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Chapter 18 Kieso

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Chapter 18
Revenue Recognition
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1. Revenue Recognition Basic Concepts
Definition of revenue (SFAC 6)Inflows or other enhancements of assets or settlement of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.General recognition criteria (SFAC 5)meets definition of an elementmeasurabilityrelevancefaithful representation
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1a. Revenue Recognition Basic Concepts
APB Statement 4Revenue is recognized whenthe earnings process is complete or virtually completean exchange has taken placeRealization principle (SFAC 5)Revenue is recognized whenthe earnings process is judged to be complete or virtually completethere is reasonable certainty as to the collectability of the asset to be received
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1a. Revenue Recognition Basic Concepts
SEC SAB No. 101persuasive evidence of an arrangement existsdelivery has occurred or services have been renderedthe seller’s price to the buyer is fixed or determinablecollectability is reasonably assured
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2. General Rule
Revenue is recognized at the point of sale
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3. Possible Points to Recognize Revenue
Most significant eventRecognition before point of saleprior to starting productioncustomer advancesduring productionlong-term construction contractsat completion of productionprecious metals, ag productsRecognition at point of salebut if right of return exists or sale with buybackRecognition after point of salecash collection methodsinstallment sales, cost recovery basisconsignments
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4. Expense Recognition
Expense – expired economic benefitsOutflows or other using up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. (SFAC 6)Expenses to be recognized can be identified bymatchingdirect expensing (period costs)systematic allocation
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5. Revenue Frauds
Obvious accounting violationsFictitious sales or fake customersPremature recording of salesInflated salesTransactions lacking integrityRoundtrip transactionsChannel stuffing and trade loadingBill and hold transactionsRelated party transactionsContracts, agreements and side letters
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6. Long-term Construction Contracts
Percentage of completion methodrevenue recognized each period based on progress of constructionthis method required ifcosts to complete and extent of progress toward completion are reasonably dependablecontract clearly specifies goods or services to be provided & received by partiesbuyer is expected to satisfy its contractual obligationscontractor is expected to perform its contractual obligations
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6a. Long-term Construction Contracts
Methods to estimate percentage of completioncost-to-cost method (input method)costs to date ÷ total estimated costs to completemost common methodmachine hours or labor hours (input measure)project milestones (output method)units of production (output method)engineer’s or architect’s estimates
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6b. Long-term Construction Contracts
Revenue and GP recognized per periodpercentage completed this period x total revenue or GPnew accountsconstruction in progress (inventory account)progress billings (contra acct to CIP)financial statement presentationnet both accounts – could be debit or credit balanceexample
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7.Completed contract method
Revenues and gross profit recognized when project finishedEntriessame entries to record costs and billingsdo not recognize revenue and gross profit each yearThe two methods are not acceptable alternativesExample
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8. Right of Return
Only recognize revenue if all of following are met (SFAS 48)sellers price is fixedbuyer has paid or is obligated to paybuyer’s obligation would not be changed by the theft or destruction of the productbuyer has economic substance apart from that provided by the sellerseller doesn’t have future significant obligationsamount of future returns can be reasonably estimated
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9. Cash Collection Methods
Emphasis placed on collection rather than on saleAPB 10generally states both methods are not acceptablebut in certain exceptional circumstances may be used
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9a. Cash Collection Methods
Installment Sales MethodEmphasis placed on collection rather than on salerevenue recognized in periods of collectionmore important method for tax than fin acctExample
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9b. Cash Collection Methods
Cost recovery methodNo gross profit recognized until all costs have been recoveredAfter all costs recoveredall additional cash received recorded as profitExample
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10. Multiple Deliverables
Revenue must be allocated to various elements based onFMVs if they are separableConsidered separable ifitemshave value on a stand-alonebasisthere is a general right of returndelivery is considered probableExamplesIT equipment and softwarefranchises
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Chapter 18 Kieso