CHAPTER 5 Commented [MOU2]: Important – heavy on midterms and final

exam
REVENUE RECOGNITION

Accounting Standards Update (ASU) No. 2014–09: “Revenue from Contracts with Customers”

Core revenue recognition principal: Companies recognize revenue when goods or services are
transferred to customers for the amount the company expects to be entitled to receive in
exchange for those goods or services.
 When: upon transfer to customers
 How much: amount the seller is entitled to receive Commented [MOU3]: Certainty on the people—their history of
whether they will pay the full amount or not

Commented [MOU4]: Contracts--- when and where will be

paid and how much

Performance obligation : delivering goods –

How much –

4th – how to separate the initial price into various parts shud there be
more than one performance obligations

I. Contracts with only one performance obligation:

Case A: Revenue recognized at a single point in time

Revenue is recognized at one specific point in time when control has transferred from the seller
to the customer.

Key indicators that control of a good or service has passed from the seller to the buyer
• Buyer has an unconditional obligation to pay.
• Buyer has legal title to the asset.
• Buyer has physical possession of the asset.
• Buyer assumes the risks and rewards of ownership.
• Buyer has accepted the asset.

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Example: On February 4, 2016 Meyers sold $800 of merchandise on account. The merchandise
cost Meyers $600. On February 16, 2016 Meyers received $800 from the customer.

Feb 4th
Dr. Accounts Receivable $800
Sales Revenue $800

Dr. COGs $600

Cr. Inventory $600

DR. Cash $800

Cr. AR $800

Case B: Revenue recognized over a period of time

Revenue is recognized over a period of time if one of the following three conditions hold:
• The customer consumes the benefit of the seller’s work as it is performed
• The customer controls the asset as it is created
• The seller is creating an asset that has no alternative use to the seller and the seller has the
legal right to receive payment for progress to date even if the contract is cancelled

On January 1, 2016, a health club signed up a new customer. The customer paid a $2,400
membership fee. It is expected that the customer will use the club for the next 2 years.

Jan 1st 2016

Dr. Cash 2.4K
CR Unearned Revenue 2.4K

Dec 31, 2016

Dr. Unearned Revenue 1.2K
Sales Revenue 1.2K

Dec 31 2017
Dr. Unearned Revenue 1.2k
Cr. Sales Revenue 1.2K

While revenue usually is earned during a period of time, revenue often is recognized at one
specific point in time.

Goods in transit (Record revenues or not?) - It depends on the shipping agreement.

If the goods are shipped f.o.b (free on board) shipping point, then legal title of the goods are
transferred to be buyer once the goods are shipped so the seller can record revenues when the
items are shipped.

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If the goods are shipped f.o.b. destination, legal title is transferred once the goods are delivered
so the seller has to wait until the products are delivered before revenues can be recorded.

II. Contracts with multiple performance obligations:

The goal is to separate the contract into parts that can be viewed on a stand-alone basis.

Goods and services are viewed as separate performance obligations if they are distinct:
 Capable of being distinct Commented [MOU5]: Apple care – example –

 Separately identifiable from other goods or services in the contract

SPECIAL ISSUES

Step 1: Identify the contract

A contract only exists if it:

• has commercial substance
• has been approved by the seller and customer
• specifies the rights of the seller and customer
• specifies payment terms
• is probable that the seller will collect the amount it is entitled to receive under the
contract
A contract does not exist if:
• neither the seller nor the customer has performed any obligations under the contract, and
• both the seller and the customer can terminate the contract without penalty

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Step 2: Identify the performance obligation(s)

Prepayments: Not considered as POs. They are accounted for as deferred revenue initially and Commented [MOU6]: Performance Obligation
later recognized as revenue as each performance obligation is satisfied.
Commented [MOU7]: Apple—Presale product—when the
customer received the product that’s when the revenue is recognized.

Warranties: Commented [MOU8]: Manufacture Warranty: Apple, Car,

 Quality-assurance warranties - Not considered as POs. The seller recognizes this cost in Extended warranty; Considered as separate performance obligations.
the period of sale as a warranty expense and related contingent liability.
 Extended warranties - Considered as POs. The seller recognizes the extended warranties
as a deferred revenue liability and then recognizes as revenue over the extended warranty
period.

Options for additional goods or services: Considered as PO if they provide a material right to
the customer that the customer would not receive otherwise.

Example: As a promotion, TrueTech Industries offers a 50% coupon for a gaming headset with
the purchase of a Tri-Box at its normal price of $240. The headset costs $120 without a coupon
(and $60 with a coupon), and the coupon must be exercised within one year of the Tri-Box
purchase. TrueTech estimates that 80% of customers will take advantage of the coupon. How
would TrueTech account for the cash sale of 100 Tri-Boxes sold under this promotion on
January 1, 2016?

Jan 1 2016
Tri-box $240 (240/288=83.33%
Coupon: 120*50%*80%= $48 (48/288=16.67%)
Total: 248

Journal Entry
Dr. Cash $24K
Cr. Sales Revenue : (24K*83.33%)= $20K
Cr. Deferred revenue($24K *16.67%)= $4K

SCENARIO#1 1/1-12/31 80% of customer redeemed the coupon

DR. Cash ($120*50%*80) $4.8K
Dr. Deferred Revenue $4K
Cr. Sales Revenue $8.8sK
SCENARION #2 100% customer redeemed the coupon
Dr. Cash $$6K
Deferred Revenue $4K
Cr. Sales Revenue $10K
SCENARION #3 40% redeemed the coupon
Dr. Cash 2.4K
Deferred Revenue $4K
Cr. Sales Revenue $6.4K

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SCENARIO#4 no one redeemed the coupon
Dr. Deferred Revenuw $4K
Sales Revenue $4k Commented [MOU9]: Applies to companies who files for
bankruptcy—such as toy r us – the gift cards

Right of return: Not considered as POs. in most retail situations revenue can be recognized at
the point of delivery if the seller is able to make reliable estimates of future returns. The
estimated returns reduce both sales and cost of goods sold.

Example: TrueTech sold 1,000 Tri-Boxes to CompStores for $240 for cash. Each Tri-box costs
TrueTech $200. TrueTech estimates that CompStores will return 5% of the Tri-Boxes purchased. Commented [MOU10]: Accrual based accounting – bad debts –
estimates is recognized as the same times as the sales revenue is
recognized.
Journal Entry
Dr. Cash $240K
Cr Sales Revenue $240K
Dr. COGS $200K
Cr. Inventory $200K

5% Return?
Dr. allowance for sales return (XR, 240K *5%) $12K
Cr. Return liabilities $12K Commented [MOU11]: Contra Revenue (XR)– Contra
Accounts
Inventory (5%* 200K) $10K
Cr. COGS $10K

Step 3: Determine the transaction price

 Variable consideration: estimated as either the expected value or the most likely amount. Commented [MOU12]: Example;; Players;; The whole amount
is not guaranteed. – Certain amount is only recognized if they meet
certain level.. Hence , It is estimated
Example: Siddhi entered into a contract offering variable consideration on January 1, 2016. The
contract paid Siddhi $12,000 upfront for six months of continuous consulting services. In
addition, there was a 60% chance the contract would pay an additional bonus of $4,000 and a 40%
chance the contract would pay an additional bonus of $6,000, depending on the outcome of the
consulting contract. This contract qualified for revenue recognition over time. After three months,
Siddhi changed its assessment and expected the chance to receive $4,000 to be 30% and the
chance to receive $6,000 to be 70%. On July 1, 2016 Siddhi received the $6,000 bonus from the
client.

1) Expected Value

Upfront (Guaranteed) $12000/6montths $2000

Variable Part (60%*4000+40%*6000)= 4,800/6 months == $800

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Journal Entry Jan 1st
Dr. Cash $12K
Cr. Deferred Service Revenue $12K Commented [MOU13]: Sales Receivable not recognized..
service is not provided yet.

Jan 31st / Feb 28th/march 31st

Dr. Deferred Service Revenue $2K
Dr. Bonus Receivables $.8K Commented [MOU14]: What we are expected to receive..
Service has been provided
Cr. Service Revenue $2.8K

March31st : Update Bonus expectation

Variable Part (30%*4000+70%*6000) 5,400/6 months = $900

Dr. Bonus Receivable (900-800*3) $300

Cr. Service revenue $300
April 30th /May 30th/June 30th
Dr. Deferred Service Revenue $2K
Dr. Bonus Receivables $.9K Commented [MOU15]: What we are expected to receive..
Service has been provided
Cr. Service Revenue $2.9K
July1st
Dr. Cash $6K
Cr. Bonus receivable. 5.4K
Service Revenue 0.6K
What if you receive less money than expected -- $4000 instead of $6000
Dr. Cash $4k
Dr. service Revenue $1.4K
Cr. Bonus Receivable $5.4K

2) Most Likely Amount

60% chances is higer.. Bonus == 4k/6montsh—0.67

Jan 1st
Dr. Cash 4K
Cr. Deferred Service Revenue 4k
Jan31st/Feb28th/March 31st
Dr. deferred Revenue 2K
Dr. Bonus Receivable 0.67K
Cr. Sales Revenue $2.67K

March 31st Adjustment to expectation—Most likely upgrade from 4K to 6K

Dr. Bonus Receivable 1K
Cr. Service Revenue $1K

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April 31st/May 31st/June 30th
Dr. deferred Revenue 2K
Dr. Bonus Receivable 1K
Cr. Service Revenue 3K
July 1st
Dr. Cash 6K
Cr. bonus receivables 6K

If you receive less than 6K

Dr. cash 4K
Dr. Service Revenue 2K
Cr . Bonus receivables 6K

 Constraint on recognizing variable consideration: sellers are constrained to only include

an estimate of variable consideration in the transaction price to the extent it is probable
that a significant revenue reversal will not occur when the uncertainty associated with the
variable consideration is resolved.

 Right of return:

What about this is the first year in business implying that you cannot estimate?

If so, do journal entry when the actual return happens.

 Is the seller a principal or agent?

Principal Agent Commented [MOU16]: Example Groupon—Agent – selling

ticket. Sales revenue from the ticket selling is not recognized. Only
the commission is
Performance • To deliver goods and • To facilitate a
Commented [MOU17]: Expedia, Air bnb etc
obligation services (so is transaction between a
vulnerable to risks principal and a
associated with holding customer
inventory)
Recording • Total sales price paid by • Only the commission it
revenue customers receives on the
• Also recognizes cost of transaction
goods sold

Example: MobileGo purchases Iphone X directly from Apple for $500. The phones are shipped
to MobileGo's warehouse and held there until a sale is made. MobileGo sells Iphone X to a
customer for $725 and ships individual phones to customers from its warehouse.

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Mobile go Agent or principle?
Principle—since they already purchased and it is stored in its warehouse rather than aplle
warehouse.. They own the goods

Dr. Cash $735

Cr. Sales Revenue $725
Dr. COGS $500
Cr. Inventory $500

Example: Mobile-Online is a web portal on which mobile phone manufacturers sell their
products. When an Ipone X is sold through Mobile-Online for $725, the phone is shipped
directly from Apple's warehouse and Mobile-Online charges $50 commission.

Agent: They don’t own the product: hence they will not recognize the sales revenue earned.

Dr. Cash $50

Cr. Commission Revenue $50

 Time value of money:

o if the period between delivery and payment is less than a year, the time value of
money can be ignored
o if payment and delivery occur relatively far apart, the time value of money should
be accounted for. In that case, the seller views the transaction price as consisting
of (a) the cash price of the good or service and (b) a “financing component”
representing the interest for the time between the sale and the cash payment.

GM sells a Truck: Current Sells Price : $12000. But the customer will pay in 2 years with
interest rate 10%

Present Value of Truck : $12,000*PV (2 years, 10%) = 10,000

Journal Entry
Dr. Account Receivable $10,000
Cr. Sales Revenue $10,000
One year end:

Dr. Account receivable (10,000*10%) $1,000

Cr. Interest Revenue $1,000
Second year end
Dr. Account Receivable ((10,000+1,000)*10%) $1,100
Cr. Interest Revenue $1,100
Dr. Cash 12,100
Cr. Accounts Receivable $12,100

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  Payments by the seller to the customer: if the seller purchases distinct goods or services
from the customer:
 At the fair value of those goods or services, the seller accounts for that purchase as a
separate transaction
 Pays more than the fair value of those goods or services, those excess payments are
viewed as a refund

Suppose we have a version store, selling $5,000,000 worth of iPhones from apple but also
receive $5,000 from apple for advertisement posts.

Two Scenario
(1) $5000 Advertisement is a fair value
Apple Cr. Sales Revenue $5M
Verizon cr. Advertisement Revenue $5K

(2) Only $3000 advertisement is considered fair value, then what?

Apple Cr. Sales Revenue $5M-($5K-$3k)= 4,998K Commented [MOU18]: Why?? Fair value is less than actual
payment. Hence considered as refund or rebate.
Verizon cr. Advertisement Revenue $3K

What is Fair value?? How much you have to pay if we have to buy the product at the
current price. Similar to market value – Why not called market value?—There may not be
market all the time.

Step 4: Allocate the transaction price

Example: On January 1, 2016, TrueTech delivers 1,000 Tri-Box Systems to CompStores at a

price of $270 per system. The Tri-Box System includes the physical Tri-Box module as well as a
one-year subscription to the Tri-Net multiuser platform of internet-based games and other
applications. The Tri-Box modules have a stand-alone selling price of $250, but TrueTech does Commented [MOU19]: Market Value
not sell one-year subscriptions separately. Other vendors charge $50 for similar one-year
subscriptions to internet games and applications. TrueTech estimates that it incurs approximately
$10 of cost by providing one-year subscription to Tri-Net multiuser platform and usually the
margin for similar services is 50% above cost.

1) Adjusted market assessment approach

Market Value module: $250 ($250/$300) = 5/6

Market Value Subscription: $50. ($50/$300) = 1/6
Total $300

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Dr. Cash ($270*1000) $270,000
Cr. Sales Revenue (270,000*5/6) $225,000
Cr. Unearned Revenue $45,000 Commented [MOU20]: Subscription – one year

2) Expected cost-plus margin approach (if Market value for subscription is not given) Cost and
margin is given

Expected Costs+ Margin = $10+($10*50%)= $15

Module $250 (250/265 = 94.34%)

Subscription $15 (5.66%)
$265

Dr. Cash ($270*1000) $270,000

Cr. Sales Revenue(270K * 94.34%) $254.718
Cr. Unearned Revenue $15,282

3) Residual approach ( If there is no information on the subscription)

Dr. Cash ($270*1000) $270,000

Cr. Sales Revenue $250,000
Cr. Unearned Revenue $20,000

Step 5: Recognize revenue when each performance obligation is satisfied

1) Licenses
 A license is said to transfer a right of use if the seller’s activities during the license period Commented [MOU21]: More like permanent ownership –
Buying Movie from Amazon prime
are not expected to affect the intellectual property being licensed to the customer. For
example, think of a music download. In that case revenue is recognized at the start of the
license period, that is, when the right is transferred.

Dr. Cash $19.99

Cr. Sales Revenue $19.99

 A license provides a right of access to the seller’s intellectual property if the seller’s Commented [MOU22]: Temporary access—Renting movie
from amazon prime
ongoing activities affect the benefit the customer receives from the intellectual property.
For example, think of an NFL trademark granted to a company over a period of time. In
that case revenue is recognized over the period of time for which access is provided.

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Dr. Cash $4.99
Cr. Deferred Revenue $4.99 Commented [MOU23]: Will be later recognized as sales
revenue when the service is provided.

2) Franchises: In a franchise sale, the fees to be paid by the franchisee to the franchisor usually
comprise (1) the initial franchise fee, and (2) continuing franchise fees.
 GAAP require that the franchisor has substantially performed the services promised in
the franchise agreement and that the collectability of the initial franchise fee is
reasonably assured before the fee can be recognized.
 Continuing franchise fees are paid to the franchisor for continuing rights as well as for
advertising and promotion and other services over the life of the agreement and are
recognized by the franchisor as revenue in the period received, which corresponds to the
periods the services are performed.

Example: On March 31, 2016, the Red Hot Chicken Wing Corporation entered into a franchise
agreement with Thomas Keller. In exchange for an initial franchise fee of $50,000, payable on
March 31, 2016, Red Hot grants Thomas Keller the exclusive right to operate Red Hot in Reston,
Virginia for a five-year period and will provide initial services including the construction
assistance($20,000), training of employees, and consulting services over five years($30,000),. In
addition, the franchisee will pay continuing franchise fees of $1,000 per month for advertising
and promotion provided by Red Hot, beginning immediately after the franchise begins
operations. Thomas Keller opened his Red Hot franchise for business on September 30, 2016.

3/31/2016
Dr. Cash $50,000
Cr. Unearned Franchise Revenue $50,000

9/30/2016
Dr. Unearned Franchise Revenue $20,000
Cr. Franchise Revenue $20,000

10/30/2016
Dr. Unearned Franchise Rev $500 Commented [MOU24]: For employee training --- 60 months /
$30,000 == 1months is $500
Cr. Franchise Reve $500
Dr. Cash $1000
Cr. Franchise Reve $1000

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3) Bill-and-hold arrangements: since the customer doesn’t have physical possession of the Commented [MOU25]: Example—Amazon – box delivery
asset until the seller has delivered it, transfer of control has not occurred, so revenue typically Example—Home renovation—ordering furniture in advance and
should not be recognized until actual delivery to the customer occurs. early payments—however, revenue is recognized only when it is
delivered to the clients.

4) Consignment arrangements: given that the consignor retains the risks of ownership, it
postpones revenue recognition until sale to a third party occurs.

5) Gift cards: sales of gift cards are recognized as deferred revenue, and then revenue is
recognized when a gift card is redeemed or the likelihood of redemption is viewed as remote.

ACCOUNTING FOR LONG-TERM CONTRACTS Commented [MOU26]: GAAP—Recognize loss immediately

Revenue may be recognized before delivery when the products takes years to deliver (e.g., long-
term contact on buildings, highways, spacecraft) to provide timely information to investors.

In these situations, there are two methods of accounting for revenue and expense recognition:
 Recognizing revenue upon the completion of the contract
 Recognizing revenue over time according to % of completion.

If a contract doesn’t qualify for revenue recognition over time, revenue recognition is delayed
until the contract is completed.

1. No revenues or expenses are recognized until the project is complete.

2. Not properly portray a company's performance over the construction period and should
only be used in unusual situations (when forecasts of costs to complete the project are
highly uncertain).
3. During the project, construction costs are recorded as “Construction in progress” (an Commented [MOU27]: What percentage has incurred?
inventory account) and billings are recorded as “Billings on construction contract” (a
Commented [MOU28]: BCC—Bill you sent to a customer
contra inventory account). – Cumulative amount

Commented [MOU29]: More bill to customer than CIP –

Considered as liability and vice versa
Construction in Progress Construction in Progress
- Billings on Construction Contract - Billings on Construction Contract
Debit Balance (Unbilled Receivable) Credit Balance (Overbilled Receivable)

Classified as Classified as
an asset a liability

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 4. At completion of the project, all accounts are closed and the entire gross profit from the
construction project is recognized.
Dr. Cost of construction…………………………..XX
Dr. Construction in progress……………………...XX (gross profit)
Cr. Revenue from long-term contract………………………………..XX
Commented [MOU30]: Reliability—deal with Canada or
Syria—
Canada—payment is likely—Percentage of completion
Syria—Less likely—Completion of Construction
Company usually make payments in installment. however, it is about
to what extent will they receive cash for the revenue provided.

Dr. Revenue from long-term contract…………….XX

Cr. Cost of construction……………………………………………...XX
Cr. R/E……………………………………………………………….XX

Example: Geller Construction entered into a three-year contract to build a containment vessel for
Southeast Power Company for a contract price of $1,400,000. Presented below is information
about the contract.

2016 2017 2018

Construction costs incurred during the $ 250,000 $ 550,000 $ 400,000 Commented [MOU31]: Real pocket money
year
Construction costs incurred in prior - 250,000 800,000
years
Construction costs to date 250,000 800,000 1,200,000
Estimated costs to complete at end of 1,000,000 425,000 -
year
Total estimated (actual) construction $1,250,000 $1,225,000 $1,200,000
costs

Billings made during the year $ 250,000 $ 525,000 $ 625,000

Cash collections during year 225,000 470,000 405,000

Percentage
2016-250K/1250K= 20%
2017-(800K/1225K=65.31%)= 65.31%-20%= $45.31%
2018= 100%-45.32%= 34.69%

How will Geller account for the revenues and cost of this project if revenue is recognized upon
completion?

2016:
Commented [MOU32]: Asset account.. what kind of asset is it?
Dr. Construction in Progress (CIP) (+A) $250K It comes under Inventory – 3 types of inventory—Raw material,
work in progress
CR. Cash, Material, Wage, etc $250K
CIP is part of work in progress
Dr. Accounts Receivable $250K
Cr. Billing on Construction contract (BCC)(+XA) $250K Commented [MOU33]: When u sent the bill to the customer –
Commented [MOU34]: BCC—contra asset to CIP /Inventory

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Dr. Cash $225K
Cr. A/R $225K

Income Statement $0; Balance Sheet: Account Receivables $25,000

2017:

Construction in progress $550K

Cash, materials, etc. $550K
A/R $525K Commented [MOU35]: How much bill sent to the customer

Billing on construction contract $525K

Cash $470K
A/R $470K

Nothing on income statement—

CIP-250K+550K= 800K Commented [MOU36]: Cumulative number—2016+2017
BCC-525K+250K=775K—Unbilled receivable of 25K Commented [MOU37]: CIP is higher than bcc—Bcc is on debit
side
Accounts receivable: 25K+55K=80K
Commented [MOU38]: These two shows on balance sheet
2018:

Construction in process 400K

Cash, materials, etc. 400K
A/R 625K
Billing on construction contract 625K
Cash 405K
A/R 405K
This is the last year
To recognize gross profit:(Revenue)

Dr. Cost of Construction 1.2M

Dr. CIP (to recognize gross profit) 0.2M Commented [MOU39]: It is gross progit – cannot put – hence
used CIP
Cr. Revenue from long-term contract 1.4M Commented [MOU40]: Total billing sent -

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Dr. Revenue from contract 1.4M
Cr. Cost of construction 1.2M
Retained Earnings 0.2M Commented [MOU41]: CLOSING ENTRY

Construction in Progress Billings on Construction Contract

2016 250,000 250,000 2016
2017 550,000 1.4 M 1.4M 525,000 2017
transfer transfer
title Title
2018 400,000 625,000 2018 Commented [MOU42]: T account before journal entry
2018 200,000
1,400,000 0 0 1,400,000

Entry to transfer title to the customer.

Dr. BCC 1.4M
Cr. CIP 1.4M

if a contract qualifies for revenue recognition over time, revenue is recognized over time by
allocating a fair share of a project's revenues and expenses to each reporting period during
construction. Commented [MOU43]: PERCENTAGE OF COMPLETION

Eg.
1 Costs incurred to date = Percent complete
Most recent estimated total costs

2 Estimated total revenue x Percent complete

= Revenue to be recognized to date

3 Revenue to be recognized to date – Revenue

recognized in PRIOR periods = Current period revenue

4 Current Period Revenue – current period costs = Gross profit

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Example: Geller Construction entered into a three-year contract to build a containment vessel for
Southeast Power Company for a contract price of $1,400,000. Presented below is information
about the contract.

2016 2017 2018

Construction costs incurred during the year $ 250,000 $ 550,000 $ 400,000
Construction costs incurred in prior years - 250,000 800,000
Construction costs to date 250,000 800,000 1,200,000
Estimated costs to complete at end of year 1,000,000 425,000 -
Total estimated (actual) construction costs $1,250,000 $1,225,000 $1,200,000

Billings made during the year $ 250,000 $ 525,000 $ 625,000

Cash collections during year 225,000 470,000 405,000

2016: I/S: COC: 250K, Revenue form l-t contract : 280K

B/S: CIP: (250K+30K): 280K, BCC:250K, Unbilled Receivables: 30K
A/R- 25K

CIP 250K
Cash, Material, etc 250K
A/R 250K
BCC 250K
Cash 225K
A/R 225K

Dr. Cost of Construction 250K

CIP(Gross Profit) 30K Commented [AM44]: Back into gross profit after calculating
that the revenue is 20%
Cr. Revenue from 1-1 Contract (20%*1.4M) 280K Commented [AM45R44]: Revenue is 20% of 1.4M

Dr. Revenue from long term contract 280K Commented [AM46R44]: 20% = percent of completion =
250K/1250K
Cr. Cost of construction 250K Commented [AM47]: Profit =Revenue – expenses = 280K-
250K=30K
R/E 30K

2017: I/S: COC: 550K, Revenue form l-t contract: 634,286

B/S: CIP: (280K+550K+84,286): 914,286, BCC:775K, Unbilled Receivables: 139,286

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A/R- 80K

Construction in progress 550k

Cash, materials, etc. 550k
A/R 525k
Billing on construction contract 525K
Cash 470K
A/R 470K

Cost of construction 550K

Construction in progress 84,286
Revenue from long-term contract (65.31%*1.4M) 634,286 Commented [AM48]: Percent of completion = 800K/1225K =
65.31%
Revenue from long-term contract 634,286 Revenue = 1.4M x 65.31%

Cost of construction 550

R/E 84,286 Commented [AM49]: Back into retained earnings = Revenue –
expenses
R/E = 634,286 – 550K = Gross Profit

2018: I/S: COC: 400K, Revenue form l-t contract: 485,714

B/S: CIP: 0// BCC:0 Commented [MOU50]: Transfer of tile—Ending balance in 0
A/R-

Construction in progress 400K

Cash, materials, etc. 400K
A/R 625K
Billing on construction contract 625K
Cash 405K
A/R 405K

Commented [AM51]: This is the final year so the revenue is the

Cost of construction 400K 1.4M minus all the previous years revenue that was earned because
the contract has a set revenue of 1.4M
Construction in progress 85,714
Commented [AM52R51]: Revenue = 1.4M – 280K – 634,286
Revenue from long-term contract 485,714 =485,714

(34.69%*1.4M) Commented [AM53R51]: Or can look it as 100% minus

previous percentage of completion which would be 100-65.31% =
34.69%

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 Revenue from long-term contract 485,714
Cost of construction 400K
R/E 85,714 Commented [AM54]: 485,714 – 400K = 85,714

Construction in Progress Billings on Construction Contract

2016 250,000 250,000 2016
30,000 1.4M 1.4M
transfer transfer
title Title
2017 550,000 525,000 2017
84,286
2018 400,000 625,000 2018
85,714
1,400,000 0 0 1,400,000

Entry to transfer title to the customer.

Dr. BCC 1.4M
Cr. CIP 1.4M

A comparison of two methods:

Revenue Recognition
Over Time Upon Completion
Gross profit recognized:
2016 30K 0
2017 84,286 0
2018 85,714 200K
Total gross profit 200K 200K

Example – Periodic loss for profitable project

2016 2017 2018

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Contract price $1,400,000 $1,400,000 $1,400,000
Yearly cost incurred 250,000 550,000 550,000
Actual costs to date $ 250,000 $ 800,000 $1,350,000
Estimated costs to complete 1,000,000 550,000 0
Total estimated construction cost $1,250,000 $1,350,000 $1,350,000
Total gross profit (Contract price - total costs) $ 150,000 $ 50,000 $ 50,000

Billings made during the year $ 250,000 $ 525,000 $ 625,000

Revenue recognition upon completion:

2018:

Cost of construction 1.35M

Construction in progress (Gross profit) 0.05M
Revenue from long-term contracts 1.4M

Construction in Progress Billings on Construction Contract

2016 250K 250K 2016

2017 550K 525K 2017

2018 550K 625K 2018

50K

1.4M 1.4M

Revenue recognition over time:

Percentage of completion
2016= 250/1250. = 20%
2017= 800/1350=59.26%-20%= 39.26%

What does this suggest abut the aggregate profit in 2016 and 2017?
1.4M*59.46%-(250K+550K)= 29.64K Commented [MOU55]: But we input 30K as a profit for first
year when infact the aggregate profit for the first two year is only
2018=100%- 59.26%= 40.74% 29.64K
Therefore, We are recognizing a temporary loss in year 2 to make up
for the number
2016:

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 Cost of construction 250K
Construction in progress (Gross profit) 30K
Revenue from long-term contracts (20%*1.4) 280K

2017:

Cost of construction 550K

Construction in progress (Loss) 360
Revenue from long-term contracts (39.26%*1.4) 549.64K

2018:

Cost of construction 550K

Construction in progress (Gross profit) 20.36K
Revenue from long-term contracts (40.74%*1.4) 570.37K

Construction in Progress Billings on Construction Contract

2016 250K 250K 2016
30K
2017 550K 525K 2017
360 2017
2018 500K 625K 2018
20.36K
1.4M

A comparison of two methods:

Revenue Recognition
Over Time Upon Completion
Gross profit recognized:
2016 30K 0 Commented [MOU56]: Cash flow—Same – Regardless of
which method you choose
2017 -0.36K 0
2018 20.36K 50K If we consider Income tax, Which method reports higher cash flow?
Paying tax—cash outflow
Total project loss 50K 50K 2017: Higher cash flow (Over time)—Inflow due to loss
2018: Over time Higher cash flow – less taxed pay
Commented [MOU57]: Which method would you chose?

Time value and money – Higher value in 2016 than in 2018—

If Overall loss on the entire project: Hence choose to pay tax as later as you can.. upon completion
method will be chosen

Dr. Cost of Construction…………………………..X+Y

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 Cr. Construction in Process (loss)…………………………….X
Cr. Revenue from long-term contracts………………………..Y

Example: Overall loss Commented [MOU58]: Loss must be recognized right away—
conservatism
2016 2017 2018
Contract price $1,400,000 $1,400,000 $1,400,000

Actual costs to date $ 250,000 $ 910,000 $1,520,000

Estimated costs to complete 1,000,000 540,000 0
Total estimated construction cost $1,250,000 $1,450,000 $1,520,000
Total gross profit (Contract price - total costs) $ 150,000 $ (50,000) $ (120,000)

Billings made during the year $ 250,000 $ 525,000 $ 625,000

Revenue recognition upon completion: Commented [MOU59]: 0 Revenue recognition in s2016

2017—50K loss must be report in revenue recognition

If you have overall loss, you need to recognize the loss amount first and then you back out the
cost of construction. -Conservatism requires you to recognize the loss first.. Hence fill the CIP
Loss in journal first to calculate the CIP.

2017:

Dr. Loss on Long term contract $50K

Cr. CIP(Loss) $50K

2018:

Dr. CIP 1.47M Commented [MOU60]: Why recognized 1.47?- the 50 thousand
loss is recognized in 2017..
Cr. CIP of (Loss) (120K-50K) 70K Commented [MOU61]: 120K is not used---Loss and gain are
not recognized twice.
Cr. Revenue from Long Term Contract 1.4M

Construction in Progress Billings on Construction Contract

2016 250K 250K 2016

2017 660K 525K 2017

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 50K 2017
2018 610K 625K 2018
70K 2018
1.4M 1.4M

2017: CIP 860K (250K +660K -50K)- BCC 765k(250K-525K) = 85K -- Unbilled Receivables.
2018: CIP 0- BCC 0 = 0K (due to transfer of title)

Revenue recognition over time:

2016= 250K/1250K= 20%

2017=(910)/1450= 62.76%-20%= 42.76%
2018= 100%-62.8%=37.24%

2016:

Cost of construction 250K

Construction in progress 30K
Revenue from long-term contracts 280K

2017:

660K—
Cost of construction
678.640
Construction in progress( 80K Commented [MOU62]: Why> 50K plus 30K that is recognized
as a profit in the first year
Revenue from long-term contracts(1.4*42.76%) 598.640

2018:

Cost of construction 591.360

Construction in progress 70K
Revenue from long-term contracts 521.360

Construction in Progress Billings on Construction Contract

2016 250K 250K 2016
30K
2017 660K 525K 2017
80K 2017
2018 610K 625K 2018

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 70K 2018
1.4M 1.4M

A comparison of two methods:

Revenue Recognition
Over Time Upon Completion Commented [MOU63]: Which method gives more volatile
earning?
Gross profit recognized: Overtime – Combination of loss and profit
2016 30K 0
Investing in stock – as an investor – Stable or more fluctuation? –
2017 -80K -50K depends on the company
2018 -70K -70K
Total project loss -120K -120K

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