Cash collection is a critical event for income recognition under the: Cost-Recovery Method Installment Method A) No Yes B) No No C) Yes No D) Yes Yes are they asking about revenue/profit?
what would be your answer to this question…
Cash collection is critical for both, D. Under the cost recovery method revenue is not recognized until you have received enough cash to cover your costs. Under the installment method you will recognize revenue as (cash received / price).
I thought in both methods, full revenue is recognized in period of sale… profits are deferred. So i dont understand why cash collection is important to recognize revenue… i know its required for profits…
Cash collection can be a triggering point for revenue recognition. In some situations when probability of receivables collection is not very high it is safer to recognize income only when you receive cash or not more than the amount of costs incurred. Therefore, for example percentage of completion method is more agressive recognition method than installment method. In my opinion only installment method requires cash to be collected. In case of cost-recovery method you recognize income up to the amount of costs incurred. I know it is explained in Schweser FSA but don’t remember in 100% whether cost+recovery is connected to cash receipt. Any comments?
I think its C. Revenue can only be recongnized to a point where costs can be recovered. It is not imporant whether it can be recovered or not.
Using percentage of completion method you say that it is highly probable you recover receivables but…you never know that. as soon as you recognize it is not recoverable you should write receivables down to the amount you are able to recover. So…it looks like you recognize income without cash. I think they ask what is the method where you recognize income ONLY if you are in the possesion of cash and not earlier…
Schweser page 51 "An installment sale occurs when a firm finances a sale and payments are expected to be received over an extended period. If collectibility is certain, revenue is recognized at the time of sale using the normal revenue recognition criteria. If collectibility cannot be reasonably estimated, the installment method is used. If collectibility is highly uncertain, the cost recovery method’is used. Under the installment method, profit is recognized as cash is collected.Under the cost recovery method, profit is recognized only when cash collected exceeds cOSts incurred…’ I think it makes it clear that cash collection is imp in both cost recovery as well as installment method.Answer is D for me.
Cash collection is important in all methods of income recognition. The problem in this question is when income in income statement should be recognized? not when a company makes profit… As HKS quoted if collectability is certain revenue is recognized at the time of sale using normal revenue recognition criteria. But i collectability cannot be reasonably estimated installment method is used and when collectability is highly uncertain than cost recovery method is used. I would understand it as in case of installment method we can recognize revenue up to the cost amount in case of cost recovery only to the amount of cash already collected.