INTERMEDIATE

ACCOUNTING
Sixth Canadian Edition
KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK

Prepared by:
Gabriela H. Schneider, CMA; Grant MacEwan College
 CHAPTER

Revenue Recognition
 Learning Objectives

1. Apply the revenue recognition principle.

2. Describe accounting issues involved with
revenue recognition for sale of goods.
3. Explain accounting for consignment sales.
4. Describe accounting issues involved with
revenue recognition for services and long-
term contracts.
 Learning Objectives

5. Apply the percentage-of-completion method

for long-term contracts.
6. Apply the completed-contract method for
long-term contracts.
7. Identify the proper accounting for losses on
long-term contracts.
8. Discuss how to deal with measurement
uncertainty.
 Learning Objectives

9. Discuss how to deal with collection

uncertainty.
10.Explain and apply the instalment sales
method of accounting.
11.Explain and apply the cost recovery method
of accounting.
 Revenue Recognition

Current Earnings Process Measurement Uncertainty

Environment Sale of goods Uncertainty Associated with
Revenue Risks and rewards Sales with buy- Collectibility
recognition back Instalment sales
Disposition of assets other than
criteria inventory Sales when Instalment
Consignment sales right of return method
exists
Continuing managerial Cost recovery
involvement Trade loading method
Completion of production and channel
stuffing
Rendering of services and long-
term contracts
% of completion method
Completed contract method
Long-term contract losses
 Guidelines for Revenue
Recognition
• Revenue is recognized based on two criteria:
• Performance
• Collectibility
• Revenue is earned when the earnings process is
substantially complete
• Earnings Process: actions taken to add value
• Substantial Performance: when little or no uncertainty
exists as to the completion of the product or service
(at this point revenue is recognized)
• Revenue is realized when goods and services are
exchanged for cash or claims to cash
 Four Types of Revenue Transactions

• Revenue from selling products is recognized

at the date of sale (date of delivery)
• Revenue from services is recognized when
services are performed and are billable
• Revenue from the use of enterprise’s assets
by others is recognized as time passes or as
the assets are used up
• Revenue from disposal of assets is recognized
at the point of sale
 Risks and Rewards

• Risks and rewards (benefits) of

ownership:
– Who has possession of the goods?
– Who has legal title?

• When the risks and rewards of

ownership have transferred
– Determines when a sale has occurred
Revenue Recognition at Point of Sale

• Revenues from manufacturing and selling are

commonly recognized at point of sale
• Revenues from sales with buyback
agreements are not recognized (not sales)
• Revenues from sales where rights of return
exist are not generally recognized
• Certain trade practices such as trade loading
and channel stuffing do not result in
recognizable sales revenues
 Consignment Sales
• Possession has transferred; however
legal title remains with the seller
• Risks and rewards have not transferred
• Seller acts as an agent
• Goods are held by seller as Merchandise
on Consignment
• Not held as inventory on consignee’s
books
 Consignment Sales
Consignor’s Books Consignee’s Books
Goods shipped to Consignee
Inventory on Consignment $$$ No Entry
Finished Goods Inventory $$$
Payment of Freight
Inventory on Consignment $$ No Entry
Cash $$
Notification of Sale Notification/Payment of Sale
Accounts Receivable $$$ Cash $$$
Relevant Expenses $$ Payable to Consignor $$$
Revenue $$$
Receipt of Cash from Sale
Cash $$$
Accounts Receivable $$$
Cost of Goods Sold $$$
Inventory on Consignment $$$
(Note: cost includes freight)
 Revenue Recognition Before
Delivery
• Revenue may be recognized before delivery
under certain circumstances
• Long-term construction contracts (percentage
of completion method), are a notable example
• The percentage method permits periodic
billing at various points in the project
• The completed contract method is used only
when the percentage method is inapplicable
 Contract Accounting
Long-Term Construction
Accounting Methods

Percentage of Completion Completed Contract

Method Method

1) Terms of contract must 1) To be used only when

be certain, enforceable the percentage method is
• Certainty of performance inapplicable [uncertain]
by both parties • For short-term contracts
Percentage Completion: Concept

• Percentage completion method permits

periodic billing
• The amount of gross profit recognized
depends upon the percent of work done
• Application of percentage completion method
requires a basis for measuring the progress
toward completion at interim dates
• See the specific steps for determining gross
profit (next slide)
 Percentage Completion:
Steps
1 Costs incurred to date = Percent complete
Most recent estimated total costs
2 Percent complete X Estimated total revenue =
Revenue to be recognized to date

3 Revenue to be recognized to date –

Revenue recognized in prior periods =
Current period revenue

4 Current Period Revenue – Current costs = Gross Profit

 Percentage Completion: Cost-to-
Cost Basis
Data: Contract price: $4,500,000 Estimated cost: $4,000,000

Start date: July, 2001 Finish: October, 2003

Balance sheet date: December 31st

Given: 2001 2002 2003

Costs to date $1,000,000 $2,916,000 $4,050,000

Estimated costs to complete $3,000,000 $1,134,000 $ -0-

Progress billings during year $ 900,000 $2,400,000 $1,200,000

Cash collected during year $ 750,000 $1,750,000 $2,000,000

 Percentage Completion:
Cost-to-Cost Basis

2001 2002 2003

Contract Price $4,500,000 $4,500,000 $4,500,000

Estimated Costs:
To Date 1,000,000 2,916,000 4,050,000
Est. Cost to Complete 3,000,000 1,134,000 -0-
Est. Total Costs 4,000,000 4,050,000 4,050,000

Estimated Total Gross $ 500,000 $ 450,000 $ 450,000

Profit

Percent Complete 25% 72% 100%

1,000,000 2,916,000 4,050,000
4,000,000 4,050,000 4,050,000
 Percentage Completion:
Cost-to-Cost Basis
2001 2002 2003
Contract Price $4,500,000 $4,500,000 $4,500,000

Percent Complete 25% 72% 100%

Revenue Recognized:
Current Year $1,125,000 $3,240,000 $4,500,000
Less: Prior Year -0- 1,125,000 3,240,000
= Revenue $1,125,000 $2,115,000 $1,260,000
Gross Profit Recognized:
Current Year $ 125,000 $ 324,000 $ 450,000
Less: Prior Year -0- 125,000 324,000
= Revenue $ 125,000 $ 199,000 $ 126,000
 Completed-Contract Method
• Revenue and gross profit recognized on
completion of contract
• Advantage: reported revenue is based on
actual results, not estimates
• Disadvantage: does not reflect current
performance; creates distortion of earnings
• Progress billings are reported contra to
‘Construction in Progress’ account on the
Balance Sheet
• Construction in Progress used to accumulate
contract costs
 Long-Term Contract Losses
• A long-term contract may produce:
• either an interim loss and an overall profit
• or an overall loss for the project
• Under the percentage completion method,
losses in any case are immediately recognized

• Under the completed contract method, losses

are recognized only when overall losses result
 Recognizing Current and Overall
Losses on Long-Term Contracts
Percentage Method:
Current Loss on Recognize loss currently
an otherwise
overall profitable Completed Method:
contract No adjustment needed

Percentage Method:
Loss on an Recognize entire loss now
overall unprofitable
contract
Completed Method:
Recognize entire loss now
 Percentage Method: Interim Loss on
Profitable Contract - Example
Data as previously given, except for the 2002 cost estimate

2001 2002 2003

Contract Price $4,500,000 $4,500,000 $4,500,000

Estimated Costs:
To Date 1,000,000 2,916,000 4,384,962
Est. Cost to Complete 3,000,000 1,468,962 -0-
Est. Total Costs 4,000,000 4,384,962 4,384,962
Percent Complete 25% 66.5% 100%
1,000,000 2,916,000 4,384,962
4,000,000 4,384,962 4,384,962

Revenue recognized in 2002: $4,500,000 * 66.5% = $2,992,500

Less: amount recognized in 2001 1,125,000
1,867,500
Less: actual costs incurred in 2002 1,916,000
Loss recognized in 2002 48,500
Percentage Method: Interim Loss on
Profitable Contract – Example
Record loss for 2002:

Construction Expense 1,916,000

Construction in Process (loss) 48,500
Revenue from Long-Term Contract 1,867,500

Loss of $48,500 reported on Income Statement

Difference between the reported revenues and
costs for the current period
Under the completed-contract method, no loss
Recognized in 2002
 Percentage Method: Interim Loss on Overall
Unprofitable Contract – Example
Data as previously given, except for the 2002 cost estimate

2001 2002 2003

Contract Price $4,500,000 $4,500,000 $4,500,000

Estimated Costs:
To Date 1,000,000 2,916,000 4,556,250
Est. Cost to Complete 3,000,000 1,640,250 -0-
Est. Total Costs 4,000,000 4,556,250 4,556,250
Percent Complete 25% 64% 100%
1,000,000 2,916,000 Gross Profit
4,000,000 4,556,250 (56,250)

Losses recognized in 2002:

Gross Profit recognized in 2001 $125,000
Expected Loss on Unprofitable Contract 56,250
$181,250
 Percentage Method: Interim Loss on
Overall Unprofitable Contract – Example
Record loss for 2002:
Construction Costs expensed in 2002:
Revenue recognized in 2002: (4,500,000 X 64%) $2,880,000
Less: revenue recognized in 2001 1,125,000
Revenue recognized in 2002 1,755,000
Less: loss recognized in 2002 181,250
Construction Cost Expense 1,936,250

Construction Expense 1,36,250

Construction in Process (loss) 181,250
Revenue from Long-Term Contract 1,755,000
Completed Contract Method: Interim Loss on
Overall Unprofitable Contract – Example

Record loss for 2002:

Loss from Long-Term Contract 56,250

Construction in Process (Loss) 56,250

The loss is recognized in the year it first becomes

evident.
 Revenue Recognition after Delivery

• Revenue recognition is deferred when

collection of sales price is not reasonably
assured
• The two methods that are used are:
• the instalment sales method
• the cost recovery method
• If cash is received prior to delivery, the
method used is the deposit method
 The Instalment Sales Method
• This method emphasizes income recognition
in periods of collection rather than at point of
sale
• Title does not pass to the buyer until all cash
payments have been made to the seller
• Income recognition deferred to period of cash
collection
• Both sales and cost of sales are recognized in the
period of sale
• Gross profit is deferred to the period of collection
• Other expenses, selling and administrative,
are not deferred
 The Instalment Sales Method:
Special Accounts
• Instalment sales must be kept separate
• Gross profit on instalment sales must be
determinable
• The amount of cash collected from instalment
accounts must be known
• The cash collected from current year’s and
prior years’ accounts must be known
• Provision must be made for the carry forward
of each year’s (deferred) gross profit
 The Instalment Sales Method:
Steps
• For instalment sales in • Determine rate of gross
any year profit on instalment sales
• Apply this rate to cash
collections of current year’s
instalment sales to yield
realized gross profit
• The gross profit not
realized is deferred
• For instalment sales • Apply the relevant rate to
made in prior years cash collections of prior
(realized gross profit) year’s instalment sales
 The Instalment Sales Method:
Example
Given: 2001 2002 2003
Instalment sales $200,000 $250,000 $240,000
Cost of sales $150,000 $190,000 $168,000
Gross Profit $ 50,000 $ 60,000 $ 72,000

Cash received in:

from 2001 sales $ 60,000 $ 100,000 $ 40,000
from 2002 sales $ -0- $ 100,000 $ 125,000
from 2003 sales $ -0- $ -0- $ 80,000

Determine the realized and deferred gross profit.

 The Instalment Sales Method:
Example
Given: 2001 2002 2003
Instalment sales $200,000 $250,000 $240,000
Gross Profit $ 50,000 $ 60,000 $ 72,000
Gross profit rate 25% 24% 30%

Realized Gross Profit:

From 2001 sales:
Realized in $15,000 $25,000 $10,000
From 2002 sales:
Realized in: $ -0- $24,000 $30,000
From 2003 sales:
Realized in: $ -0- $ -0- $24,000
 The Instalment Sales Method: Partial
Journal Entries (2001) for Gross Profit

Instalment Sales 200,000

Cost of Sales 150,000
Deferred Gross Profit, 2001 50,000
(To close 2001 accounts)

Deferred Gross Profit, 2001 15,000

Realized Gross Profit 15,000
(Realized: $60,000 * 25%)

Realized Gross Profit 15,000

Income Summary 15,000
(To close to Income Summary)
 Instalment Sales Accounting
Problems
1. Interest on instalment contracts
• Accounted for separately from the gross profit
• Recognized when cash is collected, as Interest
Revenue

1. Uncollectible accounts
• Through the use of a special bad debts expense
account

2. Defaults and repossessions

• On repossession, the Account Receivable and
related deferred Gross Profit are written-off
 The Cost Recovery Method
• Seller recognizes no profit until cash
payments by buyer exceed seller’s cost of
merchandise
• After recovering all costs, seller includes
additional cash collections in income
• This method is to be used where there is no
reasonable basis for estimating collectibility
as in franchises and real estate
• The income statement reports the amount of
gross profit recognized and the deferred
amount
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