1 Income Measurement and Profitability Analysis Sid Glandon, DBA, CPA Associate Professor of Accounting

2 Guidelines for Revenue Recognition Revenue is recognized when It is earned, and When the earning process is substantially complete It is realized or realizable When goods and services are exchanged for cash or claims to cash

3 Staff Accounting Bulletin No. 101 Persuasive evidence of an arrangement exists Delivery has occurred or services have been rendered The seller’s price to the buyer is fixed or determinable Collectibility is reasonably assured

4 Four Types of Transactions Sale of products Recognized at date of sale (delivery) Provision of services Recognized when performed and billable Revenue from use of assets Recognized as time passes or assets used up Disposal of assets Recognized at point of sale

5 Revenue Recognition Transfer of title, date of delivery Completion of production Revenue recognition after delivery if there is uncertainty of collectibility Installment sales Cost recovery Deposit method Buyback agreements Right of return Consignment sales

6 Installment Sales Recognizes income in periods of collection instead of point of sale Title does not pass to buyer until after final payment Both sales and cost of sales are deferred Selling and administrative expenses are not deferred

7 Installment Sales Example

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14 Cost Recovery Method Seller recognizes no profit until cash receipts exceed seller’s cost of merchandise After recovering all costs, seller includes additional cash collections in income Used where there is no reasonable basis for estimating collectibility Franchises and real estate Income statement Report amount of gross profit recognized and deferred

15 Deposit Method Seller receives cash before transfer Seller has no claim against purchaser Insufficient transfer of risks to buyer to warrant recording a sale Defers sale recognition until sale has occurred

16 Revenue Recognition Before Delivery Long-term construction contracts Percentage of completion Periodic billing Completed contract Only used when percentage method is inapplicable

17 Long-Term Construction Contracts Accounting Methods Percentage of completion Terms of contract must be certain and enforceable Certainty of performance Completed contract Uncertainty Short-term contracts

18 Percentage of Completion Permits periodic billing Amount of gross profit recognized Normally based on percentage of work completed

19 Percentage Completion Steps

20 Example: Percentage Completion

21 Step #1: Percentage Complete

22 Step #2: Current Period Revenue

23 Step #3: Current Period Costs

24 Step #4: Current Period Gross Profit

25 Long-Term Contract Losses Loss in Current Period on a Profitable Contract Losses are recognized in current period under the percentage of completion method Loss on an Unprofitable Contract Expected contract loss is recognized in current period under either method

26 Activity Ratios Receivables turnover ratio Inventory turnover ratio Asset turnover ratio

27 Activity Ratios

28 Profitability Ratios Profit margin on sales Return on assets Return on shareholders’ equity

29 Profitability Ratios