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Chapter7-1
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Chapter7-3
1. Apply the revenue recognition principle.
2. Describe accounting issues involved with revenuerecognition at point of sale.
3. Apply the percentage-of-completion method for long-term contracts.
4. Apply the completed-contract method for long-termcontracts.
5. Describe the installment-sales and cost-recoverymethods of accounting.
Learning ObjectivesLearning Objectives
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Chapter7-5
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.
Of the ten companies, the leading three lost
$20 billion in market value in just three days
following disclosure.
Revenue recognition has been the largest source of
public company restatements over the past decade.
The Current EnvironmentThe Current Environment
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Chapter7-6
The revenuerecognition principle provides that
companies should recognize revenue
Guidelines forRevenueRecognition
The Current EnvironmentThe Current Environment
LO 1 Apply therevenuerecognition principle.LO 1 Apply therevenuerecognition principle.
(1) when it is realized or realizable and
(2) when it is earned.
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Chapter7-8
Earlierrecognition 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.
Departures from theSale Basis
The Current EnvironmentThe Current Environment
LO 1 Apply therevenuerecognition principle.LO 1 Apply therevenuerecognition principle.
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Chapter7-9
RevenueRecognitionAlternatives
The Current EnvironmentThe Current Environment
LO 1 Apply therevenuerecognitionprinciple.LO 1 Apply therevenuerecognitionprinciple.
Illustration 7-2
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Chapter7-10
FASBs ConceptsStatement No. 5, companies
usually meet the two conditions for recognizing
revenue by the time they deliver products or renderservices to customers.
Departures from theSale Basis
RevenueRecognitionat Pointof Sale (Delivery)RevenueRecognitionat Pointof Sale (Delivery)
LO 2Describeaccounting issues forrevenuerecognitionat pointof sale.LO 2Describeaccounting issues forrevenuerecognitionat pointof sale.
Implementation problems,
Sales with buyback agreements Sales when right of return exists
Trade loading and channel stuffing
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Chapter7-11
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 relatedliability remain on the sellers books.* In other
words, no sale.
Sales with BuybackAgreements
RevenueRecognitionat Point of Sale (Delivery)RevenueRecognitionat Point of Sale (Delivery)
LO 2 Describeaccounting issues forrevenuerecognitionatpoint of sale.LO 2 Describeaccounting issues forrevenuerecognitionatpoint of sale.
* Accounting for Product Financing Arrangements, Statement ofFinancial Accounting Standards No. 49 (Stamford, Conn.: FASB, 1981).
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Chapter7-13
Sales WhenRightof ReturnExists
RevenueRecognitionat Pointof Sale (Delivery)RevenueRecognitionat Pointof Sale (Delivery)
LO 2 Describeaccounting issues forrevenuerecognitionatpointof sale.LO 2 Describeaccounting issues forrevenuerecognitionatpointof sale.
4. The buyer acquiring the product for resale has economicsubstance apart from that provided by the seller.
5. The seller does not have significant obligations for future
performance to directly bring about resale of the product
by the buyer.6. The seller can reasonably estimate the amount of future
returns.
Recognize revenue only if all six of the following
conditions have been met.
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Chapter7-14
Trade loading is a crazy, uneconomic, insidious
practice through which manufacturerstrying to
show sales, profits, and market share they dontactually haveinduce their wholesale customers,
known as the trade, to buy more product than they
can promptly resell.*
Trade Loadingand Channel Stuffing
RevenueRecognitionat Pointof Sale (Delivery)RevenueRecognitionat Pointof Sale (Delivery)
LO 2 Describeaccounting issues forrevenuerecognitionatpointof sale.LO 2 Describeaccounting issues forrevenuerecognitionatpointof sale.
* The $600 Million Cigarette Scam, Fortune (December 4, 1989), p. 89.
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Chapter7-15
Two Methods:
Percentage-of-Completion Method.
Rationale is that the buyer and seller have
enforceable rights.
Completed-Contract Method.
Most notable example is long-termconstruction
contract accounting.
RevenueRecognition Before DeliveryRevenueRecognition Before Delivery
LO 2 Describe accounting issuesforrevenuerecognition atpointofsale.LO 2 Describe accounting issuesforrevenuerecognition atpointofsale.
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Chapter7-16
Must use Percentage-of-Completion method whenestimates of progress toward completion, revenues, andcosts are reasonably dependable and all of the followingconditions exist:
RevenueRecognition Before DeliveryRevenueRecognition Before Delivery
1. The contract clearly specifies the enforceable rightsregarding goods or services by the parties, theconsideration to be exchanged, and the manner and termsof settlement.
2. The buyer can be expected to satisfy all obligations.
3. The contractor can be expected to perform under thecontract.
LO 2 Describeaccounting issues forrevenuerecognitionat pointof sale.LO 2 Describeaccounting issues forrevenuerecognitionat pointof sale.
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Chapter7-17
Companies should use the Completed-Contractmethodwhen one of the following conditions applies when:
RevenueRecognition Before DeliveryRevenueRecognition Before Delivery
1. Company has primarily short-term contracts, or
2. Company cannot meet the conditions for using thepercentage-of-completion method, or
3. There are inherent hazards in the contract beyond thenormal, recurring business risks.
LO 2 Describeaccounting issuesforrevenuerecognitionat pointof sale.LO 2 Describeaccounting issuesforrevenuerecognitionat pointof sale.
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Chapter7-18
Measuring theProgress toward Completion
Most popular measure is the cost-to-costbasis.
LO 3 Apply thepercentageLO 3 Apply thepercentage--ofof--completionmethodforlongcompletionmethodforlong--termcontracts.termcontracts.
PercentagePercentage--ofof--Completion MethodCompletion Method
The percentage that costs incurred bear to total
estimated costs, can be applied to the totalrevenue or the estimated total gross profit onthe contract.
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Chapter7-19
2007 2008 2009
Contract price $675,000 $675,000 $675,000
Cost incurred current year 150,000 287,400 170,100Estimated cost to complete
in future years 450,000 170,100 0Billings to customer current year 135,000 360,000 180,000Cash receipts from customer
Current year 112,500 262,500 300,000
A) Prepare the journal entries for2007, 2008, and 2009.
Casper Construction Co.
LO 3 Apply thepercentageLO 3 Apply thepercentage--ofof--completionmethodforlongcompletionmethodforlong--term contracts.term contracts.
PercentagePercentage--ofof--Completion MethodCompletion Method
Illustration:
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Chapter7-20 LO 3 Apply thepercentageLO 3 Apply thepercentage--ofof--completionmethodforlongcompletionmethodforlong--term contracts.term contracts.
PercentagePercentage--ofof--Completion MethodCompletion Method
2007 2008 2009
Costs incurred to date 150,000$ 437,400$ 607,500$
Estimated cost to complete 450,000 170,100
Est. total contract costs 600,000 607,500 607,500
Est. percentage complete 25.0% 72.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 486,000 675,000
Rev. recognized prior year (168,750) (486,000)
Rev. recognized currently 168,750 317,250 189,000
Costs incurred currently (150,000) (287,400) (170,100)
Income recognized currently 18,750$ 29,850$ 18,900$
Illustration:
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Chapter7-26
LongLong--Term Contract LossesTerm Contract Losses
LO 3 & 4 Losses onpercentageLO 3 & 4 Losses onpercentage--ofof--completion and completed contractcompletion and completed contract
methods onlongmethods onlong--term contracts.term contracts.
Two Methods:
Loss in the Current Period on a Profitable Contract
Percentage-of-completion method only, the estimated
cost increase requires a current-period adjustmentof gross profit recognized in prior periods.
Loss on an Unprofitable Contract
Under both percentage-of-completion and completed-contract methods, the company must recognize in the
current period the entire expected contract loss.
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Chapter7-28
2007 2008 2009
Costs incurred to date 150,000$ 437,400$ 652,836$
Estimated cost to complete 450,000 215,436
Est. total contract costs 600,000 652,836 652,836
Est. percentage complete 25.0% 67.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 452,250 675,000
Rev. recognized prior year (168,750) (452,250)Rev. recognized currently 168,750 283,500 222,750
Costs incurred currently (150,000) (287,400) (215,436)
Income recognized currently 18,750$ (3,900)$ 7,314$
LongLong--Term Contract LossesTerm Contract Losses
Illustration: Loss on Profitable Contract
LO 3 & 4 Losses onpercentageLO 3 & 4 Losses onpercentage--ofof--completion and completed contractcompletion and completed contract
methods on longmethods on long--term contracts.term contracts.
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Chapter7-29
C str ct pr ress 18 750 7 314
C str ct e pe se 150 000 215 436C str ct re e e 168 750 222 750
C str ct pr ress 3 900
C str ct e pe se 287 400
C str ct re e e 283 500
20092007 2008
LongLong--Term Contract LossesTerm Contract Losses
Illustration: Loss on Profitable Contract
LO 3 & 4 Losses onpercentageLO 3 & 4 Losses onpercentage--ofof--completion and completed contractcompletion and completed contract
methods onlongmethods onlong--term contracts.term contracts.
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Chapter
7-30
Illustration: Loss on Unprofitable Contract
LongLong--Term Contract LossesTerm Contract Losses
2007 2008 2009
Contract price $675,000 $675,000 $675,000
Cost incurred current year 150,000 287,400 246,038Estimated cost to complete
in future years 450,000 246,038 0Billings to customer current year 135,000 360,000 180,000Cash receipts from customer
Current year 112,500 262,500 300,000
c) Prepare the journal entries for 2007, 2008, and 2009 assuming theestimated cost to complete at the end of 2008 was $246,038 instead of$170,100.
Casper Construction Co.
LO 3 & 4 Losses onpercentageLO 3 & 4 Losses onpercentage--ofof--completion and completed contractcompletion and completed contractmethods onlongmethods onlong--term contracts.term contracts.
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Chapter
7-31
2007 2008 2009
Costs incurred to date 150,000$ 437,400$ 683,438$
Estimated cost to complete 450,000 246,038
Est. total contract costs 600,000 683,438 683,438Est. percentage complete 25.0% 64.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 432,000 675,000
Rev. recognized prior year (168,750) (432,000)
Rev. recognized currently 168,750 263,250 243,000Costs incurred currently (150,000) (290,438) (243,000)
Income recognized currently 18,750$ (27,188)$ -$
LongLong--Term Contract LossesTerm Contract Losses
$683,438 678,500 = 8,438 cumulative loss
Illustration: Loss on Unprofitable Contract
PlugPlug
LO 3 & 4 Losses onpercentageLO 3 & 4 Losses onpercentage--ofof--completion and completed contractcompletion and completed contractmethods on longmethods on long--term contracts.term contracts.
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Chapter
7-33
L tr t tra t 3
C tr t pr re 3
7
LongLong--Term Contract LossesTerm Contract Losses
Illustration: Loss on Unprofitable Contract
For the Completed-Contractmethod, companies wouldrecognize the following loss :
LO 4 Apply thecompleted contractmethod for longLO 4 Apply thecompleted contractmethod for long--termcontracts.termcontracts.
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Chapter
7-34
Construction contractors should disclosure:
the method of recognizing revenue,
the basis used to classify assets and liabilities ascurrent (length of the operating cycle),
the basis for recording inventory,
the effects of any revision of estimates,
the amount of backlog on uncompleted contracts, and
the details about receivables.
Disclosures inFinancial Statements
RevenueRecognition BeforeDeliveryRevenueRecognition BeforeDelivery
LO 4 Apply thecompletedcontractmethodfor longLO 4 Apply thecompletedcontractmethodfor long--termcontracts.termcontracts.
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Chapter
7-35
In certain cases companies recognize revenue at thecompletion of production even though no sale has been
made.
Completion-of-Production Basis
RevenueRecognition Before DeliveryRevenueRecognition Before Delivery
Examples are:
precious metals or
agricultural products.
LO 4 Apply thecompleted contractmethod for longLO 4 Apply thecompleted contractmethod for long--termcontracts.termcontracts.
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Chapter
7-36
When the collection of the sales price is notreasonably assured and revenue recognition isdeferred.
RevenueRecognition After DeliveryRevenueRecognition After Delivery
LO 5 Describe the installmentLO 5 Describe the installment--sales and costsales and cost--recoverymethods of accounting.recoverymethods of accounting.
Methods of deferring revenue:
Installment-sales method
Cost-recovery method
Deposit method
GenerallyGenerallyEmployedEmployed
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Chapter
7-37
Recognizes income in the periods of collection ratherthan in the period of sale.
Recognize both revenues and costs of sales in theperiod of sale, but defer gross profit to periods inwhich cash is collected.
Selling and administrative expenses are not deferred.
Installment-SalesMethod
RevenueRecognitionafter DeliveryRevenueRecognitionafter Delivery
LO 5 Describe the installmentLO 5 Describe the installment--salesand costsalesand cost--recoverymethodsofaccounting.recoverymethodsofaccounting.
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Chapter
7-38
The profession concluded that except in specialcircumstances, the installment method of recognizing
revenue is not acceptable.*The rationale: because the installment method doesnot recognize any income until cash is collected, it isnot in accordance with the accrual concept.
Acceptabilityof theInstallment-SalesMethod
*Omnibus Opinion, Opinions of the Accounting Principles Board No. 10(New York: AICPA, 1966), par. 12.
RevenueRecognitionafter DeliveryRevenueRecognitionafter Delivery
LO 5 Describe the installmentLO 5 Describe the installment--salesand costsalesand cost--recoverymethodsof accounting.recoverymethodsof accounting.
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Chapter
7-39
Recognizes no profit until cash payments by the buyerexceed the cost of the merchandise sold.
APB Opinion No. 10 allows a seller to use the cost-recovery method to account for sales in which there isno reasonable basis for estimating collectibility. Inaddition, FASB Statements No. 45 (franchises) andNo. 66 (real estate) require use of this method wherea high degree of uncertainty exists related to thecollection of receivables.
Cost-RecoveryMethod
RevenueRecognition after DeliveryRevenueRecognition after Delivery
LO 5 Describe the installmentLO 5 Describe the installment--sales and costsales and cost--recoverymethodsof accounting.recoverymethodsof accounting.
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Chapter
7-41
Measuring theProgress toward Completion
Cost-to-costbasis
LO 3 Apply the percentageLO 3 Apply the percentage--ofof--completionmethod for longcompletionmethod for long--termcontracts.termcontracts.
PercentagePercentage--ofof--CompletionMethodCompletionMethod
Illustrations 7-3,4,& 5
Costs incurred to date
Most recent estimate of total costs = Percent complete
Percent complete x Estimated total revenue =Revenue to
be recognizedto date
Revenue tobe recognized
to date
Current-periodRevenue-
Revenuerecognized inprior periods
=
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