Income Measurement
(Part 1)
I N T ERMEDIATE ACCOU N T I NG I
CHA PT ER 5
Revenue
Amounts earned for providing a good or service.
The timing of revenue recognition is
critical to income measurement and
accurate reporting.
Revenue Recognition
The realization principle indicates that revenue should be recognized when the
following two criteria have been met:
 The earnings process is judged to be complete or virtually complete
There is reasonable certainty as to the collectibility of the asset to be
received
Additional criteria from SAB No 101 & 104 include
• 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
• Collectibility is reasonably assured
POINT OF DELIVERY
 Revenue and expenses are generally recognized in the
period in which the product/service is delivered.
 Revenue from the sale of products can be delayed past
delivery if material uncertainties exist or allowed prior
to delivery for long-term contracts.
 Service revenue often is recognized over time, in
proportion to the amount of service performed. If
there is one final service that is critical to the earnings
process, revenues and costs are deferred and
recognized after this service has been performed.
POINT OF DELIVERY REVENUE RECOGNITION – TYPICAL TRANSACTION
Example
On April 1, 2014, X Company sold inventory on account to Y, Inc. for $100,000.
The inventory cost X $60,000.
Accounts Receivable
100,000
Sales
Cost of Goods Sold
Inventory
100,000
60,000
60,000
The realization principles has been met in that 1) the product has been
sold and delivered. 2) There is reasonable certainty as to the
collectibility of cash. Any minor uncertainties regarding the collection of
cash can be accounted for with allowances for returns and bad debts.
INSTALLMENT SALES
A sales transaction requiring the buyer to make a series of payments
(usually annual) over a period of time.
Revenue recognition for most installment sales takes place at the point of
delivery, because reliable estimates of potential uncollectible amounts can
be made. When extreme uncertainty exists regarding the ultimate
collectibility of cash, we delay recognizing revenue and related expenses
using either
 Installment Sales Method
 Cost Recovery Method
INSTALLMENT SALES - POINT OF DELIVERY REVENUE RECOGNITION
Example
On October 1, 2014, Harmon Company sold and delivered inventory to Lee, Inc. for
$450,000. The inventory cost Harmon $210,000. Terms of the sale called for a down
payment of $150,000 and three annual installments of $100,000 each.
Oct 1, 2014
Installment Receivables
450,000
Sales
Cost of Goods Sold
450,000
210,000
Inventory
Cash
Installment Receivables
210,000
150,000
150,000
Note that all the
revenue was
recognized when the
inventory was sold
and delivered even
though the payment
will be spread over
several installments.
INSTALLMENT SALES METHOD
•
•
•
Recognizes revenue and costs only when cash payments are received.
Each payment is composed of a partial recovery of the cost of the item
sold and a gross profit component. Gross profit on the initial sale is
deferred.
The installment sales method realizes (recognizes) gross profit as
payments are made by applying the gross profit percentage on the sale
to the amount of cash actually received.
Total Gross Profit
Gross Profit
Percentage
Sales Price – Cost of Goods Sold Gross Profit/Sales Price
Gross Profit
Recognized
Cash Collections X
Gross Profit Percentage
INSTALLMENT SALES METHOD
Example
On November 1, 2013, the Belmont Corporation, a real estate developer, sold a tract of land
for $800,000. The sales agreement requires the customer to make four equal annual payments
of $200,000 plus interest on each November 1, beginning November 1, 2013. The land cost
$560,000 to develop. The company’s fiscal year ends on December 31.
Total Gross Profit:
$800,000 – $560,000 = $240,000
Gross Profit Percentage:
$240,000/$800,000 = 30%
Annual Gross Profit Recognition
Date
Nov. 1, 2013
Nov. 1, 2014
Nov. 1, 2015
Nov. 1, 2016
Totals
Cash Collected
$200,000
200,000
200,000
200,000
$800,000
Gross Profit
($240/$800=30%)
$ 60,000
60,000
60,000
60,000
$240,000
INSTALLMENT SALES METHOD
Example (continued – journal entries)
Installment Receivables
800,000
Inventory
560,000
Deferred Gross Profit
240,000
To record installment sale
Cash
200,000
Installment Receivables
200,000
To record cash collection from installment sale
Deferred Gross Profit
Realized Gross Profit
To recognize gross profit from installment sale
60,000
60,000
COST RECOVERY METHOD
Used when there is an extremely high degree of uncertainty regarding the
ultimate cash collection on an installment sale. All gross profit recognition
is deferred until the cost of the item sold has been recovered. After costs
have been recovered, any remaining cash collections are gross profit.
COST RECOVERY METHOD
Example
On November 1, 2013, the Belmont Corporation, a real estate developer, sold a tract of land for
$800,000. The sales agreement requires the customer to make four equal annual payments of
$200,000 plus interest on each November 1, beginning November 1, 2013. The land cost
$560,000 to develop. The company’s fiscal year ends on December 31.
Gross Profit Recognition
Date
Cash Collected
Cost Recovery
Nov. 1, 2013
$200,000
$200,000
Nov. 1, 2014
200,000
200,000
-0-
Nov. 1, 2015
200,000
160,000
40,000
Nov. 1, 2016
200,000
Totals
$800,000
-0$560,000
Gross Profit
$
-0-
200,000
$240,000
Nov 1
2013
Installment Receivables
800,000
Inventory
560,000
Deferred Gross Profit
240,000
COST RECOVERY METHOD
Journal Entries
To record installment sale
Nov 1
2013
Cash
200,000
Installment Receivables
200,000
To record cash collection from installment sale
No entry to recognize gross profit from installment sale in 2013 or 2014
Nov 1,
2015
Deferred Gross Profit
40,000
Realized Gross Profit
40,000
To recognize gross profit from installment sale
Nov 1,
2016
Deferred Gross Profit
Realized Gross Profit
To recognize gross profit from installment sale
200,000
200,000
This entry will be repeated
for 2014, 2015 & 2016.
Income Measurement
(Part 1)
I N T ERMEDIATE ACCOU N T I NG I – CHA PT ER 5
E N D OF P R ESENTATION