Continuation: Accounting Revenue Recognition Methods
(8) Recognizing revenue under Proportional Performance method
Recognizing profits under this method is a modification of the percentage of completion method, where costs incurred cannot be assigned to a specific portion of the amount completed but instead allow for estimation in order to recognize the gains. This is usually applied by those providing software-related services.
The method requires the identification of the total direct costs necessary to initiate the launching or the commencement of the services to be rendered. Initial revenue recognition is computed by determining the proportion of the launching costs to the costs projected for project completion, mostly manpower costs.
If, for example, the total direct costs to initiate a $100,000 project amount to $10,000, and the total projected project cost is $60,000, the revenue that matches the launching cost can be recognized upon receipt of initial payment from the service contractor. This can be computed as follows:
Proportion of Launching Costs / Total Projected Cost = $10,000 / $60,000 x 100% = 16.67 %
Rather than wait for the entire project to be completed, the revenue earned by the launching costs will be computed as follows:
Contract Price x 16.67% = $100,000 x 16.67% = $16,667
This can now be recognized against the down payment received as conditional to the commencement of the project. Thereafter, the actual costs of IT manpower will be tracked and monitored as it now represents the greater part of the remaining projected costs.
(9) Recognizing revenue under the Deposit method
This method is used for monies held as deposits that are subject to cancellation agreement by both parties. An example to illustrate its application is the advance deposit required by landlords from their renters or lessees. Revenue will be recognized only upon expiration or extinguishment of the contract that binds them.
The landlord initially carries the deposit as a liability. If the contract is not renewed upon its expiration, the deposit amount will be applied as the renter’s final payment for the corresponding unpaid rent or damages if any. The calendar year when the deposit was applied as rent payment will be the year that the income is recognized.
(10) Revenue recognition for Transactions Under Bill & Hold
This method is the least popular since it has been cited as a method used for several fraudulent transactions, often to bloat a company’s assets. Nevertheless, if considered for its features as one of the accounting recognition revenue methods, it’s a system where the customer is billed for a product ordered but will entrust its safekeeping and inventory to the manufacturer, due to lack of adequate or proper storage facility.
Since it is presumed that this arrangement was made at the request of the buyer, there should be specific documents to serve as proof that there is such a request coming from a legitimate legal entity.
The seller has no problem with revenue recognition inasmuch as the products sold are as good as delivered and therefore recognized as income upon receipt of payment. However, the items should be physically removed from the seller's inventory, and ownership should be acknowledged by the buyer. In addition, the documents covering this transaction should bear a reasonable specific date as to when the actual delivery should take place but as a single undertaking and not on a piecemeal basis.