CIA1003 INTERMEDIATE FINANCIAL
ACCOUNTING AND REPORTING
Semester 2, 2019/2020
Lecture 4: REVENUE
1
APPENDIX 18A Long-Term Construction Contracts
LEARNING OBJECTIVE 5
Apply the percentage-of-completion method for long-term contracts.
Revenue Recognition Over Time
Under certain circumstances companies recognize revenue over time.
The most notable context in which revenue may be recognized over time is
long-term construction contract accounting.
LO 5
Revenue Recognition Over Time
Long-term contracts frequently provide Weapons-delivery systems
that seller (builder) may bill purchaser
at intervals.
► Examples:
Development of military and
commercial aircraft Space exploration hardware
LO 5
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. Customer simultaneously receives and consumes the benefits of
the seller’s performance as the seller performs [see B3-B4].
2. Company’s performance creates or enhances an asset (for
example, work in process) that the customer controls as the asset
is created or enhanced [see B5]; or
3. Company’s performance does not create an asset with an
alternative use [see para 36; B9-B13]. In addition to this
alternative use element, at least one of the following criteria must
be met:
LO 5
Revenue Recognition Over Time
In addition to this alternative use element, at least one of the
following criteria must be met:
a. Another company would not need to substantially re-perform
the work the company has completed to date if that other
company were to fulfill the remaining obligation to the
customer [B4].
b. The company has a right to payment for its performance
completed to date [see para 37], and it expects to fulfill the
contract as promised.
LO 5
Revenue Recognition Over Time
If criterion 1, 2 or 3 is met, then a company recognizes
revenue over time if it can reasonably estimate its progress
toward satisfaction of the performance obligations.
Company recognizes revenues and gross profits each
period based upon the progress of the construction—
referred to as the percentage-of-completion method.
If criteria are not met, the company recognizes revenues
and gross profit when the contract is completed, referred
to as the cost-recovery (zero-profit) method.
LO 5
Revenue Recognition Over Time
Percentage-of-Completion Method
Measuring the Progress Toward Completion
1. Output method [B15-B17]
2. Input method [B18-B19]
Most popular input measure used to determine the progress
toward completion is the cost-to-cost basis.
LO 5
Percentage-of-Completion Method
Revenue to be Recognized on Cost-to-Cost Basis
ILLUSTRATION 18A.1
ILLUSTRATION 18A.2
ILLUSTRATION 18A.3
LO 5
Percentage-of-Completion Method
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 2019, and the bridge
is to be completed in October 2021. The following data pertain to
the construction period.
2019 2020 2021
LO 5
Percentage-of-Completion Method
2019 2020 2021
2019 2020 2021
ILLUSTRATION 18A.4
Application of Percentage-of-
Completion Method, Cost-to-
Cost Basis LO 5
Percentage-of-Completion Method
2019 2020 2021
ILLUSTRATION 18A.5 2019 2020 2021
LO 5
Percentage-of-Completion Method
Illustration: Percentage-of-Completion Revenue, Costs, and
Gross Profit by Year
ILLUSTRATION 18A.6
2019
2020
2021
LO 5
ILLUSTRATION 18A.6
Percentage-of- 2019
Completion
Method 2020
2021
ILLUSTRATION 18A.7 2019 2020 2021
LO 5
Percentage-of-Completion Method
Illustration: Content of Construction in Process Account—
Percentage-of-Completion Method
ILLUSTRATION 18A.8
LO 5
Percentage-of-Completion Method
Financial Statement Presentation—Percentage-of-
Completion
Computation of Unbilled Contract Price at 12/31/19
ILLUSTRATION 18A.9
LO 5
Percentage-of-Completion Method
Financial Statement Presentation—Percentage-of-
Completion (2019)
ILLUSTRATION 18A.10
Percentage-of-Completion Method
Financial Statement Presentation—Percentage-of-
Completion (2020)
ILLUSTRATION 18A.11
Percentage-of-Completion Method
Financial Statement Presentation—Percentage-of-
Completion (2021)
ILLUSTRATION 18A.12
LO 5
APPENDIX 18A Long-Term Construction Contracts
Cost-Recovery (Zero-Profit) Method
LEARNING OBJECTIVE 6
Apply the cost-recovery method for long-term contracts.
This method recognizes revenue only to the extent of costs
incurred that are expected to be recoverable.
Only after all costs are incurred is gross profit recognized.
LO 6
Cost-Recovery (Zero-Profit) Method
Illustration: Hardhat Construction would report the following
revenues and costs for 2019–2021. ILLUSTRATION 18A.14
2019
2020
2021
LO 6
ILLUSTRATION 18A.14
Cost-Recovery Method Revenue,
Costs, and Gross Profit by Year
2019 2020 2021
ILLUSTRATION 18A.15
Journal Entries—Cost-Recovery Method
LO 6
ILLUSTRATION 18A.14
Cost-Recovery Method Revenue,
Costs, and Gross Profit by Year
ILLUSTRATION 18A.16
Comparison of Gross Profit Recognized under Different Methods
LO 6
ILLUSTRATION 18A.17
Financial Statement Presentation—Cost- Recovery Method
LO 6
APPENDIX 18A Long-Term Construction Contracts
Long-Term Contract Losses
LEARNING OBJECTIVE 7
Identify the proper accounting for losses on long-term contracts.
1. Loss in Current Period on a Profitable Contract
► Percentage-of-completion method only, the estimated
cost increase requires a current-period adjustment of
excess gross profit recognized in prior periods.
2. Loss on an Unprofitable Contract
► Under both percentage-of-completion and cost-
recovery methods, the company must recognize in the
current period the entire expected contract loss.
LO 7
Long-Term Contract Losses
Loss in Current Period
2018 2019 2020
Contract price $675,000 $675,000 $675,000
Cost incurred current year 150,000 287,400 215,436
Estimated cost to complete
in future years 450,000 215,436 0
Billings to customer current year 135,000 360,000 180,000
Cash receipts from customer
Current year 112,500 262,500 300,000
Prepare the journal entries to record revenue and expense for 2018, 2019, and
2020 assuming the estimated cost to complete at the end of 2019 was
$215,436.
LO 7
Loss in Current Period
2018
2014 2019
2015 2020
2016
Costs incurred to date $ 150,000 $ 437,400 $ 652,836
Estimated cost to complete 450,000 215,436
Est. total contract costs 600,000 652,836 652,836
Est. percentage complete 25.0% 67.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 452,250 675,000
Rev. recognized prior year (168,750) (452,250)
Rev. recognized currently 168,750 283,500 222,750
Costs incurred currently (150,000) (287,400) (215,436)
Gross profit recognized $ 18,750 $ (3,900) $ 7,314
LO 7
Loss in Current Period
2018 2019 2020
Construction in Process 18,750 7,314
Construction Expenses 150,000 215,436
Revenue from LT Contracts 168,750 222,750
Construction in Process 3,900
Construction Expenses 287,400
Revenue from LT Contracts 283,500
LO 7
Long-Term Contract Losses
Loss on Unprofitable Contract
2018 2019 2020
Casper Construction
Contract price Co. $675,000 $675,000 $675,000
Cost incurred current year 150,000 287,400 246,038
Estimated cost to complete
in future years 450,000 246,038 0
Billings to customer current year 135,000 360,000 180,000
Cash receipts from customer
Current year 112,500 262,500 300,000
Prepare the journal entries for 2018, 2019, and 2020 assuming the estimated
cost to complete at the end of 2019 was $246,038 instead of $170,100.
LO 7
Loss on Unprofitable Contract
2018
2014 2019
2015 2020
2016
Costs incurred to date $ 150,000 $ 437,400 $ 683,438
Estimated cost to complete 450,000 246,038
Est. total contract costs 600,000 683,438 683,438
Est. percentage complete 25.0% 64.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 432,000 675,000
Rev. recognized prior year (168,750) (432,000)
Rev. recognized currently 168,750 263,250 243,000
Costs incurred currently (150,000) (290,438) (243,000)
Gross profit recognized $ 18,750 $ (27,188) $ -
$675,000 – 683,438 = (8,438) cumulative loss
LO 7
Loss on Unprofitable Contract
2018 2019 2020
Construction in Process 18,750 -
Construction Expenses 150,000 243,000
Revenue from LT Contracts 168,750 243,000
Construction Expenses 290,438
Construction in Process 27,188
Revenue from LT Contracts 263,250
LO 7
Loss on Unprofitable Contract
For the Cost-Recovery method, companies would recognize the
following loss :
2018 2019 2020
Loss on LT Contracts 8,438
Construction in Process 8,438
LO 7
APPENDIX 18B Revenue Recognition for Franchises
LEARNING OBJECTIVE 8
Explain revenue recognition for franchises.
Four types of franchising arrangements have evolved:
1. Manufacturer-retailer
2. Manufacturer-wholesaler
3. Service sponsor-retailer
4. Wholesaler-retailer
LO 8
APPENDIX 18B Revenue Recognition for Franchises
Franchise companies derive their revenue from one or
both of two sources:
1. Sale of initial franchises and related assets or services,
and
2. Continuing fees based on the operations of franchises.
LO 8
APPENDIX 18B Revenue Recognition for Franchises
The franchisor normally provides the franchisee with:
1. Assistance in site selection
2. Evaluation of potential income
3. Supervision of construction activity
4. Assistance in the acquisition of signs, fixtures, and equipment
5. Bookkeeping and advisory services
6. Employee and management training
7. Quality control
8. Advertising and promotion
LO 8
APPENDIX 18B Revenue Recognition for Franchises
Franchise Accounting
Performance obligations relate to:
Right to open a business.
Use of trade name or other intellectual property of the
franchisor.
Continuing services, such as marketing help, training, and
in some cases supplying inventory and inventory
management.
LO 8
Franchise Accounting
Franchisors commonly charge an initial franchise fee and
continuing franchise fees:
► Initial franchise fee (payment for establishing the relationship
and providing some initial services).
► Continuing franchise fees received
In return for continuing rights granted by the agreement.
For providing management training, advertising and
promotion, legal assistance, and other support.
LO 8
FRANCHISE
Facts: Tum’s Pizza Inc. enters into a franchise agreement on November 1,
2019, giving Food Fight Corp. the right to operate as a franchisee of Tum’s
Pizza for 5 years. Tum’s charges Food Fight an initial franchise fee of
$50,000 for the right to operate as a franchisee. Of this amount, $20,000 is
payable when Food Fight signs the agreement, and the balance is payable
in five annual payments of $6,000 each on December 31. Food Fight also
promises to pay ongoing royalty payments of 1% of its annual sales
(payable each January 31 of the following year) and is obliged to purchase
products from Tum’s at its current standalone selling prices at the time of
purchase. The credit rating of Food Fight indicates that money can be
borrowed at 8%. The present value of an ordinary annuity of five annual
receipts of $6,000 each discounted at 8% is $23,957. The discount of
$6,043 represents the interest revenue to be accrued by Tum’s over the
payment period.
LO 8
What are the performance obligations and the point in time when the
performance obligations are satisfied and revenue is recognized?
Rights to the trade name, market area, and proprietary know-
how for 5 years are not individually distinct.
Each one is not sold separately and cannot be used with other
goods or services that are readily available to the franchisee.
Combined rights give rise to a single performance obligation.
Tum’s satisfies performance obligation at point in time when
Food Fight obtains control of the rights.
LO 8
What are the performance obligations and the point in time when the
performance obligations are satisfied and revenue is recognized?
Training services and equipment are distinct because similar
services and equipment are sold separately.
Tum’s satisfies those performance obligations when it
transfers the services and equipment to Food Fight.
Tum’s cannot recognize revenue for the royalty payments because
it is not reasonably assured to be entitled to those royalty amounts.
Tum’s recognizes revenue for the royalties when (or as) the
uncertainty is resolved.
LO 8
Franchise Accounting
Consider the following for allocation of the transaction price at
December 31, 2019.
Training is completed in January 2020, the equipment is installed in
January 2020, and Food Fight holds a grand opening on February 2,
2020.
LO 8
Franchise Accounting
On December 31, 2019, Tum’s signs the agreement and receives
upfront payment and note.
Cash 20,000
Notes Receivable 23,957
Unearned Franchise Revenue 20,000
Unearned Service Revenue (training) 9,957
Unearned Sales Revenue (equipment) 14,000
LO 8
Franchise Accounting
On February 2, 2020, franchise opens. Tum’s satisfies the performance
obligations related to the franchise rights, training, and equipment.
Unearned Franchise Revenue 20,000
Franchise Revenue 20,000
Unearned Service Revenue (training) 9,957
Service Revenue (training) 9,957
Unearned Sales Revenue (equipment) 14,000
Sales Revenue 14,000
Cost of Goods Sold 10,000
Inventory 10,000
LO 8
Franchise Accounting
During 2020, Food Fight does well, recording $525,000 of sales in its
first year of operations. The entries for Tum’s related to the first year of
operations (December 31, 2020) of the franchise are as follows.
To record continuing franchise fees.
Accounts Receivable ($525,000 × 1%) 5,250
Franchise Revenue 5,250
To record payment received and interest revenue on the note.
Cash 6,000
Notes Receivable 6,000
Notes Receivable ($23,957 × 8%) 1,917
Interest Revenue 1,917
LO 8
APPENDIX 18B Revenue Recognition for Franchises
Recognition of Franchise Rights Revenue over
Time
Depending on the economic substance of the rights, the
franchisor may be providing access to the right rather than
transferring control of the franchise rights.
In this case, the franchise revenue is recognized over time,
rather than at a point in time.
LO 8
FRANCHISE REVENUE OVER TIME
Facts: Tech Solvers Corp. is a franchisor and provides a range of
computing services (hardware/software installation, repairs, data backup,
device syncing, and network solutions) on popular Apple and PC devices.
Each franchise agreement gives a franchisee the right to open a Tech
Solvers store and sell Tech Solvers’ products and services in the area for 5
years. Under the contract, Tech Solvers also provides the franchisee with a
number of services to support and enhance the franchise brand, including
(a) advising and consulting on the operations of the store;
(b) communicating new hardware and software developments, and
service techniques;
(c) providing business and training manuals; and
(d) advertising programs and training.
LO 8
FRANCHISE REVENUE OVER TIME
Facts: As an almost entirely service operation (all parts and other supplies
are purchased as needed by customers), Tech Solvers provides few
upfront services to franchisees. Instead, the franchisee recruits service
technicians, who are given Tech Solvers’ training materials (online
manuals and tutorials), which are updated for technology changes, on a
monthly basis at a minimum. Tech Solvers enters into a franchise
agreement on December 15, 2019, giving a franchisee the rights to
operate a Tech Solvers franchise in eastern Bavaria for 5 years. Tech
Solvers charges an initial franchise fee of $5,000 for the right to operate as
a franchisee, payable upon signing the contract. Tech Solvers also
receives ongoing royalty payments of 7% of the franchisee’s annual sales
(payable each January 15 of the following year). The franchise began
operations in January 2020 and recognized $85,000 of revenue in 2020.
LO 8
What are the performance obligations and the point in time when the
performance obligations are satisfied and revenue is recognized?
Rights to the trade name, market area, and proprietary know-how
for 5 years are not individually distinct.
Each one is not sold separately and cannot be used with other
goods or services that are readily available to the franchisee.
Licensed rights and the ongoing training materials are a single
performance obligation.
Tech Solvers is providing access to the rights and must continue
(over time) to perform updates and services.
LO 8
What are the performance obligations and the point in time when the
performance obligations are satisfied and revenue is recognized?
Tech Solvers cannot recognize revenue for the royalty payments
Not reasonably assured to be entitled to those revenue-based
royalty amounts.
Payments represent variable consideration.
Recognize revenue for royalties when (or as) uncertainty is
resolved.
LO 8
FRANCHISE REVENUE OVER TIME
Franchise agreement signed and receipt of upfront payment and note,
December 15, 2019:
Cash 5,000
Unearned Franchise Revenue 5,000
Franchise begins operations in January 2020 and records $85,000 of
revenue for the year ended December 31, 2020.
Unearned Franchise Revenue 1,000
Franchise Revenue ($5,000 ÷ 5) 1,000
Accounts Receivable 5,950
Franchise Revenue ($85,000 x 7%) 5,950
LO 8
CIA1003: TUTORIAL 4
Kieso et al. (2017). Intermediate accounting: IFRS edition (3rd
Edition) - Chapter 18: Revenue Recognition
Questions: 34, 35.
Exercise(E): E18.33
Problem (P): P18.11
END OF LECTURE
