Two Questions of

Revenue Recognition

1. When should revenue be recognized

(i.e., what accounting period)?
2. How much revenue should be
recognized?

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• Johnson and Waldorf, LLC is an accounting firm that provides
tax and consulting work. During December, JW provides
$2,000 of consulting work to one of its clients. The client does
not pay for the consulting time until the following January
• Pat’s Retail, Inc. sells clothing from its retail outlets. A customer
purchases a shirt on June 15th and pays for it on a credit card.
Pat’s processes the credit card but does not actually receive
the cash until July.
• Let’s imagine that your Los Angeles-based wine store, the Vine
Cellar, runs a monthly wine club. Your customers pay you $600
up front for an annual subscription, and every month you send
them three bottles of ground-breaking organic wine to their
doorstep. When do you recognize the revenue?

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Operating Cycle

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•MAYTAS
•SATYAM

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Revenue Recognition: GAAP

• Criteria:
• When?
• Substantial performance.
• Conservatism concept.
• How much?
• Revenue and expenses can be reliably measured (i.e.,
collected or collectible).
• Realization concept (i.e., realized or realizable).

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5-6
 Revenue Recognition: Ind AS 115

•• Step 1: Identify the contract(s) with a customer

•• Step 2: Identify the performance obligation in
contract
•• Step 3: Determine the transaction price
•• Step 4: Allocate the transaction price to the
performance obligations in the contract
•• Step 5: Recognize revenue when (or as) the entity
satisfies a performance obligation

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 Delivery Method
• Most common.
• Recognize revenue when goods or services are
delivered.
• When should revenue be recognized?
• Auto repair shop?
• Prepaid hotel room?
• Dealer sold auto to customer on monthly payment
(installment) plan?

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Consignment Method
• Consignor ships goods to consignee (but retains
title until they are sold).
• Consignee attempts to sell goods.
• Revenue recognized when goods are sold.

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Franchise Revenue

• Permits franchisee to use name/product of

franchisor.
• Recognize when earned.
• Not necessarily when agreement signed or fee
received.
• Usually after franchisee commences operations.

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 Percentage-of-Completion Method
• Design/development and construction/
production projects that extends over several
years (e.g., high-rise building, aircraft).
• Could be either fixed price or cost
reimbursement contract.
• Need reasonable assurance of profit margin
and ultimate realization.
• Revenue recognized based on total percentage
of project work performed during period.

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Completed Contract Method

• Alternative to percentage-of-completion.
• Used when amount of income to be earned on
contract cannot be reliably estimated.
• Costs incurred are held as an asset (i.e., Contract
Work in Progress) until revenue is recognized.

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5-13
 Production Method
• Permitted, but not required by GAAP.
• Applies to certain agricultural and mining products.
• Recognize revenue at harvest.
• Clear market determined price.
• Performance substantially complete.

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 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.
• Conservative variation is cost recovery
method.
• Cost of sales is recorded at an amount equal to
installment payment (until total is recovered).
• No income reported until cost is recovered.

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Accounting for bad debts

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 Amount of Revenue Recognized

•Net realizable value.

• Amount reasonably estimated to be
collected.
•Adjustment for bad debts.
• Direct write-off method.
• Allowance method.
• % of sales.
• % of (analysis of) accounts receivable.

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Bad Debts:
Direct Write-Off Method
• Write-off when specific uncollectible account is
identified.
• What would be the balance sheet effect?

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 Bad Debts:
Allowance Method
• Estimate amount of current period credit sales
that will not be collected.
• % of credit sales, or
• Aging accounts receivables (i.e., use higher
uncollectible % on older receivables).
• Percentages based on experience and judgment.

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5-20
 Bad Debts:
Allowance Method
• Business makes $10,000 of sales on credit.
Estimates 3% of credit sales will be uncollectible.
Accounts Receivable Sales Revenues
Debit Credit Debit Credit
Original
Entries
+ - - +
$10,000 $10,000

Allowance for
Bad Debt Expense Doubtful Accounts

Adjusting Debit Credit Debit Credit

Entry + - - +
$300 $300
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 Bad Debts:
Allowance Method
• Business determines that a customer who owes $75
will be unable to pay.
Allowance for
Doubtful Accounts Accounts Receivable
Debit Credit Debit Credit
Write-off
Entry
- + + -
$75 $300 $10,000 $75

• Allowance for Doubtful Accounts → contra-asset

account.
• Collection of a bad debt previously written-off:
• Debit Cash and credit (reinstate) the Allowance for
Doubtful Accounts. 5-22
 Warranty Costs
Estimates usually based as a percentage of sales
(similar to bad debt expense).

Warranty Bad Debt

similar to
Expense Expense

Allowance for Allowance for

similar to Doubtful
Warranties
Accounts
 Allowance account is debited for actual expenditures.
 Warranty expense is part of cost of sales.
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 Interest Revenue
• Amount earned by lender during the period.
• Interest paid at maturity.
• Creates interest earned, but not yet paid.
• Adjusting entry:
• Debit Interest Receivable.
• Credit Interest Revenue.
• Interest Receivable account is zeroed out when loan
and interest is paid off.

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Credit card sales

• Point of sale (POS)

• Credit sale ?
• Sales discount

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