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Income Measurement and Profitability Analysis

Income Measurement and Profitability Analysis. Sid Glandon, DBA, CPA Assistant Professor of Accounting. Guidelines for Revenue Recognition. Revenue is recognized when It is earned, and When the earning process is substantially complete It is realized or realizable

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Income Measurement and Profitability Analysis

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  1. Income Measurement and Profitability Analysis Sid Glandon, DBA, CPA Assistant Professor of Accounting

  2. Guidelines for Revenue Recognition • Revenue is recognized when • It is earned, and • When the earning process is substantially complete • It is realized or realizable • When goods and services are exchanged for cash or claims to cash

  3. Staff Accounting Bulletin 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 • Collectibility is reasonably assured

  4. Four Types of Transactions • Sale of products • Recognized at date of sale (delivery) • Provision of services • Recognized when performed and billable • Revenue from use of assets • Recognized as time passes or assets used up • Disposal of assets • Recognized at point of sale

  5. Revenue Recognition • Completion of production • Revenue recognition after delivery if there is uncertainty of collectibility • Installment sales • Cost recovery • Deposit method • Buyback agreements • Right of return • Consignment sales

  6. Installment Sales • Recognizes income in periods of collection instead of point of sale • Title does not pass to buyer until after final payment • Both sales and cost of sales are deferred • Selling and administrative expenses are not deferred

  7. Installment Sales Example

  8. Installment Sales Example

  9. Cost Recovery Method • Seller recognizes no profit until cash receipts exceed seller’s cost of merchandise • After recovering all costs, seller includes additional cash collections in income • Used where there is no reasonable basis for estimating collectibility • Franchises and real estate • Income statement • Report amount of gross profit recognized and deferred

  10. Deposit Method • Seller receives cash before transfer • Seller has no claim against purchaser • Insufficient transfer of risks to buyer to warrant recording a sale • Defers sale recognition until sale has occurred

  11. Revenue Recognition Before Delivery • Long-term construction contracts • Percentage of completion • Periodic billing • Completed contract • Only used when percentage method is inapplicable

  12. Long-Term Construction Contracts Accounting Methods • Percentage of completion • Terms of contract must be certain and enforceable • Certainty of performance • Completed contract • Uncertainty • Short-term contracts

  13. Percentage of Completion • Permits periodic billing • Amount of gross profit recognized • Normally based on percentage of work completed

  14. Percentage Completion Steps

  15. Example: Percentage Completion

  16. Step #1: Percentage Complete

  17. Step #2: Current Period Revenue

  18. Step #3: Current Period Costs

  19. Step #4: Current Period Gross Profit

  20. Long-Term Contract Losses • Loss in Current Period on a Profitable Contract • Losses are recognized in current period under the percentage of completion method • Loss on an Unprofitable Contract • Expected contract loss is recognized in current period under either method

  21. Activity Ratios • Receivables turnover ratio • Inventory turnover ratio • Asset turnover ratio

  22. Activity Ratios

  23. Profitability Ratios • Profit margin on sales • Return on assets • Return on shareholders’ equity

  24. Profitability Ratios

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