2. C H A P T E R 18 REVENUE RECOGNITION
Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield

3. Learning Objectives Apply the revenue recognition principle.
Describe accounting issues for revenue recognition at point of sale.
Apply the percentage-of-completion method for long-term contracts.
Apply the completed-contract method for long-term contracts.
Identify the proper accounting for losses on long-term contracts.
Describe the installment-sales method of accounting.
Explain the cost-recovery method of accounting.
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

4. Revenue Recognition Current Environment
Revenue Recognition at the Point of Sale
Revenue Recognition before Delivery
Revenue Recognition after Delivery
Guidelines for revenue recognition
Departures from sale basis
Sales with buyback agreements
Sales when right of return exists
Trade loading and channel stuffing
Percentage-of-completion method
Completed-contract method
Long-term contract losses
Disclosures
Completion-of-production basis
Installment-sales method
Cost-recovery method
Deposit method
Summary of bases
Concluding remarks
Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation.
Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt.
Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets.
Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees.
Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss:
difference between the actual return and the expected return on plan assets and,
amortization of the unrecognized net gain or loss from previous periods

5. The Current Environment
Revenue recognition has been the largest source of public company restatements over the past decade.
One study noted restatements of revenue:
Result in larger drops in market capitalization than other types of restatement.
Caused eight of the top ten market value losses in a recent year.

6. The Current Environment
Guidelines for Revenue Recognition
The revenue recognition principle provides that companies should recognize revenue
when it is realized or realizable and
when it is earned.
LO 1 Apply the revenue recognition principle.

7. The Current Environment
Revenue Recognition Classified by Type of Transaction
Chapter 18
Chapter 18
Illustration 18-1
Type of Transaction
Sale of product from inventory
Sale of asset other than inventory
Rendering a service
Permitting use of an asset
Description of Revenue
Revenue from fees or services
Revenue from interest, rents, and royalties
Revenue from sales
Gain or loss on disposition
Timing of Revenue Recognition
Date of sale (date of delivery)
Services performed and billable
As time passes or assets are used
Date of sale or trade-in
LO 1 Apply the revenue recognition principle.

8. The Current Environment
Departures from the Sale Basis
Earlier recognition is appropriate if there is a high degree of certainty about the amount of revenue earned.
Delayed recognition is appropriate if the
degree of uncertainty concerning the amount of revenue or costs is sufficiently high or
sale does not represent substantial completion of the earnings process.
LO 1 Apply the revenue recognition principle.

9. The Current Environment
Illustration 18-2
Revenue Recognition Alternatives
LO 1 Apply the revenue recognition principle.

10. Revenue Recognition at Point of Sale (Delivery)
Departures from the Sale Basis
FASB’s Concepts Statement No. 5, companies usually meet the two conditions for recognizing revenue by the time they deliver products or render services to customers.
Implementation problems,
Sales with Buyback Agreements
Sales When Right of Return Exists
Trade Loading and Channel Stuffing
LO 2 Describe accounting issues for revenue recognition at point of sale.

11. Revenue Recognition at Point of Sale (Delivery)
Sales with Buyback Agreements
When a repurchase agreement exists at a set price and this price covers all cost of the inventory plus related holding costs, the inventory and related liability remain on the seller’s books. In other words, no sale.
LO 2 Describe accounting issues for revenue recognition at point of sale.

12. Revenue Recognition at Point of Sale (Delivery)
Sales When Right of Return Exists
Recognize revenue only if six conditions have been met.
The seller’s price to the buyer is substantially fixed or determinable at the date of sale.
The buyer has paid the seller, or the buyer is obligated to pay the seller, and the obligation is not contingent on resale of the product.
The buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product.
LO 2 Describe accounting issues for revenue recognition at point of sale.

13. Revenue Recognition at Point of Sale (Delivery)
Sales When Right of Return Exists
Recognize revenue only if six conditions have been met.
The buyer acquiring the product for resale has economic substance apart from that provided by the seller.
The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer.
The seller can reasonably estimate the amount of future returns.
LO 2 Describe accounting issues for revenue recognition at point of sale.

14. Revenue Recognition at Point of Sale (Delivery)
Trade Loading and Channel Stuffing
“Trade loading is a crazy, uneconomic, insidious practice through which manufacturers—trying to show sales, profits, and market share they don’t actually have—induce their wholesale customers, known as the trade, to buy more product than they can promptly resell.”*
* “The $600 Million Cigarette Scam,” Fortune (December 4, 1989), p. 89.
LO 2 Describe accounting issues for revenue recognition at point of sale.

15. Revenue Recognition Before Delivery
Most notable example is long-term construction contract accounting.
Two Methods:
Percentage-of-Completion Method.
Rationale is that the buyer and seller have enforceable rights.
Completed-Contract Method.
LO 2 Describe accounting issues for revenue recognition at point of sale.

16. Revenue Recognition Before Delivery
Must use Percentage-of-Completion method when estimates of progress toward completion, revenues, and costs are reasonably dependable and all of the following conditions exist:
Contract clearly specifies the enforceable rights regarding goods or services by the parties, the consideration to be exchanged, and the manner and terms of settlement.
Buyer can be expected to satisfy all obligations.
Contractor can be expected to perform the contractual obligations.
LO 2 Describe accounting issues for revenue recognition at point of sale.

17. Revenue Recognition Before Delivery
Companies should use the Completed-Contract method when one of the following conditions applies when:
Company has primarily short-term contracts, or
Company cannot meet the conditions for using the percentage-of-completion method, or
There are inherent hazards in the contract beyond the normal, recurring business risks.
*Percentage-of-completion method tend to be better. Therefore, companies should use the completed-contract method only when the percentage-of-completion is inappropriate.
LO 2 Describe accounting issues for revenue recognition at point of sale.

18. Percentage-of-Completion Method
Recognizes revenues, costs and gross profit as a company makes progress toward completion of a long-term contact.
Formula for Total Revenue to Be Recognized to Date
Illustration 18-3
<-Most popular measure is the cost-to-cost basis
Illustration 18-4
Illustration 18-5
LO 3 Apply the percentage-of-completion method for long-term contracts.

19. Percentage-of-Completion Method
Illustration: KC Construction Company has a contract to construct a $4,500,000 bridge at an estimated cost of $4,000,000. The contract is to start in July 2010, and the bridge is to be completed in October The following data pertain to the construction period.
LO 3 Apply the percentage-of-completion method for long-term contracts.

20. Percentage-of-Completion Method
Illustration: Compute percentage complete.
Illustration 18-6
Solution on notes page
LO 3 Apply the percentage-of-completion method for long-term contracts.

21. Percentage-of-Completion Method
Illustration: KC would make the following entries to record (1) the costs of construction, (2) progress billings, and (3) collections.
Illustration 18-7
Solution on notes page
LO 3 Apply the percentage-of-completion method for long-term contracts.

22. Percentage-of-Completion Method
Illustration: Percentage-of-Completion, Revenue and Gross Profit, by Year
Illustration 18-8
Solution on notes page

23. Percentage-of-Completion Method
Illustration: KC’s entries to recognize revenue and gross profit each year and to record completion and final approval of the contract.
Illustration 18-9
Solution on notes page
LO 3 Apply the percentage-of-completion method for long-term contracts.

24. Percentage-of-Completion Method
Illustration: Content of Construction in Process Account—Percentage-of-Completion Method
Illustration 18-10
LO 3 Apply the percentage-of-completion method for long-term contracts.

25. Percentage-of-Completion Method
Financial Statement Presentation—Percentage-of-Completion
Computation of Unbilled Contract Price at 12/31/10
Illustration 18-11
LO 3 Apply the percentage-of-completion method for long-term contracts.

26. Percentage-of-Completion Method
Financial Statement—Percentage-of-Completion
KC Construction Company
Illustration 18-12
LO 3 Apply the percentage-of-completion method for long-term contracts.

27. Percentage-of-Completion Method
Illustration:
Casper Construction Co.
A) Prepare the journal entries for 2010, 2011, and 2012.
LO 3 Apply the percentage-of-completion method for long-term contracts.

28. Percentage-of-Completion Method
Illustration:
LO 3 Apply the percentage-of-completion method for long-term contracts.

29. Percentage-of-Completion Method
Illustration:
LO 3 Apply the percentage-of-completion method for long-term contracts.

30. Percentage-of-Completion Method
Illustration:
LO 3 Apply the percentage-of-completion method for long-term contracts.

31. Revenue Recognition Before Delivery
Completed Contract Method
Companies recognize revenue and gross profit only at point of sale—that is, when the contract is completed.
Under this method, companies accumulate costs of long-term contracts in process, but they make no interim charges or credits to income statement accounts for revenues, costs, or gross profit.
LO 4 Apply the completed-contract method for long-term contracts.

32. Completed Contract Method
Illustration:
LO 4 Apply the completed-contract method for long-term contracts.

33. Completed Contract Method
Illustration:
LO 4 Apply the completed-contract method for long-term contracts.