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Revenue and
Monetary Assets
5-2
Operating Cycle
Collect cash
Customer from
receives customer Purchase
product materials
Receive Inspect
order from product
customer Store
product
5-3
The Current Environment
Revenue Recognition Classified by Nature of Transaction
5-4
Revenue Recognition: GAAP
• Criteria:
– When?
• Substantial performance.
• Conservatism concept.
– How much?
• Revenue and expenses can
be reliably measured (i.e.,
collected or collectible).
• Realization concept (i.e.,
realized or realizable).
5-5
Revenue Recognition: IFRS
5-6
Revenue Recognition: SEC
• Persuasive evidence of
an order.
• Delivery completed or
services performed.
– Customer has assumed
risks and rewards of
ownership.
• Price can be determined.
• Collectibility of sale is
reasonably assured.
5-7
Delivery Method
• Most common.
• Recognize revenue when
goods or services are
delivered.
• When should revenue be
recognized?
– Auto repair shop?
– Prepaid hotel room?
– Dealer sold auto to
customer on monthly
payment (installment)
plan?
5-8
Revenue Recognition at Point of Sale
Illustration 18-3
Illustration 18-4
Revenue Recognition at Point of Sale
Illustration 18-4
Butler makes the following entry to record the bill and hold sale.
Layaway Sales
Illustration 18-6
Revenue Recognition at
Point of Sale
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:
Illustration 18-7
Revenue Recognition at Point of Sale
August 1, 2011
Accounts receivable 300,000
Sales 300,000
October 15, 2011
Sales returns and allowances 10,000
Accounts receivable 10,000
LO 2
Revenue Recognition at Point of Sale
Illustration 18-8
Revenue Recognition at Point of Sale
Illustration 18-8
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
Consignment Method
• Consignor ships goods to consignee (but
retains title until they are sold).
• Consignee attempts to sell goods.
• Revenue recognized when goods are sold.
• Why? Risks (and rewards) of ownership are
not yet transferred.
5-22
Consignment Method
5-23
Franchise Revenue
5-24
Percentage-of-Completion Method
• Design/development and
construction/ production
projects that extends over
several years (e.g., high-rise
building, aircraft).
• Could be either fixed price
or cost reimbursement
contract.
• Need reasonable assurance
of profit margin and
ultimate realization.
• Revenue recognized based
on total percentage of
project work performed
during period.
5-25
Long-Term Contracts (Construction)
• Alternative to
percentage-of-
completion.
• Used when amount of
income to be earned on
contract cannot be
reliably estimated.
• Costs incurred are held as
an asset (i.e., Contract
Work in Progress) until
revenue is recognized.
5-29
Production Method
• Permitted, but not
required by GAAP.
• Applies to certain
agricultural and mining
products.
• Recognize revenue at
harvest.
– Clear market determined
price.
– Performance substantially
complete.
5-30
Installment Method
5-31
Real Estate Sales
• Developer often finances over many years.
• Uncertainty of income due to uncertainty of
receipt of future payments.
• Conditions required for revenue recognition:
– Period allowing cancellation and refund to buyer
has expired.
– Cumulative payments equal to at least 10% of
purchase price.
– Seller has completed or is clearly capable of
completing required improvements (e.g., roads).
5-32
Amount of Revenue Recognized
• Net realizable value.
– Amount reasonably estimated to be collected.
• Adjustment for bad debts.
– Direct write-off method.
– Allowance method.
• % of sales.
• % of (analysis of) accounts receivable.
5-33
Bad Debts:
Direct Write-Off Method
• Write-off when
specific
uncollectible
account is
identified.
• What accounting
concept is violated
under this method?
5-34
Bad Debts:
Allowance Method
• Estimate amount of current period credit
sales that will not be collected.
– % of credit sales, or
– Aging accounts receivables (i.e., use higher
uncollectible % on older receivables).
– Percentages based on experience and
judgment.
5-35
Bad Debts:
Allowance Method
• Business makes $10,000 of sales on credit.
Estimates 3% of credit sales will be uncollectible.
Accounts Receivable Sales Revenues
Debit Credit Debit Credit
Original
Entries
+ - - +
$10,000 $10,000
Allowance for
Bad Debt Expense Doubtful Accounts
Illustration 18-2
5-40
Credit Card Sales
Bank plan (e.g., Credit plan (e.g., American
MasterCard, Visa). Express, Discover).
Does not create Creates accounts
accounts receivable. receivable.
Sales discount is credit Sales discount is credit
card fee. card fee.
No bad debts because
card company assumes
risk of loss.
5-41
Sales Returns & Allowances
Alternative:
Skip adjusting
entry.
Write off as they
occur.
Why is this
acceptable?
Materiality vs.
matching. 5-43
Adjustment to Revenue vs. Expense
5-44
Interest Revenue
5-45
Interest Revenue
• Discounted loan.
• Interest is implicit.
• Creates liability account (i.e.,
Unearned Interest Revenue)
when loan is made.
• Adjusting entry:
• Debit Unearned Interest
Revenue.
• Credit Interest Revenue.
5-46
Monetary vs. Nonmonetary
Assets
Monetary assets.
Money or claims to receive fixed sums of money.
Appear on balance sheet at “value.”
Cash; face value.
Accounts receivable; estimated realizable value.
Marketable securities; fair value.
Non-monetary assets.
Items used in future production and sales of
goods and services.
Appear on balance sheet at unexpired cost (i.e.,
book value).
5-47
Cash
5-48
Receivables
• Accounts receivables.
– Called trade receivables for nonfinancial
institutions.
Other receivables.
E.g., advances or loans to employees for
travel expenses.
Shown separately (e.g., Due from
Employees).
5-49
Factoring
Sales
Sales of
of Receivables
Receivables
Factors are finance companies or banks that buy receivables from
businesses for a fee.
Illustration 7-19
5-50
SalesFactoring
of Receivables
Illustration: Crest Textiles, Inc. factors €500,000 of accounts
receivable with Commercial Factors, Inc., on a non-guarantee (or
without recourse) basis. Commercial Factors assesses a finance
charge of 3 percent of the amount of accounts receivable and retains
an amount equal to 5 percent of the accounts receivable (for probable
adjustments). Crest Textiles and Commercial Factors make the
following journal entries for the receivables transferred without
recourse.
5-51
Sales of Receivables
Sale with Guarantee
Seller guarantees payment to purchaser.
5-52
Summary of Transfers
Factoring
5-55
Accounting for Marketable Securities
5-56
Accounting for Marketable Securities
Available-for-sale securities:
Debt or equity securities that do not fit
either of the other 2 categories.
Reported at market value.
Realized gains and losses go through
income.
Unrealized gains and losses directly
credited (or debited) to a stockholders’
equity account. 5-57
Analysis of Monetary Assets
Current ratio.
Current assets ÷ Current liabilities.
Measures liquidity; margin of safety.
Need to also look at make up of assets (e.g.,
cash vs. inventory).
Acid-test ratio.
Monetary current assets ÷ Current liabilities.
Excludes inventories and prepaid items.
5-58
Analysis of Monetary Assets
Days’ cash.
Cash ÷ (Cash expenses 365).
Rough approximation of cash expenses is total
expenses minus noncash expenses (e.g.,
depreciation).
Shows how well company is managing cash.
Days’ receivables.
Also called collection period.
Accounts receivable ÷ (Sales ÷ 365).
If available, use credit sales.
General rule: Should not exceed 133% of payment
terms.
5-59
Thank you
5-60