Intermediate Accounting IFRS Edition Chapter 18 Revenue

18-1
Volume 2
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C H A P T E R 18
REVENUE
Intermediate Accounting
IFRS Edition
Kieso, Weygandt, and Warfield
18-3
1. Apply the revenue recognition principle.
2. Describe accounting issues for revenue recognition at point of
sale.
3. Apply the percentage-of-completion method for long-term
contracts.
4. Apply the cost-recovery method for long-term contracts.
5. Identify the proper accounting for losses on long-term contracts.
6. Describe the accounting issues for service contracts.
7. Identify the proper accounting for multiple-deliverable
arrangements.
Learning Objectives
18-4
Current
Environment
Guidelines for
revenue
recognition
Departures from
sale basis

Revenue
Recognition
(At Point of Sale)
Revenue
Recognition (Long-
Term Contracts)
Revenue
Recognition
(Other)
Measurement
Recognition
Summary

Service contracts
Multiple-
deliverable
arrangements
Other
Summary of
methods

Percentage-of-
completion method
Cost-recovery
method
Long-term contract
losses
Disclosures
Revenue
18-5
Restatements for improper revenue recognition are
relatively common and can lead to significant share price
adjustments.
Revenue recognition is a top fraud risk and regardless
of the accounting rules followed (IFRS or U.S. GAAP),
the risk or errors and inaccuracies in revenue reporting is
significant.
The Current Environment
18-6
Revenue recognition principle: Revenue is recognized
Guidelines for Revenue Recognition
LO 1 Apply the revenue recognition principle.
(1) when it is probable that the economic benefits will
flow to the company and
(2) when the benefits can be measured reliably.
18-7
Sale of product
from inventory
Type of
Transaction
Rendering a
service
Permitting use
of an asset
Sale of asset
other than
inventory
Date of sale
(date of
delivery)
Services
performed and
billable
As time passes
or assets are
used
Date of sale or
trade-in
Gain or loss on
disposition
Revenue from
interest, rents,
and royalties
Revenue from
fees or services
Revenue from
sales
Description
of Revenue
Timing of
Revenue
Recognition
Illustration 18-1
Revenue Recognition Classified by Nature of Transaction
18-8
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
sale does not represent substantial completion of the
earnings process.
Departures from the Sale Basis
18-9
Revenue should be measured at the fair value of
consideration received or receivable.
Trade discounts or volume rebates should reduce
consideration received or receivable and the related
revenue.
If payment is delayed, seller should impute an interest
rate for the difference between the cash or cash
equivalent price and the deferred amount.
Measurement of Sale Revenue
Revenue Recognition at Point of Sale
LO 2 Describe accounting issues for revenue recognition at point of sale.
18-10
Illustration 18-2
18-11
Sansung makes the following entry on March 31, 2011.
Accounts receivable 679,000
Sales 679,000
Illustration 18-2
18-12
Assuming Sansungs customers meet the discount threshold,
Sansung makes the following entry.
Cash 679,000
Illustration 18-2
18-13
If Sansungs customers fail to meet the discount threshold,
Sansung makes the following entry upon payment.
Cash 700,000
Sales discounts forfeited 21,000
Illustration 18-2
18-14
When a sales transaction involves a financing arrangement, the
fair value is determined by discounting the payment using an
imputed interest rate.
Imputed interest rate is the more clearly determinable of either
1. the prevailing rate for a similar instrument of an issuer with a
similar credit rating, or
2. a rate of interest that discounts the nominal amount of the
instrument to the current sales price of the goods or services.
Measurement of Sale Revenue
18-15
Illustration 18-3
18-16
The journal entry to record SEKs sale to Grant Company on
July 1, 2011, is as follows (ignoring cost of goods sold entry).
Notes receivable 900,000
Sales 900,000
Illustration 18-3
18-17
SEK makes the following entry to record interest revenue.
Notes receivable 54,000
Interest revenue (12% x x 900,000) 54,000
Illustration 18-3
18-18
Revenue from the sale of goods is recognized when all the following
conditions are met:
1. Company has transferred to the buyer the significant risks and
rewards of ownership of the goods;
2. Company retains neither continuing managerial involvement to the
degree usually associated with ownership nor effective control over
the goods sold;
3. The amount of revenue can be measured reliably;
4. It is probable that the economic benefits will flow to the company; and
5. The costs incurred or to be incurred can be estimated reliably.
Recognition of Sale Revenue
LO 2
18-19
Bill and Hold Sales
Buyer is not yet ready to take delivery but does take title and
accept billing.
Illustration 18-4
18-20
LO 2
Solution: Butler should record the revenue at the time title
passes, provided
1. it is probable that delivery will be made;
2. the item is on hand, identified, and ready for delivery at
the time the sale is recognized;
3. Baristo acknowledges the deferred delivery arrangement;
and
4. the usual payment terms apply.
It appears that these conditions were probably met and
therefore revenue recognition should be permitted at the time
the agreement is signed.
18-21
Butler makes the following entry to record the bill and hold sale.
Sales 450,000
Illustration 18-4
18-22
Sales Subject to Installation or Inspection
Illustration 18-5
18-23
Layaway Sales
Illustration 18-6
18-24
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:
1. not recording a sale until all return privileges have expired
or
2. recording the sale, but reducing sales by an estimate of
future returns.
18-25
Illustration 18-7
18-26
LO 2
Pesido sold $300,000 of laser equipment on August 1, 2011, and
retains only an insignificant risk of ownership. On October 15,
2011, $10,000 in equipment was returned.
August 1, 2011
Sales 300,000
October 15, 2011
Sales returns and allowances 10,000
18-27
At December 31, 2011, based on prior experience, Pesido
estimates that returns on the remaining balance will be 4 percent.
Pesido makes the following entry to record the expected returns.
December 31, 2011
Sales returns and allowances 11,600
Allowance for sales returns and allowances 11,600
[($300,000 - $10,000) x 4% = 11,600]
18-28
Illustration 18-8
18-29
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
Illustration 18-8
18-30
Principal-Agent Relationships
Amounts collected on behalf of the principal are not
revenue of the agent.
Revenue for the agent is the amount of the commission it
receives.
18-31
Consignments
Manufacturers (or wholesalers) deliver goods but retain
title to the goods until they are sold.
Consignor (manufacturer or wholesaler) ships
merchandise to the consignee (dealer), who is to act as
an agent for the consignor in selling the merchandise.
Consignor makes a profit on the sale.
Consignee makes a commission on the sale.
18-32
Trade Loading and Channel Stuffing
Trade loading - a crazy, uneconomic, insidious practice through
which manufacturerstrying to show sales, profits, and market
share they dont actually haveinduce their wholesale
customers, known as the trade, to buy more product than they
can promptly resell.
Channel stuffing. When a software maker needed to make its
financial results look good, it offered deep discounts to its
distributors to overbuy, and then recorded revenue when the
software left the loading dock.
18-33
Two methods of accounting for long-term construction
contracts:
Percentage-of-completion method.
Cost-recovery (zero-profit) method.
Long-Term Contracts (Construction)
18-34
Rationale for using percentage-of-completion accounting
is that under most of these contracts, the
Buyer and seller have enforceable rights.
Buyer has the legal right to require specific performance on
the contract.
Seller has the right to require progress payments that
provide evidence of the buyers ownership interest.
As a result, a continuous sale occurs as the work progresses
and companies should recognize revenue according to that
progression.
18-35
Companies must use the percentage-of-completion method
when all of the following conditions exist.
1. Total contract revenue can be measured reliably;
2. It is probable that the economic benefits associated with the
contract will flow to the company;
3. Both the contract costs to complete the contract and the stage
of contract completion at the end of the reporting period can
be measured reliably; and
4. The contract costs attributable to the contract can be clearly
identified and measured reliably so the actual contract costs
incurred can be compared with prior estimates.
18-36
Companies should use the cost-recovery method when one
of the following conditions applies:
1. When a company cannot meet the conditions for using the
percentage-of-completion method, or
2. When there are inherent hazards in the contract beyond the
normal, recurring business risks.
18-37
Calculation for Revenue to Be Recognized
LO 3 Apply the percentage-of-completion method for long-term contracts.
Illustration 18-11
Illustration 18-12
Illustration 18-13
Percentage-of-Completion Method
18-38
Illustration: KC Construction Company has a contract to
construct a 4,500,000 bridge at an estimated cost of
4,000,000. The contract is to start in July 2010, and the
bridge is to be completed in October 2012. The following data
pertain to the construction period.
18-39
Illustration: Compute percentage complete.
Illustration 18-6
18-40
Illustration: KC would make the following entries to record
(1) the costs of construction, (2) progress billings, and (3)
collections.
Illustration 18-7
18-41
Percentage-of-Completion, Revenue and Gross Profit, by Year
Illustration 18-16
18-42
Illustration: KCs entries to recognize revenue and gross
profit each year and to record completion and final approval
of the contract.
Illustration 18-17
18-43
Illustration: Content of Construction in Process Account
Percentage-of-Completion Method
Illustration 18-18
18-44
Financial Statement PresentationPercentage-of-
Completion
Illustration 18-19
Computation of Unbilled Contract Price at 12/31/10
18-45
Financial StatementPercentage-of-Completion
Illustration 18-20
LO 3
18-46
Illustration: For the bridge project illustrated on the preceding pages,
Hardhat Construction would report the following revenues and costs.
Cost-Recovery (Zero-Profit) Method
LO 4 Apply the cost-recovery method for long-term contracts.
Illustration 18-21
18-47
Illustration: Hardhats entries to recognize revenue and gross profit
each year and to record completion and final approval of the contract.
Illustration 18-22
18-48
Illustration: Comparison of gross profit recognized under different
methods.
Illustration 18-23
18-49
Financial StatementCost-Recovery Method
Illustration 18-24
18-50

2010 2011 2012

Contract price 675,000 675,000 675,000

Cost incurred current year 150,000 287,400 170,100

Estimated cost to complete

in future years 450,000 170,100 0

Billings to customer current year 135,000 360,000 180,000

Cash receipts from customer

Current year 112,500 262,500 300,000

A) Prepare the journal entries for 2010, 2011, and 2012.
Illustration:
Casper Construction Co.
18-51
2010 2011 2012
Costs incurred to date 150,000 437,400 607,500
Estimated cost to complete 450,000 170,100
Est. total contract costs 600,000 607,500 607,500
Est. percentage complete 25.0% 72.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 486,000 675,000
Rev. recognized prior year (168,750) (486,000)
Rev. recognized currently 168,750 317,250 189,000
Costs incurred currently (150,000) (287,400) (170,100)
Gross profit recognized 18,750 29,850 18,900
Illustration:
18-52
Construction in progress 150,000 287,400 170,100
Cash 150,000 287,400 170,100
Accounts receivable 135,000 360,000 180,000
Billings on contract 135,000 360,000 180,000
Cash 112,500 262,500 300,000
Construction expense 150,000 287,400 170,100
Construction revenue 168,750 317,250 189,000
Billings on contract 675,000
Construction in progress 675,000
2012 2010 2011
Illustration:
18-53
Income Statement 2010 2011 2012
Revenue on contracts 168,750 $ 317,250 $ 189,000 $
Cost of construction 150,000 287,400 170,100
Gross profit 18,750 29,850 18,900
Balance Sheet (12/31)
Current assets:
Accounts receivable 22,500 120,000 -
Cost & profits > billings 33,750
Current liabilities:
Billings > cost & profits 9,000
Illustration:
18-54
Companies recognize revenue only to the extent of costs
incurred that are expected to be recoverable.
Only after all costs are incurred is gross profit recognized.
Cost-Recovery Method
18-55
Illustration:
Cash 150,000 287,400 170,100
Billings on contract 135,000 360,000 180,000
Cash 112,500 262,500 300,000
Construction expense 150,000 287,400 170,100
Construction revenue 150,000 287,400 237,600
Billings on contract 675,000
2012 2010 2011
18-56
Illustration:
Income Statement 2010 2011 2012
Revenue on contracts 0 0 675,000
Cost of construction - - 607,500
Gross profit - - 67,500
Balance Sheet (12/31)
Current assets:
Accounts receivable 22,500 120,000 -
Cost & profits > billings 15,000
Current liabilities:
Billings > cost & profits 57,600
18-57
LO 5 Identify the proper accounting for losses on long-term contracts.
Loss in the Current Period on a Profitable Contract
Percentage-of-completion method only, the estimated
cost increase requires a current-period adjustment of
gross profit recognized in prior periods.
Loss on an Unprofitable Contract
Under both percentage-of-completion and completed-
contract methods, the company must recognize in the
current period the entire expected contract loss.
Long-Term Contract Losses
18-58
Illustration: Loss in Current Period

2010 2011 2012

Contract price 675,000 675,000 675,000



in future years 450,000 215,436 0



Current year 112,500 262,500 300,000

b) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated
cost to complete at the end of 2011 was 215,436 instead of 170,100.
18-59
2010 2011 2012
Contract price 675,000 675,000 675,000
Gross profit recognized 18,750 ( 3,900) 7,314
18-60
Construction in progress 18,750 7,314
Construction expense 150,000 215,436
Construction revenue 168,750 222,750
Construction expense 287,400
Construction revenue 283,500
2012 2010 2011
18-61
Illustration: Loss on Unprofitable Contract

2010 2011 2012

Contract price 675,000 675,000 675,000



in future years 450,000 246,038 0



Current year 112,500 262,500 300,000

c) Prepare the journal entries for 2010, 2011, and 2012 assuming the estimated
cost to complete at the end of 2011 was 246,038 instead of 170,100.
18-62
2010 2011 2012
Contract price 675,000 675,000 675,000
Gross profit recognized 18,750 ( 27,188) 0
LO 5
$675,000 683,438 = (8,438) cumulative loss Plug
18-63
Construction in progress 18,750 -
Construction expense 150,000 243,000
Construction revenue 168,750 243,000
2012 2010 2011
18-64
Loss on construction contract 8,438
2010 2011
For the Cost-Recovery method, companies would recognize the
following loss:
18-65
Construction contractors should disclosure:
Revenue recognized during the period and the methods used to
determine the contract revenue and stage of completion.
For contracts in progress,
aggregate amount of costs incurred and recognized net
income, amount of advances received, and amount of
retentions.
Any contingent assets or liabilities related to these contracts.
Disclosures in Financial Statements
18-66
Follow the same criteria as long-term contracts.
To recognize revenue:
It must be reliably measurable;
Economic benefits are probable;
Stage of completion must be reliably measurable; and
Costs must be reliably measurable.
Service Contracts
Other Revenue Recognition Issues
LO 6 Describe the accounting issues for service contracts.
18-67
Single Act: Revenue recognized at the time of the act.
More Than One Act: Revenue recognized as various acts
occur.
Three circumstances:
1. Specified number of identical or similar acts.
2. Specified number of defined but not identical acts.
3. Unspecified number of identical acts or similar acts with a
fixed period for performance.
Service Contracts
18-68
18-69
LO 6
Assuming R&D services are provided according to the contract in
2011, Jackson makes the following entries in 2011 to recognized
revenue on the Andes contract.
January 1, 2011
Cash 1,000,000
Unearned R&D service revenue 1,000,000
December 31, 2011
Cash 400,000
Unearned R&D Service Revenue 200,000
R&D Service Revenue 600,000
18-70
18-71
18-72
18-73
SeniorLife makes the following entries related to the contract.
January 1, 2011
Cash 300,000
Unearned service revenue 300,000
December 31, 2011
Service Revenue 60,000
December 31, 2012
Service Revenue 105,000
18-74
MDAs provide multiple products or services to customers as part
of a single arrangement.
Major accounting issues
how to allocate the revenue to the various products and
services and
how to allocate the revenue to the proper period.
Multiple-Deliverable Arrangements (MDAs)
LO 7 Identify the proper accounting for multiple-deliverable arrangements.
18-75
All units in a MDA are considered separate units of accounting,
provided that:
1. A delivered item has value to the customer on a standalone
basis; and
2. The arrangement includes a general right of return relative to
the delivered item; and
3. Delivery or performance of the undelivered item is
considered probable and substantially in the control of the
seller.
18-76
Illustration 18-33
18-77
Illustration 18-34
18-78
Interest, Royalties, and Dividends
Accretion
Completion-of-Production Basis

Other Revenue Situations
18-79
The IASB defines revenue to include both revenues and gains. U.S.
GAAP provides separate definitions for revenues and gains.
Revenue recognition fraud is a major issue in revenue recognition. The
same situation occurs in the United States as evidenced by revenue
recognition breakdowns at telecom company Global Crossing (USA),
technology company Lucent Technologies (USA), and utility company
Enron (USA).
18-80
A specific standard exists for revenue recognition under IFRS (IAS 18).
In general, the standard 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. U.S. GAAP uses concepts such as realized or realizable, and
earned as a basis for revenue recognition.
U.S. GAAP permits the use of the completed-contract method of
accounting for long-term construction contracts (IAS 11). Companies
generally use the percentage-of-completion method. If revenues and
costs are difficult to estimate, then companies recognize revenue only
to the extent of the cost incurreda zero-profit approach under IFRS.

18-81
U.S. GAAP does not allow the percentage-of-completion method for
service contracts. Under IFRS, costs can be deferred if the company is
using percentage-of-completion. Under GAAP, costs are generally
expensed as incurred.
U.S. GAAP provides detailed guidance in multiple-deliverable
arrangements. IFRS guidance is more general.

18-82
Franchises
Two sources of revenue:
1. Sale of initial franchises and related assets or
services, and
2. Continuing fees based on the operations of
franchises.
LO 8 Explain revenue recognition for franchises sales.
18-83
The franchisor normally provides the franchisee with:
1. Assistance in site selection.
2. Evaluation of potential income.
3. Supervision of construction activity.
4. Assistance in the acquisition of signs, fixtures, and equipment.
5. Bookkeeping and advisory services.
6. Employee and management training.
7. Quality control.
8. Advertising and promotion.
Franchises
18-84
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.
Substantial performance occurs when the franchisor has no
remaining obligation to refund any cash received or excuse any
nonpayment of a note and has performed all the initial services
required under the contract.
Initial Franchise Fees
18-85
Illustration: Tums Pizza Inc. charges an initial franchise fee of
$50,000 for the right to operate as a franchisee of Tums Pizza. Of this
amount, $10,000 is payable when the franchisee signs the agreement,
and the balance is payable in five annual payments of $8,000 each.
The credit rating of the franchisee indicates that money can be
borrowed at 8 percent. The present value of an ordinary annuity of five
annual receipts of $8,000 each discounted at 8 percent is $31,942. The
discount of $8,058 represents the interest revenue to be accrued by the
franchisor over the payment period.
Example of Entries for Initial Franchise Fee
18-86
Illustration: 1. If there is reasonable expectation that Tums Pizza Inc.
may refund the down payment and if substantial future services remain
to be performed by Tums Pizza Inc., the entry should be:
Cash 10,000
Notes Receivable 31,942
Unearned Franchise Fees 41,942
18-87
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:
Cash 10,000
Revenue from Franchise Fees 41,942
18-88
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 Tums Pizza in
future periods, and collectibility of the note is reasonably assured, the
entry should be:
Cash 10,000
Revenue from Franchise Fees 10,000.00
18-89
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
Revenue from Franchise Fees 10,000
18-90
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
In cases 4 and 5 where collection of the note is extremely uncertain
franchisors may recognize cash collections using the cost-recovery method.
18-91
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.
Continuing Franchise Fees
18-92
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