revenue recognition ppp
TRANSCRIPT
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1. Identify the primary criteria for revenuerecognition.
2. Apply the revenue recognition concepts
underlying the examples used in SAB 101.3. Record journal entries for long-term
construction-type contracts using
percentage-of-completion and completed-contract methods.
Learning Objectives
Continued
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4.Record journal entries for long-term service
contracts using the proportional
performance method.
5.Explain when revenue is recognized after
delivery of goods or services through
installment sales, cost recovery, and cash
methods.
Learning Objectives
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Both of these criteria
generally are met at the
point of sale.
Revenue recognition mostoften occurs when goods
are delivered or when
services are rendered.
Revenue Recognition
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Revenue Recognition
Criterion Associated With Revenue
Recognition
Criterion 1: The customer has providedpayment or a valid promise
of payment.
Criterion 2: The company has provideda product or service.
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Revenue Recognition
Before the point of Sale
EXCEPTION:
Revenue can be recognized
prior to the point of sale i f:Customer provides a valid
promise of payment ANDCriterion 1
Criterion 2 conditions exist thatcontractually guarantee
subsequent sale.
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Revenue Recognition
Point of Sale
NORMALLY:
Revenue is generally
recognized at this point oftime.
Criterion 1 is typically
satisfied at this point.Criterion 1
Criterion 2 Critical 2 is typically
satisfied at this point.
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Revenue Recognition
After the Point of Sale
EXCEPTION:
The recognition of revenue
must be deferred i f:
Customer does not provide
a valid promise at time of
receipt of product or service
OR
Criterion 1
Criterion 2 significant effort remains on
the contract.
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A product or service was provided withoutreceiving a valid promise of payment from
customer. The company has not provided the product
or service.
Revenue Recognition
Generally, revenue is not recognized prior tothe point of sale because either:
An exception occurs when the customer provides
a valid promise of payment and conditions exist
that contractually guarantee the sale.
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Revenue Recognition
AICPA Statement of Position 97-2givescompanies more guidance through a checklist
of four factors that amplify the two criteria:
a. Persuasive evidence of an arrangementexists.
b. Delivery has occurred.
c. The vendors fee is fixed or determinable.
d. Collectibility is probable.
Earned
Realised
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12Persuasive Evidence of anArrangement
The SEC issued SAB 101
in response to specific
abuses involving revenuerecognition.
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SAB 101is in a question-
and-answer format. The
answers given areinvariably No.
Persuasive Evidence of anArrangement
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14Persuasive Evidence of anArrangement
Typical questions from SAB 101
Question 1: Company A requires each sale to
be supported by a written salesagreement signed by an
authorized representative of
both Company A and the
customer.
Addresses internal controls.
Question 1: May Company A recognize
revenue in the current quarter ifthe product is delivered by the
end of the quarter but the sales
agreement is not signed by the
customer until a few days after
the end of the quarter?
ENTER
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15Persuasive Evidence of anArrangement
Typical questions from SAB 101
Question 2: Company Z delivers product to
a customer on a consignmentbasis. May Company Z
recognize revenue upon delivery
of the product to the customer?
Addresses the issue of circumventing
internal controls by side agreements.
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16Delivery has occurred or servicehas been rendered
Typical questions from SAB 101
Question 3: May Company A recognize
revenue when it completesproduction of inventory for a
customer if it segregates that
inventory from other products in
its warehouse?
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17Delivery has occurred or servicehas been rendered
Typical questions from SAB 101
Question 4: Company R is a retailer that
offers layaway sales tocustomers. A customer pays a
portion of the sales price, and
Company R sets the
Focuses on issues centered on the
bill-and-hold arrangements.
Question 4: merchandise aside until the
customer pays the remainder ofthe sales price, and takes
possession of the merchandise.
When should Company R
recognize revenue?
ENTER
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18Delivery has occurred or servicehas been rendered
bill-and-hold arrangements.
In general, revenue should not be recognised
in a bill-and-hold arrangement until the sellerhas transferred both legal ownership,
evidence by the buyer taking title to the
goods, and economic ownership, meaning
that the buyer accepts responsibility for thesafeguarding and preservation of the goods.
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19Delivery has occurred or servicehas been rendered
Receipt of $100 cash as initial layaway payment:
Cash 100
Deposit Received from Customers 100Receipt of f inal $1,400 cash payment and delivery
of goods to customer:
Cash 1,400
Deposit Received from Customers 100
Sales 1,500
Cost of Goods Sold 1,000
Inventory 1,000
Appropriate Layaway Accounting
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20Delivery has occurred or servicehas been rendered
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21Delivery has occurred or servicehas been rendered
E.g. Seller Company receives $1,000 cash from
a customer as the initial sign-up fee for a
service. In addition to the sign-up fee, the
customer is required to pay $50 per month for
100 monthswhich is the economic life of this
service agreement.
Questions 5 & 6Deal with the seller
receiving some up-front fee as well as
subsequent periodic payments
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22Delivery has occurred or servicehas been rendered
Receipt of $1,000 cash as initial sign-up fee:Cash 1,000
Unearned Initial Sign-Up Fees 1,000
Receipt of f irst monthly payment of $50:
Cash 50
Monthly Service Revenue 50
Partial recogni tion of the ini tial signup fee as
revenue ($1,000/100 months):Unearned Initial Sign-Up Fees 10
Initial Sign-Up Fee Revenue 10
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23Delivery has occurred or servicehas been rendered
Questions 7 & 9Deal with refundable
fees. In summary, the non-refundable
portion of the fees can be recognized on
a monthly basis if the number ofrefunds can be reliably estimated.
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Price is fixed or determinable
Typical questions from SAB 101
Addresses the difference between estimating
the future impact of past events and
estimating the future impact of future events.
Question 8: Company A owns a building and
leases it to a retailer. The annuallease payment is $1.2 million plus
1% of all the retailers sales in
excess of $25 million.
Question 8: Should Company A estimate and
recognize revenue associatedwith the 1% of sales over $25
million on a straight-line basis
throughout the year? ENTER
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Reporting Revenue: Gross vs. Net
Gross = Sales + commission
Net = Commission only
SAB 101 Gross is inapp rop r iate
un less the seller actual ly took
legal and econom ic ownersh ip of
the goods being so ld.
26Revenue Recognition Prior to
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26Revenue Recognition PriortoProviding Goods or Services
Completed-contract methodrecognizes all
income when project is completed.
Percentage-of-completion method
recognizes revenue throughout the term ofthe contract. (construction)
Proportional performance method
reflects revenue earned on service contractsunder which many acts of service are to be
performed before the contract is complete.
27Revenue Recognition Prior to
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GAAP requires percentage-of-
completion method unless
certain criteria are notmet.
Revenue Recognition Prior toProviding Goods or Services
28Percentage of
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28Percentage-of-Completion Accounting
Dependable estimates of: contract revenues
contract costs
progress toward completion Contract clearly specifies:
enforceable rights of the parties
consideration to be exchanged manner and terms of settlement
Continued
29Percentage of
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29Percentage-of-Completion Accounting
The buyer can be expected to satisfy
obligations under the contract.
Contractor can be expected to performthe contractual obligation.
30Percentage of
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Recognize revenue throughout life of thecontract.
Revenue recognized is a function of how
complete the project is to date. Costs are charged to an inventory account:
Construction in Process(CI P).
Profits are charged to CI P.
CI Pis valued at net realizable value.
Any anticipated loss is booked for the full
amount of the loss when it becomes measurable.
Percentage-of-Completion Accounting
31Percentage of
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Input measures: Cost-to-cost methodwhere
the degree of completion is determined by
comparing costs already incurred with the
most recent estimates of total expected coststo complete the project.
Engineers are often called
in to help provide estimates.
Percentage-of-Completion Accounting
32Accounting for Long Term
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32Accounting for Long-TermConstruction-Type Contracts
Strong Construction Company wasawarded a contract with a total price of
$3,000,000. Strong expected to earn
$400,000 profit on the contract.
33Accounting for Long Term
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33Accounting for Long-TermConstruction-Type Contracts
ActualCost
Incurred
EstimatedCost to
CompleteYear
Cost
Percentage
Total
Cost
2004 $1,040,000 $1,560,000 $2,600,000 40
2005 910,000
Total $1,950,000 650,000 2,600,000 75
2006 650,000 0 2,600,000 100
Total $2,600,000
34Percentage of
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Construction in Progress 1,040,000
Materials, Cash, etc. 1,040,000
To record costs incurred.
Accounts Receivable 1,000,000
Progress Billings on
Construction Contracts 1,000,000
To record billings.Cash 800,000
Accounts Receivable 800,000
To record cash collections.
2004
Percentage-of-Completion Accounting
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Percentage of
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Cost of Long-Term Construction
Contracts 1,040,000
Construction in Progress 160,000
Revenue from Construction Contracts 1,200,000
2004
Percentage-of-Completion Accounting
Actual Cost
$3,000,000 x .40
36Percentage of
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Construction in Progress 910,000
Materials, Cash, etc. 910,000
To record costs incurred.
Accounts Receivable 900,000
Progress Billings on
Construction Contracts 900,000
To record billings.Cash 850,000
Accounts Receivable 850,000
To record cash collections.
2005
Percentage-of-Completion Accounting
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Percentage of
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Cost of Long-Term Construction
Contracts 910,000
Construction in Progress 140,000
Revenue from Long-Term
Construction Contracts 1,050,000
2005
Percentage-of-Completion Accounting
($3,000,000 x .75)
$1,200,000
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Construction in Progress 650,000
Materials, Cash, etc. 650,000
To record costs incurred.
Accounts Receivable 1,100,000
Progress Billings on
Construction Contracts 1,100,000
To record billings.Cash 1,350,000
Accounts Receivable 1,350,000
To record cash collections.
2006
Percentage-of-Completion Accounting
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Percentage of
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Cost of Long-Term Construction
Contracts 650,000
Construction in Progress 100,000
Revenue from Long-Term
Construction Contracts 750,000
2006
$ 3,000,000
(1,200,000)
(1,050,000)
$ 750,000
Percentage-of-Completion Accounting
40Percentage of
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Progress Billings on Construction
Contracts 3,000,000
Construction in Progress 3,000,000
2006
Percentage-of-Completion Accounting
Construction in Progress
1,040,000
160,000
910,000140,000
650,000
100,000
3,000,000
Progress Billings on
Construction Contracts
1,000,000
900,0001,100,000
3,000,000
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Revision of Estimates
Instead of the previous illustration, assumethat at the end of 2005, it was estimated that
the remaining cost to complete construction
was $720,000 rather than $650,000.
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Items in bluechanged from
the previous illustration.
Revision of Estimates
ActualCost
Incurred
EstimatedCost to
CompleteYear
Cost
Percentage
Total
Cost
2004 $1,040,000 $1,560,000 $2,600,000 40
2005 910,000
Total $1,950,000 720,000 2,670,000 73
2006 700,000 0 2,650,000 100
Total $2,650,000
Note that expected gross profit was $400,000 in 2004,
$330,000 in 2005, and the actual was $350,000 in 2006.
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Revision of Estimates
2004
The entries for 2004 would
be the same as those shown
in the previous example.
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Revision of Estimates
2005
All entries for 2005 would
be the same except for the
entry to record revenueand cost.
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Revision of Estimates
Construction in Progress 700,000
Materials, Cash, etc. 700,000
To record costs incurred.
Accounts Receivable 1,100,000
Progress Billings on
Construction Contracts 1,100,000
To record billings.Cash 1,350,000
Accounts Receivable 1,350,000
To record cash collections.
2006
Same
Same
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Revision of Estimates
Cost of Long-Term Construction
Contracts 700,000
Construction in Progress 110,000
Revenue from Long-Term
Construction Contracts 810,000
2006
$3,000,000(1,200,000)
(990,000)
$ 810,000
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2006Construction in Progress
1,040,000
160,000
910,00080,000
700,000
110,000
3,000,000
Progress Billings on
Construction Contracts
1,000,000
900,0001,100,000
3,000,000
Revision of Estimates
Items in redare different for
this illustration.
Progress Billings on Construction
Contracts 3,000,000
Construction in Progress 3,000,000
49Anticipated Loss: Percentage-of-
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Anticipated Loss: Percentage ofCompletion Method
Assume the same facts for Strong
Construction Company, except that after
2004 entries have been made, the firm
determines that the total cost will be$3,250,000. The entries for 2004 would be
the same, but the loss must be dealt with in
2005in addition, the $160,000 gross profitrecognized in 2004 must be eliminated.
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Anticipated Loss: Percentage ofCompletion Method
Cost of Long-Term Construction
Contracts 910,000
Revenue from Long-Term
Construction Contracts 600,000
Construction in Progress 410,000
2005
To go from a $160,000 gross profit to an
anticipated $250,000 loss ($3,000,000
$3,250,000), the Construction in Progess
account needs to be credited $410,000.
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Accounting for Long TermService Contracts
Most service contracts involve threetypes of costs:
(1) Initial direct costs related to obtaining
and performing initial services on the
contract.
(2) Direct costs related to performing the
various acts of service.
(3) Indirect costs related to maintaining
the organization to service the
contract.
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Accounting for Long TermService Contracts
Receipt of fees:Cash 50,000
Deferred Course Revenue 50,000
Liability account
I ni tial direct costs:
Deferred Initial Costs 5,000Cash 5,000
Direct costs for lesson actually completed:
Contract Costs 12,000Cash 12,000
Expense account
Asset account
Continued
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Accounting for Long TermService Contracts
Course revenue recognized:Deferred Course Revenue 20,000
Recognized Course Revenue 20,000
Recognize contract costs from initial direct costs:
Contract Costs 2,000Deferred Initial costs 2,000
$24,000$60,000 x $50,000
$24,000
$60,000x $5,000
55Revenue Recognition After Delivery
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Revenue Recognition After Deliveryof Goods or Providing Service
I nstallment Sales Method:Recognizesrevenues and related expenses as cash isreceived (used when collection issomewhat uncertain). (Not to be confused with
installment sales, which uti l ize accrual accounting)Cost Recovery Method: No income isrecognized on sale until the cost of theitem sold is recovered through cash
receipts (used when collection is veryuncertain).Cash Method: Recognizes all expenses
immediately as incurred and all revenues
only when cash is collected.
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Full Accrual At point of saleRecognized at
point of sale
Installment
Sales
At collection of cash
(portion of receipt)
Defer and matchagainst revenue ascash is collected
Cost
Recovery
At collection of cash
(after all costs havebeen recovered)
Defer and match
against cashreceipts
Cash At collection of cash Charge to expense
as incurred
Method Timing of RevenueRecognition Treatmentof Costs
Revenue Recognition Deliveryof Goods or Providing Service
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Installment Sales Method
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Installment Sales Method
The installment salesmethod is used most
commonly in cases of
real estate sales.
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Installment Sales Method
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Installment Sales Method
George sells merchandise on
the installment basis.
Uncertainty of collectionmakes use of the installment
method necessary. Use the
accompanying data to prepareGeorges journal entries.
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Installment Sales Method
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Sales
Cost of Sales
Gross Profit
Gross ProfitPercentage
2004 2005
$150,000 $200,000
100,000 140,000
$ 50,000 $ 60,000
33.33% 30%
Cash Collection2004 Sales $ 30,000 $ 75,000
2005 Sales $ 70,000
Installment Sales Method
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Installment Sales Method
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Installment Accounts Receivable
2004 150,000
Installment Sales 150,000
Cost of Installment Sales 100,000
Inventory 100,000
Cash 30,000
Installment Accounts
Receivable2004 30,000
Installment Sales Method
2004
Continued
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Installment Sales Method
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Installment Sales 150,000
Cost of Installment Sales 100,000
Deferred Gross Profit2004 50,000
Deferred Gross Profit2004 10,000
Realized Gross Profit on
Installment Sales 10,000
Installment Sales Method
2004
$30,000 x 33.33%
Continued
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Installment Sales Method
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Installment Sales Method
Installment Accounts Receivable
2005 200,000
Installment Sales 200,000
Cost of Installment Sales 140,000
Inventory 140,000
Cash 145,000
Installment A/R2004 75,000
Installment A/R2005 70,000
2005
Continued
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Cost Recovery Method
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Cost Recovery Method
Assume George has touse the cost recovery
method, but all sales
and collections remain
the same.
CostRecoveredCost
Revenue
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Cost Recovery Method
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2005
All entries are the same except do not
book the entry to gross profit.
Deferred Gross Profit2004 5,000
Realized Gross Profit on
Installment Sales 5,000
Cost Recovery Method
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Cost Recovery Method
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2006
Deferred Gross Profit2004 30,000
Deferred Gross Profit2005 10,000Realized Gross Profit on
Installment Sales 40,000
Cost Recovery Method
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Cash Method
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If the probability ofrecovering product or
service costs is remote the
cost recovery methodof
accounting can be used.
There has to be
considerable uncertainty as
to ultimate collection of thecontract price.
Cash Method
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chapter 8
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The End
chapter8
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