Professional Documents
Culture Documents
Overview
The ultimate objective of business enterprises is one and the
same, i.e. generating a maximum profit without violating the law of
the country they are operating a maximum in. In doing this they
involve in the production and sell of goods or services. Now a day
business enterprises sell goods or services are mostly on credit.
Sometime companies enter into agreement with their customers to
produce good services for them alone. There are many types of
dealings in the business world Companies can even collect cash in
advance from their customers to produce goods of provide services.
Thus, in this section I am going to discuss the issues related to the
timing of revenue recognition.
Specific Objectives
After successfully studying this Section, you will be able to:
1.1 Revenue
Revenue is cash collected or promised for collection from the provision
of goods or services. Examples of revenue include sales fees, interest
income, dividends, rents and royalties.
Revenue is said to have been realized (Obtained or gained) when a
measurable transaction (such as a sale) or an event (such as the
rendering of services) is completed or is sufficiently finalized to warrant
the recording of earned revenue in the accounting records. The
identification of critical times for learning revenue is the foundation of
the revenue realization principle.
Rendering services;
ii.
iii.
iv.
ii.
iii.
iv.
v.
vi.
1.5
prior to production
delivered to the purchaser. Then and only then, is a sale recorded and
revenue is realized.
Newspapers and magazines subscriptions, insurance premiums, rents,
and fees for most services may be received in advance of production or
performance of the goods or service. Amount received by the sellers of
such goods or services represent deferred revenue (a liability) until
delivery or performance takes place.
1.6.2.
During production
In this Type of contracts the seller/ buyer may bill the purchaser at various
intervals of the project.
Reverence is recognized portion by portion depending
on the proportion of
exerted or may be different to the time when the project is completed and
handed over to the client.
The accounting profession recognizes two distinctly different methods of
accounting for long term construction. These Method:
i.
ii.
recognized each period based upon the progress of the construction process.
Costs incurred each year are deducted from realized contract revenue to
measure the gross profit earned in the year. The period contract completed
generally is measured by comparing the costs incurred to date with the total
estimated costs of completing the contract.
Thus, use of the percentage of completion method for revenue recognition is
appropriate only when the actual costs incurred may be measured with
20M
K.4M
Construction continued in year 2000 and total cost at the end of the year has
reached ( including last years )Br 60 M the rest of the work is estimated to
estimated (after a new revision is made )an additional cost of Br 30 m what is
the revenue of year 2000? and what about the related G. profit?
=Revenue of 2000[120) -24]
=cost incurred (60-20)
=G. profit
Br.56M
40M
16M
Let us assume further that the project was completed and handed over to the
client close to the end of year 2001 Total cost incurred has become Br. 95m
what is the revenue and the related G. profit of 2001?
= Revenue 120m- 24-56)
= cost incurred (95-600
=G. profit
Br.40 M
3
5m
Hence the contractor would realize br. 24m of revenue in 1999br.. 56m in 2000
and Br. 5 m in 2001 The illustration shows that the revenue year is proportional to
the work preformed under the percentage of contract completion method revenue
1.6.3.
on Completion of production
under the completed-contract method revenue and gross profit are recognized
only at point of sale, that is when the contract is completed Costs of long term
contracts in process and current billings are accumulated but there are no interim
charges or credits to income statement accounts for revenues, costs and gross
profit.
The principal advantage of the completed contract method is that reported
revenue is based on final results rather than on estimates of unperformed work
its major disadvantage is that s\it does not reflect current performance what the
period of a contract extends into more than accounting period. Although
operations may be fairly uniform during the period of the contract, is not until the
year of completion creating a distortion of earning.
1.6.4 Others
There are other methods of revenue recognition which are not in line with the
rules of accounting. These are:
i.
ii.
Receipt of order:
computer
hardware industries record sale at the time they receive orders from
the transaction says tat Br. 20,000 of the selling price will be paid down on June
30- at the time of sell and the rest at the rate of Br. 24,000 month for 20 months
to come ABC Companys fiscal period ends on December 31 each year.
The cash collected, recovery of cost and realized gross profit on these sales for
ABC Company are summarized below:
Year
cash collected
(I)
1999
Recovery of cost
80%
Br.164,000
Realized G. profit
20%
(II)
[I-II]
Br. 131,200
Br. 32,800
2000
288,000
230,400
57,600
2001
48,000
38,400
9,600
Br. 400,000
Br. 100,00000
Totals
Br. 400,000
installment method of accounting becomes appropriate for income tax purpose not
for financial reporting purposes
Next to this you can see the journal entries recorded in the books of the seller to
recognize the sale and cash collections at different time periods. Let us assume
ABC Company uses the perpetual inventory system.
During Year 1999
To recognize the installment sale:
Installment Receivables
Cost of installment sale
Installment sale
Inventories
500,000
400, 000
500,000
400,000
10
500,000
400,000
100,000
Deferred Gross profit represents the amount of gross profit will be realized each
time cash is collected
To recognize cash collection:
Cash
164,000
Installment Receivables
164,000
The cash collected has become 164,000 because it includes the down payment
and the monthly installments [Br. 20,000+ (6x24, 000) = 164,000]. There were six
collections made in 1999 from July to December.
To recognize the realized profit:
Deferred
32, 8000
Gross Profit
32,800
288,000
Installment sale
288,000
57,600
57,600
48,000
48,000
11
The amount collected in year 2001 is the last one In the previous years 18
months installment(six for 1999 and twelve for 2000) are already collected. Thus
the remaining are two months collection [2x24, 000= 48,000A].
To record realized gross profit:
Deferred gross profit
9,600
9,600
Here again the amount written as recognized, Br. 9,600 is 20 percent of the cash
collected in that year (.2x48,000).
While preparing financial statement at the end of each accounting year,
installment receivables from revenue transaction are included among current
assets in the balance sheet. The balance in the deferred gross profit account is
deducted from installment receivables as a valuation account.
Under the installment method, revenue will be recognized in proportion to the cash
collected.
Installment sales receivable account is current asset account and thus to be
reported in the balance sheet at its appropriate place.
Deferred gross profit that is unrealized gross profit balance at the end of the year
has to be deducted from the installment receivable account as a valuation
account.
Realized gross profit will be included in the income statement like other revenues.
8.4.1
12
Under this method revenue is recognized at the time the service or the
act is preformed It is similar to the sales method of revenue recognition
from product sales. When the provision of service is over, revenue is
realized. it constitutes no parts. A single act of entrainment or a single
provision of service to be preformed; and when it is finished revenue is
realized
The following examples can illustrate the basic assumptions of specific
performance method:
i.
ii.Service give to some one to transfer his cash from one destiny to
another (banking service)
iii.
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14
15
and they cannot avoid it. The expenses business enterprises incur
during an accounting period may be classified under one the following
three groups:
2.3.1
2.3.2
Costs associated with the period on a basis other than a
directrelationship with revenue.
2.3.3
Costs that cannot reasonably be associated with any other
period.
2.1
Cost incurred in the current period are not expected to provide any
future benefits,
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17
Recognition of losses
Section: 3
Overview
Income measurement is one of the most important functions of
accounting. The Income statement is the vehicle used to depict income
data of the organization periodically. In reporting income, we use the
accrual basis of accounting is used. Accrual basis of accounting is
consistent with the Generally Accepted Accounting principles.
Thus, because both cash basis income and economic have serious
shortcomings and are fundamentally incompatible, accountants have
adopted the accrual basis of accounting as a reasonable approach to
income measurement.
Objectives:
18
about
earnings
and
its
19
If you ignore the time value of money and effects of inflation, income of
a business enterprise is easy to measure. The reason is that the
beginning and end of the life of any entries, the value of its net assets
may be measured with reasonable accuracy.
The investment by owners and the proceeds received on liquidation
usually are definite amounts of cash or other assets.
3.3
When price level rises the amount you will receive by selling a product
will be more than what could be collected under normal circumstances.
Besides, the cost inputs will be higher than it used to be.
Business will report more than the usual profit margin if they have
stocks of goods bought during non- inflationary situation but sold when
price level rise exists.
Let us take the following example to illustrate different income
recognition options.
20
A company produced a fixed asset item for sell 1999 when price level
was 100 ,by expending a total of Br.10,000 on input. It did not sell the
product on the same year but was in the store for one year (until year,
2000) In 2000 the asset item was sold for Br. 18,000 By the time it was
sold Price has risen to 115 and the cost of producing the same type of
product gone up to Br..12,000.
3.3.1 The Nominal Gross Profit Method:
It reports the entire difference between revenue realized and
historical cost without regard to differences in the purchasing power of
the birr.
Nominal gross profit:
Revenue realized--------------- ---------------Br 18,000
Less actual cost of good sold --------------
10,000
Gross profit
8,000
Br2,000
Br8,000
11,500
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22
i.
i.
ii.
iii.
23
When there are changes of this kind, it will affect this years and the
future years amount recognized in form of depreciation. No
commutative effect will be shown in the current years income
statement unlike changes in accounting estimate.
iii.
24