Kuis RQ

1.
Comprehensive Three-Part Revenue Recognition
(a) 1. The point of sale method recognizes revenue when it is probable

that the economic benefits will flow to the company and the benefits
can be measured reliability. This can be the date goods are delivered,
when title passes, when services are rendered and billable, or as time
passes (e.g., rent or royalty income). This method most closely
follows the accrual accounting method and is in accordance with
IFRS.
2. The cost-recovery method recognizes revenue only to the extent of

costs incurred that are expected to be recoverable. This method is
used when there are inherent hazards in the contract beyond the
normal, recurring business risks. The advantage of this method is
that income is recognized on final results, not estimates. The
disadvantage is that when the contract extends over more than one
accounting period, current performance on the project is not recog-
nized and earnings are distorted. It is acceptable according to IFRS
only when the percentage-of-completion method is inappropriate.
3. The percentage-of-completion method of revenue recognition is

used on long-term projects, usually construction. To apply it, the
following conditions must exist:
(i) Total contract revenue can be measured reliably;
(ii) It is probable that the economic benefits associated with the
contract will flow to the company;
(iii) Both the contract costs to complete the contract and the stage of
contract completion at the end of the reporting period can be
measured reliabily;
(iv) 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.
Gross profit is recognized in proportion to the work completed. The

progress toward contract completion is the revenue-generating event.
Normally, progress is measured as the percentage of actual costs to
date to estimated total costs. This percentage is applied to estimated
gross profit to indicate the total profit which should be recognized to
that date. That total less the income that was recognized in previous
periods is the amount recognized in the current period. In the final
period, the actual total profit is known and the difference between this
amount and profit previously recognized is shown as profit of the
period. This method is in accordance with IFRS for long-term projects
when estimates are dependable.
(b) Depp Construction
A change of cost estimates calls for a revision of revenue and profit
to be recognized in the period in which the change was made (in this
case, the first period).
Contract price ...................................... $30,000,000
Costs: Actual costs to 11/30/10 ......... $ 7,200,000
Estimated costs to complete .............. 16,800,000
Total cost ............................................. 24,000,000
Estimated profit ................................... $ 6,000,000
Percentage of contract completed
($7,200,000 ÷ $24,000,000) ............... 30%
Revenue to be recognized in 2010
($30,000,000 X 30%) .......................... $ 9,000,000
Dement Publishing Division

Sales—fiscal 2010 ......................................................... $ 7,000,000
Less: Sales returns and allowances (20%) ................. 1,400,000
Net sales—revenue to be recognized in fiscal 2010 ... $ 5,600,000
Although distributors can return up to 30 percent of sales, prior

experi-ence indicates that 20 percent of sales is the expected average
amount of returns. The collection of 2009 sales has no impact on
fiscal 2010 revenue. The 21 percent of returns on the initial $5,500,000
of 2010 sales confirms that 20 percent of sales will provide a
reasonable estimate.
Ankiel Securities Division

Revenue for fiscal 2010 = $5,200,000.
The revenue is the amount of goods actually billed and shipped when
revenue is recognized at point of sale (terms of F.O.B. factory). Orders
for goods do not constitute sales. Down payments are not sales. The
actual freight costs are expenses made by the seller that the buyer
will reimburse at the time s/he pays for the goods.
Commissions and warranty returns are also selling expenses. Both of these
expenses will be accrued and will appear in the operating expenses section of
the income statement.
2. Franchise Fee, Initial Down Payment

(a) Down payment made on 1/1/10 .............................................. $10,000
Present value of an ordinary annuity ($8,000 X 3.69590) ............ 29,567
Total revenue recorded by Campbell and total
acquisition cost recorded by Lesley Benjamin ......................... $39,567
(b) Cash ................................................................ 10,000

Notes Receivable ........................................... 29,567
Unearned Franchise Fees ...................... 39,567
(c) 1. $10,000 cash received from down payment. ($29,567 is recorded

as unearned franchise fees.)
2. $10,000 cash received from down payment.
3. None. ($10,000 is recorded as unearned franchise fees.)
3. CA 18-2
(a) The point of sale is the most widely used basis for the timing of revenue recognition because
in most cases it provides the degree of objective evidence accountants consider necessary to
reliably measure periodic business income. In other words, sales transactions with outsiders
represent the point in the revenue-generating process when most of the uncertainty about the
final outcome of business activity has been alleviated.
It is also at the point of sale in most cases that substantially all of the costs of generating reve-
nues are known, and they can at this point be matched with the revenues generated to produce
a reliable statement of a firm’s effort and accomplishment for the period. Any attempt to
measure income prior to the point of sale would, in the vast majority of cases, introduce
considerably more subjectivity in financial reporting than most accountants are willing to accept.
(b) 1. Though it is recognized that revenue is earned throughout the entire production process,
generally it is not feasible to measure revenue on the basis of operating activity. It is not feasible
because of the absence of suitable criteria for consistently and objectively arriving at a periodic
determination of the amount of revenue to recognize.
Also, in most situations the sale represents the most important single step in the earnings
process. Prior to the sale, the amount of revenue anticipated from the processes of produc-tion
is merely prospective revenue; its realization remains to be validated by actual sales. The
accumulation of costs during production does not alone generate revenue. Rather, revenues are
earned by the completion of the entire process, including making sales.
Thus, as a general rule, the sale cannot be regarded as being an unduly conservative basis for
the timing of revenue recognition. Except in unusual circumstances, revenue recognition prior to
sale would be anticipatory in nature and unverifiable in amount.
2. To criticize the sales basis as not being sufficiently conservative because accounts receiv-
able do not represent disposable funds, it is necessary to assume that the collection of
receivables is the decisive step in the earnings process and that periodic revenue measure-
ment and, therefore, net income should depend on the amount of cash generated during the
period. This assumption disregards the fact that the sale usually represents the decisive factor
in the earnings process and substitutes for it the administrative function of managing and
collecting receivables. In other words, the investment of funds in receivables should be
regarded as a policy designed to increase total revenues, properly recognized at the point of
sale, and the cost of managing receivables (e.g., bad debts and collection costs) should be
matched with the sales in the proper period.
The fact that some revenue adjustments (e.g., sales returns) and some expenses (e.g., bad
debts and collection costs) may occur in a period subsequent to the sale does not detract from
the overall usefulness of the sales basis for the timing of revenue recognition. Both can be
estimated with sufficient accuracy so as not to detract from the reliability of reported net income.
Thus, in the vast majority of cases for which the sales basis is used, estimating errors, though
unavoidable, will be too immaterial in amount to warrant deferring revenue recognition to a later
point in time.
(c) 1. During production. This basis of recognizing revenue is frequently used by firms whose
major source of revenue is long-term construction projects. For these firms the point of sale is
far less significant to the earnings process than is production activity because the sale is
assured under the contract (except of course where performance is not substantially in
accordance with the contract terms).
To defer income recognition until the completion of long-term construction projects could impair
significantly the usefulness of the intervening annual financial statements because the volume
of contracts completed during a period is likely to bear no relationship to production volume.
During each year that a project is in process a portion of the contract price is, therefore,
appropriately recognized as that year’s revenue. The amount of the contract price to be
recognized should be proportionate to the year’s production progress on the project.
Income might be recognized on a production basis for some products whose salability at a
known price can be reasonably determined as might be the case with some precious metals
and agricultural products.
It should be noted that the use of the production basis in lieu of the sales basis for the timing of
revenue recognition is justifiable only when total profit or loss on the contracts can be estimated
with reasonable accuracy and its ultimate realization is reasonably assured.
2. At end of production. The cost-recovery method recognizes contract revenue only to the
extent of costs incurred that are expected to be recoverable. Once all costs are recognized,
profit is recognized.
Companies use the cost-recovery method when a company cannot meet the conditions for using the
percentage-of-completion method, or when there are inherent hazards in the contract beyond the
normal, recurring business risks.

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1.

Comprehensive Three-Part Revenue Recognition

(a) 1. The point of sale method recognizes revenue when it is probable

2. The cost-recovery method recognizes revenue only to the extent of

3. The percentage-of-completion method of revenue recognition is

Gross profit is recognized in proportion to the work completed. The

Dement Publishing Division

Although distributors can return up to 30 percent of sales, prior

Ankiel Securities Division

2. Franchise Fee, Initial Down Payment

(b) Cash ................................................................ 10,000

(c) 1. $10,000 cash received from down payment. ($29,567 is recorded

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