Stice | Stice | Skousen Intermediate Accounting,17E Revenue Recognition PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University © 2010 Cengage Learning Revenue Recognition Recognition refers to the time when transactions are recorded on the books The FASB’s two criteria for recognizing revenues and gains were articulated in FASB Concepts Statement No 8-2 Revenue Recognition Revenues and gains are generally recognized when: They are realized or realizable They have been earned through substantial completion of the activities involved in the earnings process 8-3 Revenue Recognition • Revenue is not recognized prior to the point of sale because either: • A valid promise of payment has not been received from the customer, or • The company has not provided the product or service • Exceptions to these rules: • The customer provides a valid promise of payment • Conditions exist that contractually guarantee the sale 8-4 Revenue Recognition AICPA Statement of Position 97-2 gives companies more guidance through a checklist of four factors that amplify the two criteria: a Persuasive evidence of an arrangement exists b Delivery has occurred c The vendor’s fee is fixed or determinable d Collectibility is probable 8-5 Appropriate Layaway Accounting Receipt of $100 cash as initial layaway payment: Cash Deposit Received from Customers 100 100 Receipt of final $1,400 cash payment and delivery of goods to customer: Cash Deposit Received from Customers Sales Cost of Goods Sold Inventory 1,400 100 1,500 1,000 1,000 8-6 Appropriate Accounting for a Service Provided Over an Extended Period Seller Company receives $1,000 cash from a customer as the initial sign-up fee for a service In addition to the sign-up fee, the customer is required to pay $50 per month for 100 months, which is the economic life of this service agreement 8-7 Appropriate Accounting for a Service Provided Over an Extended Period Receipt of $1,000 cash as initial sign-up fee: Cash 1,000 Unearned Initial Sign-Up Fees 1,000 Receipt of first monthly payment of $50: Cash Monthly Service Revenue 50 50 Partial recognition of the initial signup fee as revenue ($1,000/100 months): Unearned Initial Sign-Up Fees Initial Sign-Up Fee Revenue 10 10 8-8 EITF 00-21 A delivered element of a multiple-element arrangement is considered to be a unit of accounting if that delivered element has standalone value and if the fair value of any undelivered element can be objectively and reliably determined 8-9 Appropriate Accounting for a Refundable Membership Seller Company receives $1,200 cash from each customer as a fully refundable, one-year membership fee It is estimated that the cost to Seller Company to provide the membership service to each customer will be $360 for one year Seller Company can reliably estimate that 40% of the customers will request refunds during the year Assume all refunds occur at the end of the year There were 1,000 customers (continues) 8-10 Accounting for Long-Term Service Contracts A correspondence school enters into 100 contracts with students for an extended writing course The fee for each contract is $500, payable in advance The initial direct costs related to the contracts total $5,000 Actual direct costs for lessons for the first period are $12,000 The sales value of the lessons completed is $24,000 (if sold separately, $60,000) (continues) 8-45 Accounting for Long-Term Service Contracts Receipt of fees: Cash Deferred Course Revenue 50,000 50,000 Initial direct costs: Liability Liability account account Deferred Initial Costs Cash 5,000 Asset Asset account account Direct costs for lessons actually completed: Contract Costs Expense account12,000 Cash Expense account 5,000 12,000 (continues) 8-46 Accounting for Long-Term Service Contracts Recognize course revenue: Deferred Course Revenue Recognized Course Revenue 20,000 20,000 Recognize contract costs from initial direct $24,000 × $50,000 costs: $60,000 Contract Costs Deferred Initial Costs 2,000 2,000 $24,000 × $5,000 $60,000 8-47 Revenue Recognition After Delivery of Goods 8-48 Installment Sales Method • Under the installment sales method, profit is recognized as cash is collected rather than at the time of sale • It is used most commonly in cases of real estate sales where contracts may involve little or no down payment, payments are spread over 10 to 40 years, and a high probability of default in the early years exists 8-49 Installment Sales Method Riding Corporation sells merchandise on the installment basis, and the uncertainties of cash collection make the use of the installment method necessary The following data relate to three years of operations (continues) 8-50 Installment Sales Method 2010—During the Year Installment Accounts Receivable—2010 Installment Sales 150,000 150,000 Cost of Installment Sales Inventory Cash Installment Accounts Receivable—2010 100,000 100,000 30,000 30,000 (continues) 8-51 Installment Sales Method 2010—End of Year Installment Sales Cost of Installment Sales Deferred Gross Profit—2010 Deferred Gross Profit—2010 Realized Gross Profit on Installment Sales 150,000 100,000 50,000 10,000 10,000 $30,000 $30,000 ×× 33.33% 33.33% (continues) 8-52 Installment Sales Method 2011—During the Year Installment A/R—2011 Installment Sales 200,000 Cost of Installment Sales Inventory 140,000 Cash Installment A/R—2010 Installment A/R—2011 200,000 140,000 145,000 75,000 70,000 (continues) 8-53 Installment Sales Method 2011—End of Year Installment Sales Cost of Installment Sales Deferred Gross Profit—2011 Deferred Gross Profit—2010 Deferred Gross Profit—2011 Realized Gross Profit on Installment Sales 200,000 140,000 60,000 25,000 21,000 46,000 $75,000 $75,000 ×× 33.33% 33.33% $70,000 $70,000 ×× 30% 30% (continues) 8-54 Installment Sales Method 2012—During the Year Installment A/R—2012 Installment Sales 300,000 Cost of Installment Sales Inventory 204,000 Cash Installment A/R—2010 Installment A/R—2011 Installment A/R—2012 300,000 204,000 210,000 30,000 80,000 100,000 (continues) 8-55 Installment Sales Method 2012—End of Year Installment Sales Cost of Installment Sales Deferred Gross Profit—2012 Deferred Gross Profit—2010 Deferred Gross Profit—2011 Deferred Gross Profit—2012 Realized Gross Profit on Installment Sales 300,000 204,000 96,000 10,000 24,000 32,000 66,000 $30,000 ×× 33.33% $30,000 33.33% $80,000 $80,000 ×× 30% 30% $100,000 $100,000 ×× 32% 32% 8-56 Cost Recovery Method If the probability of recovering product or service costs is remote, the cost recovery method of accounting can be used 8-57 Cost Recovery Method All entries are the same except not record gross profit until all costs are recovered 2011 Deferred Gross Profit—2010 Realized Gross Profit on Installment Sales 5,000 5,000 (continues) 8-58 Cost Recovery Method Because the cash collected in 2011 for 2011 sales is less than the cost of inventory sold, no gross profit would be recognized in 2011 on 2011 sales 2012 Deferred Gross Profit—2010 Deferred Gross Profit—2011 Realized Gross Profit on Installment Sales 30,000 10,000 40,000 8-59 ... be a unit of accounting if that delivered element has standalone value and if the fair value of any undelivered element can be objectively and reliably determined 8-9 Appropriate Accounting for... of the year There were 1,000 customers (continues) 8-10 Appropriate Accounting for a Refundable Membership 8-11 Appropriate Accounting for a Contingent Rental On January 1, Owner Company signed... per month for 100 months, which is the economic life of this service agreement 8-7 Appropriate Accounting for a Service Provided Over an Extended Period Receipt of $1,000 cash as initial sign-up