Income Measurement and Profitability Analysis

1. Income Measurement and Profitability Analysis Sid Glandon, DBA, CPA Assistant Professor of Accounting

2. Guidelines for Revenue Recognition • Revenue is recognized when • It is earned, and • When the earning process is substantially complete • It is realized or realizable • When goods and services are exchanged for cash or claims to cash

3. Staff Accounting Bulletin No. 101 • Persuasive evidence of an arrangement exists • Delivery has occurred or services have been rendered • The seller’s price to the buyer is fixed or determinable • Collectibility is reasonably assured

4. Four Types of Transactions • Sale of products • Recognized at date of sale (delivery) • Provision of services • Recognized when performed and billable • Revenue from use of assets • Recognized as time passes or assets used up • Disposal of assets • Recognized at point of sale

5. Revenue Recognition • Completion of production • Revenue recognition after delivery if there is uncertainty of collectibility • Installment sales • Cost recovery • Deposit method • Buyback agreements • Right of return • Consignment sales

6. Installment Sales • Recognizes income in periods of collection instead of point of sale • Title does not pass to buyer until after final payment • Both sales and cost of sales are deferred • Selling and administrative expenses are not deferred

7. Installment Sales Example

8. Installment Sales Example

14. Cost Recovery Method • Seller recognizes no profit until cash receipts exceed seller’s cost of merchandise • After recovering all costs, seller includes additional cash collections in income • Used where there is no reasonable basis for estimating collectibility • Franchises and real estate • Income statement • Report amount of gross profit recognized and deferred

15. Deposit Method • Seller receives cash before transfer • Seller has no claim against purchaser • Insufficient transfer of risks to buyer to warrant recording a sale • Defers sale recognition until sale has occurred

16. Revenue Recognition Before Delivery • Long-term construction contracts • Percentage of completion • Periodic billing • Completed contract • Only used when percentage method is inapplicable

17. Long-Term Construction Contracts Accounting Methods • Percentage of completion • Terms of contract must be certain and enforceable • Certainty of performance • Completed contract • Uncertainty • Short-term contracts

18. Percentage of Completion • Permits periodic billing • Amount of gross profit recognized • Normally based on percentage of work completed

19. Percentage Completion Steps

20. Example: Percentage Completion

21. Step #1: Percentage Complete

22. Step #2: Current Period Revenue

23. Step #3: Current Period Costs

24. Step #4: Current Period Gross Profit

25. Long-Term Contract Losses • Loss in Current Period on a Profitable Contract • Losses are recognized in current period under the percentage of completion method • Loss on an Unprofitable Contract • Expected contract loss is recognized in current period under either method

26. Activity Ratios • Receivables turnover ratio • Inventory turnover ratio • Asset turnover ratio

27. Activity Ratios

28. Profitability Ratios • Profit margin on sales • Return on assets • Return on shareholders’ equity

29. Profitability Ratios