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FRA

Sessions 6-7

Revenue and Monetary


Assets

In box
When should revenue be recognized?
How much revenue should be
recognized?
How to measure monetary assets ?

Operating Cycle

Cash-to-cash

Purchase materials/services & pay


cash
Convert materials/services to
salable product
Inspect the product/service
Store product
Receive order from the customer
Ship the product and send the
invoice
Acknowledgement of receipt of
product by customer

Revenue recognition: When?


(Timing)

At one point in revenue cycle


(objectivity)
Criteria:
When Earned? (Conservatism)
Normally, goods shipped
Service performed

Basic Revenue Recognition


criteria
1. Substantial Performance
2. Reliable Measurement
3. Conversion into cash or claims for
cash

According to FASB

Revenue should not be


recognized until
It is
Realized or realizable
and earned

Can you recognize


Revenue?

When
Sales orders are received
Deposit or advance payment is received
Goods are manufactured
Goods are stored after the production
process
- Goods shipped or services rendered/
performed
- Customer pays dues/ARs

Revenue recognition: How much?


(Amount)

How much Realized or


realizable (Realization)?
Already collected or
collectible
Amount can be
measured reliably

Timing of Revenue
Recognition
Illustration 5-2 [Event-Time of RRMethod of RR]
- Sales order received
- Deposit or advance payment received
- Goods produced
- Production completed & goods stored
- Goods delivered or services performed
- Customer pays accounts receivable

IFRS vs GAAP on RR
RR on the transfer of risks and
rewards of ownership IFRS
RR when it is earned GAAP
But accounting for Revenue
transaction would be the same
under both GAAP & IFRS

Conditions for RR under IFRS


[ all need to be satisfied]
Transfer of significant risks and
rewards of ownership of goods by seller
to the buyer
No managerial involvement and control
in the goods sold by the seller
Reliable measurement of revenue amount
Economic benefits of the transaction go
to the seller
Reliable measurement of the costs of the
transaction

Common types of fraudulent RR


practices
Fictitious revenue
Swaps
,
round-tripping
&
Barter
arrangements
Sales transactions billed but not shipped
RR from transactions with unresolved
contingencies
Improper accounting for or failure to
establish appropriate reserves for
rights to refund or exchange , liberal
cancellation or refusal rights or liberal or
unconditional rights of return granted
through undisclosed oral or written

Channel stuffing is legal


when
All the GAAP requirements for
RR are met and
Disclosure of channel stuffing
to investors

SEC : Criteria for


Revenue Realized & Earned[SAB 101]
Persuasive evidence of an order
Delivery occurred or services
performed[ customers place of
business, no uncertainty exists,
substantial performance,
license term begins]
Fixed or determinable selling price
Reasonably assured collectability

Delivery Method
Recognize revenue when goods
or services are delivered
For goods: when title transfers
shipping point (when goods are
given to carrier)

Examples:
Order is received for INR 5000.
Sales entry?
Goods are produced. Sales entry?
Goods are shipped. Sales entry?

Consignment Transactions
No RR until the goods are sold by the
consignee- till that time, the
consignee does not assume the
risks and rewards of ownership
Consignment of goods- treated as
mere movement of goods

Consignment Method

Consignor ships goods to consignee.


Inventory on consignment A/c DR 1,000
To Merchandise inventory A/c 1,000

Consignor retains title until goods are sold to


customer.
At sale:
Accounts receivable A/c Dr 1,400
To Sales revenue A/c 1,400
COGS A/c Dr 1,000
To Inventory on consignment A/c

1,000

Problem 5-5

Problem 5-5
In the books of Green Lawn
- When goods were sent on consignment
Inventory on Consignment A/C Dr $8,400
To Finished Goods Inventory A/c $8,400
-When goods are sold by the consignee
[ Carson]
A/R A/c Dr To Sales A/c $ 5,040
CGS A/c Dr to Inventory on Consignment A/c
3,360

Problem 5-5
In the books of Carson
- When goods are received on
consignment
No entry- neither own the goods nor
owe to Green Lawn for the goods
- When goods received on
consignment are sold
Cash or A/R A/c Dr To Sales Revenue
A/c $6,720
CGS A/c Dr to Accounts Payable A/c

Franchise Revenue
Recognize:
When earned/ services rendered
Not necessarily when
agreement signed or fee
received
Normally after the
commencement of operations by
franchisee

Franchise Revenue Example


Mcdonalds charges a franchise
fee primarily for identifying the
site, designing the store, training
management and staff, and
otherwise helping to get the
franchise started in business.
Assume the initial fee is
INR10,00,000. When should
this 10,00,000 be recorded as

Franchise Revenue
-Example
Hudson.Agro receives
INR60,000 from a franchisee
for the right to use its
trademark for ARUN
ICECREAM for a period of 5
years. When should the
INR60,000 be recognized as
revenue?

Percentage-of-Completion Method
Design/development and
construction/production projects that
extends over several years
Customer pays either on fixed price or
cost reimbursement contract method
Reasonable assurance of profit margin and
ultimate realization
Revenue recognized based on total
percentage of project work performed
during period

Problem 5-6

Problem 5-6
Particulars
Revenue[
in $]
Expenses
[ in $]
Income
[ in $]

2004
9,80,000

2005
2006
14,70,000 22,05,000

7,21,000

11,90,000 17,15,000

2,59,000 2,80,000 4,90,000

Completed Contract
Method
When
Amount of income to be earned on
contract cannot reasonably be
determined

Alternative is completed contract


method
Costs incurred are an
asset/inventory (Contract Work in
Progress) until revenue is recognized

Illustration 5-3 [page


no.114]
Completed Contract vs Percentage
of Completion Method
Fixed Price contracts require
milestones
Cost-reimbursement contract
requires the formulae for RR
Customer payments are
irrelevant in computing revenue
under completed or percentage
of completion method

Problem 5-2

Problem 5-2

Particulars] Completed
Contract
Current
year

Completed
ContractNext Year

%
%
completion completion
current
- Next Year
year

Income
excluding
Motel[$00
0]

1,250

1,250

1,250

450

300

1,700

1,550

1,250

Income
0
from motel
project[$0
00]
EBT[$000 1,250
]

750

2,000

Production Method
Applies to agricultural and mining
companies
Criteria:
Clear market determined price
Performance substantially
completed[harvest]
Fluctuating prices of mining products

Permitted but not required by GAAP

Installment Method

Customer pays a certain amount per period


Installment payment is recognized as
revenue and a proportional part of cost of
sales is recorded- Pure Installment
method
Under cost recovery method, cost is
recorded equal to installment payment until
total cost of sales is covered
Example [ page no.115]

Problem 5-1

Problem 5-1
Sales
Jan
Method

Feb

Mar

Apr

May

June

Sales

8,000

13,000

11,000

9,000

13,500

7,800 5,200

8,450

7,150

5,850

8,775

4,200 2,800

4,550

3,850

3,150

4,725

Sales

11,00
0

10,000

11,500

10,500

10,500

9,500

CGS

7,150

6,500

7,425

6,825

6,825

6,175

Gross
Profit

3,850 3,500

4,025

3,675

3,675

3,325

CGS
Gross
Profit

12,00
0

Install
ment
method

Real
Estate
Sales
Developer often finances over many years
Uncertainty of income due to uncertainty of
receipt of future payments
Conditions required for revenue
recognition:
Period allowing cancellation and refund to buyer
has expired
Cumulative payments equal to 10% of purchase
price
Seller has completed or is clearly capable of
completing required improvement

Real Estate Sales


If seller completes the improvement- delivery
method
If the improvement is semi complete or in process% completion method
If receipt of proceeds is uncertain- Installment
method
If any of the 3 conditions not fulfilled- then
the amount received from customer shown as
Deposits on land sales in the liability side of
B/S
Similar treatment for commercial sale of land

Amount of Revenue RecognizedAR

Net realizable value (amount


reasonably estimated to be collected)
2 approaches for Bad debts
Direct write-off method[ requires
identification of specific uncollectable
accounts]
Allowance method
% of sales or % of AR

Bad Debts
Direct Write-Off Method

Write-off when specific account


that is uncollectible is identified
Bad debts expense A/c Dr
To A/R A/c
Why is this not acceptable
under GAAP?

Allowance Method
Estimate amount of current period
credit sales that will not be collected
Historical % of sales tempered by
judgment.
Historical % of aged receivables (+
judgment)

Adjusting entry at end of period


When an uncollectible account is
identified, it is written off

Bad Debt -Example


Amount of revenue recognized:
Sales for the year were INR2,000 for cash
and INR 6,000 on credit
Historically we dont collect about 5% of our
credit sales due to customer bankruptcies
or unable to locate customer
A customer, The XYZ Company went
bankrupt. They owed us 175
Entry for revenue?
Entry for bad debts - direct write-off (notGAAP)?
Entries for bad debts (allowance method)?

Bad Debt- Example


Balances in Accounts
Accounts receivable dr 3,000
Consisting of 2,000 current and 1,000 overdue

Allowance for doubtful accounts cr 50

Estimated amount of accounts that are


uncollectible:
2% for current and 10% for non-current accounts

What entry do we make at the end of the


year to accrue for bad debts?

Aging Schedule
Categories: Current, o/s less than
30 days, 30-60 days, 61-90 days, 91180, above 180 days
Amount O/S
Estimated % of uncollectible
Allowance for DD

Allowance Method
Allowance is a contra-asset
account
Collection of a bad debt that
was written-off:
Cash A/c Dr
To Allowance for Doubtful Accounts
- In B/S , AR is shown net of
allowance for doubtful accounts

If certainty exists about the non


payment of a customer
Allowance for Doubtful Accounts Dr
To A/R A/c
- In B/S both the allowance and A/R is
reduced by this amount
- If that customer repays the
amount, then
Cash A/c Dr
To Allowance for Doubtful Accounts

Problem 5-3

Problem 5-3
Under Direct Write off Method
- To record the write off
Bad debt expense A/c Dr $3,000
To Accounts Receivable A/C $3,000
-To record the partial payment
Cash A/c Dr $950
To Bad debts recovered A/c $950

Problem 5-3
Under the Allowance method
- To record the write-off
Allowance for Doubtful A/c Dr $ 3,000
To Accounts Receivable A/c $ 3,000
- To record the partial amount
Cash A/c Dr $ 950
To Allowance for Doubtful A/c $950

Problem 5-4

Problem 5-4- Allowance for Doubtful


accounts
Days
Amount [ in Expected %
Account O/S $]
uncollectibl
e
0-15 days
4,50,000
0.01
16-30 days 1,50,000
0.06
31-45 days
75,000
0.20
46-60 days
45,000
0.35
61-75 days
15,000
0.50
Balance
for
Allowance
for
Doubtful

Estimated
Uncollectibl
e[in $]
4,500
9,000
15,000
15,750
7,500
51,750

Problem 5-4- Allowance for


Doubtful accounts & Net A/R
Accounts O/S over 75 days[ $
15,000] have zero probability of
collection and would be written off
immediately and not considered for
calculation of allowance
Net Accounts Receivable
A/R = $ 7,35,000[ i.e 7,50,00015,000]
Less: Allowance for doubtful
accounts $51,750

Problem 5-4- Allowance for Doubtful


accounts& Net Income
Amount to be entered in IS[ debit
side] = New allowance + Bad Debts
written off Old Allowance otherwise
known as N+B-O
= 51,750+15,000-37,500 = 29,250