John Wiley & Sons Canada, Ltd. ©2011 FINANCIAL ACCOUNTING a user perspective Fifth Canadian Edition Prepared by: Lynn de Grace C.A. Chapter 4 Revenue Recognition.

John Wiley & Sons Canada, Ltd. ©2011

FINANCIAL ACCOUNTING a user perspective

Fifth Canadian Edition

Prepared by: Lynn de Grace C.A.

Chapter 4Revenue Recognition and Statement

of Earnings

Cash-to-Cash Cycle


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Operating activities• Includes all normal day-to-day activities of

the business• Involves normal buying and selling of goods

and/or services

Cash-to-Cash Cycle


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Budgeting & forecasting activity

Acquisition of inventory

Cash collection

Selling activity

Delivery of products or services

Warranty service

Cash-to-Cash Cycle


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Cash investment• Loans or investments by shareholders

Budgeting and planning activity Acquisitions

• Acquire property, plant, and equipment• Hire labour• Purchase inventory

Cash-to-Cash Cycle


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Selling activity• Promote and sell the product

Delivery of product Collection

• Cash received immediately, or• An amount to be received later: accounts receivable

Warranty service• Written or implied guarantee of quality• Seller is responsible for replacement or repair of the

product

Revenue Recognition


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Revenues• Inflows of cash or other assets from

normal operating activities• Sale of goods or provision of services

Expenses• Costs incurred to earn revenues

Net income• Revenues less expenses

Revenue Recognition


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Matching principle All costs incurred to produce the revenue

must be recognized at the same time the revenue is recognized

Revenue Recognition Criteria


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Revenue is recognized when:• It is earned

• Performance is substantially complete• Risks and rewards are transferred - usually

linked to a critical event in the business cycle• The amount earned can be measured

• Measurement refers to both revenues and costs

• Reasonable assurance exists as to collectibility

Revenue Recognition


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The most common type of revenue recognition is the shipment of goods to the customer:

• There has been a transfer of the risks and rewards to the buyer.

• The company no longer has managerial involvement or control over the goods sold.

• The revenue can be measured reliably.

• It is probable that economic benefits from the transaction will flow to the seller.

• The costs incurred or to be incurred with respect to the transaction can be measured reliably.

B R I C K W O R K S L I M I T E D ( 2 0 0 9 )Note 1 to the the Financial Statements

Revenue

Sales revenue is recognized when the significant risks and rewards of ownership of the items sold have passed to the buyer, and the revenue is also able to be measured reliably.

For revenue from the sale of goods, this occurs upon the delivery of goods to customers.

For revenue from the sale of land held for resale, this is recognized at the point at which any contract of sale in relation to industrial land has become unconditional, and at which settlement has occurred for residential land.

Profits on disposal of investments and property, plant and equipment are recognized at the point where title to the asset has passed


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Revenue Recognition


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When revenues are recognized, it is necessary to record all expenses associated with that revenue.

HAWKE COMPANYIncome Statement

For the Period Ended December 31, 2010

Revenues $ 30,000Cost of goods sold 22,000Gross profit 8,000Warranty expense500 Net income $ 7,500

Revenue Recognition


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Sometimes cash is received before all the revenue recognition criteria have been met.

Deposit received in advanceCash (A) 500

Unearned revenue (L) 500

When goods are delivered, the revenue can be recognized:

Unearned revenue (L) 500Sales revenue (SE) 500

Revenue Recognition


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Some industries have specific revenue recognition practices: At the time of contract signing

• Franchising and retail land sales• Basic criteria must still be met

• Only minimal costs yet to be incurred• Reasonable chance of collecting

receivables

Revenue Recognition


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At the time of production

• Long-term construction• Percentage of completion method

• Mining• Critical event is the production, not the sale, of the

ore. Sales price is known at time of production due to forward or options contracts.

Barrick Gold Corp.Revenue Recognition

Percentage of Completion Method

Expenses for the period = Percentage Total cost of project completed

Percentage X Total = Revenue to becompleted revenue recognized

this period


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Percentage of Completion Method


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Year

Completion Revenue Expenses

Profit

1 75 / 210 = 36% 36% x 300 = $108

$75 $33

2 105 / 210 = 50%

50% x 300 = 150

105 45

3 30 / 210 = 14%

14% x 300 = 42 30 12

100% $300 $210 $90

Revenue Recognition


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For the delivery of services• Similar criteria as the delivery of goods• Normally recognition occurs when the

service is completed• For long term service contracts,

percentage of completion may be used when stage of completion can be measured reliably

Revenue Recognition


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Revenue from the Use by Others of a Company’s assets• Revenue is in the form of interest,

dividends, royalties• Interest revenue is recognized in

proportion to the time that has passed

Interest Revenue


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Example: A company accepts a $5,000, 3-month, 5% interest bearing note receivable from a customer on Feb 1, 2011. Interest will be earned on March 1, April 1 and May 1.

Feb. 1 (acceptance of note receivable)

Note receivable (A) 5,000.00

Sales (SE) 5,000.00

Mar. 1 (recognition of first month’s interest)

Interest receivable (A) 20.83

Interest revenue (SE) 20.83

Interest Revenue

Example (cont’d)

Apr. 1 (recognition of second month’s interest)Interest receivable (A) 20.83


May 1 (recognition of third month’s interest)Interest receivable (A) 20.83


May 1 (collection of note and interest owed)Cash (A) 5,062.49

Note receivable (A) 5,000.00Interest receivable (A) 62.49


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Dividend Revenue

Revenues from dividends:

June 1 (date dividend declared)Dividends receivable (A) 35

Dividend revenue (SE) 35

June 21 (date dividend payment received)Cash (A) 35

Dividends receivable (A) 35


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Revenue Recognition


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Multiple lines of business• Revenue recognition criteria may

be met at different points for different products

Disclosure of revenue recognition • Notes to the Financial Statements

FinningInternational Inc

Statement of Earnings Format

Two formats• Multi-step• Single-step

Companies often use hybrid forms of these approaches, using elements of both the multi-step and single-step formats in their income statements


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Westjet Statement of Earnings

Statement of Earnings Format


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Multi-step income statement• Results of different kinds of operations are

segregated• Gross profit (or gross margin) is presented.

SALES – COGS = GROSS PROFIT

Multi-step Statement of Earnings

Income from continuing operations• Revenue and expenses resulting from the sale of

goods and services to customers Income from non-operating sources

• Transactions that do not involve the normal sales of goods and services

• Losses from unusual or infrequent items Income from unusual or infrequent sources

• Transactions that are not in the normal course of business


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Multi-step Statement of Earnings

Corporate income taxes Discontinued operations

• Income or loss from significant discontinued segment

• Gain or loss on disposal of the segment`s assets


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Earnings per Share


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Net incomeWeighted average number of common shares outstanding

EPS =

Comprehensive Income

Defined as the total change in shareholders`equity from non-owner sources.

Includes net income, as well as other potential changes from non-owners such as: Gains and losses from the translation of

foreign currencies; Gains and losses arising from changes in the

fair value of some financial instruments The category Other Comprehensive Income is

used to accumulate these gains and losses. The final total represents Comprehensive Income for the year.


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Performance Measurement


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Return on Investment

ROI = ReturnAverage investment

Example: 50 = 5% $1,000



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Return on Investment• Compare to the returns on other

investments to determine if this is a good investment

• Is the investment worth the original $1,000 plus the $50 return?



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Return on Assets (ROA)• Measures income earned per $1 of assets

Return on Equity (ROE)• Measures income earned per $1 invested in

shares of the company

Discussion Question

ESPN sells ad time for the Super Bowl well before the game is actually played in January of each year. Assuming that millions of dollars are collected in non-refundable deposits in advance of the game, how should this revenue be recognized?


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For more information and examples of revenue recognition situations, see the following link:

http://moneyterms.co.uk/revenue-recognition/

Copyright © 2011 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume 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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Copyright

John Wiley & Sons Canada, Ltd. ©2011 FINANCIAL ACCOUNTING a user perspective Fifth Canadian Edition Prepared by: Lynn de Grace C.A. Chapter 4 Revenue Recognition.

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productjohn wiley sons

expensesjohn wiley sons

cash investmentloans

revenuesinflows of cash

shipment of goods

delivery of goods

sale of land

rewards of ownership