FINANCIAL ACCOUNTING
Chapter 6: Revenue RecognitionRead: Chapter 6 and partly 13 on warrantyIn-class exercises: BE6-7, EX6-11, EX6-9, EX6-16, EX6-18
Practice exercises: EX6-7, BE6-11, P6-1, P6-2, E13-17
There are two main conceptual views on how to account for revenues/sales:
Earnings approach
Contract-based approach
Earnings Approach
Revenues are recognized when the following criteria are met:
1. Performance is achieved:
a. risks and rewards transferred and/or earnings process substantially complete, and
b. measurability reasonably assured
2. Collectibility is reasonably assured
“Earnings process” is substantially complete.
Operational functions firm that ADD VALUE in generation of revenue
Varies across different firm
Eg. Produce goods→sale →collect cash→provide after sale service
Contract-Based Approach
Contract-Based Approach
Contract is recognized when all of the following conditions are met:
1. The entity is party to the contract,
2. The contractual rights are collectible/measurable, and
3. The performance obligation is measurable
Net contract position represents the balance of contractual rights less contractual obligations
Initial balance of net contract position is generally nil due to reciprocity and assumed arm’s length transaction
Revenues are recognized when
Control passes to the buyer (as indicated by legal title / possession), or
Services are performed
Earnings Approach
Recognize revenue at different stages in the earnings process
1) DURING PRODUCTION
Many long term construction contracts
2) WHEN PRODUCTION IS COMPLETE (BEFORE SALE)
Product with guaranteed price and buyer (eg. Some agricultural products where gov’t agrees to purchase excess at set price)
3) AT SALE/DELIVERY
If revenue, cost, collection can be estimated
Buyer assumes risks & rewards at this date
Seller has no significant involvement/control of goods after this date
How should you treat goods in transit?
Risks & rewards are
Practice exercises: EX6-7, BE6-11, P6-1, P6-2, E13-17
There are two main conceptual views on how to account for revenues/sales:
Earnings approach
Contract-based approach
Earnings Approach
Revenues are recognized when the following criteria are met:
1. Performance is achieved:
a. risks and rewards transferred and/or earnings process substantially complete, and
b. measurability reasonably assured
2. Collectibility is reasonably assured
“Earnings process” is substantially complete.
Operational functions firm that ADD VALUE in generation of revenue
Varies across different firm
Eg. Produce goods→sale →collect cash→provide after sale service
Contract-Based Approach
Contract-Based Approach
Contract is recognized when all of the following conditions are met:
1. The entity is party to the contract,
2. The contractual rights are collectible/measurable, and
3. The performance obligation is measurable
Net contract position represents the balance of contractual rights less contractual obligations
Initial balance of net contract position is generally nil due to reciprocity and assumed arm’s length transaction
Revenues are recognized when
Control passes to the buyer (as indicated by legal title / possession), or
Services are performed
Earnings Approach
Recognize revenue at different stages in the earnings process
1) DURING PRODUCTION
Many long term construction contracts
2) WHEN PRODUCTION IS COMPLETE (BEFORE SALE)
Product with guaranteed price and buyer (eg. Some agricultural products where gov’t agrees to purchase excess at set price)
3) AT SALE/DELIVERY
If revenue, cost, collection can be estimated
Buyer assumes risks & rewards at this date
Seller has no significant involvement/control of goods after this date
How should you treat goods in transit?
Risks & rewards are