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CHAPTER 18

Revenue Recognition
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

Topics

Questions

Brief
Exercises

1. Revenue recognition
principle.

1, 2, 3, 4,
29

1, 2, 3,
4, 5, 6

Concepts
for Analysis

Exercises

Problems

1, 2, 3, 4,
5, 6, 7, 8,
10, 11

1, 2, 3, 4,
5, 7

2. Recognition at point of sale. 5, 6, 7, 8, 9, 1, 2, 3, 4, 5 1, 2, 3, 4,


10, 29
5, 6, 7, 8

1, 2, 3, 4, 5

1, 2, 3, 4,
5, 6, 7, 15,
16, 17, 18

1, 2, 3, 6

1, 2, 6

3. Consignments; trade
loading; channel stuffing;
multiple deliverables.

11, 12, 13,


29

5, 6

9,10, 11

4. Percentage-of-completion
method.

14, 15, 16,


17, 19, 29

7, 8, 11

12, 13, 14,


15,16, 17

5. Completed-contract method. 14, 16, 29

8, 9, 10, 11 17, 18

1, 2, 5, 6,
7, 17

6. Long-term contract losses.

18

11

5, 6, 7, 15,
17

*7. Installment-sales method.

20, 21, 23,


24, 25, 26,
28, 29, 31

12, 13, 14

19, 20, 21,


22, 23, 24

1, 8, 9, 10,
11, 12, 14

*8. Special installment sales


25, 27, 29
issues: interest; uncollectible
accounts; repossessions.

13, 14

21, 22, 25,


26

10, 11, 12,


13, 14

*9. Cost-recovery method;


deposit method.

20, 21, 22,


30, 31

15

23, 24

*10. Revenue recognition for


franchises.

32, 33,
34, 35

16

27, 28

1, 2, 3

*This material is dealt with in an Appendix to the chapter.

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ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)

Learning Objectives

Brief
Exercises

Exercises

Problems

1.

Describe and apply the revenue recognition


principle.

2.

Describe accounting issues for revenue


recognition at point of sale.

1, 2, 3, 4, 5, 6

1, 2, 3, 4, 5, 6,
7, 8, 9, 10, 11

3.

Apply the percentage-of-completion method


for long-term contracts.

7, 8

12, 13, 14,


15, 16, 17

1, 2, 3, 4, 5,
6, 7, 16, 17

4.

Apply the completed-contract method


for long-term contracts.

9, 10

12, 16,
17, 18

1, 2, 3, 5, 6, 7,
15, 16, 17

5.

Identify the proper accounting for losses


on long-term contracts.

11

18

5, 6, 7, 15

6.

Describe the installment-sales method


of accounting.

12, 13, 14

19, 20, 21, 22,


23, 24, 25, 26

1, 8, 9, 10, 11,
12, 13, 14

7.

Explain the cost-recovery method


of accounting.

15

23, 24

Explain revenue recognition for franchises.

16

27, 28

*8.

6, 7, 8, 9

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ASSIGNMENT CHARACTERISTICS TABLE


Item
E18-1
E18-2
E18-3
E18-4
E18-5
E18-6
E18-7
E18-8
E18-9
E18-10
E18-11
E18-12
E18-13
E18-14
E18-15
E18-16
E18-17
E18-18
E18-19
E18-20
E18-21
E18-22
E18-23
E18-24
*E18-25
*E18-26
*E18-27
*E18-28
P18-1
P18-2
P18-3
P18-4
P18-5
P18-6
P18-7
P18-8
P18-9
18-4

Description

Level of
Time
Difficulty (minutes)

Revenue recognition-point of sale.


Revenue recognition-point of sale.
Revenue recognition-point of sale.
Revenue recognition-point of sale.
Right of return.
Revenue recognition on book sales with high returns.
Sales recorded both gross and net.
Revenue recognition on marina sales with discounts.
Consignment computations.
Multiple-deliverable agreement.
Multiple-deliverable agreement.
Recognition of profit on long-term contracts.
Analysis of percentage-of-completion financial statements.
Gross profit on uncompleted contract.
Recognition of profit, percentage-of-completion.
Recognition of revenue on long-term contract and entries.
Recognition of profit and balance sheet amounts for long-term
contracts.
Long-term contract reporting.
Installment-sales method calculations, entries.
Analysis of installment-sales accounts.
Gross profit calculations and repossessed merchandise.
Interest revenue from installment sale.
Installment-sales method and cost-recovery method.
Installment-sales method and cost-recovery method.
Installment-salesdefault and repossession.
Installment-salesdefault and repossession.
Franchise entries.
Franchise fee, initial down payment.

Simple
Simple
Simple
Simple
Simple
Moderate
Simple
Moderate
Simple
Simple
Simple
Moderate
Moderate
Simple
Moderate
Moderate
Simple

510
510
510
1015
510
1520
1520
1015
1520
1015
510
2025
1015
1012
2530
1520
1525

Simple
Simple
Moderate
Moderate
Simple
Simple
Simple
Simple
Simple
Simple
Simple

1525
1520
1520
1520
1015
1015
1520
1015
1520
1418
1216

Comprehensive three-part revenue recognition.


Recognition of profit on long-term contract.
Recognition of profit and entries on long-term contract.
Recognition of profit and balance sheet presentation,
percentage-of-completion.
Completed contract and percentage-of-completion
with interim loss.
Long-term contract with interim loss.
Long-term contract with an overall loss.
Installment-sales computations and entries.
Installment-sales income statements.

Moderate
Simple
Moderate
Moderate

3045
2025
2535
2030

Moderate

2530

Moderate
Moderate
Moderate
Moderate

2025
2025
2530
3035

Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

ASSIGNMENT CHARACTERISTICS TABLE (Continued)


Item
P18-10
P18-11
P18-12

Description

Level of
Difficulty

Time
(minutes)

Complex
Simple
Complex

3040
2025
4050

P18-13
P18-14
P18-15
P18-16
P18-17

Installment-sales computations and entries.


Installment-sales entries.
Installment-sales computations and entriesperiodic
inventory.
Installment repossession entries.
Installment-sales computations and schedules.
Completed-contract method.
Revenue recognition methodscomparison.
Comprehensive problemlong-term contracts.

Moderate
Complex
Moderate
Complex
Complex

2025
5060
2030
4050
5060

CA18-1
CA18-2
CA18-3
CA18-4
CA18-5
CA18-6
CA18-7
CA18-8

Revenue recognitionalternative methods.


Recognition of revenuetheory.
Recognition of revenuetheory.
Recognition of revenuebonus dollars.
Recognition of revenue from subscriptions.
Long-term contractpercentage-of-completion.
Revenue recognitionmembership fees.
Franchise revenue.

Moderate
Moderate
Moderate
Moderate
Complex
Moderate
Moderate
Moderate

2030
3545
2530
3035
3545
2025
3040
2530

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LEARNING OBJECTIVES
1.
2.
3.
4.
5.
6.
7.
*8.
*9.

Describe and 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.
Identify the proper accounting for losses on long-term contracts.
Describe the installment-sales method of accounting.
Explain the cost-recovery method of accounting.
Explain revenue recognition for franchises and consignment sales.
Compare the accounting procedures related to revenue recognition under GAAP and
IFRS.

*This material is covered in an Appendix to the Chapter.

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Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

CHAPTER REVIEW
1. One of the most difficult issues facing accountants concerns the recognition of revenue by
a business organization. Although general rules and guidelines exist, the significant
variety of marketing methods for products and services make it difficult to apply the rules
consistently in all situations. Chapter 18 is devoted to a discussion and illustration of
revenue transactions that result from the sale of products and the rendering of services.
Throughout the discussion, attention is focused on the theory behind the accounting
methods used to recognize revenue. Revenue transactions that result from leasing and
the sale of productive assets other than inventory are discussed in other sections of the
text.
Revenue Recognition
2. (L.O. 1)The revenue recognition principle provides that revenue is recognized when
(1) it is realized or realizable, and (2) it is earned. Revenues are realized when goods and
services are exchanged for cash or claims to cash (receivables). Revenues are realizable
when assets received in exchange are readily convertible to known amounts of cash or
claims to cash. Revenues are earned when the entity has substantially accomplished
what it must do to be entitled to the benefits represented by the revenues, that is, when
the earnings process is complete or virtually complete.
3. The conceptual nature of revenue, as well as the basis of accounting for revenue
transactions are described in the following four statements.
a.

Companies recognize revenue from selling products at the date of sale. This date is
usually interpreted to mean the date of delivery to customers.

b.

Companies recognize revenue from services provided when services have been
performed and are billable.

c.

Companies recognize revenue from permitting others to use enterprise assets, such
as interest, rent, and royalties, as time passes or as the assets are used.

d.

Companies recognize revenue from disposing of assets other than products


at the date of sale.

4. The discussion of sales transactions in the chapter is primarily focused on product sales
transactions. The coverage of product sales transactions is further divided into the following
topics: (a) revenue recognition at point of sale (delivery), (b) revenue recognition before
delivery, (c) revenue recognition after delivery, and (d) revenue recognition for franchises
(covered in Appendix 18-A).
Point of Sale
5. (L.O. 2)Sales transactions result in the exchange of products or services of an enterprise
for other valuable assets, normally cash or a promise of cash in the future. Although most

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sales transactions are fundamentally similar, differences in the method or terms of sale
lead to real differences in the transactions themselves, and thus to differences in the
appropriate accounting for them.
6. According to the FASB, revenue is recognized when the product is delivered or the service
is rendered. This time of recognition is normally at the time of sale when the product or
service is delivered to the customer. Some problems in implementing these basic principles
arise when (a) sales have buyback agreements, (b) the right of return exists, and (c) trade
loading or channel stuffing is present.
Sales with Discounts
7. Trade and volume discounts reduce consideration received and reduce revenue earned.
Prompt payment discounts (cash discounts) reduce revenues, if material.
8. When a sales transaction involves a financing arrangement, the fair value is determined
either by measuring the consideration received or by discounting the payment using an
imputed interest rate.
Sales with Right of Return
9. The FASB concluded that if a company sells its product but gives the buyer the right to
return it, the company should recognize revenue from the sales transactions at the time of
sale only if all of the following six conditions are met:
a. The sellers price to the buyer is substantially fixed or determinable at the date of sale.
b. The buyer has paid the seller, or the buyer is obligated to pay and the obligation is not
contingent on resale of the product.
c. The buyers obligation to the seller would not be changed in the event of theft or
physical destruction or damage of the product.
d. The buyer acquiring the product for resale has economic substance apart from that
provided by the seller.
e. The seller does not have significant future performance obligations to directly bring
about resale of the product by the buyer.
f. The seller can reasonably estimate the amount of future returns.
Sales with Buyback
10. If a company sells a product in one period and agrees to buy it back in the next period, a
sales has not occurred because the seller has not satisfied its performance obligation.
Bill and Hold Sales
11. Bill and hold sales result when the buyer is not yet ready to take delivery but does take
title and accept billing. The most appropriate approach for bill and hold sales is to defer
revenue recognition until the goods are delivered because the risks and rewards of
ownership usually do not transfer until that point.
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Principal-Agent Relationships
12. In a principal-agent relationship, amounts collected on behalf of the principal are not
revenue of the agent. Instead, revenue for the agent is the amount of the commission it
receives (usually a percentage of the total revenue).
13. In a consignment sales arrangement, merchandise is shipped by the consignor to the
consignee, who acts as an agent for the consignor in selling the merchandise. The merchandise shipped to the consignee remains the property of the consignor until a sale is
made. When a sale is made, the consignee remits the proceeds, less any related expenses
plus a sales commission, to the consignor. When the consignor receives word that a sale
has been made, revenue is recognized and inventory is appropriately reduced.
Trade Loading and Channel Stuffing
14. Even when revenues are recorded at date of delivery, with neither buyback or return
provisions, some companies are recognizing revenues and earnings prematurely. This
occurs in situations where trade loading or channel stuffing are present. Trade loading
is an attempt to show sales, profits, and market share that an entity does not have by
inducing wholesale customers to buy more product then they can promptly sell. Channel
stuffing is a similar tactic found mostly in the computer software industry. In channel
stuffing, the software maker offers deep discounts to its distributors to overbuy and
records revenue when the software leaves its loading dock. When this process takes place,
the distributors inventories become bloated and the marketing channel gets stuffed, but
the software makers current-period financial statements are improved.
Multiple-Deliverable Arrangements
15. Multiple-deliverable arrangements (MDAs) provide multiple products or services to
customers as part of a single arrangement. The amount paid for the arrangement is
allocate among the separate units based on relative fair value.
Long-term Contracts
16. (L.O. 3) In most circumstances, revenue is recognized at the point of sale because most
of the uncertainties related to the earnings process are removed and the exchange price is
known. One of the exceptions to the general rule of recognition at point of sale is caused
by long-term construction-type projects. The accounting measurements associated with
long-term construction projects are difficult because events and amounts must be
estimated for a period of years. Two basic methods of accounting for long-term construction
contracts are recognized by the accounting profession. They are: (a) the percentage-of
completion method, and (b) the completed-contract method.
17. The percentage-of-completion method is used when estimates of progress toward
completion, revenues, and costs are reasonably dependable and all the following
conditions exist:
a. The contract clearly specifies the enforceable rights regarding goods or services to be
provided and received by the parties, the consideration to be exchanged, and the
manner and terms of settlement.
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b. The buyer can be expected to satisfy all obligations under the contract.
c. The contractor can be expected to perform contractual obligations.
The completed-contract method should be used only when (a) an entity has primarily
short-term contracts, or (b) the conditions for using the percentage-of-completion method
cannot be met, or (c) there are inherent hazards in the contract beyond normal, recurring
business risks.
Percentage-of-Completion Method
18. Under the percentage-of-completion method, revenue on long-term construction contracts
is recognized as construction progresses. Costs pertaining to the contract along with
gross profit earned to date are accumulated in a Construction in Process account. The
amount of revenue recognized in each accounting period is based on a percentage of the
total revenue to be recognized on the contract. The most popular method of estimating
the amount of revenue to recognize is based on the costs incurred on the contract to
date divided by the most recent estimated total costs (cost-to-cost basis).
a. The journal entry to recognize revenue under the percentage-of-completion method is
as follows:
Dr
Dr

Construction in Process
Construction Expenses
Cr
Revenue from Long-Term Contracts

b. In any subsequent year, total revenue to be recognized is estimated based on the


current cost-to-cost basis, and any revenue recognized in prior years is subtracted,
resulting in incremental revenue being recognized each year.
c. The Billings on Construction in Process account is subtracted from the Construction in
Process accounts; if the amount is a debit, it is reported as a current asset; if the
amount is a credit, it is reported as a current liability.
Completed-Contract Method
19. (L.O. 4)Under the completed-contract method, revenue and gross profit are recognized
when the contract is completed. The principal advantage of the completed-contract
method is that reported revenue is based on final results rather than on estimates of
unperformed work. Its major disadvantage is the distortion of earnings that may occur.
The accounting entries made under the completed-contract method are the same as those
made under the percentage-of-completion method, with the notable exception of periodic
income recognition.

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18-11

Contract Losses
20. (L.O. 5)Two types of losses can occur on long-term contracts.
a. A loss in the current period on a profitable contract occurs when estimated total
contract costs increase significantly, but the company still expects a profit on the
overall contract. This is treated as a change in estimate and recognized only under the
percentage-of-completion method.
b. An overall loss on an unprofitable contract occurs when a loss will result on the
entire contract. In these circumstances, a loss is recognized under both the
percentage-of-completion and completed-contract methods.
Disclosures for Long-term Contracts
21. In addition to normal financial statement disclosures, construction contractors should disclose
(a) the method of recognizing revenue, (b) the basis used to classify assets and liabilities
as current, (c) the basis for recording inventory, (d) the effects of any revisions of estimates,
(e) the amount of backlog on incomplete contracts, and (f) the details about receivables.
Revenue Recognized During Production
22. In certain cases, companies recognize revenue at the completion of production even
though no sale has been made. Examples of such situations involve precious metals or
agricultural products with assured prices.
Installment Method
23. (L.O. 6)In some cases revenue is recognized after delivery of the product to the buyer.
This is due to the fact that, in certain sales situations, the collection of the sales price is
not reasonably assured and revenue recognition is deferred. The methods generally used
to account for the deferral of revenue recognition until cash is received are (a) the
installment method, and (b) the cost recovery method.
24. Use of the installment method is justified in situations where receivables are collectible
over an extended period of time and there is no reasonable basis for estimating the
degree of collectibility. The method is used extensively in tax accounting.
25. The term installment sale describes any type of sale for which payment is required in
periodic installments over an extended period of time. The installment method places
emphasis on collection, as installment sales lead to income realization in the period of
collection rather than the period of sale. This does not mean that revenue is considered
unrealized until the entire sale price has been collected, but rather that income realization
is proportionate to collection.
26. Under the installment sales method of accounting, gross profit (sales less cost of goods
sold) on installment sales is deferred to those periods in which cash is collected.
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Operating expenses, such as selling and administrative expenses, are treated as expenses
in the period incurred. For installment sales in any one year, the following procedures
apply under the installment sales method:
a. During the year, record both sales and cost of sales using separate installment sales
accounts and compute the rate of gross profit on installment sales transactions.
b. At the end of the year, apply the rate of gross profit to the cash collections of the
current years installment sales to arrive at the realized gross profit.
c. The unrealized gross profit should be deferred to future years. Deferred gross profit is
generally treated as unearned revenue and classified as a current liability.
d. In any year in which collections from prior years installment sales are received, the
gross profit rate of each years sales must be applied against cash collections of
accounts receivable resulting from that years sales to arrive at the realized gross
profit.
27. If installment sales transactions represent a significant part of total sales, full disclosure of
installment sales, the cost of installment sales, and any expenses allocable to installment
sales is desirable.
28. To illustrate the installment sales method of accounting, assume the following facts:
Installment sales
Cost of installment sales
Gross profit
Rate of gross profit
Cash receipts:
2014 Sales
2015 Sales
2016 Sales

2014
$226,000
164,980
$ 61,020
27%

2015
$248,000
176,080
$ 71,920
29%

2016
$261,000
195,750
$ 65,250
25%

$ 85,000

$ 96,000
123,000

$ 45,000
87,000
147,000

Only the 2015 journal entries will be shown. The entries for 2014 and 2016 are the same,
but the entire set of entries for the installment method are demonstrated by the 2015 entries.
To record 2015 installment sales
Installment Accounts Receivable, 2015...................
Installment Sales................................................
To record cash collected on installment receivables
Cash.........................................................................
Installment Accounts Receivables, 2014............
Installment Accounts Receivables, 2015............
To record 2015 cost of goods sold on installment
Cost of Installment Sales.........................................
Inventory (or Purchases)....................................

248,000

219,000

176,080

248,000

96,000
123,000

176,080

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To close installment sales and cost of installment sales


Installment Sales......................................................
Cost of Installment Sales....................................
Deferred Gross Profit, 2015................................
To record realized gross profit
Deferred Gross Profit, 2014.....................................
Deferred Gross Profit, 2015.....................................
Realized Gross Profit..........................................

248,000

176,080
71,920

25,920 (a)
35,670 (b)
61,590

(a) $96,000 .27


(b) $123,000 .29
29. When interest is involved in installment sales, it should be accounted for separately as
interest income in the period received. Uncollectible installment accounts receivable should
be accounted for in a manner similar to that used for such losses on other credit sales if
repossessions do not normally compensate for uncollectible balances.
Defaults and Repossessions
30. The accounting for repossessions recognizes that the related installment receivable
account is not collectible and that it should be written off. The applicable deferred gross
profit must be removed from the ledger.
31. Repossessed merchandise should be recorded in the Repossessed Merchandise Inventory
account. The item repossessed should be recorded at its fair value. The objective should
be to put any asset acquired on the books at its fair value or, when fair value is not
ascertainable, at the best possible approximation of fair value.
Cost Recovery Method
32. (L.O. 7)Under the cost recovery method, no profit is recognized until cash payments by
the buyer exceed the sellers cost of the merchandise sold. After all the costs have been
recovered, any additional cash collections are included in income. A seller uses the cost
recovery method to account for sales in which there is no reasonable basis for estimating
collectibility. The cost recovery method is required where a high degree of uncertainty
exists related to the collection of receivables. The cost recovery method is more
appropriate than the installment method when there is a greater degree of uncertainty.
Deposit Method
33. Under the cost recovery method, no profit is recognized until cash payments are
received. In some cases, a company receives cash from the buyer before it transfers the
goods or property. In such cases, the seller has not performed under the contract and has
no claim against the purchaser. There is not sufficient transfer of the risks and rewards of
ownership for a sale to be recorded.
Franchises
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18-15

*34. (L.O. 8)Appendix 18A includes a presentation of franchise sales and consignment sales
transactions. In franchise operations a franchisor grants business rights under
a franchise agreement to a franchisee.
*35. Four types of franchise arrangements have evolved in practice: (a) manufacturer-retailer, (b)
manufacturer-wholesaler, (c) service sponsor-retailer (McDonalds, Pizza Hut, etc.), and (d)
wholesaler-retailer.
*36. Franchise companies derive their revenue from one or both of two sources: (a) the sale of
initial franchises and related assets or services, and (b) continuing fees based on the
operations of franchises.
Accounting for Franchises
*37. Current financial reporting standards were designed to curb abuses in revenue
recognition and to standardize the accounting and reporting practices in the franchise
industry. Initial franchise fees are to be recorded as revenue only when and as the
franchisor makes substantial performance of the services it is obligated to perform and
collection of the fee is reasonably assured. Continuing franchise fees should be
reported as revenue when they are earned and receivable from the franchisee, unless a
portion of them has been designated for a particular purpose. When a franchisee is given
an option to purchase equipment or supplies from a franchisor at a bargain purchase
price (lower than the normal selling price), a portion of the initial franchise fee should be
deferred and accounted for as an adjustment to the selling price of equipment or supplies.
*38. A franchisor should disclose all significant commitments and obligations resulting from
franchise agreements, including a description of services that have not yet been
substantially performed.
*Note:All asterisked (*) items relate to material contained in the Appendix to the chapter.

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LECTURE OUTLINE
The material in this chapter can be covered in three class sessions. Students are generally
unfamiliar with revenue recognition bases other than at point of sale. Illustrations 18-2,
18-3, and 18-4 should be helpful in demonstrating the accounting for long-term contracts and
installment sales.
A. (L.O. 1)Revenue Recognition Principle.
1.

Revenue recognition is one of the most difficult problems facing the accounting profession.
This problem arises from the difficulty in developing guidelines applicable to all situations.
TEACHING TIP

Illustration 18-1 describes the important concepts in revenue recognition.


2.

Recognition principle:Revenue is recognized in the accounting period in which a


performance obligation is satisfied. Under GAAP, it is recognized when:
a.

Realized or realizable (convertible to known amounts cash or claims to cash).


AND

b.
3.

Earned (company has substantially performed the required acts).

(L.O. 2)Revenue Recognition at Point of Sale.


a.

Trade discounts and volume rebates.

b.

Cash discounts

c.

Delayed payments through financing arrangements.

d.

Problems when a high ratio of returned merchandise to sales exists. Recognize sale
only if all six of following conditions are met:
(1) Sellers price is substantially fixed or determinable at the date of sale.
(2) Buyer has paid the seller, or is obligated to do so, without any contingencies.
(3) Buyers obligation to pay is not affected by theft, destruction, or damage of the
product.
(4) Buyer has economic substance apart from that provided by the seller.
(5) Seller has no significant obligations for future performance to bring about
resale of the product by the buyer.
(6) The amount of the future returns can be reasonably estimated by the seller.

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18-17

e.

Sales with buyback. If a company sells a product in one period and agrees to
buy it back in the next period, revenue is not recognized.

f.

Bill and hold sales. These result when the buyer is not yet ready to take delivery
but accepts title and the billing. Most cases require a deferral of revenue
recognition until the goods are delivered.

g.

Principal-agent relationship. The Agent does not have exposure to significant


risks and rewards, therefore, only commission is recorded as revenue, not the entire
sales price.

h.

Consignments are a type of principal-agent relationships. In a consignment, the


consignor (manufacturer or wholesaler) ships merchandise to the consignee
(dealer), who is to act as an agent for the consignor in selling the merchandise.
The consignor recognizes revenue only after receiving notification of sale and the
cash remittance from the consignee. The consignee does not record the
merchandise as an asset on its books. Upon sale of the merchandise, the
consignee has a liability for the net amount due the consignor.

i.

Trade loading and channel stuffing.These are undesirable managerial and


marketing policy decisions and actions that distort operating results.

j.

Multiple-deliverable arrangements. Multiple-deliverable arrangements (MDAs)


provided multiple products or services to customers as part of a single
arrangement.

B. Revenue Recognition Before Delivery.


1.

Revenue recognition during production is accounted for primarily under long-term


construction contracts.
a.

(L.O. 3)Percentage-of-completion method.


TEACHING TIP

Illustration 18-2 provides a numerical example that demonstrates the journal entries to be
made when using the percentage-of-completion method for a long-term construction contract.
(1) Gross profit is recognized periodically, based on the percentage of the job
that is complete, rather than when the entire job is completed.
(2) The method must be used when estimates of progress toward completion,
revenues, and costs are reasonably dependable.
(3) The most popular input measure used to determine the progress toward
completion is the cost-to-cost basis.
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b.

(L.O. 4)Completed-contract method.Revenue, cost of goods sold, and gross


profit are not recognized until the contract is completed. This method is used only
when using the percentage-of-completion method is inappropriate.

c.

The two methods should not be viewed as acceptable alternatives in the same
circumstances.
TEACHING TIP

Illustration 18-3 provides a numerical example of the journal entries made when using the
completed-contract method for long-term contracts. The example data is the same as was
used in Illustration 18-2 to demonstrate the percentage-of-completion method. Contrasting
the two illustrations will emphasize the differences between the two methods of accounting
for long-term contracts. Note that total gross profit is equal for both methods.
d.

(L.O. 5)Accounting for losses on long-term contracts.


(1) Recognize a loss in the current period on a profitable contract when costs
increase to the extent that gross profit recognized in prior periods must be
reduced. Only applies to the percentage-of-completion method.
(2) When estimates indicate that the entire contract will be unprofitable, the entire
loss is recognized immediately under both methods.

e.

Financial statement disclosures for long-term contracts.


(1)
(2)
(3)
(4)
(5)
(6)

The method of recognizing revenue.


The basis used to classify assets and liabilities as current.
The basis for recording inventory.
The effects of any revision of estimates.
The amount of backlog on uncompleted contracts.
Details of related receivables.

C. Revenue recognition at completion of production. Revenue is recognized even though no


sale has been made when the sales price is reasonably assured, the units are
interchangeable, and no significant costs are involved in distributing the product.
(1) Agricultural products.
(2) Precious metals.
D. Revenue Recognition After Delivery.
1.

(L.O. 6)Installment-sales method.Emphasizes


recognition in the period of the sale.

cash

collection

rather

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than

18-19

TEACHING TIP

Discuss the numerical example of installment sales given on pages 10701072 in the textbook.
Illustration 18-4 provides a T-account version of the first year installment sales of the textbook
example.

2.

a.

Revenue and cost of goods sold are recognized in the period of sale, but gross profit
recognition is deferred until the period of cash collection. Selling and administrative
expenses are recognized in the period of the sale.

b.

Not acceptable for financial reporting except under special circumstances since it
is not in accordance with accrual accounting.

c.

Interest on installment contracts, uncollectible accounts, and defaults and


repossessions cause complications in accounting for installment sales.

d.

Interest on installment contracts is accounted for separately as interest income in


the period received.

e.

Uncollectible accounts are accounted for in a manner similar to losses from other
receivables.

f.

Repossessions are recorded at fair value in a Repossed Merchandise Inventory


account.

g.

Financial statement presentation: If installment-sales transactions represent a


significant part of total sales, it is desirable to make full disclosure of installment
sales, the cost of installment sales, and any expenses allocable to installment
sales.

(L.O. 7)Cost-recovery method.No profit is recognized until cash payments by the


buyer exceed the sellers cost of merchandise sold.
a.

3.

A seller is permitted to use the cost-recovery method to account for sales in which
there is no reasonable basis for estimating collectibility.

Deposit method.In some cases, cash is received from the buyer before transfer of the
goods or property. In these cases, no revenue or income should be recognized until the
sale (exchange) is complete.
a.

The seller records cash received from the buyer as a liability and continues to report
the property as an asset.
(1) Once it is determined that a sale has occurred for accounting purposes, revenue
should be recognized.

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*E. (L.O. 8)Appendix 18-A. Revenue Recognition for Franchises.


1.

Franchise companies. Franchise companies derive their revenue from one or both of
two sources: (1) from the sale of initial franchises and related assets or services, and
(2) from continuing fees based on the operations of franchises.

2.

Types of franchise arrangements.


a. Manufacturerretailer.
b. Manufacturerwholesaler.
c.

Service sponsorretailer.

d. Wholesalerretailer.
3.

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Franchise terminology.
a.

Initial franchise fees. Franchisors record initial franchise fees as revenue only
when and as they make substantial performance of the services they are
obligated to perform, and when collection of the fee is reasonably assured.

b.

Continuing franchise fees. Franchisors report continuing fees as revenue when


they are earned and receivable from the franchisee, unless a portion of them has
been designated for a particular purpose.

c.

Bargain purchases. When a franchisor allows a franchisee to purchase equipment


or supplies at a bargain price, a portion of the initial franchise fee should be
deferred and accounted for as an adjustment to the price of the purchased items.

d.

Options to purchase. If it is probable at the time the option is given that the
franchisor will ultimately purchase the outlet, then the franchisor should not
recognize the initial franchise fee as revenue but should instead, record it as a
liability.

e.

Franchisers costs. Franchisors should ordinarily defer direct costs (usually


incremental costs) relating to specific franchise sales for which revenue has not
yet been recognized. They should not, however, 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.

Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

4.

Required disclosures of franchisors.


a.

Significant commitments and obligations resulting from franchise agreement.

b.

Collectability of franchise fees.

c.

Description of services not yet performed.

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*F. (L.O. 9) IFRS Insights


1.

The general concepts and principles used for revenue recognition are similar between
IFRS and GAAP. GAAP provides specific guidance related to revenue recognition for
many different industries. That is not the case for IFRS.

2.

Similarities
a.

Revenue recognition fraud is a major issue in U.S. financial reporting. The same
situation occurs overseas as evidenced by revenue recognition breakdowns at
Dutch software company Baan NV and Japanese electronics giant NEC. and
Dutch grocer AHold NV.

b.

In general, the accounting at point of sale is similar between IFRS and GAAP. As
indicated earlier, GAAP often provides detailed guidance, such as in the
accounting for right of return and multiple-deliverable arrangements.

c.

In long-term construction contracts, IFRS requires recognition of a loss


immediately if the overall contract is going to be unprofitable. In other words, GAAP
and IFRS are the same regarding this issue.

3. Differences

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a.

The IASB defines revenue to include both revenues and gains. GAAP provides
separate definitions for revenues and gains.

b.

IFRS has one basic standard on revenue recognitionIAS 18. GAAP has
numerous standards related to revenue recognition (by some counts over 100).

c.

Accounting for revenue provides a most fitting contrast of the principles-based


(IFRS) and rules-based (GAAP) approaches. While both sides have their
advocates, the IASB and the FASB have identified a number of areas for
improvement in this area.

d.

In general, the IFRS revenue recognition principle is based on the probability that
the economic benefits 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.
GAAP uses concepts such as realized, realizable, and earned as a basis for
revenue recognition.

Copyright 2013 John Wiley & Sons, Inc.Kieso, Intermediate Accounting, 15/e Instructors Manual(For Instructor Use Only)

e.

Under IFRS, revenue should be measured at fair value of the consideration


received or receivable. GAAP measures revenue based on the fair value of what is
given up (goods or services) or the fair value of what is receivedwhichever is
more clearly evident.

f.

IFRS prohibits the use of the completed-contract method of accounting for longterm construction contracts (IAS 13). Companies must use the percentage-ofcompletion method. If revenues and costs are difficult to estimate, then companies
recognize revenue only to the extent of the cost incurreda cost-recovery (zeroprofit) approach.
*Note:All asterisked (*) items relate to material contained in the Appendix to the
chapter.

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18-25

ILLUSTRATION 18-1
REVENUE RECOGNITION

18-26

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18-27

ILLUSTRATION 18-2
PERCENTAGE-OF-COMPLETION METHOD

18-28

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18-29

ILLUSTRATION 18-3
COMPLETED-CONTRACT METHOD

18-30

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ILLUSTRATION 18-4
A T ACCOUNT VERSION OF THE TEXT EXAMPLE

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18-31

18-32

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