ABA201 -Chapter 8

7/29/2019 ABA201 -Chapter 8

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Chapter 8 – Revenue Recognition

Scope

This Standard shall be applied in accounting for revenue arising from the following transactions and

events:

(a) the sale of goods;

(b) the rendering of services; and

(c) the use by others of entity assets yielding interest, royalties and dividends.

Measurement of revenue

Revenue shall be measured at the fair value of the consideration received or receivable.

It is measured at the fair value of the consideration received or receivable

taking into account the amount of any trade discounts and volume rebates allowed by the entity.

Sale of goods

Revenue from the sale of goods shall be recognised when all the following conditions have been

satisfied:

(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;

(b) the entity retains neither continuing managerial involvement to the degree usually associated with

ownership nor effective control over the goods sold;

(c) the amount of revenue can be measured reliably;

(d) it is probable that the economic benefits associated with the transaction will flow to the entity; and

(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.

Rendering of services

When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue

associated with the transaction shall be recognised by reference to the stage of completion of the

transaction at the end of the reporting period. The outcome of a transaction can be estimated reliably

when all the following conditions are satisfied:

(a) the amount of revenue can be measured reliably;

(b) it is probable that the economic benefits associated with the transaction will flow to the entity;

(c) the stage of completion of the transaction at the end of the reporting period can be measured

reliably; and

(d) the costs incurred for the transaction and the costs to complete the transaction can be measured

reliably.*

Interest, royalties and dividends

Revenue arising from the use by others of entity assets yielding interest, royalties and dividends shall

be recognised on the bases set out in paragraph 30 when:

(a) it is probable that the economic benefits associated with the transaction will flow to the entity; and

(b) the amount of the revenue can be measured reliably.

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Table 1 - Revenue Recognition Time Line and Criteria

Before the Point of

Sale

EXPECTION:

Revenue can be

recognized prior to

the point of sale it.

NORMAL:

Revenue is

generallyrecognized at this

point in time

After the Point of

Sales

EXCEPTION:

The recognition of

revenue must be

deffered it.

Criterion 1: Realized Customer provides

a valid promise of

payment AND

Criterion 1 is

typically satisfied

at this point.

Customer does not

provide a valid

promise at time of

receipt of product

or service OR

Criterion 2: Sunstantially complete Conditions existthat contractually

guarantee

subsequent sale

Criterion 2 istypically satisfied

at this point.

Significant effortremains on contract.

*Realized* can be interpreted as having cash or other assets received at some future time.

Revenue Recognition

AICPA Statement of Position 97-2 gives companies more guidance through a checklist of four factors

that amplify the two criteria:

1) Persuasive evidence of an arrangement exists.

2) Delivery has occurred.

3) The vendor’s fee is fixed or determinable.

4) Collectibility is probable.

Proportional Revenue Recognition

Most service contracts involve three different types of costs:

1. Initial direct costs related to obtaining and performing initial services on the contract

2. Direct costs related to performing the various service acts

3. Indirect costs related to maintaining the organization to service the contract

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Example

Sales of goods

Accounting for a Layaway Sale

Seller Company receives $100 cash from a customer. The $100 payment is a partial payment for goods

costing $1,000 with a total retail price of $1,500. The following entry shows the receipt of $100 cash as

initial layaway payment.

Cash 100

Deposit Received from Customers 100

Recording the receipt of the final $1,400 cash payment and the delivery of goods to customers requires

two entries. One to record the sale and the second to remove the item from inventory and to record its

cost.

Cash 1,400Deposit Received from Customer 100

Sales 1,500

Cost of Goods Sold 1,000

Inventory 1,000

Rendering of services

Appropriate Accounting for a Service Provided Over an Extended PeriodSeller Company receives $1,000 cash from a customer as the initial sign-up fee for a service. In addition

to the sign-up fee, the customer is required to pay $50 per month for the service. The expected economic

life of this service agreement is 100 months. An entry is required to show receipt of cash.

Cash 1,000

Unearned Initial Sign-up Fees 1,000

A second entry is required to record receipt of the monthly payment.

Cash 50

Monthly Service Revenue 50

Another entry is necessary to record partial recognition of the initial sign-up fee as revenue ($1,000/100

months).

Unearned Initial Sign-up Fees 10

Initial Sign-up Fee Revenue 10

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Rendering of service: Appropriate Accounting for a Contingent Rental

On January 1, the company signed a 1-year rental for a total of $120,000, with monthly payments of

$10,000 due at the end of each month. In addition, the renter must pay contingent rent of 10% of all

annual sales in excess of $3,000,000 each month. The contingent payment is paid in one payment on

December 31.

Rendering of service: Appropriate Accounting for a Contingent Rental

On January 31, sales for the renter had reached $700,000. On July 31, the renter had reached a sales

level of $3,150,000. On December 31, the renter had reached a sales level of $5,000,000.

Sale of Goods and Rendering of service: Asset-and-Liability Approach

A Contract Approach to Revenue Recognition

Wilks Company sells a plasma TV and 2-year warranty to a customer for the joint price of $2,000. Wilks

Company has generated the following information regarding the sale of the plasma TV.

• Cost of plasma TV, $1,500

• Sales price of plasma TV sold separately is unknown. Other consumer electronic products have

profit margins that range between 16% and 22% of cost.

• Sales price of warranty if sold separately, unknown. A 2-year warranty for a refrigerator/freezer

with the same wholesale cost sells for $300. Wilks estimates that repair costs for the plasma TV

would be 5% higher ($300 + ($300 x .05) = $315).

TV delivery obligation: $1,700 = $2,000 x [$1,785/($1,785 + $315)]

Warranty service obligation: $300 = $2,000 x [$315/$1,785 + $315)]

Rendering of service: Accounting for Long-Term Service Contracts

- A school enters into 100 contracts with students for a course.

- Each contract is $500, payable in advance.

- The total initial direct casts is $5,000.

- Actual direct costs for the first period are $12,000.

- The sales value of the lessons completed is $24,000 (if sold separately, $60,000)

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Accounting for Consignments

Seller Company ships goods costing $1,000 on consignment to Consignee Company. The retail price of

the goods is $1,500.

-No sale should be recorded. However, there may be a journal entry made to reclassify the

inventory.-

Inventory on Consignment 1,000 Inventory 1,000

Documents

ABA201 -Chapter 8