Point of Sale Software Contract - DOC

Document Sample
Point of Sale Software Contract - DOC Powered By Docstoc
					              Acctg 301 – Revenue Recognition Issues
I.    Preview

         basic recognition criteria -- most significant abuse area

         revenue recognition alternatives

             at point of sale – a.k.a. delivery

             before delivery

             after delivery

             at end of production

II.     Basic Revenue Recognition Criteria

        realized or realizable

        Ideally – record as earned, but what if realizability issues?

Acctg301 – Widdison – Revenue Recognition Issues                R.R. 1
III.    Alternatives

                               Before                                    Special
 Point of Sale                Delivery              After Delivery      Situations
General Rule                % completion           As cash           Franchises
                                                   collected –       Software sales
                                                   installment       Real estate
                                                   method.           sales
 Right of return? At production                    After all costs
                  completion                       recovered –
                                                   cost recovery

A.      General Rule – Point of Sale means At Delivery

        Goods – when title passes. (F.O.B. terms)
        Services – when all contractual services completed

        Issue: Right of return? Estimation of returns critical.
        If not reliably estimable, delay recognition until return date

B.      Before Delivery – During or End of Earnings Process

             During earnings process -- % completion method for
              long-term construction contracts. Rationale?

             End of earnings process – immediately upon
              completion of production and before delivery. (e.g.
              mining, agricultural production). Rationale? (Text Page

Acctg301 – Widdison – Revenue Recognition Issues                          R.R. 2
Accounting for Long-Term Construction Contracts1 – Mechanics

Percentage of Completion Method – Preferred Method.

Process: Revenues and gross profit recognized during
construction process based on estimate of percentage of
accomplishment during the period.

Criteria:         buyer and seller have enforceable rights re. goods and
                  services to be performed and received by the parties.
                  buyer can be expected to satisfy all obligations under
                  contractor can be expected to perform contractual

If criteria not met, completed-contract method must be used.

Mechanics: Progress made on project is measured using “cost-
to-cost” basis at the end of each period.

Cost incurred to date/Total estimated project costs = % completed

Contract revenue x percent completed = total revenue earned
Total revenue earned less revenue recorded previous periods =
period revenue recognized.
(Contract gross profit x percent completed = gross profit earned)

    Accounting Research Bulletin 45 (ARB45)

Acctg301 – Widdison – Revenue Recognition Issues                R.R. 3
Accounts Used:

Balance Sheet:
Construction in Progress –                         Asset. Inventory of construction
asset account, Dr. balance.                        costs during project. Also
                                                   marked up each period by
                                                   period’s gross profit.
Billings on Construction                           Contra-asset to Construction in
Contract – valuation account,                      Progress account.
Cr. balance.                                       Accumulation of billings made
                                                   to customer throughout project
Accounts Receivable                                Asset. Amounts still owed by
                                                   customers re. billings.
Cash                                               Asset. Records receipt of
                                                   receivables from customers
Income Statement Accounts:
Revenue from Long-Term                             Amount of revenue recorded for
Contracts                                          period
Cost of Construction                               Like “Cost of Goods Sold”
                                                   account. Period construction
                                                   costs expensed.

Examples of Journal Entries Relating to Particular Events:

Construction contract won and work begins:                           No entries.

During each period:

 Materials, direct labor, etc. applied to project (% and cc)

Construction in Progress                                       Dr.
    Materials, payables, etc.                                             Cr.

Acctg301 – Widdison – Revenue Recognition Issues                           R.R. 4
 Progress Billings sent to customers: (% and cc)

        Accounts receivable                        Dr.
            Billings on Construction Contract              Cr.

 Payments received from customers: (% and cc)

        Cash                                       Dr.
            Accounts Receivable                            Cr

Please note that the above entries have absolutely nothing to do
with how much profit is recognized for the period. They are
irrelevant to the revenue recognition process.

End of each period: (% completion only)

Measurement of progress on contract (see above). Revenue,
expenses, and gross profit recognized.

        Cost of Construction                       Dr.
        Construction in Progress (gross profit)    Dr.
             Revenue from Construction                     Cr.

(Rationale for putting gross profit into CIP account. Since we are
recognizing revenues and costs during construction, not at point
of sale, the gross profit that arises must be reflected as an asset
on the balance sheet. Thus, the inventory item that is being
prepared for sale is marked up to its contract value from its cost.)

Balance sheet shows Construction in Progress net of the balance
in the Billings account. If a net debit balance – asset side; if a net
credit balance – liability side.

Revenue and Cost of Construction accounts closed into Retained

Acctg301 – Widdison – Revenue Recognition Issues            R.R. 5
End of Project: (% and cc)

Construction in Progress and Billings Accounts are closed: (Note
that these accounts should have the same total balances.)

         Billings on Construction Contract                                         Dr.
               Construction in Progress                                                              Cr.

1.       Kinks in the System!

If cost estimation changes, it may be necessary to remove some
gross profit previously recorded. If cost overrun is significant, the
whole project may become a loss. What do we do?

a.       Removal of previously recorded gross profit (period loss) –
         overall project still anticipated to be profitable. (P. 915)

         Cost of Construction                                            Dr.
              Construction in Progress                                                      Dr. or Cr.2
              Revenue from Construction                                                     Cr.

b.       Overall project now estimated to be probable loss. Take
         entire loss predicted. (Conservatism.) (P. 916). Remove
         from Construction in Progress all previously recorded gross
         profit and add to that amount the anticipated overall project

         Cost of Construction                                            Dr.
              Revenue from Construction                                                     Cr.
              Construction in Progress                                                      Cr.

 Depends on relationship between new gross profit and amount already in CIP. Could need to remove all
previously record gross profit, in which case CIP is credited, or only some of it, in which case CIP is debited.

Acctg301 – Widdison – Revenue Recognition Issues                                                       R.R. 6
2. Completed Contract Method. Recognition at delivery. Note
that matching principle will not allow periodic recognition of
contract expenses since no related revenue is being recorded.

(a). Entries during the period to record construction costs and
billings, etc. are the same as percentage method.

(b)     Revenues, expenses, and gross profit recognized in entirety
        at end of construction and delivery.

        Construction in Progress                   Dr. (gross profit)
        Construction Costs                         Dr. (total expenses)
            Revenue from Construction                    Cr. (total revenue)

(c). End of project – closing entry the same as percentage
method. Construction in Progress and Billings accounts closed to
each other.

Application: WeBuilditBetter Corporation attached. Use text
book examples and journal entry guidance above to assist you.

Acctg301 – Widdison – Revenue Recognition Issues                    R.R. 7
C.      After Delivery – Installment Sales

Scenario: Follow general rule if realization reasonably assured. If
significant uncertainty exists, use installment sale method or cost
recovery method.

Installment Sale Method: Determine gross profit percent when
sale is made. Recognize gross profit as deferred. Record in a
contra-asset account. (Contra to installment receivables.) As
cash installments received, recognize a portion of the payment as
gross profit realized.

Sale is made:

        Installment receivables                    Dr. for total due.
             Inventory                                   Cr. for cost of item.
             Deferred gross profit                       Cr. Future profit.

Cash installments received:

        Cash                                       Dr. cash received.
            Installment receivables                    Cr.

        Deferred gross profit                      Dr. (cash x gross profit %)
            Realized gross profit                        Cr. (income statemen)

Cost Recovery method: Extremely significant doubt about
realization. As installments received, no profit is recognized until
total cash received is equal to cost of item sold. Once cost
recovered, deferred profit is reclassified to realized gross profit as
installments come in.

Sales is made: Entry the same as installment sale.

Acctg301 – Widdison – Revenue Recognition Issues                          R.R. 8
Installments up to cost recovery:

        Cash                                       Dr.
            Installment receivables                      Cr.

Installments once cost recovery made:

        Recognize cash as above.

        Deferred gross profit                      Dr. (installment amount)
            Gross profit realized                        Cr.

Application: Complete SudsGalore activity attached to this

D.      At Production Completion and Before Delivery

Certain industries have “for sure” sales upon completion of
production. Criteria – certain market at a known and reasonably
assured sales price. Precious metal mining, agricultural products
with assured prices.

Acctg301 – Widdison – Revenue Recognition Issues                        R.R. 9
Contract Accounting Class Activity:

On July 1, 2004, WeBuilditBetter Corp. contracted to build an
office building for WeWantitBetter Corp. for a total contract price
of $1,900,000. The building was completed on December 31,
2006. Cost, billings, and collections information is presented in
the table below.

            Item                                   2004       2005         2006
Contract costs incurred
during the year.                                   $150,000   $650,000   $900,000
Estimated costs to
complete as of 12/31 each                      1,350,000       800,000             0
Billings to WeWantit
Better Corp.                                        300,000    700,000     900,000
Collections from
WeWantitBetter Corp.                                300,000    600,000   1,000,000

1.      Using the percentage-of-completion method, cost-to-cost
        approach, prepare the necessary journal entries to record
        the above information for each year.

2.      Suppose the estimated cost to complete as of December 31,
        2005, were $1,200,000 and the estimation proves to be
        correct. Using the percentage-of-completion method,
        prepare the necessary journal entries to record the revised
        information for each year.

3.      Using the completed contract method and the data originally
        presented in the table above, prepare the necessary journal
        entries to record the activity related to the contract for each

Acctg301 – Widdison – Revenue Recognition Issues                         R.R. 10
Installment Sales Class Activity:

SudsGalore Company sells washing machines to interested
customers, regardless of their credit history. In 2005 and 2006,
the company’s sales were $250,000 and $260,000 respectively,
and the costs of these sales were $150,000 and $169,000
respectively. Cash collections were $75,000 in 2005 and
$250,000 in 2006 ($100,000 from 2001 sales and $150,000 from
2002 sales.) In 2007, SudsGalore repossessed a washing
machine that was sold to a customer in 2005 for $300. The
machine had originally cost SudsGalore $180. The customer had
paid $100 in 2005 and nothing in 2006. At the date of the
repossession, the washing machine in its current condition had a
market value of $150.

1.      Using the installment method, prepare the necessary journal
        entries to record the above information.

2.      Using the cost-recovery method, prepare the necessary
        journal entries to record the above information.

Acctg301 – Widdison – Revenue Recognition Issues          R.R. 11

Description: Point of Sale Software Contract document sample