Rev.

Recog - 1

REVENUE AND EXPENSE

RECOGNITION

Rev. Recog - 2

LEARNING OBJECTIVES
Understand the revenue and matching
principles
Familiarize yourself with applications of the
revenue principle with special attention to:
Installment and cost recovery methods
Accounting 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

Rev. Recog - 3

Revenues

DEFINITIONS

Inflows of assets or settlements of liabilities during

a period from delivering or producing goods or
services.

Expenses
Outflows of assets or incurrence of liabilities
during a period from delivering or producing
goods or services.
Incurred in an attempt to produce revenues

Rev. Recog - 4

REVENUE PRINCIPLE

Revenue should be recognized in the

financial statement when . . .

It is earned, and

It is realized or realizable
(Measurable)

Rev. Recog - 5

REVENUE PRINCIPLE
Revenue is earned when the earnings process
is completed or virtually completed.
Revenue is realized when cash is received.
Revenue is realizable when claims to cash are
received that can be converted into a known
amount of cash.

Rev. Recog - 6

REVENUE PRINCIPLE

Revenue is typically recognized:

At delivery (point of sale)

After delivery
Before delivery

of product or service

Rev. Recog - 7

REVENUE RECOGNITION POINTS

Recognition
before delivery
Design and production,
construction in progress,
minerals discovered

Recognition
at delivery

Goods completed
and ready for sale,
contract complete

Percentage-of
completion method

Delivery of
product or
service

Production
method

Completed
contract
method

RELEVANCE

Point
of sale
method

Recognition
after delivery
Cash collected
for goods or
services

Installment
method
Cost
recovery
method

RELIABILITY

Right of
return expires

Right of
return
expiration
method

Rev. Recog - 8

REVENUE RECOGNITION
Point of Sale
Revenue is earned and realized at the
point of sale.
The product or service has been
delivered to the customer and cash has
been received or is receivable.
This method is sometimes called the
sales method, or delivery method.

Rev. Recog - 9

REVENUE RECOGNITION
After Delivery

Uncertainties about collectibility or

future performance by seller.
Sale with right of return.
Product-financing arrangements.

Rev. Recog - 10

INSTALLMENT SALES
When we are uncertain about the collectibility
of the sales revenue or the ability of the seller
to deliver futures services, we should defer
revenue recognition.
Two commonly used accounting methods are
the . . .
Installment sales method.
Cost recovery method.

Rev. Recog - 11

INSTALLMENT SALES

Installment Sales Method

Sale and cost of sale recorded as usual.
Compute gross margin rate on the
installment sales.
Recognize gross margin as cash is
received.
Gross margin not realized is deferred until
a future period.

Rev. Recog - 12

INSTALLMENT SALES
Example

Sams Appliances made sales of $200,000 in 19X5

that qualified for the installment sales method of
accounting. The items sold have a cost to Sams
of $130,000. During 19X5, Sams collected cash
from installment customers of $90,000. The
remaining amount will be collected in 19X6.
Prepare the journal entries to record the
installment sales transactions during 19X5.

Rev. Recog - 13

INSTALLMENT SALES
Example

Sam's Appliances
Installment Sales
Dollars
Percent
Installment sales revenue $ 200,000
100%
Cost of goods sold
130,000
65%
Gross margin
$ 70,000
35%

Rev. Recog - 14

INSTALLMENT SALES
Example

GENERAL JOURNAL
Date

Description
Installment Accounts Receivable
Installment Revenue

Page 34
Post.
Ref.

Debit

Credit

200,000
200,000

Rev. Recog - 15

INSTALLMENT SALES
Example

GENERAL JOURNAL
Date

Description
Installment Accounts Receivable

Page 34
Post.
Ref.

Debit
200,000

Installment Revenue

Cost of Installment Sales

Inventory

Credit
200,000

130,000
130,000

Rev. Recog - 16

INSTALLMENT SALES
Example

GENERAL JOURNAL
Date

Description
Cash
Installment Accounts Receivable

Page 34
Post.
Ref.

Debit

Credit

90,000
90,000

Rev. Recog - 17

INSTALLMENT SALES
Example

GENERAL JOURNAL
Date

Description
Installment Revenue
Cost of Installment Sales
Deferred Gross Margin

Page 34
Post.
Ref.

Debit

Credit

200,000
130,000
70,000

Rev. Recog - 18

INSTALLMENT SALES
Example

GENERAL JOURNAL
Date

Description
Installment Revenue

Page 34
Post.
Ref.

Debit
200,000

Cost of Installment Sales

130,000

Deferred Gross Margin

Deferred Gross Margin
Realized Gross Margin

Credit

70,000
31,500
31,500

Rev. Recog - 19

INSTALLMENT SALES
Example

GENERAL JOURNAL
Date

Description
Installment Revenue

Page 34
Post.
Ref.

Debit
200,000

Cost of Installment Sales

130,000

Deferred Gross Margin

Deferred Gross Margin
Realized Gross Margin

Cash collection in 19X5

Gross margin percentage
Gross profit to recognize

Credit

70,000
31,500
31,500

$90,000
35%
$31,500

Rev. Recog - 20

INSTALLMENT SALES
Example

Balance Sheet
Installment accounts receivable
$ 110,000
Less: Deferred gross margin
38,500
Net Installment accounts receivable $ 71,500

Rev. Recog - 21

INSTALLMENT SALES
Example

Balance Sheet
Installment accounts receivable
$ 110,000
Less: Deferred gross margin
38,500
Net Installment accounts receivable $ 71,500
Installment accounts receivable
Less: Cash collections
Installment accounts receivable

$ 200,000
(90,000)
$ 110,000

Deferred gross margin

Less: Gross margin recognized
Deferred gross margin

$ 70,000
(31,500)
$ 38,500

Rev. Recog - 22

COST RECOVERY METHOD

Like the installment sales method, cost
recovery is used when we are uncertain
about the collectibility of the sales revenue or
the ability of the seller to complete future
performance.

UNCERTAINTY IS GREATER!
No profit is recognized until cost of item sold
is fully recovered.

Rev. Recog - 23

COST RECOVERY
Example

Sams Appliances made sales of $200,000 in

19X5 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 installment
customers of $90,000. The remaining
amount will be collected in 19X6.
Prepare the journal entries to record the
installment sales transactions during 19X5.

Rev. Recog - 24

COST RECOVERY
Example

GENERAL JOURNAL
Date

Description
Installment Accounts Receivable
Installment Revenue

Page 34
Post.
Ref.

Debit

Credit

200,000
200,000

Rev. Recog - 25

COST RECOVERY
Example

GENERAL JOURNAL
Date

Description
Installment Accounts Receivable

Page 34
Post.
Ref.

Debit
200,000

Installment Revenue

Cost of Installment Sales

Inventory

Credit
200,000

130,000
130,000

Rev. Recog - 26

COST RECOVERY
Example

GENERAL JOURNAL
Date

Description
Installment Revenue
Cost of Installment Sales
Deferred Gross Margin

Page 34
Post.
Ref.

Debit

Credit

200,000
130,000
70,000

Rev. Recog - 27

COST RECOVERY
Example

GENERAL JOURNAL
Date

Description
Cash
Installment Accounts Receivable

Page 34
Post.
Ref.

Debit

Credit

90,000
90,000

No profit is recognized in 19X5 because the cost of the

item sold ($130,000) has not been recovered in the
form of cash receipts. Once we collect $130,000 in
cash, profit recognition begins.

Rev. Recog - 28

COST RECOVERY
Example

Balance Sheet
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.

Rev. Recog - 29

RIGHT OF RETURN

In some industries it is common

practice that the sales terms allow
customers the right to return goods
under specified conditions and over
long periods of time.

Book Publishing

Equipment
Manufacturing

Rev. Recog - 30

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.

Rev. Recog - 31

PRODUCT-FINANCING
ARRANGEMENTS
An agreement in which a sponsoring
company sells a product to another
company and in a related transaction
agrees to repurchase the product.
The sponsoring company

Records a liability when the proceeds are

received.
No sale is recorded and inventory is not
adjusted.

Wait for a sale to outside party.

Rev. Recog - 32

REVENUE RECOGNITION
Before Delivery
Accounting for long-term construction
contracts
Completed-Contract Method
Percentage-of-Completion Method

Rev. Recog - 33

REVENUE RECOGNITION
Before Delivery

Percentage-of-completion method is
appropriate when . . .
Contract specifies the amount of
consideration to be exchanged and the
terms of settlement.
Buyer is expected to satisfy the obligation.
Contractor can perform according to the
terms of the contract.

Rev. Recog - 34

MEASURING PROGRESS TOWARD

COMPLETION
Input Measures
Effort devoted to project compared to total
effort expected (cost incurred to date
compared to total estimated costs)

Output Measures
Results to date compared to total results

Rev. Recog - 35

MEASURING PROGRESS TOWARD

COMPLETION
Cost-to-Cost Method
Total costs incurred to date
Percent complete =

Most recent estimate of total

costs of the project

Rev. Recog - 36

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

Rev. Recog - 37

LONG-TERM CONTRACTS
Example

During 19X6, West, Inc. enters into a

contract with Putnam County to build a
bridge over Cane River. The project will
take 3 years to complete and has a fixed
price 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.

Rev. Recog - 38

LONG-TERM CONTRACTS

Example
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-completion

method to account for all long-term
construction projects.
Prepare the necessary 19X6 journal entries
for this project.

Rev. Recog - 39

LONG-TERM CONTRACTS
Example

GENERAL JOURNAL
Date

Description
Construction-In-Process
Cash, Payables, etc.

Page 34
Post.
Ref.

Debit

Credit

750,000
750,000

Rev. Recog - 40

LONG-TERM CONTRACTS
Example

GENERAL JOURNAL
Date

Description
Construction-In-Process

Page 34
Post.
Ref.

Debit
750,000

Cash, Payables, etc.

Accounts Receivable
Billings on Contracts

Credit
750,000

800,000
800,000

Rev. Recog - 41

LONG-TERM CONTRACTS
Example

GENERAL JOURNAL
Date

Description
Construction-In-Process

Page 34
Post.
Ref.

Debit
750,000

Cash, Payables, etc.

Accounts Receivable

750,000
800,000

Billings on Contracts
Cash
Accounts Receivable

Credit

800,000
790,000
790,000

Rev. Recog - 42

LONG-TERM CONTRACTS
Example

GENERAL JOURNAL
Date

Description

Page 34
Post.
Ref.

Debit

Construction-In-Process

375,000

Cost of Construction

750,000

Construction Revenue

Credit

1,125,000

$ 750,000 $ 3,000,000 =
25% complete
$ 4,500,000
25% = $ 1,125,000 revenue
$ 1,500,000
25% = $ 375,000 profit

Rev. Recog - 43

LONG-TERM CONTRACTS
Example

GENERAL JOURNAL
Date

Description

Page 34
Post.
Ref.

Debit

Construction-In-Process

375,000

Cost of Construction

750,000

Construction Revenue

Credit

1,125,000

If West uses the Completed-Contract method, no

revenue is recognized during 19X6. All
revenue and profit is recognized at the
end of the contract when delivery of the bridge to
Putnam County is made.

Rev. Recog - 44

REVENUE RECOGNITION
Before Delivery

Completion of Production
Accretion Basis
Discovery Basis

Rev. Recog - 45

REVENUE RECOGNITION
Service Sales
Specific Performance Method
Proportional Performance Method
Completed Performance Method

Collection

Rev. Recog - 46

SPECIFIC PERFORMANCE

Used to account for revenue that is

earned by performing a single act.
Franchise revenue (SFAS No. 45)

Bobs
Burgers

Rev. Recog - 47

PROPORTIONAL PERFORMANCE

Used to recognize service revenue that

is earned by more than a single act and
when the service is rendered in more
than one accounting period.
Similar performance acts - equal amount
for each act
Dissimilar performance acts - in proportion
to direct costs of each act
Similar acts with a fixed period for
performance

Rev. Recog - 48

COMPLETED PERFORMANCE

Used when revenue is earned by

performing a series of acts, and the last
act is so important that revenue is only
considered earned if it is performed.

Rev. Recog - 49

COLLECTION

Used to account for service revenue

when the uncertainty of collection is
very high.
Revenue recognized when cash is
received.

Rev. Recog - 50

EXPENSE RECOGNITION

Expenses are outflows of assets or

incurrences of liabilities during a period
from delivery or producing goods or
rendering services.

Rev. Recog - 51

MATCHING

Once revenues are determined, the

expenses incurred in generating the
revenue should be recognized.
As revenues are earned, certain assets
are consumed and services are used.

Rev. Recog - 52

EXPENSES
Recognition Methods

Direct

Period
Allocated

Rev. Recog - 53

GAINS AND LOSSES

Gains and losses result from peripheral or
incidental transactions, events, or
circumstances.
Most gains and losses are recognized when
the transaction is completed.

Estimated losses are recognized before

realization if they are probable and can be

reasonably estimated.

Rev. Recog - 54

ETHICAL CONSIDERATIONS
Im sorry we shipped your
order on Dec. 28 instead of
on the delivery date of Jan.
10. But the important thing is
that you have the products
you need...Right?

Rev. Recog - 55

Ready to Move On?

Midterm
Exam