Chapter5: Income Measurement and Profitability Analysis
Revenue Recognition at Delivery
The basic journal entries to record revenue upon delivery should look familiar. As an example, assume that Taft Company sells a supercomputer for $5,000,000 that cost $4,100,000 to produce. The journal entries to record the sale, assuming that Taft uses the perpetual inventory method, would be
This sale yields gross profit of $900,000 ($5,000,000 − 4,100,000).
At the product delivery date we know the product has been sold, the price, and the buyer. However, usually the buyer is given a length of time, say 30 days, to pay for the goods after they have been delivered. Therefore, the only remaining uncertainty at the time of delivery involves the ultimate cash collection, which usually can be accounted for by estimating and recording allowances for possible return of the product and for uncollectibility of the cash, that is, bad debts. Both of these estimates are discussed in Chapter 7. As we discuss later in this chapter, significant uncertainty at point of product delivery related to either collectibility or product return causes a delay in revenue recognition.
Service revenue, too, often is recognized at a point in time if there is one final activity that is deemed critical to the earnings process. In this case, all revenue is deferred until this final activity has been performed. For example, a moving company will pack, load, transport, and deliver household goods for a fixed fee. Although packing, loading, and transporting all are important to the earning process, delivery is the culminating event of the earnings process. So, the entire service fee is recognized as revenue after the goods have been delivered. FedEx recognizes revenue in this manner. The Company's Summary of Significant Accounting Policies disclosure note indicates that “Revenue is recognized upon delivery of shipments.” As with the sale of product, estimates of uncollectible amounts must be made for service revenue provided to customers on a credit basis.p. 239
However, in many instances, service revenue activities occur over extended periods, so recognizing revenue at any single date within one period would be inappropriate. Instead, it's more meaningful to recognize revenue over time as the service is performed.
A similar situation occurs if you buy a season pass to Disney World. When would Walt Disney Co. recognize revenue for the cash it collects for the sale of a 365-day pass? Rationalizing that a pass can be used any number of times during the season, thus making it difficult to determine when service is provided, many companies once recognized all revenue from the sale of season passes on the date of sale. However, the SEC's Staff Accounting Bulletin No. 101, discussed earlier in the chapter, motivated most of these companies to change to recognizing revenue throughout the service period. For example, Graphic 5-4 provides a disclosure note Walt Disney Co. included in a recent annual report. Notice that the company now recognizes revenue over time, based on the anticipated usage of the season pass over the operating season.
Real World Financials
9As you will learn later in this chapter when we discuss the percentage-of-completion method, revenue can be recognized during the earnings process rather than at one particular point in time as long as particular criteria have been met.
10We discuss this aspect of title transfer in Chapter 7.