Intructor manual intermediate accounting 15th kiesoch18

Describe accounting issues for revenue recognition at point of sale.. Describe accounting issues for revenue recognition at point of sale.. The coverage of product sales transactions is

CHAPTER 18 Revenue Recognition

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

Brief

Concepts for Analysis

1 Revenue recognition

principle.

1, 2, 3, 4, 29

* 8 Special installment sales

issues: interest; uncollectible

ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)

Learning Objectives

Brief

1 Describe and apply the revenue recognition

principle.

6, 7, 8, 9

2 Describe accounting issues for revenue

recognition at point of sale.

1, 2, 3, 4, 5, 6 1, 2, 3, 4, 5, 6,

7, 8, 9, 10, 11

1

3 Apply the percentage-of-completion

method for long-term contracts.

7, 8 12, 13, 14,

15, 16, 17

1, 2, 3, 4, 5,

6, 7, 16, 17

4 Apply the completed-contract method

for long-term contracts.

ASSIGNMENT CHARACTERISTICS TABLE

Level of Difficulty

Time (minutes)

E18-1 Revenue recognition-point of sale Simple 5–10

E18-2 Revenue recognition-point of sale Simple 5–10

E18-3 Revenue recognition-point of sale Simple 5–10

E18-4 Revenue recognition-point of sale Simple 10–15

E18-6 Revenue recognition on book sales with high returns Moderate 15–20

E18-7 Sales recorded both gross and net Simple 15–20

E18-8 Revenue recognition on marina sales with discounts Moderate 10–15

E18-9 Consignment computations Simple 15–20

E18-10 Multiple-deliverable agreement Simple 10–15

E18-11 Multiple-deliverable agreement Simple 5–10

E18-12 Recognition of profit on long-term contracts Moderate 20–25

E18-13 Analysis of percentage-of-completion financial statements Moderate 10–15

E18-14 Gross profit on uncompleted contract Simple 10–12

E18-15 Recognition of profit, percentage-of-completion Moderate 25–30

E18-16 Recognition of revenue on long-term contract and entries Moderate 15–20

E18-17 Recognition of profit and balance sheet amounts for long-term

contracts.

Simple 15–25 E18-18 Long-term contract reporting Simple 15–25

E18-19 Installment-sales method calculations, entries Simple 15–20

E18-20 Analysis of installment-sales accounts Moderate 15–20

E18-21 Gross profit calculations and repossessed merchandise Moderate 15–20

E18-22 Interest revenue from installment sale Simple 10–15

E18-23 Installment-sales method and cost-recovery method Simple 10–15

E18-24 Installment-sales method and cost-recovery method Simple 15–20

* E18-25 Installment-sales—default and repossession Simple 10–15

* E18-26 Installment-sales—default and repossession Simple 15–20

*E18-27 Franchise entries Simple 14–18

*E18-28 Franchise fee, initial down payment Simple 12–16

P18-1 Comprehensive three-part revenue recognition Moderate 30–45

P18-2 Recognition of profit on long-term contract Simple 20–25

P18-3 Recognition of profit and entries on long-term contract Moderate 25–35

P18-4 Recognition of profit and balance sheet presentation,

percentage-of-completion.

Moderate 20–30

P18-5 Completed contract and percentage-of-completion

with interim loss.

Moderate 25–30 P18-6 Long-term contract with interim loss Moderate 20–25

P18-7 Long-term contract with an overall loss Moderate 20–25

P18-8 Installment-sales computations and entries Moderate 25–30

P18-9 Installment-sales income statements Moderate 30–35

ASSIGNMENT CHARACTERISTICS TABLE (Continued)

Level of Difficulty

Time (minutes)

P18-10 Installment-sales computations and entries Complex 30–40

P18-11 Installment-sales entries Simple 20–25

P18-12 Installment-sales computations and entries—periodic

inventory.

Complex 40–50 P18-13 Installment repossession entries Moderate 20–25

P18-14 Installment-sales computations and schedules Complex 50–60

P18-15 Completed-contract method Moderate 20–30

P18-16 Revenue recognition methods—comparison Complex 40–50

P18-17 Comprehensive problem—long-term contracts Complex 50–60

CA18-1 Revenue recognition—alternative methods Moderate 20–30

CA18-2 Recognition of revenue—theory Moderate 35–45

CA18-3 Recognition of revenue—theory Moderate 25–30

CA18-4 Recognition of revenue—bonus dollars Moderate 30–35

CA18-5 Recognition of revenue from subscriptions Complex 35–45

CA18-6 Long-term contract—percentage-of-completion Moderate 20–25

CA18-7 Revenue recognition—membership fees Moderate 30–40

CA18-8 Franchise revenue Moderate 25–30

LEARNING OBJECTIVES

1 Describe and apply the revenue recognition principle

2 Describe accounting issues for revenue recognition at point of sale

3 Apply the percentage-of-completion method for long-term contracts

4 Apply the completed-contract method for long-term contracts

5 Identify the proper accounting for losses on long-term contracts

6 Describe the installment-sales method of accounting

7 Explain the cost-recovery method of accounting

*8 Explain revenue recognition for franchises and consignment sales

*9 Compare the accounting procedures related to revenue recognition under GAAP andIFRS

*This material is covered in an Appendix to the Chapter

CHAPTER REVIEW

1 One of the most difficult issues facing accountants concerns the recognition of revenue by

a business organization Although general rules and guidelines exist, the significantvariety of marketing methods for products and services make it difficult to apply the rulesconsistently in all situations Chapter 18 is devoted to a discussion and illustration ofrevenue transactions that result from the sale of products and the rendering of services.Throughout the discussion, attention is focused on the theory behind the accountingmethods used to recognize revenue Revenue transactions that result from leasing andthe sale of productive assets other than inventory are discussed in other sections of thetext

Revenue Recognition

2 (L.O 1) The   revenue recognition principle provides that revenue is recognized when (1) it is realized or realizable, and (2) it is earned Revenues are realized when goods and services are exchanged for cash or claims to cash (receivables) Revenues are realizable

when assets received in exchange are readily convertible to known amounts of cash or

claims to cash Revenues are earned when the entity has substantially accomplished

what it must do to be entitled to the benefits represented by the revenues, that is, whenthe earnings process is complete or virtually complete

3 The conceptual nature of revenue, as well as the basis of accounting for revenuetransactions are described in the following four statements

a Companies recognize revenue from selling products at the date of sale This date is usually interpreted to mean the date of delivery to customers

b Companies recognize revenue from services provided when services have been performed and are billable

c Companies recognize revenue from permitting others to use enterprise assets, such

as interest, rent, and royalties, as time passes or as the assets are used

d Companies recognize revenue from disposing of assets other than products

at the date of sale

4 The discussion of sales transactions in the chapter is primarily focused on product sales transactions The coverage of product sales transactions is further divided into the following

topics: (a) revenue recognition at point of sale (delivery), (b) revenue recognition beforedelivery, (c) revenue recognition after delivery, and (d) revenue recognition for franchises

(covered in Appendix 18-A)

Point of Sale

5 (L.O 2) Sales transactions result in the exchange of products or services of an enterprise 

for other valuable assets, normally cash or a promise of cash in the future Although mostsales transactions are fundamentally similar, differences in the method or terms of sale

lead to real differences in the transactions themselves, and thus to differences in theappropriate accounting for them.

6 According to the FASB, revenue is recognized when the product is delivered or the service

is rendered This time of recognition is normally at the time of sale when the product orservice is delivered to the customer Some problems in implementing these basic principlesarise when (a) sales have buyback agreements, (b) the right of return exists, and (c) tradeloading or channel stuffing is present

Sales with Discounts

7 Trade and volume discounts reduce consideration received and reduce revenue earned.Prompt payment discounts (cash discounts) reduce revenues, if material

8 When a sales transaction involves a financing arrangement, the fair value is determinedeither by measuring the consideration received or by discounting the payment using animputed interest rate

Sales with Right of Return

9 The FASB concluded that if a company sells its product but gives the buyer the right toreturn it, the company should recognize revenue from the sales transactions at the time of

sale only if all of the following six conditions are met:

a The seller’s price to the buyer is substantially fixed or determinable at the date of sale

b The buyer has paid the seller, or the buyer is obligated to pay and the obligation is notcontingent on resale of the product

c The buyer’s obligation to the seller would not be changed in the event of theft orphysical destruction or damage of the product

d The buyer acquiring the product for resale has economic substance apart from thatprovided by the seller

e The seller does not have significant future performance obligations to directly bringabout resale of the product by the buyer

f The seller can reasonably estimate the amount of future returns

Sales with Buyback

10 If a company sells a product in one period and agrees to buy it back in the next period, asales has not occurred because the seller has not satisfied its performance obligation

Bill and Hold Sales

11 Bill and hold sales result when the buyer is not yet ready to take delivery but does taketitle and accept billing The most appropriate approach for bill and hold sales is to deferrevenue recognition until the goods are delivered because the risks and rewards ofownership usually do not transfer until that point

Principal-Agent Relationships

12 In a principal-agent relationship, amounts collected on behalf of the principal are notrevenue of the agent Instead, revenue for the agent is the amount of the commission itreceives (usually a percentage of the total revenue)

13 In a consignment sales arrangement, merchandise is shipped by the consignor to the consignee, who acts as an agent for the consignor in selling the merchandise The mer- chandise shipped to the consignee remains the property of the consignor until a sale is

made When a sale is made, the consignee remits the proceeds, less any related expensesplus a sales commission, to the consignor When the consignor receives word that a salehas been made, revenue is recognized and inventory is appropriately reduced

Trade Loading and Channel Stuffing

14 Even when revenues are recorded at date of delivery, with neither buyback or returnprovisions, some companies are recognizing revenues and earnings prematurely This

occurs in situations where trade loading or channel stuffing are present Trade loading

is an attempt to show sales, profits, and market share that an entity does not have byinducing wholesale customers to buy more product then they can promptly sell Channelstuffing is a similar tactic found mostly in the computer software industry In channelstuffing, the software maker offers deep discounts to its distributors to overbuy andrecords revenue when the software leaves its loading dock When this process takesplace, the distributors’ inventories become bloated and the marketing channel getsstuffed, but the software maker’s current-period financial statements are improved

Multiple-Deliverable Arrangements

15 Multiple-deliverable arrangements (MDAs) provide multiple products or services tocustomers as part of a single arrangement The amount paid for the arrangement isallocate among the separate units based on relative fair value

Long-term Contracts

16 (L.O 3) In most circumstances, revenue is recognized at the point of sale because most

of the uncertainties related to the earnings process are removed and the exchange price isknown One of the exceptions to the general rule of recognition at point of sale is caused

by long-term construction-type projects The accounting measurements associated withlong-term construction projects are difficult because events and amounts must beestimated for a period of years Two basic methods of accounting for long-term construction

contracts are recognized by the accounting profession They are: (a) the percentage-of completion method, and (b) the completed-contract method.

17 The percentage-of-completion method is used when estimates of progress towardcompletion, revenues, and costs are reasonably dependable and all the followingconditions exist:

a The contract clearly specifies the enforceable rights regarding goods or services to beprovided and received by the parties, the consideration to be exchanged, and themanner and terms of settlement

b The buyer can be expected to satisfy all obligations under the contract.

c The contractor can be expected to perform contractual obligations

The completed-contract method should be used only when (a) an entity has primarilyshort-term contracts, or (b) the conditions for using the percentage-of-completion methodcannot be met, or (c) there are inherent hazards in the contract beyond normal, recurringbusiness risks

Percentage-of-Completion Method

18 Under the percentage-of-completion method, revenue on long-term construction contracts

is recognized as construction progresses Costs pertaining to the contract along with

gross profit earned to date are accumulated in a Construction in Process account The

amount of revenue recognized in each accounting period is based on a percentage of thetotal revenue to be recognized on the contract The most popular method of estimating

the amount of revenue to recognize is based on the costs incurred on the contract to date divided by the most recent estimated total costs (cost-to-cost basis)

a The journal entry to recognize revenue under the percentage-of-completion method is

as follows:

Dr Construction in Process

Dr Construction Expenses

Cr Revenue from Long-Term Contracts

b In any subsequent year, total revenue to be recognized is estimated based on thecurrent cost-to-cost basis, and any revenue recognized in prior years is subtracted,resulting in incremental revenue being recognized each year

c The Billings on Construction in Process account is subtracted from the Construction inProcess accounts; if the amount is a debit, it is reported as a current asset; if theamount is a credit, it is reported as a current liability

Completed-Contract Method

19 (L.O 4) Under the completed-contract method, revenue and gross profit are recognized 

when the contract is completed The principal advantage of the completed-contractmethod is that reported revenue is based on final results rather than on estimates ofunperformed work Its major disadvantage is the distortion of earnings that may occur.The accounting entries made under the completed-contract method are the same as thosemade under the percentage-of-completion method, with the notable exception of periodicincome recognition

Contract Losses

20 (L.O 5) Two types of losses can occur on long-term contracts. 

a A loss in the current period on a profitable contract occurs when estimated total

contract costs increase significantly, but the company still expects a profit on theoverall contract This is treated as a change in estimate and recognized only under thepercentage-of-completion method

b An overall loss on an unprofitable contract occurs when a loss will result on the

entire contract In these circumstances, a loss is recognized under both thepercentage-of-completion and completed-contract methods

Disclosures for Long-term Contracts

21 In addition to normal financial statement disclosures, construction contractors should disclose(a) the method of recognizing revenue, (b) the basis used to classify assets and liabilities

as current, (c) the basis for recording inventory, (d) the effects of any revisions ofestimates, (e) the amount of backlog on incomplete contracts, and (f) the details aboutreceivables

Revenue Recognized During Production

22 In certain cases, companies recognize revenue at the completion of production even

though no sale has been made Examples of such situations involve precious metals oragricultural products with assured prices

Installment Method

23 (L.O 6) In some cases revenue is recognized after delivery of the product to the buyer. 

This is due to the fact that, in certain sales situations, the collection of the sales price isnot reasonably assured and revenue recognition is deferred The methods generally used

to account for the deferral of revenue recognition until cash is received are (a) the installment method, and (b) the cost recovery method.

24 Use of the installment method is justified in situations where receivables are collectible

over an extended period of time and there is no reasonable basis for estimating thedegree of collectibility The method is used extensively in tax accounting

25 The term installment sale describes any type of sale for which payment is required in

periodic installments over an extended period of time The installment method placesemphasis on collection, as installment sales lead to income realization in the period ofcollection rather than the period of sale This does not mean that revenue is consideredunrealized until the entire sale price has been collected, but rather that income realization

is proportionate to collection

26 Under the installment sales method of accounting, gross profit (sales less cost of goodssold) on installment sales is deferred to those periods in which cash is collected

Operating expenses, such as selling and administrative expenses, are treated as expenses

in the period incurred For installment sales in any one year, the following proceduresapply under the installment sales method:

a During the year, record both sales and cost of sales using separate installment salesaccounts and compute the rate of gross profit on installment sales transactions

b At the end of the year, apply the rate of gross profit to the cash collections of thecurrent year’s installment sales to arrive at the realized gross profit

c The unrealized gross profit should be deferred to future years Deferred gross profit isgenerally treated as unearned revenue and classified as a current liability

d In any year in which collections from prior years’ installment sales are received, thegross profit rate of each year’s sales must be applied against cash collections ofaccounts receivable resulting from that year’s sales to arrive at the realized grossprofit

27 If installment sales transactions represent a significant part of total sales, full disclosure ofinstallment sales, the cost of installment sales, and any expenses allocable to installmentsales is desirable

28 To illustrate the installment sales method of accounting, assume the following facts:

To record 2015 installment sales

Installment Accounts Receivable, 2015 248,000Installment Sales 248,000

To record cash collected on installment receivables

Cash 219,000Installment Accounts Receivables, 2014 96,000Installment Accounts Receivables, 2015 123,000

To record 2015 cost of goods sold on installment

Cost of Installment Sales 176,080Inventory (or Purchases) 176,080

To close installment sales and cost of installment sales

Installment Sales 248,000Cost of Installment Sales 176,080Deferred Gross Profit, 2015 71,920

To record realized gross profit

Deferred Gross Profit, 2014 25,920 (a)Deferred Gross Profit, 2015 35,670 (b)Realized Gross Profit 61,590

Defaults and Repossessions

30 The accounting for repossessions recognizes that the related installment receivable

account is not collectible and that it should be written off The applicable deferred grossprofit must be removed from the ledger

31 Repossessed merchandise should be recorded in the Repossessed Merchandise Inventory account The item repossessed should be recorded at its fair value The objective should

be to put any asset acquired on the books at its fair value or, when fair value is notascertainable, at the best possible approximation of fair value

Cost Recovery Method

32 (L.O 7) Under the   cost recovery method, no profit is recognized until cash payments by

the buyer exceed the seller’s cost of the merchandise sold After all the costs have beenrecovered, any additional cash collections are included in income A seller uses the costrecovery method to account for sales in which “there is no reasonable basis for estimating

collectibility.” The cost recovery method is required where a high degree of uncertainty

exists related to the collection of receivables The cost recovery method is moreappropriate than the installment method when there is a greater degree of uncertainty

Deposit Method

33 Under the cost recovery method, no profit is recognized until cash payments are

received In some cases, a company receives cash from the buyer before it transfers thegoods or property In such cases, the seller has not performed under the contract and has

no claim against the purchaser There is not sufficient transfer of the risks and rewards ofownership for a sale to be recorded

Franchises