MGAC01 Intermediate Accounting I S. Daga TOPIC: REVENUE RECOGNITION TEXT: E6-1, P6-3, P6-6, Case CA6-1 LEARNING GOALS: 1. Understand the Basic Concepts of Revenue Recognition, including RCMP. 2. The Earnings Approach consider how it is different depending on type of business. 3. Be able to be proficient in applying specific revenue recognition methods. CLASS OUTLINE: LEARNING GOAL 1: Understand the Basic Concepts of Revenue Recognition, including RCMP. Deciding which period to RECOGNIZE revenue requires JUDGEMENT for particular situations, even though specific criteria for revenue recognition exists A Decision Framework to be used to decide in a business situation if revenue and be recognized: E6-1 R Risks and Rewards have the risks and rewards of ownership of the product/service passed on to the new owner? C Is Collectability from the customer assured in this situation? M Is Measurement of revenue determinable? Do we know how much? P Has Performance has been achieved, i.e. have we done enough of the work to earn the revenue?
LEARNING GOAL 2: Earnings Approach consider how it is different depending on type of business. EARNING PROCESSES (CYCLES) MERCHANDISING ORDER RECEIVE STORE SELL COLLECT FROM GOODS AND ADVERTISE ON CASH SUPPLIERS DISPLAY ACCOUNT TIME AGRICULTURE ASSEMBLE PLANTING & WEED HARVEST DELIVER RECEIVE INPUTS FERTILIZING TREATMENT & STORE CASH TIME SERVICE ASSEMBLE PROMOTION SIGN PERFORM BILL COLLECT RESOURCES CONTRACT SERVICE CLIENT CASH
TIME LEARNING GOAL 3: Be able to account for Long-term Contracts. Two Methods of Revenue Recognition are used in accounting for contracts that are long-term in nature (greater than 1 year): 1. Percentage-of-completion method -Gross profit is recognized periodically, based on the percentage of the job that is complete, rather than when the entire job is completed. 2. Completed Contract Method - Gross profit is not recognized until the contract is completed. The completed contract method is not allowed under IFRS, and is only used under ASPE. P6-3, P6-6
In-Class Concept Questions to consider: 1. Revenue is defined as: a) possession of economic resources. b) increases in economic resources resulting from ordinary activities. c) increases in economic resources from incidental transactions. d) residual interest in economic resources of an entity. 2. Using the earnings approach, revenue is recognized when: a) the revenue is substantially earned. b) the revenue is realized. c) performance is substantially complete and collection is reasonably assured. d) cash is received. 3. Which of the following is not true of a critical event? a) A critical event signals substantial completion or performance for purposes of revenue recognition. b) In businesses that sell goods, the critical event is normally the point of delivery. c) If the earnings process has a critical event, it is usually referred to as a discrete earnings process. d) In businesses that sell services, the critical event is normally the acceptance of a service contract. 4. Revenue from selling products is generally recognized: a) at the point of delivery. b) at the completion of production. c) after costs are recovered. d) as cash is collected.
CLASS DISCUSSION QUESTIONS E6-4, P6-3, P6-6, CASE CA6-1 E6-1 (Economics of the Transaction Various Consumer Industries) The following are independent situations that require professional judgement for determining when to recognize revenue from the transactions. 1. Costco sells you a one-year membership with a single, one-time upfront payment. This nonrefundable fee is paid at the time of signing the contract, and entitles you to shop at Costco for one year. 2. DOT Home and Patio sells you patio furniture on a no money down, no interest, and no payments for one year promotional deal. The furniture is delivered to your home the same day. 3. The Toronto Blue Jays sell season tickets on-line to games in the Rogers Centre. Fans can purchase the tickets at any time, although the season does not officially begin until April 1. The season runs from April 1 through October each year. Payment is due in full at the time of purchase. 4. CIBC lends you money in August. The loan and interest are repayable in full in two years. 5. Students pre-register for fall classes at Seneca College in August. The fall term runs from September through December. 6. Sears sells you a sweater. In August, you place the order using Sears' on-line catalogue. The sweater is shipped and arrives in September and you charge it to your Sears credit card. In October, you receive the Sears credit card statement and pay the amount due. 7. In March, Hometown Appliances sells a washing machine with an extended warranty plan for five years. The washing machine will not be delivered to the customer until June. Payment is due upon delivery. The extended warranty plans are normally sold separately. 8. Premier Health Clubs sells you a membership with an initiation fee (which covers a medical assessment) and an ongoing monthly fee. The initiation fee is payable at the time of the medical assessment and approximates the cost of the medical assessment.
P6-3 Granite Engineering Ltd. has entered into a contract beginning January 1, 2013, to build a bridge in Tuktoyuktuk Shores. It estimates that the bridge will cost $14.8 million and will take three years to construct. The bridge will be billed to the municipality at $15.5 million. The following data are for the construction period: 2014 2015 2016 Costs to date $ 4,500,000 $13,790,000 $15,700,000 Estimated costs to complete 10,500,000 1,934,000-0- Progress billings to date 4,600,000 10,000,000 15,500,000 Cash collected to date 3,000,000 9,000,000 15,500,000 Instructions Under the earnings approach: (a) Using the percentage-of-completion method, calculate the estimated gross profit or loss that would be recognized during each year of the construction period. Round percentages to two decimal places. (b) Prepare all necessary journal entries for 2014 to 2016, including the entries for closing the contract accounts upon completion, assuming the percentage-of-completion method is used. (c) Prepare a partial comparative income statement for the fiscal years ending December 31, 2014 and 2015. (d) Prepare a balance sheet at December 31, 2014 and 2015, that shows the accounts related to the contract and includes their classifications assuming the percentage-ofcompletion method is used. (e) Calculate the estimated gross profit or loss that would be recognized during each year of the construction period under the completed-contract method. Prepare any necessary entries to accrue contract losses (note the year the entry would be made). Prepare partial income statements for the fiscal years ending December 31, 2015 and 2016. (f) Prepare the necessary entry in 2016 to close the contract accounts and to recognize the revenues and costs upon completion, assuming the completed-contract method is used. (g) Prepare a balance sheet at December 31, 2014 and 2015, that shows the accounts related to the contract and includes their classifications assuming the completedcontract method is used. (h) If in 2015 estimated cost to complete construction is $1,700,000 instead of $1,934,000, what would be the effect on Granite's financial statements in 2015? As a potential investor in Granite, what would be the impact of Granite's estimate on your decision to invest in the company?
P6-6 Jupiter Inc. was established in 1985 by Joyce Fukomoto and initially operated under contracts to build highly energy-efficient, customized homes. In the 1990s, Joyce's two daughters joined the firm and expanded the company's activities into the high-rise apartment and commercial markets. When the company's long-time financial manager retired, Joyce's daughters hired Jean-Guy Beaulieu as controller. Jean-Guy, a former university friend of Joyce's daughters, had been working for a public accounting firm for the last four years. When he reviewed the company's accounting practices, Jean-Guy noticed that the company followed the completed-contract method of revenue recognition, as it always had since the years when individual home building was the company's main focus. Several years ago, most of the company's activities shifted to the high-rise and commercial building areas. From land acquisition to the completion of construction, most building contracts now cover several years. Under the circumstances, Jean-Guy believes that the company should follow the percentage-of-completion method of accounting. From a typical building contract, Jean-Guy developed the following data: JUPITER INC. Contract price: $10,000,000 2014 2015 2016 Estimated costs for the year $2,010,000 $4,015,000 $1,675,000 Progress billings for the year 2,000,000 2,500,000 5,500,000 Cash collections for the year 1,800,000 2,300,000 5,900,000 Instructions Under the earnings approach: (a) Explain the difference between completed-contract revenue recognition and percentage-ofcompletion revenue recognition. (b) Using the data provided for Jupiter Inc. and assuming the percentage-of-completion method of revenue recognition is used, calculate the company's revenue and gross profit for 2014 to 2016, under each of the following circumstances. Round all percentages to two decimal places. 1. Assume that all costs are incurred, all billings to customers are made, and all collections from customers are received within 30 days of billing as planned. 2. The company came across unexpected local bylaws that it had to comply with. The building site is in a wetlands area and it had to overcome environmental barriers to construction. As a result, the company had cost overruns of $1.2 million in 2014 to pay for changes to the site. 3. Further assume that, in addition to the cost overruns of $1.2 million for this contract, inflation was greater than expected when the original contract cost was set and caused an additional cost overrun of $1,240,000 in 2015. No cost overruns are expected to occur in 2016. (CMA adapted. Used with permission.)
Refer to the Case Primer to help you answer these cases. CA6-1 Cutting Edge is a monthly magazine that has been on the market for 18 months. It is owned by a private company and has a circulation of 1.4 million copies. Negotiations are underway to obtain a bank loan in order to update its facilities. It is producing close to capacity and expects to grow at an average of 20% per year over the next three years. After reviewing the financial statements of Cutting Edge, Gary Hall, the bank loan officer, said that a loan could only be offered to Cutting Edge if it could increase its current ratio and decrease its debt-to-equity ratio to a specified level. Alexander Pang, the marketing manager of Cutting Edge, has devised a plan to meet these requirements. Pang indicates that an advertising campaign can be used to immediately increase circulation. The potential customers would be contacted after purchasing another magazine's mailing list. The campaign would include: 1. An offer to subscribe to Cutting Edge at three-quarters the normal price 2. A special offer to all new subscribers to receive the most current world atlas whenever requested at a guaranteed price of $2.00 3. An unconditional guarantee of a full refund for any subscriber who is dissatisfied with the magazine Although the offer of a full refund is risky, Pang claims that few people will ask for a refund after receiving half of their subscription issues. Pang notes that other magazine companies have tried this sales promotion technique and experienced great success. Their average cancellation rate was 25%. On average, each company increased its initial circulation threefold and in the long run increased circulation to twice the level that it was before the promotion. In addition, 60% of the new subscribers are expected to take advantage of the atlas premium. Pang feels confident that the increased subscriptions from the advertising campaign will increase the current ratio and decrease the debt-toequity ratio. In addition to the above, Pang has just signed a large deal with a newly opened store to take delivery of the current edition of the magazine. The new customer has asked that the magazines be held by Cutting Edge for a couple of weeks to a month. Instructions Assume the role of the controller and discuss the financial reporting issues assuming that Cutting Edge uses ASPE.