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Intermediate Financial Accounting I
Revenue Recognition
Income Measurement And Profit Analysis 2
Objectives of the Chapter1. Discuss the revenue recognition
principle and the problems associated with revenue recognition at point of sale.
2. Discuss the cases that revenue is recognized at a point other than at point of sale (i.e., before delivery).
3. Study the percentage-of-completion method for long-term contracts.
Income Measurement And Profit Analysis 3
Objectives of the Chapter (contd.)
4. Study the completed-contract method for long-term contracts.
5. Discuss the installment method of accounting.
6. Study the accounting treatments for franchise, software sales and consignment.
Income Measurement And Profit Analysis 4
Revenue Recognition Principle (SFAS No. 5) (-An Accrual Basis) Revenue is recognized when it is earned and
realized or realizable (SFAC 5, par. 83). Earned : the entity has substantially accomplished
what it must do to be entitled to compensation. Realized: goods are exchanged for cash or claims. Realizable: assets received as compensation are
readily convertible into cash or claims to cash. In general, these conditions are met at time of sale
(delivery) or when services are rendered (SFAC 5, par. 84). .
Income Measurement And Profit Analysis 5
Revenue Recognition Principle Other conditions for revenue
recognition (Staff Accounting Bulletin No. 101(1999)):
Persuasive evidence of a sale. Price is fixed or determinable. Collectibility is reasonably assured. Delivery has occurred or services have
been rendered.
Income Measurement And Profit Analysis 6
Impact of SAB 101 on Revenue Recognition for Service Industry FedEx: Recognizes revenue upon delivery of
shipments (not during the packing, loading or transporting).
United Airlines (UA): (Accounting Changes) Beginning Q1, 2000, UA recognizes mileage sale through Citibank credit card or long-distance phone companies after the transportation is provided, not when mileage were sold.
Others: season tickets, annual membership, etc.
Income Measurement And Profit Analysis 7
Type of Transactions Sale of product from Inventory: revenue
recognized at time of sale. Rendering a service: revenue recognized
when services have been performed and billable.
Permitting use of an asset: revenue (i.e., interest, rents and royalties) recognized as time passes or assets are used.
Sale of asset other than inventory: gain or loss recognized at date of sale or trade-in.
Income Measurement And Profit Analysis 8
Problems Associated with Revenue Recognized at Point of Sale (Delivery) 1. Sales with buyback agreements:
inventory should remain on the seller’s book and no revenue can be recognized.
2a. Sales with right of return exists: Revenue recognized if expecting insignificant amount of returns.
Income Measurement And Profit Analysis 9
Problems Associated with Revenue Recognized at Point of Sale (contd.)2b. Sales with right of return: When
expecting high sales returns, no revenue can be recognized unless the following six conditions are met.(i) Sales price is determined;(ii) Buyers have paid or have the
obligations to pay;
Income Measurement And Profit Analysis 10
Problems Associated with Revenue Recognized at Point of Sale (contd.)
2b. Sales with right of return (contd.)(iii) The buyers’ obligation would not be
changed due to theft of damage of the product after sales;
(iv)Sellers are not responsible for the performance of the product;
(v) Buyers and sellers are two separate economic entities;
(vi)The amount of returns can be estimated.
Income Measurement And Profit Analysis 11
Problems Associated with Revenue Recognized at Point of Sale (contd.)3. Trade loading: Manufacturers reduced
the price for wholesale at the fiscal year end to create instant sales. The wholesaler is loaded with more inventory than it can promptly resell.
Income Measurement And Profit Analysis 12
Revenue Recognition over Time (during the earnings process) and others 1. During the production process(i.e.,
long-term contract): accounting methods of revenue recognition are percentage-of completion method and completed-contract method.
2. At the completion of production (i.e., for agriculture products and precious metals).
Income Measurement And Profit Analysis 13
Revenue Recognition after Delivery
3. Installment Sales: revenue recognized after time of sale (delivery) as cash is collected.
4. Revenue recognition delayed until a future event occurred (i.e., real estate sale, sale of division). Accounting method: Deposit method.
Income Measurement And Profit Analysis 14
Conditions for Revenue to Be Recognized at Completion of Production
Market is reasonably assured; Costs of selling and distribution are
insignificant and can be estimated; Production, not sale, is considered to
be the most critical event in the earning process.
Income Measurement And Profit Analysis 15
Conditions for Revenue to Be Recognized at Completion of Production (contd.) Example: Revenue is recognized
when precious metals are mined or when agricultural crops are harvested because all conditions are met.
Income Measurement And Profit Analysis 16
Conditions for Recognizing Revenue during Production Buyers can be identified and price has
been agreed on;
Future costs can be estimated and significant portion of service has been performed;
The collectability of cash can be reasonable assured;
Income Measurement And Profit Analysis 17
Conditions for Recognizing Revenue during Production The contract specifies the rights about
goods or services to be performed and received by both parties;
Both parties are expected to fulfil their obligations (AICPA statement of position 81).
Income Measurement And Profit Analysis 18
If all conditions are met, the percentage-of-completion (P-O-C) method must be applied to recognize construction revenue prior to the completion date.
If conditions are not met, the completed-contract method will be applied to recognize revenue at or after the completion date.
Choice of P-O-C vs. C-C Method
Income Measurement And Profit Analysis 19
Example: For long-term construction contract, when all conditions are met, the P-O-C method is used to account for construction revenue and construction expenses.
Choice of P-O-C vs. C-C Method (contd.)
Income Measurement And Profit Analysis 20
Financial Reporting of Long-Term (Construction) Contract Percentage-of-completion method:
revenue is recognized according to the percentage of completion. The percentage of completion is computed based on costs.
Completed-contract method: postpone the revenue recognition until time of sale.
Income Measurement And Profit Analysis 21
Construction Estimated Estimated Cummulative Costs Costs to Total Percentage of
Year Incurred Complete Cost Completion (%)x1 $100 $400 $500 1 20% 4
x2 $186 $264 $550 2 52% 5
x3 $314 - $ 600 3 100% 6
Example A: (Long-Term Construction Contract)
1. 500=100+4002. 550=100+186+2643. 600=100+186+314
(actual)
4. 20% = 100/5005. 52% = (100 + 186)/5506. 100%=(100+186+314)/ 600
Contract Price = $700
Income Measurement And Profit Analysis 22
Example A (contd.)
Partial Cash Year Billings Collection x1 $ 80 $ 50 x2 350 330 x3 270 320Total $700 $700
Income Measurement And Profit Analysis 23
Cumulative Current Current GrossYear Revenue Revenue Expense7 Profit8
x1 $ 140 1 $ 140 4 100 $40x2 364 2 224 5 186 38x3 700 3 336 6 314 22
Total $700 $600 $100
Example A (contd.)
1. $140 = 700 x 20% (contract price x cumulative % of completion)
2. 364 = 700 x 52%3. 700 = 700 x 100%4. 140 = 140 - 0 (cumulative
revenue - previous years’ revenue)
5. 224 = 364 -1406. 336 = 700 - 140 - 2247. Current expense =
construction costs incurred
8. Net Income = current revenue - current expense
(P-O-C)
23
Income Measurement And Profit Analysis 24
Total % Cum.Estimated of Gross Gross
Year Profit Completion Profit Profitx1 $200 20% $40 $40x2 150 52% 78 38x3 100 100% 100 22
Example A (contd.) An alternative method to compute the gross
profit:
Income Measurement And Profit Analysis 25
Year x1 Year x2 Year x3a. To Record Actual
Cost:Construction in Progress A/P
100100
186186
314314
b. Partial Billings:A/R Progress Billings
8080
350350
270270
c. Cash CollectionCash A/R
5050
330330
320320
Example A - Journal Entries (P-O-C)
Note: Progress Billings = Billings on Construction
construction contract25
Income Measurement And Profit Analysis 26
Example A - Journal Entries (P-O-C) (contd.)
Note: Construction Expense = Cost of Construction Construction Revenue = Revenue from Long-Term Contracts
Year x1 Year x2 Year x3d. End of Period- Recognition
of annual income1. Construction Expense C-I-P
Construction Revenue2. Closing Entries: Construction Revenue
Construction ExpenseIncome Summary
10040
140
140100
40
18638
224
224186 38
31422
336
336314
22e. The end of Construction(Customer is fully Billed)Progress Billings
C-I-P
NoEntry
NoEntry 700
700
26
Income Measurement And Profit Analysis 27
B/S Year x3C.A.:CIP 700 P.B (700)
0
B/S Year x1Current Assets:CIP 140 Progress Billings (80)
60 Unbilled Revenue
Example AFinancial Statement Presentation (P-O-C)
B/S Year x2
Current Liability:P-B
430 C-I-P
(364)
66
Billing in excess of costs and recognized profit
Income Measurement And Profit Analysis 28
CIP100401863831422
Year x1($140)
Year x2($224)Year x3($336)
Financial Statement Presentation (P-O-C)(contd.)
Note: Balance of CIP = cumulative revenue
Progress Billings 80 -- 1998350 -- 1999270 -- 2000700 -- E.B.
Income Measurement And Profit Analysis 29
Financial Statement Presentation (P-O-C)(contd.)Income Statement Year x1 Year x2 Year x3Revenue from
Long-term contract 140 224336
Construction Expenses 100 186
314Gross Profit 40 38
22
Income Measurement And Profit Analysis 30
Financial Statement Presentation (P-O-C)(contd.) Year Balance Sheet(12/31) x1 x2 x3 Current Assets:
A/R 30 50 -- Inventories Construction in Progress 140 700 Less: Billings (80) (700)Costs and recognized profits in excess of billings 60 0
Current Liabilities:Billings 430 Construction in Progress (364)Billings in excess of costs and recognized profits 66
Income Measurement And Profit Analysis 31
Financial Statement Presentation (P-O-C)(contd.)Note1 Summary of significant accounting policyLong-Term Construction Contracts. The company recognized revenues and reports profits from long-term construction contracts under the percentage-of-completion method….
Income Measurement And Profit Analysis 32
Example A (contd.) - Completed-Contract Method
Gross Profit:X1 $0X2 $0X3 $100X3: Total Revenues - Total Expenses
= $ 700 - (100+186+314)= $ 700 - 600= 100
Income Measurement And Profit Analysis 33
Example A (contd.) - Journal Entries (Completed-Contract)
Year x1 Year x2 Year x3a. Recording Actual Cost:CIP A/P
100100
186186
314314
b. Partial Billings:A/R Progress Billings
8080
350350
270270
c. Cash CollectionCash A/R
5050
330330
320320
d. End of Period -Recognition of annualincome
NoEntry
NoEntry
NoEntry
Income Measurement And Profit Analysis 34
Journal Entries(Completed-Contract)(contd.)
Year x1 Year x2 Year x3e. The End of Construction(Recognize total expenseand total revenue)1. Construction Exp.
C-I-P Construction Revenue
No No 600100
7002. Construction Revenue Construction Expense Income Summary
No No700
600100
3. Progress Billings CIP
No No 700700
Income Measurement And Profit Analysis 35
Financial Statement Presentation (C-C Method)
Income Statement Year x1 Year x2 Year x3Revenue from
Long-term contract --- ---700
Construction Expenses --- ---
600 Gross Profit --- ---
100
Income Measurement And Profit Analysis 36
Financial Statement Presentation (C-C Method) (contd.)
Balance Sheet (12/31) Year x1 Year x2 Year x3Current Assets:
A/R 30 50 --- Inventories:Construction in Progress 100 700 Less: Billings (80)(700)
Contract Costs in Excess of Billings 20 0 Current Liabilities:
Billings 430 Construction in Progress (286)
Billing in Excess of Contract Costs 144
36
Income Measurement And Profit Analysis 37
EstimatedConstruction Costs to Estimated Cumulative
Costs Complete Total % of Year Incurred the Contract Cost Completionx1 $100 400 $500 20%x2 186 364 650 44%x3 314 - 600 100%
Example B
Contract Price $700
Income Measurement And Profit Analysis 38
Cummulative Current Current G.P. G.P.Year Revenue Revenue Expense (L) (L)x1 $140 $140 $100 40 0x2 308 168 186 -18 0x3 700 392 314 78 100
Total $700 $600 $100 $100
Example B (contd.)
P-O-C C-C
Income Measurement And Profit Analysis 39
Example B (contd.) An alternative method to compute the gross
profit:Total Cumm. Cumm.
Estimated % of Gross GrossYear G. Profit Completion Profit Profit
x1 $200 20% $40 $40x2 50 44% 22 (18)x3 100 100% 100 78
Income Measurement And Profit Analysis 40
Example B (contd.)
Other Information (Billing and cash collection):
Year Partial Billings Cash Collection
x1 $80 $50
x2 350 330
x3 270 320
Total $ 700 $ 700
Income Measurement And Profit Analysis 41
Year x1 Year x2 Year x3a. Recording Actual
Cost:C-I-P A/P
100100
186186
314314
b. Partial Billings:A/R Progress Billings
8080
350350
270270
c. Cash CollectionCash A/R
5050
330330
320320
Example B - Journal Entries (P-O-C)
Income Measurement And Profit Analysis 42
Example B - Journal Entries (P-O-C) (contd.)
Year x1 Year x2 Year x3 d. End of Period 1. Construction Expense C-I-P Construction Revenue C-I-P 2. Closing Entries: Construction Revenue I/S Construction Expense Income Summary
100 40 140
- 140 - 100 40
186 - 168 18 168 18 186
-
314 78 392
- 392 - 314 78
e. The end of Construction Progress Billings C-I-P
No
No
700 700
Income Measurement And Profit Analysis 43
Progress Billings 80 -- x1350 -- x2270 -- x3
Example B (contd.)
C-I-P100 18 4018631478700
Year x1x2x3
x2
Income Measurement And Profit Analysis 44
Example B (contd.) - Journal Entries (Completed-Contract)
Year x1 Year x2 Year x3a. Recording Actual Cost:CIP A/P
100100
186186
314314
b. Partial Billings:A/R Progress Billings
8080
350350
270270
c. Cash CollectionCash A/R
5050
330330
320320
d. End of Period No No No
Income Measurement And Profit Analysis 45
Journal Entries(Completed-Contract)(contd.)
Year x1 Year x2 Year x3e. The End of Construction(Recognize total expenseand total revenue)1. Construction Exp.
C-I-P Construction Revenue
No No 600100
7002. Construction Revenue Construction Expense Income Summary
No No700
600100
3. Progress Billings CIP
No No 700700
Income Measurement And Profit Analysis 46
(Long-Term Contract Example C with an Overall Loss)
* $715 > 700 (contract price) => a total estimated loss occurs and must be recognized immediately (source: ARB 45 and AICPA statement of position 81-1)
EstimatedConstruction Costs to Estimated Cumulative
Costs Complete Total % of Year Incurred the Contract Cost Completionx1 $100 400 $500 20%x2 186 429 715* 40%x3 429 - 715 100%
Contract Price $700
Income Measurement And Profit Analysis 47
Example C (contd.)
* $40 gross profit was recognized in year x1. This profit is not expected to be realized in the future. Thus, the $40 profit must be offset in year x2. In addition, the estimated total loss of $15 should also be recognized immediately in year x2. Therefore, a loss of $55 ($40+$15) should be recognized in year x2.
** Billings and cash collection data are the same as those of example A.
Cummulative Current Current G.P. G.P.Year Revenue Revenue Expense (L) (L)x1 $140 $140 $100 40 0x2 280 140 186 (55)* (15)x3 700 420 429 0 0
Total $700 $715 ($15) ($15)
P-O-C C-C
Income Measurement And Profit Analysis 48
Example C (contd.) An alternative method to compute the gross
profit:
Total Cumm. Cumm.Estimated % of Gross Gross
Year G. Profit Completion Profit Profitx1 $200 20% $40 $40x2 (15) 40% (15) (55)x3 (15) 100% (15) 0
Income Measurement And Profit Analysis 49
Example C (contd.) - Journal Entries (P-O-C)
Year x1 Year x2 Year x3a. CIP A/P
100100
186186
429429
b. A/R Progress Billings
8080
350350
270270
c. Cash A/R
5050
330330
320320
Income Measurement And Profit Analysis 50
Journal Entries(P-O-C) (contd.)
Year x1 Year x2 Year x3d. End of Period:1. Construction Expense
C-I-P Construction Revenue C-I-P
10040
140 -
195 -
14055*
420 -
420 -
2. Closing Entriese. The End of Construction: Progress Billings
C-I-P700
700
* C-I-P and provision for loss on contract are combined.
Income Measurement And Profit Analysis 51
CIP (Year x1)100 40140
Partial Billings (x1) 80
B/S (x1)Current Assets:CIP 140P-B (80)
60
Example C (contd.)Year x1:
Income Measurement And Profit Analysis 52
Year x2: (with a total estimated loss of $15) CIP (Year x2) 100 55 40 186 271
P-B (Year x2) 80
350 430
* The estimated overall loss must be reported separately on the B/S as a current lia. The overall loss needs to be taken out of the CIP account for reporting purposes.
Example C (contd.)
B/S (Year x2)Current Lia:P-B
430 CIP
(286)*Billings in excess of costs and recognized profit
144 Estimated liability from long-term contract
15
52
Income Measurement And Profit Analysis 53
Example C (contd.)
CIP (2000)100 55 40186429700
P-B (2000) 80350270700
Income Measurement And Profit Analysis 54
Example C (contd.) - Journal Entries (C-C)
Year x1 Year x2 Year x3a. CIP A/P
100100
186186
429429
b. A/R Progress Billings
8080
350350
270270
c. Cash A/R
5050
330330
320320
Income Measurement And Profit Analysis 55
Journal Entries(C-C) (contd.)
Year x1 Year x2 Year x3d. End of Period:Estimated Loss from Long- Term Contract
C-I-P15*
15*e. The End of Construction:Contract Expense Construction Revenue
700700
Progress Billings C-I-P 700
700
* To recognize the total estimated loss of ($15).
Income Measurement And Profit Analysis 56
EstimatedConstruction Costs Estimated Cummulative
Costs to Complete Total % ofYear Incurred the Contract Cost Completionx1 $100 $400 500 20%x2 186 429 715 * 40%x3 529 - 815 ** 100%
L-T Construction Contract with a Total Estimated LossExample D
* a total estimated loss of $15 incurred.** a total estimated loss of $115.
Contract Price = $700
Income Measurement And Profit Analysis 57
Cummulative Current Current G.P. G.P.Year Revenue Revenue Expense (L) (L)x1 $140 $140 $100 40 0x2 280 140 186 (55) (15)x3 700 420 529 (100) (100)
Total $700 $815 ($115) ($115)
Example D (contd.)
Billings and cash collection data are the same as those in example A.
P-O-C C-C
Income Measurement And Profit Analysis 58
EstimatedConstruction Costs Estimated Cummulative
Costs to Complete Total % ofYear Incurred the Contract Cost Completionx1 $100 $400 $500 20%x2 $186 $429 $715 * 40%x3 $329 - $615 100%
L-T Construction Contract with a Total Estimated Loss Example E
* a total estimated loss of $15 incurred.
Contract Price = $700
Income Measurement And Profit Analysis 59
Cummulative Current Current G.P. G.P.Year Revenue Revenue Expense (L) (L)x1 $140 $140 $100 40 0x2 280 140 186 (55) (15)x3 700 420 329 100* 100*
Total $700 $615 $85 $85
Example E (contd.)
* $15 total estimated loss was recognized in Year x2. The overall income of Year x3 is $ 85. In order to have an overall income of x3 equals to $ 85, we need to recognize $100 income in x3.
** Billings and cash collection data are the same as those of example A.
P-O-C C-C
59
Income Measurement And Profit Analysis 60
EstimatedConstruction Costs Estimated Cummulative
Costs to Complete Total % ofYear Incurred the Contract Cost Completionx1 $100 $700 800 * 13%x2 186 429 715 ** 40%x3 529 - 815 100%
L-T Construction Contract with a Total Estimated LossExample F
* an estimated loss of $100 incurred.** an estimated loss of $15 incurred.*** an loss of $115 incurred.
Contract Price = $700
Income Measurement And Profit Analysis 61
Cummulative Current Current G.P. G.P.Year Revenue Revenue Expense (L) (L)x1 $91 $91 $100 ($100) ($100)x2 280 189 186 85 85x3 700 420 529 (100) (100)
Total $700 $815 ($115) ($115)
Example F (contd.)
** Billings and cash collection data are the same as those of example A.
P-O-C C-C
Income Measurement And Profit Analysis 62
The Application of the P-O-C Method in the Service Industry
Many transactions in the service industry require the performance of several acts that extend over a period of time.
An accounting method called "proportional performance method” can be used to account for the revenues and expenses for these transactions.
Income Measurement And Profit Analysis 63
The Application of the P-O-C Method (contd.) Example:
With fixed number of acts:Additional acts are not fixed:Estimation of additional acts is required to
compute the proportion of revenue to be recognized (as in P-O-C method).
Note: If the service requires a final act, a completed performance method will be applied to account for revenues and expenses.
Income Measurement And Profit Analysis 64
The Application of the P-O-C Method (contd.)
Aging product: Wine, lumber, etc. No value increase can be recognized as
revenue, unlessa. a contract to age a specific product for a
specific customer has been signed; andb. no return of product even if the customer
is not satisfied with the product; andc. if future cost can be estimated.
Income Measurement And Profit Analysis 65
The Application of the P-O-C Method (contd.)
If all three conditions are met, the P-O-C method may (referred to as an accretion method) be applied to account for revenues and expenses prior to the completion of the production.
IFRS Insights
IFRS only allows the POC method. If future costs cannot be estimated, the
recognized cost will be set to equal the revenue (therefore, zero profit).
Similar to GAAP, IFRS also requires the recognition of the projected overall loss when loss is expected for the entire long-term construction contracts.
Income Measurement And Profit Analysis 66
Income Measurement And Profit Analysis 67
Revenue Recognition after Time of Sale (i.e., at time of cash collection)
Accounting Methods:
a. Installment Sales Method
b. Cost Recovery Method
Income Measurement And Profit Analysis 68
a. Installment Method1
Postpone the recognition of revenue (or profit) until the period of cash collection. This is not consistent with accrual accounting concept.1. Rarely used for financial reporting (except for special
cases)2 but commonly used for tax filing purposes.2. Special case: when receivables are collectible over
an extended period of time and no reasonable basis for estimating the degree of collectibility (i.e., B/D expense Estimation) --> Source: APB 10, para. 12, footnote 8.
Income Measurement And Profit Analysis 69
a. Installment Method (contd.) If uncollectible account is expected, bad
debt expense should be estimated and recognized rather than postponing the recognition of revenue until cash is collected.
Income Measurement And Profit Analysis 70
b. Cost Recovery Method1
Postpone the recognition of revenue until cost is recovered.
1. Not acceptable for tax filing purposes; rarely used for financially reporting except for special cases.
Income Measurement And Profit Analysis 71
Installment Sales Method
Example Assume the following information:
20x1 20x2Installment sales $1,200$2,000Cost of installment 900 1,700Gross profit $300 $300
Rate of gross profit on sales 25%15%
Cash receipts20x1 Sales $600$60020x2 Sales $500
Income Measurement And Profit Analysis 72
Installment Sales Method
Example (contd.) Note: the following entries are based on
the procedures which only defer the gross profit. This procedure has the same effect as deferring both sales revenue and cost of goods sold.
Income Measurement And Profit Analysis 73
Installment Sales Method
Example (contd.) 20x1 20x2 1. Installment A/R 1,2002,000
Installment Sales 1,2002,0002. Cash 6001,100
I A/R 600 1,1003. Cost of Install. Sales 9001,700
Inventory 900 1,7004. Installment Sales 1,2002,000
Cost of Install. Sales 900 1,700Deferred Gross Profit 300 300
(to close installment sales and cost of installment sales and to recognize entire profit as deferred profit)
Income Measurement And Profit Analysis 74
Installment Sales Method
Example (contd.) 20x1 20x2 5. Deferred Gross Profit 150a
225bRealized Gross Profit on Installment sales 150
225
a. 25% x $600 = $150.b. 25% x $600 + 15% x $500 = $225.
Income Measurement And Profit Analysis 75
Additional Problems of Installment Sales Accounting The following three problems are
related to accounting for installment sales:
1. Interest on installment contract;
2. Uncollectible accounts;
3. Defaults and repossessions.
Income Measurement And Profit Analysis 76
1. Interest on Installment Contract Using the installment sales made in 20x1
and assuming a 3% interest charge per quarter, the quarterly installment payment from customers should be:
? 3.7171 = $1,200 P4]3% present value of an annuity
? = $1,200 3.7171 = $322.83
Income Measurement And Profit Analysis 77
1. Interest on Installment Contract (contd.)
The following table summaries the interest earned, cash received, installment A/R, installment A/R balance and realized gross profit of each quarter:
Income Measurement And Profit Analysis 78
1. Interest on Installment Contract (contd.)
(1) (2) (3) (4) (5)Cash Interest Install. Bal. Of RealizedEarned A/R Install. Gross(Debit) (Credit) (Credit) A/R Profit5/1/x1 --- --- --- $1,200 ---Q3, x1 $322.83 $36 $286.83 $913.17 $71.70Q4, x1 322.83 27.40 295.43 617.74 73.86Q1, x2 322.83 18.53 304.30 313.44 76.08Q2, x2 322.83 9.40 313.43 0 78.36$300
(1) as computed on previous page.(2) 3% x previous balance in (4).(3) (1) - (2).
(4) previous balance of (4) - (3).
(5) 25% x (3).
Income Measurement And Profit Analysis 79
2. Uncollectible Accounts
If repossession cannot compensate for uncollectible balances, the potential loss should be charged against bad debt expense account as in the case of other credit sales.
Income Measurement And Profit Analysis 80
3. Defaults and Repossessions Assuming merchandize of $800 of
installment sales made in 20x2 was repossessed in 20x3. The fair value of the repossessed item is only $400. Therefore, a loss of $280 occurs.If a bad debt expense was charged in 20x2, the allowance for uncollectible account will be debited instead of the loss account.
Income Measurement And Profit Analysis 81
3. Defaults and Repossessions (contd.)
When repossession occurs in year 20x3, the following entry will be recorded:
Repossessed Merchandize 400Deferred Gross Profit 120Loss on Repossession 280
Installment A/R800
Income Measurement And Profit Analysis 82
Financial Statement Presentation of Installment Sales Transactions
A. Installment sales constitute an insignificant part of total sales.
B. Installment sales are a significant part of total sales.
Income Measurement And Profit Analysis 83
A. Installment Sales Constitute an Insignificant Part of Total Sales
In this case, the accountant only needs to include the realized gross profit of the installment sales in the income statement as a special item following the gross profit on other sales.
Income Measurement And Profit Analysis 84
Income StatementFor the Year Ended 12/31/x1
Sales $500,000 Cost of Goods Sold (270,000)Gross Profit on Sales $230,000 Gross Profit realized on
Installment Sales 150 Total Gross Profit on Sales $230,150
Income Measurement And Profit Analysis 85
B. Installment Sales Are a Significant Part of Total Sales
If installment sales are a significant part of total sales, the following presentation may be used:
Income Measurement And Profit Analysis 86
Income StatementFor the Year Ended 12/31/x2a
Install. Other Sales Sales Total
Sales 150,000200,000350,000Cost of goods sold (80,000)(150,000)(230,000)Gross profit 70,00050,000120,000Less deferred gross profit on install. sales of this year(50,000) (50,000)Realized gross profit on this year’s sales 20,00050,00070,000Add gross profit realized on prior years 15,000 15,000Gross profit real. this year 35,00050,00085,000
a. All amounts are assumed.
86
Income Measurement And Profit Analysis 87
Cost Recovery Method No gross profit is recognized until cash
collected exceeding the cost. Thus, all gross profit is deferred until cash collected exceeding the cost.
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Cost Recovery MethodExample Assuming in Jan. 20x1, Gateway Corp.
sells merchandize costing $10,000 to Mendy Corp. for $15,000 with payments receivable of $9,000, $3,000 and $3,000 in 20x1, 20x2, and 20x3, respectively. The following entries will be recorded following the cost recovery method:
Income Measurement And Profit Analysis 89
Cost Recovery MethodExample (contd.)20x1 A/R 15,000
Sales 15,000CGS 10,000Inventory 10,000Cash 9,000A/R 9,000Sales 15,000CGS 10,000Deferred Gross Profit5,000
Income Measurement And Profit Analysis 90
Cost Recovery MethodExample (contd.)(To close sales and CGS and to record deferred gross profit under the cost recovery method)20x2 Cash 3,000
A/R 3,000Deferred Gross Profit 2,000Gross Profit2,000
20x3 Cash 3,000A/R 3,000Deferred Gross Profit 3,000Gross Profit3,000
Income Measurement And Profit Analysis 91
Gift Card Sale Revenue Recognition
Revenue should be recognized when service is provided to the gift-card holder.
When to recognize the expired unused balance on the gift-card?
Income Measurement And Profit Analysis 92
States Do Not Require to Turn Over the Abandoned and Unclaimed Property For states recognize expiration date: Can recognize the revenue upon the expiration date.
For states do not recognize expiration date: In order to recognize the unused expired balance as revenue, the company needs to prove that the expired unused balance is unlikely to be redeemed after certain periods statistically.
Income Measurement And Profit Analysis 93
States Require to Turn Over the Abandoned and Unclaimed PropertyThe expired unused balance of gift-card may need to be remitted to the state after five- year period.
Income Measurement And Profit Analysis 94
Franchise SalesMany retail outlets (I.e., fast food, restaurants,etc.) are operated as franchises.
A franchise agreement: the franchisor (I.e., McDonald's Corporation) grants the franchisee (I.e., an individual) the right to sell the franchisor's product and use its name for a specific period of time.
The fees paid by the franchisee include: 1) the initial franchise fee and 2) continuing franchise fees.
Income Measurement And Profit Analysis 95
Franchise Sales (contd.)The initial franchise fee is to cover:
1)the right to use its name and sell its products;
2)assistance in finding a location and constructing the facilities,
3) training employees.The initial franchise fee is usually a fixed amount but payable in installments.
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Franchise Sales (contd.)The continuing franchise fees are paid for continuing rights and for advertising and promotion provided by the franchisor.
These fees can be a fixed monthly or annual amount or a % of the sales.
Income Measurement And Profit Analysis 97
Franchise Sales (contd.)Recognition of Franchise Fees:For the initial franchise fee: (based on SFAS 45) can only be recognized as revenue after substantial amount of the initial services (required by the franchise agreement) have been performed .
For the continuing franchise fees: these fees are recognized by the franchisor as revenue in the periods they are received.
Income Measurement And Profit Analysis 98
Franchise Sales –ExampleOn 3/31/x2, the Applebee Corporation entered into a franchise agreement with Mary Armstrong in exchange for an initial franchise fee of $100,000.
The initial services provided by Applebee include the selection of a location, construction of the building, training of employees and consulting services over several year.
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Franchise Sales –Example (Contd.)$30,000 is payable on 3/31/x2, with the remaining balance payable in annual installments over a 3-year periods with a 7% annual interest rate.
The franchisee will also pay continuing franchise fees of $2,000 per month for advertising and promotion provided by Applebee, beginning immediately after the franchise begins operations.
Mary Armstrong opens her Applebee Restaurant on 9/6/x2.
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Franchise Sales –Example (Contd.)Assume that the initial services to be performed by Applebee subsequent to the contract signing are substantial and the collectibility of the fee is reasonable certain the following entry is recorded: 3/31/x2:
Cash 30,000 Note Receivable 70,000
Unearned franchise fee revenue 100,000
to record franchise agreement and down payment
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Franchise Sales –Example (Contd.)Assume that substantial performance have occurred when the franchise began operation on 9/6/x2, the following entry would be recorded:
9/6/x2 Unearned franchise fee revenue 100,000 Franchise fee revenue 100,000 To recognize franchise fee revenue
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Franchise Sales –Example (Contd.) Note:If collectibility of the initial fee is uncertain and there is no basis for estimating the uncollectible amounts, the initial entry(on 3/31/02) should be:
Cash 30,000 Note Receivable 70,000
Deferred franchise fee revenue 100,000 The deferred franchise fee revenue is recognized as revenue using either the installment sales or cost recovery methods.
Income Measurement And Profit Analysis 103
Franchise Sales –Example (Contd.) Revenue Recognition for Continuing Franchise Fees:
Continuing franchise fee is recognized on a monthly basis as follows:
Cash 2,000 Service revenue 2,000
Multiple-Element Arrangements (ASC605-25-25-5) When one price is paid for multiple
elements (i.e., software, upgrade, maintenance, etc.), this transaction is referred to as a multiple-element arrangement.
These elements are considered separate deliverables (or separate units of accounting) if both of the following conditions are met:
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Multiple-Element Arrangements (contd.)1. the delivered item or items have value to
the customer on a standalone basis and2. If the arrangement includes a general right
of return relative to the delivered item, delivery or performance of the undelivered item or items is considered probable and substantially in the control of the vendor.
When both conditions are met, the elements are considered separate deliverables.
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Multiple-Element Arrangements (contd.) The consideration/fee of the arrangement will
be allocated to all deliverables/elements based on the relative fair value of these elements.
The revenue of each element will be recognized upon the completion of each element.
Fair value (ASU2009-13): Vendor’s sales price, or Third-party evidence of sales price, or Vendor’s estimates .
Income Measurement And Profit Analysis 106
Multiple-Element Arrangements (contd.) If the conditions are not met, the delivered
item(s) should be combined with other undelivered item(s) within the arrangement as one unit of accounting.
The revenue of the arrangement will be deferred until all elements are delivered.
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Income Measurement And Profit Analysis 108
Consignment A manufacturer or a wholesaler may transfer
goods to a dealer but the title of the goods remains with the manufacturer or the wholesaler.
Party Manufacturer DealerAccount Used Consignment-out Consignment-inPurpose ofaccount
To record thetransfer of thegoods (Debit) andtransportationcost (Debit)
To record any saleof consignmentgoods (Credit) andto record expensesoccurred for theconsignment(Debit)
Income Measurement And Profit Analysis 109
ConsignmentExample On 2/8/98, 300 units of goods were shipped to a
dealer on a consignment basis. The total cost of goods is $ 1,800 ($6 each). The transportation cost $150 was paid by the consignor on 2/8. The consignee spent $100 on advertisement on 2/9/98.
On 4/4, all the consignment units were sold for $10 each and the proceeds subtracted advertising expense ($100) and commission charge ($100), have been forwarded to the consignor on 4/20/98.
Income Measurement And Profit Analysis 110
ConsignmentExample (contd.) Consignor (manufacturer) Consignee (Dealer)
2/8 Consignmentout
Inventory1800
1800
No Entry
2/8 Consignmentout
Cash150
150
No Entry
2/9 No Entry 2/9 (Adv.)Consignment-In Cash
100100
2/9 No Entry 4/4 Sale of 300Units at $10
Cash Consignment- In
3000
3000110
Income Measurement And Profit Analysis 111
ConsignmentExample (contd.)
Consignor (manufacturer) Consignee (Dealer)4/20 receiving $2800 fromdealer (deduct $100commission and $100Advertisement)1. Cash 2800
Commission Exp. 100Adv. Exp. 100
Sales Rev. 30002. CGS 1950
Consignment-out 1950
*If consignment-out has adebit balance, it is a currentasset account to theconsignor.
4/20Consignment- In 2900 Cash 2800 Commission
Earned 100
* If the consignment-In hasa debit balance, it would bea current asset account forthe consignee. If theconsignment-In has a creditbalance, it would be acurrent liability account tothe consignee.
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