Income Measurement and Profit Analysis

8/4/2019 Income Measurement and Profit Analysis

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Intermediate

Financial Accounting I

Revenue Recognition



Income Measurement And Profit Analysis 2

Objectives of the Chapter

1. Discuss the revenue recognitionprinciple and the problems associatedwith revenue recognition at point of

sale.2. Discuss the cases that revenue is

recognized at a point other than at

point of sale (i.e., before delivery).

3. Study the percentage-of-completionmethod for long-term contracts.




Objectives of the Chapter (contd.)

4. Study the completed-contract methodfor long-term contracts.

5. Discuss the installment method ofaccounting.

6. Study the accounting treatments forfranchise, software sales andconsignment.




Revenue Recognition Principle(SFAS No. 5) Revenue is recognized when it is realized

and earned.

Realized: goods are exchanged for cash or

claims (to cash). Earned: the entity has substantially

accomplished what it must do to be entitledto compensation.

In general, these conditions are met at timeof sale (delivery) or when services arerendered.




Revenue Recognition Principle

Other conditions for revenuerecognition (Staff Accounting BulletinNo. 101(1999)):

Persuasive evidence of a sale.

Price is fixed or determinable.

Collectibility is reasonably assured. Delivery has occurred or services

have been rendered.




Impact of SAB 101 on RevenueRecognition for Service Industry FedEx: Recognizes revenue upon delivery of

shipments (not during the packing, loading ortransporting).

United Airlines (UA): (Accounting Changes)Beginning Q1, 2000, UA recognizes mileagesale through Citibank credit card or long-distance phone companies after thetransportation is provided, not when mileagewere sold.

Others: season tickets, annual membership,etc.


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Type of Transactions

Sale of product from Inventory: revenuerecognized at time of sale.

Rendering a service: revenue recognized

when services have been performed andbillable.

Permitting use of an asset: revenue (i.e.,interest, rents and royalties) recognized as

time passes or assets are used. Sale of asset other than inventory: gain or

loss recognized at date of sale or trade-in.



Problems Associated with RevenueRecognized at Point of Sale (Delivery)

1. Sales with buyback agreements:inventory and related liability remain onthe seller’s book. No sale isrecognized.

2a. Sales with right of return exists:

Revenue recognized if expectinginsignificant amount of returns.



Problems Associated with RevenueRecognized at Point of Sale (contd.)

2b. Sales with right of return: Whenexpecting high sales returns, norevenue can be recognized unlessthe following six conditions are met.

(i) Sales price is determined;

(ii) Buyers have paid or have theobligations to pay;




2b. Sales with right of return (contd.)

(iii) The buyers’ obligation would not bechanged due to theft of damage of

the product after sales;(iv) Sellers are not responsible for the

performance of the product;

(v) Buyers and sellers are twoseparate economic entities;

(vi) The amount of returns can be

estimated.




3. Trade loading: Manufacturers reducedthe price for wholesale at the fiscal yearend to create instant sales. The

wholesaler is loaded with more inventorythan it can promptly resell.



Revenue Recognition over Time (duringthe earnings process) and others

1. During the production process(i.e.,long-term contract): accountingmethods of revenue recognition arepercentage-of completion method and completed-contract method.

2. At the completion of production (i.e.,for agriculture products and preciousmetals).



Revenue Recognition after Delivery

3. Installment Sales: revenuerecognized after time of sale (delivery)as cash is collected.

4. Revenue recognition delayed until afuture event occurred (i.e., real estate

sale, sale of division). Accountingmethod: Deposit method.



Conditions for Revenue to Be Recognizedat Completion of Production

Market is reasonably assured;

Costs of selling and distribution are

insignificant and can be estimated;

Production, not sale, is considered to

be the most critical event in theearning process.



Conditions for Revenue to Be Recognizedat Completion of Production (contd.)

Example: Revenue is recognizedwhen precious metals are mined or

when agricultural crops are harvestedbecause all conditions are met.



Conditions for RecognizingRevenue during Production

Buyers can be identified and price hasbeen agreed on;

Cost can be estimated and significantportion of service has been performed;

The collectability of cash can bereasonable assured;



Conditions for Recognizing Revenueduring Production

The contract specifies the rights aboutgoods or services to be performed and

received by both parties; Both parties are expected to fulfil their

obligations (AICPA statement ofposition 81).



If all conditions are met, thepercentage-of-completion (P-O-C)method must be applied to recognize

construction revenue prior to thecompletion date.

If conditions are not met, thecompleted-contract method will beapplied to recognize revenue at or afterthe completion date.

Choice of P-O-C vs. C-C Method



Example: For long-term constructioncontract, when all conditions are met,

the P-O-C method is used to accountfor construction revenue andconstruction expenses.

Choice of P-O-C vs. C-C Method (contd.)



Financial Reporting of Long-Term(Construction) Contract

Percentage-of-completion method:revenue is recognized according to thepercentage of completion. The

percentage of completion is computedbased on costs.

Completed-contract method: postponethe revenue recognition until time ofsale.



Construction Estimated Estimated CummulativeCosts Costs to Total Percentage of

Year Incurred Complete Cost Completion (%)

x1 $100 $400 $500 1 20% 4

x2 $186 $264 $550 2 52% 5

x3 $314 - $ 600 3 100% 6

Example A:(Long-Term Construction Contract)

1. 500=100+400 2. 550=100+186+264

3. 600=100+186+314 (actual)

4. 20% = 100/500

5. 52% = (100 + 186)/550

6. 100%=(100+186+314)/ 600

Contract Price = $700




Example A (contd.)

Partial CashYear Billings Collection

x1 $ 80 $ 50x2 350 330

x3 270 320

Total $700 $700

E l A ( td )




Cumulative Current Current Gross

Year Revenue Revenue Expense7 Profit8

x1 $ 1401

$ 1404

100 $40

x2 3642

2245

186 38

x3 700 3

3366

314 22

Total $700 $600 $100

Example A (contd.)

1. $140 = 700 x 20% (contract price x cumulative % of completion)

2. 364 = 700 x 52% 3. 700 = 700 x 100% 4. 140 = 140 - 0 (cumulative

revenue - previous years’

revenue)

5. 224 = 364 -1406. 336 = 700 - 140 - 224

7. Current expense =construction costsincurred

8. Net Income = current revenue - current

expense

(P-O-C)

23




Total % Cum.Estimated of Gross Gross

Year Profit Completion Profit Profit

x1 $200 20% $40 $40

x2 150 52% 78 38

x3 100 100% 100 22

Example A (contd.)

An alternative method to compute the grossprofit:

E l A J l E t i (P O C)




Year x1 Year x2 Year x3

a. To Record ActualCost:Construction in Progress

A/P100

100186

186

314314

b. Partial Billings:A/R

Progress Billings80

80350

350270

270

c. Cash Collection

CashA/R

5050

330330

320320

Example A - Journal Entries (P-O-C)

Note: Progress Billings = Billings on Construction

construction contract 25

E l A




Example A - Journal Entries (P-O-C) (contd.)

Note: Construction Expense = Cost of Construction

Construction Revenue = Revenue from Long-TermContracts

Year x1 Year x2 Year x3

d. End of Period- Recognitionof annual income

1. Construction ExpenseC-I-P

Construction Revenue

2. Closing Entries:Construction RevenueConstruction ExpenseIncome Summary

10040

140

140100

40

18638

224

224186

38

31422

336

336314

22e. The end of Construction

(Customer is fully Billed)Progress Billings

C-I-P

NoEntry

NoEntry 700

700

26




B/S Year x3C.A.:CIP 700

P.B (700)0

B/S Year x1Current Assets:CIP 140Progress Billings (80)

60 Unbilled Revenue

Example AFinancial Statement Presentation (P-O-C)

B/S Year x2

Current Liability:P-B 430C-I-P (364)

66 Billing in excess of costs and recognized profit

Financial Statement Presentation (P O




CIP

10040

18638

31422

Year x1($140)

Year x2($224)

Year x3($336)

Financial Statement Presentation (P-O-C)

(contd.)

Note: Balance of CIP = cumulative revenue

Progress Billings

80 -- 1998350 -- 1999270 -- 2000700 -- E.B.






(contd.)Income Statement Year x1 Year x2 Year x3

Revenue fromLong-term contract 140 224 336

ConstructionExpenses 100 186 314

Gross Profit 40 38 22






(contd.) YearBalance Sheet(12/31) x1 x2 x3Current Assets:

A/R 30 50 --

InventoriesConstruction in Progress 140 700Less: Billings (80) (700)

Costs and recognizedprofits in excess of billings 60 0

Current Liabilities:Billings 430Construction in Progress (364)Billings in excess of costs

and recognized profits 66






(contd.)Note1 Summary of significant accounting policy

Long-Term Construction Contracts. The

company recognized revenues and reportsprofits from long-term construction contractsunder the percentage-of-completion method….




Example A (contd.)- Completed-Contract Method

Gross Profit:

X1 $0

X2 $0

X3 $100

X3: Total Revenues - Total Expenses

= $ 700 - (100+186+314)

= $ 700 - 600

= 100




Example A (contd.) - Journal Entries(Completed-Contract)

Year x1 Year x2 Year x3a. Recording Actual Cost:CIP

A/P100

100186

186314

314


Progress Billings80

80350

350270

270c. Cash Collection

Cash A/R 50 50 330330 320 320d. End of Period -

Recognition of annualincome

NoEntry

NoEntry

NoEntry

J l E t i (C l t d C t t)




Journal Entries(Completed-Contract)(contd.)

Year x1 Year x2 Year x3e. The End of Construction(Recognize total expenseand total revenue)1. Construction Exp.

C-I-PConstruction Revenue

No No 600100

7002. Construction Revenue

Construction ExpenseIncome Summary No No

700

6001003. Progress Billings

CIPNo No 700

700

Fi i l St t t P t ti




Financial Statement Presentation(C-C Method)

Income Statement Year x1 Year x2 Year x3

Revenue fromLong-term contract --- --- 700

ConstructionExpenses --- --- 600

Gross Profit --- --- 100

Financial Statement Presentation (C C Method) (contd )




Financial Statement Presentation (C-C Method) (contd.)

Balance Sheet (12/31) Year x1 Year x2 Year x3Current Assets:

A/R 30 50 ---Inventories:

Constructionin Progress 100 700

Less: Billings (80) (700)Contract Costsin Excess of Billings 20 0

Current Liabilities:Billings 430Construction in Progress (286)

Billing in Excess

of Contract Costs 144 36




EstimatedConstruction Costs to Estimated Cumulative

Costs Complete Total % ofYear Incurred the Contract Cost Completion

x1 $100 400 $500 20%

x2 186 364 650 44%

x3 314 - 600 100%

Example B

Contract Price $700




Cummulative Current Current G.P. G.P.Year Revenue Revenue Expense (L) (L)

x1 $140 $140 $100 40 0

x2 308 168 186 -18 0

x3 700 392 314 78 100

Total $700 $600 $100 $100

Example B (contd.)

P-O-C C-C




Example B (contd.)


Total Cumm. Cumm.Estimated % of Gross Gross

Year G. Profit Completion Profit Profit

x1 $200 20% $40 $40

x2 50 44% 22 (18)

x3 100 100% 100 78




Example B (contd.)

Other Information (Billing and cash collection):

Year Partial Billings Cash Collection

x1 $80 $50

x2 350 330

x3 270 320Total $ 700 $ 700




Year x1 Year x2 Year x3a. Recording Actual

Cost:

C-I-P A/P 100 100 186 186 314 314


Progress Billings

80

80

350

350

270

270c. Cash CollectionCash

A/R50

50330

330320

320

Example B - Journal Entries (P-O-C)




Example B - Journal Entries (P-O-C) (contd.)

Year x1 Year x2 Year x3d. End of Period1. Construction Expense

C-I-P

Construction RevenueC-I-P2. Closing Entries:

Construction RevenueI/S

Construction ExpenseIncome Summary

10040

140-

140-

10040

186-

16818

16818

186-

31478

392-

392-

31478e. The end of Construction

Progress BillingsC-I-P

No No 700700




Progress Billings80 -- x1

350 -- x2270 -- x3

Example B (contd.)

C-I-P100 1840

18631478700

Yearx1

x2x3

x2

E l B ( td )




Example B (contd.) - Journal Entries(Completed-Contract)

Year x1 Year x2 Year x3a. Recording Actual Cost:CIP

A/P100

100

186

186

314314


Progress Billings80

80350

350270

270c. Cash Collection

CashA/R

5050

330330

320320

d. End of Period No No No

Jo rnal Entries(Completed Contract)




Journal Entries(Completed-Contract)(contd.)

Year x1 Year x2 Year x3e. The End of Construction(Recognize total expenseand total revenue)1. Construction Exp.

C-I-PConstruction Revenue

No No 600100

7002. Construction Revenue

Construction ExpenseIncome Summary No No

700

6001003. Progress Billings

CIPNo No 700

700




(Long-Term ContractExample C with an Overall Loss)

* $715 > 700 (contract price) => a total estimated loss occurs and must be recognized immediately (source: ARB 45 and AICPA statement of position 81-1)

EstimatedConstruction Costs to Estimated Cumulative

Costs Complete Total % of

Year Incurred the Contract Cost Completionx1 $100 400 $500 20%

x2 186 429 715* 40%

x3 429 - 715 100%

Contract Price $700




Example C (contd.)

* $40 gross profit was recognized in year x1. This profit is

not expected to be realized in the future. Thus, the $40 profit must be offset in year x2. In addition, the estimated total loss of $15 should also be recognized immediately in year x2. Therefore, a loss of $55 ($40+$15) should be recognized in year x2.

** Billings and cash collection data are the same as those of example A.

Cummulative Current Current G.P. G.P.Year Revenue Revenue Expense (L) (L)x1 $140 $140 $100 40 0

x2 280 140 186 (55)*

(15)x3 700 420 429 0 0

Total $700 $715 ($15) ($15)

P-O-C C-C




Example C (contd.)


Total Cumm. Cumm.Estimated % of Gross Gross

Year G. Profit Completion Profit Profit

x1 $200 20% $40 $40

x2 (15) 40% (15) (55)

x3 (15) 100% (15) 0




Example C (contd.) - Journal Entries (P-O-C)

Year x1 Year x2 Year x3a. CIP

A/P100

100186

186429

429

b. A/RProgress Billings

8080

350350

270270

c. CashA/R

5050

330330

320320




Journal Entries(P-O-C) (contd.)

Year x1 Year x2 Year x3d. End of Period:1. Construction Expense

C-I-P

Construction RevenueC-I-P

10040

140-

195-

14055*

420-

420-

2. Closing Entries

e. The End of Construction:

Progress BillingsC-I-P

700700

* C-I-P and provision for loss on contract are

combined.




CIP (Year x1)100

40140

Partial Billings (x1)80

B/S (x1)

Current Assets:CIP 140P-B (80)

60

Example C (contd.)

Year x1:

Example C (contd )




Year x2: (with a total estimated loss of $15)CIP (Year x2)

100 5540

186271

P-B (Year x2)80350430

* The estimated overall loss must be reported separately on the B/S as a current lia. The overall loss needs to be taken out of the CIP account for reporting purposes .

Example C (contd.)

B/S (Year x2)Current Lia:P-B 430CIP (286)*

Billings in excess of costsand recognized profit 144Estimated liability from

long-term contract 15

52




Example C (contd.)

CIP (2000)100 55

40186429700

P-B (2000)80

350270700




Example C (contd.) - Journal Entries (C-C)

Year x1 Year x2 Year x3a. CIP

A/P100

100186

186429

429

b. A/RProgress Billings

8080

350350

270270

c. CashA/R

5050

330330

320320




Journal Entries(C-C) (contd.)

Year x1 Year x2 Year x3d. End of Period:Estimated Loss from Long-Term Contract

C-I-P

15*

15* e. The End of Construction:Contract Expense

Construction Revenue700

700

Progress BillingsC-I-P 700700

* To recognize the total estimated loss of ($15).

L T Construction Contract with a Total Estimated Loss




Estimatedonstruct on osts st mate ummu at ve

Costs to Complete Total % ofYear Incurred the Contract Cost Completionx1 $100 $400 500 20%x2 186 429 715 * 40%x3 529 - 815 ** 100%

L-T Construction Contract with a Total Estimated Loss

Example D

* a total estimated loss of $15 incurred. ** a total estimated loss of $115.






x1 $140 $140 $100 40 0x2 280 140 186 (55) (15)

x3 700 420 529 (100) (100)

Total $700 $815 ($115) ($115)

Example D (contd.)

Billings and cash collection data are the same as those in example A.

P-O-C C-C





Estimatedonstruct on osts st mate ummu at ve

Costs to Complete Total % ofYear Incurred the Contract Cost Completionx1 $100 $400 $500 20%x2 $186 $429 $715 * 40%x3 $329 - $615 100%


Example E

* a total estimated loss of $15 incurred.


Example E (contd )





x1 $140 $140 $100 40 0

x2 280 140 186 (55) (15)

x3 700 420 329 100* 100*

Total $700 $615 $85 $85

Example E (contd.)

* $15 total estimated loss was recognized in Year x2. The overall income of Year x3 is $ 85. In order to have an overall income of x3 equals to $ 85, we need to recognize $100 income in x3.

** Billings and cash collection data are the same as

those of example A.

P-O-C C-C

59





EstimatedConstruction Costs Estimated Cummulative

Costs to Complete Total % ofYear Incurred the Contract Cost Completionx1 $100 $700 800 * 13%x2 186 429 715 ** 40%

x3 529 - 815 100%


Example F

* an estimated loss of $100 incurred.** an estimated loss of $15 incurred.*** an loss of $115 incurred.


E l F ( td )





x1 $91 $91 $100 ($100) ($100)x2 280 189 186 85 85

x3 700 420 529 (100) (100)

Total $700 $815 ($115) ($115)

Example F (contd.)

** Billings and cash collection data are the same as those of example A.

P-O-C C-C

The Application of the P O C Method




The Application of the P-O-C Methodin the Service Industry Many transactions in the service

industry require the performance ofseveral acts that extend over a period

of time. An accounting method called

"proportional performance method”

can be used to account for therevenues and expenses for thesetransactions.





The Application of the P-O-C Method (contd.) Example:

With fixed number of acts:

Additional acts are not fixed:

Estimation of additional acts is required tocompute the proportion of revenue to berecognized (as in P-O-C method).

Note: If the service requires a final act, acompleted performance method willbe applied to account for revenues andexpenses.





The Application of the P-O-C Method (contd.) Aging product: Wine, lumber, etc. No value increase can be recognized

as revenue, unless

a. a contract to age a specific product fora specific customer has been signed;and

b. no return of product even if thecustomer is not satisfied with theproduct; and

c. if future cost can be estimated.

The Application of the P-O-C Method




The Application of the P-O-C Method (contd.)

If all three conditions are met, theP-O-C method may (referred to as

an accretion method) be applied toaccount for revenues andexpenses prior to the completion of

the production.

IFRS I i ht



IFRS Insights

IFRS only allows the POC method.

If future costs cannot be estimated, therecognized cost will be set to equal therevenue (therefore, zero profit).

Similar to GAAP, IFRS also requires therecognition of the projected overall loss

when loss is expected for the entire long-term construction contracts.


Revenue Recognition after Time of Sale




Revenue Recognition after Time of Sale (i.e., at time of cash collection)

Accounting Methods:

a. Installment Sales Method

b. Cost Recovery Method

I t ll t M th d1




a. Installment Method1

Postpone the recognition of revenue (orprofit) until the period of cash collection.This is not consistent with accrual

accounting concept.1. Rarely used for financial reporting (except for special cases)2 but commonly used for tax filing purposes.

2. Special case: when receivables are collectible over an extended period of time and no reasonable basis for estimating the degree of collectibility (i.e., B/D expense Estimation) --> Source: APB 10, para. 12, footnote 8.

I t ll t M th d ( td )




a. Installment Method (contd.)

If uncollectible account is expected, baddebt expense should be estimated andrecognized rather than postponing therecognition of revenue until cash iscollected.

C 1




b. Cost Recovery Method1

Postpone the recognition of revenueuntil cost is recovered.

1. Not acceptable for tax filing purposes; rarely

used for financially reporting except for special cases.

Installment Sales Method




ExampleAssume the following information:

20x1 20x2Installment sales $1,200 $2,000

Cost of installment 900 1,700Gross profit $300 $300

Rate of gross profit on sales 25% 15%

Cash receipts20x1 Sales $600 $60020x2 Sales $500





Example (contd.)

Note: the following entries are based onthe procedures which only defer thegross profit. This procedure has the

same effect as deferring both salesrevenue and cost of goods sold.





Example (contd.)

20x1 20x21. Installment A/R 1,200 2,000

Installment Sales 1,200 2,0002. Cash 600 1,100

I A/R 600 1,1003. Cost of Install. Sales 900 1,700

Inventory 900 1,7004. Installment Sales 1,200 2,000

Cost of Install. Sales 900 1,700Deferred Gross Profit 300 300

(to close installment sales and cost of installmentsales and to recognize entire profit as deferred profit)





Example (contd.)

20x1 20x25. Deferred Gross Profit 150a 225b

Realized Gross Profit

on Installment sales 150 225

a. 25% x $600 = $150.b. 25% x $600 + 15% x $500 = $225.

Additional Problems of Installment




Additional Problems of InstallmentSales Accounting

The following three problems arerelated to accounting for installmentsales:

1. Interest on installment contract;

2. Uncollectible accounts;

3. Defaults and repossessions.

1 I t t I t ll t C t t




1. Interest on Installment Contract

Using the installment sales made in 20x1and assuming a 3% interest charge perquarter, the quarterly installment payment

from customers should be:? 3.7171 = $1,200

P 4]3% present value of an annuity

? = $1,200 3.7171 = $322.83





1. Interest on Installment Contract(contd.)

The following table summaries theinterest earned, cash received,installment A/R, installment A/Rbalance and realized gross profit ofeach quarter:





te est o sta e t Co t act(contd.)

(1) (2) (3) (4) (5) Cash Interest Install. Bal. Of Realized

Earned A/R Install. Gross(Debit) (Credit) (Credit) A/R Profit

5/1/x1 --- --- --- $1,200 ---Q3, x1 $322.83 $36 $286.83 $913.17 $71.70Q4, x1 322.83 27.40 295.43 617.74 73.86Q1, x2 322.83 18.53 304.30 313.44 76.08Q2, x2 322.83 9.40 313.43 0 78.36

$300 (1) as computed on previous page. (2) 3% x previous balance in (4). (3) (1) - (2).

(4) previous balance of (4) - (3).

(5) 25% x (3).

2 Uncollectible Accounts




2. Uncollectible Accounts

If repossession cannot compensatefor uncollectible balances, thepotential loss should be chargedagainst bad debt expense account asin the case of other credit sales.

3 Defaults and Repossessions




3. Defaults and Repossessions

Assuming merchandize of $800 ofinstallment sales made in 20x2 wasrepossessed in 20x3. The fair value of

the repossessed item is only $400.Therefore, a loss of $280 occurs.

If a bad debt expense was charged in

20x2, the allowance for uncollectibleaccount will be debited instead of theloss account.

3. Defaults and Repossessions




p(contd.)

When repossession occurs in year 20x3,the following entry will be recorded:

Repossessed Merchandize 400Deferred Gross Profit 120

Loss on Repossession 280

Installment A/R 800

Financial Statement Presentation




Financial Statement Presentationof Installment Sales Transactions

A. Installment sales constitute aninsignificant part of total sales.

B. Installment sales are a significant part of total sales.

A. Installment Sales Constitute an




sta e t Sa es Co st tute aInsignificant Part of Total Sales

In this case, the accountant only needsto include the realized gross profit ofthe installment sales in the incomestatement as a special item followingthe gross profit on other sales.

Income Statement




For the Year Ended 12/31/x1

Sales $500,000Cost of Goods Sold (270,000)

Gross Profit on Sales $230,000Gross Profit realized on

Installment Sales 150

Total Gross Profit on Sales $230,150

B. Installment Sales Are a




Significant Part of Total Sales

If installment sales are a significantpart of total sales, the followingpresentation may be used:

Income StatementFor the Year Ended 12/31/x2a




For the Year Ended 12/31/x2a

Install. Other

Sales Sales TotalSales 150,000 200,000 350,000

Cost of goods sold (80,000) (150,000) (230,000)

Gross profit 70,000 50,000 120,000Less deferred gross profit oninstall. sales of this year (50,000) (50,000)

Realized gross profit on

this year’s sales 20,000 50,000 70,000Add gross profit realized onprior years 15,000 15,000

Gross profit real. this year 35,000 50,000 85,000

a. All amounts are assumed. 86

Cost Recovery Method





No gross profit is recognized until cashcollected exceeding the cost. Thus, allgross profit is deferred until cash

collected exceeding the cost.




E l ( td )




Example (contd.)

20x1 A/R 15,000Sales 15,000

CGS 10,000

Inventory 10,000Cash 9,000

A/R 9,000Sales 15,000

CGS 10,000Deferred Gross Profit 5,000


E l ( td )




Example (contd.)

(To close sales and CGS and to recorddeferred gross profit under the cost recoverymethod)

20x2 Cash 3,000A/R 3,000

Deferred Gross Profit 2,000Gross Profit 2,000

20x3 Cash 3,000A/R 3,000Deferred Gross Profit 3,000

Gross Profit 3,000

Gift Card Sale Revenue Recognition




Gift Card Sale Revenue Recognition

Revenue should be recognized whenservice is provided to the gift-cardholder.

When to recognize the expired unusedbalance on the gift-card?

States Do Not Require to Turn Over the




Abandoned and Unclaimed Property

For states recognize expiration date: Canrecognize the revenue upon the expirationdate.

For states do not recognize expiration date: In order to recognize the unusedexpired balance as revenue, the company

needs to proof that the expired unusedbalance is unlikely to be redeemed aftercertain periods statistically.

States Require to Turn Over the




Abandoned and Unclaimed Property

The expired unused balance of gift-cardmay need to be remitted to the stateafter five- year period.

Franchise Sales




Franchise Sales

Many retail outlets (I.e., fast food,restaurants,etc.) are operated asfranchises.

A franchise agreement: the franchisor(I.e., McDonald's Corporation) grants thefranchisee (I.e., an individual) the right tosell the franchisor's product and use its

name for a specific period of time.The fees paid by the franchisee include: 1)the initial franchise fee and 2) continuingfranchise fees.

Franchise Sales (contd )




Franchise Sales (contd.)

The initial franchise fee is to cover: 1)the right to use its name and sell

its products;

2)assistance in finding a locationand constructing the facilities,

3) training employees.

The initial franchise fee is usually a fixedamount but payable in installments.

Franchise Sales (contd )




Franchise Sales (contd.)

The continuing franchise fees are paidfor continuing rights and for advertisingand promotion provided by thefranchisor.

These fees can be a fixed monthly orannual amount or a % of the sales.



Franchise Sales –Example




Franchise Sales Example

On 3/31/x2, the Applebee Corporationentered into a franchise agreement withMary Armstrong in exchange for aninitial franchise fee of $100,000.

The initial services provided byApplebee include the selection of alocation, construction of the building,

training of employees and consultingservices over several year.

Franchise Sales –Example (Contd )




Franchise Sales Example (Contd.)

$30,000 is payable on 3/31/x2, with theremaining balance payable in annualinstallments over a 3-year periods with a7% annual interest rate.

The franchisee will also pay continuingfranchise fees of $2,000 per month foradvertising and promotion provided by

Applebee, beginning immediately after thefranchise begins operations.

Mary Armstrong opens her ApplebeeRestaurant on 9/6/x2.

Franchise Sales –Example (Contd.)





Assume that the initial services to beperformed by Applebee subsequent to thecontract signing are substantial and thecollectibility of the fee is reasonable certain

the following entry is recorded:3/31/x2:

Cash 30,000Note Receivable 70,000

Unearned franchise fee revenue 100,000 to record franchise agreement and down payment






Assume that substantial performancehave occurred when the franchise beganoperation on 9/6/x2, the following entrywould be recorded:

9/6/x2

Unearned franchise fee revenue 100,000

Franchise fee revenue 100,000To recognize franchise fee revenue






Note:If collectibility of the initial fee isuncertain and there is no basis for estimatingthe uncollectible amounts, the initial entry(on3/31/02) should be:

Cash 30,000Note Receivable 70,000

Deferred franchise fee revenue 100,000

The deferred franchise fee revenue is recognizedusing either the installment sales or cost recoverymethods.






Revenue Recognition for ContinuingFranchise Fees:

Continuing franchise fee is recognized

on a monthly basis as follows:Cash 2,000

Service revenue 2,000

Consignment




Consignment

A manufacturer or a wholesaler may transfergoods to a dealer but the title of the goodsremains with the manufacturer or thewholesaler.

Party Manufacturer DealerAccount Used Consi nment-out Consignment-inPurpose ofaccount

To record thetransfer of the

oods (Debit) andtransportationcost (Debit)

To record any saleof consignment

goods (Credit) andto record ex ensesoccurred for theconsignment(Debit)

Consignment

E l




Example On 2/8/98, 300 units of goods were shipped

to a dealer on a consignment basis. Thetotal cost of goods is $ 1,800 ($6 each). Thetransportation cost $150 was paid by the

consignor on 2/8. The consignee spent $100on advertisement on 2/9/98.

On 4/4, all the consignment units were sold

for $10 each and the proceeds subtractedadvertising expense ($100) and commissioncharge ($100), have been forwarded to theconsignor on 4/20/98.

ConsignmentExample (contd.)




p ( )Consignor (manufacturer) Consignee (Dealer)

2/8 Consignmentout

Inventory1800

1800

No Entry

2/8 Consignmentout

Cash150

150

No Entry

2/9 No Entry 2/9 (Adv.)Consignment-In

Cash100

100

2/9 No Entry 4/4 Sale of 300Units at $10Cash

Consi nment-In

3000

3000106

ConsignmentExample (contd.)



a p e (co td ) Consignor (manufacturer) Consignee (Dealer)

4/20 receiving $2800 fromdealer (deduct $100commission and $100Advertisement)1. Cash 2800

Commission Ex . 100Adv. Ex . 100Sales Rev. 3000

. CGS 1950Consi nment-out 1950

*If consignment-out has adebit balance, it is a currentasset account to the

4/20Consignment- In 2900

Cash 2800CommissionEarned 100

* If the consignment-In hasa debit balance, it would bea current asset account forthe consignee. If the

consi nment-In has a creditbalance, it would be acurrent liability account tothe consignee

Income Measurement and Profit Analysis

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