kieso inter ch18 - ifrs (revenue)

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Volume 2Volume 2

http://downloadslide.blogspot.comhttp://downloadslide.blogspot.com

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C H A P T E R C H A P T E R 1818

REVENUEREVENUE

Intermediate AccountingIFRS Edition

Kieso, Weygandt, and Warfield http://downloadslide.blogspot.comhttp://downloadslide.blogspot.com

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 cost-recovery method for long-term contracts.

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

6. Describe the accounting issues for service contracts.

7. Identify the proper accounting for multiple-deliverable arrangements.

Learning ObjectivesLearning Objectives

18-4

Current Environment

Guidelines for revenue recognition

Departures from sale basis

Revenue Recognition (At Point of Sale)

Revenue Recognition (Long-

Term Contracts)

Revenue Recognition

(Other)

Measurement

Recognition

Summary

Service contracts

Multiple-deliverable arrangements

Other

Summary of methods

Percentage-of-completion method

Cost-recovery method

Long-term contract losses

Disclosures

Revenue

18-5

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.

The Current EnvironmentThe Current Environment

18-6

Revenue recognition principle: Revenue is recognized

Guidelines for Revenue Recognition


LO 1 Apply the revenue recognition principle.LO 1 Apply the revenue recognition principle.

(1) when it is probable that the economic benefits will flow to the company and

(2) when the benefits can be measured reliably.

18-7

Sale of product from inventory

Type of Transaction

Rendering a service

Permitting use of an asset

Sale of asset other than inventory

Date of sale (date of delivery)

Services performed and

billable

As time passes or assets are

used

Date of sale or trade-in

Gain or loss on disposition

Revenue from interest, rents, and royalties

Revenue from fees or

services

Revenue from sales

Description of Revenue

Timing of Revenue

Recognition



Illustration 18-1

Revenue Recognition Classified by Nature of Transaction

18-8

Earlier recognition is appropriate if there is a high degree of certainty about the amount of revenue earned.

Delayed recognition is appropriate if the

degree of uncertainty concerning the amount of revenue or costs is sufficiently high or

sale does not represent substantial completion of the earnings process.

Departures from the Sale Basis



18-9

Revenue should be measured at the fair value of consideration received or receivable.

Trade discounts or volume rebates should reduce consideration received or receivable and the related revenue.

If payment is delayed, seller should impute an interest rate for the difference between the cash or cash equivalent price and the deferred amount.

Measurement of Sale Revenue

Revenue Recognition at Point of SaleRevenue Recognition at Point of Sale

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

18-10



Illustration 18-2

18-11



Sansung makes the following entry on March 31, 2011.

Accounts receivable 679,000

Sales 679,000

Illustration 18-2

18-12



Assuming Sansung’s customers meet the discount threshold, Sansung makes the following entry.

Cash 679,000


Illustration 18-2

18-13



If Sansung’s customers fail to meet the discount threshold, Sansung makes the following entry upon payment.

Cash 700,000


Sales discounts forfeited 21,000

Illustration 18-2

18-14

When a sales transaction involves a financing arrangement, the fair value is determined by discounting the payment using an imputed interest rate.

Imputed interest rate is the more clearly determinable of either

1. the prevailing rate for a similar instrument of an issuer with a similar credit rating, or

2. a rate of interest that discounts the nominal amount of the instrument to the current sales price of the goods or services.

Measurement of Sale Revenue



18-15



Illustration 18-3

18-16



The journal entry to record SEK’s sale to Grant Company on July 1, 2011, is as follows (ignoring cost of goods sold entry).

Notes receivable 900,000

Sales 900,000

Illustration 18-3

18-17



SEK makes the following entry to record interest revenue.

Notes receivable 54,000

Interest revenue (12% x ½ x €900,000) 54,000

Illustration 18-3

18-18

Revenue from the sale of goods is recognized when all the following conditions are met:

1. Company has transferred to the buyer the significant risks and rewards of ownership of the goods;

2. Company retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

3. The amount of revenue can be measured reliably;

4. It is probable that the economic benefits will flow to the company; and

5. The costs incurred or to be incurred can be estimated reliably.

Recognition of Sale Revenue


LO 2LO 2

18-19

Bill and Hold Sales


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


Illustration 18-4

18-20


LO 2LO 2

Solution: Butler should record the revenue at the time title passes, provided

1. it is probable that delivery will be made;

2. the item is on hand, identified, and ready for delivery at the time the sale is recognized;

3. Baristo acknowledges the deferred delivery arrangement; and

4. the usual payment terms apply.

It appears that these conditions were probably met and therefore revenue recognition should be permitted at the time the agreement is signed.

18-21



Butler makes the following entry to record the bill and hold sale.


Sales 450,000

Illustration 18-4

18-22

Sales Subject to Installation or Inspection



Illustration 18-5

18-23

Layaway Sales



Illustration 18-6

18-24

Sales with Right of Return



Two possible revenue recognition methods are available when the right of return exposes the seller to continued risks of ownership:

1. not recording a sale until all return privileges have expired or

2. recording the sale, but reducing sales by an estimate of future returns.

18-25



Illustration 18-7

18-26


LO 2LO 2

Pesido sold $300,000 of laser equipment on August 1, 2011, and retains only an insignificant risk of ownership. On October 15, 2011, $10,000 in equipment was returned.

August 1, 2011


Sales 300,000

October 15, 2011

Sales returns and allowances 10,000

Accounts receivable10,000

18-27


At December 31, 2011, based on prior experience, Pesido estimates that returns on the remaining balance will be 4 percent. Pesido makes the following entry to record the expected returns.

December 31, 2011

Sales returns and allowances 11,600

Allowance for sales returns and allowances11,600

[($300,000 - $10,000) x 4% = 11,600]


18-28



Illustration 18-8

18-29



Morgan records the sale and related cost of goods sold as follows.

Cash 135,000

Sales 135,000

Cost of Goods Sold 115,000

Inventory 115,000

Illustration 18-8

18-30

Principal-Agent Relationships



Amounts collected on behalf of the principal are not revenue of the agent.

Revenue for the agent is the amount of the commission it receives.

18-31

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.

18-32

Trade Loading and Channel Stuffing



Trade loading - a crazy, uneconomic, insidious practice through which manufacturers—trying to show sales, profits, and market share they don’t actually have—induce their wholesale customers, known as the trade, to buy more product than they can promptly resell.

Channel stuffing. When a software maker needed to make its financial results look good, it offered deep discounts to its distributors to overbuy, and then recorded revenue when the software left the loading dock.

18-33

Two methods of accounting for long-term construction contracts:

Percentage-of-completion method.

Cost-recovery (zero-profit) method.

Long-Term Contracts (Construction)Long-Term Contracts (Construction)

18-34

Rationale for using percentage-of-completion accounting is that under most of these contracts, the

Buyer and seller have enforceable rights.

Buyer has the legal right to require specific performance on the contract.

Seller has the right to require progress payments that provide evidence of the buyer’s ownership interest.

As a result, a continuous sale occurs as the work progresses and companies should recognize revenue according to that progression.


18-35

Companies must use the percentage-of-completion method when all of the following conditions exist.

1. Total contract revenue can be measured reliably;

2. It is probable that the economic benefits associated with the contract will flow to the company;

3. Both the contract costs to complete the contract and the stage of contract completion at the end of the reporting period can be measured reliably; and

4. The contract costs attributable to the contract can be clearly identified and measured reliably so the actual contract costs incurred can be compared with prior estimates.


18-36

Companies should use the cost-recovery method when one of the following conditions applies:

1. When a company cannot meet the conditions for using the percentage-of-completion method, or

2. When there are inherent hazards in the contract beyond the normal, recurring business risks.


18-37

Calculation for Revenue to Be Recognized

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

Illustration 18-11

Illustration 18-12

Illustration 18-13

Percentage-of-Completion Method


18-38 LO 3 Apply the percentage-of-completion method for long-term contracts.LO 3 Apply the percentage-of-completion method for long-term contracts.

Illustration: KC Construction Company has a contract to construct a €4,500,000 bridge at an estimated cost of €4,000,000. The contract is to start in July 2010, and the bridge is to be completed in October 2012. The following data pertain to the construction period.



Illustration: Compute percentage complete.Illustration 18-6



Illustration: KC would make the following entries to record (1) the costs of construction, (2) progress billings, and (3) collections.

Illustration 18-7


18-41

Percentage-of-Completion, Revenue and Gross Profit, by YearIllustration 18-16



Illustration: KC’s entries to recognize revenue and gross profit each year and to record completion and final approval of the contract.

Illustration 18-17



Illustration: Content of Construction in Process Account—Percentage-of-Completion Method

Illustration 18-18



Financial Statement Presentation—Percentage-of-Completion

Illustration 18-19

Computation of Unbilled Contract Price at 12/31/10


18-45

Financial Statement—Percentage-of-Completion


Illustration 18-20

LO 3LO 3

18-46

Illustration: For the bridge project illustrated on the preceding pages, Hardhat Construction would report the following revenues and costs.

Cost-Recovery (Zero-Profit) MethodCost-Recovery (Zero-Profit) Method

LO 4 Apply the cost-recovery method for long-term contracts.LO 4 Apply the cost-recovery method for long-term contracts.

Illustration 18-21

18-47

Illustration: Hardhat’s entries to recognize revenue and gross profit each year and to record completion and final approval of the contract.



Illustration 18-22

18-48

Illustration: Comparison of gross profit recognized under different methods.



Illustration 18-23

18-49

Financial Statement—Cost-Recovery Method


Illustration 18-24


18-50

2010 2011 2012 Contract price €675,000 €675,000 €675,000 Cost incurred current year 150,000 287,400 170,100 Estimated cost to complete in future years 450,000 170,100 0 Billings to customer current year 135,000 360,000 180,000 Cash receipts f rom customer Current year 112,500 262,500 300,000

A) Prepare the journal entries for 2010, 2011, and 2012.

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

Illustration:


Casper Construction Co.


2010 2011 2012Costs incurred to date € 150,000 € 437,400 € 607,500Estimated cost to complete 450,000 170,100 Est. total contract costs 600,000 607,500 607,500 Est. percentage complete 25.0% 72.0% 100.0%Contract price 675,000 675,000 675,000 Revenue recognizable 168,750 486,000 675,000 Rev. recognized prior year (168,750) (486,000) Rev. recognized currently 168,750 317,250 189,000 Costs incurred currently (150,000) (287,400) (170,100) Gross profi t recognized € 18,750 € 29,850 € 18,900

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 18,750 29,850 18,900 Construction expense 150,000 287,400 170,100

Construction revenue 168,750 317,250 189,000

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

20122010 2011


Illustration:


Income Statement 2010 2011 2012Revenue on contracts 168,750$ 317,250$ 189,000$ Cost of construction 150,000 287,400 170,100 Gross profit 18,750 29,850 18,900

Balance Sheet (12/31)Current assets:

Accounts receivable 22,500 120,000 - Cost & profits > billings 33,750

Current liabilities:Billings > cost & profits 9,000


Illustration:

18-54

Companies recognize revenue only to the extent of costs incurred that are expected to be recoverable.

Only after all costs are incurred is gross profit recognized.


Cost-Recovery Method


18-55

Cost-Recovery MethodCost-Recovery 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 150,000 287,400 170,100

Construction revenue 150,000 287,400 237,600

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

20122010 2011


18-56

Illustration:

Income Statement 2010 2011 2012Revenue on contracts € 0 € 0 € 675,000Cost of construction - - 607,500 Gross profit - - 67,500

Balance Sheet (12/31)Current assets:

Accounts receivable 22,500 120,000 - Cost & profits > billings 15,000

Current liabilities:Billings > cost & profits 57,600

Cost-Recovery MethodCost-Recovery Method


18-57 LO 5 Identify the proper accounting for losses on long-term contracts.LO 5 Identify the proper accounting for losses on long-term contracts.

Loss in the Current Period on a Profitable Contract

► Percentage-of-completion method only, the estimated cost increase requires a current-period adjustment of gross profit recognized in prior periods.

Loss on an Unprofitable Contract

► Under both percentage-of-completion and completed-contract methods, the company must recognize in the current period the entire expected contract loss.

Long-Term Contract Losses


18-58

Illustration: Loss in Current Period

Long-Term Contract LossesLong-Term Contract Losses

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

2010 2011 2012 Contract price €675,000 €675,000 €675,000 Cost incurred current year 150,000 287,400 215,436 Estimated cost to complete in future years 450,000 215,436 0 Billings to customer current year 135,000 360,000 180,000 Cash receipts f rom customer Current year 112,500 262,500 300,000 b) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated cost to complete at the end of 2011 was €215,436 instead of €170,100.


18-59

2010 2011 2012Costs incurred to date € 150,000 € 437,400 € 652,836Estimated cost to complete 450,000 215,436 Est. total contract costs 600,000 652,836 652,836 Est. percentage complete 25.0% 67.0% 100.0%Contract price 675,000 675,000 675,000 Revenue recognizable 168,750 452,250 675,000 Rev. recognized prior year (168,750) (452,250) Rev. recognized currently 168,750 283,500 222,750 Costs incurred currently (150,000) (287,400) (215,436) Gross profi t recognized € 18,750 (€ 3,900) € 7,314




18-60

Construction in progress 18,750 7,314 Construction expense 150,000 215,436

Construction revenue 168,750 222,750

Construction in progress 3,900 Construction expense 287,400

Construction revenue 283,500

20122010 2011




18-61

Illustration: Loss on Unprofitable Contract



2010 2011 2012 Contract price €675,000 €675,000 €675,000 Cost incurred current year 150,000 287,400 246,038 Estimated cost to complete in future years 450,000 246,038 0 Billings to customer current year 135,000 360,000 180,000 Cash receipts f rom customer Current year 112,500 262,500 300,000

c) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated cost to complete at the end of 2011 was € 246,038 instead of € 170,100.


18-62

2010 2011 2012Costs incurred to date € 150,000 € 437,400 € 683,438Estimated cost to complete 450,000 246,038 Est. total contract costs 600,000 683,438 683,438 Est. percentage complete 25.0% 64.0% 100.0%Contract price 675,000 675,000 675,000 Revenue recognizable 168,750 432,000 675,000 Rev. recognized prior year (168,750) (432,000) Rev. recognized currently 168,750 263,250 243,000 Costs incurred currently (150,000) (290,438) (243,000) Gross profi t recognized € 18,750 (€ 27,188) € 0


LO 5LO 5

$675,000 – 683,438 = (8,438) cumulative loss PlugPlug


18-63

Construction in progress 18,750 - Construction expense 150,000 243,000

Construction revenue 168,750 243,000

Construction in progress 27,188 Construction expense 290,438

Construction revenue 263,250

20122010 2011




18-64

Loss on construction contract 8,438 Construction in progress 8,438

Construction expense 287,400 Construction revenue 287,400

2010 2011



For the Cost-Recovery method, companies would recognize the following loss:


18-65

Construction contractors should disclosure:

Revenue recognized during the period and the methods used to determine the contract revenue and stage of completion.

For contracts in progress,

► aggregate amount of costs incurred and recognized net income, amount of advances received, and amount of retentions.

Any contingent assets or liabilities related to these contracts.

Disclosures in Financial Statements



18-66

Follow the same criteria as long-term contracts.

To recognize revenue:

It must be reliably measurable;

Economic benefits are probable;

Stage of completion must be reliably measurable; and

Costs must be reliably measurable.

Service Contracts

Other Revenue Recognition IssuesOther Revenue Recognition Issues

LO 6 Describe the accounting issues for service contracts.LO 6 Describe the accounting issues for service contracts.

18-67

Single Act: Revenue recognized at the time of the act.

More Than One Act: Revenue recognized as various acts occur.

Three circumstances:

1. Specified number of identical or similar acts.

2. Specified number of defined but not identical acts.

3. Unspecified number of identical acts or similar acts with a fixed period for performance.

Service Contracts



18-68



18-69


LO 6LO 6

Assuming R&D services are provided according to the contract in 2011, Jackson makes the following entries in 2011 to recognized revenue on the Andes contract.

January 1, 2011

Cash 1,000,000

Unearned R&D service revenue 1,000,000

December 31, 2011

Cash 400,000

Unearned R&D Service Revenue 200,000

R&D Service Revenue 600,000

18-70



18-71 LO 6 Describe the accounting issues for service contracts.LO 6 Describe the accounting issues for service contracts.


18-72 LO 6 Describe the accounting issues for service contracts.LO 6 Describe the accounting issues for service contracts.


18-73


SeniorLife makes the following entries related to the contract.

January 1, 2011

Cash 300,000

Unearned service revenue 300,000

December 31, 2011


Service Revenue 60,000

December 31, 2012


Service Revenue 105,000

18-74

MDAs provide multiple products or services to customers as part of a single arrangement.

Major accounting issues

how to allocate the revenue to the various products and services and

how to allocate the revenue to the proper period.

Multiple-Deliverable Arrangements (MDAs)


LO 7 Identify the proper accounting for multiple-deliverable arrangements.LO 7 Identify the proper accounting for multiple-deliverable arrangements.

18-75

All units in a MDA are considered separate units of accounting, provided that:

1. A delivered item has value to the customer on a standalone basis; and

2. The arrangement includes a general right of return relative to the delivered item; and

3. Delivery or performance of the undelivered item is considered probable and substantially in the control of the seller.




18-76




Illustration 18-33

18-77 LO 7 Identify the proper accounting for multiple-deliverable arrangements.LO 7 Identify the proper accounting for multiple-deliverable arrangements.

Illustration 18-34

18-78

Interest, Royalties, and Dividends

Accretion

Completion-of-Production Basis

Other Revenue Situations



18-79

The IASB defines revenue to include both revenues and gains. U.S. GAAP provides separate definitions for revenues and gains.

Revenue recognition fraud is a major issue in revenue recognition. The same situation occurs in the United States as evidenced by revenue recognition breakdowns at telecom company Global Crossing (USA), technology company Lucent Technologies (USA), and utility company Enron (USA).

18-80

A specific standard exists for revenue recognition under IFRS (IAS 18). In general, the standard is based on the probability that the economic benefits associated with the transaction will flow to the company selling the goods, rendering the service, or receiving investment income. In addition, the revenues and costs must be capable of being measured reliably. U.S. GAAP uses concepts such as realized or realizable, and earned as a basis for revenue recognition.

U.S. GAAP permits the use of the completed-contract method of accounting for long-term construction contracts (IAS 11). Companies generally use the percentage-of-completion method. If revenues and costs are difficult to estimate, then companies recognize revenue only to the extent of the cost incurred—a zero-profit approach under IFRS.

18-81

U.S. GAAP does not allow the percentage-of-completion method for service contracts. Under IFRS, costs can be deferred if the company is using percentage-of-completion. Under GAAP, costs are generally expensed as incurred.

U.S. GAAP provides detailed guidance in multiple-deliverable arrangements. IFRS guidance is more general.

18-82

FranchisesTwo sources of revenue:

1. Sale of initial franchises and related assets or services, and

2. Continuing fees based on the operations of franchises.

LO 8 Explain revenue recognition for franchises sales.LO 8 Explain revenue recognition for franchises sales.

18-83 LO 8 Explain revenue recognition for franchises sales.LO 8 Explain revenue recognition for franchises sales.

The franchisor normally provides the franchisee with:

1. Assistance in site selection.

2. Evaluation of potential income.

3. Supervision of construction activity.

4. Assistance in the acquisition of signs, fixtures, and equipment.

5. Bookkeeping and advisory services.

6. Employee and management training.

7. Quality control.

8. Advertising and promotion.

Franchises

18-84

Franchisors record initial franchise fees as

revenue only when and as they make “substantial performance” of the services they are obligated to perform and

when collection of the fee is reasonably assured.

Substantial performance occurs when the franchisor has no remaining obligation to refund any cash received or excuse any nonpayment of a note and has performed all the initial services required under the contract.

Initial Franchise Fees


18-85

Illustration: Tum’s Pizza Inc. charges an initial franchise fee of $50,000 for the right to operate as a franchisee of Tum’s Pizza. Of this amount, $10,000 is payable when the franchisee signs the agreement, and the balance is payable in five annual payments of $8,000 each. The credit rating of the franchisee indicates that money can be borrowed at 8 percent. The present value of an ordinary annuity of five annual receipts of $8,000 each discounted at 8 percent is $31,942. The discount of $8,058 represents the interest revenue to be accrued by the franchisor over the payment period.

Example of Entries for Initial Franchise Fee


18-86

Illustration: 1. If there is reasonable expectation that Tum’s Pizza Inc. may refund the down payment and if substantial future services remain to be performed by Tum’s Pizza Inc., the entry should be:


Cash 10,000

Notes Receivable 31,942

Unearned Franchise Fees 41,942


18-87

Illustration: 2. If the probability of refunding the initial franchise fee is extremely low, the amount of future services to be provided to the franchisee is minimal, collectibility of the note is reasonably assured, and substantial performance has occurred, the entry should be:


Cash 10,000


Revenue from Franchise Fees 41,942


18-88

Illustration: 3. If the initial down payment is not refundable, represents a fair measure of the services already provided, with a significant amount of services still to be performed by Tum’s Pizza in future periods, and collectibility of the note is reasonably assured, the entry should be:


Cash 10,000


Revenue from Franchise Fees 10,000.00

Unearned Franchise Fees31,942


18-89

Illustration: 4. If the initial down payment is not refundable and no future services are required by the franchisor, but collection of the note is so uncertain that recognition of the note as an asset is unwarranted, the entry should be:


Cash 10,000

Revenue from Franchise Fees 10,000


18-90

Illustration: 5. Under the same conditions as those listed in case 4 above, except that the down payment is refundable or substantial services are yet to be performed, the entry should be:


Cash 10,000

Unearned Franchise Fees 10,000

In cases 4 and 5 — where collection of the note is extremely uncertain—franchisors may recognize cash collections using the cost-recovery method.


18-91

Continuing franchise fees are received in return for the continuing rights granted by the franchise agreement and for providing such services as management training, advertising and promotion, legal assistance, and other support.

Franchisors report continuing fees as revenue when they are earned and receivable from the franchisee.

Continuing Franchise Fees


18-92

Copyright © 2011 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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kieso inter ch18 - ifrs (revenue)

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