ch06 - Chapter 6 Prepared by: Patricia Zima, CA Mohawk...

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Unformatted text preview: Chapter 6 Prepared by: Patricia Zima, CA Mohawk College of Applied Arts and Technology Revenue Recognition Revenue Recognition Current Current Environment Environment •Revenue Revenue recognition criteria criteria Earnings Earnings Process Process •Sale of Sale goods goods Measurement Measurement Uncertainty Uncertainty •Sales with Sales right of return right Uncertainty Perspectives Uncertainty Associated •Analysis with Collectibility •International Collectibility •Rendering of Rendering services and long-term contracts contracts •Trade loading Trade and channel stuffing stuffing •Instalment Instalment sales sales •Barter and Barter non-monetary transactions transactions •Reporting Reporting gross vs. net revenues revenues •Bundled sales •Instalment Instalment method method •Cost recovery Cost method method Appendix Appendix 6A: Franchises Franchises •Initial fees •Continuing Continuing fees fees •Special Special issues issues •Disclosures Guidelines for Revenue Recognition • Revenue is recognized when the following criteria are met: 1. Performance is achieved: a. risks and rewards transferred b. measurability reasonably assured • Collectibility is reasonably assured REVENUE RECOGNITION • Cnd perspective (Section 3400) – Inflow in the course of ordinary activities normally from the sale of goods or rendering of services and the use of entity resources yielding interest, royalties and dividends • IFRS (IAS 18) – Gross inflow of economic resources arising in the course of ordinary activities when those iflows result in increases in equity other than increases related to contributions from equity participants Guidelines for Revenue Recognition • EIC 141 clarifies the meaning of performance: 1. Persuasive evidence of an arrangement exists 2. Delivery has occurred, or service rendered 3. Seller’s price is fixed and determinable • To determine persuasive evidence of an arrangement, consider the following: 1. Customary business practice 2. Any side arrangements with customer 3. The economic substance of the transaction (e.g. consignment sales) Guidelines for Revenue Recognition • IFRS standard less rigorous • Existence of pervasive agreement NOT required Earnings Process • Revenue is recognized (recorded) when the earnings process is complete or substantially complete • What about long term construction contracts? Risks and Rewards of Ownership • To determine who has risks and rewards (benefits) of ownership, need to look at whether a sale has occurred at point of delivery: – Who has possession of the goods? – Who has legal title? • Consider the terms of sale (e.g., f.o.b. shipping point and f.o.b. destination) • Bill and hold transactions Risks and Rewards of Ownership • Revenues from manufacturing and selling are commonly recognized at point of sale • Revenues from sales with buyback agreements are not recognized (not sales) if rights and risks have not been passed to buyer (the seller retains the risk) • Customer acceptance provisions result in various accounting treatment Customer Acceptance Provisions Type of acceptance provision Accounting Treatment 1. Trial or evaluation basis 1. No sale until evaluation basis evaluation period lapses or customer accepts 2. Right of return 2. Recognize sale if company can estimate returns or specifications are met or customer signs off Consignment Sales • Consignor ships inventory to the consignee • The consignee acts as an agent to sell the inventory • Possession has transferred; however legal title and risk and rewards remains with the seller • Goods are recorded by seller as “Merchandise on Consignment” • Not held as inventory on consignee’s books • When merchandise sold, the consignee remits cash to the consignor (after deducting commission and other chargeable expenses) Consignment Sales Consignor’s Books Goods shipped to Consignee Inventory on Consignment $$$ Finished Goods Inventory $$$ Finished Payment of Freight Inventory on Consignment $$$ Cash $$$ Cash Notification of Sale Accounts Receivable $$$ Relevant Expenses $$$ Consignment Sales $$$ Consignment Cost of Goods Sold $$$ Inventory on Consignment $$$ (Note: cost includes freight) Receipt of Cash from Sale Cash $$$ Accounts Receivable $$$ Accounts Consignee’s Books No Entry No Entry Notification/Payment of Sale Cash $$$ Payable to Consignor $$$ Payable Remittance to Consignor Payable to Consignor $$$ Commission Revenue $$$ Commission Cash $$$ Cash Risks and RewardsSpecial Circumstances • Special considerations: Non-Refundable Fees: Unless the company has earned these fees, they should not be recognized as revenue Continuing Managerial Involvement: If the seller retains some managerial involvement, revenue recognition is normally prevented Services and Long-Term Contracts • The earnings process for services is different than for the sale of goods • For the sale of goods, delivery of the goods is the critical event • For services, the performance of the service (which may be ongoing or continuous) is the determination of revenue recognition • Recognize revenue at each critical event, as long as it is collectible Revenue Recognition Before Delivery-Long Term Contracts • IAS 11-Revenue may be recognized before delivery under certain circumstances • Long-term construction contracts (percentageof-completion method), is an example • The percentage-of-completion method permits periodic billing at various points in the project and revenue recognition based on measuring costs incurred against total estimated costs • The completed contract method is not applicable (IFRS) Percentage-of-Completion: Concept • The amount of revenues, costs and gross profit recognized on long term contracts depends upon the percentage of work done • Application of percentage-of-completion method requires a basis for measuring the progress toward completion at interim dates • Can use input measures (e.g. costs incurred- which is the most popular method, or labour hours worked) Percentage-of-Completion: Steps 1 Costs incurred to date = Percent complete Percent Most recent estimated total costs 2 Percent complete x Estimated total revenue = Revenue to be recognized to date Revenue 3 Revenue to be recognized to date – Revenue recognized in prior periods = Current period revenue* Current 4 *Current period revenue – Current costs = Gross Profit *Current Percentage-of-Completion: Cost-to-Cost Basis Data: Contract price: $4,500,000 Estimated cost: $4,000,000 Contract Start date: July, 2008 Balance sheet date: Given: Given: Costs to date Finish: October, 2010 December 31st 2008 2008 2009 2009 2010 2010 $1,000,000 $2,916,000 $4,050,000 Estimated costs to complete $3,000,000 $1,134,000 $ Estimated $3,000,000 -0- Progress billings during year $ 900,000 $2,400,000 $1,200,000 Cash collected during year $ 750,000 $1,750,000 $2,000,000 Percentage-of-Completion: Cost-to-Cost Basis 2008 Contract Price (a) Less: Estimated Costs Costs to Date Est. Cost to Complete Est. Total Costs (b) Estimated Total Gross Profit (a – b) Percent Complete 2009 $4,500,000 $4,500,000 $4,500,000 $4,500,000 1,000,000 1,000,000 3,000,000 3,000,000 4,000,000 4,000,000 2,916,000 1,134,000 1,134,000 4,050,000 4,050,000 4,050,000 -04,050,000 4,050,000 $ 500,000 500,000 $ 450,000 25% 1,000,000 1,000,000 4,000,000 4,000,000 72% 2,916,000 2,916,000 4,050,000 2010 $ 450,000 100% 4,050,000 4,050,000 4,050,000 Percentage-of-Completion: Cost-to-Cost Basis 2008 2009 To record cost of construction: Construction in Process 1,000,000 1,000,000 900,000 Materials, Cash, Payables 1,916,00 0 2,400,00 0 750,000 1,750,00 0 To record progress billings Accounts Receivable 900,000 Billings on Construction in Process 1,916,00 0 2,400,00 0 To record collections: Cash Accounts Receivable 750,000 1,750,00 0 Note: Journal entries for 2010 are not shown due to space limitations Percentage-of-Completion: Cost-to-Cost Basis 2008 Contract Price (a) $4,500,000 Percent complete (b) 25% Revenue recognized: Revenue to date (a x b) Less: Prior years revenue Current year revenue Gross profit recognized: G.P. to date (Total x %) Less: G.P. in prior years Current year G. P. 2009 $4,500,000 72% 2010 $4,500,000 100% $1,125,000 -0-0$1,125,000 $1,125,000 $3,240,000 1,125,000 $2,115,000 $4,500,000 3,240,000 $1,260,000 $ 125,000 -0-0$ 125,000 125,000 $ 324,000 125,000 $ 199,000 $ 450,000 324,000 $ 126,000 Percentage-of-Completion: Cost-to-Cost Basis 2008 2009 To recognize revenue and gross profit: Construction in Process 125,000 199,000 Construction Expenses 1,000,000 1,916,000 Revenue from Long-Term Contract 1,125,000 2,115,000 To record completion of contract (recorded on completion date in 2010): Billings on Construction in Process Construction in Process 4,500,000 4,500,000 Note: Journal entries for 2010 are not shown due to space limitations Percentage-of-Completion: Financial Statement Presentation • The difference between “Construction in process” and “Billings on construction in process” is recorded on the Balance Sheet as either: – Current asset* (with Inventories) if difference is a debit balance or – Current liability* if difference is a credit balance *May be non-current depending on length of contract Percentage-of-Completion: Financial Statement Presentation • The balance in the Construction in Process account represents the costs incurred + gross profit recognized to date • The balance in the Billings on Construction in process represents the billings made to customers to date Long-Term Contract Losses • A long-term contract may produce either: • an interim loss on a profitable contract or • an overall loss for the contract • Under the percentage-of-completion method, all losses are immediately recognized Percentage Method: Interim Loss on Profitable Contract–Example 2008 2009 2010 Contract Price $4,500,000 $4,500,000 $4,500,000 Costs to date Est. Cost to Complete Est. Total Costs 1,000,000 2,916,000 1,468,962 1,468,962 4,384,962 4,384,962 4,384,962 -04,384,962 4,384,962 Percent Complete 3,000,000 3,000,000 4,000,000 4,000,000 25% 25% 1,000,000 1,000,000 4,000,000 4,000,000 66.5% 66.5% 2,916,000 2,916,000 4,384,962 100% 4,384,962 4,384,962 4,384,962 Revenue recognized to date in 2009: $4,500,000 x 66.5% = $2,992,500 Less: Amount recognized in 2008 1,125,000 1,125,000 Revenue recognized in 2009 1,867,500 Less: Actual costs incurred in 2009 1,916,000 1,916,000 Loss recognized in 2009 $48,500 $48,500 Percentage Method: Interim Loss on Profitable Contract– Example Record loss for 2009: Construction Expenses 1,916,000 Construction 1,916,000 Construction in Process (loss) 48,500 Construction Revenue from Long-Term Contract 1,867,500 Revenue Percentage Method: Interim Loss on Overall Unprofitable Contract– Example 2008 Contract Price Costs To Date Est. Cost to Complete Est. Total Costs Percent Complete 2009 2010 $4,500,000 $4,500,000 $4,500,000 (a) 1,000,000 2,916,000 1,640,250 1,640,250 4,556,250 4,556,250 4,556,250 -04,556,250 (b) 4,556,250 64% 64% 2,916,000 4,556,250 100% Gross Loss (56,250)* 3,000,000 3,000,000 4,000,000 4,000,000 25% 25% 1,000,000 1,000,000 4,000,000 4,000,000 Losses recognized in 2009: Gross profit recognized in 2008 (needs to be reversed) $125,000 Expected total loss on unprofitable contract (a – b) *56,250 Total loss to be recognized in 2009 $181,250 Percentage Method: Interim Loss on Overall Unprofitable Contract– Example Record loss in 2009 for percentage-of-completion method: Construction Costs expensed in 2009: Revenue recognized in 2009: (4,500,000 X 64%) $2,880,000 Less: Revenue recognized in 2008 1,125,000 Revenue recognized in 2009 1,755,000 Less: Loss recognized in 2009 (see previous slide) 181,250 Construction Cost Expense 1,936,250 Construction Expenses 1,936,250 Construction Construction in Process (Loss) Construction Revenue from Long-Term Contract Revenue 181,250 1,755,000 Non-Monetary Transactions • Non-monetary transactions are transactions where minimal or no monetary assets are received as payment for goods/services sold • Generally, transaction is treated as a sale and recorded at the value that can be measured more reliably: the fair value of the asset given up or the fair value of the asset received Non-Monetary Transactions • Transaction is treated as a sale and measured at fair value unless any of following exists: 1. It lacks commercial substance 2. It is an exchange of a product/property to facilitate a sale to a customer 3. The fair value cannot be measured reliably 4. It is a non-monetary, non-reciprocal transfer to owners Non-monetary Transactions • Commercial substance – Determined by post-transaction cash flows – Accounted for at fair value • Lacking commercial substance, transaction accounted for at book value Reporting Gross vs. Net Revenues • Revenues can be recorded as the gross amount billed or as the net amount retained • Consideration should be given to the following factors: – whether company acts as a principal or as an agent/broker – whether company takes title to the goods sold – whether company has risks and rewards of ownership of goods sold Measurement Uncertainty Sales with Rights of Return: • Three revenue recognition alternatives available: – Sale recorded only when right of return expired – Sale recorded but subtracting estimate of future returns -only available if returns measurable – Sale and returns recorded when they occur Measurement Uncertainty Sales with Rights of Return continued: • Revenue not recognized when right of return exists even though title to goods has passed when: 1. The price is not fixed 2. Buyer does not pay until product is resold, consumed or used Measurement Uncertainty Bundled Sales: • When sale creates multiple deliverables (e.g., a product and a service GAAP says to separate each deliverable if: • Each deliverable is valuable to customer on its own and the undelivered deliverable has a value that can be determined objectively (e.g., fair value) • Completion of contract is probable and within CUSTOMER LOYALTY INCENTIVES • Covered under IFRIC 13 • Current (GAAP PE) requires a liability and expense for the estimated cost of the incentive • IFRS requires an offset to revenue to be recognized only when the incentive is realized ...
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