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Revenue Recognition - Production

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Revenue Recognition - Production

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When can revenue be recognized upon completion of production?

Revenue is recognized prior to sale or exchange.

There must be:
o A stable selling price
o Absence of material marketing costs to complete the final transfer.
o Interchangeability in units This approach is used:
o With agricultural products, byproducts, and precious metals when the aforementioned criteria are met.
o In accounting for construction contracts under the completed contract method.

When can I recognize revenue during production?
In the case of long-term production situations, revenue recognition is made when:
o An assured price for the completed item exists by contractual agreement, and a reliable measure of the degree of completion at various stages of the production process is possible.
EXAMPLE: The percentage of completion method used in accounting for long-term construction contracts.

Which is preferable-completed contract or percentage of completion method?

Under the completed contract method, revenue should not be recognized until completion of a contract. In general, the completed contract method should be used only when the use of the percentage of completion method is inappropriate.

How is revenue matched with costs in the percentage of completion method? Under the percentage of completion method, revenue is recognized as production activity is occurring. The gradual recognition of revenue levels out earnings over the years and is more realistic since revenue is recognized as performance takes place.

RECOMMENDATION: Percentage completed method is preferred over the completed contract method and should be used when reliable estimates of the extent of completion each period are possible. If not, the completed contract method should be used. Percentage of completion results in a matching of revenue against related expenses in the benefit period.

Using the cost-to-cost method, revenue recognized for the period equals:

Actual Costs to Date x Contract Price Total Estimated Costs = Cumulative

Revenue Revenue recognized in prior years is deducted from the cumulative revenue to determine the revenue in the current period.

Regardless of whether the percentage of completion method or the completed contract method is used, conservatism dictates that an obvious loss on a contract should immediately be recognized even before contract completion.

A good book to read is The Vest Pocket CPA, written by Joel G. Siegel, Nick A. Dauber, and Jae K. Shim. This book can be found on Amazon and Amazon Kindle.

Return to CPA Review.

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