After completing this chapter you should be able to: Apply the revenue recognition principle, describe accounting issues for revenue recognition at point of sale, apply the percentage-of-completion method for long-term contracts, apply the completed-contract method for long-term contracts.... and other contents.
Chapter 18-1 CHAPTER 18 REVENUE RECOGNITION Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield Chapter 18-2 Learning Objectives Learning Objectives Apply the revenue recognition principle Describe accounting issues for revenue recognition at point of sale Apply the percentageofcompletion method for longterm contracts Apply the completedcontract method for longterm contracts Identify the proper accounting for losses on longterm contracts Describe the installmentsales method of accounting Explain the costrecovery method of accounting Chapter 18-3 Revenue Recognition Revenue Recognition Current Environment Guidelines for revenue recognition Departures from sale basis Revenue Recognition at the Point of Sale Revenue Recognition before Delivery Revenue Recognition after Delivery Sales with buyback agreements Sales when right of return exists Trade loading and channel stuffing Percentage-ofcompletion method Completedcontract method Long-term contract losses Disclosures Installment-sales method Cost-recovery method Deposit method Completion-ofproduction basis Chapter 18-4 Summary of bases Concluding remarks The Current Environment The Current Environment Revenue recognition has been the largest source of public company restatements over the past decade One study noted restatements of revenue: Result in larger drops in market capitalization than other types of restatement Caused eight of the top ten market value losses in a recent year Chapter 18-5 The Current Environment The Current Environment Guidelines for Revenue Recognition The revenue recognition principle provides that companies should recognize revenue Chapter 18-6 (1) when it is realized or realizable and (2) when it is earned LO 1 Apply the revenue recognition principle The Current Environment The Current Environment Revenue Recognition Classified by Type of Transaction Chapter 18 Type of Transaction Sale of product from inventory Description of Revenue Timing of Revenue Recognition Chapter 18-7 Chapter 18 Illustration 181 Rendering a service Permitting use of an asset Revenue from sales Revenue from fees or services Revenue from interest, rents, and royalties Date of sale (date of delivery) Services performed and billable As time passes or assets are used Sale of asset other than inventory Gain or loss on disposition Date of sale or tradein LO 1 Apply the revenue recognition principle The Current Environment The Current Environment Departures from the Sale Basis Earlier recognition is appropriate if there is a high degree of certainty about the amount of revenue earned Delayed recognition is appropriate if the degree of uncertainty concerning the amount of revenue or costs is sufficiently high or Chapter 18-8 sale does not represent substantial completion of the earnings process LO 1 Apply the revenue recognition principle The Current Environment The Current Environment Illustration 182 Revenue Recognition Alternatives Chapter 18-9 LO 1 Apply the revenue recognition principle Revenue Recognition at Point of Sale (Delivery) Revenue Recognition at Point of Sale (Delivery) Departures from the Sale Basis FASB’s Concepts Statement No. 5, companies usually meet the two conditions for recognizing revenue by the time they deliver products or render services to customers Implementation problems, Chapter 18-10 Sales with Buyback Agreements Sales When Right of Return Exists Trade Loading and Channel Stuffing LO 2 Describe accounting issues for revenue recognition at point of sale Example of Entries for Initial Franchise Fee Illustration: 1. If there is reasonable expectation that Tum’s Pizza Inc. may refund the down payment and if substantial future services remain to be performed by Tum’s Pizza Inc., the entry should be: Cash 10,000.00 Notes Receivable 40,000.00 Discount on Notes Receivable Unearned Franchise Fees Chapter 18-62 8,058.32 41,941.68 LO 8 Explain revenue recognition for franchises and consignment sales Example of Entries for Initial Franchise Fee 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: Chapter 18-63 Cash 10,000.00 Notes Receivable 40,000.00 Discount on Notes Receivable 8,058.32 Revenue from Franchise Fees 41,941.68 LO 8 Explain revenue recognition for franchises and consignment sales Example of Entries for Initial Franchise Fee 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 Tum’s Pizza in future periods, and collectibility of the note is reasonably assured, the entry should be: Chapter 18-64 Cash 10,000.00 Notes Receivable 40,000.00 Discount on Notes Receivable 8,058.32 Revenue from Franchise Fees 10,000.00 Unearned Franchise Fees 31,941.68 LO 8 Explain revenue recognition for franchises and consignment sales Example of Entries for Initial Franchise Fee 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 10,000.00 Revenue from Franchise Fees Chapter 18-65 10,000.00 LO 8 Explain revenue recognition for franchises and consignment sales Example of Entries for Initial Franchise Fee 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 10,000.00 Unearned Franchise Fees 10,000.00 In cases 4 and 5 — where collection of the note is extremely uncertain—franchisors may recognize cash collections using the installmentsales method or the costrecovery method Chapter 18-66 LO 8 Explain revenue recognition for franchises and consignment sales Continuing Franchise Fees Continuing franchise fees are received in return for the continuing rights granted by the franchise agreement and for providing such services as management training, advertising and promotion, legal assistance, and other support. Franchisors report continuing fees as revenue when they are earned and receivable from the franchisee Chapter 18-67 LO 8 Explain revenue recognition for franchises and consignment sales Bargain Purchases Sometimes the franchise agreement grants the franchisee the right to make bargain purchases of equipment or supplies after the franchisee has paid the initial franchise fee. If the bargain price is lower than the normal selling price of the same product, or if it does not provide the franchisor a reasonable profit, then the franchisor should defer a portion of the initial franchise fee. The franchisor would account for the deferred portion as an adjustment of the selling price when the franchisee subsequently purchases the equipment or supplies Chapter 18-68 LO 8 Explain revenue recognition for franchises and consignment sales Options to Purchase As a matter of management policy, the franchisor may reserve the right to purchase a profitable franchise outlet, or to purchase one that is in financial difficulty If it is probable at the time the option is given that the franchisor will ultimately purchase the outlet, then the franchisor should Chapter 18-69 not recognize the initial franchise fee as revenue but should instead record it as a liability. LO 8 Explain revenue recognition for franchises and consignment sales Franchisor’s Cost Should ordinarily defer direct costs (usually incremental costs) relating to specific franchise sales for which revenue has not yet been recognized. Should not defer costs without reference to anticipated revenue and its realizability. Indirect costs of a regular and recurring nature, such as selling and administrative expenses that are incurred irrespective of the level of franchise sales, should be expensed as incurred Chapter 18-70 LO 8 Explain revenue recognition for franchises and consignment sales Disclosure of Franchisors All significant commitments and obligations resulting from franchise agreements. Any resolution of uncertainties regarding the collectibility of franchise fees. Where possible, revenues and costs related to franchisor owned outlets should be distinguished from those related to franchised outlets Chapter 18-71 LO 8 Explain revenue recognition for franchises and consignment sales Consignments Consignor recognizes revenue only after receiving notification of sale and cash remittance from the consignee. Consignor carries the merchandise as inventory throughout the consignment, separately classified as Merchandise on Consignment. Consignee does not record the merchandise as an asset. Upon sale of the merchandise, the consignee has a liability for the net amount due the consignor. Chapter 18-72 Revenue is then recognized by the consignor LO 8 Explain revenue recognition for franchises and consignment sales Consignments Illustration: Nelba Manufacturing Co. ships merchandise costing $36,000 on consignment to Best Value Stores. Nelba pays $3,750 of freight costs, and Best Value pays $2,250 for local advertising costs that are reimbursable from Nelba. By the end of the period, Best Value has sold twothirds of the consigned merchandise for $40,000 cash. Best Value notifies Nelba of the sales, retains a 10 percent commission, and remits the cash due Nelba. Chapter 18-73 LO 8 Explain revenue recognition for franchises and consignment sales Consignments Chapter 18-74 LO 8 Explain revenue recognition for franchises and consignment sales Consignments Chapter 18-75 LO 8 Explain revenue recognition for franchises and consignment sales Copyright Copyright Copyright © 2009 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make backup copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Chapter 18-76 ... offered deep discounts to its distributors to overbuy, and then recorded revenue? ?when the software left the loading Chapter 1 8-1 5 LO 2 Describe? ?accounting? ?issues for? ?revenue? ?recognition? ?at point of sale Revenue? ?Recognition? ?Before Delivery Revenue? ?Recognition? ?Before Delivery... Identify the proper? ?accounting? ?for losses on longterm contracts Describe the installmentsales method of? ?accounting Explain the costrecovery method of? ?accounting Chapter 1 8-3 Revenue? ?Recognition Revenue? ?Recognition. .. Chapter 1 8-5 The Current Environment The Current Environment Guidelines for? ?Revenue? ?Recognition The? ?revenue? ?recognition? ?principle provides that companies should recognize? ?revenue Chapter 1 8-6