HIGHLIGHTS OF CHAPTER 5: Income Measurement & Profitability Analysis

HIGHLIGHTS OF CHAPTER 5: Income Measurement & Profitability Analysis September 2004

SIGNIFICANT ISSUES Revenue recognition criteria Installment sales & cost recovery Revenue recognition & right of return % of completion & completed contract methods Software & franchise sales Profitability ratios

REALIZATION PRINCIPLE Earnings process complete or virtually complete Reasonable certainty as to collectibility

CURRENT DEVELOPMENTS SAB No. 101 FASB projects Amended Concept Statement Broad-based Recognition Standard

INSTALLMENT SALES Sale initially recorded on balance sheet only Gross profit netted against installment receivables Gross profit recognized in income as installments received

COST RECOVERY METHOD Sale initially recorded on balance sheet only Gross profit netted against installment receivables Gross profit recognized in income only after all costs are recovered from installments received

RIGHT OF RETURN/CONSIGNED Delayed revenue recognition when significant, unpredictable level of returns Consignment to distributors

SERVICE REVENUES Recognize immediately ? . . . over time? . . . on service provided?

LONG-TERM CONTRACTS Completed contract method Percentage-of-completion method

COMPLETED CONTRACT Accumulate costs during project Report billings to date as contra asset Record revenue & cost at completion

PERCENTAGE-OFCOMPLETION Accumulate costs during project Report billings as contra-asset Record revenue & cost based on % of actual costs to date to total actual & estimated costs Accounting for losses?

INDUSTRY SPECIFIC Software revenue recognition Franchise revenue recognition Precious metals Other

RATIOS Receivables turnover Days-to-collect (Average collection period) Inventory turnover Days-to-sell (Average days in inventory) Asset turnover

MORE RATIOS Gross margin Profit margin Return on assets (ROA) Return on equity (ROE)