Volume 2

18-1

CHAPTER
REVENUE

18

Intermediate Accounting IFRS Edition Kieso, Weygandt, and Warfield
18-2

Learning Objectives
1. 2. Apply the revenue recognition principle. Describe accounting issues for revenue recognition at point of sale. Apply the percentage-of-completion method for long-term contracts. Apply the cost-recovery method for long-term contracts. Identify the proper accounting for losses on long-term contracts. Describe the accounting issues for service contracts.

3.

4. 5. 6.

7.

Identify the proper accounting for multiple-deliverable arrangements.

18-3

Revenue Current Environment Revenue Recognition (At Point of Sale) Measurement Recognition Summary Revenue Recognition (LongTerm Contracts) Percentage-ofcompletion method Cost-recovery method Long-term contract losses Revenue Recognition (Other) Service contracts Multipledeliverable arrangements Other Summary of methods Guidelines for revenue recognition Departures from sale basis Disclosures 18-4 .

S.The Current Environment Revenue recognition is a top fraud risk and regardless of the accounting rules followed (IFRS or U. 18-5 . GAAP). Restatements for improper revenue recognition are relatively common and can lead to significant share price adjustments. the risk or errors and inaccuracies in revenue reporting is significant.

.The Current Environment Guidelines for Revenue Recognition Revenue recognition principle: Revenue is recognized (1) when it is probable that the economic benefits will flow to the company and (2) when the benefits can be measured reliably. 18-6 LO 1 Apply the revenue recognition principle.

rents. and royalties Gain or loss on disposition Timing of Revenue Recognition 18-7 Date of sale (date of delivery) Services performed and billable As time passes or assets are used Date of sale or trade-in LO 1 Apply the revenue recognition principle.The Current Environment Revenue Recognition Classified by Nature of Transaction Illustration 18-1 Type of Transaction Sale of product from inventory Rendering a service Permitting use of an asset Sale of asset other than inventory Description of Revenue Revenue from sales Revenue from fees or services Revenue from interest. .

18-8 LO 1 Apply the revenue recognition principle.The Current Environment Departures from the Sale Basis Earlier recognition is appropriate if there is a high degree of certainty about the amount of revenue earned. . Delayed recognition is appropriate if the  degree of uncertainty concerning the amount of revenue or costs is sufficiently high or  sale does not represent substantial completion of the earnings process.

 Trade discounts or volume rebates should reduce consideration received or receivable and the related revenue. seller should impute an interest rate for the difference between the cash or cash equivalent price and the deferred amount.Revenue Recognition at Point of Sale Measurement of Sale Revenue Revenue should be measured at the fair value of consideration received or receivable.  18-9 LO 2 Describe accounting issues for revenue recognition at point of sale. If payment is delayed. .

Revenue Recognition at Point of Sale Illustration 18-2 18-10 LO 2 Describe accounting issues for revenue recognition at point of sale. .

000 18-11 LO 2 Describe accounting issues for revenue recognition at point of sale. Accounts receivable Sales 679. .000 679. 2011.Revenue Recognition at Point of Sale Illustration 18-2 Sansung makes the following entry on March 31.

Revenue Recognition at Point of Sale Illustration 18-2 Assuming Sansung’s customers meet the discount threshold. .000 18-12 LO 2 Describe accounting issues for revenue recognition at point of sale. Sansung makes the following entry.000 679. Cash Accounts receivable 679.

Cash Accounts receivable Sales discounts forfeited 700.000 21. .000 18-13 LO 2 Describe accounting issues for revenue recognition at point of sale.Revenue Recognition at Point of Sale Illustration 18-2 If Sansung’s customers fail to meet the discount threshold. Sansung makes the following entry upon payment.000 679.

a rate of interest that discounts the nominal amount of the instrument to the current sales price of the goods or services. the prevailing rate for a similar instrument of an issuer with a similar credit rating. Imputed interest rate is the more clearly determinable of either 1. .Revenue Recognition at Point of Sale Measurement of Sale Revenue When a sales transaction involves a financing arrangement. or 2. 18-14 LO 2 Describe accounting issues for revenue recognition at point of sale. the fair value is determined by discounting the payment using an imputed interest rate.

Revenue Recognition at Point of Sale Illustration 18-3 18-15 LO 2 Describe accounting issues for revenue recognition at point of sale. .

Notes receivable Sales 900.Revenue Recognition at Point of Sale Illustration 18-3 The journal entry to record SEK’s sale to Grant Company on July 1. 2011. is as follows (ignoring cost of goods sold entry). .000 18-16 LO 2 Describe accounting issues for revenue recognition at point of sale.000 900.

.000 18-17 LO 2 Describe accounting issues for revenue recognition at point of sale.000 54.000) 54.Revenue Recognition at Point of Sale Illustration 18-3 SEK makes the following entry to record interest revenue. Notes receivable Interest revenue (12% x ½ x €900.

Company has transferred to the buyer the significant risks and rewards of ownership of the goods. 18-18 LO 2 . 3.Revenue Recognition at Point of Sale Recognition of Sale Revenue Revenue from the sale of goods is recognized when all the following conditions are met: 1. 4. It is probable that the economic benefits will flow to the company. and 5. The amount of revenue can be measured reliably. The costs incurred or to be incurred can be estimated reliably. Company retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold. 2.

. Illustration 18-4 18-19 LO 2 Describe accounting issues for revenue recognition at point of sale.Revenue Recognition at Point of Sale Bill and Hold Sales Buyer is not yet ready to take delivery but does take title and accept billing.

2. and ready for delivery at the time the sale is recognized. and 4. Baristo acknowledges the deferred delivery arrangement. the item is on hand. 18-20 LO 2 . the usual payment terms apply.Revenue Recognition at Point of Sale Solution: Butler should record the revenue at the time title passes. It appears that these conditions were probably met and therefore revenue recognition should be permitted at the time the agreement is signed. it is probable that delivery will be made. identified. 3. provided 1.

Accounts receivable 450. .000 Sales 450.Revenue Recognition at Point of Sale Illustration 18-4 Butler makes the following entry to record the bill and hold sale.000 18-21 LO 2 Describe accounting issues for revenue recognition at point of sale.

.Revenue Recognition at Point of Sale Sales Subject to Installation or Inspection Illustration 18-5 18-22 LO 2 Describe accounting issues for revenue recognition at point of sale.

Revenue Recognition at Point of Sale Layaway Sales Illustration 18-6 18-23 LO 2 Describe accounting issues for revenue recognition at point of sale. .

recording the sale. but reducing sales by an estimate of future returns. not recording a sale until all return privileges have expired or 2. 18-24 LO 2 Describe accounting issues for revenue recognition at point of sale. .Revenue Recognition at Point of Sale Sales with Right of Return Two possible revenue recognition methods are available when the right of return exposes the seller to continued risks of ownership: 1.

.Revenue Recognition at Point of Sale Illustration 18-7 18-25 LO 2 Describe accounting issues for revenue recognition at point of sale.

August 1.000 10. 2011. 2011 300.Revenue Recognition at Point of Sale Pesido sold $300. On October 15.000 Sales returns and allowances Accounts receivable 18-26 10.000 of laser equipment on August 1. 2011.000 300.000 LO 2 .000 in equipment was returned. $10. 2011 Accounts receivable Sales October 15. and retains only an insignificant risk of ownership.

Pesido makes the following entry to record the expected returns. 2011. Pesido estimates that returns on the remaining balance will be 4 percent. .600 [($300. 2011 Sales returns and allowances Allowance for sales returns and allowances 11. December 31.000 .600] 18-27 LO 2 Describe accounting issues for revenue recognition at point of sale.000) x 4% = 11. based on prior experience.600 11.Revenue Recognition at Point of Sale At December 31.$10.

.Revenue Recognition at Point of Sale Illustration 18-8 18-28 LO 2 Describe accounting issues for revenue recognition at point of sale.

000 115.000 135. Cash Sales Cost of Goods Sold Inventory 115.000 135.Revenue Recognition at Point of Sale Illustration 18-8 Morgan records the sale and related cost of goods sold as follows.000 18-29 LO 2 Describe accounting issues for revenue recognition at point of sale. .

Revenue Recognition at Point of Sale Principal-Agent Relationships  Amounts collected on behalf of the principal are not revenue of the agent.  18-30 LO 2 Describe accounting issues for revenue recognition at point of sale. Revenue for the agent is the amount of the commission it receives. .

   Consignee makes a commission on the sale. .Revenue Recognition at Point of Sale Consignments  Manufacturers (or wholesalers) deliver goods but retain title to the goods until they are sold. who is to act as an agent for the consignor in selling the merchandise. 18-31 LO 2 Describe accounting issues for revenue recognition at point of sale. Consignor makes a profit on the sale. Consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer).

known as the trade. uneconomic. and then recorded revenue when the software left the loading dock. insidious practice through which manufacturers—trying to show sales. Channel stuffing.a crazy. it offered deep discounts to its distributors to overbuy. and market share they don’t actually have—induce their wholesale customers. profits. When a software maker needed to make its financial results look good.Revenue Recognition at Point of Sale Trade Loading and Channel Stuffing Trade loading . 18-32 LO 2 Describe accounting issues for revenue recognition at point of sale. to buy more product than they can promptly resell. .

Long-Term Contracts (Construction) Two methods of accounting for long-term construction contracts:   Percentage-of-completion method. Cost-recovery (zero-profit) method. 18-33 .

Long-Term Contracts (Construction) Rationale for using percentage-of-completion accounting is that under most of these contracts. a continuous sale occurs as the work progresses and companies should recognize revenue according to that progression.   18-34 . Seller has the right to require progress payments that provide evidence of the buyer’s ownership interest. Buyer has the legal right to require specific performance on the contract. the   Buyer and seller have enforceable rights. As a result.

2. and 4. It is probable that the economic benefits associated with the contract will flow to the company. Total contract revenue can be measured reliably. Both the contract costs to complete the contract and the stage of contract completion at the end of the reporting period can be measured reliably. 3. 1.Long-Term Contracts (Construction) Companies must use the percentage-of-completion method when all of the following conditions exist. 18-35 . The contract costs attributable to the contract can be clearly identified and measured reliably so the actual contract costs incurred can be compared with prior estimates.

Long-Term Contracts (Construction) Companies should use the cost-recovery method when one of the following conditions applies: 1. When a company cannot meet the conditions for using the percentage-of-completion method. When there are inherent hazards in the contract beyond the normal. or 2. recurring business risks. 18-36 .

Long-Term Contracts (Construction) Percentage-of-Completion Method Calculation for Revenue to Be Recognized Illustration 18-11 Illustration 18-12 Illustration 18-13 18-37 LO 3 Apply the percentage-of-completion method for long-term contracts. .

000 bridge at an estimated cost of €4. and the bridge is to be completed in October 2012. 18-38 LO 3 Apply the percentage-of-completion method for long-term contracts. .000.000. The following data pertain to the construction period.500. The contract is to start in July 2010.Long-Term Contracts (Construction) Illustration: KC Construction Company has a contract to construct a €4.

.Long-Term Contracts (Construction) Illustration: Compute percentage complete. Illustration 18-6 18-39 LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Illustration: KC would make the following entries to record (1) the costs of construction. and (3) collections. . Illustration 18-7 18-40 LO 3 Apply the percentage-of-completion method for long-term contracts. (2) progress billings.

Revenue and Gross Profit.Long-Term Contracts (Construction) Percentage-of-Completion. by Year Illustration 18-16 18-41 .

Illustration 18-17 18-42 LO 3 Apply the percentage-of-completion method for long-term contracts. .Long-Term Contracts (Construction) Illustration: KC’s entries to recognize revenue and gross profit each year and to record completion and final approval of the contract.

.Long-Term Contracts (Construction) Illustration: Content of Construction in Process Account— Percentage-of-Completion Method Illustration 18-18 18-43 LO 3 Apply the percentage-of-completion method for long-term contracts.

.Long-Term Contracts (Construction) Financial Statement Presentation—Percentage-ofCompletion Computation of Unbilled Contract Price at 12/31/10 Illustration 18-19 18-44 LO 3 Apply the percentage-of-completion method for long-term contracts.

Long-Term Contracts (Construction) Financial Statement—Percentage-of-Completion Illustration 18-20 18-45 LO 3 .

Cost-Recovery (Zero-Profit) Method
Illustration: For the bridge project illustrated on the preceding pages, Hardhat Construction would report the following revenues and costs.
Illustration 18-21

18-46

LO 4 Apply the cost-recovery method for long-term contracts.

Cost-Recovery (Zero-Profit) Method
Illustration: Hardhat’s entries to recognize revenue and gross profit each year and to record completion and final approval of the contract.
Illustration 18-22

18-47

LO 4 Apply the cost-recovery method for long-term contracts.

Cost-Recovery (Zero-Profit) Method
Illustration: Comparison of gross profit recognized under different methods.
Illustration 18-23

18-48

LO 4 Apply the cost-recovery method for long-term contracts.

Long-Term Contracts (Construction) Financial Statement—Cost-Recovery Method Illustration 18-24 18-49 LO 4 Apply the cost-recovery method for long-term contracts. .

000 170.000 300. 18-50 LO 3 Apply the percentage-of-completion method for long-term contracts. . Contract price Cost incurred current year Estimated cost to complete in future years Billings to customer current year Cash receipts from customer Current year 2010 €675.000 A) Prepare the journal entries for 2010.400 170. 2011.000 262. and 2012.500 2011 €675.100 0 180.000 450.000 287.000 135.000 150.Long-Term Contracts (Construction) Illustration: Casper Construction Co.500 2012 €675.100 360.000 112.

000) € 18.000 450.750 2010 € 150.750 (150.750 2011 € 437.750) 317.0% 675. percentage complete Contract price Revenue recognizable Rev. recognized currently Costs incurred currently Gross profit recognized 168.850 607.000 (168.000) 189.000 600.0% 675.000 168. recognized prior year Rev.Long-Term Contracts (Construction) Illustration: Costs incurred to date Estimated cost to complete Est.250 (287.0% 675.000 25.100 607.100) € 18.500 72.900 2012 € 607.500 100.000 (486.400) € 29.000 (170. total contract costs Est.500 18-51 LO 3 Apply the percentage-of-completion method for long-term contracts.000 486. .000 675.400 170.

000 135.000 262.500 112.Long-Term Contracts (Construction) Illustration: Construction in progress Cash Accounts receivable Billings on contract Cash Accounts receivable Construction in progress Construction expense Construction revenue Billings on contract Construction in progress 2010 150.000 150.100 189.000 2012 170.000 675.850 287.000 2011 287.000 180.100 170.400 287. .500 18.000 18-52 LO 3 Apply the percentage-of-completion method for long-term contracts.100 180.500 262.000 135.000 168.750 29.400 317.750 150.000 300.900 170.500 18.000 300.000 112.400 360.250 675.000 360.

400 29.250 287.000 18.500 33.000 - 9.850 2012 $ 189.000 170.000 18-53 LO 3 Apply the percentage-of-completion method for long-term contracts.750 120.750 2011 $ 317.750 150.900 Balance Sheet (12/31) Current assets: Accounts receivable Cost & profits > billings Current liabilities: Billings > cost & profits 22. .100 18.Long-Term Contracts (Construction) Illustration: Income Statement Revenue on contracts Cost of construction Gross profit 2010 $ 168.

18-54 LO 4 Apply the cost-recovery method for long-term contracts. . Only after all costs are incurred is gross profit recognized.Long-Term Contracts (Construction) Cost-Recovery Method Companies recognize revenue only to the extent of costs incurred that are expected to be recoverable.

400 287.400 287.000 360.000 LO 4 Apply the cost-recovery method for long-term contracts.500 2012 170.000 300.000 675.000 135.500 2011 287.Cost-Recovery Method Illustration: Construction in progress Cash Accounts receivable Billings on contract Cash Accounts receivable Construction in progress Construction expense Construction revenue Billings on contract Construction in progress 18-55 2010 150. .100 170.500 112.000 150.000 180.600 675.000 112.400 360.100 150.000 135.000 262.000 287.400 237.100 180.000 300.000 150.000 67.500 170.500 262.

Cost-Recovery Method Illustration: Income Statement Revenue on contracts Cost of construction Gross profit 2010 €0 2011 €0 2012 € 675.600 18-56 LO 4 Apply the cost-recovery method for long-term contracts.000 120.500 15.000 607. .000 - 57.500 Balance Sheet (12/31) Current assets: Accounts receivable Cost & profits > billings Current liabilities: Billings > cost & profits 22.500 67.

 Loss on an Unprofitable Contract ► Under both percentage-of-completion and completedcontract methods. . the estimated cost increase requires a current-period adjustment of gross profit recognized in prior periods.Long-Term Contracts (Construction) Long-Term Contract Losses  Loss in the Current Period on a Profitable Contract ► Percentage-of-completion method only. the company must recognize in the current period the entire expected contract loss. 18-57 LO 5 Identify the proper accounting for losses on long-term contracts.

436 0 180.000 287. 18-58 LO 5 Identify the proper accounting for losses on long-term contracts.436 instead of €170.500 2011 €675.100.000 112. 2011.000 b) Prepare the journal entries for 2010.436 360. .000 262. and 2012 assuming the estimated cost to complete at the end of 2011 was €215.400 215.Long-Term Contract Losses Illustration: Loss in Current Period Casper Construction Co.000 215.000 300. Contract price Cost incurred current year Estimated cost to complete in future years Billings to customer current year Cash receipts from customer Current year 2010 €675.500 2012 €675.000 450.000 150.000 135.

0% 675.000) € 18.750) 283.250 (168.836 652.750 168.250) 222. percentage complete Contract price Revenue recognizable Rev. recognized currently Costs incurred currently Gross profit recognized 18-59 2011 € 437.400) (€ 3.Long-Term Contract Losses Illustration: Loss in Current Period 2010 Costs incurred to date Estimated cost to complete Est.314 € 150.750 (215.436 652.000 168.000 25.400 215.436) € 7.000 600. total contract costs Est.836 67.750 (150.0% 675.0% 675.000 450. recognized prior year Rev.000 452.750 LO 5 Identify the proper accounting for losses on long-term contracts.000 (452. .500 (287.900) 2012 € 652.000 675.836 100.

500 2011 2012 7.750 150.900 287.400 283.314 215.Long-Term Contract Losses Illustration: Loss in Current Period 2010 Construction in progress Construction expense Construction revenue Construction in progress Construction expense Construction revenue 18.436 222. .000 168.750 3.750 18-60 LO 5 Identify the proper accounting for losses on long-term contracts.

038 instead of € 170. and 2012 assuming the estimated cost to complete at the end of 2011 was € 246.000 135.500 2012 €675.000 112. . Contract price Cost incurred current year Estimated cost to complete in future years Billings to customer current year Cash receipts from customer Current year 2010 €675.000 287.000 150. 2011.000 300.100.Long-Term Contract Losses Illustration: Loss on Unprofitable Contract Casper Construction Co.400 246.038 360.000 450.000 c) Prepare the journal entries for 2010. 18-61 LO 5 Identify the proper accounting for losses on long-term contracts.500 2011 €675.038 0 180.000 246.000 262.

000 600.000 168.000 (243.750) 263.000) €0 2012 € 683.438) (€ 27. recognized currently Costs incurred currently Gross profit recognized 168.000) 243.000) € 18.750 2011 € 437.000 450.038 683.000 – 683.000 675.0% 675.750 € 150.000 25.0% 675.000 432.000 (432.188) 683.0% 675. recognized prior year Rev.438 $675.438 100. total contract costs Est. percentage complete Contract price Revenue recognizable Rev.Long-Term Contract Losses Illustration: Loss on Unprofitable Contract 2010 Costs incurred to date Estimated cost to complete Est.000 (168.438 = (8.750 (150.438) cumulative loss 18-62 Plug LO 5 .400 246.250 (290.438 64.

188 290.Long-Term Contract Losses Illustration: Loss on Unprofitable Contract 2010 Construction in progress Construction expense Construction revenue Construction in progress Construction expense Construction revenue 18. .000 168.000 243.750 27.000 18-63 LO 5 Identify the proper accounting for losses on long-term contracts.250 2011 2012 243.438 263.750 150.

.438 18-64 LO 5 Identify the proper accounting for losses on long-term contracts.Long-Term Contract Losses Illustration: Loss on Unprofitable Contract For the Cost-Recovery method.438 8. companies would recognize the following loss: 2010 Loss on construction contract Construction in progress Construction expense Construction revenue 287.400 2011 8.400 287.

Long-Term Contract Losses Disclosures in Financial Statements Construction contractors should disclosure:  Revenue recognized during the period and the methods used to determine the contract revenue and stage of completion. For contracts in progress. amount of advances received. and amount of retentions. 18-65 LO 5 Identify the proper accounting for losses on long-term contracts.  Any contingent assets or liabilities related to these contracts. ►  aggregate amount of costs incurred and recognized net income. .

18-66 LO 6 Describe the accounting issues for service contracts. and Costs must be reliably measurable. Stage of completion must be reliably measurable.    Economic benefits are probable.Other Revenue Recognition Issues Service Contracts Follow the same criteria as long-term contracts. . To recognize revenue:  It must be reliably measurable.

.Other Revenue Recognition Issues Service Contracts Single Act: Revenue recognized at the time of the act. 3. Unspecified number of identical acts or similar acts with a fixed period for performance. More Than One Act: Revenue recognized as various acts occur. 18-67 LO 6 Describe the accounting issues for service contracts. 2. Specified number of identical or similar acts. Three circumstances: 1. Specified number of defined but not identical acts.

.Other Revenue Recognition Issues 18-68 LO 6 Describe the accounting issues for service contracts.

000.000 200.000. Jackson makes the following entries in 2011 to recognized revenue on the Andes contract.000 LO 6 .000 December 31.000 600.Other Revenue Recognition Issues Assuming R&D services are provided according to the contract in 2011. 2011 Cash Unearned R&D service revenue 1. January 1.000 1. 2011 Cash Unearned R&D Service Revenue R&D Service Revenue 18-69 400.

Other Revenue Recognition Issues 18-70 LO 6 Describe the accounting issues for service contracts. .

Other Revenue Recognition Issues

18-71

LO 6 Describe the accounting issues for service contracts.

Other Revenue Recognition Issues

18-72

LO 6 Describe the accounting issues for service contracts.

Other Revenue Recognition Issues

SeniorLife makes the following entries related to the contract.
January 1, 2011

Cash Unearned service revenue
December 31, 2011

300,000 300,000

Unearned service revenue Service Revenue
December 31, 2012

60,000 60,000

Unearned service revenue Service Revenue
18-73

105,000 105,000

Other Revenue Recognition Issues Multiple-Deliverable Arrangements (MDAs) MDAs provide multiple products or services to customers as part of a single arrangement. Major accounting issues  how to allocate the revenue to the various products and services and how to allocate the revenue to the proper period.  18-74 LO 7 Identify the proper accounting for multiple-deliverable arrangements. .

provided that: 1. A delivered item has value to the customer on a standalone basis. . Delivery or performance of the undelivered item is considered probable and substantially in the control of the seller. and 2.Other Revenue Recognition Issues Multiple-Deliverable Arrangements (MDAs) All units in a MDA are considered separate units of accounting. and 3. 18-75 LO 7 Identify the proper accounting for multiple-deliverable arrangements. The arrangement includes a general right of return relative to the delivered item.

Other Revenue Recognition Issues Multiple-Deliverable Arrangements (MDAs) Illustration 18-33 18-76 LO 7 Identify the proper accounting for multiple-deliverable arrangements. .

.Illustration 18-34 18-77 LO 7 Identify the proper accounting for multiple-deliverable arrangements.

.Other Revenue Recognition Issues Other Revenue Situations    Interest. Royalties. and Dividends Accretion Completion-of-Production Basis 18-78 LO 7 Identify the proper accounting for multiple-deliverable arrangements.

The same situation occurs in the United States as evidenced by revenue recognition breakdowns at telecom company Global Crossing (USA). 18-79 . and utility company Enron (USA).S. The IASB defines revenue to include both revenues and gains. U.  Revenue recognition fraud is a major issue in revenue recognition. technology company Lucent Technologies (USA). GAAP provides separate definitions for revenues and gains.

If revenues and costs are difficult to estimate. the revenues and costs must be capable of being measured reliably.  18-80 . U. or receiving investment income. Companies generally use the percentage-of-completion method. GAAP permits the use of the completed-contract method of accounting for long-term construction contracts (IAS 11). then companies recognize revenue only to the extent of the cost incurred—a zero-profit approach under IFRS. rendering the service.S. In addition. the standard is based on the probability that the economic benefits associated with the transaction will flow to the company selling the goods. U. A specific standard exists for revenue recognition under IFRS (IAS 18). GAAP uses concepts such as realized or realizable.S. and earned as a basis for revenue recognition. In general.

 18-81 .S. Under GAAP. GAAP does not allow the percentage-of-completion method for service contracts. Under IFRS. GAAP provides detailed guidance in multiple-deliverable arrangements. U. costs can be deferred if the company is using percentage-of-completion.S. IFRS guidance is more general. U. costs are generally expensed as incurred.

. 18-82 LO 8 Explain revenue recognition for franchises sales. Continuing fees based on the operations of franchises.Franchises Two sources of revenue: 1. Sale of initial franchises and related assets or services. and 2.

5. and equipment. 18-83 LO 8 Explain revenue recognition for franchises sales. 8. Employee and management training. Quality control. Assistance in the acquisition of signs. 3. fixtures. Evaluation of potential income. Advertising and promotion. . Bookkeeping and advisory services. 7. 2.Franchises The franchisor normally provides the franchisee with: 1. 6. Supervision of construction activity. Assistance in site selection. 4.

.Initial Franchise Fees Franchisors record initial franchise fees as  revenue only when and as they make “substantial performance” of the services they are obligated to perform and when collection of the fee is reasonably assured. 18-84 LO 8 Explain revenue recognition for franchises sales. Substantial performance occurs when the franchisor has no remaining obligation to refund any cash received or excuse any nonpayment of a note and has performed all the initial services required under the contract.

$10. . charges an initial franchise fee of $50.000 each.000 for the right to operate as a franchisee of Tum’s Pizza.000 is payable when the franchisee signs the agreement. and the balance is payable in five annual payments of $8.942.000 each discounted at 8 percent is $31. Of this amount. The credit rating of the franchisee indicates that money can be borrowed at 8 percent. 18-85 LO 8 Explain revenue recognition for franchises sales. The present value of an ordinary annuity of five annual receipts of $8.058 represents the interest revenue to be accrued by the franchisor over the payment period. The discount of $8.Example of Entries for Initial Franchise Fee Illustration: Tum’s Pizza Inc.

942 18-86 LO 8 Explain revenue recognition for franchises sales.Example of Entries for Initial Franchise Fee Illustration: 1. the entry should be: Cash Notes Receivable Unearned Franchise Fees 10.000 31.. If there is reasonable expectation that Tum’s Pizza Inc.942 41. may refund the down payment and if substantial future services remain to be performed by Tum’s Pizza Inc. .

the amount of future services to be provided to the franchisee is minimal.000 31.Example of Entries for Initial Franchise Fee Illustration: 2. . the entry should be: Cash Notes Receivable Revenue from Franchise Fees 10.942 18-87 LO 8 Explain revenue recognition for franchises sales. and substantial performance has occurred. collectibility of the note is reasonably assured.942 41. If the probability of refunding the initial franchise fee is extremely low.

with a significant amount of services still to be performed by Tum’s Pizza in future periods.000 31. and collectibility of the note is reasonably assured.942 18-88 LO 8 Explain revenue recognition for franchises sales.942 Revenue from Franchise Fees Unearned Franchise Fees 10.000. represents a fair measure of the services already provided. . the entry should be: Cash Notes Receivable 10.00 31. If the initial down payment is not refundable.Example of Entries for Initial Franchise Fee Illustration: 3.

000 18-89 LO 8 Explain revenue recognition for franchises sales. If the initial down payment is not refundable and no future services are required by the franchisor. .000 10.Example of Entries for Initial Franchise Fee Illustration: 4. but collection of the note is so uncertain that recognition of the note as an asset is unwarranted. the entry should be: Cash Revenue from Franchise Fees 10.

Under the same conditions as those listed in case 4 above. 18-90 LO 8 Explain revenue recognition for franchises sales. .000 In cases 4 and 5 — where collection of the note is extremely uncertain— franchisors may recognize cash collections using the cost-recovery method. the entry should be: Cash Unearned Franchise Fees 10. except that the down payment is refundable or substantial services are yet to be performed.Example of Entries for Initial Franchise Fee Illustration: 5.000 10.

Continuing Franchise Fees Continuing franchise fees are received in return for the continuing rights granted by the franchise agreement and for providing such services as management training. Franchisors report continuing fees as revenue when they are earned and receivable from the franchisee. and other support. 18-91 LO 8 Explain revenue recognition for franchises sales. legal assistance. . advertising and promotion.

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