1.To Identify the Primary Criteria for Revenue Recognition. They Follow

Chapter 7

|You Will Learn...

1.To identify the primary criteria for revenue recognition. They follow:

Revenue is typically recognized and recorded when two criteria are met: (1) realizability (the seller has received payment or a valid promise of payment), and (2) the earnings process is substantially complete.
Substantial completion means the seller has provided the product or service (or a large portion of the product or service) to the purchaser.

2.To explain when revenue is appropriately recognized prior to delivery of goods or services through percentage-of-completion accounting.

Revenue may be recognized before the actual delivery of goods or services (i.e., long-term contract) if four criteria are met: (1) estimates are made of the amount of work remaining; (2) a contract exists outlining each party’s responsibilities; (3) the buyer can be expected to fulfill the contract; and (4) the seller can be expected to fulfill the contract.
If these conditions are met, revenue may be recognized prior to the point of sale and the revenue recognition method is termed percentage-of-completion (and then revenue is recognized based on an estimate of the degree to which the contract is complete).
Using the cost-to-cost method for estimating the degree of completion results in matching actual contract costs with estimated revenues.

3.To record journal entries for long-term construction-type contracts using percentage-of-completion and completed-contract methods. Bear in mind:

With long-term contracts, journal entries are required to record costs incurred, billings made to customers, and collections from customers (the entries are the same for both the percentage-of-completion and the completed-contract methods).
An additional journal entry is made each period under the percentage-of-completion method to record the recognition of revenue and related expenses for the period (the revenue amount is a function of the amount of costs incurred to date).
With the completed-contract method, revenue is recognized only when the contract has been completed.

4.To record journal entries for long-term service contracts using the proportional performance methods. Remember:

With long-term service contracts, revenue can be recognized prior to completion based on the degree to which the contract is completed.
Estimates of completion are made based on the ratio of actual costs incurred relative to total costs expected to be incurred.
The amount of revenue recognized is computed by multiplying this ratio by the contract price.

5.To explain when revenue is recognized after delivery of goods or services through installment sales, cost recovery, and cash methods.

It is not appropriate to recognize revenue at the point of sale in cases where a valid promise of payment has not been received (the revenue’s recognition is deferred until cash is actually received).
The installment sales method recognizes profit based on a gross profit percentage (of every dollar collected, a portion is recorded as profit based on the gross profit percentage).
With cost recovery, cash collections are first considered to be a recovery of the costs associated with the sale (once costs are recovered, each subsequent dollar received is recorded as profit).
With the cash method, profit is determined by comparing cash received from customers with the cash expended during the period relating to inventory or services.

6.To describe accounting for the transfer of assets prior to the recognition of revenue with the deposit method and consignment sales.

CWhen a customer prepays for a purchase, a liability is recorded on the seller’s books until services are provided to the customer (once the service is provided, the liability is reduced and revenue is recorded).

CConsignment sales occur when inventory is shipped to a vendor who holds the inventory for subsequent resale (title to the inventory does not pass to the vendor but remains with the original holder of the inventory).

COnce the inventory is sold by the vendor, the consignor is notified and makes the appropriate entries to record the sale.

| Important Points

Timing of Revenue Recognition and Asset Recognition

You are confronted with many revenue recognition methods in this chapter. It is useful to facilitate your perspective of these methods by relating all of the methods to a time continuum with the focal point being the point of product delivery or rendering of service. As you depart from this point in either time direction, note seller or buyer performance as being the basis for a revenue recognition method’s departure from the point of product delivery. This approach can potentially clarify the differences among the various methods addressed in this chapter.

Construction in Progress

You may have difficulty with the nature of the construction in progress account, especially with the profit component under the percentage-of-completion method. Gross profit is included in this inventory account because the related revenue is recognized on the income statement. Consequently, the percentage-of-completion method results in the inventory account being valued at market, not cost. Under the completed-contract method, construction-in-progress includes accumulated costs, but not profit. This is similar to work in process in a manufacturing entity’s inventory.