Presentation on theme: "Gabriela H. Schneider, CMA; Grant MacEwan College"— Presentation transcript:
1Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEKPrepared by:Gabriela H. Schneider, CMA; Grant MacEwan College2
3Learning 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.
4Learning Objectives5. 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.
5Learning Objectives9. 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.
6Revenue Recognition Current Environment Earnings Process Revenue recognition criteriaEarnings ProcessSale of goodsRisks and rewardsDisposition of assets other than inventoryConsignment salesContinuing managerial involvementCompletion of productionRendering of services and long-term contracts% of completion methodCompleted contract methodLong-term contract lossesDisclosuresMeasurement UncertaintySales with buy-backSales when right of return existsTrade loading and channel stuffingUncertainty Associated with CollectibilityInstalment salesInstalment methodCost recovery method
7Guidelines for Revenue Recognition Revenue is recognized based on two criteria:PerformanceCollectibilityRevenue is earned when the earnings process is substantially completeEarnings Process: actions taken to add valueSubstantial 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
8Four 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 billableRevenue from the use of enterprise’s assets by others is recognized as time passes or as the assets are used upRevenue from disposal of assets is recognized at the point of sale
9Risks 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 transferredDetermines when a sale has occurred
10Revenue Recognition at Point of Sale Revenues from manufacturing and selling are commonly recognized at point of saleRevenues from sales with buyback agreements are not recognized (not sales)Revenues from sales where rights of return exist are not generally recognizedCertain trade practices such as trade loading and channel stuffing do not result in recognizable sales revenues
11Consignment SalesPossession has transferred; however legal title remains with the sellerRisks and rewards have not transferredSeller acts as an agentGoods are held by seller as Merchandise on ConsignmentNot held as inventory on consignee’s books
12Consignment Sales Consignor’s Books Consignee’s Books Goods shipped to ConsigneeInventory on Consignment $$$Finished Goods Inventory $$$Payment of FreightInventory on Consignment $$Cash $$Notification of SaleAccounts Receivable $$$Relevant Expenses $$Revenue $$$Receipt of Cash from SaleCash $$$Accounts Receivable $$$Cost of Goods Sold $$$(Note: cost includes freight)No EntryNotification/Payment of SaleCash $$$Payable to Consignor $$$
13Revenue Recognition Before Delivery Revenue may be recognized before delivery under certain circumstancesLong-term construction contracts (percentage of completion method), are a notable exampleThe percentage method permits periodic billing at various points in the projectThe completed contract method is used only when the percentage method is inapplicable
14Contract Accounting Long-Term Construction Accounting Methods Percentage of CompletionMethodCompleted ContractMethodTerms of contract mustbe certain, enforceableCertainty of performanceby both partiesTo be used only whenthe percentage method isinapplicable [uncertain]For short-term contracts
15Percentage Completion: Concept Percentage completion method permits periodic billingThe amount of gross profit recognized depends upon the percent of work doneApplication of percentage completion method requires a basis for measuring the progress toward completion at interim datesSee the specific steps for determining gross profit (next slide)
16Percentage Completion: Steps Costs incurred to date = Percent completeMost recent estimated total costs1Percent complete X Estimated total revenue =Revenue to be recognized to date2Revenue to be recognized to date –Revenue recognized in prior periods =Current period revenue3Current Period Revenue – Current costs = Gross Profit4
17Percentage Completion: Cost-to-Cost Basis Data: Contract price: $4,500,000 Estimated cost: $4,000,000Start date: July, Finish: October, 2003Balance sheet date: December 31stGiven:Costs to date $1,000,000 $2,916,000 $4,050,000Estimated costs to complete $3,000,000 $1,134,000 $Progress billings during year $ 900,000 $2,400,000 $1,200,000Cash collected during year $ 750,000 $1,750,000 $2,000,000
20Completed-Contract Method Revenue and gross profit recognized on completion of contractAdvantage: reported revenue is based on actual results, not estimatesDisadvantage: does not reflect current performance; creates distortion of earningsProgress billings are reported contra to ‘Construction in Progress’ account on the Balance SheetConstruction in Progress used to accumulate contract costs
21Long-Term Contract Losses A long-term contract may produce:either an interim loss and an overall profitor an overall loss for the projectUnder the percentage completion method, losses in any case are immediately recognizedUnder the completed contract method, losses are recognized only when overall losses result
22Recognizing Current and Overall Losses on Long-Term Contracts Percentage Method:Recognize loss currentlyCurrent Loss onan otherwiseoverall profitablecontractCompleted Method:No adjustment neededPercentage Method:Recognize entire loss nowLoss on anoverall unprofitablecontractCompleted Method:Recognize entire loss now
23Percentage Method: Interim Loss on Profitable Contract - Example Data as previously given, except for the 2002 cost estimate$4,500, $4,500, $4,500,000Contract Price1,000, ,916, ,384,9623,000, ,468,4,000, ,384, ,384,962Estimated Costs:To DateEst. Cost to CompleteEst. Total Costs25% % %1,000, ,916, ,384,9624,000, ,384, ,384,962Percent CompleteRevenue recognized in 2002: $4,500,000 * 66.5% = $2,992,500Less: amount recognized in ,125,0001,867,500Less: actual costs incurred in ,916,000Loss recognized in ,500
24Percentage Method: Interim Loss on Profitable Contract – Example Record loss for 2002:Construction Expense ,916,000Construction in Process (loss) 48,500Revenue from Long-Term Contract ,867,500Loss of $48,500 reported on Income StatementDifference between the reported revenues andcosts for the current periodUnder the completed-contract method, no lossRecognized in 2002
25Percentage Method: Interim Loss on Overall Unprofitable Contract – Example Data as previously given, except for the 2002 cost estimate$4,500, $4,500, $4,500,000Contract Price1,000, ,916, ,556,2503,000, ,640,4,000, ,556, ,556,250Estimated Costs:To DateEst. Cost to CompleteEst. Total Costs25% % %1,000, ,916, Gross Profit4,000, ,556, (56,250)Percent CompleteLosses recognized in 2002:Gross Profit recognized in $125,000Expected Loss on Unprofitable Contract ,250$181,250
26Percentage 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%) $2,880,000Less: revenue recognized in ,125,000Revenue recognized in ,755,000Less: loss recognized in ,250Construction Cost Expense 1,936,250Construction Expense ,36,250Construction in Process (loss) ,250Revenue from Long-Term Contract ,755,000
27Completed Contract Method: Interim Loss on Overall Unprofitable Contract – Example Record loss for 2002:Loss from Long-Term Contract 56,250Construction in Process (Loss) 56,250The loss is recognized in the year it first becomesevident.
28Revenue Recognition after Delivery Revenue recognition is deferred when collection of sales price is not reasonably assuredThe two methods that are used are:the instalment sales methodthe cost recovery methodIf cash is received prior to delivery, the method used is the deposit method
29The Instalment Sales Method This method emphasizes income recognition in periods of collection rather than at point of saleTitle does not pass to the buyer until all cash payments have been made to the sellerIncome recognition deferred to period of cash collectionBoth sales and cost of sales are recognized in the period of saleGross profit is deferred to the period of collectionOther expenses, selling and administrative, are not deferred
30The Instalment Sales Method: Special Accounts Instalment sales must be kept separateGross profit on instalment sales must be determinableThe amount of cash collected from instalment accounts must be knownThe cash collected from current year’s and prior years’ accounts must be knownProvision must be made for the carry forward of each year’s (deferred) gross profit
31The Instalment Sales Method: Steps For instalment sales in any yearFor instalment sales made in prior years (realized gross profit)Determine rate of gross profit on instalment salesApply this rate to cash collections of current year’s instalment sales to yield realized gross profitThe gross profit not realized is deferredApply the relevant rate to cash collections of prior year’s instalment sales
34The Instalment Sales Method: Partial Journal Entries (2001) for Gross Profit Cost of Sales ,000 Deferred Gross Profit, ,000 (To close 2001 accounts)Deferred Gross Profit, ,000 Realized Gross Profit ,000 (Realized: $60,000 * 25%)Realized Gross Profit ,000 Income Summary ,000(To close to Income Summary)
35Instalment Sales Accounting Problems Interest on instalment contractsAccounted for separately from the gross profitRecognized when cash is collected, as Interest RevenueUncollectible accountsThrough the use of a special bad debts expense accountDefaults and repossessionsOn repossession, the Account Receivable and related deferred Gross Profit are written-off
36The Cost Recovery Method Seller recognizes no profit until cash payments by buyer exceed seller’s cost of merchandiseAfter recovering all costs, seller includes additional cash collections in incomeThis method is to be used where there is no reasonable basis for estimating collectibility as in franchises and real estateThe income statement reports the amount of gross profit recognized and the deferred amount