Contract Losses A long-term contract may produce: either an
interim loss and an overall profit or an overall loss for the project
Under the
percentage completion
method, losses
in any case are immediately recognizedUnder the
completed contract
method, losses are recognized only when
overall losses
resultSlide22
Recognizing Current and OverallLosses on Long-Term Contracts
Current Loss onan otherwise
overall profitable
contract
Completed Method:
No adjustment needed
Percentage Method:
Recognize loss currently
Loss on an
overall unprofitable
contract
Percentage Method:
Recognize entire loss now
Completed Method:
Recognize entire loss nowSlide23
Percentage Method: Interim Loss on Profitable Contract - Example
2001 2002 2003
$4,500,000 $4,500,000 $4,500,000
Contract Price
1,000,000 2,916,000 4,384,962
3,000,000
1,468,962
-0-
4,000,000
4,384,962
4,384,962
Estimated Costs:
To Date
Est. Cost to Complete
Est. Total Costs
25%
66.5%
100%
1,000,000
2,916,000
4,384,962
4,000,000 4,384,962 4,384,962
Percent Complete
Data as previously given, except for the 2002 cost estimate
Revenue recognized in 2002: $4,500,000 * 66.5% = $2,992,500
Less: amount recognized in 2001
1,125,000
1,867,500
Less: actual costs incurred in 2002
1,916,000
Loss recognized in 2002
48,500Slide24
Percentage Method: Interim Loss on Profitable Contract – Example
Record loss for 2002:
Construction Expense 1,916,000
Construction in Process (loss) 48,500
Revenue from Long-Term Contract 1,867,500
Loss of $48,500 reported on Income Statement
Difference between the reported revenues and
costs for the current period
Under the completed-contract method, no loss
Recognized in 2002Slide25
Percentage Method: Interim Loss on Overall Unprofitable Contract – Example
2001 2002 2003
$4,500,000 $4,500,000 $4,500,000
Contract Price
1,000,000 2,916,000 4,556,250
3,000,000
1,640,250
-0-
4,000,000
4,556,250
4,556,250
Estimated Costs:
To Date
Est. Cost to Complete
Est. Total Costs
25%
64%
100%
1,000,000
2,916,000
Gross Profit
4,000,000 4,556,250
(56,250)
Percent Complete
Data as previously given, except for the 2002 cost estimate
Losses recognized in 2002:
Gross Profit recognized in 2001 $125,000
Expected Loss on Unprofitable Contract
56,250
$181,250Slide26
Percentage Method: Interim Loss on Overall Unprofitable Contract – Example
Record loss for 2002:
Construction Costs expensed in 2002:
Revenue recognized in 2002:
(4,500,000 X 64%)
$2,880,000Less: revenue recognized in 2001
1,125,000
Revenue recognized in 2002 1,755,000
Less: loss recognized in 2002
181,250
Construction Cost Expense
1,936,250
Construction Expense 1,36,250
Construction in Process (loss) 181,250
Revenue from Long-Term Contract 1,755,000Slide27
Completed Contract Method: Interim Loss on Overall Unprofitable Contract – Example
Record loss for 2002:
Loss from Long-Term Contract 56,250
Construction in Process (Loss) 56,250
The loss is recognized in the year it first becomes
evident.Slide28
Revenue Recognition after DeliveryRevenue recognition is deferred when collection of sales price is
not reasonably assuredThe two methods that are used are:
the instalment sales method
the cost recovery method
If cash is received prior to delivery, the method used is the
deposit method Slide29
The Instalment Sales MethodThis method emphasizes income recognition
in periods of collection rather than at point of saleTitle does not pass to the buyer until all cash payments have been made to the seller
Income recognition deferred to period of cash collection
Both
sales and cost of sales
are recognized in the period of sale
Gross profit is deferred to the period of collection
Other expenses, selling and administrative, are not deferredSlide30
The Instalment Sales Method: Special AccountsInstalment sales must be kept separateGross profit on instalment sales must be determinable
The amount of cash collected from instalment accounts must be knownThe cash collected from current year’s and prior years’ accounts must be known
Provision must be made for the carry forward of each year’s (deferred) gross profitSlide31
The Instalment Sales Method: StepsFor instalment sales in
any year For instalment sales made in prior years
(realized gross profit)
Determine
rate of gross profit
on instalment sales
Apply this rate to cash collections of current year’s instalment sales to yield
realized
gross profit
The gross profit not realized is
deferred
Apply the
relevant rate
to cash collections of prior year’s instalment sales Slide32
The Instalment Sales Method: ExampleGiven:
2001 2002
2003
Instalment sales $200,000 $250,000 $240,000
Cost of sales $150,000 $190,000 $168,000
Gross Profit $ 50,000 $ 60,000 $ 72,000
Cash received in:
from 2001 sales $ 60,000 $ 100,000 $ 40,000
from 2002 sales $ -0- $ 100,000 $ 125,000
from 2003 sales $ -0- $ -0- $ 80,000
Determine the realized and deferred gross profit.Slide33
The Instalment Sales Method: Example
Given: 2001
2002
2003
Instalment sales $200,000 $250,000 $240,000
Gross Profit $ 50,000 $ 60,000 $ 72,000
Gross profit rate 25% 24% 30%
Realized Gross Profit
:
From 2001 sales
:
Realized in $15,000 $25,000 $10,000
From 2002 sales
:
Realized in: $ -0- $24,000 $30,000
From 2003 sales
:
Realized in: $ -0- $ -0- $24,000Slide34
The Instalment Sales Method: Partial Journal Entries (2001) for Gross ProfitInstalment Sales 200,000
Cost of Sales 150,000 Deferred Gross Profit, 2001 50,000 (To close 2001 accounts)
Deferred Gross Profit, 2001 15,000 Realized Gross Profit 15,000
(Realized: $60,000 * 25%)
Realized Gross Profit 15,000 Income Summary 15,000
(To close to Income Summary)Slide35
Instalment Sales Accounting ProblemsInterest on instalment contractsAccounted for separately from the gross profit
Recognized when cash is collected, as Interest Revenue
Uncollectible accounts
Through the use of a special bad debts expense account
Defaults and repossessions
On repossession, the Account Receivable and related deferred Gross Profit are written-offSlide36
The Cost Recovery MethodSeller recognizes no profit until cash payments by buyer exceed seller’s cost of merchandiseAfter recovering all costs, seller includes additional cash collections in income
This method is to be used where there is no reasonable basis for estimating collectibility as in
franchises and real estate
The income statement reports the amount of gross profit recognized and the deferred amountSlide37
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