Short-Term Revenue Recognition Examples
The revenue recognition principle requires that, in some instances, revenue is recognized before receiving a cash payment. In these situations, the customer still owes the company money. This money owed to the company is a type of receivable for the company and a payable for the company’s customer.
A receivable is an outstanding amount owed from a customer. One specific receivable type is called accounts receivable. Accounts receivable is an outstanding customer debt on a credit sale. The company expects to receive payment on accounts receivable within the company’s operating period (less than a year). Accounts receivable is considered an asset, and it typically does not include an interest payment from the customer. Some view this account as extending a line of credit to a customer. The customer would then be sent an invoice with credit payment terms. If the company has provided the product or service at the time of credit extension, revenue would also be recognized.
For example, Billie’s Watercraft Warehouse (BWW) sells various watercraft vehicles. They extend a credit line to customers purchasing vehicles in bulk. A customer bought 10 Jet Skis on credit at a sales price of $100,000. The cost of the sale to BWW is $70,000. The following journal entries occur.
Accounts Receivable increases (debit) and Sales Revenue increases (credit) for $100,000. Accounts Receivable recognizes the amount owed from the customer, but not yet paid. Revenue recognition occurs because BWW provided the Jet Skis and completed the earnings process. Cost of Goods Sold increases (debit) and Merchandise Inventory decreases (credit) for $70,000, the expense associated with the sale. By recording both a sale and its related cost entry, the matching principle requirement is met.
When the customer pays the amount owed, the following journal entry occurs.
Cash increases (debit) and Accounts Receivable decreases (credit) for the full amount owed. If the customer made only a partial payment, the entry would reflect the amount of the payment. For example, if the customer paid only $75,000 of the $100,000 owed, the following entry would occur. The remaining $25,000 owed would remain outstanding, reflected in Accounts Receivable.
Another credit transaction that requires recognition is when a customer pays with a credit card (Visa and MasterCard, for example). This is different from credit extended directly to the customer from the company. In this case, the third-party credit card company accepts the payment responsibility. This reduces the risk of nonpayment, increases opportunities for sales, and expedites payment on accounts receivable. The tradeoff for the company receiving these benefits from the credit card company is that a fee is charged to use this service. The fee can be a flat figure per transaction, or it can be a percentage of the sales price. Using BWW as the example, let’s say one of its customers purchased a canoe for $300, using his or her Visa credit card. The cost to BWW for the canoe is $150. Visa charges BWW a service fee equal to 5% of the sales price. At the time of sale, the following journal entries are recorded.
Accounts Receivable: Visa increases (debit) for the sale amount ($300) less the credit card fee ($15), for a $285 Accounts Receivable balance due from Visa. BWW’s Credit Card Expense increases (debit) for the amount of the credit card fee ($15; 300 × 5%), and Sales Revenue increases (credit) for the original sales amount ($300). BWW recognizes revenue as earned for this transaction because it provided the canoe and completed the earnings process. Cost of Goods Sold increases (debit) and Merchandise Inventory decreases (credit) for $150, the expense associated with the sale. As with the previous example, by recording both a sale and cost entry, the matching principle requirement is met. When Visa pays the amount owed to BWW, the following entry occurs in BWW’s records.
Cash increases (debit) and Accounts Receivable: Visa decreases (credit) for the full amount owed, less the credit card fee. Once BWW receives the cash payment from Visa, it may use those funds in other business activities.
An alternative to the journal entries shown is that the credit card company, in this case Visa, gives the merchant immediate credit in its cash account for the $285 due the merchant, without creating an account receivable. If that policy were in effect for this transaction, the following single journal entry would replace the prior two journal entry transactions. In the immediate cash payment method, an account receivable would not need to be recorded and then collected. The separate journal entry—to record the costs of goods sold and to reduce the canoe inventory that reflects the $150 cost of the sale—would still be the same.
Here’s a final credit transaction to consider. A company allows a sales discount on a purchase if a customer charges a purchase but makes the payment within a stated period of time, such as 10 or 15 days from the point of sale. In such a situation, a customer would see credit terms in the following form: 2/10, n/30. This particular example shows that a customer who pays his or her account within 10 days will receive a 2% discount. Otherwise, the customer will have 30 days from the date of the purchase to pay in full, but will not receive a discount. Both sales discounts and purchase discounts were addressed in detail in Merchandising Transactions.
Maine Lobster Market
Maine Lobster Market (MLM) provides fresh seafood products to customers. It allows customers to pay with cash, an in-house credit account, or a credit card. The credit card company charges Maine Lobster Market a 4% fee, based on credit sales using its card. From the following transactions, prepare journal entries for Maine Lobster Market.
|Aug. 5||Pat paid $800 cash for lobster. The cost to MLM was $480.|
|Aug. 10||Pat purchased 30 pounds of shrimp at a sales price per pound of $25. The cost to MLM was $18.50 per pound and is charged to Pat’s in-store account.|
|Aug. 19||Pat purchased $1,200 of fish with a credit card. The cost to MLM is $865.|
Jamal’s Music Supply
Jamal’s Music Supply allows customers to pay with cash or a credit card. The credit card company charges Jamal’s Music Supply a 3% fee, based on credit sales using its card. From the following transactions, prepare journal entries for Jamal’s Music Supply.
|May 10||Kerry paid $1,790 for music supplies with a credit card. The cost to Jamal’s Music Supply was $1,100.|
|May 19||Kerry purchased 80 drumstick pairs at a sales price per pair of $14 with a credit card. The cost to Jamal’s Music Supply was $7.30 per pair.|
|May 28||Kerry purchased $345 of music supplies with cash. The cost to Jamal’s Music Supply was $122.|
Journal entries: August 5 debit Cash 800, credit Sales Revenue 800. Explanation: To record cash sale. August 5 debit COGS 480, credit Merchandise Inventory: Lobster 480. Explanation: to record cost of sale. August 10 debit Accounts Receivable 750, credit Sales Revenue 750. Explanation: To record credit sale, 30 times $25. August 10 debit COGS 555, credit Merchandise Inventory: Shrimp 555. Explanation: to record cost of sale; 30 times $18.50. August 10 debit Accounts Receivable 1,152, debit Credit Card Expense 48, credit Sales Revenue 1,200. Explanation: To record credit card sale, 4 percent fee, 1200 times 4 percent. August 19 debit COGS 865, credit Merchandise Inventory: Fish 865. Explanation: To record cost of sale. Return
JJournal entries: May 10: debit Accounts Receivable 1,736.30, debit Credit Card Expense 53.70, credit Sales Revenue 1790. Explanation: To record credit card sale, 3 percent fee. 1790 times 3 percent. May 10: debit COGS 1,100, credit Merchandise Inventory 1,100. Explanation: to record cost of sale. May 19: debit Accounts Receivable 1086.40, debit Credit Card Expense 33.60, credit Sales Revenue 1,120. Explanation: To record credit card sale, 3 percent fee, (80 times $14) times 3 percent. May 19: debit COGS 584, credit Merchandise Inventory 584. Explanation: to record cost of sale; 80 times $7.30. May 28: debit Cash 345, credit Sales Revenue 345. Explanation: To record cash sale. May 28: debit COGS 122, credit Merchandise Inventory 122. Explanation: To record cost of sale. Return