Book cover for Intermediate Accounting

Intermediate Accounting

Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield

ISBN #9780470374948

13th Edition

695 Questions

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7,109 Students Helped

Homework Questions

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Summary
Learning Objectives
Key Concepts
Example Problems
Explanations
Common Mistakes

Summary

Chapter 18 delves into the complexities of revenue recognition in financial reporting. It emphasizes that revenue must be recorded when it is both realized and earned, and highlights several methods tailored to different transaction types. Understanding the nuances of each method—from straightforward point-of-sale transactions to more sophisticated approaches like the percentage-of-completion method—is crucial for accurate financial reporting. Adequate disclosures enhance the reliability of financial statements, ensuring they truly reflect the economic performance of a business.

Learning Objectives

1

Explain the concept of revenue recognition and its importance in financial reporting.

2

Identify and differentiate among various revenue recognition methods such as point-of-sale, percentage-of-completion, completed-contract, installment-sales, cost-recovery, and deposit methods.

3

Apply appropriate revenue recognition methods based on the nature of transactions and criteria for realization and earnability.

4

Demonstrate the ability to provide adequate disclosures to ensure financial statements reflect a company’s true economic performance.

Key Concepts

CONCEPT

DEFINITION

Revenue Recognition

The process by which businesses record revenue when it is realized (or realizable) and earned, ensuring that financial statements are accurate and reflective of economic performance.

Point-of-Sale Method

A method where revenue is recognized immediately at the time of sale when delivery occurs and payment is received.

Percentage-of-Completion Method

A method used in long-term contracts where revenue is recognized based on the progress of work completed relative to the total work expected.

Completed-Contract Method

A method where revenue and associated costs are recognized only when a contract is fully completed.

Installment-Sales Method

A method used when collectibility is uncertain, recognizing revenue as cash payments are collected over time.

Cost-Recovery Method

A revenue recognition method where revenue is recorded only after costs have been recovered from customer payments.

Deposit Method

A method used for pre-delivery cash receipts where revenue is recognized after the delivery of goods or services.

Example Problems

Example 1

Explain the current environment regarding revenue recognition

Example 2

Explain the difference between pretax financial income and taxable income.

Example 3

When is revenue conventionally recognized? What conditions should exist for the recognition at date of sale of all or part of the revenue of any sale transaction?

Example 4

When is revenue conventionally recognized? What conditions should exist for the recognition at date of sale of all or part of the revenue of any sale transaction?

Example 5

When is revenue recognized in the following situations: (a) Revenue from selling products? (b) Revenue from services rendered? (c) Revenue from permitting others to use enterprise assets? (d) Revenue from disposing of assets other than products?

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Step-by-Step Explanations

QUESTION

How do you recognize revenue using the percentage-of-completion method in a long-term contract?

STEP-BY-STEP ANSWER:

Step 1: Identify all contract-related costs and the total estimated cost for the project.
Step 2: Calculate the percentage of completion by dividing the costs incurred to date by the total estimated costs.
Step 3: Multiply the total contract revenue by the percentage of completion to determine the cumulative revenue to be recognized.
Step 4: Subtract any revenue that has already been recognized in previous periods.
Step 5: Record the current period’s revenue as the difference calculated in Step 4.
Final Answer: Revenue recognized in the current period equals the adjusted percentage-of-completion revenue, ensuring that revenue recognition is aligned with work progress.

Percentage-of-Completion Method

QUESTION

How is revenue recognized using the point-of-sale method?

STEP-BY-STEP ANSWER:

Step 1: Confirm that the sale is complete and the exchange of goods or services has occurred.
Step 2: Verify that payment has been received or that there is a high certainty of collectibility.
Step 3: Record the revenue at the time of sale as the earnings process is complete.
Final Answer: Revenue is immediately recorded at the point of sale, reflecting the use of the point-of-sale method.

Point-of-Sale Method

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Common Mistakes

  • Confusing revenue recognition with cash collection, rather than focusing on when revenue is earned and realizable.
  • Applying a method unsuitable for the transaction type, for example, using the completed-contract method for a long-term project without considering percentage-of-completion.
  • Neglecting the need for proper disclosures which can lead to financial statements that do not fully capture a company’s economic performance.
  • Overlooking the criteria required to recognize revenue, especially in situations where collectibility is uncertain.