Revenue is usually recognized at delivery, but sometime before the delivery or after delivery
- Long-term contracts (15)
- Percentage-of-completion method (16)
- when outcome of contract can be reliably estimated
- Revenue, expense, profit are recognized as work is performed.
- Completed-contract method (17)
- When the outcome of the project can not be reliably measured
- Revenue is recognized to the extent of contract costs
- Revenue, expense, profit are recognized only when the contract is complete
Effects of using different revenues
- Installment sales (18)
- Occurs when payments are expected to be received over an extended period
- Installment method (19)
- Used when collectibility can not be reasonably estimated
- Profit recognized as cash is collected
- Profit = cash collected * total expected profit as a percentage of sales
- Cost recovery method (19)
- The method is used when collectibility is highly uncertain
- Profit recognized only cash collected > cost incurred
- Both cost recovery and installment method are typically used for real estate
- Example of effect using installment and the cost recovery methods
- Barter Transactions (20)
- Two parties exchange goods or services without cash payment
- Round-trip transaction involves the sale of goods to one party with simultaneous purchase of almost identical goods from the same party
- Revenue from barter transaction
- can be recognized at fair value only if the firm has received cash payment for such goods in the past
- Otherwise → record revenue at carrying value of the asset surrendered
- Gross and Net Reporting of revenue
- Gross revenue reporting (21): report sales revenue and cost of goods sold separately
- Net revenue reporting (22): Only difference in sales and cost is reported
- Profit is the same, sales are higher using gross revenue
- Condition to use gross revenue:
- Primary Obligor under the contract
- Bear inventory and credit risk
- Be able to choose its supplier
- Reasonable latitude to establish the price
- Implication for financial analysis
- Two to consider when analyzing a firm’s revenue
- How conversative are the firm’s revenue recognition policies
- The extent to which the firm’s policies rely on judgement and estimates
- Two to consider when analyzing a firm’s revenue
Notes:
- Accrual method: Method of accounting transactions for revenue when earned and expense incurred
- transaction price: The price of a good or service expressed relative to the same quantity of another good or service. Transaction prices help distinguish price changes due to inflation from real price changes.
- Ending inventory is the cost of those goods on hand at the end of a reporting period.
- Long-term contracts
- Long-term contract means a contract of more than five years in duration