I2 CH18 13ed Fall 09

I2 CH18 13ed Fall 09 - Chapter 18, Page 1 of 9 CHAPTER 18...

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Chapter 18, Page 1 of 9 CHAPTER 18 NOTES—REVENUE RECOGNITION 1. Revenue recognition criteria per SFAC No. 5 : The revenue recognition principle provides that revenue is recognized when (1) it is realized or realizable and (2) it is earned. Note: Revenues are REALIZED when goods and services are exchanged for cash or claims to cash. Revenues are REALIZABLE when assets received in exchange are readily convertible to known amounts of cash or claims to cash. 2. Another set of Revenue Recognition criteria with approximately the same meaning is : (1) The earnings process must be substantially complete. (2) There must be an objective measure of the value of the output. (3) Collectibility must be reasonably assured. 3. Timing of Revenue Recognition A. At time of sale (or when title passes) Example: Wholesale or retail sale of mass produced merchandise. B. During Production Example: Percentage completion method of accounting for long-term contracts. C. At Completion of Production (before sale) (Not generally used in practice) Example: Precious metals or agricultural grain production with assured prices (no significant costs to distribute) Note: Recognition times B and C are accomplished by valuing the inventory at selling price. D. When Cash is Collected (after sale) Example: Installment basis of accounting (allowed for financial accounting purposes only if the degree of collectibility cannot be reasonably estimated) 4. In order to appear financially better off than is really the case, occasionally Co. executives have recognized revenue too soon; this action overstates Net Income and overstates net assets and Retained Earnings. Recognizing revenue too soon (before criteria in (1) or (2) above are met) has sometimes been referred to as “Front End Loading.” Some areas that have experienced such problems in the past are: A. Franchise Sales B. Retail Land Sales C. Real Estate Sales
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Chapter 18, Page 2 of 9 5. If the right of return or refund exists at time of sale, generally use the DEPOSIT METHOD. The Deposit Method --not a method of revenue recognition. It means recording any money received from the customer as a liability (unearned revenue) until the period for possible return or refund is over. 6. Installment Method --recognition of revenue as cash is collected after sale--is accomplished by recognizing a portion of each payment received as gross profit (based on gross profit percentage) and the remainder of each payment as a recovery of cost. 7. Cost Recovery Method --used when collection is extremely doubtful--recognizes no profit until cost of sale is recovered, then all remaining cash collections are recognized as gross profit. 8. In accordance with APB# 10, the Installment method of accounting for installment sales may be used for financial accounting purposes only if the degree of collectibility cannot be reasonably estimated; otherwise, revenue recognition must be at time of sale with appropriate estimate of annual bad debts, i.e., accrual accounting basis.
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I2 CH18 13ed Fall 09 - Chapter 18, Page 1 of 9 CHAPTER 18...

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