Revenue Recognition

1
Revenue Recognition Revenue is recognized when
(1) it is realized or realizable and (2) it is
earned. Transaction Type of Revenue Timing of
Recognition Product Sale Sales Date of Sale
(delivery) Service Service Revenue Service
performed and is billable Use of
Asset Interest, Rent, Passage of time or
Royalty usage of asset Disposal of Gain or
loss Time of sale or trade-in other asset
2
Example Fred, a farmer harvests all his corn in
October when the price per bushel is 1.60 and
immediately sells it for 1.60. Jim, also a
farmer, harvests all his corn in October when the
price is 1.60, but Jim thinks prices will
improve so he stores his corn for .02 per bushel
per month and sells it in February for 1.75 per
bushel. What is the selling price for each
farmer and how should the 0.02 per month be
accounted for in order to reflect the economic
substance of what is happening?
3
Revenue with Right of Return Sales with buy back
agreements at a set price that covers all costs
of the inventory plus related holding costs, no
sale is recognized. When returns are very high,
revenue recognition may have to be deferred until
return privilege lapses. Sales with right of
return must meet 6 conditions to be
recognized. Price is fixed or
determinable Buyer has paid or is obligated to
pay Buyer bears risk of loss for goods Buyer
has economic substance apart from seller Seller
does not have significant obligations to bring
about resale of goods The amount of future
returns can be reasonably estimated Ex 1, 2
4
Long Term Contracts Completed contract records
profit only at the end of the contract with Work
in Process inventory being offset by Billings on
Construction in Process Percentage of Completion
recognizes gross profit based on costs incurred
to date versus revenue earned to date. Must use
percentage of completion if estimates of
completion, revenues and cost are reasonably
dependable and all of these Contract specifies
terms Buyer can be expected to satisfy
obligations Contractor can be expected to
perform obligations Ex 5 Pb 5
5
Other Revenue Recognition Bases Completion of
Production for cases when product is readily
saleable at a determinable price, mostly use for
commodities The installment method delays
recognition of revenue until cash is received,
and each payment is apportioned among cost
recovery, interest and gross profit. Use where
collectibility is suspect. Ex 10, P12 The cost
recovery method defers profit recognition until
all of the cost of goods sold has been
collected Ex 17
6
Franchises Franchise fees should not be
recognized until earned and the collectibility is
reasonably assured. There is a presumption that
the earliest a fee should be recognized is when
the franchisee begins operations. Continuing
franchise fees should be recognized as revenue
when earned. If franchisee is given the right to
buy supplies or equipment at bargain prices, the
discount should be deferred from profit. If the
franchisor has a realistic right to purchase the
franchisee, the franchisor should treat cash
received as a liability. Ex 18
7
Consignments Merchandise is placed physically on
the premises of another business, but titles
stays with consignor. Transfer merchandise to
inventory on consignment, and recognize revenue
when consignee reports that merchandise is
sold. Consignee uses receivable and payable
accounts to account for its side of
transactions Ex 20