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Chapter 8 Revenue Recognition

Scope
This Standard shall be applied in accounting for revenue arising from the following transactions and events: (a) the sale of goods; (b) the rendering of services; and (c) the use by others of entity assets yielding interest, royalties and dividends.

Measurement of revenue
Revenue shall be measured at the fair value of the consideration received or receivable. It is measured at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed by the entity.

Sale of goods
Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied: (a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) the amount of revenue can be measured reliably; (d) it is probable that the economic benefits associated with the transaction will flow to the entity; and (e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.

Rendering of services
When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognised by reference to the stage of completion of the transaction at the end of the reporting period. The outcome of a transaction can be estimated reliably when all the following conditions are satisfied: (a) the amount of revenue can be measured reliably; (b) it is probable that the economic benefits associated with the transaction will flow to the entity; (c) the stage of completion of the transaction at the end of the reporting period can be measured reliably; and (d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.*

Interest, royalties and dividends


Revenue arising from the use by others of entity assets yielding interest, royalties and dividends shall be recognised on the bases set out in paragraph 30 when: (a) it is probable that the economic benefits associated with the transaction will flow to the entity; and (b) the amount of the revenue can be measured reliably.

Table 1 - Revenue Recognition Time Line and Criteria Before the Point of Sale EXPECTION: Revenue can be recognized prior to the point of sale it. Criterion 1: Realized Customer provides a valid promise of payment AND After the Point of Sales EXCEPTION: The recognition of revenue must be deffered it. Customer does not provide a valid promise at time of receipt of product or service OR Significant effort remains on contract.

NORMAL: Revenue is generally recognized at this point in time Criterion 1 is typically satisfied at this point.

Criterion 2: Sunstantially complete

Conditions exist that contractually guarantee subsequent sale

Criterion 2 is typically satisfied at this point.

*Realized* can be interpreted as having cash or other assets received at some future time.

Revenue Recognition
AICPA Statement of Position 97-2 gives companies more guidance through a checklist of four factors that amplify the two criteria: 1) Persuasive evidence of an arrangement exists. 2) Delivery has occurred. 3) The vendors fee is fixed or determinable. 4) Collectibility is probable.

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

Example
Sales of goods

Accounting for a Layaway Sale


Seller Company receives $100 cash from a customer. The $100 payment is a partial payment for goods costing $1,000 with a total retail price of $1,500. The following entry shows the receipt of $100 cash as initial layaway payment. Cash 100 Deposit Received from Customers 100 Recording the receipt of the final $1,400 cash payment and the delivery of goods to customers requires two entries. One to record the sale and the second to remove the item from inventory and to record its cost. Cash 1,400 Deposit Received from Customer 100 Sales 1,500 Cost of Goods Sold Inventory Rendering of services 1,000 1,000

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 the service. The expected economic life of this service agreement is 100 months. An entry is required to show receipt of cash. Cash 1,000 Unearned Initial Sign-up Fees 1,000 A second entry is required to record receipt of the monthly payment. Cash 50 Monthly Service Revenue 50 Another entry is necessary to record partial recognition of the initial sign-up fee as revenue ($1,000/100 months). Unearned Initial Sign-up Fees 10 Initial Sign-up Fee Revenue 10

Rendering of service: Appropriate Accounting for a Contingent Rental On January 1, the 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 each month. The contingent payment is paid in one payment on December 31.

Rendering of service: 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.

Sale of Goods and Rendering of service: Asset-and-Liability Approach

A Contract Approach to Revenue Recognition


Wilks Company sells a plasma TV and 2-year warranty to a customer for the joint price of $2,000. Wilks Company has generated the following information regarding the sale of the plasma TV. Cost of plasma TV, $1,500 Sales price of plasma TV sold separately is unknown. Other consumer electronic products have profit margins that range between 16% and 22% of cost. Sales price of warranty if sold separately, unknown. A 2-year warranty for a refrigerator/freezer with the same wholesale cost sells for $300. Wilks estimates that repair costs for the plasma TV would be 5% higher ($300 + ($300 x .05) = $315). TV delivery obligation: $1,700 = $2,000 x [$1,785/($1,785 + $315)] Warranty service obligation: $300 = $2,000 x [$315/$1,785 + $315)] Rendering of service: Accounting for Long-Term Service Contracts A school enters into 100 contracts with students for a course. Each contract is $500, payable in advance. The total initial direct casts is $5,000. Actual direct costs for the first period are $12,000. The sales value of the lessons completed is $24,000 (if sold separately, $60,000)

Accounting for Consignments


Seller Company ships goods costing $1,000 on consignment to Consignee Company. The retail price of the goods is $1,500. -No sale should be recorded. However, there may be a journal entry made to reclassify the inventory.Inventory on Consignment 1,000 Inventory 1,000