Chapter 18
Revenue Recognition
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1. Revenue Recognition Basic Concepts

Definition of revenue (SFAC 6)
◦ Inflows or other enhancements of assets or
settlement of liabilities during a period from delivering
or producing goods, rendering services, or other
activities that constitute the entity’s ongoing major or
central operations.

General recognition criteria (SFAC 5)
◦
◦
◦
◦
meets definition of an element
measurability
relevance
faithful representation
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1a. Revenue Recognition Basic Concepts

APB Statement 4
◦ Revenue is recognized when
 the earnings process is complete or virtually complete
 an exchange has taken place

Realization principle (SFAC 5)
◦ Revenue is recognized when
 the earnings process is judged to be complete or
virtually complete
 there is reasonable certainty as to the collectability of
the asset to be received
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1a. Revenue Recognition Basic Concepts

SEC SAB No. 101
◦ persuasive evidence of an arrangement exists
◦ delivery has occurred or services have been
rendered
◦ the seller’s price to the buyer is fixed or
determinable
◦ collectability is reasonably assured
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2. General Rule

Revenue is recognized at the point of sale
Activity
Revenue recognized when
Selling products
Point of sale (date of delivery;
when title passes)
Providing services
Services have been performed
and amounts are billable
Permitting others to use the
firm’s assets
As time passes
Disposing of assets
Date of sale
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3. Possible Points to Recognize Revenue


Most significant event
Recognition before point of sale
◦ prior to starting production
 customer advances
◦ during production
 long-term construction contracts
◦ at completion of production
 precious metals, ag products

Recognition at point of sale
◦ but if right of return exists or sale with buyback

Recognition after point of sale
◦ cash collection methods
 installment sales, cost recovery basis
◦ consignments
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4. Expense Recognition

Expense – expired economic benefits
Outflows or other using up of assets or incurrence of liabilities
during a period from delivering or producing goods, rendering
services, or other activities that constitute the entity’s ongoing
major or central operations. (SFAC 6)

Expenses to be recognized can be identified
by
◦ matching
◦ direct expensing (period costs)
◦ systematic allocation
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5. Revenue Frauds

Obvious accounting violations
◦ Fictitious sales or fake customers
◦ Premature recording of sales
◦ Inflated sales

Transactions lacking integrity
◦
◦
◦
◦

Roundtrip transactions
Channel stuffing and trade loading
Bill and hold transactions
Related party transactions
Contracts, agreements and side letters
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6. Long-term Construction Contracts

Percentage of completion method
◦ revenue recognized each period based on
progress of construction
◦ this method required if
 costs to complete and extent of progress toward
completion are reasonably dependable
 contract clearly specifies goods or services to be
provided & received by parties
 buyer is expected to satisfy its contractual obligations
 contractor is expected to perform its contractual
obligations
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6a. Long-term Construction Contracts

Methods to estimate percentage of
completion
◦ cost-to-cost method (input method)
 costs to date ÷ total estimated costs to complete
 most common method
◦
◦
◦
◦
machine hours or labor hours (input measure)
project milestones (output method)
units of production (output method)
engineer’s or architect’s estimates
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6b. Long-term Construction Contracts

Revenue and GP recognized per period
◦ percentage completed this period x total
revenue or GP
◦ new accounts
 construction in progress (inventory account)
 progress billings (contra acct to CIP)
◦ financial statement presentation
 net both accounts – could be debit or credit balance
◦ example
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7. Completed contract method


Revenues and gross profit recognized when
project finished
Entries
◦ same entries to record costs and billings
◦ do not recognize revenue and gross profit each
year


The two methods are not acceptable
alternatives
Example
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8. Right of Return

Only recognize revenue if all of following are met
(SFAS 48)
◦ sellers price is fixed
◦ buyer has paid or is obligated to pay
◦ buyer’s obligation would not be changed by the theft
or destruction of the product
◦ buyer has economic substance apart from that
provided by the seller
◦ seller doesn’t have future significant obligations
◦ amount of future returns can be reasonably estimated
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9. Cash Collection Methods
Emphasis placed on collection rather than
on sale
 APB 10

◦ generally states both methods are not
acceptable
◦ but in certain exceptional circumstances may
be used
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9a. Cash Collection Methods

Installment Sales Method
◦ Emphasis placed on collection rather than on
sale
 revenue recognized in periods of collection
 more important method for tax than fin acct
◦ Example
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9b. Cash Collection Methods

Cost recovery method
◦ No gross profit recognized until all costs have
been recovered
◦ After all costs recovered
 all additional cash received recorded as profit
◦ Example
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10. Multiple Deliverables


Revenue must be allocated to various
elements based on FMVs if they are
separable
Considered separable if
◦ items have value on a stand-alone basis
◦ there is a general right of return
◦ delivery is considered probable

Examples
◦ IT equipment and software
◦ franchises
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