Intermediate Accounting IFRS Edition Chapter 18 Revenue

5/22/2018 Intermediate Accounting IFRS Edition Chapter 18 Revenue

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Volume 2


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C H A P T E R 18

REVENUE

Intermediate Accounting

IFRS Edition

Kieso, Weygandt, and Warfield


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1. Apply the revenue recognition principle.

2. Describe accounting issues for revenue recognition at point of

sale.

3. Apply the percentage-of-completion method for long-term

contracts.

4. Apply the cost-recovery method for long-term contracts.

5. Identify the proper accounting for losses on long-term contracts.

6. Describe the accounting issues for service contracts.

7. Identify the proper accounting for multiple-deliverable

arrangements.

Learning Objectives


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Current

Environment

Guidelines forrevenue

recognition

Departures from

sale basis

Revenue

Recognition

(At Point of Sale)

Revenue

Recognition (Long-

Term Contracts)

Revenue

Recognition

(Other)

Measurement

Recognition

Summary

Service contracts

Multiple-

deliverable

arrangements

Other

Summary of

methods

Percentage-of-completion method

Cost-recovery

method

Long-term contract

losses

Disclosures

Revenue


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Restatementsfor improper revenue recognitionare

relatively common and can lead to significant share price

adjustments.

Revenue recognitionis a top fraud risk and regardless

of the accounting rules followed (IFRS or U.S. GAAP),

the risk or errors and inaccuracies in revenue reporting is

significant.

The Current Environment


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Revenue recognition principle: Revenue is recognized

Guidelines for Revenue Recognition


LO 1 Ap ply the revenue recogni t ion pr inc ip le.

(1) when it is probable that the economic benefits will

flow to the companyand

(2) when the benefits can be measured reliably.


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Sale of product

from inventory

Type of

TransactionRendering a

service

Permitting use

of an asset

Sale of asset

other than

inventory

Date of sale

(date of

delivery)

Services

performed and

billable

As time passes

or assets are

used

Date of sale or

trade-in

Gain or loss on

disposition

Revenue from

interest, rents,

and royalties

Revenue from

fees or servicesRevenue from

sales

Description

of Revenue

Timing of

Revenue

Recognition



Illustration 18-1

Revenue Recognition Classified by Nature of Transaction


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Earlier recognition is appropriate if there is a high degree of

certainty about the amount of revenue earned.

Delayedrecognition is appropriate if the

degree of uncertainty concerning the amount of revenue

or costs is sufficiently high or

sale does not represent substantial completion of theearnings process.

Departures from the Sale Basis




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Revenue should be measuredat the fair value of

consideration received or receivable.

Trade discounts or volume rebatesshould reduceconsideration received or receivable and the related

revenue.

If payment is delayed, seller should impute an interest

rate for the difference between the cash or cashequivalent price and the deferred amount.

Measurement of Sale Revenue

Revenue Recognition at Point of Sale

LO 2 Descr ibe account ing issues for revenue recogni t ion at point of sale.


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Illustration 18-2


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Sansung makes the following entry on March 31, 2011.

Accounts receivable 679,000

Sales 679,000

Illustration 18-2


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Assuming Sansungs customers meet the discount threshold,

Sansung makes the following entry.

Cash 679,000


Illustration 18-2


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If Sansungs customers fail to meet the discountthreshold,

Sansung makes the following entry upon payment.

Cash 700,000


Sales discounts forfeited 21,000

Illustration 18-2


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When a sales transaction involves a financing arrangement, the

fair value is determined by discounting the payment using an

imputed interest rate.

Imputed interest rateis the more clearly determinable of either

1. the prevailing rate for a similar instrument of an issuer with a

similar credit rating, or

2. a rate of interest that discounts the nominal amount of the

instrument to the current sales price of the goods or services.

Measurement of Sale Revenue




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Illustration 18-3


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The journal entry to record SEKs sale to Grant Company onJuly 1, 2011, is as follows (ignoring cost of goods sold entry).

Notes receivable 900,000

Sales 900,000

Illustration 18-3


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SEK makes the following entry to record interest revenue.

Notes receivable 54,000

Interest revenue (12% x x900,000) 54,000

Illustration 18-3


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Revenue from the sale of goodsis recognized when allthe following

conditions are met:

1. Company has transferred to the buyer the significant risks and

rewards of ownership of the goods;

2. Company retains neither continuing managerial involvement to the

degree usually associated with ownership nor effective control over

the goods sold;

3. The amount of revenue can be measured reliably;

4. It is probable that the economic benefits will flow to the company; and

5. The costs incurred or to be incurred can be estimated reliably.

Recognition of Sale Revenue


LO 2


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Bill and Hold Sales


Buyer is not yet ready to take deliverybut does take title and

accept billing.


Illustration 18-4


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LO 2

Solution: Butler should record the revenue at the time titlepasses, provided

1. it is probable that delivery will be made;

2. the item is on hand, identified, and ready for delivery at

the time the sale is recognized;

3. Baristo acknowledges the deferred delivery arrangement;

and

4. the usual payment terms apply.

It appears that these conditions were probably metand

therefore revenue recognition should be permitted at the time

the agreement is signed.


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Butler makes the following entry to record the bill and hold sale.


Sales 450,000

Illustration 18-4


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Sales Subject to Installation or Inspection



Illustration 18-5


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Layaway Sales



Illustration 18-6


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Sales with Right of Return



Two possible revenue recognition methods are available when

the right of return exposes the seller to continued risks of

ownership:

1. not recording a sale until all return privileges have expired

or

2. recording the sale, but reducing sales by an estimate of

future returns.


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Illustration 18-7


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LO 2

Pesido sold $300,000 of laser equipment on August 1, 2011, and

retains only an insignificant risk of ownership. On October 15,

2011, $10,000 in equipment was returned.

August 1, 2011


Sales 300,000

October 15, 2011

Sales returns and allowances 10,000



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At December 31, 2011, based on prior experience, Pesido

estimates that returns on the remaining balance will be 4 percent.

Pesido makes the following entry to record the expected returns.

December 31, 2011

Sales returns and allowances 11,600

Allowance for sales returns and allowances 11,600

[($300,000 - $10,000) x 4% = 11,600]



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Illustration 18-8


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Morgan records the sale and related cost of goods sold as follows.

Cash 135,000

Sales 135,000

Cost of Goods Sold 115,000

Inventory 115,000

Illustration 18-8


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Principal-Agent Relationships



Amounts collected on behalf of the principal are not

revenue of the agent.

Revenue for the agent is the amount of the commission itreceives.


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Consignments



Manufacturers (or wholesalers) deliver goods but retain

title to the goodsuntil they are sold.

Consignor(manufacturer or wholesaler) shipsmerchandise to the consignee(dealer), who is to act as

an agent for the consignor in selling the merchandise.

Consignormakes a profit on the sale.

Consigneemakes a commission on the sale.


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Trade Loading and Channel Stuffing



Trade loading- a crazy, uneconomic, insidious practice through

which manufacturerstrying to show sales, profits, and market

share they dont actually haveinduce their wholesale

customers, known as the trade, to buy more product than they

can promptly resell.

Channel stuffing. When a software maker needed to make its

financial results look good, it offered deep discounts to its

distributors to overbuy, and then recorded revenue when the

software left the loading dock.


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Two methodsof accounting for long-term constructioncontracts:

Percentage-of-completion method.

Cost-recovery (zero-profit) method.

Long-Term Contracts (Construction)


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Rationalefor using percentage-of-completionaccountingis that under most of these contracts, the

Buyer and seller have enforceable rights.

Buyer has the legal right to require specific performance on

the contract.

Seller has the right to require progress payments that

provide evidence of the buyers ownership interest.

As a result, a continuous sale occurs as the work progressesand companies should recognize revenue according to that

progression.



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Companies must use the percentage-of-completionmethodwhen all of the following conditions exist.

1. Total contract revenue can be measured reliably;

2. It is probable that the economic benefits associated with the

contract will flow to the company;

3. Both the contract costs to complete the contract and the stage

of contract completion at the end of the reporting period can

be measured reliably; and

4. The contract costs attributable to the contract can be clearly

identified and measured reliably so the actual contract costs

incurred can be compared with prior estimates.



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Companies should use the cost-recovery methodwhen oneof the following conditions applies:

1. When a company cannot meet the conditions for using the

percentage-of-completion method, or

2. When there are inherent hazards in the contract beyond the

normal, recurring business risks.



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Calculation for Revenue to Be Recognized

LO 3 App ly the percentage-of-complet ion m ethod for long-term co ntracts.

Illustration 18-11

Illustration 18-12

Illustration 18-13

Percentage-of-Completion Method



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18-38 LO 3 App ly the percentage-of-complet ion m ethod for long-term co ntracts.

Illustration: KC Construction Company has a contract toconstruct a4,500,000 bridge at an estimated cost of

4,000,000. The contract is to start in July 2010, and the

bridge is to be completed in October 2012. The following data

pertain to the construction period.



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Illustration: Compute percentage complete.Illustration 18-6



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Illustration: KC would make the following entries to record(1) the costs of construction, (2) progress billings, and (3)

collections.Illustration 18-7



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Percentage-of-Completion, Revenue and Gross Profit, by YearIllustration 18-16



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Illustration: KCs entries to recognize revenue and grossprofit each year and to record completion and final approval

of the contract.Illustration 18-17



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Illustration: Content of Construction in Process AccountPercentage-of-Completion Method

Illustration 18-18



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Financial Statement PresentationPercentage-of-Completion

Illustration 18-19

Computation of Unbilled Contract Price at 12/31/10



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Financial StatementPercentage-of-Completion


Illustration 18-20

LO 3


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Illustration: For the bridge project illustrated on the preceding pages,

Hardhat Construction would report the following revenues and costs.

Cost-Recovery (Zero-Profit) Method

LO 4 App ly the cost-recovery method for long -term contracts.

Illustration 18-21


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Illustration: Hardhats entries to recognize revenue and gross profit

each year and to record completion and final approval of the contract.



Illustration 18-22


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Illustration: Comparison of gross profit recognized under different

methods.



Illustration 18-23


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Financial Statement

Cost-Recovery Method


Illustration 18-24



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2010 2011 2012

Contract price 675,000 675,000 675,000

Cost incurred current year 150,000 287,400 170,100

Estimated cost to complete

in future years 450,000 170,100 0

Billings to customer current year 135,000 360,000 180,000

Cash receipts from customer

Current year 112,500 262,500 300,000

A) Prepare the journal entries for 2010, 2011, and 2012.

LO 3 App ly the percentage-of-complet ion m ethod for long-term co ntracts.

Illustration:


Casper Construction Co.


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2010 2011 2012

Costs incurred to date 150,000 437,400 607,500

Estimated cost to complete 450,000 170,100

Est. total contract costs 600,000 607,500 607,500

Est. percentage complete 25.0% 72.0% 100.0%

Contract price 675,000 675,000 675,000

Revenue recognizable 168,750 486,000 675,000

Rev. recognized prior year (168,750) (486,000)

Rev. recognized currently 168,750 317,250 189,000Costs incurred currently (150,000) (287,400) (170,100)

Gross profit recognized 18,750 29,850 18,900

Illustration:



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Construction in progress 150,000 287,400 170,100

Cash 150,000 287,400 170,100

Accounts receivable 135,000 360,000 180,000

Billings on contract 135,000 360,000 180,000

Cash 112,500 262,500 300,000


Construction in progress 18,750 29,850 18,900

Construction expense 150,000 287,400 170,100

Construction revenue 168,750 317,250 189,000

Billings on contract 675,000

Construction in progress 675,000

20122010 2011


Illustration:


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Income Statement 2010 2011 2012

Revenue on contracts 168,750$ 317,250$ 189,000$

Cost of construction 150,000 287,400 170,100

Gross profit 18,750 29,850 18,900

Balance Sheet (12/31)

Current assets:

Accounts receivable 22,500 120,000 -Cost & profits > billings 33,750

Current liabilities:

Billings > cost & profits 9,000


Illustration:


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Companies recognize revenue only to the extent of costs

incurred that are expected to be recoverable.

Only after all costs are incurred is gross profit recognized.

LO 4 Ap ply the cost-recovery method for long-term co ntracts.




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Illustration:Construction in progress 150,000 287,400 170,100

Cash 150,000 287,400 170,100


Billings on contract 135,000 360,000 180,000

Cash 112,500 262,500 300,000



Construction expense 150,000 287,400 170,100Construction revenue 150,000 287,400 237,600

Billings on contract 675,000


20122010 2011



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Illustration:

Income Statement 2010 2011 2012

Revenue on contracts 0 0 675,000

Cost of construction - - 607,500

Gross profit - - 67,500

Balance Sheet (12/31)

Current assets:

Accounts receivable 22,500 120,000 -

Cost & profits > billings 15,000

Current liabilities:

Billings > cost & profits 57,600




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18-57 LO 5 Ident i fy the prop er accoun t ing for losses on long-term co ntracts.

Loss in the Current Period on a Profitable Contract

Percentage-of-completion method only, the estimated

cost increase requires a current-period adjustment ofgross profit recognized in prior periods.

Loss on an Unprofitable Contract

Under both percentage-of-completion and completed-contract methods, the company must recognize in the

current period the entire expected contract loss.

Long-Term Contract Losses



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Illustration: Loss in Current Period


LO 5 Ident i fy the prop er accoun t ing for losses on long-term co ntracts.

2010 2011 2012

Contract price 675,000 675,000 675,000

Cost incurred current year 150,000 287,400 215,436Estimated cost to complete

in future years 450,000 215,436 0



Current year 112,500 262,500 300,000

b) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimatedcost to complete at the end of 2011 was215,436instead of 170,100.



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2010 2011 2012



Est. total contract costs 600,000 652,836 652,836Est. percentage complete 25.0% 67.0% 100.0%

Contract price 675,000 675,000 675,000


Rev. recognized prior year (168,750) (452,250)Rev. recognized currently 168,750 283,500 222,750

Costs incurred currently (150,000) (287,400) (215,436)

Gross profit recognized 18,750 ( 3,900) 7,314





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Construction in progress 18,750 7,314

Construction expense 150,000 215,436

Construction revenue 168,750 222,750


Construction expense 287,400

Construction revenue 283,500

20122010 2011





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Illustration: Loss on Unprofitable Contract



2010 2011 2012

Contract price 675,000 675,000 675,000

Cost incurred current year 150,000 287,400 246,038Estimated cost to complete

in future years 450,000 246,038 0



Current year 112,500 262,500 300,000

c) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimatedcost to complete at the end of 2011 was246,038instead of170,100.



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2010 2011 2012



Est. total contract costs 600,000 683,438 683,438Est. percentage complete 25.0% 64.0% 100.0%

Contract price 675,000 675,000 675,000


Rev. recognized prior year (168,750) (432,000)

Rev. recognized currently 168,750 263,250 243,000Costs incurred currently (150,000) (290,438) (243,000)

Gross profit recognized 18,750 ( 27,188) 0


LO 5

$675,000683,438 = (8,438) cumulative loss Plug



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Construction in progress 18,750 -

Construction expense 150,000 243,000

Construction revenue 168,750 243,000




20122010 2011





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Loss on construction contract 8,438




2010 2011



For the Cost-Recoverymethod, companies would recognize the

following loss:



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Construction contractors should disclosure:

Revenue recognized during the period and the methods used to

determine the contract revenue and stage of completion.

For contracts in progress,

aggregate amount of costs incurred and recognized net

income, amount of advances received, and amount of

retentions.

Any contingent assets or liabilities related to these contracts.

Disclosures in Financial Statements




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Follow the same criteria as long-term contracts.

To recognize revenue:

It must be reliably measurable;

Economic benefits are probable;

Stage of completion must be reliably measurable; and

Costs must be reliably measurable.

Service Contracts

Other Revenue Recognition Issues

LO 6 Descr ibe the accou nt ing issu es for serv ice contracts.


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Single Act: Revenue recognized at the time of the act.

More Than One Act: Revenue recognized as various acts

occur.Three circumstances:

1. Specified number of identical or similar acts.

2. Specified number of defined but not identical acts.

3. Unspecified number of identical acts or similar acts with a

fixed period for performance.

Service Contracts




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LO 6

Assuming R&D services are provided according to the contract in

2011, Jackson makes the following entries in 2011 to recognized

revenue on the Andes contract.

January 1, 2011

Cash 1,000,000

Unearned R&D service revenue 1,000,000

December 31, 2011

Cash 400,000

Unearned R&D Service Revenue 200,000

R&D Service Revenue 600,000


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18-71 LO 6 Descr ibe the accou nt ing issu es for serv ice contracts.


O


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18-72 LO 6 Descr ibe the accou nt ing issu es for serv ice contracts.


Oth R R iti I


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SeniorLife makes the following entries related to the contract.

January 1, 2011

Cash 300,000

Unearned service revenue 300,000

December 31, 2011


Service Revenue 60,000

December 31, 2012


Service Revenue 105,000

Oth R R iti I


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MDAsprovide multiple products or services to customers as part

of a single arrangement.

Major accounting issues

how to allocate the revenue to the various products and

services and

how to allocate the revenue to the proper period.

Multiple-Deliverable Arrangements (MDAs)


LO 7 Ident i fy the proper account ing for mult ip le-del iverable arrangements.

Oth R R iti I


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All units in a MDA are considered separate units of accounting,

provided that:

1. A delivered item has value to the customer on a standalone

basis; and

2. The arrangement includes a general right of return relative to

the delivered item; and

3. Delivery or performance of the undelivered item isconsidered probable and substantially in the control of the

seller.




Oth R R iti I


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Illustration 18-33


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18-77 LO 7 Ident i fy the proper account ing for mult ip le-del iverable arrangements.

Illustration 18-34

Oth R R iti I


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Interest, Royalties, and Dividends

Accretion

Completion-of-Production Basis

Other Revenue Situations




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The IASB defines revenue to include both revenues and gains. U.S.

GAAP provides separate definitions for revenues and gains.

Revenue recognition fraud is a major issue in revenue recognition. The

same situation occurs in the United States as evidenced by revenue

recognition breakdowns at telecom company Global Crossing (USA),

technology company Lucent Technologies (USA), and utility company

Enron (USA).


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A specific standard exists for revenue recognition under IFRS (IAS 18).

In general, the standard is based on the probability that the economicbenefits associated with the transaction will flow to the company selling

the goods, rendering the service, or receiving investment income. In

addition, the revenues and costs must be capable of being measured

reliably. U.S. GAAP uses concepts such as realized or realizable, and

earned as a basis for revenue recognition.

U.S. GAAP permits the use of the completed-contract method of

accounting for long-term construction contracts (IAS 11). Companies

generally use the percentage-of-completion method. If revenues and

costs are difficult to estimate, then companies recognize revenue only

to the extent of the cost incurreda zero-profit approach under IFRS.


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U.S. GAAP does not allow the percentage-of-completion method for

service contracts. Under IFRS, costs can be deferred if the company isusing percentage-of-completion. Under GAAP, costs are generally

expensed as incurred.

U.S. GAAP provides detailed guidance in multiple-deliverable

arrangements. IFRS guidance is more general.


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FranchisesTwo sources of revenue:

1. Sale of initial franchises and related assets or

services, and

2. Continuing fees based on the operations of

franchises.

LO 8 Expla in revenue recogni t ion for franchises sales.


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18-83 LO 8 Expla in revenue recogni t ion for franchises sales.

The franchisornormally provides the franchiseewith:

1. Assistance in site selection.

2. Evaluation of potential income.

3. Supervision of construction activity.

4. Assistance in the acquisition of signs, fixtures, and equipment.

5. Bookkeeping and advisory services.

6. Employee and management training.

7. Quality control.

8. Advertising and promotion.

Franchises


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Franchisors record initial franchise fees as

revenue only when and as they make substantial

performanceof the services they are obligated to perform andwhen collection of the fee is reasonably assured.

Substantial performanceoccurs when the franchisor has no

remaining obligation to refund any cash received or excuse any

nonpayment of a note and has performed all the initial services

required under the contract.

Initial Franchise Fees



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Illustration: Tums Pizza Inc. charges an initial franchise fee of

$50,000 for the right to operate as a franchisee of Tums Pizza. Of this

amount, $10,000 is payable when the franchisee signs the agreement,

and the balance is payable in five annual payments of $8,000 each.

The credit rating of the franchisee indicates that money can be

borrowed at 8 percent. The present value of an ordinary annuity of five

annual receipts of $8,000 each discounted at 8 percent is $31,942. The

discount of $8,058 represents the interest revenue to be accrued by thefranchisor over the payment period.

Example of Entries for Initial Franchise Fee



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Illustration: 1. If there is reasonable expectation that Tums Pizza Inc.

may refund the down payment and if substantial future services remain

to be performed by Tums Pizza Inc., the entry should be:


Cash 10,000

Notes Receivable 31,942

Unearned Franchise Fees 41,942



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Illustration: 2. If the probability of refunding the initial franchise fee is

extremely low, the amount of future services to be provided to the

franchisee is minimal, collectibility of the note is reasonably assured,

and substantial performance has occurred, the entry should be:


Cash 10,000


Revenue from Franchise Fees 41,942



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Illustration: 3. If the initial down payment is not refundable,

represents a fair measure of the services already provided, with a

significant amount of services still to be performed by Tums Pizza in

future periods, and collectibility of the note is reasonably assured, theentry should be:


Cash 10,000


Revenue from Franchise Fees 10,000.00




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Illustration: 4. If the initial down payment is not refundable and no

future services are required by the franchisor, but collection of the note

is so uncertain that recognition of the note as an asset is unwarranted,

the entry should be:


Cash 10,000

Revenue from Franchise Fees 10,000



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Illustration: 5.Under the same conditions as those listed in case 4

above, except that the down payment is refundable or substantial

services are yet to be performed, the entry should be:


Cash 10,000


In cases 4 and 5 where collection of the note is extremely uncertainfranchisors may recognize cash collections using the cost-recovery method.



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Continuing franchise fees are received in return for the

continuing rights granted by the franchise agreement and for

providing such services as management training, advertisingand promotion, legal assistance, and other support.

Franchisors report continuing fees as revenuewhen they are

earned and receivable from the franchisee.

Continuing Franchise Fees


Copyright


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Intermediate Accounting IFRS Edition Chapter 18 Revenue

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