Accounting Chapter 5 Homework Note These General Conditions Typically Will Lead

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subject Words 1477
subject Authors David Spiceland, James Sepe, Mark Nelson, Wayne Thomas

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T5-41
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DUPONT FRAMEWORK
The DuPont Framework helps identify how profitability, activity, and financial
leverage trade off to determine return to shareholders:
Return on
equity
=
Profit
margin
X
Asset
turnover
X
Equity
multiplier
Because profit margin and asset turnover combine to equal return on assets, the
DuPont framework can also be written as:
=
Return on
assets
X
Equity
multiplier
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T5-42
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HOW WAS GAAP CHANGED BY ASU 2014-09?
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Previous GAAP
New GAAP
Under ASU No. 2014-09
Key concept
underlying
revenue
recognition
The realization principle: Recognize revenue
when both the earnings process is complete
and there is reasonable certainty as to
collectibility of the asset(s) to be received.
The core revenue recognition principle: Recognize
revenue when goods or services are transferred to
customers for the amount the company expects
to be entitled to receive in exchange for those
goods and services.
Criteria for
recognizing
revenue over time
Depends on the earnings process. For long-
term contracts, recognizing revenue over
time is generally required unless reliable
estimates can’t be made.
Depends on characteristics of the contract and of
the performance obligations being satisfied.
Accounting for
multiple
Depends on the industry. Sometimes
performance obligations are ignored (e.g.,
Regardless of industry, apply criteria for
determining whether goods and services are
Treatment of
customer options
for additional
goods or services
Depends on the industry. Sometimes
treated as a separate deliverable (e.g.,
software upgrades), other times ignored
(e.g., frequent flyer miles).
Regardless of industry, treat an option as a
separate performance obligation if it provides a
material right to the customer that the customer
would not have otherwise.
Treatment of time
value of money
Interest revenue recognized for long-term
receivables but interest expense typically
not recognized for long-term prepayments.
Interest revenue or expense recognized for both
long-term receivables and long-term customer
prepayments if amount is significant.
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T5-43
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REALIZATION PRINCIPLE
The realization principle requires that two criteria be satisfied before revenue can be
recognized:
The earnings process is judged complete or virtually complete (the earnings
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T5-44
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INTERNATIONAL FINANCIAL REPORTING STANDARDS
Revenue Recognition Concepts. IAS No. 18 governs most revenue recognition
under IFRS. Similar to U.S. GAAP, it defines revenue as “the gross inflow of economic
benefits during the period arising in the course of the ordinary activities of an entity
when those inflows result in increases in equity, other than increases relating to
contributions from equity participants.” IFRS allows revenue to be recognized when the
following conditions have been satisfied:
1. The amount of revenue and costs associated with the transaction can be
measured reliably,
3. (for sales of goods) the seller has transferred to the buyer the risks and rewards
of ownership, and doesn’t effectively manage or control the goods,
4. (for sales of services) the stage of completion can be measured reliably.
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T5-45
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RELATION BETWEEN EARNINGS PROCESS
AND REVENUE RECOGNITION METHODS
In most situations, the revenue recognition criteria are satisfied at
the point of product delivery.
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T5-46
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REVENUE RECOGNITION
Usually Recognize Revenue for:
Nature of the Revenue
Sale of a Product
Sale of a Service
Revenue Recognition Prior
to Delivery, Because:
Dependable estimates of
progress are available.
Each period during the earnings process
(e.g., long-term construction contract) in
Not applicable
Revenue Recognition
at Delivery
When product is delivered and title transfers
As the service is provided or the key
activity is performed
Revenue Recognition After
Delivery, Because:
Payments are
When cash is collected (installment sales or
When cash is collected
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T5-47
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INTERNATIONAL FINANCIAL REPORTING STANDARDS
Long-Term Construction Contracts. IAS No. 11 governs revenue recognition
for long-term construction contracts. Like U.S. GAAP, IAS No. 11 requires use of
percentage-of-completion accounting when estimates can be made precisely. Unlike
U.S. GAAP, IAS No. 11 requires use of the cost recovery method rather than the
completed contract method when estimates cannot be made precisely enough to allow
To see the difference, here is a version of Illustration 5-12B that compares cost and
gross profit recognition under the two methods:
COMPLETED CONTRACT:
Construction in progress
900,000
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T5-48
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INSTALLMENT SALES METHOD
The installment sales method recognizes gross profit by applying the gross profit
percentage on the sale to the amount of cash actually received.
On November 1, 2016, the Belmont Corporation, a real estate developer, sold a tract
Illustration 5-A3
Gross Profit Recognition
Date
Cash Collected
Cost Recovery
($560/$800=70%)
Gross Profit
($240/$800=30%)
Nov. 1, 2016
$200,000
$140,000
$ 60,000
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T5-49
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INSTALLMENT SALES METHOD
(continued)
Journal Entries
Nov. 1, 2016 To record installment sale
Installment receivables ................................................... 800,000
Nov. 1, 2016 To record cash collection from installment sale
To recognize gross profit from installment sale
T5-49 (continued)

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