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McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. INCOME MEASUREMENT AND PROFITABLITY ANALYSIS Chapter 5.

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Presentation on theme: "McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. INCOME MEASUREMENT AND PROFITABLITY ANALYSIS Chapter 5."— Presentation transcript:

1 McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. INCOME MEASUREMENT AND PROFITABLITY ANALYSIS Chapter 5

2 Slide Realization Principle Record revenue when: AND there is reasonable certainty as to the collectibility of the asset to be received (usually cash). the earnings process is complete or virtually complete.

3 Slide SEC Staff Accounting Bulletin No. 101 The SEC issued Staff Accounting Bulletin No. 101 to crackdown on earnings management. The bulletin provides additional criteria for judging whether or not the realization principle is satisfied: 1.Persuasive evidence of an arrangement exists. 2.Delivery has occurred or services have been performed. 3.The sellers price to the buyer is fixed or determinable. 4.Collectibility is reasonably assured. The SEC issued Staff Accounting Bulletin No. 101 to crackdown on earnings management. The bulletin provides additional criteria for judging whether or not the realization principle is satisfied: 1.Persuasive evidence of an arrangement exists. 2.Delivery has occurred or services have been performed. 3.The sellers price to the buyer is fixed or determinable. 4.Collectibility is reasonably assured.

4 Slide Completion of the Earnings Process within a Single Reporting Period When the product or service has been delivered to the customer and cash has been received or a receivable has been generated that has reasonable assurance of collectibility. Recognize Revenue

5 Slide Significant Uncertainty of Collectibility 1.Installment Sales Method 2.Cost Recovery Method 1.Installment Sales Method 2.Cost Recovery Method When uncertainties about collectibility exist, revenue recognition is delayed.

6 Slide Installment Sales Method On November 1, 2009, the Belmont Corporation, a real estate developer, sold a tract of land for $800,000. The sales agreement requires the customer to make four equal annual payments of $200,000 plus interest on each November 1, beginning November 1, The land cost $560,000 to develop. The companys fiscal year ends on December 31. Gross Profit $240,000 ÷ $800,000 = 30%

7 Slide Installment Sales Method During 2009, Belmont Corporation collected $200,000 on its installment sales. This entry records the Realized Gross Profit by adjusting the Deferred Gross Profit account.

8 Slide Cost Recovery Method On November 1, 2009, the Belmont Corporation, a real estate developer, sold a tract of land for $800,000. The sales agreement requires the customer to make four equal annual payments of $200,000 plus interest on each November 1, beginning November 1, The land cost $560,000 to develop. The companys fiscal year ends on December 31.

9 Slide Cost Recovery Method

10 Slide Right of Return In most situations, even though the right to return merchandise exists, revenues and expenses can be appropriately recognized at point of delivery. Estimate the returns Reduce both Sales and Cost of Goods Sold

11 Slide Completion of the Earnings Process over Multiple Reporting Periods Completed Contract Method Percentage-of- Completion Method Long-term Contracts

12 Slide Companies Engaged in Long-term Contracts

13 Slide Completed Contract Method Geller Construction entered into a three-year contract to build a containment vessel for Southeast Power Company for a contract price of $1,400,000. Presented below is information about the contract: Lets see how Geller will account for the revenues and cost of this project using the completed contract method.

14 Slide Completed Contract Method Gross profit is not recognized until project is complete.

15 Slide Completed Contract Method Classified as an asset Classified as a liability

16 Slide Completed Contract Method Gross profit is not recognized until project is complete.

17 Slide Completed Contract Method

18 Slide Completed Contract Method Gross profit is recognized in year 3 since project is complete. Remember that the contract price was $1,400,000.

19 Slide Completed Contract Method Entry to transfer title to the customer.

20 Slide Percentage-of-Completion Method Geller Construction entered into a three-year contract to build a containment vessel for Southeast Power Company for a contract price of $1,400,000. Presented below is information about the contract: Lets see how Geller will account for the revenues and cost of this project using the percentage-of-completion method.

21 Slide Percentage-of-Completion Method

22 Slide Percentage-of-Completion Method Cost incurred to date Gross profit estimate Measuring Progress Toward Completion Estimate of projects total cost Total costs incurred to date Percent complete = Most recent estimate of total project cost

23 Slide Percentage-of-Completion Method

24 Slide Percentage-of-Completion Method Classified as an asset Classified as a liability Contra account to CIP

25 Slide Percentage-of-Completion Method Closing Entry

26 Slide Percentage-of-Completion Method

27 Slide Percentage-of-Completion Method

28 Slide Percentage-of-Completion Method

29 Slide Percentage-of-Completion Method

30 Slide Percentage-of-Completion Method

31 Slide Percentage-of-Completion Method

32 Slide Percentage-of-Completion Method Entry to transfer title to the customer.

33 Slide Long-term Contract Losses Periodic Loss for Profitable Projects Determine periodic loss and record loss as a credit to the Construction in Progress account. Loss Projected for Entire Project Estimated loss is fully recognized in the first period the loss is anticipated and is recorded by a credit to Construction in Progress account.

34 Slide International Accounting Standards and Long-term Contracts Under the International Financial Reporting Standards, International Accounting Standard (IAS) No. 11 governs revenue recognition for long-term construction contracts. Like U.S. GAAP, IAS No. 11 requires use of percentage-of- completion accounting when estimates can be made precisely. Unlike U.S. GAAP, IAS No. 11 requires use of the cost recovery method rather than the completed contract method when estimates cannot be made precisely enough to allow percentage-of-completion accounting.

35 Slide Software and Other Multiple Deliverable Arrangements Statement of Position 97-2 If a sale includes multiple elements (software, future upgrades, postcontract customer support, etc.), the revenue should be allocated to the various elements based on the relative fair value of the individual elements. This will likely result in a portion of the proceeds received from the sale of software being deferred and recognized as revenue in future periods.

36 Slide Other Multiple Deliverable Arrangements For multiple-deliverable arrangements, revenue should be allocated to individual deliverables that qualify for separate revenue recognition. Otherwise, revenue is delayed until completion of later deliverables.

37 Slide Franchise Sales Source: SFAS 45 Initial Franchise Fees Generally are recognized at a point in time when the earnings process is virtually complete. Continuing Franchise Fees Recognized over time as the services are performed.


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