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CH 18 Revenue Recognition
CH 18 Revenue Recognition
18-1
CHAPTER 18
REVENUE RECOGNITION
Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield
Chapter
18-2
Learning
Learning Objectives
Objectives
1. Apply the revenue recognition principle.
2. Describe accounting issues for revenue recognition at point
of sale.
3. Apply the percentage-of-completion method for long-term
contracts.
4. Apply the completed-contract method for long-term
contracts.
5. Identify the proper accounting for losses on long-term
contracts.
6. Describe the installment-sales method of accounting.
7. Explain the cost-recovery method of accounting.
Chapter
18-3
Revenue
Revenue Recognition
Recognition
Chapter
18-4
The
The Current
Current Environment
Environment
Chapter
18-5
The
The Current
Current Environment
Environment
Chapter
18-6 LO 1 Apply the revenue recognition principle.
The
The Current
Current Environment
Environment
Revenue Recognition Classified by Type of Transaction
Chapter 18 Chapter 18 Illustration 18-1
Chapter
18-7 LO 1 Apply the revenue recognition principle.
The
The Current
Current Environment
Environment
Chapter
18-8 LO 1 Apply the revenue recognition principle.
The
The Current
Current Environment
Environment
Illustration 18-2
Revenue
Recognition
Alternatives
Chapter
18-9 LO 1 Apply the revenue recognition principle.
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale (Delivery)
(Delivery)
Implementation problems,
Sales with Buyback Agreements
Sales When Right of Return Exists
Trade Loading and Channel Stuffing
Chapter
18-10 LO 2 Describe accounting issues for revenue recognition at point of sale.
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale (Delivery)
(Delivery)
Chapter
18-11 LO 2 Describe accounting issues for revenue recognition at point of sale.
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale (Delivery)
(Delivery)
Chapter
18-13 LO 2 Describe accounting issues for revenue recognition at point of sale.
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale (Delivery)
(Delivery)
Chapter
18-14 LO 2 Describe accounting issues for revenue recognition at point of sale.
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale (Delivery)
(Delivery)
Chapter
18-15 LO 2 Describe accounting issues for revenue recognition at point of sale.
Revenue
Revenue Recognition
Recognition Before
Before Delivery
Delivery
Two Methods:
Percentage-of-Completion Method.
Rationale is that the buyer and seller have
enforceable rights.
Completed-Contract Method.
Chapter
18-16 LO 2 Describe accounting issues for revenue recognition at point of sale.
Revenue
Revenue Recognition
Recognition Before
Before Delivery
Delivery
Must use Percentage-of-Completion method when estimates
of progress toward completion, revenues, and costs are
reasonably dependable and all of the following conditions
exist:
1. Contract clearly specifies the enforceable rights
regarding goods or services by the parties, the
consideration to be exchanged, and the manner and
terms of settlement.
2. Buyer can be expected to satisfy all obligations.
3. Contractor can be expected to perform under the
contract.
Chapter
18-17 LO 2 Describe accounting issues for revenue recognition at point of sale.
Revenue
Revenue Recognition
Recognition Before
Before Delivery
Delivery
Chapter
18-18 LO 2 Describe accounting issues for revenue recognition at point of sale.
Percentage-of-Completion
Percentage-of-Completion Method
Method
Percentage-of-Completion Method
Formula for Total Revenue to Be Recognized to Date
Illustration 18-3
Illustration 18-4
Illustration 18-5
Chapter
18-19 LO 3 Apply the percentage-of-completion method for long-term contracts.
Percentage-of-Completion
Percentage-of-Completion Method
Method
Chapter
18-20 LO 3 Apply the percentage-of-completion method for long-term contracts.
Percentage-of-Completion
Percentage-of-Completion Method
Method
Solution on
notes page
Chapter
18-21 LO 3 Apply the percentage-of-completion method for long-term contracts.
Percentage-of-Completion
Percentage-of-Completion Method
Method
Solution on
notes page
Chapter
18-23
Percentage-of-Completion
Percentage-of-Completion Method
Method
Chapter
18-25 LO 3 Apply the percentage-of-completion method for long-term contracts.
Percentage-of-Completion
Percentage-of-Completion Method
Method
Illustration 18-11
Chapter
18-26 LO 3 Apply the percentage-of-completion method for long-term contracts.
Percentage-of-Completion
Percentage-of-Completion Method
Method
Financial Statement—Percentage-of-Completion
KC Construction Company Illustration 18-12
Chapter
18-27 LO 3 Apply the percentage-of-completion method for long-term contracts.
Percentage-of-Completion
Percentage-of-Completion Method
Method
2010
2010 2011
2011 2012
2012
Contract
Contractprice
price $675,000
$675,000 $675,000
$675,000 $675,000
$675,000
Cost
Costincurred
incurredcurrent
currentyear
year 150,000
150,000 287,400
287,400 170,100
170,100
Estimated
Estimatedcostcostto
tocomplete
complete
ininfuture
futureyears
years 450,000
450,000 170,100
170,100 00
Billings
Billingstotocustomer
customercurrent
currentyear
year 135,000
135,000 360,000
360,000 180,000
180,000
Cash
Cashreceipts
receiptsfrom
fromcustomer
customer
Current
Currentyear
year 112,500
112,500 262,500
262,500 300,000
300,000
A)
A) Prepare
Prepare the
the journal
journal entries
entries for
for 2010,
2010, 2011,
2011, and
and 2012.
2012.
Chapter
18-28 LO 3 Apply the percentage-of-completion method for long-term contracts.
Percentage-of-Completion
Percentage-of-Completion Method
Method
Chapter
18-29 LO 3 Apply the percentage-of-completion method for long-term contracts.
Percentage-of-Completion
Percentage-of-Completion Method
Method
Illustration:
2010 2011 2012
Construction in progress 150,000 287,400 170,100
Cash 150,000 287,400 170,100
Chapter
18-30 LO 3 Apply the percentage-of-completion method for long-term contracts.
Percentage-of-Completion
Percentage-of-Completion Method
Method
Illustration:
Income Statement 2010 2011 2012
Revenue on contracts $ 168,750 $ 317,250 $ 189,000
Cost of construction 150,000 287,400 170,100
Gross profit 18,750 29,850 18,900
Chapter
18-31 LO 3 Apply the percentage-of-completion method for long-term contracts.
Revenue
Revenue Recognition
Recognition Before
Before Delivery
Delivery
Chapter
18-32 LO 4 Apply the completed-contract method for long-term contracts.
Completed
Completed Contract
Contract Method
Method
Illustration:
2010 2011 2012
Construction in progress 150,000 287,400 170,100
Cash 150,000 287,400 170,100
Chapter
18-33 LO 4 Apply the completed-contract method for long-term contracts.
Completed
Completed Contract
Contract Method
Method
Illustration:
Income Statement 2010 2011 2012
Revenue on contracts $ - $ - $ 675,000
Cost of construction - - 607,500
Gross profit - - 67,500
Chapter
18-34 LO 4 Apply the completed-contract method for long-term contracts.
Revenue
Revenue Recognition
Recognition Before
Before Delivery
Delivery
Chapter
18-35 LO 5 Identify the proper accounting for losses on long-term contracts.
Long-Term
Long-Term Contract
Contract Losses
Losses
Illustration: Loss on Profitable Contract
b)
b) Prepare
Preparethe
thejournal
journalentries
entriesfor
for2010,
2010,2011,
2011,and
and2012
2012assuming
assumingthe
the
estimated
estimatedcost
costto
tocomplete
completeat
atthe
theend
endof
of2011
2011was
was$215,436
$215,436instead
insteadof
of
$170,100.
$170,100.
Chapter
18-36 LO 5 Identify the proper accounting for losses on long-term contracts.
Long-Term
Long-Term Contract
Contract Losses
Losses
Illustration: Loss on Profitable Contract
2010 2011 2012
Costs incurred to date $ 150,000 $ 437,400 $ 652,836
Estimated cost to complete 450,000 215,436
Est. total contract costs 600,000 652,836 652,836
Est. percentage complete 25.0% 67.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 452,250 675,000
Rev. recognized prior year (168,750) (452,250)
Rev. recognized currently 168,750 283,500 222,750
Costs incurred currently (150,000) (287,400) (215,436)
Gross profit recognized $ 18,750 $ (3,900) $ 7,314
Chapter
18-37 LO 5 Identify the proper accounting for losses on long-term contracts.
Long-Term
Long-Term Contract
Contract Losses
Losses
Illustration: Loss on Profitable Contract
2010 2011 2012
Chapter
18-38 LO 5 Identify the proper accounting for losses on long-term contracts.
Long-Term
Long-Term Contract
Contract Losses
Losses
Illustration: Loss on Unprofitable Contract
Casper Construction Co.
2010
2010 2011
2011 2012
2012
Contract
Contractprice
price $675,000
$675,000 $675,000
$675,000 $675,000
$675,000
Cost
Costincurred
incurredcurrent
currentyear
year 150,000
150,000 287,400
287,400 246,038
246,038
Estimated
Estimatedcost
costto
tocomplete
complete
ininfuture
futureyears
years 450,000
450,000 246,038
246,038 00
Billings
Billingstotocustomer
customercurrent
currentyear
year 135,000
135,000 360,000
360,000 180,000
180,000
Cash
Cashreceipts
receiptsfrom
fromcustomer
customer
Current
Currentyear
year 112,500
112,500 262,500
262,500 300,000
300,000
c)
c) Prepare
Preparethe
thejournal
journalentries
entriesfor
for2010,
2010,2011,
2011,and
and2012
2012assuming
assumingthe
the
estimated
estimatedcost
costto
tocomplete
completeatatthe
theend
endof
of2011
2011was
was$246,038
$246,038instead
insteadof
of
$170,100.
$170,100.
Chapter
18-39 LO 5 Identify the proper accounting for losses on long-term contracts.
Long-Term
Long-Term Contract
Contract Losses
Losses
Illustration: Loss on Unprofitable Contract
2010 2011 2012
Costs incurred to date $ 150,000 $ 437,400 $ 683,438
Estimated cost to complete 450,000 246,038
Est. total contract costs 600,000 683,438 683,438
Est. percentage complete 25.0% 64.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 432,000 675,000
Rev. recognized prior year (168,750) (432,000)
Rev. recognized currently 168,750 263,250 243,000
Costs incurred currently (150,000) (290,438) (243,000)
Gross profit recognized $ 18,750 $ (27,188) $ -
Chapter
18-41 LO 5 Identify the proper accounting for losses on long-term contracts.
Long-Term
Long-Term Contract
Contract Losses
Losses
Illustration: Loss on Unprofitable Contract
For the Completed-Contract method, companies would
recognize the following loss :
Chapter
18-42 LO 5 Identify the proper accounting for losses on long-term contracts.
Revenue
Revenue Recognition
Recognition Before
Before Delivery
Delivery
Completion-of-Production Basis
In certain cases companies recognize revenue at the
completion of production even though no sale has been
made.
Examples are:
precious metals or
agricultural products.
Chapter
18-44 LO 5 Identify the proper accounting for losses on long-term contracts.
Revenue
Revenue Recognition
Recognition After
After Delivery
Delivery
Chapter
18-45 LO 6 Describe the installment-sales method of accounting.
Revenue
Revenue Recognition
Recognition After
After Delivery
Delivery
Installment-Sales Method
Recognizes income in the periods of collection rather
than in the period of sale.
Chapter
18-46 LO 6 Describe the installment-sales method of accounting.
Revenue
Revenue Recognition
Recognition After
After Delivery
Delivery
Chapter
18-47 LO 6 Describe the installment-sales method of accounting.
Revenue
Revenue Recognition
Recognition After
After Delivery
Delivery
Cost-Recovery Method
Recognizes no profit until cash payments by the buyer
exceed the cost of the merchandise sold.
Chapter
18-48 LO 7 Explain the cost-recovery method of accounting.
Cost-Recovery
Cost-Recovery Method
Method
Illustration: In 2010, Fesmire Manufacturing sells inventory with
a cost of $25,000 to Higley Company for $36,000. Higley will
make payments of $18,000 in 2010, $12,000 in 2011, and $6,000
in 2012. If the cost-recovery method applies to this transaction
and Higley makes payments as scheduled, Fesmire recognizes cash
collections, revenue, cost, and gross profit as follows.
Illustration 18-28
Chapter
18-49 LO 7 Explain the cost-recovery method of accounting.
Cost-Recovery
Cost-Recovery Method
Method
Illustration: Fesmire’s journal entry to record the
deferred gross profit on the Higley sale transaction (after
recording the sale and the cost of sale in the normal
manner) at the end of 2010 is as follows.
Sales 36,000
Cost of Sales 25,000
Deferred Gross Profit 11,000
Chapter
18-50 LO 7 Explain the cost-recovery method of accounting.
Cost-Recovery
Cost-Recovery Method
Method
Illustration: In 2011 and 2012, the deferred gross profit
becomes realized gross profit as the cumulative cash
collections exceed the total costs, by recording the
following entries.
Chapter
18-51 LO 7 Explain the cost-recovery method of accounting.
Revenue
Revenue Recognition
Recognition After
After Delivery
Delivery
Deposit Method
Seller reports the cash received from the buyer as a
deposit on the contract and classifies it on the balance
sheet as a liability.
Chapter
18-52 LO 7 Explain the cost-recovery method of accounting.
Revenue
Revenue Recognition
Recognition After
After Delivery
Delivery
Illustration 18-29
Chapter
18-53
The IASB defines revenue to include both revenues and gains. U.S.
GAAP provides separate definitions for revenues and gains.
Revenue recognition fraud is a major issue in U.S. financial
reporting. The same situation occurs overseas as evidenced by
revenue recognition breakdowns at Dutch software company Baan
NV, Japanese electronics giant NEC, and Dutch grocer AHold NV.
A specific standard exists for revenue recognition under iGAAP
(IAS 18). U.S. GAAP uses concepts such as realized, realizable, and
earned as a basis for revenue recognition.
Chapter
18-54
iGAAP prohibits the use of the completed-contract method of
accounting for long-term construction contracts (IAS 13).
Companies must use the percentage-of-completion method. If
revenues and costs are difficult to estimate, then companies
recognize revenue only to the extent of the cost incurred—a zero-
profit approach.
In long-term construction contracts, iGAAP requires recognition of
a loss immediately if the overall contract is going to be
unprofitable. In other words, U.S. GAAP and iGAAP are the same
regarding this issue.
Chapter
18-55
Franchises
Four types of franchising arrangements have evolved:
1. manufacturer-retailer,
2. manufacturer-wholesaler,
4. wholesaler-retailer.
Chapter
18-56 LO 8 Explain revenue recognition for franchises and consignment sales.
Franchises
Fastest-growing category of franchising is service
sponsor-retailer:
Soft ice cream/frozen yogurt stores (Tastee Freeze,
TCBY, Dairy Queen)
Food drive-ins (McDonald’s, KFC, Burger King)
Restaurants (TGI Friday’s, Pizza Hut, Denny’s)
Motels (Holiday Inn, Marriott, Best Western)
Auto rentals (Avis, Hertz, National)
Others (H & R Block, Meineke Mufflers, 7-Eleven Stores)
Chapter
18-57 LO 8 Explain revenue recognition for franchises and consignment sales.
Franchises
Two sources of revenue:
Chapter
18-58 LO 8 Explain revenue recognition for franchises and consignment sales.
Franchises
The franchisor normally provides the franchisee with:
1. Assistance in site selection
2. Evaluation of potential income
3. Supervision of construction activity
4. Assistance in the acquisition of signs, fixtures, and equipment
5. Bookkeeping and advisory services
6. Employee and management training
7. Quality control
8. Advertising and promotion
Chapter
18-59 LO 8 Explain revenue recognition for franchises and consignment sales.
Initial Franchise Fees
Franchisors record initial franchise fees as
Chapter
18-60 LO 8 Explain revenue recognition for franchises and consignment sales.
Example of Entries for Initial Franchise Fee
Illustration: Tum’s Pizza Inc. charges an initial franchise fee of
$50,000 for the right to operate as a franchisee of Tum’s Pizza.
Of this amount, $10,000 is payable when the franchisee signs the
agreement, and the balance is payable in five annual payments of
$8,000 each. The credit rating of the franchisee indicates that
money can be borrowed at 8 percent. The present value of an
ordinary annuity of five annual receipts of $8,000 each discounted
at 8 percent is $31,941.68. The discount of $8,058.32 represents
the interest revenue to be accrued by the franchisor over the
payment period.
Chapter
18-61 LO 8 Explain revenue recognition for franchises and consignment sales.
Example of Entries for Initial Franchise Fee
Illustration: 1. If there is reasonable expectation that Tum’s
Pizza Inc. may refund the down payment and if substantial future
services remain to be performed by Tum’s Pizza Inc., the entry
should be:
Cash 10,000.00
Notes Receivable 40,000.00
Discount on Notes Receivable 8,058.32
Unearned Franchise Fees 41,941.68
Chapter
18-62 LO 8 Explain revenue recognition for franchises and consignment sales.
Example of Entries for Initial Franchise Fee
Illustration: 2. If the probability of refunding the initial
franchise fee is extremely low, the amount of future services to be
provided to the franchisee is minimal, collectibility of the note is
reasonably assured, and substantial performance has occurred, the
entry should be:
Cash 10,000.00
Notes Receivable 40,000.00
Discount on Notes Receivable 8,058.32
Revenue from Franchise Fees 41,941.68
Chapter
18-63 LO 8 Explain revenue recognition for franchises and consignment sales.
Example of Entries for Initial Franchise Fee
Illustration: 3. If the initial down payment is not refundable,
represents a fair measure of the services already provided, with a
significant amount of services still to be performed by Tum’s Pizza
in future periods, and collectibility of the note is reasonably
assured, the entry should be:
Cash 10,000.00
Notes Receivable 40,000.00
Discount on Notes Receivable 8,058.32
Revenue from Franchise Fees 10,000.00
Unearned Franchise Fees 31,941.68
Chapter
18-64 LO 8 Explain revenue recognition for franchises and consignment sales.
Example of Entries for Initial Franchise Fee
Illustration: 4. If the initial down payment is not refundable and
no future services are required by the franchisor, but collection of
the note is so uncertain that recognition of the note as an asset is
unwarranted, the entry should be:
Cash 10,000.00
Revenue from Franchise Fees 10,000.00
Chapter
18-65 LO 8 Explain revenue recognition for franchises and consignment sales.
Example of Entries for Initial Franchise Fee
Illustration: 5. Under the same conditions as those listed in case
4 above, except that the down payment is refundable or substantial
services are yet to be performed, the entry should be:
Cash 10,000.00
Unearned Franchise Fees 10,000.00
Chapter
18-66 LO 8 Explain revenue recognition for franchises and consignment sales.
Continuing Franchise Fees
Chapter
18-67 LO 8 Explain revenue recognition for franchises and consignment sales.
Bargain Purchases
Sometimes the franchise agreement grants the franchisee the
right to make bargain purchases of equipment or supplies after
the franchisee has paid the initial franchise fee.
If the bargain price is lower than the normal selling price of the
same product, or if it does not provide the franchisor a
reasonable profit, then the franchisor should defer a portion of
the initial franchise fee. The franchisor would account for the
deferred portion as an adjustment of the selling price when the
franchisee subsequently purchases the equipment or supplies.
Chapter
18-68 LO 8 Explain revenue recognition for franchises and consignment sales.
Options to Purchase
As a matter of management policy, the franchisor may reserve
the right to purchase a profitable franchise outlet, or to
purchase one that is in financial difficulty.
Chapter
18-69 LO 8 Explain revenue recognition for franchises and consignment sales.
Franchisor’s Cost
Should ordinarily defer direct costs (usually incremental
costs) relating to specific franchise sales for which revenue
has not yet been recognized.
Chapter
18-71 LO 8 Explain revenue recognition for franchises and consignment sales.
Consignments
Consignor recognizes revenue only after receiving
notification of sale and cash remittance from the consignee.
Consignor carries the merchandise as inventory throughout
the consignment, separately classified as Merchandise on
Consignment.
Consignee does not record the merchandise as an asset.
Upon sale of the merchandise, the consignee has a liability
for the net amount due the consignor.
Revenue is then recognized by the consignor.
Chapter
18-72 LO 8 Explain revenue recognition for franchises and consignment sales.
Consignments
Illustration: Nelba Manufacturing Co. ships merchandise
costing $36,000 on consignment to Best Value Stores.
Nelba pays $3,750 of freight costs, and Best Value pays
$2,250 for local advertising costs that are reimbursable
from Nelba. By the end of the period, Best Value has sold
two-thirds of the consigned merchandise for $40,000
cash. Best Value notifies Nelba of the sales, retains a 10
percent commission, and remits the cash due Nelba.
Chapter
18-73 LO 8 Explain revenue recognition for franchises and consignment sales.
Consignments
Chapter
18-74 LO 8 Explain revenue recognition for franchises and consignment sales.
Consignments
Chapter
18-75 LO 8 Explain revenue recognition for franchises and consignment sales.
Copyright
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Chapter
18-76