Presentation on theme: "PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright."— Presentation transcript:
5-2 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. Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entitys ongoing major or central operations.
5-3 SEC Staff Accounting Bulletin No. 101 and 104 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. 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. In addition to these four criteria, the SABs also pose a number of revenue recognition questions relating to each of the criteria.
5-4 Realization Principle Revenue recognition is often tied to delivery of the product from the seller to the buyer.
5-5 U. S. GAAP vs. IFRS Earnings process is complete or virtually complete. Reasonable certainty as to the collectibility of the asset to be received. Revenue recognition criteria for U.S. GAAP and IFRS include: Revenue and costs can be measured reliably. Probable that economic benefits will flow to the seller. Risk and rewards are transferred to buyer and seller does not manage or control the goods. Stage of completion can be measured reliably.
5-6 Revenue Recognition at Delivery 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
5-7 Is the Seller a Principal or Agent? Principal Has primary responsibility for delivering product or service and is vulnerable to risks associated with delivery and collection. Agent Does not have primary responsibility for delivering product or service but acts as a facilitator that earns a commission Recognizes as revenue the gross (total) amount received from a customer. Recognizes as revenue the net commission it receives for facilitating the sale.
5-8 Revenue Recognition after Delivery 1.Installment Sales Method 2.Cost Recovery Method 1.Installment Sales Method 2.Cost Recovery Method Recognizing revenue at delivery of the product or service assumes we are able to make reasonable estimates of amounts due from customers that potentially might be uncollectible and amounts not collectible due to customers returning the products they purchased.
5-9 Installment Sales Method On November 1, 2013, 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%
5-10 Installment Sales Method During 2013, Belmont Corporation collected $200,000 on its installment sales. This entry records the realized gross profit by adjusting the deferred gross profit account.
5-11 Cost Recovery Method On November 1, 2013, 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.
5-12 Cost Recovery Method
5-13 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
5-14 Consignment Sales Sometimes a company arranges for another company to sell its product under consignment. Because the consignor retains the risks and rewards of ownership of the product and title does not pass to the consignee, the consignor does not record a sale until the consignee sells the goods and title passes to the eventual customer.
5-16 Completed Contract and Percentage-of- Completion Methods Compared At the beginning of 2013, the Harding Construction Company received a contract to build an office building for $5 million. The project is estimated to take three years to complete. According to the contract, Harding will bill the buyer in installments over the construction period according to a prearranged schedule. Information related to the contract is as follows:
5-17 Accounting for the Cost of Construction and Accounts Receivable With both the completed contract and percentage-of- completion methods, all costs of construction are recorded in an asset account called construction in progress.
5-18 Gross Profit RecognitionGeneral Approach In both methods the same amounts of revenue, cost, and gross profit are recognized. In both methods we add gross profit to the construction in progress asset.
5-19 Gross Profit RecognitionGeneral Approach The same journal entry is recorded to close out the billings on construction contract and construction in progress accounts under the completed contract and percentage-of- completion methods.
5-20 Timing of Gross Profit Recognition Under the Completed Contract Method Under the completed contract method, all revenues and expenses related to the project are recognized when the contract is completed.
5-21 Timing of Gross Profit Recognition Under the Percentage-of-Completion Method Under the percentage-of-completion method, profit is recognized over the life of the project as the project is completed. We determine the amount of gross profit recognized in each period using the following logic:
5-22 Percentage-of-Completion Method Allocation of Gross Profit
5-23 Percentage-of-Completion Method Allocation of Gross Profit Notice that the gross profit recognized in each period is added to the construction in progress account.
5-24 Percentage-of-Completion Method Allocation of Gross Profit The income statement for each year will report the appropriate revenue and cost of construction amounts.
5-25 Income Recognition The same total amount of profit or loss is recognized under both the completed contract and the percentage-of- completion methods, but the timing of recognition differs.
5-26 Balance Sheet Recognition The balance in the construction in progress account differs between methods because of the earlier gross profit recognition that occurs under the percentage-of-completion method.
5-27 Balance Sheet Recognition Billings on construction contract are subtracted from construction in progress to determine balance sheet presentation. CIP > BillingsAssetBillings > CIPLiability
5-28 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.
5-29 U. S. GAAP vs. IFRS Requires percentage-of- completion when reliable estimates can be made. Requires completed contract method when reliable estimates cant be made. There are similarities and differences between IFRS and U.S. GAAP when considering revenue recognition for long-term construction contracts. Requires percentage-of- completion when reliable estimates can be made. Requires cost recovery method when reliable estimates cant be made.
5-30 U. S. GAAP vs. IFRS Notice that revenue recognition occurs earlier under the cost recovery method than under the completed contract method, but gross profit recognition occurs at the end of the contract for both methods.
5-31 Software and Other Multiple Deliverable Arrangements If a sale includes multiple elements (software, future upgrades, post contract customer support, etc.), the revenue should be allocated to the various elements based onvendor-specific objective evidence (VSOE) of fair values of the individual elements.
5-32 Software and Other Multiple Deliverable Arrangements Sellers offering other multiple-deliverable contracts now are allowed to estimate selling prices when they lack VSOE from stand-alone sales prices. Using estimated selling prices allows earlier revenue recognition than would be allowed if sellers had to have VSOE in order to recognize revenue. The FASBs Emerging Issues Task Force (EITF) issued guidance to broaden the application of this basic perspective to other arrangements that involve multiple deliverables, such as sales of appliances with maintenance contracts, cellular phone contracts that come with a free phone, and even painting services that include sales of paint as well as labor.
5-33 U. S. GAAP vs. IFRS Revenue should be allocated to the various elements based onvendor-specific objective evidence (VSOE) of fair values of the individual elements. IFRS contains very little guidance about multiple-deliverable arrangements. May be necessary to apply the recognition criteria to the separately identifiable components of a single transaction. Allocation of total revenue to individual components are based on fair value, with no requirements to focus on VSOE.
5-34 Franchise Sales 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.
5-35 U. S. GAAP vs. IFRS Has over 100 revenue-related standards that sometimes contradict each other. The FASB and IASB are currently working on a new, comprehensive approach to revenue recognition. Has two primary standards that also sometimes contradict each other and that dont offer guidance in some important areas (like multiple deliverables). The Boards appear committed to improving accounting in this area.
5-36 Activity Ratios Whenever a ratio divides an income statement balance by a balance sheet balance, the average for the year is used in the denominator.
5-38 This is called the DuPont framework because the DuPont Company was a pioneer in emphasizing this relationship. Because profit margin and asset turnover combine to equal return on assets, the DuPont framework can also be written as: DuPont Framework Return on equity= Profit marginX Asset turnoverX Equity multiplier Net income Avg. total equity = Net income Total salesX Avg. total assets X Avg. total equity The DuPont framework helps identify how profitability, activity, and financial leverage trade off to determine return to shareholders: Return on equity= Return on assetsX Equity multiplier Net income Avg. total equity = Net income Avg. total assets X Avg. total equity
5-39 Appendix 5: Interim Reporting Issued for periods of less than a year, typically as quarterly financial statements. Serves to enhance the timeliness of financial information. Fundamental debate centers on the choice between the discrete and integral part approaches.
5-40 Interim Reporting Reporting Revenues and Expenses With only a few exceptions, the same accounting principles applicable to annual reporting are used for interim reporting. Reporting Unusual Items Discontinued operations and extraordinary items are reported entirely within the interim period in which they occur. Earnings Per Share Quarterly EPS calculations follow the same procedures as annual calculations. Reporting Accounting Changes Accounting changes made in an interim period are reported by retrospectively applying the changes to prior financial statements.
5-41 U. S. GAAP vs. IFRS Costs for repairs, property taxes, and advertising that do not meet the definition of an asset at the end of an interim period are accrued or deferred and then charged to each of the periods they benefit. Costs for repairs, property taxes, and advertising that do not meet the definition of an asset at the end of an interim period are expensed entirely in the period in which they occur. IAS No. 34 requires that a company apply the same accounting policies in its interim financial statements as it applies in its annual financial statements. This difference would tend to make interim period income more volatile under IFRS than under U.S. GAAP.
5-42 Appendix 5: Interim Reporting Minimum Disclosures 1.Sales, income taxes, and net income 2.Earnings per share 3.Seasonal revenues, costs, and expenses 4.Significant changes in estimates for income taxes 5.Discontinued operations, extraordinary items, and unusual or infrequent items 6.Contingencies 7.Changes in accounting principles or estimates 8.Information about fair value of financial instruments and the methods and assumptions used to estimate fair values 9.Significant changes in financial position
5-43 Revenue Recognition: A Chapter Supplement Core Revenue Recognition Principle A company must recognize revenue when goods or services are transferred to customers in an amount that reflects the consideration the company expects to receive in exchange for those goods or services. Key Steps in Applying the Principle 1.Identify a contract with a customer. 2.Identify the performance obligation(s) in the contract. 3.Determine the transaction price. 4.Allocate the transaction price to the performance obligations. 5.Recognize revenue when each performance obligation is satisfied.
5-44 Step 1: Identify the Contract Under the proposed ASU, we recognize revenue associated with contracts that are legally enforceable.
5-45 Step 2: Identify the Performance Obligation(s) Performance obligations are promises to transfer goods or services to the buyer and are accounted for separately if they are distinct. A performance obligation is accounted for separately from other performance obligations if it is distinct, which is the case if either: 1.The seller regularly sells the good or service separately, or 2.The seller could sell it separately (the customer can use the good or service on its own or together with other readily available resources).
5-46 Step 2: Identify the Performance Obligation(s) If a seller integrates goods and services into one asset, they are viewed as providing an integration service that qualifies as a single performance obligation. A bundle of goods or services is viewed as a single performance obligation if both of the following are true: 1.The goods or services in the bundle are highly interrelated and the seller provides a significant service of integrating them into a combined item. 2.The bundle is significantly modified or customized for the customer.
5-47 Step 3: Determine the Transaction Price Determining the transaction price is simple if the buyer pays a fixed amount immediately or in the near future. Variable Consideration Time Value of Money Collectability of the Transaction Price Complications in Determining Transaction Price
5-48 Accounting for Variable Consideration When it Can be Reasonably Estimated
5-49 Accounting for Variable Consideration When it Can be Reasonably Estimated
5-50 The Time Value of Money If the time value of money is significant, a sales transaction is viewed as including two parts: a delivery component and a financing component.
5-51 The Time Value of Money
5-52 Step 4: Allocate the Transaction Price to the Performance Obligations If an arrangement has more than one distinct performance obligation, the seller allocates the transaction price to the separate performance obligations in proportion to the standalone selling price of the goods or services underlying those performance obligations.
5-53 Step 4: Allocate the Transaction Price to the Performance Obligations
5-54 Step 5: Recognize Revenue When Each Performance Obligation Is Satisfied In general, a seller recognizes revenue allocated to each performance obligation when it satisfies the performance obligation.
5-55 Step 5: Recognize Revenue When Each Performance Obligation Is Satisfied If a performance obligation is not satisfied over time, it is satisfied at a single point in time, when the seller transfers control of goods to the buyer. Often transfer of control is obvious and coincides with delivery. In other circumstances, though, transfer of control is not as clear.