1. Complexities of Revenue Recognition

2. Learning Objectives
Identify the primary criteria for revenue recognition.
Explain when revenue is appropriately recognized prior to delivery of goods or services through percentage-of-completion accounting.
Record journal entries for long-term construction-type contracts using percentage-of-completion and completed-contract methods.

3. Learning Objectives
Record journal entries for long-term service contracts using the proportional performance method.
Explain when revenue is recognized after delivery of goods or services through installment sales, cost recovery, and cash methods.

4. Learning Objectives
EXPANDED MATERIAL:
Describe accounting for the transfer of assets prior to the recognition of revenue with the deposit method and consignment sales.

5. Revenue Recognition Criteria
FASB’s two criteria for recognizing revenues and gains:
They are realized or realizable, and
They have been earned through substantial completion of the activities involved in the earnings process. 2

6. Revenue Recognition Criteria
This most often occurs when goods are delivered or when services are rendered.
Both of these criteria generally are met at the point of sale.

7. Revenue Recognition--Exceptions
A product or service was provided without receiving a valid promise of payment from customer.
The company has not provided the product or service. 3

8. Revenue Recognition--IAS 18
A company should recognize revenue from the SALE OF GOODS when all of the following conditions have been satisfied:
The significant risks and rewards of ownership of the goods have been transferred to the buyer and the selling company retains no effective control over what happens to the goods,
Both the amount of the revenue and of the costs associated with the transaction can be reliably measured, and
It is probable that the economic benefits of the sale will flow to the selling company.

9. Revenue Recognition--IAS 18
A company should recognize revenue from the RENDERING OF SERVICES when both of the following conditions have been satisfied:
The total amount of the revenue, the total amount of the costs, and the stage of completion of the transaction can be reliably measured, and
It is probable that the economic benefits of the transaction will flow to the company rendering the services.

10. Revenue Recognition--Exceptional Cases
Long-Term Contracts
Uncertain Collections
Deposit Method
Consignment Sales

11. Long-Term Contracts--Recognition Choices
Completed-Contract Method: recognize all income when project is completed.
Percentage-of-Completion Method: recognize revenue throughout the term of the contract.
GAAP requires percentage-of-completion method unless certain criteria are not met. 6

12. Percentage-of-Completion Criteria
Dependable estimates of:
revenues.
costs.
progress toward completion.
Contract clearly specifies:
enforceable rights of the parties.
consideration to be exchanged.
manner and terms of settlement. 7

13. Percentage-of-Completion Criteria
The buyer can be expected to satisfy obligations under the contract.
Contractor can be expected to perform the contractual obligation. 8

14. Percentage-of-Completion--General Concepts
Recognize revenue throughout life of the contract.
Revenue recognized is a function of how complete the project is.
Costs are charged to an inventory account: Construction in Process (CIP).
Profits are charged to CIP.
CIP is valued at net realizable value.
Any anticipated loss is booked for the full amount of the loss when it becomes measurable. 9

15. Percentage-of-Completion
Input measures: Cost-to-cost method where the degree of completion is determined by comparing costs already incurred with the most recent estimates of total expected costs to complete the project.
Engineers are often called in to help provide estimates. 10

16. Percentage-of-Completion
2001 __
2002
2003
Costs incurred to date
$ 72,000
$192,000
$240,000
At the beginning of the contract, costs are expected to be incurred each year as shown. 11

17. Percentage-of-Completion
2001 _
2002
2003
Costs incurred to date
$ 72,000
$192,000
$240,000
Total estimated costs
$240,000
Estimated costs to complete
168,000
48,000
Total cost of the project at completion is expected to be $240,000. The difference between the costs incurred to date and the total estimated costs at completion is defined as the estimated costs remaining to complete the project. 12

18. Percentage-of-Completion
2001
2002
2003
Costs incurred to date
$ 72,000
$192,000
$240,000
Estimated costs to complete
168,000
48,000
Total estimated costs
$240,000
$240,000
$240,000
Percentage complete
30%
80%
100%
Percentage complete is the ratio of costs incurred to date to total estimated costs at completion. 13

19. Percentage-of-Completion
2001
2002
2003
Costs incurred to date
$ 72,000
$192,000
$240,000
Estimated costs to complete
168,000
48,000
Total estimated costs
$240,000
$240,000
$240,000
Total Contract $300,000
Percentage complete
30%
80%
100%
Estimated total income
$ 60,000
$ 60,000
Estimated total income is the difference between the contract price and total expected costs. Assume the contract price in this example is $300,000. 14

20. Percentage-of-Completion
2001
2002
2003
Costs incurred to date
$ 72,000
$192,000
$240,000
Estimated costs to complete
168,000
48,000
Total estimated costs
$240,000
$240,000
$240,000
Percentage complete
30%
80%
100%
Estimated total income
$ 60,000
$ 60,000
$ 60,000
Estimated total income to date
$ 18,000
$ 48,000
$ 60,000
Estimated total income to date is computed based on the cumulative percentage complete. 15

21. Percentage-of-Completion
2001
2002
2003
Costs incurred to date
$ 72,000
$192,000
$240,000
Estimated costs to complete
168,000
48,000
Total estimated costs
$240,000
$240,000
$240,000
Income recognized in the current period is the difference between total income to date and income previously recognized.
Percentage complete
30%
80%
100%
Estimated total income
$ 60,000
$ 60,000
$ 60,000
Estimated total income to date
$ 18,000
$ 48,000
$ 60,000
Less:Iincome previously recognized
18,000
48,000
Income recognized this period
$ 18,000
$ 30,000
$ 12,000 16

22. Percentage-of-Completion
2001
2002
2003
Costs incurred to date
$ 72,000
$192,000
$240,000
Estimated costs to complete
168,000
48,000
Total estimated costs
$240,000
$240,000
$240,000
Percentage complete
30%
80%
100%
Estimated total income
$ 60,000
$ 60,000
$ 60,000
Estimated total income to date
$ 18,000
$ 48,000
$ 60,000
Less: Income previously recognized
18,000
48,000
Income recognized this period
$ 18,000
$ 30,000
$ 12,000

23. Percentage-of-Completion
2001
Construction in Progress…………. 72,000
Materials, Cash, etc………… ,000
To record costs incurred.
Accounts Receivable…………….. 100,000
Progress Billings on
Construction Contracts……… 100,000
To record billings (amount assumed).
Cash………………………………. 90,000
Accounts Receivable………….. 90, To record cash collections (amount assumed).

24. Percentage-of-Completion
2002
Construction in Progress………… 120,000
Materials, Cash, etc………… ,000
To record costs incurred.
Accounts Receivable……………. 140,000
Progress Billings on
Construction Contracts…… ,000
To record billings (amount assumed).
Cash……………………………… 125,000
Accounts Receivable………… 125,000
To record cash collections (amount
assumed).

25. Percentage-of-Completion
2003
Construction in Progress…………. 48,000
Materials, Cash, etc………… ,000
To record costs incurred.
Accounts Receivable…………….. 60,000
Progress Billings on
Construction Contracts……… 60,000
To record billings (amount assumed).
Cash………………………………. 85,000
Accounts Receivable………… ,000 To record cash collections (amount
assumed).

26. Revenue Recognition--Exceptional Cases
Long-Term Contracts
Uncertain Collections
Deposit Method
Consignment Sales

27. Uncertain Collections--Recognition Alternatives
Installment Sales Method: Recognizes revenues and related expenses as cash is received (used when collection is somewhat uncertain).
Cost Recovery Method: No income is recognized on sale until the cost of the item sold is recovered through cash receipts (used when collection is very uncertain).
Cash Method: Recognizes all expenses immediately as incurred and all revenues only when cash is collected. 18

28. Uncertain Collections--Comparison of Recognition Methods
Timing of Revenue
Treatment
Method
Recognition
of Costs
Full Accrual
At point of sale
Revenue at point of sale
Installment Sales
At collection of cash (portion of receipt)
Defer and match
against revenue as
cash is collected
Cost Recovery
At collection of cash
(after all costs have
been recovered)
Defer and match
against cash
receipts
Cash
At collection of cash
Charge to expense
as incurred 19

29. Installment Sales Method
The installment sales method is used most commonly in cases of real estate sales.

30. Example: Installment Sales Method
George sells merchandise on the installment basis. Uncertainty of collection makes use of the installment method necessary. Use the accompanying data to prepare George’s journal entries. 24

31. Example: Installment Sales Method
Sales
Cost of Sales
Gross Profit
Percentage
$ $200
$ 50 $ 60
33.33% %
Cash Collection
2001 Sales $ $ 75
2002 Sales $ 70 25

32. Example: Installment Sales Method
2001:
Accounts Receivable--2001……
Installment Sales………………
Cost of Installment Sales………
Inventory………………………
Cash……………………………… 30
Accounts Receivable--2001… 26

33. Example: Installment Sales Method
2001:
Installment Sales…………………. 150
Cost of Installment Sales………
Deferred Gross Profit--2001…
Deferred Gross Profit--2001……
Realized Income………………
($30 x 33.33%)

34. Example: Installment Sales Method
2002:
Accounts Receivable--2002……….. 200
Installment Sales………………… 200
Cost of Installment Sales………….. 140
Inventory………………………… 140
Cash………………………………
Accounts Receivable--2001……
Accounts Receivable--2002…… 31

35. Example: Installment Sales Method
2002:
Installment Sales…………………
Cost of Installment Sales………
Deferred Gross Profit--2002……
Deferred Gross Profit--2001………. 25
Deferred Gross Profit--2002………. 21
Realized Gross Profit on
Installment Sales……………… 34

36. Example: Cost Recovery Method
Assume George has to use the cost recovery method, but all sales and collections remain the same. 36

37. Example: Cost Recovery Method
2002:
All entries are the same except do not book the entry to gross profit.
Deferred Gross Profit--2001……….. 5
Realized Gross Profit on
Installment Sales……………….. 5 37

38. Revenue Recognition--Exceptional Cases
Long-Term Contracts
Uncertain Collections
Deposit Method
Consignment Sales

39. Deposit Method--General Requirement
Used when cash is received before a sale is completed.
All revenue is initially deferred.
Seller retains property sold as a recognized asset until sale is completed.
Revenue is recognized when sale is completed. 40

40. Deposit Method and Franchises
Relates primarily to initial franchise fees.
Franchiser defers initial fee at time cash is received.
Franchiser recognizes initial fee revenue when “substantial performance” of services is achieved.
Franchiser may use any appropriate recognition method once substantial performance is achieved. 41

41. Example: Franchise
Mary sells Bob a franchise for $1,000 cash on June 1. Substantial performance is agreed upon that Mary will complete $700 of renovation on Bob’s restaurant (which occurs on July 10). Prepare Mary’s journal entries. 42

42. Example: Franchise June 1 Cash……………………………... 1,000
Deposit on Franchise (or
Unearned Franchise Fee)…... 1,000
July 10
Cost of Franchise Fee Revenue…
Cash…………………………
Deposit on Franchise (or
Unearned Franchise Fee)……… 1,000
Franchise Fee Revenue……... 1,000 43

43. Revenue Recognition--Exceptional Cases
Long-Term Contracts
Uncertain Collections
Deposit Method
Consignment Sales 45

44. Consignment Sales-- General Principles
Definitions:
Consignee: Title holder/seller of merchandise.
Consignor: Merchandise selling agent.
Consignor does not recognize revenue upon shipment to consignee.
Consignor accounts for consigned goods in separate Inventory on Consignment account. 46

45. Consignment Sales-- General Principles
Consignee does not recognize consigned goods as inventory.
Consignor records all pre-sale expenses as Inventory on Consignment.
Consignor recognizes revenue when informed of a sale by consignee.
Consignee recognizes revenue only for consignment commission. 47

46. Example: Consignment Sales
Bob agrees to consign goods worth $1,000 to Lucy. Lucy agrees to sell the goods at her store for a 5 percent of net sales consignment commission and reimbursement of selling expenses.
The next several slides demonstrate the transactions and journal entries for Bob and Lucy throughout the consignment cycle. (All numbers are assumed.) 48

47. Example: Consignment Sales
Transaction: Shipment of Goods
Entry in Bob’s (consignor’s) books:
Inventory on Consignment…… 1,000
Finished Goods Inventory….. 1,000
Entry in Lucy’s (consignee’s) books:
None--memorandum inventory control record. 49

48. Example: Consignment Sales
Transaction: Incurrence of $200 of selling expenses by Lucy.
Entry in Bob’s books:
Inventory on Consignment…
Consignee Payable………
Entry in Lucy’s books:
Consignor Receivable………
Cash……………………… 50

49. Example: Consignment Sales
Transaction: Sale of merchandise for $2,000.
Entry in Bob’s books:
None.
Entry in Lucy’s books:
Cash……………………… 2,000
Consignor Payable…….. 2,000 51

50. Example: Consignment Sales
Transaction: Lucy notifies Bob of the sale and sends him net cash proceeds.
Entry in Bob’s books:
Commission Expense…………
Cash…………………………….. 1,700
Consignee Payable……………
Cost of Goods Sold…………….. 1,000
Consignment Sales Revenue…. 2,000
Inventory on Consignment…… 1,000 52

51. Example: Consignment Sales
Entry in Lucy’s books:
Consignor Payable…………. 2,000
Cash………………………. 1,700
Commission Revenue……
Consignor Receivable…… 54

52. The End