CHAPTER 18
REVENUE RECOGNITION
Sommers – ACCT 3311
Guidelines for Revenue Recognition
What are the two general criteria that must be satisfied
before a company can recognize revenue?
The realization principle requires that two criteria be
satisfied before revenue can be recognized:
1. When it is realized or realizable – there is reasonable
certainty as to the collectibility of the asset to be
received (usually cash).
2. When it is earned– the earnings process is judged to be
complete or virtually complete.
Discussion Question
Q18-2 What is viewed as a major criticism of GAAP as
regards to revenue recognition?
Revenue Recognition Matters
• Revenue recognition is a top fraud risk and regardless of
the accounting rules followed (IFRS or U.S. GAAP), the
risk or errors and inaccuracies in revenue reporting is
significant.
• Restatements for improper revenue recognition are
relatively common and can lead to significant share price
adjustments.
Messing with Revenue
“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.”
A similar practice is referred to as channel stuffing. When
a software maker needed to make its financial results look
good, it offered deep discounts to its distributors to
overbuy, and then recorded revenue when the software left
the loading.
Rev Rec at Point of Sale (Delivery)
• Companies usually meet the two conditions for
recognizing revenue by the time they deliver products or
render services to customers.
• Implementation problems
– Sales with Discounts
– Sales When Right of Return
– Sales with Buybacks
– Bill and Hold Sales
– Principal-Agent Relationships
– Trade Loading and Channel Stuffing
– Multiple-Deliverable Arrangements
Multiple-Deliverable Arrangements
• MDAs provide multiple products or services to customers as
part of a single arrangement.
• The major accounting issues related to this type of
arrangement are how to allocate the revenue to the various
products and services and how to allocate the revenue to the
proper period.
• All units in a multiple-deliverable arrangement are considered
separate units of accounting, provided that:
– A delivered item has value to the customer on a
standalone basis; and
– The arrangement includes a general right of return relative
to the delivered item; and
– Delivery or performance of the undelivered item is
considered probable and substantially in the control of the
seller.
Overview of New Revenue Rec Standard
• In 2013, the FASB and IASB issued a converged
standard on revenue recognition entitled
Revenue from Contracts with Customers.
Overview of Revenue Recognition
• Revenue from Contracts with Customers, adopts an
asset-liability approach. Companies:
– Account for revenue based on the asset or liability
arising from contracts with customers.
– Are required to analyze contracts with customers
• Contracts indicate terms and measurement of
consideration.
• Without contracts, companies cannot know
whether promises will be met.
New Revenue Recognition Standard
• Key Concepts of Revenue Recognition
Performance Obligation is Satisfied
The Five-Step Process
Assume that Boeing Corporation signs a contract to sell airplanes to
Delta Air Lines for $100 million.
Step 1: Identify the
contract
with customers.
A contract is an agreement between two parties
that creates enforceable rights or obligations. In
this case, Boeing has signed a contract to deliver
airplanes to Delta.
Step 2: Identify the
separate performance
obligations in the
contract.
A Boeing has only one performance obligation—to
deliver airplanes to Delta. If Boeing also agreed to
maintain the planes, a separate performance
obligation is recorded for this promise.
The Five-Step Process
Step 3: Determine the
transaction
price.
Transaction price is the amount of consideration
that a company expects to receive from a
customer in exchange for transferring a good or
service. In this case, the transaction price is
straightforward—it is $100 million.
Step 4: Allocate the
transaction price to the
separate
performance
obligations.
In this case, Boeing has only one performance
obligation—to deliver airplanes to Delta.
The Five-Step Process
Step 5: Recognize
revenue when
each performance
obligation
is satisfied.
Boeing recognizes revenue of $100 million for the
sale of the airplanes to Delta when it satisfies its
performance obligation—the delivery of the
airplanes to Delta.
LO 2
Revenue Rec Articles – WSJ and CFO
• What is effective date?
• What should firms be aware of?
• What should investors be aware of?
Discussion Questions
Q18-14 What are the two basic methods of accounting for long-term
construction contracts? Indicate the circumstances that determine
when one or the other should be used.
Discussion Questions
Q18-14 What are the two basic methods of accounting for long-term
construction contracts? Indicate the circumstances that determine
when one or the other should be used.
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.
Percentage-of-Completion Method
Must use when estimates of progress toward completion,
revenues, and costs are reasonably dependable and all of the
following conditions exist:
1. 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.
2. Buyer can be expected to satisfy all obligations.
3. Contractor can be expected to perform under the contract.
Percentage-of-Completion Method
Formula for Total Revenue to Be Recognized to Date
Percentage-of-Completion Example
Assume Nortel Networks contracted to provide a customer with Internet infrastructure for
$2,000,000. The project began in 2011 and was completed in 2012. Data relating to the
contract are summarized below:
2011
2012
Costs incurred during the year
$ 300,000
$1,575,000
Estimated costs to complete as of 12/31
1,200,000
–0–
Billings during the year
380,000
1,620,000
Cash collections during the year
250,000
1,750,000
2011
Percentage-of-Completion Example Cont.
Assume Nortel Networks contracted to provide a customer with Internet infrastructure for
$2,000,000. The project began in 2011 and was completed in 2012. Data relating to the
contract are summarized below:
2011
2012
Costs incurred during the year
$ 300,000
$1,575,000
Estimated costs to complete as of 12/31
1,200,000
–0–
Billings during the year
380,000
1,620,000
Cash collections during the year
250,000
1,750,000
Gross profit recognition:
Balance Sheet:
Percentage-of-Completion Example Cont.
Assume Nortel Networks contracted to provide a customer with Internet infrastructure for
$2,000,000. The project began in 2011 and was completed in 2012. Data relating to the
contract are summarized below:
2011
2012
Costs incurred during the year
$ 300,000
$1,575,000
Estimated costs to complete as of 12/31
1,200,000
–0–
Billings during the year
380,000
1,620,000
Cash collections during the year
250,000
1,750,000
2012
Percentage-of-Completion Example Cont.
Assume Nortel Networks contracted to provide a customer with Internet infrastructure for
$2,000,000. The project began in 2011 and was completed in 2012. Data relating to the
contract are summarized below:
2011
2012
Costs incurred during the year
$ 300,000
$1,575,000
Estimated costs to complete as of 12/31
1,200,000
–0–
Billings during the year
380,000
1,620,000
Cash collections during the year
250,000
1,750,000
Gross profit recognition:
Balance Sheet:
Completed-Contract Method
Companies should use when one of the following conditions
applies when:
1. Company has primarily short-term contracts, or
2. Company cannot meet the conditions for using the
percentage-of-completion method, or
3. There are inherent hazards in the contract beyond the normal,
recurring business risks.
Completed Contract Example
Assume Nortel Networks contracted to provide a customer with Internet infrastructure for
$2,000,000. The project began in 2011 and was completed in 2012. Data relating to the
contract are summarized below:
2011
2012
Costs incurred during the year
$ 300,000
$1,575,000
Estimated costs to complete as of 12/31
1,200,000
–0–
Billings during the year
380,000
1,620,000
Cash collections during the year
250,000
1,750,000
2011
Completed Contract Example
Assume Nortel Networks contracted to provide a customer with Internet infrastructure for
$2,000,000. The project began in 2011 and was completed in 2012. Data relating to the
contract are summarized below:
2011
2012
Costs incurred during the year
$ 300,000
$1,575,000
Estimated costs to complete as of 12/31
1,200,000
–0–
Billings during the year
380,000
1,620,000
Cash collections during the year
250,000
1,750,000
Gross profit recognition:
Balance sheet:
Completed Contract Example
Assume Nortel Networks contracted to provide a customer with Internet infrastructure for
$2,000,000. The project began in 2011 and was completed in 2012. Data relating to the
contract are summarized below:
2011
2012
Costs incurred during the year
$ 300,000
$1,575,000
Estimated costs to complete as of 12/31
1,200,000
–0–
Billings during the year
380,000
1,620,000
Cash collections during the year
250,000
1,750,000
2012
Completed Contract Example
Assume Nortel Networks contracted to provide a customer with Internet infrastructure for
$2,000,000. The project began in 2011 and was completed in 2012. Data relating to the
contract are summarized below:
2011
2012
Costs incurred during the year
$ 300,000
$1,575,000
Estimated costs to complete as of 12/31
1,200,000
–0–
Billings during the year
380,000
1,620,000
Cash collections during the year
250,000
1,750,000
Gross profit recognition:
Balance Sheet:
Long-Term Contract Losses

Loss in the Current Period on a Profitable Contract
►
Percentage-of-completion method only, the estimated cost
increase requires a current-period adjustment of gross profit
recognized in prior periods.

Loss on an Unprofitable Contract
►
Under both percentage-of-completion and completedcontract methods, the company must recognize in the
current period the entire expected contract loss.