2. CHAPTER 6: REVENUE RECOGNITION

3. Chapter 6: Revenue Recognition
After studying this chapter, you should be able to:
Understand the economics and legalities of selling transactions from a business perspective.
Identify the five steps in the revenue recognition process
Identify the contract with customers
Identify the separate performance obligations in the contract
Determine the transaction price
Allocate the transaction price to the separate performance obligations
Understand how to recognize revenue when the company satisfies its performance obligation
Analyze and determine whether a company has earned revenues under the earnings approach.
Identify other revenue recognition issues
Describe presentation and disclosure regarding revenue
Identify differences in accounts between IFRS and ASPE and potential changes
After studying this Appendix 6A, you should be able to:
Apply the percentage of completion method for long-term contracts
Apply the completed-contract method for long-term contracts

4. Revenue Recognition

5. Understanding Sales Transactions
Accounting for revenues is often very complex
Much of complexity is caused by the structure of the sales transactions
To properly account for sales transactions, accountants must understand the business of the entity and the nature of the transaction
Key questions for understanding the sales transactions from a business perspective are:
What is being given up?
What is being received?
Normally specified in sales agreements
L01 5

6. What is being sold?
Sales transactions often involve transfer of goods, services, or both (known as deliverables)
Accounting is different under each situation
Sale of goods: tangible assets with a finite point when control transfers to buyer (generally with transfer of legal title and possession)
Sale of services: legal title and possession irrelevant
Sale of goods and/or services combinations: complexity in measuring each component of bundled sales or multiple deliverables
L01

7. = What is being received? Value of deliverables sold
Most business transactions are reciprocal, something is given up and something is received
Consideration being received for goods and/or services sold is either:
Cash or cash-like (monetary)
Non-monetary (another good/service, also known as barter)
Generally assume that the transaction is at arm’s length (between unrelated parties) such that
L01
Value of deliverables sold
Value of consideration received =

8. Concessionary Terms
It is critical to understand if sales are done under normal terms, or are special/unusual and contain concessionary terms such as:
Lenient return/payment policy
Selling price is deeply discounted
Continued involvement by the seller
More accommodating credit policy
“Bill and hold” transactions
Inclusion of “extras”
Concessionary terms may create additional obligations, or may indicate that control has not passed to the buyer
L01

9. Legalities
Rights and obligations of sales transactions are described and governed by law
Contract law is most relevant as each sales transaction represents a contract with the customer
Contract creates enforceable obligations and establishes the terms of the deal
Sales contract generally determines the point when legal title and possession of goods sold pass on to the customer:
FOB shipping point
FOB destination
Implicit obligations not specifically outlined in the sales contract (i.e. constructive obligation) may also be enforced under common or other law
L01

10. Revenue/sales is described as:
Sales Transactions
Revenue/sales is described as:
inflow of economic benefits (e.g. Cash, receivables, etc)
arising from ordinary activities
There are two approaches to recognizing sales/revenues:
Asset-liability approach (contract based approach)
Earnings approach
L02

11. Asset-Liability Approach

12. Five-Step Process to Revenue Recognition
L02
Continued…

13. Five-Step Process to Revenue Recognition

14. Identifying the Contract with Customers – Step 1
A contract is an agreement between two or more parties that creates enforceable rights or obligations.
Can be written, oral or implied
L03

15. Identifying the Contract with Customers – Step 1
Upon entering into a contract with a customer, a company obtains rights to receive consideration from the customer and assumes obligations to transfer goods or services to the customer.
A company does not recognize contract assets or liabilities, nor is a journal entry performed, until one or both parties perform their contracted obligations
L03

16. Identifying Separate Performance Obligations – Step 2
Performance obligation is a promise to provide a product or service
Promise may be explicit, implicit or possibly based on customary business practice
L04

17. Identifying Separate Performance Obligations – Step 2

18. 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
Transaction price is usually stated within the contract
Must consider the following:
Variable consideration
Time value of money
Noncash consideration
Consideration paid or payable to the customer
L05

19. Allocating the Transaction Price to Separate Performance Obligations – Step 4
Transaction prices are allocated to performance obligations based on relative fair values
Fair value is what the company could sell the good or service for on a standalone basis (standalone selling price)
If this information is not available, best estimates are used
L06

20. Indicators of control:
Recognizing Revenue when 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:
The company has a right to payment for the asset
The company has transferred legal title to the asset
The company has transferred physical possession of the asset
The customer has significant risks and rewards of ownership
The customer has accepted the asset
L07

21. Summary of the five step revenue recognition process
L07
Continued…

22. Summary of the five step revenue recognition process

23. Earnings Approach
Revenues for the sale of goods are recognized when the following criteria are met:
Risks and rewards of ownership are transferred to the buyer
Seller has no continuing involvement in, nor effective control over the sold goods
Costs and revenues can be reliably measured; and
Collectibility is probable
L08

24. Other Revenue Recognition Issues
There are several situations where revenue recognition issues arise.
This is based on IFRS 15 as ASPE has little specific guidance in these areas
The situations are:
Right of return
Repurchase agreements
Bill and Hold
Principal-agent relationships
Consignments
Warranties
Non-refundable upfront fees
L09

25. Right of Return
Sales with rights of return have long been a challenge in the area of revenue recognition
If there is an expectation that items may be returned, an estimate must be made and accounted for the initial transaction
L09

26. Right of Return
Continued…

27. Right of Return

28. Repurchase Agreements
If a company enters into a repurchase agreement, it will allow them to transfer an asset to customer but have an obligation or right to repurchase the asset at a later date
Raises the question, “did the company actually sell the asset?”
Generally reported as a financing transaction (borrowing)
L09

29. Bill-and-Hold Arrangements
A contract under which one entity bills a customer for a product but the entity retains physical possession of the product until it is transferred to the customer at a point in the future
May occur when the purchasing company has limited available space for the product, delays in their production schedule, more than sufficient inventory in its distribution channel
L09

30. Principal-Agent Relationships
Principals obligation = provide goods or services to the customer
Agents obligation = arrange for the principal to provide goods or services to the customer
In these situations, amounts collected on behalf of the principal are not revenue of the agent
Usually commission is paid and the agent would record this as their revenue
L09

31. Consignment Sales Consignor ships inventory to the consignee
The consignee acts as an agent to sell the inventory
Possession has transferred; however legal title remains with the seller
Risks and rewards have not transferred
Goods are held by seller as “Inventory on Consignment”
Not held as inventory on consignee’s books
When merchandise sold, the consignee remits cash to the consignor (after deducting commission and other chargeable expenses)
L09

32. Consignment Sales – Earnings
Consignor’s Books
Consignee’s Books
Goods shipped to Consignee
Inventory on Consignment $$$
Finished Goods Inventory $$$
Payment of Freight
Inventory on Consignment $$$
Cash $$$
Notification of Sale
Accounts Receivable $$$
Relevant Expenses $$$
Consignment Sales $$$
Cost of Goods Sold $$$
Inventory on Consignment $$$
(Note: cost includes freight)
Receipt of Cash from Sale
Cash $$$
Accounts Receivable $$$
No Entry
Notification/Payment of Sale
Cash $$$
Payable to Consignor $$$
Remittance to Consignor
Commission Revenue $$$
Cash $$$
L09

33. Warranties
Companies often provide one of two types of warranties to customers:
Warranties that the product meets agreed-upon specifications in the contract at the time the product is sold
This type of warranty is included in the sales price of a company’s product (assurance type warranty)
Warranties that provide an additional service beyond the assurance-type warranty
This type of warrant is not included in the sales price of a company’s product (service type warranty)
L09

34. Non-refundable Upfront Fees
Companies sometimes receive payments (upfront fees) from customers before they deliver a product or perform a service
Generally relate to the initiation, activation or setup of a good or service to be provided or performed in the future
In most cases the upfront payment is non- refundable
L09

35. Presentation and Disclosure
Contract assets and contract liabilities must be recorded on the balance sheet
There are two types of contract assets
Unconditional rights to receive consideration
Conditional rights to receive consideration
A contract liability is a company’s obligation to transfer goods or services to a customer for which the company has received consideration from the customer
If it is probable that the transaction price will not be collected, this is an indication that the parties are not committed to their obligations
As long as a contract exists the amount recognized as revenue is not adjusted for customer credit risk
L10

36. Presentation and Disclosure
The disclosure requirements for revenue recognition are designed to help financial statement users understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers
To achieve this, companies disclose quantitative and qualitative information about the following:
Contracts with customers
Significant judgements
Assets recognized from costs incurred to fulfil a contract
L10

37. IFRS/ASPE Comparison
L11

38. IFRS/ASPE Comparison

39. IFRS/ASPE Comparison

40. IFRS/ASPE Comparison

41. IFRS/ASPE Comparison

42. Percentage-of-Completion: Earnings Approach
The amount of revenues, costs and gross profit recognized on long term contracts depends upon the percentage of work done
Application of percentage-of-completion method requires a basis for measuring the progress toward completion at interim dates, and is based on significant judgement
Can use input measures (e.g. costs incurred—which is the most popular method—or labour hours worked)
Can use output measures (e.g. storeys of a building completed, tonnes produced)
L012

43. Percentage-of-Completion: Steps
Costs incurred to date = Percent complete
Most recent estimated total costs 1
Percent complete x Estimated total revenue (or GP) =
Revenue to be recognized to date 2
Revenue (or GP) to be recognized to date –
Revenue (or GP) recognized in prior periods =
Current period revenue (or GP)*
*Current period revenue – Current costs = Gross Profit 3 4
L012

44. Percentage-of-Completion: Cost-to-Cost Basis
Data: Contract price: $4,500,000 Estimated cost: $4,000,000
Start date: July, Finish: October, 2019
Balance sheet date: December 31st
Given:
Costs to date $1,000,000 $2,916,000 $4,050,000
Estimated costs to complete $3,000,000 $1,134,000 $
Progress billings during year $ 900,000 $2,400,000 $1,200,000
Cash collected during year $ 750,000 $1,750,000 $2,000,000
L012

45. Percentage-of-Completion: Cost-to-Cost Basis
$4,500, $4,500, $4,500,000
Contract Price (a)
1,000, ,916, ,050,000
3,000, ,134,
4,000, ,050, ,050,000
Less: Estimated Costs
Costs to Date
Est. Cost to Complete
Est. Total Costs (b)
25% % %
1,000, ,916, ,050,000
4,000, ,050, ,050,000
Percent Complete
$ 500, $ 450, $ 450,000
Estimated Total Gross
Profit (a – b)
L012

46. Percentage-of-Completion: Cost-to-Cost Basis
1,750,000
750,000
Accounts Receivable
Cash
To record collections:
2,400,000
900,000
Billings on Construction in Process
To record progress billings:
1,916,000
1,000,000
Materials, Cash, Payables
Construction in Process
To record cost of construction:
2018
2017
L012
Note: Journal entries for 2016 are not shown due to space limitations

47. Percentage-of-Completion: Cost-to-Cost Basis
$4,500, $4,500, $4,500,000
Contract Price (a)
25% % %
Percent complete (b)
$1,125, $3,240, $4,500,000
,125, ,240,000
$1,125, $2,115, $1,260,000
Revenue recognized:
Revenue to date (a x b)
Less: Prior years revenue
Current year revenue
Gross profit recognized:
G.P. to date (Total x %)
Less: G.P. in prior years
Current year G. P.
L012
$ 125, $ 324, $ 450,000
, ,000
$ 125, $ 199, $ 126,000

48. Percentage-of-Completion: Cost-to-Cost Basis
199,000
125,000
Construction in Process
1,916,000
1,000,000
Construction Expenses
4,500,000
Billings on Construction in Process
To record completion of contract
(recorded on completion date in 2016):
2,115,000
1,125,000
Revenue from Long-Term Contract
To recognize revenue and gross profit:
2018
2017
L012
Note: Some journal entries for 2016 are not shown due to space limitations

49. Percentage-of-Completion: Financial Statement Presentation
The difference between “Construction in process” and “Billings on construction in process” is recorded on the Balance Sheet as either:
Current asset* (with Inventories) if difference is a debit balance or
Current liability* if difference is a credit balance
*May be non-current depending on length of contract
L012

50. Percentage-of-Completion: Financial Statement Presentation
The balance in the Construction in Process account represents the costs incurred + gross profit recognized to date
The balance in the Billings on Construction in process represents the billings made to customers to date
L012

51. Completed-Contract Method: Earnings Approach
Revenue and gross profit are recognized on the completion of the contract
Advantage: reported revenue is based on actual results, not estimates
Disadvantage: does not reflect current performance; creates distortion of earnings
All journal entries are the same as the percentage-of-completion method except that no entry is recorded at the end of the period to recognize revenue and gross profit
IFRS does not address this method explicitly (unlike ASPE)
L013

52. Comparison of Results (Gross Profit Recognition)
Year
Percentage-of- Completion
Completed- Contract
2017
$125,000 $
2018
199,000
2019
126,000
450,000
L013
Total
$450,000
$450,000

53. Long-Term Contract Losses
A long-term contract may produce either:
an interim loss on a profitable contract or
an overall loss on unprofitable contract
Under the percentage-of-completion method, all losses are immediately recognized
Under the completed-contract method, losses are recognized only when overall losses result
L013

54. Recognizing Current and Overall Losses on Long-Term Contracts
Percentage Method:
Recognize loss currently
Current Loss on
an otherwise
overall profitable
contract
Completed Method:
No adjustment needed
Percentage Method:
Recognize entire loss now
Loss on an
overall unprofitable
contract
L013
Completed Method:
Recognize entire loss now

55. Percentage Method: Interim Loss on Profitable Contract–Example
Data as previously given, except for the 2017 cost estimate
$4,500, $4,500, $4,500,000
Contract Price
1,000, ,916, ,384,962
3,000, ,468,
4,000, ,384, ,384,962
Costs to date
Est. Cost to Complete
Est. Total Costs
25% % %
1,000, ,916, ,384,962
4,000, ,384, ,384,962
Percent Complete
Cost to date (12/31/2018) $2,916,000
Estimated costs to complete (revised) ,468,962
Estimated total costs 4,384,962
Percent complete (2,916,000 / 4,384,962) ½%
Revenue recognized in 2018
(4,500,000 x 66 ½% ) – 1,125,000 $1,867,500
Costs incurred in ,916,000
Loss recognized in $48,500
L013

56. Percentage Method: Interim Loss on Profitable Contract–Example
Record loss for 2018:
Construction Expenses ,916,000
Construction in Process (loss) ,500
Revenue from Long-Term Contract ,867,500
Under the percentage-of completion method the Loss
of $48,500 is reported on the Income Statement in 2017
Under the completed-contract method, no loss would be
recognized in 2017
L013