Kế toán, kiểm toán - Chapter 5: Income Measurement and Profitability Analysis

Income Measurement and Profitability Analysis5 Learning ObjectivesDiscuss the general objective of the timing of revenue recognition, list the two general criteria that must be satisfied before revenue can be recognized, and explain why these criteria usually are satisfied at a specific point in time.LO1Revenue RecognitionRevenue should be recognized in the period or periods that the revenue-generating activities of the company are performed.Realization PrincipleRecord revenue when: ANDThere is reasonable certainty as to the collectibility of the asset to be received (usually cash).The earnings process is complete or virtually complete.SEC Staff Accounting Bulletin No. 101The SEC issued Staff Accounting Bulletin No. 101 to crackdown on earnings management. The bulletin provides additional guidance to determine if the realization principle is satisfied:Persuasive evidence of an arrangement exists.Delivery has occurred or services have been performed.The seller’s price to the buyer is fixed or determinable.Collectibility is reasonably assured. Completion of the Earnings Process Within a Single Reporting PeriodWhen the product or service has been delivered to the customer and cash has been received or a receivable has been generated that has reasonable assurance of collectibility.Recognize RevenueLearning ObjectivesDescribe the installment sales and cost recovery methods of recognizing revenues for certain installment sales and explain the unusual conditions under which these methods might be used.LO2Significant Uncertainty of CollectibilityInstallment Sales MethodCost Recovery MethodWhen uncertainties about collectibility exist, revenue recognition is delayed.Installment Sales MethodThe installment sales method recognizes the gross profit by applying the gross profit percentage on the sale to the amount of cash actually collected.Installment Sales MethodClarke, Inc. had the following installment sales in addition to its regular sales.$45,000 ÷ $200,000 = 22.50%Installment Sales MethodClarke, Inc. had the following installment sales in addition to its regular sales.At Dec. 31, 2007, Clarke, Inc. is still owed $30,000 from the 2006 sales and $75,000 from the 2007 sales.Installment Sales MethodDeferred gross profit is the difference between the selling price and the cost of the inventory.Installment Sales MethodDuring 2005, Clarke collected $100,000 on its installment sales.This entry records the Realized Gross Profit by adjusting the Deferred Gross Profit account.Installment Sales MethodDuring 2006, Clarke sold $250,000 on installments and collected $50,000 on its 2005 installment sales and $195,000 on its 2006 installment sales.Installment Sales MethodInstallment Sales MethodInstallment Sales MethodBalance SheetCost Recovery MethodClarke, Inc. had the following installment sales in addition to its regular sales. The company uses the cost recovery method to account for installment sales.$45,000 ÷ $200,000 = 22.50%Cost Recovery MethodThe following schedule shows the pattern of cash collections for the three year period.Under the cost recovery method profit is not recognized until the seller has recovered all of the cost of the goods sold.Cost Recovery MethodThe entries are exactly the same as under the Installment Method—EXCEPT that there is not an entry to realize gross profit. Since we have not collected cash in excess of COGS, no gross profit is recognized in 2005.Cost Recovery MethodIn 2006, let’s concentrate on the entries relating to 2005 sales only.Now can we recognize some profit?Cost Recovery MethodHere are the entries we would make in 2007 relating to 2005 sales.We have fully recovered the $155,000 cost during 2007, so the entire deferred gross profit will be recognized.Learning ObjectivesDiscuss the implications for revenue recognition of allowing customers the right of return.LO3Right of ReturnIn most situations, even though the right to return merchandise exists, revenues and expenses can be appropriately recognized at point of delivery.Estimate the returns.Reduce both Sales and Cost of Goods Sold.Learning ObjectivesIdentify situations that call for the recognition of revenue over time and distinguish between the percentage-of-completion and completed contract methods of recognizing revenue for long-term contracts.LO4Completion of the Earnings Process Over Multiple Reporting PeriodsCompleted Contract MethodPercentage-of-Completion MethodLong-term ContractsCompleted Contract MethodRecognizes revenue at a point in time when the earnings process is completeCompleted Contract MethodGeller 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.Let’s see how Geller will account for the revenues and cost of this project using the completed contract method.Completed Contract MethodGross profit is not recognized until project is complete.Completed Contract MethodClassified as an assetClassified as a liabilityCompleted Contract MethodGross profit is not recognized until project is complete.Completed Contract MethodCompleted Contract MethodGross profit is recognized in year 3 since project is complete.Remember that the contract price was $1,400,000.Completed Contract MethodEntry to transfer title to the customer.Percentage-of-Completion MethodCost incurred to dateGross profit estimateMeasuring Progress Toward CompletionEstimate of project’s total costPercentage-of-Completion Method Total costs incurred to date Percent complete = Most recent estimate of total project cost Let’s look at an example.Percentage-of-Completion MethodGeller 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.Let’s see how Geller will account for the revenues and cost of this project using the percentage-of-completion method.Percentage-of-Completion MethodPercentage-of-Completion MethodContra account to CIPEntries are identical to the entries for the completed contract method.Percentage-of-Completion MethodClassified as an assetClassified as a liabilityPercentage-of-Completion MethodPercentage-of-Completion MethodClosing EntryPercentage-of-Completion MethodPercentage-of-Completion MethodPercentage-of-Completion MethodPercentage-of-Completion MethodPercentage-of-Completion MethodPercentage-of-Completion MethodPercentage-of-Completion MethodEntry to transfer title to the customer.Long-term Contract LossesPeriodic Loss for Profitable ProjectsDetermine periodic loss and record loss as a credit to the Construction in Progress account.Loss Projected for Entire ProjectEstimated loss is fully recognized in the first period the loss is anticipated and is recorded by a credit to Construction in Progress account.Learning ObjectivesDiscuss the revenue recognition issues involving software and franchise sales.LO5Software Revenue RecognitionStatement of Position 97-2If a sale includes multiple elements (software, future upgrades, postcontract customer support, etc.), the revenue should be allocated to the various elements based on the relative fair value of the individual elements. This will likely result in a portion of the proceeds received from the sale of software being deferred and recognized as revenue in future periods.Franchise SalesSource: SFAS 45Initial Franchise FeesGenerally are recognized at a point in time when the earnings process is virtually complete.Continuing Franchise FeesRecognized over time as the services are performed.Learning ObjectivesIdentify and calculate the common ratios used to assess profitability.LO6Receivables Turnover RatioWhenever a ratio divides an income statement balance by a balance sheet balance, the average for the year is used in the denominator. Net Sales Average Accounts ReceivableReceivablesTurnoverRatio=This ratio measures how many times a company converts its receivables into cash each year.Average Collection PeriodThis ratio is an approximation of the number of days the average accounts receivable balance is outstanding. 365 Receivables Turnover RatioAverage Collection Period=Inventory Turnover RatioThis ratio measures the numberof times merchandise inventoryis sold and replaced during the year. Cost of Goods Sold Average InventoryInventoryTurnoverRatio=Average Days in InventoryThis ratio indicates the numberof days it normally takes to sell inventory. 365 Inventory Turnover RatioAverage Days in Inventory=Asset Turnover RatioThis ratio measures how efficiently a company utilizes all of its assets to generate revenue. Net Sales Average Total AssetsAssetTurnoverRatio=Profit Margin on SalesProfit Marginon SalesNet Income Net Sales=This ratio indicates the portion of each dollar of revenue that is available to cover expenses.Return on Total AssetsReturn onTotal AssetsNet Income Average Total Assets=This ratio measures how well assets have been employed.Return on EquityReturn onEquityNet Income Average Shareholders’ Equity=This ratio measures the ability of management to generate net income from the resources the owners provide. Appendix 5Interim ReportingInterim ReportingIssued for periods of less than a year, typically as quarterly financial statements.Serves to enhance the timeliness of financial information.Fundamental debate centers on the choice between the discrete and integral part approaches.Interim ReportingReporting Revenues and ExpensesWith only a few exceptions, the same accounting principles applicable to annual reporting are used for interim reporting. Reporting Unusual ItemsDiscontinued operations and extraordinary items are reported entirely within the interim period in which they occur. Earnings Per ShareQuarterly EPS calculations follow the same procedures as annual calculations. Reporting Accounting ChangesAccounting changes made in an interim period are reported by retrospectively applying the changes to prior financial statements. Minimum DisclosuresSales, income taxes, and net incomeEarnings per shareSeasonal revenues, costs, and expensesSignificant changes in estimates for income taxesDiscontinued operations, extraordinary items, and unusual or infrequent itemsContingenciesChanges in accounting principles or estimatesSignificant changes in financial positionEnd of Chapter 5