Transcript
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REVENUE AND EXPENSE
RECOGNITION
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LEARNING OBJECTIVES
Understand the revenue and matchingprinciples
Familiarize yourself with applications of therevenue principle with special attention to:
Installment and cost recovery methodsAccounting for long-term contracts
Completed contract method
Percentage of completion method
Right of return method Product financing arrangements
Franchising agreements
Obtain overall understanding of matching
principle
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DEFINITIONS
Revenues Inflows of assets or settlements of liabilities during
a period from delivering or producing goods orservices.
Expenses Outflows of assets or incurrence of liabilities
during a period from delivering or producinggoods or services.
Incurred in an attempt to produce revenues
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REVENUE PRINCIPLE
Revenue should be recognized in thefinancial statement when . . .
It is earned, and
It is realized or realizable
(Measurable)
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REVENUE PRINCIPLE
Revenue is earned when the earnings processis completed or virtually completed.
Revenue is realized when cash is received.
Revenue is realizable when claims to cash arereceived that can be converted into a knownamount of cash.
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REVENUE PRINCIPLE
Revenue is typically recognized:
At delivery (point of sale)
After delivery
Before delivery
of product or service
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REVENUE RECOGNITION POINTS
Design and production,
construction in progress,
minerals discovered
Goods completed
and ready for sale,
contract complete
Delivery of
product or
service
Cash collected
for goods or
services
Right of
return expires
Recognition
before delivery
Recognition
after delivery
Recognition
at delivery
Percentage-of
completion method
Production
method
Completed
contract
method
Pointof sale
methodInstallment
method
Cost
recovery
method
Right of
return
expiration
method
RELEVANCE RELIABILITY
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Revenue is earned and realized at thepoint of sale.
The product or service has beendelivered to the customer and cash has
been received or is receivable.
This method is sometimes called the
sales method, or delivery method.
REVENUE RECOGNITIONPoint of Sale
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Uncertainties about collectibility orfuture performance by seller.
Sale with right of return.
Product-financing arrangements.
REVENUE RECOGNITION
After Delivery
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INSTALLMENT SALES
When we are uncertain about the collectibilityof the sales revenue or the ability of the sellerto deliver futures services, we should deferrevenue recognition.
Two commonly used accounting methods are
the . . . Installment sales method. Cost recovery method.
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INSTALLMENT SALES
Installment Sales Method
Sale and cost of sale recorded as usual.
Compute gross margin rate on theinstallment sales.
Recognize gross margin as cash is
received. Gross margin not realized is deferred until
a future period.
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INSTALLMENT SALESExample
Sams Appliances made sales of $200,000 in 19X5that qualified for the installment sales method of
accounting. The items sold have a cost to Samsof $130,000. During 19X5, Sams collected cash
from installment customers of $90,000. Theremaining amount will be collected in 19X6.
Prepare the journal entries to record theinstallment sales transactions during 19X5.
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INSTALLMENT SALES
Example
Sam's Appliances
Installment Sales
Dollars PercentInstallment sales revenue 200,000$ 100%
Cost of goods sold 130,000 65%
Gross margin 70,000$ 35%
R R 14
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INSTALLMENT SALESExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Installment Accounts Receivable 200,000
Installment Revenue 200,000
R R 15
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INSTALLMENT SALESExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Installment Accounts Receivable 200,000
Installment Revenue 200,000
Cost of Installment Sales 130,000
Inventory 130,000
R R 16
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INSTALLMENT SALESExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Cash 90,000
Installment Accounts Receivable 90,000
Re Re o 17
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INSTALLMENT SALESExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Installment Revenue 200,000
Cost of Installment Sales 130,000Deferred Gross Margin 70,000
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INSTALLMENT SALESExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Installment Revenue 200,000
Cost of Installment Sales 130,000Deferred Gross Margin 70,000
Deferred Gross Margin 31,500
Realized Gross Margin 31,500
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GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Installment Revenue 200,000
Cost of Installment Sales 130,000Deferred Gross Margin 70,000
Deferred Gross Margin 31,500
Realized Gross Margin 31,500
INSTALLMENT SALESExample
Cash collection in 19X5 $90,000Gross margin percentage 35%Gross profit to recognize $31,500
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INSTALLMENT SALESExample
Installment accounts receivable 110,000$
Less: Deferred gross margin 38,500
Net Installment accounts receivable 71,500$
Balance Sheet
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INSTALLMENT SALESExample
Installment accounts receivable 110,000$
Less: Deferred gross margin 38,500
Net Installment accounts receivable 71,500$
Installment accounts receivable 200,000$
Less: Cash collections (90,000)
Installment accounts receivable 110,000$
Deferred gross margin 70,000$
Less: Gross margin recognized (31,500)
Deferred gross margin 38,500$
Balance Sheet
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COST RECOVERY METHOD
Like the installment sales method, costrecovery is used when we are uncertain
about the collectibility of the sales revenue orthe ability of the seller to complete futureperformance.
UNCERTAINTY IS GREATER! No profit is recognized until cost of item soldis fully recovered.
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COST RECOVERYExample
Sams Appliances made sales of $200,000 in19X5 that qualified for the cost recovery
method of accounting. The items sold have
a cost to Sams of $130,000. During 19X5,Sams collected cash from installmentcustomers of $90,000. The remaining
amount will be collected in 19X6.
Prepare the journal entries to record theinstallment sales transactions during 19X5.
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COST RECOVERYExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Installment Accounts Receivable 200,000
Installment Revenue 200,000
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COST RECOVERYExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Installment Revenue 200,000
Cost of Installment Sales 130,000
Deferred Gross Margin 70,000
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COST RECOVERYExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Cash 90,000
Installment Accounts Receivable 90,000
No profit is recognized in 19X5 because the cost of theitem sold ($130,000) has not been recovered in the
form of cash receipts. Once we collect $130,000 incash, profit recognition begins.
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COST RECOVERYExample
Installment accounts receivable 110,000$
Less: Deferred gross margin (70,000)
Net Installment accounts receivable 40,000$
All gross profit has been deferred until we recover the$130,000 cost of the item sold.
Balance Sheet
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RIGHT OF RETURN
In some industries it is commonpractice that the sales terms allow
customers the right to return goodsunder specified conditions and over
long periods of time.
Book Publishing EquipmentManufacturing
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RIGHT OF RETURN
Recognize revenue at point of sale if,
Selling price is fixed or determinable. Buyer is obligated to pay the seller and payment is not
contingent upon resale of the product. Buyer is obligated even in case of theft or physical
destruction. Buyer has economic substance apart from that
provided by the seller. Seller has no obligation for future performance. Future returns can be estimated.
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PRODUCT-FINANCINGARRANGEMENTS
An agreement in which a sponsoringcompany sells a product to another
company and in a related transactionagrees to repurchase the product.
The sponsoring company
Records a liability when the proceeds arereceived. No sale is recorded and inventory is not
adjusted.
Wait for a sale to outside party.
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REVENUE RECOGNITIONBefore Delivery
Accounting for long-term constructioncontracts
Completed-Contract Method Percentage-of-Completion Method
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REVENUE RECOGNITION
Before Delivery Percentage-of-completion method is
appropriate when . . .
Contract specifies the amount ofconsideration to be exchanged and theterms of settlement.
Buyer is expected to satisfy the obligation.
Contractor can perform according to theterms of the contract.
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MEASURING PROGRESS TOWARD
COMPLETION
Input Measures
Effort devoted to project compared to totaleffort expected (cost incurred to datecompared to total estimated costs)
Output Measures
Results to date compared to total results
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MEASURING PROGRESS TOWARD
COMPLETION
Cost-to-Cost Method
Total costs incurred to datePercent complete =
Most recent estimate of total
costs of the project
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MEASURING PROGRESS TOWARD
COMPLETION Cost-to-Cost Method
Current Period Revenue
Total Revenue from Contract
Percent Complete
Total Revenue to Recognize
- Revenue Recognized in Prior Periods
= Revenue Recognized in Current Period
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LONG-TERM CONTRACTS
Example
During 19X6, West, Inc. enters into a
contract with Putnam County to build abridge over Cane River. The project willtake 3 years to complete and has a fixedprice of $4,500,000. Wests engineers
estimate the total cost of the bridge to be$3,000,000. At the end of 19X6, the
information on the next page was gathered
by Wests accountant.
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LONG-TERM CONTRACTSExample
Project costs incurred during 19X6 750,000$Estimated cost to complete the bridge 2,250,000
Amounts billed to Putnam Co. in 19X6 800,000
Cash collections from Putnam Co. 790,000
West uses the percentage-of-completionmethod to account for all long-term
construction projects.
Prepare the necessary 19X6 journal entriesfor this project.
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LONG-TERM CONTRACTSExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Construction-In-Process 750,000
Cash, Payables, etc. 750,000
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LONG-TERM CONTRACTSExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Construction-In-Process 750,000
Cash, Payables, etc. 750,000
Accounts Receivable 800,000
Billings on Contracts 800,000
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LONG-TERM CONTRACTSExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Construction-In-Process 750,000
Cash, Payables, etc. 750,000
Accounts Receivable 800,000
Billings on Contracts 800,000
Cash 790,000Accounts Receivable 790,000
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LONG-TERM CONTRACTSExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Construction-In-Process 375,000
Cost of Construction 750,000
Construction Revenue 1,125,000
750,000$ 3,000,000$ = 25% complete4,500,000$ 25% = 1,125,000$ revenue
1,500,000$ 25% = 375,000$ profit
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LONG-TERM CONTRACTSExample
GENERAL JOURNAL Page 34
Date Description
Post.
Ref. Debit Credit
Construction-In-Process 375,000
Cost of Construction 750,000
Construction Revenue 1,125,000
If West uses the Completed-Contract method, norevenue is recognized during 19X6. All
revenue and profit is recognized at theend of the contract when delivery of the bridge to
Putnam County is made.
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REVENUE RECOGNITION
Before Delivery Completion of Production
Accretion Basis
Discovery Basis
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REVENUE RECOGNITIONService Sales
Specific Performance Method
Proportional Performance Method
Completed Performance Method
Collection
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SPECIFIC PERFORMANCE
Used to account for revenue that isearned by performing a single act.
Franchise revenue (SFAS No. 45)
BobsBurgers
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PROPORTIONAL PERFORMANCE
Used to recognize service revenue thatis earned by more than a single act and
when the service is rendered in morethan one accounting period. Similar performance acts - equal amount
for each act
Dissimilar performance acts - in proportionto direct costs of each act
Similar acts with a fixed period for
performance
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COMPLETED PERFORMANCE
Used when revenue is earned byperforming a series of acts, and the last
act is so important that revenue is onlyconsidered earned if it is performed.
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COLLECTION
Used to account for service revenuewhen the uncertainty of collection is
very high. Revenue recognized when cash is
received.
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EXPENSE RECOGNITION
Expenses are outflows of assets orincurrences of liabilities during a period
from delivery or producing goods orrendering services.
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MATCHING
Once revenues are determined, theexpenses incurred in generating the
revenue should be recognized.
As revenues are earned, certain assets
are consumed and services are used.
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EXPENSES
Recognition Methods
Direct
Period
Allocated
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GAINS AND LOSSES
Gains and losses result from peripheral or
incidentaltransactions, events, or
circumstances.
Most gains and losses are recognized whenthe transaction is completed.
Estimated losses are recognized before
realization if they are probable and can be
reasonably estimated. Rev. Recog - 54
ETHICAL CONSIDERATIONS
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ETHICAL CONSIDERATIONS
Im sorry we shipped yourorder on Dec. 28 instead ofon the delivery date of Jan.
10. But the important thing isthat you have the products
you need...Right?
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