1. Gabriela H. Schneider, CMA; Grant MacEwan College
INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK
Prepared by:
Gabriela H. Schneider, CMA; Grant MacEwan College 2

2. C H A P T E R 6
Revenue Recognition

3. 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.

4. 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.

5. 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.

6. Revenue Recognition Current Environment Earnings Process
Revenue recognition criteria
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
Measurement Uncertainty
Sales with buy-back
Sales when right of return exists
Trade loading and channel stuffing
Uncertainty Associated with Collectibility
Instalment sales
Instalment method
Cost recovery method

7. Guidelines for Revenue Recognition
Revenue is recognized based on two criteria:
Performance
Collectibility
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 cash

8. Four Types of Revenue Transactions
Revenue 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 sale

9. Risks and Rewards Risks 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 occurred

10. Revenue Recognition at Point of Sale
Revenues 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 revenues

11. Consignment Sales
Possession has transferred; however legal title remains with the seller
Risks and rewards have not transferred
Seller acts as an agent
Goods are held by seller as Merchandise on Consignment
Not held as inventory on consignee’s books

12. Consignment Sales 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 $$$
Relevant Expenses $$
Revenue $$$
Receipt of Cash from Sale
Cash $$$
Accounts Receivable $$$
Cost of Goods Sold $$$
(Note: cost includes freight)
No Entry
Notification/Payment of Sale
Cash $$$
Payable to Consignor $$$

13. Revenue Recognition Before Delivery
Revenue 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 inapplicable

14. Contract Accounting Long-Term Construction Accounting 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 contracts

15. Percentage Completion: Concept
Percentage 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)

16. 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 4

17. Percentage Completion: Cost-to-Cost Basis
Data: Contract price: $4,500,000 Estimated cost: $4,000,000
Start date: July, Finish: October, 2003
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

18. Percentage Completion: Cost-to-Cost Basis
$4,500, $4,500, $4,500,000
Contract Price
1,000, ,916, ,050,000
3,000, ,134,
4,000, ,050, ,050,000
Estimated Costs:
To Date
Est. Cost to Complete
Est. Total Costs
$ 500, $ 450, $ 450,000
Estimated Total Gross
Profit
25% % %
1,000, ,916, ,050,000
4,000, ,050, ,050,000
Percent Complete

19. Percentage Completion: Cost-to-Cost Basis
$4,500, $4,500, $4,500,000
Contract Price
25% % %
Percent Complete
$1,125, $3,240, $4,500,000
,125, ,240,000
$1,125, $2,115, $1,260,000
Revenue Recognized:
Current Year
Less: Prior Year
= Revenue
$ 125, $ 324, $ 450,000
, ,000
$ 125, $ 199, $ 126,000
Gross Profit Recognized:
Current Year
Less: Prior Year
= Revenue

20. Completed-Contract Method
Revenue and gross profit recognized on completion of contract
Advantage: reported revenue is based on actual results, not estimates
Disadvantage: does not reflect current performance; creates distortion of earnings
Progress billings are reported contra to ‘Construction in Progress’ account on the Balance Sheet
Construction in Progress used to accumulate contract costs

21. 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 recognized
Under the completed contract method, losses are recognized only when overall losses result

22. 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
Completed Method:
Recognize entire loss now

23. Percentage Method: Interim Loss on Profitable Contract - Example
Data as previously given, except for the 2002 cost estimate
$4,500, $4,500, $4,500,000
Contract Price
1,000, ,916, ,384,962
3,000, ,468,
4,000, ,384, ,384,962
Estimated Costs:
To Date
Est. Cost to Complete
Est. Total Costs
25% % %
1,000, ,916, ,384,962
4,000, ,384, ,384,962
Percent Complete
Revenue recognized in 2002: $4,500,000 * 66.5% = $2,992,500
Less: amount recognized in ,125,000
1,867,500
Less: actual costs incurred in ,916,000
Loss recognized in ,500

24. Percentage Method: Interim Loss on Profitable Contract – Example
Record loss for 2002:
Construction Expense ,916,000
Construction in Process (loss) 48,500
Revenue from Long-Term Contract ,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 2002

25. Percentage Method: Interim Loss on Overall Unprofitable Contract – Example
Data as previously given, except for the 2002 cost estimate
$4,500, $4,500, $4,500,000
Contract Price
1,000, ,916, ,556,250
3,000, ,640,
4,000, ,556, ,556,250
Estimated Costs:
To Date
Est. Cost to Complete
Est. Total Costs
25% % %
1,000, ,916, Gross Profit
4,000, ,556, (56,250)
Percent Complete
Losses recognized in 2002:
Gross Profit recognized in $125,000
Expected Loss on Unprofitable Contract ,250
$181,250

26. 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%) $2,880,000
Less: revenue recognized in ,125,000
Revenue recognized in ,755,000
Less: loss recognized in ,250
Construction Cost Expense 1,936,250
Construction Expense ,36,250
Construction in Process (loss) ,250
Revenue from Long-Term Contract ,755,000

27. 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.

28. Revenue Recognition after Delivery
Revenue recognition is deferred when collection of sales price is not reasonably assured
The 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

29. The Instalment Sales Method
This method emphasizes income recognition in periods of collection rather than at point of sale
Title 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 deferred

30. The Instalment Sales Method: Special Accounts
Instalment sales must be kept separate
Gross profit on instalment sales must be determinable
The amount of cash collected from instalment accounts must be known
The 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 profit

31. The Instalment Sales Method: Steps
For 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

32. The Instalment Sales Method: Example
Given:
Instalment sales $200,000 $250, $240,000
Cost of sales $150,000 $190, $168,000
Gross Profit $ 50,000 $ 60, $ 72,000
Cash received in:
from 2001 sales $ 60,000 $ 100,000 $ 40,000
from 2002 sales $ $ 100,000 $ 125,000
from 2003 sales $ $ $ 80,000
Determine the realized and deferred gross profit.

33. The Instalment Sales Method: Example
Given:
Instalment sales $200,000 $250, $240,000
Gross Profit $ 50,000 $ 60, $ 72,000
Gross profit rate % % 30%
Realized Gross Profit:
From 2001 sales:
Realized in $15, $25, $10,000
From 2002 sales:
Realized in: $ $24, $30,000
From 2003 sales:
Realized in: $ $ $24,000

34. The Instalment Sales Method: Partial Journal Entries (2001) for Gross Profit
Cost of Sales ,000 Deferred Gross Profit, ,000 (To close 2001 accounts)
Deferred Gross Profit, ,000 Realized Gross Profit ,000 (Realized: $60,000 * 25%)
Realized Gross Profit ,000 Income Summary ,000
(To close to Income Summary)

35. Instalment Sales Accounting Problems
Interest on instalment contracts
Accounted 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-off

36. The Cost Recovery Method
Seller recognizes no profit until cash payments by buyer exceed seller’s cost of merchandise
After 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 amount

37. COPYRIGHT
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