18-1 prepared by coby harmon university of california, santa barbara intermediate accounting

18-1

Prepared by Coby Harmon

University of California, Santa Barbara

Intermediate Accounting

18-2

Intermediate Accounting

14th Edition

18 Revenue Recognition

Kieso, Weygandt, and Warfield

18-3

1. Apply the revenue recognition principle.

2. Describe accounting issues for revenue recognition at point of

sale.

3. Apply the percentage-of-completion method for long-term

contracts.

4. Apply the completed-contract method for long-term contracts.

5. Identify the proper accounting for losses on long-term contracts.

6. Describe the installment-sales method of accounting.

7. Explain the cost-recovery method of accounting.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

18-4

The Current EnvironmentThe Current EnvironmentThe Current EnvironmentThe Current Environment

Restatements for improper revenue recognition are

relatively common and can lead to significant share price

adjustments.

Revenue recognition is a top fraud risk and regardless

of the accounting rules followed (IFRS or U.S. GAAP),

the risk or errors and inaccuracies in revenue reporting is

significant.

18-5

The revenue recognition principle provides that

companies should recognize revenue

Guidelines for Revenue Recognition


LO 1 Apply the revenue recognition principle.

(1) when it is realized or realizable and

(2) when it is earned.

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LO 1 Apply the revenue recognition principle.

Illustration 18-2

Revenue Recognition Alternatives

18-7

FASB’s Concepts Statement No. 5, companies usually

meet the two conditions for recognizing revenue by the time

they deliver products or render services to customers.

LO 2 Describe accounting issues for revenue recognition at point of sale.

Implementation problems,

Sales with Discounts

Sales When Right of

Return

Sales with Buybacks

Bill and Hold Sales

Principal-Agent Relationships

Trade Loading and Channel

Stuffing

Multiple-Deliverable

Arrangements

Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery)Revenue Recognition at Point of Sale (Delivery)

18-8

Bill and Hold Sales

Revenue Recognition at Point of SaleRevenue Recognition at Point of SaleRevenue Recognition at Point of SaleRevenue Recognition at Point of Sale

Buyer is not yet ready to take delivery but does take title.

Illustration 18-4

BILL AND HOLDBILL AND HOLD Illustration 18-7

Facts: Butler Company sells $450,000 of fireplaces to a local coffee

shop, Baristo, which is planning to expand its locations around the

city. Under the agreement, Baristo asks Butler to retain these

fireplaces in its warehouses until the new coffee shops that will

house the fireplaces are ready. Title passes to Baristo at the time the

agreement is signed.

Question: Should Butler report the revenue from this bill and hold Question: Should Butler report the revenue from this bill and hold arrangement when the agreement is signed, or should revenue be arrangement when the agreement is signed, or should revenue be deferred and reported when the fireplaces are delivered?deferred and reported when the fireplaces are delivered?

LO 2

18-9


Solution: Butler should record the revenue at the time title

passes, provided

1. the risks of ownership have passed to Baristo, that is,

Butler does not have specific performance obligations

other than storage;

2. Baristo makes a fixed commitment to purchase the goods,

requests that the transaction be on a bill and hold basis,

and sets a fixed delivery date; and

3. goods must be segregated, complete, and ready for

shipment.


18-10



Accounts receivable 450,000

Sales 450,000

Illustration 18-4BILL AND HOLDBILL AND HOLD Illustration 18-7

Facts: Butler Company sells $450,000 of fireplaces to a local coffee

shop, Baristo, which is planning to expand its locations around the

city. Under the agreement, Baristo asks Butler to retain these

fireplaces in its warehouses until the new coffee shops that will

house the fireplaces are ready. Title passes to Baristo at the time the

agreement is signed. Butler makes the following entry.

18-11

Consignments



Manufacturers (or wholesalers) deliver goods but retain

title to the goods until they are sold.

Consignor (manufacturer or wholesaler) ships

merchandise to the consignee (dealer), who is to act as

an agent for the consignor in selling the merchandise.

Consignor makes a profit on the sale.

Consignee makes a commission on the sale.

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Two Methods:

Percentage-of-Completion Method.

► Rationale is that the buyer and seller have

enforceable rights.

Completed-Contract Method.

Most notable example is long-term construction contract

accounting.

Revenue Recognition Before DeliveryRevenue Recognition Before DeliveryRevenue Recognition Before DeliveryRevenue Recognition Before Delivery


18-13

Must use Percentage-of-Completion method when estimates

of progress toward completion, revenues, and costs are

reasonably dependable and all of the following conditions

exist:


1. Contract clearly specifies the enforceable rights regarding

goods or services by the parties, the consideration to be

exchanged, and the manner and terms of settlement.

2. Buyer can be expected to satisfy all obligations.

3. Contractor can be expected to perform under the contract.


18-14

Companies should use the Completed-Contract method when

one of the following conditions applies when:


1. Company has primarily short-term contracts, or

2. Company cannot meet the conditions for using the percentage-of-completion method, or

3. There are inherent hazards in the contract beyond the normal, recurring business risks.


18-15

Formula for Total Revenue to Be Recognized to Date

LO 3 Apply the percentage-of-completion method for long-term contracts.

Illustration 18-13

Percentage-of-Completion MethodPercentage-of-Completion MethodPercentage-of-Completion MethodPercentage-of-Completion Method

Illustration 18-14

Illustration 18-15

Percentage-of-Completion Method

18-16 LO 3 Apply the percentage-of-completion method for long-term contracts.


Illustration: Compute percentage complete.Illustration 18-16

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Illustration: Percentage-of-Completion Revenue, Costs, and

Gross Profit by YearIllustration 18-18

LO 3 Apply the percentage-of-completion method for long-term contracts.

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Companies recognize revenue and gross profit only at point of

sale—that is, when the contract is completed.

Under this method, companies accumulate costs of long-term

contracts in process, but they make no interim charges or credits

to income statement accounts for revenues, costs, or gross

profit.

LO 4 Apply the completed-contract method for long-term contracts.


Completed Contract Method

18-19 LO 4 Apply the completed-contract method for long-term contracts.

Completed Contract MethodCompleted Contract MethodCompleted Contract MethodCompleted Contract Method

Illustration:

Construction in progress 150,000 287,400 170,100 Cash 150,000 287,400 170,100

Accounts receivable 135,000 360,000 180,000 Billings on contract 135,000 360,000 180,000

Cash 112,500 262,500 300,000 Accounts receivable 112,500 262,500 300,000

Construction in progress 67,500 Construction expense 607,500

Construction revenue 675,000

Billings on contract 675,000 Construction in progress 675,000

20122010 2011

18-20

Construction contractors should disclosure:

the method of recognizing revenue,

the basis used to classify assets and liabilities as current

(nature and length of the operating cycle),

the basis for recording inventory,

the effects of any revision of estimates,

the amount of backlog on uncompleted contracts, and

the details about receivables.

Disclosures in Financial Statements


LO 5 Identify the proper accounting for losses on long-term contracts.

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In certain cases companies recognize revenue at the

completion of production even though no sale has been

made.

Completion-of-Production Basis


LO 5 Identify the proper accounting for losses on long-term contracts.

Examples are:

precious metals or

agricultural products.

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When the collection of the sales price is not reasonably assured and revenue recognition is deferred.

Revenue Recognition After DeliveryRevenue Recognition After DeliveryRevenue Recognition After DeliveryRevenue Recognition After Delivery

LO 6 Describe the installment-sales method of accounting.

Methods of deferring revenue:

Installment-sales method

Cost-recovery method

Deposit method

Generally Employed

18-23

Recognizes income in the periods of collection rather than in the period of sale.

Recognize both revenues and costs of sales in the period of sale, but defer gross profit to periods in which cash is collected.

Selling and administrative expenses are not deferred.

Installment-Sales Method



18-24

The profession concluded that except in special circumstances,

“the installment method of recognizing revenue is not

acceptable.”

The rationale: because the installment method does not

recognize any income until cash is collected, it is not in

accordance with the accrual concept.

Acceptability of the Installment-Sales Method



18-25

Recognizes no profit until cash payments by the buyer exceed

the cost of the merchandise sold.

A seller is permitted to use the cost-recovery method to account

for sales in which “there is no reasonable basis for estimating

collectibility.” In addition, use of this method is required where a

high degree of uncertainty exists related to the collection of

receivables.

Cost-Recovery Method


LO 7 Explain the cost-recovery method of accounting.

18-26

Seller reports the cash received from the buyer as a deposit on the contract and classifies it on the balance sheet as a liability.

The seller does not recognize revenue or income until the sale is complete.

Deposit Method


LO 7 Explain the cost-recovery method of accounting.

18-27

Summary of Product Revenue Recognition Summary of Product Revenue Recognition Summary of Product Revenue Recognition Summary of Product Revenue Recognition

Illustration 18-42

LO 7

18-1 prepared by coby harmon university of california, santa barbara intermediate accounting

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