1. Chapter 18 Revenue Recognition ACCT-30301

2. 1. Revenue Recognition Basic Concepts Definition of revenue (SFAC 6) ◦ Inflows or other enhancements of assets or settlement of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. General recognition criteria (SFAC 5) ◦ meets definition of an element ◦ measurability ◦ relevance ◦ faithful representation ACCT-30302

3. 1a. Revenue Recognition Basic Concepts APB Statement 4 ◦ Revenue is recognized when  the earnings process is complete or virtually complete  an exchange has taken place Realization principle (SFAC 5) ◦ Revenue is recognized when  the earnings process is judged to be complete or virtually complete  there is reasonable certainty as to the collectability of the asset to be received ACCT-30303

4. 1a. Revenue Recognition Basic Concepts SEC SAB 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 ◦ collectability is reasonably assured ACCT-30304

5. 2. General Rule Revenue is recognized at the point of sale ACCT-30305 ActivityRevenue recognized when Selling productsPoint of sale (date of delivery; when title passes) Providing servicesServices have been performed and amounts are billable Permitting others to use the firm’s assets As time passes Disposing of assetsDate of sale

6. 3. Possible Points to Recognize Revenue Most significant event Recognition before point of sale ◦ prior to starting production  customer advances ◦ during production  long-term construction contracts ◦ at completion of production  precious metals, ag products Recognition at point of sale ◦ but if right of return exists or sale with buyback Recognition after point of sale ◦ cash collection methods  installment sales, cost recovery basis ◦ consignments ACCT-30306

7. 4. Expense Recognition Expense – expired economic benefits Outflows or other using up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. (SFAC 6) Expenses to be recognized can be identified by ◦ matching ◦ direct expensing (period costs) ◦ systematic allocation ACCT-30307

8. 5. Revenue Frauds Obvious accounting violations ◦ Fictitious sales or fake customers ◦ Premature recording of sales ◦ Inflated sales Transactions lacking integrity ◦ Roundtrip transactions ◦ Channel stuffing and trade loading ◦ Bill and hold transactions ◦ Related party transactions Contracts, agreements and side letters ACCT-30308

9. 6. Long-term Construction Contracts Percentage of completion method ◦ revenue recognized each period based on progress of construction ◦ this method required if  costs to complete and extent of progress toward completion are reasonably dependable  contract clearly specifies goods or services to be provided & received by parties  buyer is expected to satisfy its contractual obligations  contractor is expected to perform its contractual obligations ACCT-30309

10. 6a. Long-term Construction Contracts Methods to estimate percentage of completion ◦ cost-to-cost method (input method)  costs to date ÷ total estimated costs to complete  most common method ◦ machine hours or labor hours (input measure) ◦ project milestones (output method) ◦ units of production (output method) ◦ engineer’s or architect’s estimates ACCT-303010

11. 6b. Long-term Construction Contracts Revenue and GP recognized per period ◦ percentage completed this period x total revenue or GP ◦ new accounts  construction in progress (inventory account)  progress billings (contra acct to CIP) ◦ financial statement presentation  net both accounts – could be debit or credit balance ◦ example example ACCT-303011

12. 7. Completed contract method Revenues and gross profit recognized when project finished Entries ◦ same entries to record costs and billings ◦ do not recognize revenue and gross profit each year The two methods are not acceptable alternatives Example ACCT-303012

13. 8. Right of Return Only recognize revenue if all of following are met (SFAS 48) ◦ sellers price is fixed ◦ buyer has paid or is obligated to pay ◦ buyer’s obligation would not be changed by the theft or destruction of the product ◦ buyer has economic substance apart from that provided by the seller ◦ seller doesn’t have future significant obligations ◦ amount of future returns can be reasonably estimated ACCT-303013

14. 9. Cash Collection Methods Emphasis placed on collection rather than on sale APB 10 ◦ generally states both methods are not acceptable ◦ but in certain exceptional circumstances may be used ACCT-303014

15. 9a. Cash Collection Methods Installment Sales Method ◦ Emphasis placed on collection rather than on sale  revenue recognized in periods of collection  more important method for tax than fin acct ◦ Example Example ACCT-303015

16. 9b. Cash Collection Methods Cost recovery method ◦ No gross profit recognized until all costs have been recovered ◦ After all costs recovered  all additional cash received recorded as profit ◦ Example ACCT-303016

17. 10. Multiple Deliverables Revenue must be allocated to various elements based on FMVs if they are separable Considered separable if ◦ items have value on a stand-alone basis ◦ there is a general right of return ◦ delivery is considered probable Examples ◦ IT equipment and software ◦ franchises ACCT-303017