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Prepared by: Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT,

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Presentation on theme: "Prepared by: Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT,"— Presentation transcript:

1 Prepared by: Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK

2 C H A P T E R 6 Revenue Recognition

3 Learning Objectives 1.Apply the revenue recognition principle. 2.Describe accounting issues involved with revenue recognition for sale of goods. 3.Explain accounting for consignment sales. 4.Describe accounting issues involved with revenue recognition for services and long- term contracts.

4 Learning Objectives 5.Apply the percentage-of-completion method for long-term contracts. 6.Apply the completed-contract method for long-term contracts. 7.Identify the proper accounting for losses on long-term contracts. 8.Discuss how to deal with measurement uncertainty.

5 Learning Objectives 9.Discuss how to deal with collection uncertainty. 10.Explain and apply the instalment sales method of accounting. 11.Explain and apply the cost recovery method of accounting.

6 Revenue Recognition Current Environment Revenue recognition criteria Measurement Uncertainty Sales with buy- back Sales when right of return exists Trade loading and channel stuffing Earnings Process Sale of goods Risks and rewards Disposition of assets other than inventory Consignment sales Continuing managerial involvement Completion of production Rendering of services and long- term contracts % of completion method Completed contract method Long-term contract losses Disclosures Uncertainty Associated with Collectibility Instalment sales Instalment method Cost recovery method

7 Guidelines for Revenue Recognition Revenue is recognized based on two criteria: Performance Collectibility Revenue is earned when the earnings process is substantially complete Earnings Process: actions taken to add value Substantial Performance: when little or no uncertainty exists as to the completion of the product or service (at this point revenue is recognized) Revenue is realized when goods and services are exchanged for cash or claims to cash

8 Four Types of Revenue Transactions Revenue from selling products is recognized at the date of sale (date of delivery) Revenue from services is recognized when services are performed and are billable Revenue from the use of enterprises assets by others is recognized as time passes or as theassets are used up Revenue from disposal of assets is recognized at the point of sale

9 Risks and Rewards Risks and rewards (benefits) of ownership: –Who has possession of the goods? –Who has legal title? When the risks and rewards of ownership have transferred –Determines when a sale has occurred

10 Revenue Recognition at Point of Sale Revenues from manufacturing and selling are commonly recognized at point of sale Revenues from sales with buyback agreements are not recognized (not sales) Revenues from sales where rights of return exist are not generally recognized Certain trade practices such as trade loading and channel stuffing do not result in recognizable sales revenues

11 Consignment Sales Possession has transferred; however legal title remains with the seller Risks and rewards have not transferred Seller acts as an agent Goods are held by seller as Merchandise on Consignment Not held as inventory on consignees books

12 Consignment Sales Goods shipped to Consignee Inventory on Consignment $$$ Finished Goods Inventory $$$ Payment of Freight Inventory on Consignment $$ Cash $$ Notification of Sale Accounts Receivable $$$ Relevant Expenses $$ Revenue $$$ Receipt of Cash from Sale Cash $$$ Accounts Receivable $$$ Cost of Goods Sold $$$ Inventory on Consignment $$$ (Note: cost includes freight) No Entry Notification/Payment of Sale Cash$$$ Payable to Consignor $$$ Consignors BooksConsignees Books

13 Revenue Recognition Before Delivery Revenue may be recognized before delivery under certain circumstances Long-term construction contracts (percentage of completion method), are a notable example The percentage method permits periodic billing at various points in the project The completed contract method is used only when the percentage method is inapplicable

14 Contract Accounting Long-Term Construction Accounting Methods Percentage of Completion Method Completed Contract Method 1)Terms of contract must be certain, enforceable Certainty of performance by both parties 1)To be used only when the percentage method is inapplicable [uncertain] For short-term contracts

15 Percentage Completion: Concept Percentage completion method permits periodic billing The amount of gross profit recognized depends upon the percent of work done Application of percentage completion method requires a basis for measuring the progress toward completion at interim dates See the specific steps for determining gross profit (next slide)

16 Percentage Completion: Steps Costs incurred to date = Percent complete Most recent estimated total costs 1 Percent complete X Estimated total revenue = Revenue to be recognized to date 2 Revenue to be recognized to date – Revenue recognized in prior periods = Current period revenue 3 Current Period Revenue – Current costs = Gross Profit4

17 Percentage Completion: Cost-to- Cost Basis Data: Contract price: $4,500,000 Estimated cost: $4,000,000 Start date: July, 2001 Finish: October, 2003 Balance sheet date: December 31 st Given: 2001 2002 2003 Costs to date$1,000,000 $2,916,000 $4,050,000 Estimated costs to complete $3,000,000 $1,134,000 $ -0- Progress billings during year$ 900,000 $2,400,000 $1,200,000 Cash collected during year$ 750,000 $1,750,000 $2,000,000

18 Percentage Completion: Cost-to-Cost Basis 2001 2002 2003 $4,500,000 $4,500,000 $4,500,000 Contract Price 1,000,000 2,916,000 4,050,000 3,000,000 1,134,000 -0- 4,000,000 4,050,000 4,050,000 Estimated Costs: To Date Est. Cost to Complete Est. Total Costs 25% 72% 100% 1,000,000 2,916,000 4,050,000 4,000,000 4,050,000 4,050,000 Percent Complete $ 500,000 $ 450,000 $ 450,000Estimated Total Gross Profit

19 Percentage Completion: Cost-to-Cost Basis 2001 2002 2003 $4,500,000 $4,500,000 $4,500,000 Contract Price 25% 72% 100% Percent Complete $1,125,000 $3,240,000 $4,500,000 -0- 1,125,000 3,240,000 $1,125,000 $2,115,000 $1,260,000 Revenue Recognized: Current Year Less: Prior Year = Revenue $ 125,000 $ 324,000 $ 450,000 -0- 125,000 324,000 $ 125,000 $ 199,000 $ 126,000 Gross Profit Recognized: Current Year Less: Prior Year = Revenue

20 Completed-Contract Method Revenue and gross profit recognized on completion of contract Advantage: reported revenue is based on actual results, not estimates Disadvantage: does not reflect current performance; creates distortion of earnings Progress billings are reported contra to Construction in Progress account on the Balance Sheet Construction in Progress used to accumulate contract costs

21 Long-Term Contract Losses A long-term contract may produce: either an interim loss and an overall profit or an overall loss for the project Under the percentage completion method, losses in any case are immediately recognized Under the completed contract method, losses arerecognized only when overall losses result

22 Recognizing Current and Overall Losses on Long-Term Contracts Current Loss on an otherwise overall profitable contract Completed Method: No adjustment needed Percentage Method: Recognize loss currently Loss on an overall unprofitable contract Percentage Method: Recognize entire loss now Completed Method: Recognize entire loss now

23 Percentage Method: Interim Loss on Profitable Contract - Example 2001 2002 2003 $4,500,000 $4,500,000 $4,500,000 Contract Price 1,000,000 2,916,000 4,384,962 3,000,000 1,468,962 -0- 4,000,000 4,384,962 4,384,962 Estimated Costs: To Date Est. Cost to Complete Est. Total Costs 25% 66.5% 100% 1,000,000 2,916,000 4,384,962 4,000,000 4,384,962 4,384,962 Percent Complete Data as previously given, except for the 2002 cost estimate Revenue recognized in 2002: $4,500,000 * 66.5% = $2,992,500 Less: amount recognized in 2001 1,125,000 1,867,500 Less: actual costs incurred in 2002 1,916,000 Loss recognized in 2002 48,500

24 Percentage Method: Interim Loss on Profitable Contract – Example Record loss for 2002: Construction Expense 1,916,000 Construction in Process (loss) 48,500 Revenue from Long-Term Contract 1,867,500 Loss of $48,500 reported on Income Statement Difference between the reported revenues and costs for the current period Under the completed-contract method, no loss Recognized in 2002

25 Percentage Method: Interim Loss on Overall Unprofitable Contract – Example 2001 2002 2003 $4,500,000 $4,500,000 $4,500,000 Contract Price 1,000,000 2,916,000 4,556,250 3,000,000 1,640,250 -0- 4,000,000 4,556,250 4,556,250 Estimated Costs: To Date Est. Cost to Complete Est. Total Costs 25% 64% 100% 1,000,000 2,916,000 Gross Profit 4,000,000 4,556,250 (56,250) Percent Complete Data as previously given, except for the 2002 cost estimate Losses recognized in 2002: Gross Profit recognized in 2001$125,000 Expected Loss on Unprofitable Contract 56,250 $181,250

26 Percentage Method: Interim Loss on Overall Unprofitable Contract – Example Record loss for 2002: Construction Costs expensed in 2002: Revenue recognized in 2002: (4,500,000 X 64%) $2,880,000 Less: revenue recognized in 2001 1,125,000 Revenue recognized in 2002 1,755,000 Less: loss recognized in 2002 181,250 Construction Cost Expense 1,936,250 Construction Expense 1,36,250 Construction in Process (loss) 181,250 Revenue from Long-Term Contract 1,755,000

27 Completed Contract Method: Interim Loss on Overall Unprofitable Contract – Example Record loss for 2002: Loss from Long-Term Contract56,250 Construction in Process (Loss)56,250 The loss is recognized in the year it first becomes evident.

28 Revenue Recognition after Delivery Revenue recognition is deferred when collection of sales price is not reasonably assured The two methods that are used are: the instalment sales method the cost recovery method If cash is received prior to delivery, the method used is the deposit method

29 The Instalment Sales Method This method emphasizes income recognition in periods of collection rather than at point of sale Title does not pass to the buyer until all cash payments have been made to the seller Income recognition deferred to period of cash collection Both sales and cost of sales are recognized in the period of sale Gross profit is deferred to the period of collection Other expenses, selling and administrative, are not deferred

30 The Instalment Sales Method: Special Accounts Instalment sales must be kept separate Gross profit on instalment sales must be determinable The amount of cash collected from instalment accounts must be known The cash collected from current years and prior years accounts must be known Provision must be made for the carry forward of each years (deferred) gross profit

31 The Instalment Sales Method: Steps For instalment sales in any year For instalment sales made in prior years (realized gross profit) Determine rate of gross profit on instalment sales Apply this rate to cash collections of current years instalment sales to yield realized gross profit The gross profit not realized is deferred Apply the relevant rate to cash collections of prior years instalment sales

32 The Instalment Sales Method: Example Given: 2001 2002 2003 Instalment sales$200,000$250,000 $240,000 Cost of sales$150,000$190,000 $168,000 Gross Profit$ 50,000$ 60,000 $ 72,000 Cash received in: from 2001 sales$ 60,000$ 100,000 $ 40,000 from 2002 sales$ -0-$ 100,000 $ 125,000 from 2003 sales$ -0-$ -0- $ 80,000 Determine the realized and deferred gross profit.

33 The Instalment Sales Method: Example Given: 2001 2002 2003 Instalment sales$200,000$250,000 $240,000 Gross Profit$ 50,000$ 60,000 $ 72,000 Gross profit rate 25% 24% 30% Realized Gross Profit: From 2001 sales: Realized in $15,000 $25,000 $10,000 From 2002 sales: Realized in: $ -0- $24,000 $30,000 From 2003 sales: Realized in: $ -0- $ -0- $24,000

34 The Instalment Sales Method: Partial Journal Entries (2001) for Gross Profit Instalment Sales 200,000 Cost of Sales 150,000 Deferred Gross Profit, 2001 50,000 (To close 2001 accounts) Deferred Gross Profit, 2001 15,000 Realized Gross Profit 15,000 (Realized: $60,000 * 25%) Realized Gross Profit 15,000 Income Summary 15,000 (To close to Income Summary)

35 Instalment Sales Accounting Problems 1.Interest on instalment contracts Accounted for separately from the gross profit Recognized when cash is collected, as Interest Revenue 1.Uncollectible accounts Through the use of a special bad debts expense account 2.Defaults and repossessions On repossession, the Account Receivable and related deferred Gross Profit are written-off

36 The Cost Recovery Method Seller recognizes no profit until cash payments by buyer exceed sellers cost of merchandise After recovering all costs, seller includes additional cash collections in income This method is to be used where there is no reasonable basis for estimating collectibility as in franchises and real estate The income statement reports the amount of gross profit recognized and the deferred amount

37 COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) 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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