# 5 9 module 5 i revenue recognition and operating

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5-9 Module 5 I Revenue Recognition and Operating Income Cash 1M UR 1M Cash 1MT UR r 1M COGS 4.5M Cash 4.5M COGS 4.5M I Cash 14.5M AR 5M UR 1M REV 6M AR 5MT UR 1MT REV r 6M Cash 2M AR 2M Cash 2M! AR r 2M Construction costs incurred Percentage complete Revenue recognized Year 1 . . . . . . . . . . \$4,500,000 \$4,500,000 = 60% \$10,000,000 x 60% = \$6,000,000 \$7,500,000 - ..... ~ \$3,000,000 = 40% \$10,000,000 x 40% = \$4,000,000 \$7,500,000 - ..... ~ Year 2 . . . . . . . . .. \$3,000,000 This table reveals that Bayer would report \$6 million in revenue and \$1.5 million (\$6 million - \$4.5 million) in gross profit on the construction project in the first year; it would report \$4 million in revenue and \$1 million (\$4 million c- \$3 million) in gross profit in the second year. Next, assume that Bayer's client makes a \$1 million deposit at the signing of the contract and that Bayer submits bills to the client based on the percentage of completion. The following table reflects the bills sent to, and the cash received from, the client. Rev~.n~e .recogni~~d C.lient billed Cash received At signing . Year 1 . Year 2 . \$ 0 6,000,000 4,000,000 \$1,000,000 2,000,000 7,000,000 \$ 0 5,000,000 4,000,000 At the signing of the contract, Bayer recognizes no revenue because construction has noe begun and thus, Bayer has not earned any revenue. By the end of the second year, Bayer has recognized all of the contract revenue and the client has paid all monies owed per the accounts receivable. The following template captures Bayer Construction's transactions over this two-year period (M indicates millions). Balance Sheet Cash 'Transaction .'L',: Asset + Nonci'lsh Assets Liabil- ities + Cqntrib. +'. ~arned Capital A -Capital Exp~r· ses Net Income Start of year 1: Record \$1M deposit received at contract signing +1M Cash +1M = Unearned Revenue = Year 1: Record \$4.5M con- struction costs -4.5M Cash -4.5M Retained Earnings +4.5M Cost of = -4.5M Sales = Year 1: Recognize \$6M revenue on partly completed contract +5M -1M Accounts = Unearned Receivable Revenue +6M Retained Earnings +6M Revenue = +6M Year 1.: Record \$2M cash received from client = +2M Cash -2M Accounts = Receivable continuec

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..., ..... ".'R1from prior page Module 5 I Revenue Recognition and Operating Income 5-10 Balance Sheet Income Statement Cash + Noncash Liabil- + Contrib. + Earned Rev- __________ A_s_se_t~~~A=s~s_e_ts~~=_~ij_ie~s~ C_a~p~i_ta_Ic_a~p_it_a_I-=4\enues '~~ , l ------------------------------------------------------------------------------------------------------,}------------------------------------------------------- ec- V ~==~:4M +4M +4M 1. Accounts = Retained Receivable Earnings Expen- ses Net Income -3M -3M +3M Cost 01 = Sales -3M Cash = Retained Earnings +4M = +4M Revenue +7M Cash -7M Accounts = Receivable = -----------------------------------------------------------------------------------------------------------., ---------------------------------------------------------- ~ -enue recognition policies for these types of contracts are disclosed in a manner typical to wing from the 2010 lO-K report footnotes of Raytheon Company, nue Recognition We account for our long-term contracts, , _using the percentage-of-com- - -' n accounting method. Under this method, revenue is recognized based on the extent of prog- towards completion of the long-term contract __. We generally use the cost-to-cost measure -= progress for all of our long-term contracts ... Under the cost-to-cost measure of progress, the t of progress towards completion is measured based on the ratio of costs incurred-to-date to otal estimated costs at completion of the contract.
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