1. REVENUE AND EXPENSE RECOGNITION2 2 2 2

2. LEARNING OBJECTIVES Understand the revenue and matching principles
Familiarize yourself with applications of the revenue principle with special attention to:
Installment and cost recovery methods
Accounting for long-term contracts
Completed contract method
Percentage of completion method
Right of return method
Product financing arrangements
Franchising agreements
Obtain overall understanding of matching principle

3. DEFINITIONS Revenues Expenses
Inflows of assets or settlements of liabilities during a period from delivering or producing goods or services.
Expenses
Outflows of assets or incurrence of liabilities during a period from delivering or producing goods or services.
Incurred in an attempt to produce revenues 3 3 3 3

4. Revenue should be recognized in the financial statement when . . .
REVENUE PRINCIPLE
Revenue should be recognized in the financial statement when . . .
It is earned, and
It is realized or realizable
(Measurable) 7 7 7 7

5. REVENUE PRINCIPLE
Revenue is earned when the earnings process is completed or virtually completed.
Revenue is realized when cash is received.
Revenue is realizable when claims to cash are received that can be converted into a known amount of cash. 8 8 8 8

6. Revenue is typically recognized:
REVENUE PRINCIPLE
Revenue is typically recognized:
At delivery (point of sale)
After delivery
Before delivery
of product or service 9 9 9 9

7. REVENUE RECOGNITION POINTS
before delivery
Recognition
at delivery
Recognition
after delivery
Design and production,
construction in progress,
minerals discovered
Goods completed
and ready for sale,
contract complete
Delivery of
product or
service
Cash collected
for goods or
services
Right of
return expires
Percentage-of
completion method
Production
method
Point
of sale
method
Installment
method
Right of
return
expiration
method
Completed
contract
method
Cost
recovery
method
RELEVANCE
RELIABILITY

8. REVENUE RECOGNITION Point of Sale
Revenue is earned and realized at the point of sale.
The product or service has been delivered to the customer and cash has been received or is receivable.
This method is sometimes called the “sales method,” or “delivery method.” 10 10 10 10

9. REVENUE RECOGNITION After Delivery
Uncertainties about collectibility or future performance by seller.
Sale with right of return.
Product-financing arrangements. 11 11 11 11

10. INSTALLMENT SALES
When we are uncertain about the collectibility of the sales revenue or the ability of the seller to deliver futures services, we should defer revenue recognition.
Two commonly used accounting methods are the . . .
Installment sales method.
Cost recovery method. 15 15 15 15

11. Installment Sales Method
Sale and cost of sale recorded as usual.
Compute gross margin rate on the installment sales.
Recognize gross margin as cash is received.
Gross margin not realized is deferred until a future period. 16 16 16 16

12. INSTALLMENT SALES Example
Sam’s Appliances made sales of $200,000 in 19X5 that qualified for the installment sales method of accounting. The items sold have a cost to Sam’s of $130,000. During 19X5, Sam’s collected cash from installment customers of $90,000. The remaining amount will be collected in 19X6.
Prepare the journal entries to record the installment sales transactions during 19X5. 17 17 17 17

13. INSTALLMENT SALES Example18 18 18 18

14. INSTALLMENT SALES Example19 19 19 19

15. INSTALLMENT SALES Example20 20 20 20

16. INSTALLMENT SALES Example21 21 21 21

17. INSTALLMENT SALES Example22 22 22 22

18. INSTALLMENT SALES Example23 23 23 23

19. INSTALLMENT SALES Example
Cash collection in 19X $90,000
Gross margin percentage %
Gross profit to recognize $31,500 24 24 24 24

20. INSTALLMENT SALES Example
Balance Sheet 25 25 25 25

21. INSTALLMENT SALES Example
Balance Sheet 26 26 26 26

22. UNCERTAINTY IS GREATER!
COST RECOVERY METHOD
Like the installment sales method, cost recovery is used when we are uncertain about the collectibility of the sales revenue or the ability of the seller to complete future performance.
UNCERTAINTY IS GREATER!
No profit is recognized until cost of item sold is fully recovered. 27 27 27 27

23. COST RECOVERY Example
Sam’s Appliances made sales of $200,000 in 19X5 that qualified for the cost recovery method of accounting. The items sold have a cost to Sam’s of $130,000. During 19X5, Sam’s collected cash from installment customers of $90,000. The remaining amount will be collected in 19X6.
Prepare the journal entries to record the installment sales transactions during 19X5. 28 28 28 28

24. COST RECOVERY Example 29 29 29 29

25. COST RECOVERY Example 30 30 30 30

26. COST RECOVERY Example 31 31 31 31

27. COST RECOVERY Example
No profit is recognized in 19X5 because the cost of the
item sold ($130,000) has not been recovered in the
form of cash receipts. Once we collect $130,000 in
cash, profit recognition begins. 32 32 32 32

28. All gross profit has been deferred until we recover the
COST RECOVERY Example
Balance Sheet
All gross profit has been deferred until we recover the
$130,000 cost of the item sold. 33 33 33 33

29. Equipment Manufacturing
RIGHT OF RETURN
In some industries it is common practice that the sales terms allow customers the right to return goods under specified conditions and over long periods of time.
Equipment Manufacturing
Book Publishing 13 13 13 13

30. Recognize revenue at point of sale if,
RIGHT OF RETURN
Recognize revenue at point of sale if,
Selling price is fixed or determinable.
Buyer is obligated to pay the seller and payment is not contingent upon resale of the product.
Buyer is obligated even in case of theft or physical destruction.
Buyer has economic substance apart from that provided by the seller.
Seller has no obligation for future performance.
Future returns can be estimated. 14 14 14 14

31. PRODUCT-FINANCING ARRANGEMENTS
An agreement in which a sponsoring company sells a product to another company and in a related transaction agrees to repurchase the product.
The sponsoring company
Records a liability when the proceeds are received.
No sale is recorded and inventory is not adjusted.
Wait for a sale to outside party. 12 12 12 12

32. REVENUE RECOGNITION Before Delivery
Accounting for long-term construction contracts
Completed-Contract Method
Percentage-of-Completion Method 34 34 34 34

33. REVENUE RECOGNITION Before Delivery
Percentage-of-completion method is appropriate when . . .
Contract specifies the amount of consideration to be exchanged and the terms of settlement.
Buyer is expected to satisfy the obligation.
Contractor can perform according to the terms of the contract. 35 35 35 35

34. MEASURING PROGRESS TOWARD COMPLETION
Input Measures
Effort devoted to project compared to total effort expected (cost incurred to date compared to total estimated costs)
Output Measures
Results to date compared to total results 36 36 36 36

35. MEASURING PROGRESS TOWARD COMPLETION
Cost-to-Cost Method
Total costs incurred to date
Percent complete =
Most recent estimate of total
costs of the project 37 37 37 37

36. MEASURING PROGRESS TOWARD COMPLETION
Cost-to-Cost Method
Current Period Revenue
Total Revenue from Contract
× Percent Complete
Total Revenue to Recognize
- Revenue Recognized in Prior Periods
= Revenue Recognized in Current Period 38 38 38 38

37. LONG-TERM CONTRACTS Example
During 19X6, West, Inc. enters into a contract with Putnam County to build a bridge over Cane River. The project will take 3 years to complete and has a fixed price of $4,500,000. West’s engineers estimate the total cost of the bridge to be $3,000,000. At the end of 19X6, the information on the next page was gathered by West’s accountant. 39 39 39 39

38. LONG-TERM CONTRACTS Example
West uses the percentage-of-completion
method to account for all long-term
construction projects.
Prepare the necessary 19X6 journal entries
for this project. 40 40 40 40

39. LONG-TERM CONTRACTS Example41 41 41 41

40. LONG-TERM CONTRACTS Example42 42 42 42

41. LONG-TERM CONTRACTS Example43 43 43 43

42. LONG-TERM CONTRACTS Example44 44 44 44

43. LONG-TERM CONTRACTS Example
If West uses the Completed-Contract method, no
revenue is recognized during 19X6. All
revenue and profit is recognized at the
end of the contract when delivery of the bridge to
Putnam County is made. 45 45 45 45

44. REVENUE RECOGNITION Before Delivery
Completion of Production
Accretion Basis
Discovery Basis 46 46 46 46

45. REVENUE RECOGNITION Service Sales
Specific Performance Method
Proportional Performance Method
Completed Performance Method
Collection 47 47 47 47

46. Used to account for revenue that is earned by performing a single act.
SPECIFIC PERFORMANCE
Used to account for revenue that is earned by performing a single act.
Franchise revenue (SFAS No. 45)
Bob’s
Burgers 48 48 48 48

47. PROPORTIONAL PERFORMANCE
Used to recognize service revenue that is earned by more than a single act and when the service is rendered in more than one accounting period.
Similar performance acts - equal amount for each act
Dissimilar performance acts - in proportion to direct costs of each act
Similar acts with a fixed period for performance 49 49 49 49

48. COMPLETED PERFORMANCE
Used when revenue is earned by performing a series of acts, and the last act is so important that revenue is only considered earned if it is performed. 50 50 50 50

49. Revenue recognized when cash is received.
COLLECTION
Used to account for service revenue when the uncertainty of collection is very high.
Revenue recognized when cash is received. 51 51 51 51

50. EXPENSE RECOGNITION
Expenses are outflows of assets or incurrences of liabilities during a period from delivery or producing goods or rendering services. 52 52 52 52

51. MATCHING
Once revenues are determined, the expenses incurred in generating the revenue should be recognized.
As revenues are earned, certain assets are consumed and services are used. 53 53 53 53

52. EXPENSES Recognition Methods
Direct
Period
Allocated 54 54 54 54

53. GAINS AND LOSSES
Gains and losses result from peripheral or incidental transactions, events, or circumstances.
Most gains and losses are recognized when the transaction is completed.
Estimated losses are recognized before realization if they are probable and can be reasonably estimated. 55 55 55 55

54. ETHICAL CONSIDERATIONS
I’m sorry we shipped your order on Dec. 28 instead of on the delivery date of Jan But the important thing is that you have the products you need...Right? 56 56 56 56

55. Ready to Move On?
Midterm
Exam 57 57 57 57