AS 9 : Revenue
Recognition
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Revenue is the gross inflow of cash,
receivables or other consideration arising in
the course of the ordinary activities of an
enterprise from the
Sale of goods
Rendering of services and
Use by others, of enterprise resources, yielding
interest, royalties and dividends
Recognition - Process of recording and
reporting an item as an element of financial
statement
Principles
The revenue recognition principle provides
that revenue is recognized:
◦ when it is earned, and
◦ when it is realized or realizable
Revenue is earned when the earnings
process is substantially complete
Revenue is realized when goods and
services are exchanged for cash or claims to
cash
Revenue is realizable when assets received
are convertible into a known amount of cash
Four Types of Revenue Transactions
 Revenue from selling products is
recognized at the date of sale (date of
delivery).
 Revenue from services is recognized when
services are performed and are billable.
 Revenue from the use of enterprise’s assets
by others is recognized as time passes or as
the assets are used up.
 Revenue from disposal of assets (other than
inventory) is recognized at the point of sale
as gain or loss.
Revenue Recognition Classified by
Nature of Transaction
Revenue Recognition at Point of Sale
Revenues from manufacturing and selling
are commonly recognized at point of sale
Exceptions:
1. Sales with buyback agreements
2. Sales when right of return exists (high rates that
are not reliably estimable)
3. Trade loading/channel stuffing
Revenue Recognition Before Delivery
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Revenue may be recognized before delivery
under certain circumstances
Long-term construction contracts are a
notable example
Two methods available are :
The percentage-of-completion method,
and
The completed contract method
Revenue Recognition Before Delivery
Long-Term Construction
Accounting Methods
Percentage-of-Completion
Method
1) Terms of contract must
be certain, enforceable
2) Certainty of performance
by both parties
3) Estimates of completion
can be made reliably
Completed Contract
Method
1) To be used only when
the percentage method is
inapplicable [uncertain]
2) For short-term contracts
Percentage-of-Completion: Steps
1
Costs incurred to date
= Percent complete
Most recent estimated total costs
2 Estimated total revenue x Percent complete
= Revenue to be recognized to date
3 Total revenue to be recognized to date less Revenue
recognized in PRIOR periods = Current period revenue
4 Current Period Revenue less current costs = Gross profit
Percentage-of-Completion: Example
Data: Contract price: $4,500,000
Start date:
July, 2003
Balance sheet date:
Given:
Estimated cost: $4,000,000
Finish: October, 2005
Dec. 31
2003
Costs to date
$1,000,000
Estimated costs to complete $3,000,000
Progress Billings during year
$900,000
Cash collected during year
$750,000
2004
$2,916,000
$1,134,000
$2,400,000
$1,750,000
2005
$4,050,000
$
-0$1,200,000
$2,000,000
What is the percent complete, revenue and gross
profit recognized each year?
Percentage-of-Completion: Example
2003
2004
2005
% complete
to-date
1,000,000 = 25% 2,916,000= 72%
4,000,000
4,050,000
100 %
Revenue
recognized
4,500,000 * 25%
= 1,125,000
4,500,000 * 72% 4,500,000
less 1,125,000 less 3,240,000
= 2,115,000
= 1,260,000
Gross Profit
recognized
1,125,000 less
1,000,000
= 125,000
2,115,000 less
1,916,000
= 199,000
1,260,000
less 1,134,000
= 126,000
Revenue Recognition After Delivery
Revenue recognition is deferred when
collection of sales price is not reasonably
assured and no reliable estimates can be
made
The two methods that are used are:
 the installment sales method
 the cost recovery method
If cash is received prior to delivery, the
method used is the deposit method
The Installment Sales Method
 This method emphasizes income
recognition in periods of collection rather
than at point of sale
 Title does not pass to the buyer until all
cash payments have been made to the seller
 Both sales and cost of sales are deferred to
the periods of collection
 Other expenses, selling and administrative,
are not deferred
The Cost Recovery Method
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Seller recognizes no profit until cash
payments by buyer exceed seller’s cost of
merchandise.
After recovering all costs, seller includes
additional cash collections in income.
This method is to be used where there is
no reasonable basis for estimating
collectibility as in franchises and real
estate.
The income statement reports the amount
of gross profit recognized and the amount
deferred.
The Deposit Method
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Seller receives cash from buyer before
transfer of goods or performance
The seller has no claim against the
purchaser.
There is insufficient transfer of risks to
buyer to warrant recording a sale by seller
In the case of such incomplete transactions,
the deposit method is used
The deposit method thus defers sale
recognition until a sale has occurred for
accounting purposes
Recognition Basis
Criteria for Use
Reason of Departing from Sale Basis
Percentage of Completion
Method
Long term construction of property,
and reliable estimates and
information about the project.
Better measure of periodic income,
and revenues and costs.
Completed Contract Method
Use on short term contracts, when
percentage of completion method is
not used
Percentage of Completion Method is
not applicable
Completion of Production Basis
Immediate marketability at quoted
prices, unit interchangeability and
etc
Determinable revenues, but inability
to determine the cost, thereby defer
expense
Installment-sales method and
cost recovery method
Absence of reasonable basis for
estimating degree of collectibility and
cost of collection.
Collectibility of receivable is so
uncertain, gross profit is recognized
until cash is received
Deposit Method
Cash is received before the sales
transaction completed
Not sufficient transfer of the risks
and ownership
Thank You