Intermediate accounting 17e stice skousen cengage chapter 08

Receipt of $1,000 cash as initial sign-up fee: Unearned Initial Sign-Up Fees 1,000 Receipt of first monthly payment of $50: Monthly Service Revenue 50 Partial recognition of the initial

Revenue Recognition

Recognition refers to the time

when transactions are recorded on the books The FASB’s two criteria

for recognizing revenues and gains

substantial completion of the activities involved in the

earnings process.

Revenue Recognition

Revenue Recognition

• Revenue is not recognized prior to the point of

sale because either:

• A valid promise of payment has not been

received from the customer, or

• The company has not provided the product or service

• Exceptions to these rules:

• The customer provides a valid promise of

payment

• Conditions exist that contractually guarantee the sale

AICPA Statement of Position 97-2 gives

companies more guidance through a

checklist of four factors that amplify the

two criteria:

a Persuasive evidence of an arrangement

exists.

b Delivery has occurred.

c The vendor’s fee is fixed or

determinable.

d Collectibility is probable.

Revenue Recognition

Deposit Received from Customers 100

Receipt of final $1,400 cash payment and delivery of goods to customer:

Seller Company receives $1,000

cash from a customer as the initial

sign-up fee for a service In addition

to the sign-up fee, the customer is

required to pay $50 per month for

100 months, which is the economic life of this service agreement.

Appropriate Accounting for a Service Provided Over an Extended Period

Receipt of $1,000 cash as initial sign-up

fee:

Unearned Initial Sign-Up Fees 1,000

Receipt of first monthly payment of $50:

Monthly Service Revenue 50

Partial recognition of the initial signup

fee as revenue ($1,000/100 months):

Unearned Initial Sign-Up Fees 10

Initial Sign-Up Fee Revenue 10

Appropriate Accounting for a Service Provided Over an Extended Period

accounting if that delivered

element has standalone value

and if the fair value of any

undelivered element can be

objectively and reliably

determined.

Appropriate Accounting for a

Refundable Membership

Seller Company receives $1,200 cash

from each customer as a fully refundable, one-year membership fee It is estimated that the cost to Seller Company to provide the membership service to each customer will be $360 for one year Seller Company can reliably estimate that 40% of the

customers will request refunds during the year Assume all refunds occur at the end

of the year There were 1,000 customers.

Appropriate Accounting for a

Refundable Membership

On January 1, Owner Company signed

a 1-year rental for a total of

$120,000, with monthly payments of

$10,000 due at the end of each

month In addition, the renter must

pay contingent rent of 10% of all

annual sales in excess of $3,000,000 The contingent payment is paid in

one payment on December 31.

Appropriate Accounting for a

Contingent Rental

On January 31, sales for the renter

had reached $700,000 On July 31,

the renter had reached a sales level

of $3,150,000 On December 31, the renter had reached a sales level of

Appropriate Accounting for a

Contingent Rental

Asset-and-Liability Approach to Revenue Recognition Example

Wilks Company sells a plasma TV screen and

2-year warranty to a customer for a joint price of

$2,000 All cash is collected upfront Other

relevant data:

• Cost of plasma TV screen, $1,500

• Sales price of TV if sold separately, $1,785

• Sales price of 2-year warranty if sold separately,

$315

• Amount payable to a TV wholesaler to accept

responsibility to provide TV, $1,650

• Amount payable to service company to accept

responsibility of providing warranty, $240

(continues)

Journal entries on delivery of TV:

Contract Liability—TV Screen 1,700

The fair values of the performance

obligation liabilities create a

contract signing Recall that a TV

wholesaler would charge $1,650

for accepting the responsibility of

providing the plasma TV to the

customer Likewise, a service

company would charge $240 for

providing the two years of

Measurement Model

The entry to record the cash asset

and the two performance

obligations created at the contract

Revenue Recognition Prior to Providing Goods or Services

• Completed-contract method recognizes all

income when project is completed.

• Percentage-of-completion method recognizes revenue throughout the term of the contract.

• Proportional performance method reflects

revenue earned on service contracts under

which many acts of service are to be performed before the contract is complete.

• progress toward completion

2 Contract clearly specifies:

• enforceable rights of the parties

• consideration to be exchanged

• manner and terms of settlement

3 The buyer can be expected to satisfy

obligations under the contract.

4 Contractor can be expected to perform the

contractual obligation.

Percentage-of-Completion

Method Requirements

Percentage-of-Completion

Input Measures

• Cost-to-cost method is perhaps the most

popular of the input measures The degree of

completion is determined by comparing costs

already incurred with the most recent estimates

of total expected costs to complete the project.

• Engineers are often called in to help provide

estimates.

In January 2010, Strong Construction Company was awarded a contract

with a total price of $3,000,000

Strong expects to earn $400,000

profit on the contract The

construction was completed over a year period The table shown next

3-provides the actual cost that Strong experienced and the completion rate.

Measuring the Percentage of Completion

Measuring the Percentage of Completion

Completed-Contract Method

Construction in Progress 1,040,000

Materials, Cash, etc 1,040,000

To record costs incurred.

Construction in Progress 910,000

Materials, Cash, etc 910,000

To record costs incurred.

Construction in Progress 650,000

Materials, Cash, etc 650,000

To record costs incurred.

Percentage-of-Completion

Method

• The entries we recorded using the

completed-contract method are also

the same entries that would be used for the percentage-of-completion method

• The completed-contract method is

“wrapped up” using the entries shown

in Slides 30 and 31 The

percentage-of-completion method requires the entries presented in Slides 32 to 34.

Under the completed-contract method, the following entries would be made to recognize revenue and costs and to

close out the inventory and billing

Completed-Contract Method

2012

Under the completed-contract method, the following entries would be made to recognize revenue and costs and to

close out the inventory and billing

Under the percentage-of-completion

method, the following additional entries would be made to recognize revenue.

($3,000,000 × 0.75) − $1,200,000

Percentage-of-Completion

(continues)

Cost of Long-Term Construction

Contracts 650,000

Construction in Progress 100,000

Revenue from Long-Term

Construction Contracts 750,000

2012

$3,000,000 − $1,200,000 − $1,500,000

Percentage-of-Completion

Revision of Estimate

Instead of the previous illustration,

assume that at the end of 2011, it was estimated that the remaining cost to

complete construction was $720,000

rather than $650,000 This would

increase the total estimated cost to

$2,670,000, reduce the expected profit

to $330,000, and change the

percentage of completion for 2011.

(continues)

Revision of Estimate

• The entries for 2010 would be the same as those

shown in the previous example.

Cost of Long-Term Construction

Construction in Progress 80,000

Revenue from Long-Term

Construction Contracts 990,000

Cost of Long-Term Construction

Assume the same facts for Strong

Construction Company, except the

estimated cost to complete the

contract at the end of 2011 was

$1,300,000 Because $1,950,000 of costs had already been incurred, the total estimated cost would be

$3,250,000.

Reporting Anticipated

Contract Losses

(continues)

Reporting Anticipated

Contract Losses

Anticipated Contract Loss: Percentage-of-Completion

(continues)

Anticipated Contract Loss: Percentage-of-Completion

The entry to record the revenue, costs, and adjustments to Construction in Process for the loss in 2011 would be as follows:

Cost of Long-Term Construction

Contracts 1,010,000

Revenue from Long-Term

Construction Contracts 600,000Construction in Process 410,000

Anticipated Contract Loss: Percentage-of-Completion

Proportional Revenue

Recognition

1 Initial direct costs related to obtaining and

performing initial services on the contract

Most service contracts involve three

different types of costs:

the various service acts

3 Indirect costs related to maintaining

the organization to service the contract

A correspondence school enters into 100 contracts with students for an extended writing course The fee for each contract

is $500, payable in advance The initial

direct costs related to the contracts total

$5,000 Actual direct costs for lessons for the first period are $12,000 The sales

value of the lessons completed is

$24,000 (if sold separately, $60,000).

Accounting for Long-Term

Service Contracts

(continues)

Receipt of fees:

Deferred Course Revenue 50,000

Direct costs for lessons actually

completed:Contract Costs 12,000

Cash Expense accountExpense account 12,000

Deferred Initial Costs 5,000

Recognize course revenue:

Deferred Course Revenue 20,000

Recognized Course Revenue 20,000

Recognize contract costs from initial direct costs:

Revenue Recognition After

Delivery of Goods

Installment Sales Method

• Under the installment sales method ,

profit is recognized as cash is collected rather than at the time of sale.

• It is used most commonly in cases of

real estate sales where contracts may

involve little or no down payment,

payments are spread over 10 to 40

years, and a high probability of default

in the early years exists.

Installment Sales Method

Riding Corporation sells merchandise on the

installment basis, and the uncertainties of

cash collection make the use of the

installment method necessary The following

data relate to three years of operations.

Installment Sales 150,000

Cost of Installment Sales 100,000Deferred Gross Profit—2010 50,000

Deferred Gross Profit—2010 10,000

Realized Gross Profit on

2011—During the Year

Installment Sales Method

(continues)

Installment Sales 200,000

Cost of Installment Sales 140,000Deferred Gross Profit—2011 60,000

Realized Gross Profit on

2012—During the Year

Installment Sales Method

(continues)

Installment Sales 300,000

Cost of Installment Sales 204,000Deferred Gross Profit—2012 96,000

Realized Gross Profit on

Cost Recovery Method

If the probability of recovering

product or service costs is

method of accounting can be

used

All entries are the same except do not record

gross profit until all costs are recovered.

Deferred Gross Profit—2010 5,000

Realized Gross Profit on

Because the cash collected in 2011 for 2011 sales is less than the cost of inventory sold, no gross profit

would be recognized in 2011 on 2011 sales.

Realized Gross Profit on

2012

Cost Recovery Method