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PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA
Anticipated Long-Term Contract Losses:Type I - loss in one year (page 253)
• In 2011, @ 40% completion, we recognized $500,000 of gross profit (40% of $1,250,000)
• assume that in 2012, @ 60% completion, we estimate total gross profit for the project will be only $400,000.
• 60% of $400,000 = $240,000 (correct recognition at this point in time)
• We must record a LOSS of $260,000 in 2012– Profit in 2011 of $500,000, loss in 2012 of $260,000– Adds up to total profit recognition of $240,000
• See 2012 journal entry on bottom of page 253 to record 2012 loss of $260,000!
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Long-Term Contract Losses:Type II - expected total loss for project (p. 254)
• In 2011, @ 40% completion, we recognized $500,000 of gross profit (40% of $1,250,000)
• assume that in 2012, we estimate that the project will have a loss (in total) of $100,000
• We must fully recognize this loss in 2012:
– Since profit in 2011 of $500,000 was recorded– We record a loss in 2012 of $600,000
• 2011 profit of $500,000• 2012 loss of $600,000• Total loss = $100,000
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U. S. GAAP vs. IFRS
• Requires completed contract method when reliable estimates can’t be made.
Both require percentage-of-completionmethod, but …
• Requires cost recovery method when reliable estimates can’t be made.
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Other Revenue Recognition Topics
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Software and Other Multiple- Deliverable Arrangements (p. 259)
• If a sale includes multiple elements …
• such as: software, future upgrades, postcontract customer support, etc.
• the revenue should be allocated to the elements that have stand-alone value
• for software: base allocation on sales price if sold separately (VSOE = vendor specific objective evidence)
• if VSOE does not exist, defer revenue recognition until the last item delivered.
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Franchise Sales (pages 260-261)
Initial Franchise Fees
Revenue recognition is challenging:
Generally when the earnings process is virtually complete.
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U. S. GAAP vs. IFRS
• Has over 100 revenue-related standards that sometimes contradict each other.
The FASB and IASB are currently working on a new, comprehensive approach to revenue
recognition.
• Has two primary standards that also sometimes contradict each other and that don’t offer guidance in some important areas (like multiple deliverables).
The Boards appear committed to improving accounting in this area.
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Activity Ratios
Asset Turnover Ratio Net Sales ÷ Average Total Assets
Receivables Turnover Ratio Net Sales ÷ Average Accounts Receivable
Average Collection Period 365 ÷ Receivables Turnover Ratio
Inventory Turnover Ratio Cost of Goods Sold ÷ Average Inventory
Average Days in Inventory 365 ÷ Inventory Turnover Ratio
Activity Ratios
Whenever a ratio divides an income statement balance by a
balance sheet balance, the average for the year is used in
the denominator.
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Profitability Ratios
Profit Margin on Sales Net Income ÷ Net Sales
Return on Assets Net Income ÷ Average Total Assets
Return on Shareholders' Equity Net Income ÷ Average Shareholders' Equity
Profitability Ratios
Return on Equity Key ComponentsProfitability
ActivityFinancial Leverage
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This is called the DuPont framework because the DuPont
Company was a pioneer in emphasizing this relationship.
DuPont Framework
Return on equity =
Profit margin X
Asset turnover X
Equity multiplier
Net incomeAvg. total
equity=
Net incomeTotal sales X
Total salesAvg. total
assetsX
Avg. total assetsAvg. total equity
The DuPont Framework helps identify how profitability, activity, and financial leverage trade off to determine