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Revenue Recognition
MANAC I
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Issues involved
When to recognize?
Timing
How much to recognize?
Amount
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Determinants
Operating Cycle
Accounting System
Accrual accounting system
AS 1
Realization, Conservatism, Matching
Concepts
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Readings
Accounting Standard 9
HBS-Revenue Recognition and Reporting
AHM Chapter 5
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What is revenue?
All the receipts are not revenue
It is the gross inflow of cash, receivables or
other considerations arising in the ordinary
course of business
It is charge made to customers
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Revenue
Sale of goods
Services
OthersInterest, Royalties and dividends
Note: Assume that company follow Accrual Accounting System
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AS9 - Does not include revenue from Construction contracts (AS 7)
Hire-purchase and lease agreements (AS 19)
Government grants and subsidies (AS 12)
Insurance contracts (partly AS 30, 31)
Changes in foreign exchange rates (AS 11)
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Revenue Recognition Methods
1. Sales
2. Installment Sales
3. Production
4. Long-term contracts I
5. Long-term contracts II
6.
Cost recovery7. Delivery
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Revenue Recognition Methods
1. Sales Methodrecognition at the time
services are rendered or goods shipped
2. Installment Sales Methodrecognition at
the time the sale price is collected
3. Production Methodrecognition at the
time the product is completed but before
delivery
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Revenue Recognition Methods
4. Percentage-of-completion methodrecognition proportionally over the
performance of a long-term contract
5. Completed contract methodrecognition
at the completion of a long-term contract
6. Cost recovery methodrecognition after
the buyers cumulative cash payments
exceed the sellers total costs 7. Delivery methodrecognition at time of
delivery if the sale is made and cash is
received prior to delivery or production
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Event Revenue Recognition Revenue
at this time Recognition Method
1 Sales order received NO NONE2 Deposit or advance payment received NO NONE
3 Goods are produced For certain long-term contracts Percentage of completion
4 Production completed; goods stored For precious metals and certain Production
agrrcultural products5 Goods shipped or services provided Usualy Delivery
6 Customer pays account receivable Collection is uncertain Installment
Timing of Revenue Recognition
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Services
When service is performed
Proportionate completion method
Multiple acts
Completed service contract
Single acts
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Others
Interestdue but not received
Royaltiesaccrue and either paid or due
Dividendsright to receive payment is
established
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Format
Turnover (Gross) XXX
Less: Excise Duty XX
Turnover (Net) XXX
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Cash and Trade Discounts
Trade discountsreductions to the gross
selling price for a particular class of
customers
Cash discountsreductions of invoice prices
awarded for prompt payment
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Cash and Trade discount
Credit terms Meaning
n/30 The full billed price (net price) is ude on thirtieth day after the invoice date
1/5, n/30 A 1% discount can be taken for payment within 5 days of the invoice date;
othewise, the full billed price is due in 30 days
15 E.O.M. The full price is due within 15 days after the End Of the Monthof salean invoice dated January 20 is due February 15
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Illustration .. A manufacturer sells 30000 of computer
equipment to IBM on terms 2/10, n/60
Ans..
IBM may remit 30000 less a cash discount of0.02 X 30000 and pay 29400, if it makes
payment within 10 days after the invoice date
Otherwise it must pay the full 30000 within 60days
WHAT IS THE ENTRY FOR THIS
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Transaction analysis or Journal entries
1. Accounts receivablesDr30000 and
SalesCr30000
2. CashDr29400; Cash discounts on sales
Dr600 and Accounts receivablesCr30000
OR
1. CashDr30000 and Accountsreceivables - 30000
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Question to think / discuss
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Sale of goods
Delivery is delayed at buyers request and
buyer takes title and accepts billing
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Sale of goods
What is delivery subject to conditions ?
Installation and inspection
On approval
Guaranteed sales
Provide allowance for the same
Consignment sales Cash on Delivery
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HUL AR 2008-09 page 112
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Infosys AR 2007-08 page 73
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Jindal Steel and Power AR-2007-08
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AXIS bank AR-2007-08
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Cost of Sales and Inventory
:
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Issues involved
What is inventory?
What costs are included in inventory?
How do we separate CGOS and closing
inventory?
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Resources
AS 2
AS-2 deals with determination of value of
inventory
HBR-The Question of LIFO and FIFO
AHM Chapter 6
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What is inventory?
Asset items held for sale in the ordinary
course of business or goods that will be used
or consumed in the production of goods to be
sold
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Types of Companies
Merchandising company
Sells goods in same form as acquired.
Manufacturing company
Converts raw material into finished goods.
Service company Provides intangible services.
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Merchandising company
Merchandising
Sells goods in same form in which they are
acquired.
Inventory costs (and costs of goods sold) =acquisition costs.
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Manufacturing company
Manufacturing company converts raw
materials and purchased parts into finished
goods.
3 types of inventories; Raw Materials.
Work-in-process.
Finished goods.
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Service company
Service organizations (hotels, beauty parlors,
plumbers)
May have materials inventories.
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Professional Service Inventories
Professional service firms (accounting firms,
legal firms)
Intangible inventory costs are costs incurred for
client but not yet billed called jobs-in-progress orunbilled costs.
Example: law and accounting firms.
Labor , overhead, and incidental product costs but nomaterials cost.
Expensed in period billed (i.e., when revenues are
recognized).
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Terminology
Inventories: are assets
a. held for sale in the ordinary course of business
b. in the process of production for such sale
c. in the form of materials or supplies to beconsumed in the production process or in the
rendering of services
Net Realizable Value:
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Measurement
Inventories should be valued at the lower of
cost and net realizable value (as per AS 2)
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Cost Formulas
FIFO
LIFO
Weighted Average
Average
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Inventory valuation Method
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What is the value of inventory? Under
. FIFO
LIFO
Average
Weighted Average
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What is the value of inventory? Under
. FIFO 4500
LIFO 3800
Average 4141
Weighted Average
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Question to all?
The Question of LIFO or FIFO: Which is
Preferable?
Ans: . . .
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Answer this .
Sales 100000
Less: Cost of goods sold
Op inventory 20000
Purchases 30000
Cost of goods available 50000
Less: Cl. Inventory 14000Cost of goods sold 36000
Gross Profit 64000
Operating Exp 29000
Net Income 35000
If Cl inventory is overstated by 2000
What is the impact on
a. Cost of goods sold
b. Net income
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Advantages for LIFO
If prices are based on current costs, results in
best matching of revenues and costs and
therefore most useful income statement.
Closest to reflecting current or replacementcosts of goods sold.
However, it is still historical costs and could differ
from current costs
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Relationship of Inventory and Cost of
Goods Sold
Beginning inventory + net purchases = goods
available for sale
Goods available for sale = cost of goods sold
+ ending inventory. Equivalently: Beg. inventory + net purchases
-ending inventory = cost of goods sold.
Net purchases = gross purchases -purchasereturns and allowances + freight-in
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Calculate value of inventory for reporting in
Financial Statementson ITEM by ITEM
Item Units Cost per unit NRV per unit
Z 200 4.00 4.50Y 250 5.00 5.50
X 300 6.00 5.00
W 350 7.00 6.00
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Calculate value of inventory for reporting in
Financial Statementson ITEM by ITEM
Lower of
Item Units Cost per unit NRV per unit Cost or MV
Z 200 4.00 4.50 800 COSTY 250 5.00 5.50 1250 COST
X 300 6.00 5.00 1500 MV
W 350 7.00 6.00 2100 MV
5650 total
l l l f f
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Calculate value of inventory for reporting in FS
onTOTAL INVENTORY basis
Item Units Cost per unit NRV per unit COST MV
Z 200 4.00 4.50 800 900
Y 250 5.00 5.50 1250 1375
X 300 6.00 5.00 1800 1500
W 350 7.00 6.00 2450 2100
6300 5875
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Why lower of cost or market price
Market price may be below cost due to:
Physical deterioration.
Change in consumer tastes.
Technological obsolescence.
LCM is a reflection of conservatism concept.
Market is defined as replacement cost.
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AS - 2
In India, as per AS 2Valuation of
Inventories,
the cost of inventories should be assigned by
using First-in, First out (FIFO) method or
Weighted Average Cost of method
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Disclosure Requirements
The financial statements should disclose:
a. the accounting policies adopted in measuring
inventories, including the cost formula used and
b. the total carrying amount of inventories and itsclassification appropriate to the enterprise
Like: raw materials and components, work in progress,
finished goods, stores and spares and loose tools.
d l A
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Jindal AR- 2007-08
f A 200 08
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Infosys AR 2007-08
Inventory value will be.
?
I f AR 2007 08 64
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Infosys AR 2007-08 page no. 64
TCS AR 2010 11
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TCS AR2010-11
Inventoryas a part of CA (Scheduled H)
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HUL AR 2008 09 64
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HUL AR- 2008-09 page no. 64
R i
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Revise ..
1. Inventory is reported in the Balance Sheet as
an ___________
2. The inventory method which assumes thatgoods are sold in the reverse order of their
acquisition is know as ________ method
3. A company should select the ____ inventory
method if it wishes to keep its taxes to
minimum
R i
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Revise ..
1. Inventory is reported in the Balance Sheet as
an_CURRENT ASSET
2. The inventory method which assumes thatgoods are sold in the reverse order of their
acquisition is know as_LIFO_ method
3. A company should select the_LIFO_inventory
method if it wishes to keep its taxes to
minimum