2. Intermediate Financial Accounting I Revenue Recognition

3. Income Measurement And Profit Analysis2 Objectives of the Chapter 1. Discuss the revenue recognition principle and the problems associated with revenue recognition at point of sale. 2. Discuss the cases that revenue is recognized at a point other than at point of sale (i.e., before delivery). 3. Study the percentage-of-completion method for long-term contracts.

4. Income Measurement And Profit Analysis3 Objectives of the Chapter (contd.) 4. Study the completed-contract method for long-term contracts. 5. Discuss the installment method of accounting. 6. Study the accounting treatments for franchise, software sales and consignment.

5. Income Measurement And Profit Analysis4 Revenue Recognition Principle (SFAS No. 5) (-An Accrual Basis) n Revenue is recognized when it is earned and realized or realizable (SFAC 5, par. 83). n Earned : the entity has substantially accomplished what it must do to be entitled to compensation. n Realized: goods are exchanged for cash or claims. n Realizable: assets received as compensation are readily convertible into cash or claims to cash. n In general, these conditions are met at time of sale (delivery) or when services are rendered (SFAC 5, par. 84). n.n.

6. Income Measurement And Profit Analysis5 Revenue Recognition Principle n Other conditions for revenue recognition (Staff Accounting Bulletin No. 101(1999)): n Persuasive evidence of a sale. n Price is fixed or determinable. n Collectibility is reasonably assured. n Delivery has occurred or services have been rendered.

7. Income Measurement And Profit Analysis6 Impact of SAB 101 on Revenue Recognition for Service Industry n FedEx: Recognizes revenue upon delivery of shipments (not during the packing, loading or transporting). n United Airlines (UA): (Accounting Changes) Beginning Q1, 2000, UA recognizes mileage sale through Citibank credit card or long- distance phone companies after the transportation is provided, not when mileage were sold. n Others: season tickets, annual membership, etc.

8. Income Measurement And Profit Analysis7 Type of Transactions n Sale of product from Inventory: revenue recognized at time of sale. n Rendering a service: revenue recognized when services have been performed and billable. n Permitting use of an asset: revenue (i.e., interest, rents and royalties) recognized as time passes or assets are used. n Sale of asset other than inventory: gain or loss recognized at date of sale or trade-in.

9. Income Measurement And Profit Analysis8 Problems Associated with Revenue Recognized at Point of Sale (Delivery) 1.Sales with buyback agreements: inventory should remain on the seller’s book and no revenue can be recognized. 2a. Sales with right of return exists: Revenue recognized if expecting insignificant amount of returns.

10. Income Measurement And Profit Analysis9 Problems Associated with Revenue Recognized at Point of Sale (contd.) 2b. Sales with right of return: When expecting high sales returns, no revenue can be recognized unless the following six conditions are met. (i)Sales price is determined; (ii)Buyers have paid or have the obligations to pay;

11. Income Measurement And Profit Analysis10 Problems Associated with Revenue Recognized at Point of Sale (contd.) 2b. Sales with right of return (contd.) (iii)The buyers’ obligation would not be changed due to theft of damage of the product after sales; (iv)Sellers are not responsible for the performance of the product; (v)Buyers and sellers are two separate economic entities; (vi)The amount of returns can be estimated.

12. Income Measurement And Profit Analysis11 Problems Associated with Revenue Recognized at Point of Sale (contd.) 3. Trade loading: Manufacturers reduced the price for wholesale at the fiscal year end to create instant sales. The wholesaler is loaded with more inventory than it can promptly resell.

13. Income Measurement And Profit Analysis12 Revenue Recognition over Time (during the earnings process) and others n 1. During the production process(i.e., long-term contract): accounting methods of revenue recognition are percentage-of completion method and completed-contract method. n 2. At the completion of production (i.e., for agriculture products and precious metals).

14. Income Measurement And Profit Analysis13 Revenue Recognition after Delivery n 3. Installment Sales: revenue recognized after time of sale (delivery) as cash is collected. n 4. Revenue recognition delayed until a future event occurred (i.e., real estate sale, sale of division). Accounting method: Deposit method.

15. Income Measurement And Profit Analysis14 Conditions for Revenue to Be Recognized at Completion of Production n Market is reasonably assured; n Costs of selling and distribution are insignificant and can be estimated; n Production, not sale, is considered to be the most critical event in the earning process.

16. Income Measurement And Profit Analysis15 Conditions for Revenue to Be Recognized at Completion of Production (contd.) n Example: Revenue is recognized when precious metals are mined or when agricultural crops are harvested because all conditions are met.

17. Income Measurement And Profit Analysis16 Conditions for Recognizing Revenue during Production n Buyers can be identified and price has been agreed on; n Future costs can be estimated and significant portion of service has been performed; n The collectability of cash can be reasonable assured;

18. Income Measurement And Profit Analysis17 Conditions for Recognizing Revenue during Production n The contract specifies the rights about goods or services to be performed and received by both parties; n Both parties are expected to fulfil their obligations (AICPA statement of position 81).

19. Income Measurement And Profit Analysis18 n If all conditions are met, the percentage-of-completion (P-O-C) method must be applied to recognize construction revenue prior to the completion date. n If conditions are not met, the completed-contract method will be applied to recognize revenue at or after the completion date. Choice of P-O-C vs. C-C Method

20. Income Measurement And Profit Analysis19 n Example: For long-term construction contract, when all conditions are met, the P-O-C method is used to account for construction revenue and construction expenses. Choice of P-O-C vs. C-C Method (contd.)

21. Income Measurement And Profit Analysis20 Financial Reporting of Long-Term (Construction) Contract n Percentage-of-completion method: revenue is recognized according to the percentage of completion. The percentage of completion is computed based on costs. n Completed-contract method: postpone the revenue recognition until time of sale.

22. Income Measurement And Profit Analysis21 Example A: (Long-Term Construction Contract) 1. 500=100+400 2. 550=100+186+264 3. 600=100+186+314 (actual) 4. 20% = 100/500 5. 52% = (100 + 186)/550 6. 100%=(100+186+314)/ 600 Contract Price = $700

23. Income Measurement And Profit Analysis22 Example A (contd.) Partial Cash Year Billings Collection x1$ 80$ 50 x2350330 x3 270 320 Total$700$700

24. Income Measurement And Profit Analysis23 Example A (contd.) 1.$140 = 700 x 20% (contract price x cumulative % of completion) 2.364 = 700 x 52% 3.700 = 700 x 100% 4.140 = 140 - 0 (cumulative revenue - previous years’ revenue) 5.224 = 364 -140 6.336 = 700 - 140 - 224 7.Current expense = construction costs incurred 8.Net Income = current revenue - current expense (P-O-C) 23

25. Income Measurement And Profit Analysis24 Example A (contd.) n An alternative method to compute the gross profit:

26. Income Measurement And Profit Analysis25 Example A - Journal Entries (P-O-C) Note: Progress Billings = Billings on Construction construction contract 25

27. Income Measurement And Profit Analysis26 Example A - Journal Entries (P-O-C) (contd.) Note: Construction Expense = Cost of Construction Construction Revenue = Revenue from Long-Term Contracts 26

28. Income Measurement And Profit Analysis27 B/S Year x3 C.A.: CIP700 P.B(700) 0 B/S Year x1 Current Assets: CIP140 Progress Billings(80) 60 Unbilled Revenue Example A Financial Statement Presentation (P-O-C) B/S Year x2 Current Liability: P-B430 C-I-P(364) 66 Billing in excess of costs and recognized profit

29. Income Measurement And Profit Analysis28 CIP 100 40 186 38 314 22 Year x1 ($140) Year x2 ($224) Year x3 ($336) Financial Statement Presentation (P-O- C) (contd.) Note: Balance of CIP = cumulative revenue Progress Billings 80 -- 1998 350 -- 1999 270 -- 2000 700 -- E.B.

30. Income Measurement And Profit Analysis29 Financial Statement Presentation (P-O- C) (contd.) Income Statement Year x1 Year x2 Year x3 Revenue from Long-term contract140224336 Construction Expenses100186314 Gross Profit403822

31. Income Measurement And Profit Analysis30 Financial Statement Presentation (P-O- C) (contd.) Year Balance Sheet(12/31) x1 x2 x3 Current Assets: A/R30 50 -- Inventories Construction in Progress140 700 Less: Billings (80) (700) Costs and recognized profits in excess of billings60 0 Current Liabilities: Billings430 Construction in Progress (364) Billings in excess of costs and recognized profits66

32. Income Measurement And Profit Analysis31 Financial Statement Presentation (P-O- C) (contd.) Note1 Summary of significant accounting policy Long-Term Construction Contracts. The company recognized revenues and reports profits from long-term construction contracts under the percentage-of-completion method….

33. Income Measurement And Profit Analysis32 Example A (contd.) - Completed-Contract Method Gross Profit: X1 $0 X2 $0 X3 $100 X3: Total Revenues - Total Expenses = $ 700 - (100+186+314) = $ 700 - 600 = 100

34. Income Measurement And Profit Analysis33 Example A (contd.) - Journal Entries (Completed-Contract)

35. Income Measurement And Profit Analysis34 Journal Entries(Completed-Contract) (contd.)

36. Income Measurement And Profit Analysis35 Financial Statement Presentation (C-C Method) Income Statement Year x1 Year x2 Year x3 Revenue from Long-term contract------700 Construction Expenses------ 600 Gross Profit------100

37. Income Measurement And Profit Analysis36 Financial Statement Presentation (C-C Method) (contd.) Balance Sheet (12/31) Year x1 Year x2 Year x3 Current Assets: A/R 30 50 --- Inventories: Construction in Progress100 700 Less: Billings(80)(700) Contract Costs in Excess of Billings 20 0 Current Liabilities: Billings430 Construction in Progress (286) Billing in Excess of Contract Costs144 36

38. Income Measurement And Profit Analysis37 Example B Contract Price $700

39. Income Measurement And Profit Analysis38 Example B (contd.) P-O-C C-C

40. Income Measurement And Profit Analysis39 Example B (contd.) n An alternative method to compute the gross profit:

41. Income Measurement And Profit Analysis40 Example B (contd.) Other Information (Billing and cash collection): Year Partial Billings Cash Collection x1$80$50 x2350330 x3270320 Total$ 700$ 700

42. Income Measurement And Profit Analysis41 Example B - Journal Entries (P-O-C)

43. Income Measurement And Profit Analysis42 Example B - Journal Entries (P-O-C) (contd.)

44. Income Measurement And Profit Analysis43 Progress Billings 80 -- x1 350 -- x2 270 -- x3 Example B (contd.) C-I-P 100 18 40 186 314 78 700 Year x1 x2 x3 x2

45. Income Measurement And Profit Analysis44 Example B (contd.) - Journal Entries (Completed-Contract)

46. Income Measurement And Profit Analysis45 Journal Entries(Completed-Contract) (contd.)

47. Income Measurement And Profit Analysis46 (Long-Term Contract Example C with an Overall Loss) * $715 > 700 (contract price) => a total estimated loss occurs and must be recognized immediately (source: ARB 45 and AICPA statement of position 81-1) Contract Price $700

48. Income Measurement And Profit Analysis47 Example C (contd.) * $40 gross profit was recognized in year x1. This profit is not expected to be realized in the future. Thus, the $40 profit must be offset in year x2. In addition, the estimated total loss of $15 should also be recognized immediately in year x2. Therefore, a loss of $55 ($40+$15) should be recognized in year x2. ** Billings and cash collection data are the same as those of example A. P-O-C C-C

49. Income Measurement And Profit Analysis48 Example C (contd.) n An alternative method to compute the gross profit:

50. Income Measurement And Profit Analysis49 Example C (contd.) - Journal Entries (P-O-C)

51. Income Measurement And Profit Analysis50 Journal Entries(P-O-C) (contd.) * C-I-P and provision for loss on contract are combined.

52. Income Measurement And Profit Analysis51 CIP (Year x1) 100 40 140 Partial Billings (x1) 80 B/S (x1) Current Assets: CIP 140 P-B (80) 60 Example C (contd.) Year x1:

53. Income Measurement And Profit Analysis52 Year x2: (with a total estimated loss of $15) CIP (Year x2) 100 55 40 186 271 P-B (Year x2) 80 350 430 * The estimated overall loss must be reported separately on the B/S as a current lia. The overall loss needs to be taken out of the CIP account for reporting purposes. Example C (contd.) B/S (Year x2) Current Lia: P-B430 CIP(286)* Billings in excess of costs and recognized profit 144 Estimated liability from long-term contract15 52

54. Income Measurement And Profit Analysis53 Example C (contd.) CIP (2000) 10055 40 186 429 700 P-B (2000) 80 350 270 700

55. Income Measurement And Profit Analysis54 Example C (contd.) - Journal Entries (C-C)

56. Income Measurement And Profit Analysis55 Journal Entries(C-C) (contd.) * To recognize the total estimated loss of ($15).

57. Income Measurement And Profit Analysis56 L-T Construction Contract with a Total Estimated Loss Example D * a total estimated loss of $15 incurred. ** a total estimated loss of $115. Contract Price = $700

58. Income Measurement And Profit Analysis57 Example D (contd.) u Billings and cash collection data are the same as those in example A. P-O-C C-C

59. Income Measurement And Profit Analysis58 L-T Construction Contract with a Total Estimated Loss Example E * a total estimated loss of $15 incurred. Contract Price = $700

60. Income Measurement And Profit Analysis59 Example E (contd.) *$15 total estimated loss was recognized in Year x2. The overall income of Year x3 is $ 85. In order to have an overall income of x3 equals to $ 85, we need to recognize $100 income in x3. ** Billings and cash collection data are the same as those of example A. P-O-C C-C 59

61. Income Measurement And Profit Analysis60 L-T Construction Contract with a Total Estimated Loss Example F * an estimated loss of $100 incurred. ** an estimated loss of $15 incurred. *** an loss of $115 incurred. Contract Price = $700

62. Income Measurement And Profit Analysis61 Example F (contd.) ** Billings and cash collection data are the same as those of example A. P-O-C C-C

63. Income Measurement And Profit Analysis62 The Application of the P-O-C Method in the Service Industry n Many transactions in the service industry require the performance of several acts that extend over a period of time. n An accounting method called "proportional performance method” can be used to account for the revenues and expenses for these transactions.

64. Income Measurement And Profit Analysis63 The Application of the P-O-C Method (contd.) n Example: With fixed number of acts: Additional acts are not fixed: Estimation of additional acts is required to compute the proportion of revenue to be recognized (as in P-O-C method). Note: If the service requires a final act, a completed performance method will be applied to account for revenues and expenses.

65. Income Measurement And Profit Analysis64 The Application of the P-O-C Method (contd.) n Aging product: Wine, lumber, etc. u No value increase can be recognized as revenue, unless a. a contract to age a specific product for a specific customer has been signed; and b. no return of product even if the customer is not satisfied with the product; and c. if future cost can be estimated.

66. Income Measurement And Profit Analysis65 The Application of the P-O-C Method (contd.) u If all three conditions are met, the P-O-C method may (referred to as an accretion method) be applied to account for revenues and expenses prior to the completion of the production.

67. IFRS Insights  IFRS only allows the POC method.  If future costs cannot be estimated, the recognized cost will be set to equal the revenue (therefore, zero profit).  Similar to GAAP, IFRS also requires the recognition of the projected overall loss when loss is expected for the entire long- term construction contracts. Income Measurement And Profit Analysis66

68. Income Measurement And Profit Analysis67 Revenue Recognition after Time of Sale (i.e., at time of cash collection) n Accounting Methods: a. Installment Sales Method b. Cost Recovery Method

69. Income Measurement And Profit Analysis68 a. Installment Method 1 n Postpone the recognition of revenue (or profit) until the period of cash collection. This is not consistent with accrual accounting concept. 1. Rarely used for financial reporting (except for special cases) 2 but commonly used for tax filing purposes. 2. Special case: when receivables are collectible over an extended period of time and no reasonable basis for estimating the degree of collectibility (i.e., B/D expense Estimation) --> Source: APB 10, para. 12, footnote 8.

70. Income Measurement And Profit Analysis69 a. Installment Method (contd.) n If uncollectible account is expected, bad debt expense should be estimated and recognized rather than postponing the recognition of revenue until cash is collected.

71. Income Measurement And Profit Analysis70 b. Cost Recovery Method 1 n Postpone the recognition of revenue until cost is recovered. 1.Not acceptable for tax filing purposes; rarely used for financially reporting except for special cases.

72. Income Measurement And Profit Analysis71 Installment Sales Method Example n Assume the following information: 20x1 20x2 Installment sales$1,200$2,000 Cost of installment 900 1,700 Gross profit $300 $300 Rate of gross profit on sales25%15% Cash receipts 20x1Sales$600$600 20x2Sales$500

73. Income Measurement And Profit Analysis72 Installment Sales Method Example (contd.) n Note: the following entries are based on the procedures which only defer the gross profit. This procedure has the same effect as deferring both sales revenue and cost of goods sold.

74. Income Measurement And Profit Analysis73 Installment Sales Method Example (contd.) 20x1 20x2 1. Installment A/R1,2002,000 Installment Sales1,2002,000 2. Cash6001,100 I A/R6001,100 3. Cost of Install. Sales9001,700 Inventory9001,700 4. Installment Sales1,2002,000 Cost of Install. Sales9001,700 Deferred Gross Profit300300 (to close installment sales and cost of installment sales and to recognize entire profit as deferred profit)

75. Income Measurement And Profit Analysis74 Installment Sales Method Example (contd.) 20x1 20x2 5. Deferred Gross Profit150 a 225 b Realized Gross Profit on Installment sales150225 a. 25% x $600 = $150. b. 25% x $600 + 15% x $500 = $225.

76. Income Measurement And Profit Analysis75 Additional Problems of Installment Sales Accounting n The following three problems are related to accounting for installment sales: 1. Interest on installment contract; 2. Uncollectible accounts; 3. Defaults and repossessions.

77. Income Measurement And Profit Analysis76 1. Interest on Installment Contract n Using the installment sales made in 20x1 and assuming a 3% interest charge per quarter, the quarterly installment payment from customers should be: ?  3.7171 = $1,200 P 4]3% present value of an annuity ? = $1,200  3.7171 = $322.83

78. Income Measurement And Profit Analysis77 1. Interest on Installment Contract (contd.) n The following table summaries the interest earned, cash received, installment A/R, installment A/R balance and realized gross profit of each quarter:

79. Income Measurement And Profit Analysis78 1. Interest on Installment Contract (contd.) (1)(2)(3)(4)(5) CashInterestInstall.Bal. Of Realized EarnedA/RInstall.Gross (Debit)(Credit)(Credit)A/RProfit 5/1/x1---------$1,200--- Q3, x1$322.83$36$286.83$913.17$71.70 Q4, x1 322.8327.40 295.43 617.74 73.86 Q1, x2 322.8318.53 304.30 313.44 76.08 Q2, x2 322.83 9.40 313.43 0 78.36 $300 (1) as computed on previous page. (2) 3% x previous balance in (4). (3) (1) - (2). (4) previous balance of (4) - (3). (5) 25% x (3).

80. Income Measurement And Profit Analysis79 2. Uncollectible Accounts n If repossession cannot compensate for uncollectible balances, the potential loss should be charged against bad debt expense account as in the case of other credit sales.

81. Income Measurement And Profit Analysis80 3. Defaults and Repossessions n Assuming merchandize of $800 of installment sales made in 20x2 was repossessed in 20x3. The fair value of the repossessed item is only $400. Therefore, a loss of $280 occurs. If a bad debt expense was charged in 20x2, the allowance for uncollectible account will be debited instead of the loss account.

82. Income Measurement And Profit Analysis81 3. Defaults and Repossessions (contd.) n When repossession occurs in year 20x3, the following entry will be recorded: Repossessed Merchandize400 Deferred Gross Profit120 Loss on Repossession280 Installment A/R800

83. Income Measurement And Profit Analysis82 Financial Statement Presentation of Installment Sales Transactions A. Installment sales constitute an insignificant part of total sales. B. Installment sales are a significant part of total sales.

84. Income Measurement And Profit Analysis83 A. Installment Sales Constitute an Insignificant Part of Total Sales n In this case, the accountant only needs to include the realized gross profit of the installment sales in the income statement as a special item following the gross profit on other sales.

85. Income Measurement And Profit Analysis84 Income Statement For the Year Ended 12/31/x1 Sales$500,000 Cost of Goods Sold (270,000) Gross Profit on Sales$230,000 Gross Profit realized on Installment Sales 150 Total Gross Profit on Sales $230,150

86. Income Measurement And Profit Analysis85 B. Installment Sales Are a Significant Part of Total Sales n If installment sales are a significant part of total sales, the following presentation may be used:

87. Income Measurement And Profit Analysis86 Income Statement For the Year Ended 12/31/x2 a Install. Other Sales Sales Total Sales150,000200,000350,000 Cost of goods sold(80,000)(150,000)(230,000) Gross profit70,00050,000120,000 Less deferred gross profit on install. sales of this year(50,000) (50,000) Realized gross profit on this year’s sales20,00050,00070,000 Add gross profit realized on prior years15,000 15,000 Gross profit real. this year35,00050,00085,000 a. All amounts are assumed. 86

88. Income Measurement And Profit Analysis87 Cost Recovery Method n No gross profit is recognized until cash collected exceeding the cost. Thus, all gross profit is deferred until cash collected exceeding the cost.

89. Income Measurement And Profit Analysis88 Cost Recovery Method Example n Assuming in Jan. 20x1, Gateway Corp. sells merchandize costing $10,000 to Mendy Corp. for $15,000 with payments receivable of $9,000, $3,000 and $3,000 in 20x1, 20x2, and 20x3, respectively. The following entries will be recorded following the cost recovery method:

90. Income Measurement And Profit Analysis89 Cost Recovery Method Example (contd.) 20x1A/R15,000 Sales15,000 CGS10,000 Inventory10,000 Cash9,000 A/R9,000 Sales15,000 CGS10,000 Deferred Gross Profit5,000

91. Income Measurement And Profit Analysis90 Cost Recovery Method Example (contd.) (To close sales and CGS and to record deferred gross profit under the cost recovery method) 20x2Cash3,000 A/R3,000 Deferred Gross Profit2,000 Gross Profit2,000 20x3Cash3,000 A/R3,000 Deferred Gross Profit3,000 Gross Profit3,000

92. Income Measurement And Profit Analysis91 Gift Card Sale Revenue Recognition n Revenue should be recognized when service is provided to the gift-card holder. n When to recognize the expired unused balance on the gift-card?

93. Income Measurement And Profit Analysis92 States Do Not Require to Turn Over the Abandoned and Unclaimed Property n For states recognize expiration date: Can recognize the revenue upon the expiration date. n For states do not recognize expiration date: In order to recognize the unused expired balance as revenue, the company needs to prove that the expired unused balance is unlikely to be redeemed after certain periods statistically.

94. Income Measurement And Profit Analysis93 States Require to Turn Over the Abandoned and Unclaimed Property n The expired unused balance of gift-card may need to be remitted to the state after five- year period.

95. Income Measurement And Profit Analysis94 Franchise Sales n Many retail outlets (I.e., fast food, restaurants,etc.) are operated as franchises. n A franchise agreement: the franchisor (I.e., McDonald's Corporation) grants the franchisee (I.e., an individual) the right to sell the franchisor's product and use its name for a specific period of time. n The fees paid by the franchisee include: 1) the initial franchise fee and 2) continuing franchise fees.

96. Income Measurement And Profit Analysis95 Franchise Sales (contd.) n The initial franchise fee is to cover: u 1)the right to use its name and sell its products; u 2)assistance in finding a location and constructing the facilities, u 3) training employees. n The initial franchise fee is usually a fixed amount but payable in installments.

97. Income Measurement And Profit Analysis96 Franchise Sales (contd.) n The continuing franchise fees are paid for continuing rights and for advertising and promotion provided by the franchisor. n These fees can be a fixed monthly or annual amount or a % of the sales.

98. Income Measurement And Profit Analysis97 Franchise Sales (contd.) n Recognition of Franchise Fees: n For the initial franchise fee: (based on SFAS 45) can only be recognized as revenue after substantial amount of the initial services (required by the franchise agreement) have been performed. n For the continuing franchise fees: these fees are recognized by the franchisor as revenue in the periods they are received.

99. Income Measurement And Profit Analysis98 Franchise Sales –Example n On 3/31/x2, the Applebee Corporation entered into a franchise agreement with Mary Armstrong in exchange for an initial franchise fee of $100,000. n The initial services provided by Applebee include the selection of a location, construction of the building, training of employees and consulting services over several year.

100. Income Measurement And Profit Analysis99 Franchise Sales –Example (Contd.) n $30,000 is payable on 3/31/x2, with the remaining balance payable in annual installments over a 3-year periods with a 7% annual interest rate. n The franchisee will also pay continuing franchise fees of $2,000 per month for advertising and promotion provided by Applebee, beginning immediately after the franchise begins operations. n Mary Armstrong opens her Applebee Restaurant on 9/6/x2.

101. Income Measurement And Profit Analysis100 Franchise Sales –Example (Contd.) n Assume that the initial services to be performed by Applebee subsequent to the contract signing are substantial and the collectibility of the fee is reasonable certain the following entry is recorded: 3/31/x2: n Cash 30,000 Note Receivable 70,000 Unearned franchise fee revenue 100,000 n to record franchise agreement and down payment

102. Income Measurement And Profit Analysis101 Franchise Sales –Example (Contd.) n Assume that substantial performance have occurred when the franchise began operation on 9/6/x2, the following entry would be recorded: n 9/6/x2 n Unearned franchise fee revenue 100,000 n Franchise fee revenue 100,000 n To recognize franchise fee revenue n

103. Income Measurement And Profit Analysis102 Franchise Sales –Example (Contd.) n Note:If collectibility of the initial fee is uncertain and there is no basis for estimating the uncollectible amounts, the initial entry(on 3/31/02) should be: n Cash 30,000 Note Receivable 70,000 n Deferred franchise fee revenue 100,000 n The deferred franchise fee revenue is recognized as revenue using either the installment sales or cost recovery methods.

104. Income Measurement And Profit Analysis103 Franchise Sales –Example (Contd.) n Revenue Recognition for Continuing Franchise Fees: n Continuing franchise fee is recognized on a monthly basis as follows: n Cash 2,000 n Service revenue 2,000

105. Multiple-Element Arrangements (ASC605-25-25-5) When one price is paid for multiple elements (i.e., software, upgrade, maintenance, etc.), this transaction is referred to as a multiple-element arrangement. These elements are considered separate deliverables (or separate units of accounting) if both of the following conditions are met: Income Measurement And Profit Analysis104

106. Multiple-Element Arrangements (contd.) 1.the delivered item or items have value to the customer on a standalone basis and 2.If the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item or items is considered probable and substantially in the control of the vendor.  When both conditions are met, the elements are considered separate deliverables. Income Measurement And Profit Analysis105

107. Multiple-Element Arrangements (contd.)  The consideration/fee of the arrangement will be allocated to all deliverables/elements based on the relative fair value of these elements.  The revenue of each element will be recognized upon the completion of each element.  Fair value (ASU2009-13):  Vendor’s sales price, or  Third-party evidence of sales price, or  Vendor’s estimates. Income Measurement And Profit Analysis106

108. Multiple-Element Arrangements (contd.)  If the conditions are not met, the delivered item(s) should be combined with other undelivered item(s) within the arrangement as one unit of accounting.  The revenue of the arrangement will be deferred until all elements are delivered. Income Measurement And Profit Analysis107

109. Income Measurement And Profit Analysis108 Consignment n A manufacturer or a wholesaler may transfer goods to a dealer but the title of the goods remains with the manufacturer or the wholesaler.

110. Income Measurement And Profit Analysis109 Consignment Example n On 2/8/98, 300 units of goods were shipped to a dealer on a consignment basis. The total cost of goods is $ 1,800 ($6 each). The transportation cost $150 was paid by the consignor on 2/8. The consignee spent $100 on advertisement on 2/9/98. n On 4/4, all the consignment units were sold for $10 each and the proceeds subtracted advertising expense ($100) and commission charge ($100), have been forwarded to the consignor on 4/20/98.

111. Income Measurement And Profit Analysis110 Consignment Example (contd.) 110

112. Income Measurement And Profit Analysis111 Consignment Example (contd.) 111