Lecture07 Spring 2009 v2

Lecture07 Spring 2009 v2 - Lecture 7 Spring 2009 Timing of...

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1 Lecture 7 Spring 2009 Timing of Revenue Recognition
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2 Goals of Today’s Class Discuss Revenue Recognition Issues Percentage of Completion Completed Contract SAB 101 Discuss cases of improper or questionable revenue recognition practices
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3 Accounting for Sales Revenue The revenue principle requires that revenues be recorded when earned: An exchange has taken place. An exchange has taken place. Collection is probable. Collection is probable. The earnings process is nearly complete. The earnings process is nearly complete.
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4 What if production takes much longer? Long-term contractors Production spans multiple accounting cycles Percentage of completion method Using this method, revenue is recognized during the period of production – as work on the project progresses – rather than later, at the time of delivery.
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5 Recognize revenue from long-term contracts under the percentage of completion method if: The ongoing construction/production effort reflects the continuing earnings process for the project, and the cost of construction can be estimated reasonably accurately, and Cash collection is virtually assured
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6 Percentage of Completion Method Revenues and associated expenses from a long-term project are recognized during each accounting period on the basis of the progress made on the project during the period. How do we measure the progress made on the project?
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7 Measurement of progress and revenue allocation Estimated % of project completed to date = Actual cost incurred on the project to date Estimated Total Cost for the project
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8 Example Total revenue for the project (specified in the contract): $200,000 Total estimated cost to complete the project: $160,000 Actual Costs Incurred During Production: Year 1: $40,000 (25% of estimated total) Year 2: $80,000 (50% of estimated total) Year 3: $40,000 (25% of estimated total) The contract also requires that the customer make the following cash payments to the contractor: December 31, Year 1: $ 30,000 December 31, Year 2: $ 30,000 Project Completion: $140,000
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9 Example – Percentage of Completion Method Year Revenue Profit 1 2 3 Total (200,000 x 25%) – 0 (200,000 x 75%) – 50,000 (200,000 x 100%) – 150,000 =$50,000 =100,000 =50,000 $200,000 $40,000 80,000 40,000 $160,000 $10,000 20,000 10,000 $40,000 Project Expenses (Actual Costs)
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10 Comparison of Percentage of Completion Method and Point of Sale Method Revenue and expenses directly related to the long-term contract are recognized before the “delivery”. There is no association between the amount of cash received and the revenue recognized.
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11 What happens if the cost estimates change? - Example Total revenues for the project (specified in the contract): $200,000 Total Estimated Cost to Complete the Project: $160,000 Actual Costs Incurred During Production: Year 1: $40,000 Year 2: $80,000 However, at the end of Year 2, before recording revenues for the year, the firm revised its estimate of the costs to be incurred in Year 3 from $40,000 to $60,000 .
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Lecture07 Spring 2009 v2 - Lecture 7 Spring 2009 Timing of...

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