Accounting - Revenue Recognition 2010 11

Accounting - Revenue Recognition 2010 11 - Financial...

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Unformatted text preview: Financial Accounting Revenue Recognition 1 Learning Objectives 1. Apply the revenue recognition principle. 2. Describe accounting issues for revenue recognition Describe at point of sale. at 3. Apply the percentage-of-completion method for Apply long-term contracts. long-term 4. Identify the proper accounting for losses on longterm contracts. 5. Describe the installment-sales method of Describe accounting. accounting. 2 Four Types of Revenue Transactions 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 enterprise’s 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. 3 The Current Environment Revenue recognition has been the largest source of public company restatements over the past decade. One study noted restatements of revenue: Result in larger drops in market capitalization than other types of restatement. Caused eight of the top ten market value losses in a recent year. 4 The Current Environment Guidelines for Revenue Recognition The revenue recognition principle provides that companies should recognize revenue (1) when it is realized or realizable and (2) when it is earned. (3) When the risk has passed from one party to the other. 5 The Current Environment • 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 realisable when assets received are convertible into a known amount of cash. 6 The Current Environment Revenue Recognition Classified by Type of Transaction Type of Transaction Sale of product from inventory Rendering a service Permitting use of an asset Sale of asset other than inventory Description of Revenue Revenue from sales Revenue from fees or services Revenue from interest, rents, and royalties Gain or loss on disposition Timing of Revenue Recognition Date of sale (date of delivery) Services performed and billable As time passes or assets are used Date of sale or trade-in 7 The Current Environment Departures from the Sale Basis Earlier recognition is appropriate if there is a high degree of certainty about the amount of revenue earned. Delayed recognition is appropriate if the degree of uncertainty concerning the amount of revenue or costs is sufficiently high or sale does not represent substantial completion of the earnings process. 8 Point of Sale (Delivery) Departures from the Sale Basis Companies usually meet the two conditions for recognizing revenue by the time they deliver products or render services to customers. Implementation problems, Sales with Buyback Agreements Sales When Right of Return Exists Trade Loading and Channel Stuffing 9 Point of Sale (Delivery) Sales with Buyback Agreements When a repurchase agreement exists at a set price and this price covers all cost of the inventory plus related holding costs, the inventory and related liability remain on the seller’s books.* In other words, no sale. 10 10 Point of Sale (Delivery) Trade Loading and Channel Stuffing “Trade loading is a crazy, uneconomic, insidious practice through which manufacturers—trying to show sales, profits, and market share they don’t actually have—induce their wholesale customers, known as the trade, to buy more product than they can promptly resell”. 11 11 Revenue Recognition Before Delivery Most notable example is long-term construction contract accounting. Two Methods: Percentage­of­Completion Method. Rationale is that the buyer and seller have enforceable rights. Completed­Contract Method. (Note not permitted by IFRS. 12 12 Revenue Recognition Before Delivery Long­Term Construction Accounting Methods Percentage­of­Completion 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 No Longer to be used 13 13 Revenue Recognition Before Delivery Must use Percentage-of-Completion method when estimates of progress toward completion, revenues, and costs are reasonably dependable and all of the following conditions exist: 1. The contract clearly specifies the enforceable rights regarding goods or services by the parties, the consideration to be exchanged, and the manner and terms of settlement. 2. The buyer can be expected to satisfy all obligations. 3. The contractor can be expected to perform under the contract. 14 14 Percentage­of­Completion Method Measuring the Progress toward Completion Most popular measure is the cost-to-cost basis. The percentage that costs incurred bear to total estimated costs, can be applied to the total revenue or the estimated total gross profit on the contract. 15 15 Percentage­of­Completion Method Measuring the Progress toward Completion Cost-to-cost basis Costs incurred to date Most recent estimate of total costs Percent complete x Estimated total revenue = Revenue to be recognized to date Revenue recognized in prior periods = ­ = Percent complete Revenue to be recognized to date Current­period Revenue 16 16 Long­Term Contract Losses Two Methods: Loss in the Current Period on a Profitable Contract Percentage­of­completion method only, the estimated cost increase requires a current­period adjustment of gross profit recognized in prior periods. Loss on an Unprofitable Contract Under both percentage­of­completion and completed­contract methods, the company must recognize in the current period the entire expected contract loss. 17 17 Revenue Recognition Before Delivery Disclosures in Financial Statements Construction contractors should disclosure: the method of recognizing revenue, the basis used to classify assets and liabilities as current (length of the operating cycle), the basis for recording inventory, the effects of any revision of estimates, the amount of backlog on uncompleted contracts, and the details about receivables. 18 18 Revenue Recognition After Delivery When the collection of the sales price is not reasonably assured and revenue recognition is deferred. Methods of deferring revenue: Installment­sales method Cost­recovery method Deposit method Generally Employed 19 19 Revenue Recognition after Delivery Installment-Sales Method Recognizes income in the periods of collection rather than in the period of sale. Recognize both revenues and costs of sales in the period of sale, but defer gross profit to periods in which cash is collected. Selling and administrative expenses are not deferred. 20 20 Revenue Recognition after Delivery Acceptability of the Installment-Sales Method The profession concluded that except in special circumstances, “the installment method of recognizing revenue is not acceptable’’. The rationale: because the installment method does not recognize any income until cash is collected, it is not in accordance with the accrual concept. 21 21 Revenue Recognition after Delivery Cost-Recovery Method Recognizes no profit until cashpayments by the buyer exceed the cost of the merchandise sold. APB Opinion No. 10 allows a seller to use the cost­recovery method to account for sales in which “there is no reasonable basis for estimating collectibility.” In addition, FASB Statements No. 45 (franchises) and No. 66 (real estate) require use of this method where a high degree of uncertainty exists related to the collection of receivables. 22 22 Revenue Recognition after Delivery Deposit Method Seller reports the cash received from the buyer as a deposit on the contract and classifies it on the balance sheet as a liability. The seller does not recognize revenue or income until the sale is complete. 23 23 US GAAP vs. IFRS (it’s coming fast!) IFRS – revenue from rendering services recognized in accordance with long­term contract accounting, including considering the stage of completion, whenever revenues and costs can be measured reliably and it is probable the economic benefits will flow to the company (seller). 24 24 US GAAP vs. IFRS (it’s coming fast!) IFRS – Multiple Elements – IAS 18 requires recognition of revenue on an element of a transaction if that element has commercial substance on its own; otherwise, the separate elements must be linked and accounted for as a single transaction. (No other specific guidance, yet.) 25 25 US GAAP vs. IFRS (it’s coming fast!) IFRS – Multiple Elements – IAS 18 requires recognition of revenue on an element of a transaction if that element has commercial substance on its own; otherwise, the separate elements must be linked and accounted for as a single transaction. (No other specific guidance, yet.) 26 26 US GAAP vs. IFRS (it’s coming fast!) IFRS – Construction Contracts – IAS 18 requires the use of the percentage­of­completion method if certain criteria are met. Otherwise, revenue recognition is limited to recoverable costs incurred. (Completed contract method is not permitted.) 27 27 Coffee Break • 9.2.1 28 28 Study Pack 2 29 29 Financial Accounting Expenditure Recognition 30 30 Capital Vs Revenue Expenditure • A Capital expense is not consumed • A revenue expense is consumed 31 31 Capital Exp Revenue Exp Balance Sheet Income Statement Not Consumed Consumed 32 32 Lets look at that long term contract through the eyes of the Company Contracting 33 33 • They have to invest for many years with no income to match the expenditure. • Their profile might look like this… 34 34 Example: Long Term Contract Income Expenditure Income Expenditure Income Income Income Expenditure Expenditure Expenditure 35 35 Example: Long Term Contract Nil $100m Capitalise In Balance Sheet Nil $100m Capitalise In Balance Sheet Nil $100m Capitalise In Balance Sheet $200m $50m Capitalise In Balance Sheet $400 Nil 36 36 Example: R & D Windows 15 Income Expenditure Income Expenditure Income Income Income Expenditure Expenditure Expenditure 37 37 Example: Long Term Contract Nil $100m Capitalise In Balance Sheet nil $200m Capitalise In Balance Sheet Nil $200m Capitalise In Balance Sheet Nil $200m Capitalise In Balance Sheet $500m Nil 38 38 Returning to the Matching principal • We now need to match expenditure with the income. • We need a policy to release expenditure to match against the revenue generated. 39 39 40 40 Video 41 41 Video 42 42 The End… • to be continued….. 43 43 ...
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This note was uploaded on 11/11/2010 for the course MGT MGT567 taught by Professor Simon during the Spring '10 term at Lethbridge College.

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