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CHAPTER 18

REVENUE

Intermediate Accounting
IFRS Edition
Kieso, Weygandt, and Warfield

18-1
Revenue
Revenue

Revenue Revenue Revenue


Current
Recognition (At Recognition (Long- Recognition
Environment
Point of Sale) Term Contracts) (Other)

Guidelines for Measurement Percentage-of- Service contracts


revenue Recognition completion method Multiple-
recognition Cost-recovery deliverable
Summary
Departures from method arrangements
sale basis Long-term contract Other
losses Summary of
Disclosures methods

18-2
The
The Current
Current Environment
Environment

Revenue recognition is a top fraud risk and regardless


of the accounting rules followed (IFRS or U.S. GAAP),
the risk or errors and inaccuracies in revenue reporting is
significant.

Restatements for improper revenue recognition are


relatively common and can lead to significant share price
adjustments.


(IFRS )




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18-3
.
The
The Current
Current Environment
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.


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18-4
The
The Current
Current Environment
Environment

Revenue Recognition Classified by Nature of Transaction
Illustration 18-1

Type of Sale of asset


Sale of product Rendering a Permitting use
Transaction other than
from inventory service of an asset
inventory

Description Revenue from Revenue from Gain or loss on


Revenue from
of Revenue fees or interest, rents, disposition
sales
services and royalties

Timing of Date of sale Services As time passes


Date of sale or
Revenue (date of performed and or assets are
trade-in
Recognition delivery) billable used

18-5
The
The Current
Current Environment
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.



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18-6

Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Measurement of Sale Revenue


Revenue should be measured at the fair value of
consideration received or receivable.
Trade discounts or volume rebates should reduce
consideration received or receivable and the related
revenue.
If payment is delayed, seller should impute an interest
rate for the difference between the cash or cash
equivalent price and the deferred amount.


.

18-7 .

Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Illustration 18-2

18-8
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Illustration 18-2

Sansung makes the following entry on March 31, 2011.

Accounts receivable 679,000


Sales 679,000

18-9
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Illustration 18-2

Assuming Sansungs customers meet the discount threshold,


Sansung makes the following entry.

Cash 679,000
Accounts receivable 679,000

18-10
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Illustration 18-2

If Sansungs customers fail to meet the discount threshold,


Sansung makes the following entry upon payment.

Cash 700,000
Accounts receivable 679,000
Sales discounts forfeited 21,000

18-11
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Measurement of Sale Revenue


When a sales transaction involves a financing arrangement, the
fair value is determined by discounting the payment using an
imputed interest rate.

Imputed interest rate is the more clearly determinable of either

1. the prevailing rate for a similar instrument of an issuer with a


similar credit rating, or

2. a rate of interest that discounts the nominal amount of the


instrument to the current sales price of the goods or services.

.

18-12
.
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale
Illustration 18-3

18-13
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale
Illustration 18-3

The journal entry to record SEKs sale to Grant Company on


July 1, 2011, is as follows (ignoring cost of goods sold entry).

Notes receivable 900,000


Sales 900,000

18-14
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale
Illustration 18-3

SEK makes the following entry to record interest revenue.

Notes receivable 54,000


Interest revenue (12% x x 900,000) 54,000

18-15
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale
Recognition of Sale Revenue
Revenue from the sale of goods is recognized when all the following conditions are
met:

1. Company has transferred to the buyer the significant risks and rewards of
ownership of the goods;

2. Company retains neither continuing managerial involvement to the degree


usually associated with ownership nor effective control over the goods sold;

3. The amount of revenue can be measured reliably;

4. It is probable that the economic benefits will flow to the company; and

5. The costs incurred or to be incurred can be estimated reliably.

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18-16 .
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Bill and Hold Sales


Buyer is not yet ready to take delivery but does take title and
accept billing.

Illustration 18-4

18-17
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale
Solution: Butler should record the revenue at the time title passes,
provided
1. it is probable that delivery will be made;
2. the item is on hand, identified, and ready for delivery at the time the
sale is recognized;
3. Baristo acknowledges the deferred delivery arrangement; and
4. the usual payment terms apply.
It appears that these conditions were probably met and therefore
revenue recognition should be permitted at the time the agreement is
signed.
:
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Baristo .

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18-18 .
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale
Illustration 18-4

Butler makes the following entry to record the bill and hold sale.

Accounts receivable 450,000


Sales 450,000

18-19
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Sales Subject to Installation or Inspection
Illustration 18-5

18-20
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Layaway Sales
Illustration 18-6

18-21
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
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. not recording a sale until all return privileges have expired


or

2. recording the sale, but reducing sales by an estimate of


future returns.



:
18-22
.
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale
Illustration 18-7

18-23
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Pesido sold $300,000 of laser equipment on August 1, 2011, and


retains only an insignificant risk of ownership. On October 15,
2011, $10,000 in equipment was returned.

August 1, 2011
Accounts receivable 300,000
Sales 300,000
October 15, 2011
Sales returns and allowances 10,000
Accounts receivable 10,000

18-24 Pesido $ 10000 2011 15 . 2011 1 $ 300000



Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

At December 31, 2011, based on prior experience, Pesido


estimates that returns on the remaining balance will be 4 percent.
Pesido makes the following entry to record the expected returns.

December 31, 2011


Sales returns and allowances 11,600
Allowance for sales returns and allowances 11,600

[($300,000 - $10,000) x 4% = 11,600] 2011 31


Pesido
4 .
18-25 Pesido
.
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale
Illustration 18-8

18-26
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale
Illustration 18-8

Morgan records the sale and related cost of goods sold as


follows.
Cash 135,000
Sales 135,000
Cost of Goods Sold 115,000
Inventory 115,000

18-27
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Principal-Agent Relationships
Amounts collected on behalf of the principal are not
revenue of the agent.
Revenue for the agent is the amount of the commission it
receives.



18-28 .
.
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Consignments
Manufacturers (or wholesalers) deliver goods but retain
title to the goods until they are sold.

Consignor (manufacturer or wholesaler) ships


merchandise to the consignee (dealer), who is to act as
an agent for the consignor in selling the merchandise.

Consignor makes a profit on the sale.

Consignee makes a commission on the sale.



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18-29
.
Revenue
Revenue Recognition
Recognition at
at Point
Point of
of Sale
Sale

Trade Loading and Channel Stuffing


Trade loading - a crazy, uneconomic, insidious practice through
which manufacturerstrying to show sales, profits, and market
share they dont actually haveinduce their wholesale
customers, known as the trade, to buy more product than they
can promptly resell.

Channel stuffing. When a software maker needed to make its


financial results look good, it offered deep discounts to its
distributors to overbuy, and then recorded revenue when the
software left the loading dock.

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18-30 .
overbuy
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)

Two methods of accounting for long-term construction


contracts:
Percentage-of-completion method.
Cost-recovery (zero-profit) method.

:
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( ) .
18-31
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Rationale for using percentage-of-completion accounting
is that under most of these contracts, the
Buyer and seller have enforceable rights.
Buyer has the legal right to require specific performance on
the contract.
Seller has the right to require progress payments that
provide evidence of the buyers ownership interest.
As a result, a continuous sale occurs as the work
progresses and companies should recognize revenue
according to that progression.

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18-32
.
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Companies must use the percentage-of-completion method
when all of the following conditions exist.
1. Total contract revenue can be measured reliably;

2. It is probable that the economic benefits associated with the


contract will flow to the company;

3. 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; and

4. 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.
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18-33

Long-Term
Long-Term Contracts
Contracts (Construction)
(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, or

2. When there are inherent hazards in the contract beyond the


normal, recurring business risks.


:
18-34

Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)

Percentage-of-Completion Method
Calculation for Revenue to Be Recognized

Illustration 18-11

Illustration 18-12

Illustration 18-13

18-35
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Illustration: KC Construction Company has a contract to
construct a 4,500,000 bridge at an estimated cost of
4,000,000. The contract is to start in July 2010, and the
bridge is to be completed in October 2012. The following data
pertain to the construction period.

18-36
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Illustration: Compute percentage complete.
Illustration 18-6

18-37
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Illustration: KC would make the following entries to record
(1) the costs of construction, (2) progress billings, and (3)
collections.
Illustration 18-7

18-38
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Percentage-of-Completion, Revenue and Gross Profit, by Year
Illustration 18-16

18-39
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Illustration: KCs entries to recognize revenue and gross
profit each year and to record completion and final approval
of the contract.
Illustration 18-17

18-40
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Illustration: Content of Construction in Process Account
Percentage-of-Completion Method
Illustration 18-18

18-41
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)

Financial Statement PresentationPercentage-of-


Completion

Computation of Unbilled Contract Price at 12/31/10

Illustration 18-19

18-42
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Financial StatementPercentage-of-Completion
Illustration 18-20

18-43
LO 3
Cost-Recovery
Cost-Recovery (Zero-Profit)
(Zero-Profit) Method
Method
Illustration: For the bridge project illustrated on the preceding
pages, Hardhat Construction would report the following revenues and
costs. Illustration 18-21

18-44
Cost-Recovery
Cost-Recovery (Zero-Profit)
(Zero-Profit) Method
Method
Illustration: Hardhats entries to recognize revenue and gross profit
each year and to record completion and final approval of the contract.

Illustration 18-22

18-45
Cost-Recovery
Cost-Recovery (Zero-Profit)
(Zero-Profit) Method
Method
Illustration: Comparison of gross profit recognized under different
methods.

Illustration 18-23

18-46
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Financial StatementCost-Recovery Method
Illustration 18-24

18-47
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)

Illustration:

Casper Construction Co.

A)
A) Prepare
Preparethe
thejournal
journalentries
entriesfor
for2010,
2010,2011,
2011,and
and2012.
2012.

18-48
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)

Illustration:

18-49
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)

Illustration:

18-50
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)

Illustration:

18-51
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Cost-Recovery Method

Companies recognize revenue only to the extent of costs


incurred that are expected to be recoverable.

Only after all costs are incurred is gross profit recognized.


18-52 .

Cost-Recovery
Cost-Recovery Method
Method
Illustration:

18-53
Cost-Recovery
Cost-Recovery Method
Method
Illustration:

18-54
Long-Term
Long-Term Contracts
Contracts (Construction)
(Construction)
Long-Term Contract Losses
Loss in the Current Period on a Profitable Contract
Percentage-of-completion method only, the estimated
cost increase requires a current-period adjustment of
gross profit recognized in prior periods.

Loss on an Unprofitable Contract


Under both percentage-of-completion and completed-
contract methods, the company must recognize in the
current period the entire expected contract loss.



.
18-55

Long-Term
Long-Term Contract
Contract Losses
Losses

Illustration: Loss in Current Period

Casper Construction Co.

b)
b) Prepare
Preparethe
thejournal
journalentries
entriesfor
for2010,
2010,2011,
2011,and
and2012
2012assuming
assumingthetheestimated
estimated
cost
costto
tocomplete
completeatatthe
theend
endof
of2011
2011was
was215,436 insteadofof170,100.
215,436instead 170,100.

18-56
Long-Term
Long-Term Contract
Contract Losses
Losses

Illustration: Loss in Current Period

18-57
Long-Term
Long-Term Contract
Contract Losses
Losses

Illustration: Loss in Current Period

18-58
Long-Term
Long-Term Contract
Contract Losses
Losses

Illustration: Loss on Unprofitable Contract

Casper Construction Co.

c)c) Prepare
Preparethe
thejournal
journalentries
entriesfor
for2010,
2010,2011,
2011,and
and2012
2012assuming
assumingthetheestimated
estimated
cost
costtotocomplete
completeatatthe
theend
endof
of2011
2011was
was246,038
246,038instead
insteadofof170,100.
170,100.

18-59
Long-Term
Long-Term Contract
Contract Losses
Losses

Illustration: Loss on Unprofitable Contract

$675,000 683,438 = (8,438) cumulative loss Plug


18-60
LO 5
Long-Term
Long-Term Contract
Contract Losses
Losses

Illustration: Loss on Unprofitable Contract

18-61
Long-Term
Long-Term Contract
Contract Losses
Losses

Illustration: Loss on Unprofitable Contract


For the Cost-Recovery method, companies would recognize the
following loss:

18-62
Long-Term
Long-Term Contract
Contract Losses
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,

aggregate amount of costs incurred and recognized net


income, amount of advances received, and amount of
retentions.

Any contingent assets or liabilities related to these contracts.



:
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18-63 .
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues

Service Contracts
Follow the same criteria as long-term contracts.

To recognize revenue:
It must be reliably measurable;
Economic benefits are probable;
Stage of completion must be reliably measurable; and
Costs must be reliably measurable.

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18-64 .
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues
Service Contracts
Single Act: Revenue recognized at the time of the act.

More Than One Act: Revenue recognized as various acts


occur.

Three circumstances:
1. Specified number of identical or similar acts.

2. Specified number of defined but not identical acts.

3. Unspecified number of identical acts or similar acts with a


fixed period for performance.
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18-65 .
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues

18-66
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues

Assuming R&D services are provided according to the contract in


2011, Jackson makes the following entries in 2011 to recognized
revenue on the Andes contract.
January 1, 2011
Cash 1,000,000
Unearned R&D service revenue 1,000,000

December 31, 2011


Cash 400,000
Unearned R&D Service Revenue 200,000
R&D Service Revenue 600,000
18-67
LO 6
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues

18-68
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues

18-69
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues

18-70
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues

SeniorLife makes the following entries related to the contract.


January 1, 2011
Cash 300,000
Unearned service revenue 300,000

December 31, 2011


Unearned service revenue 60,000
Service Revenue 60,000

December 31, 2012


Unearned service revenue 105,000
Service Revenue 105,000
18-71
Other
Other Revenue
Revenue Recognition
Recognition Issues
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.

( MDAs)
MDAs .


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18-72
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues

Multiple-Deliverable Arrangements (MDAs)


All units in a MDA are considered separate units of accounting,
provided that:

1. A delivered item has value to the customer on a standalone


basis; and

2. The arrangement includes a general right of return relative to


the delivered item; and

3. Delivery or performance of the undelivered item is


considered probable and substantially in the control of the
seller.
:
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18-73 .
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues

Multiple-Deliverable Arrangements (MDAs)


Illustration 18-33

18-74
Illustration 18-34

18-75
Other
Other Revenue
Revenue Recognition
Recognition Issues
Issues

Other Revenue Situations


Interest, Royalties, and Dividends
Accretion
Completion-of-Production Basis



18-76

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