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Intermediate Accounting,17E
Revenue Recognition
PowerPoint presented by: Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
© 2010 Cengage Learning
Revenue Recognition
Recognition refers to the time when
transactions are recorded on the
books. The FASB’s two criteria for
recognizing revenues and gains were
articulated in FASB Concepts
Statement No. 5.
8-2
Revenue Recognition
Revenues and gains are generally
recognized when:
1. They are realized or realizable.
2. They have been earned through
substantial completion of the
activities involved in the earnings
process.
8-3
Revenue Recognition
• Revenue is not recognized prior to the point
of sale because either:
• A valid promise of payment has not been
received from the customer, or
• The company has not provided the product or
service.
• Exceptions to these rules:
• The customer provides a valid promise of
payment.
• Conditions exist that contractually guarantee
the sale.
8-4
Revenue Recognition
AICPA Statement of Position 97-2 gives
companies more guidance through a
checklist of four factors that amplify the two
criteria:
a. Persuasive evidence of an arrangement
exists.
b. Delivery has occurred.
c. The vendor’s fee is fixed or determinable.
d. Collectibility is probable.
8-5
Appropriate Layaway
Accounting
Receipt of $100 cash as initial layaway
payment:
Cash
Deposit Received from Customers
100
100
Receipt of final $1,400 cash payment and
delivery of goods to customer:
Cash
Deposit Received from Customers
Sales
Cost of Goods Sold
Inventory
1,400
100
1,500
1,000
1,000
8-6
Appropriate Accounting for a Service
Provided Over an Extended Period
Seller Company receives $1,000
cash from a customer as the initial
sign-up fee for a service. In addition
to the sign-up fee, the customer is
required to pay $50 per month for
100 months, which is the economic
life of this service agreement.
8-7
Appropriate Accounting for a Service
Provided Over an Extended Period
Receipt of $1,000 cash as initial sign-up fee:
Cash
Unearned Initial Sign-Up Fees
1,000
1,000
Receipt of first monthly payment of $50:
Cash
Monthly Service Revenue
50
50
Partial recognition of the initial signup fee
as revenue ($1,000/100 months):
Unearned Initial Sign-Up Fees
Initial Sign-Up Fee Revenue
10
10
8-8
EITF 00-21
A delivered element of a multipleelement arrangement is considered
to be a unit of accounting if that
delivered element has standalone
value and if the fair value of any
undelivered element can be
objectively and reliably
determined.
8-9
Appropriate Accounting for a
Refundable Membership
Seller Company receives $1,200 cash from
each customer as a fully refundable, oneyear membership fee. It is estimated that
the cost to Seller Company to provide the
membership service to each customer will
be $360 for one year. Seller Company can
reliably estimate that 40% of the customers
will request refunds during the year.
Assume all refunds occur at the end of the
year. There were 1,000 customers.
(continues)
8-10
Appropriate Accounting for a
Refundable Membership
8-11
Appropriate Accounting for a
Contingent Rental
On January 1, Owner Company signed
a 1-year rental for a total of $120,000,
with monthly payments of $10,000
due at the end of each month. In
addition, the renter must pay
contingent rent of 10% of all annual
sales in excess of $3,000,000. The
contingent payment is paid in one
payment on December 31.
(continues)
8-12
Appropriate Accounting for a
Contingent Rental
On January 31, sales for the renter
had reached $700,000. On July 31,
the renter had reached a sales level of
$3,150,000. On December 31, the
renter had reached a sales level of
$5,000,000, of which $1,000,000
occurred in December.
(continues)
8-13
Appropriate Accounting for a
Contingent Rental
8-14
Asset-and-Liability Approach to
Revenue Recognition Example
Wilks Company sells a plasma TV screen and 2year warranty to a customer for a joint price of
$2,000. All cash is collected upfront. Other
relevant data:
• Cost of plasma TV screen, $1,500
• Sales price of TV if sold separately, $1,785
• Sales price of 2-year warranty if sold separately,
$315
• Amount payable to a TV wholesaler to accept
responsibility to provide TV, $1,650
• Amount payable to service company to accept
responsibility of providing warranty, $240
(continues)
8-15
Asset-and-Liability Approach to
Revenue Recognition Example
Journal entry at point of cash receipt:
Cash
Contract Liability—TV Screen
Contract Liability—Warranty
2,000
1,700¹
300²
¹$2,000  [$1,785/($1,785 + $315)]
²$2,000  [$315/($1,785 + $315)]
Journal entries on delivery of TV:
Contract Liability—TV Screen
Sales Revenue
Cost of Goods Sold
Inventory
1,700
1,700
1,500
1,500
8-16
Measurement Model
The fair values of the performance
obligation liabilities create a
contract signing. Recall that a TV
wholesaler would charge $1,650 for
accepting the responsibility of
providing the plasma TV to the
customer. Likewise, a service
company would charge $240 for
providing the two years of warranty.
(continues)
8-17
Measurement Model
The entry to record the cash asset
and the two performance
obligations created at the contract
signing is as follows:
Cash
Contract Liability—TV Screen
Contract Liability—Warranty
Revenue
2,000
1,650
240
110
8-18
Revenue Recognition Prior to
Providing Goods or Services
• Completed-contract method recognizes
all income when project is completed.
• Percentage-of-completion method
recognizes revenue throughout the term of
the contract.
• Proportional performance method
reflects revenue earned on service
contracts under which many acts of
service are to be performed before the
contract is complete.
8-19
Percentage-of-Completion
Method Requirements
1. Dependable estimates of:
• contract revenues
• contract costs
• progress toward completion
2. Contract clearly specifies:
• enforceable rights of the parties
• consideration to be exchanged
• manner and terms of settlement
(continues)
8-20
Percentage-of-Completion
Method Requirements
3. The buyer can be expected to satisfy
obligations under the contract.
4. Contractor can be expected to
perform the contractual obligation.
8-21
Percentage-of-Completion
Input Measures
• Cost-to-cost method is perhaps the most
popular of the input measures. The degree
of completion is determined by comparing
costs already incurred with the most
recent estimates of total expected costs to
complete the project.
• Engineers are often called in to help
provide estimates.
8-22
Measuring the Percentage
of Completion
In January 2010, Strong Construction
Company was awarded a contract with
a total price of $3,000,000. Strong
expects to earn $400,000 profit on the
contract. The construction was
completed over a 3-year period. The
table shown next provides the actual
cost that Strong experienced and the
completion rate.
8-23
Measuring the Percentage
of Completion
8-24
Accounting for Long-Term
Construction Contracts
Continuing with the Strong Construction
Company illustration, the direct and
indirect costs, billings, and collections
are as follows:
8-25
Completed-Contract Method
2010
Construction in Progress
Materials, Cash, etc.
To record costs incurred.
1,040,000
Accounts Receivable
Progress Billings on
Construction Contracts
To record billings.
1,000,000
Cash
Accounts Receivable
To record cash collections.
(continues)
1,040,000
1,000,000
800,000
800,000
8-26
Completed-Contract Method
2011
Construction in Progress
Materials, Cash, etc.
To record costs incurred.
910,000
Accounts Receivable
Progress Billings on
Construction Contracts
To record billings.
Cash
Accounts Receivable
To record cash collections.
900,000
(continues)
910,000
900,000
850,000
850,000
8-27
Completed-Contract Method
2012
Construction in Progress
Materials, Cash, etc.
To record costs incurred.
650,000
650,000
Accounts Receivable
Progress Billings on
Construction Contracts
To record billings.
1,100,000
Cash
Accounts Receivable
To record cash collections.
1,350,000
1,100,000
1,350,000
8-28
Percentage-of-Completion
Method
• The entries we recorded using the
completed-contract method are also the
same entries that would be used for the
percentage-of-completion method.
• The completed-contract method is
“wrapped up” using the entries shown in
Slides 30 and 31. The percentage-ofcompletion method requires the entries
presented in Slides 32 to 34.
8-29
Completed-Contract Method
2012
Under the completed-contract method,
the following entries would be made to
recognize revenue and costs and to close
out the inventory and billing accounts.
Progress Billings on Construction
Contracts
Revenue from Long-Term
Construction Contracts
(continues)
3,000,000
3,000,000
8-30
Completed-Contract Method
2012
Under the completed-contract method,
the following entries would be made to
recognize revenue and costs and to close
out the inventory and billing accounts.
Cost of Long-Term Construction
Contracts
Construction in Process
2,600,000
2,600,000
8-31
Percentage-of-Completion
2010
Under the percentage-of-completion
method, the following additional entries
would be made to recognize revenue.
Cost of Long-Term Construction
Contracts
Construction in Progress
Revenue from Long-Term
Construction Contracts
(continues)
1,040,000
160,000
1,200,000
8-32
Percentage-of-Completion
2011
Cost of Long-Term Construction
Contracts
Construction in Progress
Revenue from Long-Term
Construction Contracts
910,000
140,000
1,050,000
($3,000,000  0.75)  $1,200,000
(continues)
8-33
Percentage-of-Completion
2012
Cost of Long-Term Construction
Contracts
Construction in Progress
Revenue from Long-Term
Construction Contracts
650,000
100,000
750,000
$3,000,000  $1,200,000  $1,500,000
8-34
Revision of Estimate
Instead of the previous illustration,
assume that at the end of 2011, it was
estimated that the remaining cost to
complete construction was $720,000
rather than $650,000. This would
increase the total estimated cost to
$2,670,000, reduce the expected profit
to $330,000, and change the percentage
of completion for 2011.
(continues)
8-35
Revision of Estimate
(continues)
8-36
Revision of Estimate
• The entries for 2010 would be the same as
those shown in the previous example.
• All entries for 2011 would be the same except
for the entry to record revenue and cost.
Cost of Long-Term Construction
Contracts
Construction in Progress
Revenue from Long-Term
Construction Contracts
910,000
80,000
990,000
($3,000,000  0.73)  $1,200,000
(continues)
8-37
Revision of Estimate
2012
Cost of Long-Term Construction
Contracts
Construction in Progress
Revenue from Long-Term
Construction Contracts
700,000
110,000
810,000
8-38
Reporting Anticipated
Contract Losses
Assume the same facts for Strong
Construction Company, except the
estimated cost to complete the
contract at the end of 2011 was
$1,300,000. Because $1,950,000 of
costs had already been incurred, the
total estimated cost would be
$3,250,000.
(continues)
8-39
Reporting Anticipated
Contract Losses
8-40
Anticipated Contract Loss:
Percentage-of-Completion
(continues)
8-41
Anticipated Contract Loss:
Percentage-of-Completion
The entry to record the revenue, costs, and
adjustments to Construction in Process for
the loss in 2011 would be as follows:
Cost of Long-Term Construction
Contracts
Revenue from Long-Term
Construction Contracts
Construction in Process
1,010,000
600,000
410,000
(continues)
8-42
Anticipated Contract Loss:
Percentage-of-Completion
8-43
Proportional Revenue
Recognition
Most service contracts involve three
different types of costs:
1. Initial direct costs related to obtaining
and performing initial services on the
contract
2. Direct costs related to performing the
various service acts
3. Indirect costs related to maintaining
the organization to service the
contract
8-44
Accounting for Long-Term
Service Contracts
A correspondence school enters into 100
contracts with students for an extended
writing course. The fee for each contract is
$500, payable in advance. The initial
direct costs related to the contracts total
$5,000. Actual direct costs for lessons for
the first period are $12,000. The sales
value of the lessons completed is $24,000
(if sold separately, $60,000).
(continues)
8-45
Accounting for Long-Term
Service Contracts
Receipt of fees:
Cash
Deferred Course Revenue
50,000
50,000
Initial direct costs:
Liability account
Deferred Initial Costs
Cash
5,000
Asset account
5,000
Direct costs for lessons actually completed:
Contract Costs
Cash
Expense account12,000
12,000
(continues)
8-46
Accounting for Long-Term
Service Contracts
Recognize course revenue:
Deferred Course Revenue
Recognized Course Revenue
20,000
20,000
Recognize contract costs from
initial direct
$24,000
 $50,000
costs:
$60,000
Contract Costs
Deferred Initial Costs
2,000
2,000
$24,000  $5,000
$60,000
8-47
Revenue Recognition After
Delivery of Goods
8-48
Installment Sales Method
• Under the installment sales method,
profit is recognized as cash is collected
rather than at the time of sale.
• It is used most commonly in cases of
real estate sales where contracts may
involve little or no down payment,
payments are spread over 10 to 40
years, and a high probability of default
in the early years exists.
8-49
Installment Sales Method
Riding Corporation sells merchandise on
the installment basis, and the
uncertainties of cash collection make the
use of the installment method necessary.
The following data relate to three years of
operations.
(continues)
8-50
Installment Sales Method
2010—During the Year
Installment Accounts
Receivable—2010
Installment Sales
150,000
150,000
Cost of Installment Sales
Inventory
100,000
Cash
Installment Accounts
Receivable—2010
30,000
100,000
30,000
(continues)
8-51
Installment Sales Method
2010—End of Year
Installment Sales
Cost of Installment Sales
Deferred Gross Profit—2010
Deferred Gross Profit—2010
Realized Gross Profit on
Installment Sales
150,000
100,000
50,000
10,000
10,000
$30,000  33.33%
(continues)
8-52
Installment Sales Method
2011—During the Year
Installment A/R—2011
Installment Sales
200,000
Cost of Installment Sales
Inventory
140,000
Cash
Installment A/R—2010
Installment A/R—2011
145,000
200,000
(continues)
140,000
75,000
70,000
8-53
Installment Sales Method
2011—End of Year
Installment Sales
Cost of Installment Sales
Deferred Gross Profit—2011
Deferred Gross Profit—2010
Deferred Gross Profit—2011
Realized Gross Profit on
Installment Sales
200,000
140,000
60,000
25,000
21,000
46,000
$75,000  33.33%
$70,000  30%
(continues)
8-54
Installment Sales Method
2012—During the Year
Installment A/R—2012
Installment Sales
300,000
Cost of Installment Sales
Inventory
204,000
Cash
Installment A/R—2010
Installment A/R—2011
Installment A/R—2012
210,000
300,000
(continues)
204,000
30,000
80,000
100,000
8-55
Installment Sales Method
2012—End of Year
Installment Sales
Cost of Installment Sales
Deferred Gross Profit—2012
Deferred Gross Profit—2010
Deferred Gross Profit—2011
Deferred Gross Profit—2012
Realized Gross Profit on
Installment Sales
300,000
204,000
96,000
10,000
24,000
32,000
$30,000  33.33%
66,000
$80,000  30%
$100,000  32%
8-56
Cost Recovery Method
If the probability of recovering
product or service costs is remote,
the cost recovery method of
accounting can be used.
8-57
Cost Recovery Method
All entries are the same except do not
record gross profit until all costs are
recovered.
2011
Deferred Gross Profit—2010
Realized Gross Profit on
Installment Sales
5,000
5,000
(continues)
8-58
Cost Recovery Method
Because the cash collected in 2011 for
2011 sales is less than the cost of
inventory sold, no gross profit would be
recognized in 2011 on 2011 sales.
2012
Deferred Gross Profit—2010
Deferred Gross Profit—2011
Realized Gross Profit on
Installment Sales
30,000
10,000
40,000
8-59