StIce | StIce |Skousen
Revenue Recognition
Chapter 8
Intermediate Accounting
16E
Prepared by: Sarita Sheth | Santa Monica College
COPYRIGHT © 2007
Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
Learning Objectives
1. Identify the primary criteria for
revenue recognition.
2. Apply the revenue recognition
concepts underlying the examples
used in SAB 101/104.
3. Record journal entries for longterm constructions-type contracts
using percentage of completion
and completed-contract methods.
Learning Objectives
4. Record journal entries for longterm service contracts using the
proportional performance
method.
5. Explain when revenue is
recognized after delivery of
goods or services through
installment sales, cost recovery,
and cash methods.
Revenue Recognition
•
1.
2.
•
1.
2.
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.
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.
Revenue Recognition
• The SEC issued SEC 101 in response
to specific abuses involving revenue
recognition.
• SAB 101 is in a question-and-answer
format. The answers given are
invariably “No.”
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.
GAAP requires percentage-of-completion method
unless certain criteria are not met.
Percentage-of-Completion
Method Requires
• Dependable estimates of:
– contract revenues
– contract costs
– progress toward completion
• Contract clearly specifies:
– enforceable rights of the parties
– consideration to be exchange
– manner and terms of settlement
• The buyer can be expected to satisfy
obligations under the contract.
• Contractor can be expected to perform
the contractual obligation.
Percentage-of-Completion
Method Requires
• Recognize revenue throughout life of the
contract.
• Revenue recognized is a function of how
complete the project is to date.
• Costs are charged to an inventory account:
Construction in Process (CIP).
• Profits are charged to CIP.
• CIP is valued at net realizable value.
• Any anticipated loss is booked for the full
amount of the loss when it becomes
measurable.
Percentage-of-Completion
Input Measures
• Cost-to-cost method-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.
Revision of Estimate
Instead of the previous illustration, assume that
at the end of 2005, it was estimated that the
remaining cost to complete construction was
$720,000 rather than $650,000.
Revision of Estimate
Year
2004
Actual
Cost
Incurred
Estimated
Cost to
Complete
Total
Cost
Cost
Percentage
$1,040,000 $1,560,000 $2,600,000
40
2005
910,000
Total
$1,950,000
720,000 2,670,000
73
2006
700,000
0 2,650,000
100
Total
$2,650,000
Note that expected
Items
gross
in profit
blue changed
was $400,000 in 2004,
$330,000 in 2005,
from
andthe
theprevious
actual was $350,000 in
illustration.
2006.
Revision of Estimate
• The entries for 2004 would be the same as those
shown in the previous example.
• All entries for 2005 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 x .73) –
$1,200,000
Revision of Estimate
2006
Construction in Progress
Materials, Cash, etc.
To record costs incurred.
Accounts Receivable
Progress Billings on
Construction Contracts
To record billings.
700,000
700,000
1,100,000
Same
1,100,000
Cash
L1,350,000
Accounts Receivable
1,350,000
Same
To record cash collections.
Revision of Estimate
2006
Cost of Long-Term Construction
Contracts
700,000
Construction in Progress
110,000
Revenue from Long-Term
Construction Contracts
810,000
$3,000,000
(1,200,000)
(990,000)
$ 810,000
Revenue Recognition After
Delivery of Goods
• Installment Sales Method- Recognizes
revenues and related expenses as cash is
received (used when collection is somewhat
uncertain).
• Cost Recovery Method- No income is
recognized on sale until the cost of the item
sold is recovered through cash receipts
(used when collection is very uncertain).
• Cash Method- Recognizes all expenses
immediately as incurred and all revenues
only when cash is collected.