Chapter 6 Intermediate

Intermediate Accounting
Seventeenth Edition
Kieso; Weygandt; Warfield
Chapter 18
Revenue Recognition
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Learning Objectives
After studying this chapter, you should be able to:
1. Discuss the fundamental concepts related to revenue
recognition and measurement.
2. Explain and apply the five-step revenue recognition
process.
3. Apply the five-step process to major revenue
recognition issues.
4. Describe presentation and disclosure regarding
revenue.
Copyright ©2019 John Wiley & Sons, Inc. 2

New Revenue Recognition Standard
Key Concepts of Revenue Recognition
Key Objective
Recognize revenue to depict the transfer of goods or services to customers in an amount
that reflects the consideration that the company receives, or expects to receive, in
exchange for these goods or services.
Five-Step Process for Revenue Recognition
1. Identify the contract with customers.
2. Identify the separate performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the separate performance obligations.
5. Recognize revenue when each performance obligation is satisfied.
Revenue Recognition Principle

Recognize revenue in the accounting period when the performance obligation is satisfied.
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The Five-Step Process—Boeing Example
Assume that Boeing Corporation signs a contract to sell
airplanes to Delta Air Lines for $100 million.

Boeing Example Step 3 and Step 4

Boeing Example Step 5

Recognizing Revenue When (or as)
Each Performance Obligation Is
Satisfied—Step 5
Company satisfies its performance obligation when the customer
obtains control of the good or service.
Change in Control Indicators
1. Company has a right to payment for the asset.
2. Company has transferred legal title to the asset.
3. Company has transferred physical possession of the asset.
4. Customer has significant risks and rewards of ownership.
5. Customer has accepted the asset.
Performance Obligation Satisfied
Recognize revenue from a performance obligation over
time by measuring progress toward completion
• Method for measuring progress should depict transfer
of control from company to customer.
• Objective of methods is to measure extent of progress
in terms of costs, units, or value added.

Summary-Step 1
Step in Process Description Implementation
1. Identify the contract A contract is an agreement A company applies the
with customers. that creates enforceable revenue guidance to
rights or obligations. contracts with customers.
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Summary-Step 2
2. Identify the separate A performance obligation is A contract may be
performance a promise in a contract to comprised of multiple
obligations in the provide a product or service performance obligations.
contract. to a customer. Accounting is based on
A performance obligation evaluation of whether the
exists if the customer can product or service is distinct
benefit from the good or within the contract.
service on its own or
together with other readily If each of the goods or
available resources. services is distinct, but is
interdependent and
interrelated, these goods
and services are combined
and reported as one
performance obligation.
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Summary-Step 3
3. Determine the Transaction price is the In determining the
transaction price. amount of consideration transaction price,
that a company expects to companies must consider
receive from a customer in the following factors:
exchange for transferring 1. variable consideration,
goods and services. 2. time value of money,
3. noncash consideration,
and
4. consideration paid or
payable to customer.
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Summary-Step 4
4. Allocate the If more than one The best measure of fair
transaction price to the performance obligation value is what the good
separate performance exists, allocate the service could be sold for on
obligation. transaction price based on a standalone basis
relative fair values. (standalone selling price).
Estimates of standalone
selling price can be based
on
1. adjusted market
assessment,
2. expected cost plus a
margin approach, or
3. a residual approach.
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Summary-Step 5
5. Recognize revenue A company satisfies Companies satisfy performance
when each its performance obligations either at a point in time
performance obligation obligation when the or over a period of time. Companies
is satisfied. customer obtains recognize revenue over a period of
control of the good time if one of following criteria are
or service. met:
1. the customer receives and
consumes the benefits as the
seller performs,
2. the customer controls the asset
as it is created, or
3. the company does not have an
alternative use for the asset.
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Learning Objective 3
Apply the Five-Step Process to Major
Revenue Recognition Issues

Accounting for Revenue Recognition
Issues
• Sales returns and allowances
• Repurchase agreements
• Bill and hold
• Principal-agent relationships
• Consignments
• Warranties
• Nonrefundable upfront fees

Sales Returns and Allowances
• Right of return is granted for product for various
reasons (e.g., dissatisfaction with product).
• Company returning the product receives any
combination of the following.
1. Full or partial refund of any consideration paid.
2. Credit that can be applied against amounts
owed, or that will be owed, to the seller.
3. Another product in exchange.

Credit Sales with Returns and
Allowances Illustration
On January 12, 2020, Venden Company sells 100 cameras for $100 each
on account to Amaya Inc. Venden allows Amaya to return any unused
cameras within 45 days of purchase. The cost of each product is $60.
Venden estimates that:
1. Three products will be returned.
2. The costs of recovering the products will be immaterial.
3. The returned products are expected to be resold at a profit.
On January 24, Amaya returns two of the cameras because they were the
wrong color. On January 31, Venden prepares financial statements and
determines that it is likely that only one more camera will be returned.
Venden makes the following entries related to these transactions.
Repurchase Agreements
• Allows company to transfer an asset to a customer but
have an unconditional (forward) obligation or
unconditional right (call option) to repurchase the asset
at a later date.
• If obligation or right to repurchase is for an amount
greater than or equal to selling price, then transaction
is a financing transaction.

Repurchase Agreements
Illustration
Facts: Morgan Inc., an equipment dealer, sells equipment on January 1,
2020, to Lane Company for $100,000. It agrees to repurchase this
equipment on December 31, 2021, for a price of $121,000.
Question: Should Morgan Inc. record a sale for this transaction?
Assuming an interest rate of 10 percent is imputed from the agreement, Morgan
makes the following entry to record the financing on January 1, 2020.
Cash 100,000
Liability to Lane Company 100,000

Bill-and-Hold Arrangements
• Contract under which an entity bills a customer for a
product but the entity retains physical possession of the
product until a point in time in the future.
• Result when buyer is not yet ready to take delivery but
does take title and accepts billing.

Illustration
Facts: Butler Company sells $450,000 (cost $280,000) of fireplaces on
March 1, 2020, to a local coffee shop, Baristo, which is planning to
expand its locations around the city. Under the agreement, Baristo asks
Butler to retain these fireplaces in its warehouses until the new coffee
shops that will house the fireplaces are ready. Title passes to Baristo at
the time the agreement is signed.
Question: When should Butler recognize the revenue from this bill-and-
hold arrangement?
Butler determines when it has satisfied its performance obligation to
transfer a product by evaluating when Baristo obtains control of that
product.

Question: When should Butler recognize the revenue from this bill-and-hold
arrangement?
For Baristo to have obtained control of a product in a bill-and-hold arrangement,

it must meet all of the conditions for change in control plus all of the following
criteria:
(a) The reason for the bill-and-hold arrangement must be substantive.
(b) The product must be identified separately as belonging to Baristo.
(c) The product currently must be ready for physical transfer to Baristo.
(d) Butler cannot have the ability to use the product or to direct it to another
customer.
In this case, it appears that the above criteria were met, and therefore revenue
recognition should be permitted at the time the contract is signed.

Principal-Agent Relationships
• Agent’s performance obligation is to arrange for principal to
provide goods or services to a customer.
• Examples:
• Preferred Travel Company (agent) facilitates booking of
cruise for Regency Cruise Company (principal).
• Priceline (agent) facilitates sale of various services such
as car rentals at Hertz (principal).
• Amounts collected on behalf of the principal are not
revenue of the agent.
• Revenue for agent is amount of commission received.

Consignments
• Manufacturers (or wholesalers) deliver goods but retain
title to the goods until they are sold.
• Consignor (manufacturer or wholesaler) ships
merchandise to the consignee (dealer), who is to act as
an agent for the consignor in selling the merchandise.
• Consignor makes a profit on the sale.
• Carries merchandise as inventory.
• Consignee makes a commission on the sale.

Learning Objective *5
Apply the Percentage-of-Completion
Method for Long-Term Contracts

Long-Term Construction Contracts
Revenue Recognition Over Time
A company satisfies a performance obligation and recognizes revenue
over time if at least one of the following three criteria is met:
1. The customer simultaneously receives and consumes the benefits
of the seller’s performance as the seller performs.
2. The company’s performance creates or enhances an asset (for
example, work in process) that the customer controls as the asset
is created or enhanced; or
3. The company’s performance does not create an asset with an
alternative use.

Revenue Recognition Over Time
Two Methods of Accounting:
• Percentage-of-Completion Method
• Recognize revenues and gross profits each period
based upon the progress of the construction
• Buyer and seller have enforceable rights
• Completed-Contract Method
• Recognize revenues and gross profit only when the
contract is completed

Percentage-of-Completion Method
Revenue to Recognized Cost-to-Cost Basis

Illustration
Hardhat Construction Company has a contract to construct a
$4,500,000 bridge at an estimated cost of $4,000,000. The
contract is to start in July 2020, and the bridge is to be
completed in October 2022. The following data pertain to the
construction period.
Blank 2020 2021 2022
Costs to date $1,000,000 $2,916,000 $4,050,000
Estimated costs to complete 3,000,000 1,134,000 -
Progress billings during the year 900,000 2,400,000 1,200,000
Cash collected during the year 750,000 1,750,000 2,000,000

Application of Percentage-of-Completion Method,
Cost-to-Cost Basis
2020 2021 2022

Contract price $4,500,000 $4,500,000 $ 4,500,000
Less estimated cost:
Costs to date 1,000,000 2,916,000 4,050,000
Estimated costs to complete 3,000,000 1,134,000 —
Estimated total costs 4,000,000 4,050,000 4,050,000
Estimated total gross profit $ 500,000 $ 450,000 $ 450,000
25% 72% 100%
Percent complete  $1, 000, 000   $2,916, 000   $4, 050, 000 
 $4, 000, 000   $4, 050, 000   $4, 050, 000 
     

Journal Entries—Percentage-of-Completion Method, Cost-to-
Cost Basis

Percentage-of-Completion Revenue, Costs, and Gross
Profit by Year
Recognized in Recognized in
To Date Prior Years Current Year
2020
Revenues ($4,500,000 × .25) $1,125,000 $1,125,000
Costs 1,000,000 1,000,000
Gross profit $ 125,000 $ 125,000
2021
Revenues ($4,500,000 × .72) $3,240,000 $1,125,000 $2,115,000
Costs 2,916,000 1,000,000 1,916,000
Gross profit $ 324,000 $ 125,000 $ 199,000
2022
Revenues ($4,500,000 × 1.00) $4,500,000 $3,240,000 $1,260,000
Costs 4,050,000 2,916,000 1,134,000
Gross profit $ 450,000 $ 324,000 $ 126,000

Journal Entries to Recognize Revenue and Gross Profit
and to Record Contract Completion—Percentage-of-
Completion Method, Cost-to-Cost Basis

Content of Construction in Process Account—Percentage-
of-Completion Method

Financial Statement Presentation—
Percentage-of-Completion
Computation of Unbilled Contract Price at 12/31/20
Contract revenue recognized to date: $4,500,000  $1,000,000 $1,125,000

$4,000,000
Billings to date (900,000)
Unbilled revenue $ 225,000

Financial Statement Presentation—
Percentage-of-Completion (2020)

Learning Objective *6
Apply the Completed-Contract Method
for Long-Term Contracts

Completed-Contract Method
Companies recognize revenue and gross profit only at
point of sale—that is, when the contract is completed.
Under this method, companies accumulate costs of long-
term contracts in process, but they make no interim
charges or credits to income statement accounts for
revenues, costs, or gross profit.

Illustration
Under the completed-contract method for the bridge project
previously illustrated, Hardhat Construction Company would make
the following entries in 2022 to recognize revenue and costs and to
close out the inventory and billing accounts.
Billings on Construction in Process 4,500,000

Revenue from Long-Term Contracts 4,500,000
Costs of Construction 4,050,000

Construction in Process 4,050,000

Comparison of Gross Profit Recognized under Different
Methods
Percentage-of-Completion Completed-Contract
2020 $125,000 $ 0
2021 199,000 0
2022 126,000 450,000

Financial Statement Presentation

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Intermediate Accounting

Kieso; Weygandt; Warfield

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Revenue Recognition Principle

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For Baristo to have obtained control of a product in a bill-and-hold arrangement,

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2020 2021 2022

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Contract revenue recognized to date: $4,500,000  $1,000,000 $1,125,000

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Billings on Construction in Process 4,500,000

Costs of Construction 4,050,000

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