revenue recognition

JE to book period income or loss (POC)

(5 step equations) debit "CIP" for the amount of current period income (#3) and credit "construction revenue" for current period revenue (#4), revenue should be greater than income so resulting debit plug will be to "construction expense", if there is a loss state than CIP will be a credit (rather than a debit) to increase the overall construction expense, at the end of each period on B/S if CIP>billings: current asset labelled "costs and gross profit in excess of billings"

completed contract method

(actual numbers, slightly irrelevant yet reliable recognition method) recognize revenue only when the contract is complete, no estimates are made to book income while contract is ongoing except if total estimated income is negative (total loss state, not interim loss) then book entire loss as soon as its known, cost accumulation, billings, and collections entries are the same as with POC, entry to recognize profit occurs in year of completion (except with total loss state)

total loss state with completed contract method

(do page 10 of practice problems) once an overall loss state world has been determined book the loss as a debit to "loss on LT contract" and a credit to "CIP" for the amount of the loss itself

percentage of completion method

(involves the use of estimates but is very relevant in the F/S), this method is used if: (1) contract clearly states rights of parties, consideration to be exchanged, and method of exchange, (2) buyer is expected to satisfy obligations, and (3) contractor expected to perform all duties (if these three aren't met then use completed contract), progress (which determines revenue) is measured with input measures (costs-this class and labor) and output measures (units delivered, floors completed, miles)

incentives for revenue recognition

(tendency to aggressively recognize revenue, FASB sets forth policies to conservatively recognize revenue) financial executives not that revenue recognition is difficult to manage, poses problems, and it is a top fraud risk for GAAP accounting because: revenue is a really important figure for investors and valuation, investors are involved in CEO employment, and revenues can determine stock compensation

revenue recognition

according to the FASB, revenue should be recognized when it is earned and realized (realizable)

installment sale with interest

an interest component will create a discount (credit) upon sale of good/service, at each collection a portion of the discount is removed and recognized as interest revenue, the portion remaining from the cash collection (after interest) is portioned from deferred GP to income summary based on GP%

recognized

an item is recognized when it is incorporated in both words and numbers in the financial statements and included in the totals shown on the F/S (different from a disclosure), revenue recognition -> I/S

how to finish completed contract method

at the end of the period, billings will have accumulated through billings to customers, so just reverse this as a debit to "billings" and a credit to "construction revenue" also CIP will be equal to total costs incurred so close it out as a credit to "CIP" and a debit to "construction expense"

JE at the end of the project (POC)

at the end of the project billings = CIP so adjust those to balance out

installment sales

based on: (1) sales and COGS are recorded normally during year, but reversed at year end to deferred gross profit account instead of income summary, (2) apply gross profit % (from year the sale took place) to cash collected during year to get gross profit to realize, (3) keep separate A/R and deferred G.P. accounts for each year, (4) tie income recognition to collection, and (5) interest income in connection to collections is accounted for separately

JE as firm bills customer (POC)

debit "A/R" and credit "billings" for the amount billed to customer, billings is a contra asset account to CIP

journal transactions with POS transaction

debit "A/R", credit "sales revenue" for the amount of the purchase price, then debit "COGS" and credit "inventory" for the cost of the good or service

JE as cash is collected (POC)

debit "cash" and credit "A/R" for the amount of monies remitted by the customer

JE as costs are incurred (POC)

debit "construction in progress or CIP" and credit "construction materials" for the amount of cost incurred

revenue

definition: inflows of assets from entities primary operations, most revenue transactions do not pose problems for recognition

multiple deliverables

firms can provide multiple products/services as a single transaction, first identify separate units of accounting and then assign value (total sales price) to each item based on relative fair value (determined through vendor specific evidence, third party evidence, and best estimates)

separate units of accounting

for a product to be a separate unit of accounting it must: (1) have value to customers on stand-alone basis, (2) allow right of return, and (3) delivery or performance of undelivered items is probable and under sellers control

sales with high returns

for some firms, greater than 50% of sales are eventually returned, the FASB says companies can recognize revenue (net of estimated returns) at the time of sale only if: (1) sales price is fixed and determinable at time of sale, (2) buyer has paid the seller (or is obligated to pay), (3) buyer has an obligation to pay even if the product is damaged or destroyed (risk of loss with buyer), (4) buyer is an entity distinct from the seller (to avoid related party issues), (5) seller doesn't have additional obligations (like return privilege) beyond delivering product to seller, and (6) the seller can reasonably estimate future returns (sales returns and allowances, contra revenue account), without these six conditions, seller can recognize revenue only when the return privilege has expired or when all six conditions are met

point of sale transaction

in general, most revenue is recognized on a "sale basis", at the point of sale when the goods/services have been delivered to the client

installment sales method

income is recognized when cash is collected, not in the period of sale, method allocates every dollar collected as part of cost recovery and part profit realized, GP from installment sales is presented on the I/S after GP, deferred GP = % x outstanding A/R balance

cost recovery method

income is recognized when costs have been fully recovered out of collections, if collections > costs then income recognition will occur, sales and COGS are recorded like normal during the year and deferred GP account set up at year end (revenue and COGS reversed to this), initial cash collections are 100% cost recovery and 0% GP, final cash collections are 0% cost recovery and 100% GP, use this method for the lowest quality of receivables, revenue isn't realized until costs are recovered

determining income/loss state

must determine if project exists in total income or total loss world: (1) total income = revenue - total costs, (2) percent complete (PC) = costs to date / total costs (incurred in past and estimated moving forward), (3) current period income = (PC x total income) - prior period income (loss would offset the decrease), (4) current period revenue = (PC x total revenue) - prior period revenue, and (5) current expense = plug

earned

revenues are earned when the company has done substantially all that it needs to do in order to have rights to the benefits (cash or other assets) represented by the revenues

realizable

revenues are realizable when a company exchanges goods and/or services for assets that are readily convertible to known amounts of cash or claims to cash

realized

revenues are realized when a company exchanges goods and/or services for cash or receivables

bill and hold transactions

the buyer is not ready to take delivery of the goods but does take title and accepts billing, seller should recognize revenue when title passes (which is before delivery takes place) if: (1) the risks of ownership pass to the buyer (title), (2) the buyer commits to purchase the goods on a bill and hold basis and sets a fixed delivery date, and (3) the goods are segregated, complete, and available for shipment (can't recognize revenue for unfinished inventory)

repossession (when default occurs)

the only other way for deferred GP to hit the books besides cash collections, asset is debited for FMV on the date of repo, deferred GP is debited for the outstanding A/R balance x GP%, loss or gain might occur, and A/R is removed for outstanding balance as a credit

total loss world

the project is ongoing yet total income is NEGATIVE (#1), same as profit state except #3 = current period income = total loss - prior period income (or + prior period loss)

sales method

the sale and acquisition of the receivable (not the collection) is the critical event

methods for long term construction

there are two methods for recognizing revenue, before the delivery of good, with a long term project: (1) percentage of completion and (2) completed contract

long term construction issues

this involves the recognition of revenue BEFORE the delivery of product/service, issues: (1) project may span several years/periods, (2) buyer pays for project over time (realizability), and (3) if work is still ongoing then how can revenue be earned

deferred GP

this is a current liability account (normal credit balance) for unearned revenues

late recognition of revenue

this is a recognition of revenue in the F/S after the delivery of a good/service (or portion thereof) (includes installment sale)

early recognition of revenue

this is a recognition of revenue in the financial statements before the delivery of a good/service (or portion thereof) (includes long term construction projects)

revenue recognition after delivery

whether the seller will collect the sales price (realizability) is not reasonably assured, company must defer revenue recognition until cash is collected, three methods: (1) sales (quality of receivable is very good and timing of recognition is at the point of sale), (2) installment sale (quality of receivable is medium and timing of recognition is based on cash collection), and (3) cost recovery (quality of receivable is horrible and timing of recognition is after costs are recovered)

difference between interim and overall loss

with an interim loss when doing equation #3 you will get a negative number, with an overall loss when doing equation #1 you will get a negative number