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1 Income Measurement and Profitability Analysis Sid Glandon, DBA, CPA Associate Professor of...
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![Page 1: 1 Income Measurement and Profitability Analysis Sid Glandon, DBA, CPA Associate Professor of Accounting.](https://reader034.fdocuments.in/reader034/viewer/2022042717/56649dd15503460f94ac7bc1/html5/thumbnails/1.jpg)
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Income Measurement and Profitability Analysis
Sid Glandon, DBA, CPAAssociate Professor of Accounting
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Guidelines for Revenue Recognition
Revenue is recognized whenIt 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
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Staff Accounting Bulletin No. 101
Persuasive evidence of an arrangement existsDelivery has occurred or services have been renderedThe seller’s price to the buyer is fixed or determinableCollectibility is reasonably assured
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Four Types of Transactions
Sale of productsRecognized at date of sale (delivery)
Provision of servicesRecognized when performed and billable
Revenue from use of assetsRecognized as time passes or assets used up
Disposal of assetsRecognized at point of sale
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Revenue RecognitionTransfer of title, date of deliveryCompletion of productionRevenue recognition after delivery if there is uncertainty of collectibility
Installment salesCost recoveryDeposit methodBuyback agreementsRight of returnConsignment sales
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Installment Sales
Recognizes income in periods of collection instead of point of saleTitle does not pass to buyer until after final paymentBoth sales and cost of sales are deferredSelling and administrative expenses are not deferred
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Installment Sales ExampleFact Pattern 2004 2005 2006
Installment sales $200,000 $250,000 $240,000Cost of sales 150,000 190,000 168,000Gross profit $50,000 $60,000 $72,000
Gross profit percentage 25% 24% 30%
Cash received: 2004 2005 2006 from 2004 sales $60,000 $100,000 $40,000 from 2005 sales 100,000 125,000 from 2006 sales 80,000 Total cash received (by year) $60,000 $200,000 $245,000
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Installment Sales ExampleRecognized gross profit: 2004 2005 2006Collections, 2004 $60,000 $100,000 $40,000 Gross profit percentage 25% 25% 25% Gross profit recognized $15,000 $25,000 $10,000
Collections, 2005 $100,000 $125,000 Gross profit percentage 24% 24% Gross profit recognized $24,000 $30,000
Collections, 2006 $80,000 Gross profit percentage 30% Gross profit recognized $24,000
Total profit recognized (by year) $15,000 $49,000 $64,000
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Date Account Debit Credit2004 Installment receivables $200,000
Inventory $150,000 Deferred gross profit, 2004 50,000
2004 Cash $60,000 Installment sales $60,000
12/31/04 Deferred gross profit, 2004 $15,000 Recognized gross profit from installment sales $15,000
Analysis of realized gross profit:Collections on installment sales, 2004 $60,000Gross profit percentage, 2004 25% Recognized gross profit on installment sales $15,000
To record installment sales fo 2004
To record collections on installment sales for 2004
To recognize gross profit from 2004 installment sales
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Date Account Debit Credit2005 Installment receivables $250,000
Inventory $190,000 Deferred gross profit, 2005 60,000
2005 Cash $200,000 Installment sales $200,000
12/31/05 Deferred gross profit, 2004 $25,000Deferred gross profit, 2005 $24,000 Recognized gross profit from installment sales $49,000
To record installment sales fo 2005
To record collections on installment sales for 2005
To recognize gross profit from 2004 and 2005 installment sales
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Analysis of realized gross profit:Collections on installment sales, 2004 $100,000Gross profit percentage, 2004 25% Recognized gross profit on installment sales $25,000
Collections on installment sales, 2005 $100,000Gross profit percentage, 2005 24% Recognized gross profit on installment sales $24,000
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Date Account Debit Credit2006 Installment receivables $240,000
Inventory $168,000 Deferred gross profit, 2006 72,000
2006 Cash $245,000 Installment sales $245,000
12/31/06 Deferred gross profit, 2004 $10,000Deferred gross profit, 2005 $30,000Deferred gross profit, 2006 $24,000 Recognized gross profit from installment sales $64,000
To record installment sales fo 2006
To record collections on installment sales for 2006
To recognize gross profit from 2004, 2005 and 2006 installment sales
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Analysis of realized gross profit:Collections on installment sales, 2004 $40,000Gross profit percentage, 2004 25% Recognized gross profit on installment sales $10,000
Collections on installment sales, 2005 $125,000Gross profit percentage, 2005 24% Recognized gross profit on installment sales $30,000
Collections on installment sales, 2006 $80,000Gross profit percentage, 2006 30% Recognized gross profit on installment sales $24,000
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Cost Recovery MethodSeller recognizes no profit until cash receipts exceed seller’s cost of merchandiseAfter recovering all costs, seller includes additional cash collections in incomeUsed where there is no reasonable basis for estimating collectibility
Franchises and real estate
Income statementReport amount of gross profit recognized and deferred
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Deposit Method
Seller receives cash before transferSeller has no claim against purchaserInsufficient transfer of risks to buyer to warrant recording a saleDefers sale recognition until sale has occurred
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Revenue Recognition Before Delivery
Long-term construction contractsPercentage of completion• Periodic billing
Completed contract• Only used when percentage method is
inapplicable
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Long-Term Construction Contracts Accounting Methods
Percentage of completionTerms of contract must be certain and enforceableCertainty of performance
Completed contractUncertaintyShort-term contracts
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Percentage of Completion
Permits periodic billingAmount of gross profit recognized
Normally based on percentage of work completed
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Percentage Completion StepsStep #1: Percentage Complete
Costs incurred to-date $X,XXXEstimated total costs $X,XXX
Step #2: Current Period Revenue Contract price $X,XXX Percentage complete to date X % Revenue recognized to date $X,XXX Revenue recognized in prior periods ($X,XXX) Current period revenue $X,XXX
Step #3: Current Period Costs Costs incurred to date $X,XXX Costs incurred in prior period ($X,XXX) Current period costs $X,XXX
Step #4: Current Period Gross Profit Current period revenue $X,XXX Current period costs ($X,XXX) Current period gross profit $X,XXX
= X %
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Example: Percentage CompletionFact Pattern:Contract price $4,500,000Estimated cost 4,000,000Start date 7/1/04Finish date 10/31/06Balance sheet date 12/31
Annual Data: 2004 2005 2006Cost-to-date $1,000,000 $2,916,000 $4,050,000Estimated cost-to-complete 3,000,000 1,134,000 0Progress billings during the year 900,000 2,400,000 1,200,000Cash collected during the year 750,000 1,750,000 2,000,000
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Step #1: Percentage CompletePercentage Complete 2004 2005 2006
Cost incurred to-date $1,000,000 $2,916,000 $4,050,000Cost to complete 3,000,000 1,134,000 0 Estimated total cost $4,000,000 $4,050,000 $4,050,000
Cost incurred to-date $1,000,000 $2,916,000 $4,050,000Estimated total cost $4,000,000 $4,050,000 $4,050,000
Percentage complete 25% 72% 100%
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Step #2: Current Period RevenueCurrent Period Revenue 2004 2005 2006
Contract price $4,500,000 $4,500,000 $4,500,000Percentage complete to-date 25% 72% 100% Revenue recognized to-date 1,125,000 3,240,000 4,500,000Revenue recognized in prior periods 0 1,125,000 3,240,000 Current period revenue $1,125,000 $2,115,000 $1,260,000
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Step #3: Current Period CostsCurrent Period Cost 2004 2005 2006
Cost incurred to-date $1,000,000 $2,916,000 $4,050,000Cost incurrent in prior period 0 1,000,000 2,916,000 Current period cost $1,000,000 $1,916,000 $1,134,000
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Step #4: Current Period Gross ProfitCurrent Period Gross Profit 2004 2005 2006
Current period reveune $1,125,000 $2,115,000 $1,260,000Current period cost 1,000,000 1,916,000 1,134,000 Current period gross profit $125,000 $199,000 $126,000
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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 ContractExpected contract loss is recognized in current period under either method
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Activity Ratios
Receivables turnover ratioInventory turnover ratioAsset turnover ratio
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Activity RatiosNet sales
Average accounts receivable (net)
Cost of goods soldAverage inventory
Net salesAverage total assets
Asset turnover ratio =
=Receivables turnover ratio
Inventory turnover ratio =
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Profitability Ratios
Profit margin on salesReturn on assetsReturn on shareholders’ equity
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Profitability RatiosNet income
Net sales
Net incomeAverage total assets
Net incomeAverage shareholders' equity
Return on shareholders' equity =
=Profit margin on sales
Return on assets =