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Chapter 18

Chapter 18. Revenue Recognition. 1. Revenue Recognition Basic Concepts. Definition of revenue (SFAC 6)

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Chapter 18

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  1. Chapter 18 Revenue Recognition

  2. 1. Revenue Recognition Basic Concepts • Definition of revenue (SFAC 6) • Inflows or other enhancements of assets or settlement of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. • General recognition criteria (SFAC 5) • meets definition of an element • measurability • relevance • faithful representation

  3. 1a. Revenue Recognition Basic Concepts • APB Statement 4 • Revenue is recognized when • the earnings process is complete or virtually complete • an exchange has taken place • Realization principle (SFAC 5) • Revenue is recognized when • the earnings process is judged to be complete or virtually complete • there is reasonable certainty as to the collectability of the asset to be received

  4. 1a. Revenue Recognition Basic Concepts • SEC SAB No. 101 • persuasive evidence of an arrangement exists • delivery has occurred or services have been rendered • the seller’s price to the buyer is fixed or determinable • collectability is reasonably assured

  5. 2. General Rule • Revenue is recognized at the point of sale

  6. 3. Possible Points to Recognize Revenue • Most significant event • Recognition before point of sale • prior to starting production • customer advances • during production • long-term construction contracts • at completion of production • precious metals, ag products • Recognition at point of sale • but if right of return exists or sale with buyback • Recognition after point of sale • cash collection methods • installment sales, cost recovery basis • consignments

  7. 4. Expense Recognition • Expense – expired economic benefits Outflows or other using up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. (SFAC 6) • Expenses to be recognized can be identified by • matching • direct expensing (period costs) • systematic allocation

  8. 5. Revenue Frauds • Obvious accounting violations • Fictitious sales or fake customers • Premature recording of sales • Inflated sales • Transactions lacking integrity • Roundtrip transactions • Channel stuffing and trade loading • Bill and hold transactions • Related party transactions • Contracts, agreements and side letters

  9. 6. Long-term Construction Contracts • Percentage of completion method • revenue recognized each period based on progress of construction • this method required if • costs to complete and extent of progress toward completion are reasonably dependable • contract clearly specifies goods or services to be provided & received by parties • buyer is expected to satisfy its contractual obligations • contractor is expected to perform its contractual obligations

  10. 6a. Long-term Construction Contracts • Methods to estimate percentage of completion • cost-to-cost method (input method) • costs to date ÷ total estimated costs to complete • most common method • machine hours or labor hours (input measure) • project milestones (output method) • units of production (output method) • engineer’s or architect’s estimates

  11. 6b. Long-term Construction Contracts • Revenue and GP recognized per period • percentage completed this period x total revenue or GP • new accounts • construction in progress (inventory account) • progress billings (contra acct to CIP) • financial statement presentation • net both accounts – could be debit or credit balance • example

  12. 7. Completed contract method • Revenues and gross profit recognized when project finished • Entries • same entries to record costs and billings • do not recognize revenue and gross profit each year • The two methods are not acceptable alternatives • Example

  13. 8. Right of Return • Only recognize revenue if all of following are met (SFAS 48) • sellers price is fixed • buyer has paid or is obligated to pay • buyer’s obligation would not be changed by the theft or destruction of the product • buyer has economic substance apart from that provided by the seller • seller doesn’t have future significant obligations • amount of future returns can be reasonably estimated

  14. 9. Cash Collection Methods • Emphasis placed on collection rather than on sale • APB 10 • generally states both methods are not acceptable • but in certain exceptional circumstances may be used

  15. 9a. Cash Collection Methods • Installment Sales Method • Emphasis placed on collection rather than on sale • revenue recognized in periods of collection • more important method for tax than fin acct • Example

  16. 9b. Cash Collection Methods • Cost recovery method • No gross profit recognized until all costs have been recovered • After all costs recovered • all additional cash received recorded as profit • Example

  17. 10. Multiple Deliverables • Revenue must be allocated to various elements based on FMVs if they are separable • Considered separable if • items have value on a stand-alone basis • there is a general right of return • delivery is considered probable • Examples • IT equipment and software • franchises

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