Intermediate
Financial Accounting I
Revenue Recognition
Objectives of the Chapter
1. 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
2
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
3
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
4
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
5
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 longdistance phone companies after the
transportation is provided, not when mileage
were sold.
Others: season tickets, annual membership,
etc.
Income Measurement And Profit Analysis
6
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
7
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
8
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
9
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
10
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
11
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
12
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
13
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
14
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
15
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
16
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
17
Choice of P-O-C vs. C-C Method


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.
Income Measurement And Profit Analysis
18
Choice of P-O-C vs. C-C Method (contd.)

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.
Income Measurement And Profit Analysis
19
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
20
Example A:
(Long-Term Construction Contract)
Contract Price = $700
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
3
6
$ 600
100%
x3
$314
-
1. 500=100+400
2. 550=100+186+264
3. 600=100+186+314
(actual)
4. 20% = 100/500
5. 52% = (100 + 186)/550
6. 100%=(100+186+314)/ 600
Income Measurement And Profit Analysis
21
Example A (contd.)
Year
x1
x2
x3
Total
Partial
Billings
$ 80
350
270
$700
Cash
Collection
$ 50
330
320
$700
Income Measurement And Profit Analysis
22
Example A (contd.)
(P-O-C)
Cumulative Current Current
7
Year Revenue Revenue Expense
$ 140 1
$ 140 4
x1
100
364 2
224 5
x2
186
700 3
336 6
x3
314
Total
$700
$600
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)
Gross
Profit8
$40
38
22
$100
5. 224 = 364 -140
6. 336 = 700 - 140 - 224
7. Current expense =
construction costs
incurred
8. Net Income = current
revenue - current
expense
Income Measurement And Profit Analysis
23
Example A (contd.)

An alternative method to compute the gross
profit:
Total
%
Cum.
Estimated
of
Gross
Year Profit Completion Profit
x1
$200
20%
$40
x2
150
52%
78
x3
100
100%
100
Income Measurement And Profit Analysis
Gross
Profit
$40
38
22
24
Example A - Journal Entries (P-O-C)
Year x1 Year x2 Year x3
a. To Record Actual
Cost:
Construction in Progress 100
314
186
A/P
314
100
186
b. Partial Billings:
80
350
270
A/R
80
350
270
Progress Billings
c. Cash Collection
50
330
320
Cash
50
330
320
A/R
Note:
Progress Billings = Billings on Construction
construction contract
Income Measurement And Profit Analysis
25
Example A - Journal Entries (P-O-C) (contd.)
Year x1 Year x2 Year x3
d. End of Period- Recognition
of annual income
100
1. Construction Expense
40
C-I-P
140
Construction Revenue
2. Closing Entries:
140
Construction Revenue
100
Construction Expense
40
Income Summary
e. The end of Construction
No
(Customer is fully Billed)
Entry
Progress Billings
C-I-P
186
38
314
22
224
224
336
336
186
38
No
Entry
314
22
700
700
Note: Construction Expense = Cost of Construction
Construction Revenue = Revenue from Long-Term
IncomeContracts
Measurement And Profit Analysis
26
Example A
Financial Statement Presentation (P-O-C)
B/S Year x1
Current Assets:
CIP
140
Progress Billings (80)
60
Unbilled Revenue
B/S Year x2
Current Liability:
P-B
430
C-I-P
(364)
66
B/S Year x3
C.A.:
CIP
700
P.B
(700)
0
Billing in excess of costs
and recognized profit
Income Measurement And Profit Analysis
27
Financial Statement Presentation (P-OC)
(contd.)
Year x1
($140)
Year x2
($224)
Year x3
($336)
CIP
100
40
186
38
314
22
Progress Billings
80 -- 1998
350 -- 1999
270 -- 2000
700 -- E.B.
Note:
Balance of CIP
= cumulative revenue
Income Measurement And Profit Analysis
28
Financial Statement Presentation (P-OC)
(contd.)
Income Statement
Year x1 Year x2 Year x3
Revenue from
Long-term contract 140
224
336
Construction
Expenses
100
186
314
Gross Profit
40
38
Income Measurement And Profit Analysis
22
29
Financial Statement Presentation (P-OC)
(contd.)
Balance Sheet(12/31)
Current Assets:
A/R
Inventories
Construction in Progress
Less: Billings
Costs and recognized
profits in excess of billings
Current Liabilities:
Billings
Construction in Progress
Billings in excess of costs
and recognized profits
x1
Year
x2
30
50
x3
--
140
(80)
700
(700)
60
0
430
(364)
Income Measurement And Profit Analysis
66
30
Financial Statement Presentation (P-OC)
(contd.)
Note1 Summary of significant accounting policy
Long-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
31
Example A (contd.)
- Completed-Contract Method
Gross Profit:
X1 $0
X2 $0
X3 $100
X3: Total Revenues - Total Expenses
= $ 700 - (100+186+314)
= $ 700 - 600
= 100
Income Measurement And Profit Analysis
32
Example A (contd.) - Journal Entries
(Completed-Contract)
Year x1 Year x2 Year x3
a. Recording Actual Cost:
CIP
314
100
186
A/P
314
100
186
b. Partial Billings:
80
350
270
A/R
80
350
270
Progress Billings
c. Cash Collection
50
330
320
Cash
50
330
320
A/R
d. End of Period No
No
No
Recognition of annual
Entry
Entry
Entry
income
Income Measurement And Profit Analysis
33
Journal Entries(Completed-Contract)
(contd.)
Year x1 Year x2 Year x3
e. The End of Construction
(Recognize total expense
and total revenue)
1. Construction Exp.
C-I-P
Construction Revenue
2. Construction Revenue
Construction Expense
Income Summary
3. Progress Billings
CIP
No
No
600
100
700
700
No
No
No
No
Income Measurement And Profit Analysis
600
100
700
700
34
Financial Statement Presentation
(C-C Method)
Income Statement
Year x1 Year x2 Year x3
Revenue from
Long-term contract
----700
Construction
Expenses
----600
Gross Profit
---
---
Income Measurement And Profit Analysis
100
35
Financial Statement Presentation (C-C Method) (contd.)
Balance Sheet (12/31)
Current Assets:
A/R
Inventories:
Construction
in Progress
Less: Billings
Contract Costs
in Excess of Billings
Year x1 Year x2 Year x3
30
50
---
100
(80)
700
(700)
20
0
Current Liabilities:
Billings
430
Construction in Progress
(286)
Billing in Excess
of Contract Costs Income Measurement And Profit Analysis
144
36
Example B
Contract Price $700
Estimated
Construction Costs to Estimated Cumulative
Costs
Complete
Total
% of
Year Incurred the Contract Cost Completion
x1
$100
400
$500
20%
x2
186
364
650
44%
x3
314
600
100%
Income Measurement And Profit Analysis
37
Example B (contd.)
Year
x1
x2
x3
Total
P-O-C C-C
Cummulative Current Current G.P. G.P.
Revenue Revenue Expense (L)
(L)
$140
$140
$100
40
0
308
168
186
-18
0
700
392
314
78
100
$700
$600
$100 $100
Income Measurement And Profit Analysis
38
Example B (contd.)

An alternative method to compute the gross
profit:
Total
Cumm. Cumm.
Estimated
% of
Gross Gross
Year G. Profit Completion Profit Profit
x1
$200
20%
$40
$40
x2
50
44%
22
(18)
x3
100
100%
100
78
Income Measurement And Profit Analysis
39
Example B (contd.)
Other Information (Billing and cash collection):
Year
Partial Billings
Cash Collection
x1
$80
$50
x2
350
330
x3
270
320
$ 700
$ 700
Total
Income Measurement And Profit Analysis
40
Example B - Journal Entries (P-O-C)
Year x1 Year x2 Year x3
a. Recording Actual
Cost:
C-I-P
314
100
186
A/P
314
100
186
b. Partial Billings:
80
350
270
A/R
80
350
270
Progress Billings
c. Cash Collection
50
330
320
Cash
50
330
320
A/R
Income Measurement And Profit Analysis
41
Example B - Journal Entries (P-O-C) (contd.)
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
e. The end of Construction
Progress Billings
C-I-P
Year x1 Year x2
Year x3
100
40
314
78
186
140
-
140
-
168
18
392
-
168
392
18
100
186
314
40
78
No
No
Income Measurement And Profit Analysis
700
700
42
Example B (contd.)
Year
x1
x2
x3
C-I-P
100
18
40
186
314
78
700
x2
Progress Billings
80 -- x1
350 -- x2
270 -- x3
Income Measurement And Profit Analysis
43
Example B (contd.) - Journal Entries
(Completed-Contract)
Year x1 Year x2 Year x3
a. Recording Actual Cost:
CIP
314
100
186
A/P
314
100
186
b. Partial Billings:
80
350
270
A/R
80
350
270
Progress Billings
c. Cash Collection
50
330
320
Cash
50
330
320
A/R
No
No
No
d. End of Period
Income Measurement And Profit Analysis
44
Journal Entries(Completed-Contract)
(contd.)
Year x1 Year x2 Year x3
e. The End of Construction
(Recognize total expense
and total revenue)
1. Construction Exp.
C-I-P
Construction Revenue
2. Construction Revenue
Construction Expense
Income Summary
3. Progress Billings
CIP
No
No
600
100
700
700
No
No
No
No
Income Measurement And Profit Analysis
600
100
700
700
45
Example C
(Long-Term Contract
with an Overall Loss)
Contract Price $700
Estimated
Construction Costs to Estimated Cumulative
Costs
Complete
Total
% of
Year Incurred the Contract Cost Completion
x1
$100
400
$500
20%
x2
186
429
715*
40%
x3
429
715
100%
* $715 > 700 (contract price) => a total estimated loss
occurs and must be recognized immediately (source:
ARB 45 and AICPA statement of position 81-1)
Income Measurement And Profit Analysis
46
Example C (contd.)
P-O-C C-C
Cummulative Current Current G.P.
G.P.
Year Revenue Revenue Expense (L)
(L)
x1
$140
$140
$100
40
0
x2
280
140
186
(55)*
(15)
x3
700
420
429
0
0
Total
$700
$715
($15) ($15)
* $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.
Income Measurement And Profit Analysis
47
Example C (contd.)

An alternative method to compute the gross
profit:
Total
Cumm. Cumm.
Estimated
% of
Gross Gross
Year G. Profit Completion Profit Profit
x1
$200
20%
$40
$40
x2
(15)
40%
(15)
(55)
x3
(15)
100%
(15)
0
Income Measurement And Profit Analysis
48
Example C (contd.) - Journal Entries (P-O-C)
Year x1 Year x2 Year x3
429
100
186
429
100
186
a. CIP
A/P
b. A/R
80
Progress Billings
c. Cash
A/R
350
80
50
270
350
270
330
320
50
330
320
Income Measurement And Profit Analysis
49
Journal Entries(P-O-C) (contd.)
Year x1 Year x2 Year x3
d. End of Period:
1. Construction Expense
420
100
195
C-I-P
40
Construction Revenue
420
140
140
C-I-P
55*
2. Closing Entries
e. The End of Construction:
Progress Billings
C-I-P
700
700
* C-I-P and provision for loss on contract are
combined.
Income Measurement And Profit Analysis
50
Example C (contd.)
Year x1:
CIP (Year x1)
100
40
140
Partial Billings (x1)
80
B/S (x1)
Current Assets:
CIP
140
P-B
(80)
60
Income Measurement And Profit Analysis
51
Example C (contd.)
Year x2: (with a total estimated loss of $15)
CIP (Year x2)
P-B (Year x2)
100
55
80
40
350
186
430
271
B/S (Year x2)
Current Lia:
* The estimated
P-B
430 overall loss must
CIP
(286)* be reported
separately on the
Billings in excess of costs
B/S as a current
and recognized profit
144 lia. The overall
loss needs to be
Estimated liability from
out of the
long-term contract
15 taken
CIP account for
reporting
purposes.
Income Measurement And Profit Analysis
52
Example C (contd.)
CIP (2000)
100
55
40
186
429
700
P-B (2000)
80
350
270
700
Income Measurement And Profit Analysis
53
Example C (contd.) - Journal Entries (C-C)
Year x1 Year x2 Year x3
429
100
186
429
100
186
a. CIP
A/P
b. A/R
80
Progress Billings
c. Cash
A/R
350
80
50
270
350
270
330
320
50
330
320
Income Measurement And Profit Analysis
54
Journal Entries(C-C) (contd.)
Year x1 Year x2 Year x3
d. End of Period:
Estimated Loss from LongTerm Contract
C-I-P
e. The End of Construction:
Contract Expense
Construction Revenue
Progress Billings
C-I-P
15*
15*
700
700
700
700
* To recognize the total estimated loss of ($15).
Income Measurement And Profit Analysis
55
L-T Construction Contract with a Total Estimated Loss
Example D
Contract Price = $700
Estimated
Construction
Costs
Estimated Cummulative
Costs
to Complete Total
% of
Year Incurred the Contract Cost
Completion
x1
$100
$400
500
20%
x2
186
429
715 *
40%
815 **
x3
529
100%
* a total estimated loss of $15 incurred.
** a total estimated loss of $115.
Income Measurement And Profit Analysis
56
Example D (contd.)
P-O-C
Year
x1
x2
x3
Total

Cummulative Current Current G.P.
Revenue Revenue Expense (L)
$140
$140
$100
40
280
140
186
(55)
700
420
529
(100)
$700
$815 ($115)
C-C
G.P.
(L)
0
(15)
(100)
($115)
Billings and cash collection data are the same as
those in example A.
Income Measurement And Profit Analysis
57
L-T Construction Contract with a Total Estimated Loss
Example E
Contract Price = $700
Estimated
Construction
Costs
Estimated Cummulative
Costs
to Complete Total
% of
Year Incurred the Contract Cost
Completion
x1
$100
$400
$500
20%
x2
$186
$429
$715 *
40%
x3
$329
$615
100%
* a total estimated loss of $15 incurred.
Income Measurement And Profit Analysis
58
Example E (contd.)
Year
x1
x2
x3
Total
P-O-C
C-C
Cummulative Current Current G.P.
Revenue Revenue Expense (L)
$140
$140
$100
40
280
140
186
(55)
700
420
329
100*
$700
$615
$85
G.P.
(L)
0
(15)
100*
$85
* $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.
Income Measurement And Profit Analysis
59
L-T Construction Contract with a Total Estimated Loss
Example F
Contract Price = $700
Estimated
Construction
Costs
Estimated Cummulative
Costs
to Complete Total
% of
Year Incurred the Contract Cost
Completion
x1
$100
$700
800 *
13%
x2
186
429
715 **
40%
x3
529
815
100%
* an estimated loss of $100 incurred.
** an estimated loss of $15 incurred.
*** an loss of $115 incurred.
Income Measurement And Profit Analysis
60
Example F (contd.)
P-O-C
Year
x1
x2
x3
Total
C-C
Cummulative Current Current G.P. G.P.
Revenue Revenue Expense (L)
(L)
$91
$91
$100
($100) ($100)
280
189
186
85
85
700
420
529
(100) (100)
$700
$815
($115) ($115)
** Billings and cash collection data are the same as
those of example A.
Income Measurement And Profit Analysis
61
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
62
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
63
The Application of the P-O-C Method
(contd.)

Aging product: Wine, lumber, etc.
 No value increase can be recognized
as revenue, unless
a. a contract to age a specific product for
a specific customer has been signed;
and
b. no return of product even if the
customer is not satisfied with the
product; and
c. if future cost can be estimated.
Income Measurement And Profit Analysis
64
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.
Income Measurement And Profit Analysis
65
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 longterm construction contracts.
Income Measurement And Profit Analysis
66
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
67
a. Installment Method

1
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
68
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
69
1
b. Cost Recovery Method

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
70
Installment Sales Method
Example

Assume the following information:
Installment sales
Cost of installment
Gross profit
20x1
$1,200
900
$300
20x2
$2,000
1,700
$300
Rate of gross profit on sales
25%
15%
Cash receipts
20x1 Sales
20x2 Sales
$600
$600
$500
Income Measurement And Profit Analysis
71
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
72
Installment Sales Method
Example (contd.)
20x1
1. Installment A/R
1,200
Installment Sales
1,200
2. Cash
600
I A/R
600
3. Cost of Install. Sales
900
Inventory
900
4. Installment Sales
1,200
Cost of Install. Sales
900
Deferred Gross Profit
300
20x2
2,000
2,000
1,100
1,100
1,700
1,700
2,000
1,700
300
(to close installment sales and cost of installment
sales and to recognize entire profit as deferred profit)
Income Measurement And Profit Analysis
73
Installment Sales Method
Example (contd.)
20x1
5. Deferred Gross Profit
Realized Gross Profit
on Installment sales
150a
20x2
225b
150
225
a. 25% x $600 = $150.
b. 25% x $600 + 15% x $500 = $225.
Income Measurement And Profit Analysis
74
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
75
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
76
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
77
1. Interest on Installment Contract
(contd.)
5/1/x1
Q3, x1
Q4, x1
Q1, x2
Q2, x2
(1)
(2)
Cash Interest
Earned
(Debit) (Credit)
----$322.83 $36
322.83 27.40
322.83 18.53
322.83 9.40
(3)
Install.
A/R
(Credit)
--$286.83
295.43
304.30
313.43
(4)
(5)
Bal. Of Realized
Install. Gross
A/R
Profit
$1,200
--$913.17 $71.70
617.74 73.86
313.44 76.08
0
78.36
$300
(1) as computed on previous page. (4) previous balance
(2) 3% x previous balance in (4).
of (4) - (3).
(3) (1) - (2).
(5) 25% x (3).
Income Measurement And Profit Analysis
78
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
79
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
80
3. Defaults and Repossessions
(contd.)

When repossession occurs in year 20x3,
the following entry will be recorded:
Repossessed Merchandize
Deferred Gross Profit
Loss on Repossession
Installment A/R
Income Measurement And Profit Analysis
400
120
280
800
81
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
82
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
83
Income Statement
For the Year Ended 12/31/x1
Sales
Cost of Goods Sold
Gross Profit on Sales
Gross Profit realized on
Installment Sales
$500,000
(270,000)
$230,000
Total Gross Profit on Sales
$230,150
150
Income Measurement And Profit Analysis
84
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
85
Income Statement
For the Year Ended 12/31/x2a
Install.
Sales
Other
Sales
Total
Sales
150,000 200,000 350,000
Cost of goods sold
(80,000) (150,000) (230,000)
Gross profit
70,000 50,000 120,000
Less deferred gross profit on
install. sales of this year (50,000)
(50,000)
Realized gross profit on
this year’s sales
20,000 50,000 70,000
Add gross profit realized on
prior years
15,000
15,000
Gross profit real. this year 35,000 50,000 85,000
Income Measurement And Profit Analysis
a. All amounts are assumed.
86
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.
Income Measurement And Profit Analysis
87
Example

Cost Recovery Method
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
88
Example (contd.)
20x1 A/R
Cost Recovery Method
15,000
Sales
15,000
CGS
10,000
Inventory
10,000
Cash
9,000
A/R
9,000
Sales
15,000
CGS
10,000
Deferred Gross Profit
5,000
Income Measurement And Profit Analysis
89
Example (contd.)
Cost Recovery Method
(To close sales and CGS and to record
deferred gross profit under the cost recovery
method)
20x2 Cash
3,000
A/R
3,000
Deferred Gross Profit 2,000
Gross Profit
2,000
20x3 Cash
3,000
A/R
3,000
Deferred Gross Profit 3,000
Gross Profit
3,000
Income Measurement And Profit Analysis
90
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
91
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
92
States Require to Turn Over the
Abandoned and Unclaimed Property
The expired unused balance of gift-card
may need to be remitted to the state
after five- year period.

Income Measurement And Profit Analysis
93
Franchise Sales



Many 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
94
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.
Income Measurement And Profit Analysis
95
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
96
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
97
Franchise Sales –Example
On 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.

Income Measurement And Profit Analysis
98
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.
Income Measurement And Profit Analysis
99
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
Income Measurement And Profit Analysis
100
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

Income Measurement And Profit Analysis
101
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
102
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
Income Measurement And Profit Analysis
103
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:
Income Measurement And Profit Analysis
104
Multiple-Element Arrangements
(contd.)
1. the delivered item or items have value to
the customer on a standalone basis and
2. 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.
Income Measurement And Profit Analysis
105
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
Income Measurement
And Profit Analysis
 Vendor’s estimates
.
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.
Income Measurement And Profit Analysis
107
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
Dealer
Account Used Consignment-out Consignment-in
Purpose of
To record the
To record any sale
account
transfer of the
of consignment
goods (Debit) and goods (Credit) and
transportation
to record expenses
cost (Debit)
occurred for the
consignment
(Debit)
Income Measurement And Profit Analysis
108
Example


Consignment
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
109
Example (contd.)
Consignment
Consignor (manufacturer)
Consignee (Dealer)
2/8 Consignment
No Entry
out
1800
Inventory
1800
2/8 Consignment
No Entry
out
150
Cash
150
2/9 No Entry
2/9 (Adv.)
Consignment-In 100
Cash
100
2/9 No Entry
4/4 Sale of 300
Units at $10
Cash
3000
ConsignmentIn
3000
Income Measurement And Profit Analysis
110
Example (contd.)
Consignment
Consignor (manufacturer)
Consignee (Dealer)
4/20 receiving $2800 from
dealer (deduct $100
commission and $100
Advertisement)
1. Cash
2800
Commission Exp. 100
Adv. Exp.
100
Sales Rev.
3000
2. CGS
1950
Consignment-out 1950
4/20
Consignment- In 2900
Cash
2800
Commission
Earned
100
*If consignment-out has a
debit balance, it is a current
asset account to the
consignor.
* If the consignment-In has
a debit balance, it would be
a current asset account for
the consignee. If the
consignment-In has a credit
balance, it would be a
current liability account to
the consignee.
Income Measurement And Profit Analysis
111