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Accounting Standards

Revenue recognition standards provide guidance on when revenue can be recognized from various types of transactions. Revenue is recognized when it is earned and realizable. There are several methods for recognizing revenue depending on the nature of the transaction, including at the point of sale, over time using percentage of completion for long-term contracts, after delivery using installment or cost recovery methods, and deposit method when cash is received before delivery. The key principles involve determining when performance obligations are satisfied and the transaction price is realizable.

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54 views

Accounting Standards

Revenue recognition standards provide guidance on when revenue can be recognized from various types of transactions. Revenue is recognized when it is earned and realizable. There are several methods for recognizing revenue depending on the nature of the transaction, including at the point of sale, over time using percentage of completion for long-term contracts, after delivery using installment or cost recovery methods, and deposit method when cash is received before delivery. The key principles involve determining when performance obligations are satisfied and the transaction price is realizable.

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vaish2u8862
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© Attribution Non-Commercial (BY-NC)
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ACCOUNTING STANDARDS

PRESENTATION ON ACCOUNTING STANDARDS


Team 4 AS 9 : Revenue Recognition

REVENUE RECOGNITION

Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the Sale of goods Rendering of services and Use by others, of enterprise resources, yielding interest, royalties and dividends Recognition - Process of recording and reporting an item as an element of financial statement

Principles
The revenue recognition principle provides that revenue is recognized:

when it is earned, and when it is realized or realizable

Revenue is earned when the earnings process is substantially complete Revenue is realized when goods and services are exchanged for cash or claims to cash Revenue is realizable when assets received are convertible into a known amount of cash

Four Types of Revenue Transactions


Revenue from selling products is recognized at

the date of sale (date of delivery). Revenue from services is recognized when services are performed and are billable. Revenue from the use of enterprises assets by others is recognized as time passes or as the assets are used up. Revenue from disposal of assets (other than inventory) is recognized at the point of sale as gain or loss.

Revenue Recognition Classified by Nature of Transaction

Revenue Recognition at Point of Sale


Revenues from manufacturing and selling are commonly recognized at point of sale Exceptions: 1. Sales with buyback agreements 2. Sales when right of return exists (high rates that are not reliably estimable) 3. Trade loading/channel stuffing

Revenue Recognition Before Delivery


Revenue may be recognized before delivery under certain circumstances Long-term construction contracts are a notable example Two methods available are : The percentage-of-completion method, and The completed contract method

Revenue Recognition Before Delivery


Long-Term Construction Accounting Methods
Percentage-of-Completion Method 1) Terms of contract must be certain, enforceable 2) Certainty of performance by both parties 3) Estimates of completion can be made reliably Completed Contract Method 1) To be used only when the percentage method is inapplicable [uncertain] 2) For short-term contracts

Percentage-of-Completion: Steps
1 Costs incurred to date = Percent complete Most recent estimated total costs

2 Estimated total revenue x Percent complete = Revenue to be recognized to date 3 Total revenue to be recognized to date less Revenue recognized in PRIOR periods = Current period revenue 4 Current Period Revenue less current costs = Gross profit

Percentage-of-Completion: Example
Data: Contract price: $4,500,000 Start date: July, 2003 Balance sheet date: Given: 2003 Estimated cost: $4,000,000 Finish: October, 2005 Dec. 31 2004
$2,916,000 $1,134,000 $2,400,000 $1,750,000

2005
$4,050,000 $ -0$1,200,000 $2,000,000

Costs to date $1,000,000 Estimated costs to complete $3,000,000 Progress Billings during year $900,000 Cash collected during year $750,000

What is the percent complete, revenue and gross profit recognized each year?

Percentage-of-Completion: Example
2003
% complete to-date Revenue recognized

2004

2005
100 %

1,000,000 = 25% 2,916,000= 72% 4,000,000 4,050,000 4,500,000 * 25% = 1,125,000 1,125,000 less 1,000,000 = 125,000

4,500,000 * 72% 4,500,000 less 1,125,000 less 3,240,000 = 2,115,000 = 1,260,000 2,115,000 less 1,916,000 = 199,000 1,260,000 less 1,134,000 = 126,000

Gross Profit recognized

Revenue Recognition After Delivery


Revenue recognition is deferred when collection of sales price is not reasonably assured and no reliable estimates can be made The two methods that are used are: the installment sales method the cost recovery method If cash is received prior to delivery, the method used is the deposit method

The Installment Sales Method


This method emphasizes income recognition in

periods of collection rather than at point of sale Title does not pass to the buyer until all cash payments have been made to the seller Both sales and cost of sales are deferred to the periods of collection Other expenses, selling and administrative, are not deferred

The Cost Recovery Method


Seller recognizes no profit until cash payments by buyer exceed sellers cost of merchandise. After recovering all costs, seller includes additional cash collections in income. This method is to be used where there is no reasonable basis for estimating collectibility as in franchises and real estate. The income statement reports the amount of gross profit recognized and the amount deferred.

The Deposit Method


Seller receives cash from buyer before transfer of goods or performance The seller has no claim against the purchaser. There is insufficient transfer of risks to buyer to warrant recording a sale by seller In the case of such incomplete transactions, the deposit method is used The deposit method thus defers sale recognition until a sale has occurred for accounting purposes

SUMMARY OF REVENUE RECOGNITION BASES


Recognition Basis
Criteria for Use Reason of Departing from Sale Basis

Percentage of Completion Method Completed Contract Method

Long term construction of property, and reliable estimates and information about the project. Use on short term contracts, when percentage of completion method is not used Immediate marketability at quoted prices, unit interchangeability and etc Absence of reasonable basis for estimating degree of collectibility and cost of collection. Cash is received before the sales transaction completed

Better measure of periodic income, and revenues and costs.

Percentage of Completion Method is not applicable

Completion of Production Basis

Determinable revenues, but inability to determine the cost, thereby defer expense Collectibility of receivable is so uncertain, gross profit is recognized until cash is received Not sufficient transfer of the risks and ownership

Installment-sales method and cost recovery method Deposit Method

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