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Here's a question. I'm working with a company that will

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Hello! Here's a question...

Hello! Here's a question. I'm working with a company that will launch satellites. If a launch occurs in Month 20, the company receives revenues starting in Month 1, in advance of the launch. They start incurring costs related to the launch in Month 10. I believe that the Advance Revenue should be a liability on the Balance Sheet, and Revenue should not be reflected on the P&L until earned. But since there are COGS before the launch, should Revenue be reflected to match the early COGS? Thanks, Paul.

Accountant's Assistant: The Accountant will know how to help. Is there anything else important you think the Accountant should know?

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Submitted: 9 months ago.Category: Finance
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9/13/2017
Financial Professional: Lane, JD, CFP, MBA, CRPS replied 9 months ago
Lane
Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 14,406
Experience: Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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Hi Paul. Does this company really have a Cost of Goods Sold. What is actually being sold here?

...

Also, (given that there is an accrual aspect to COGS even when the company is under case method) what IS the method of account here. Cash or accrual?

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Customer reply replied 9 months ago
Hi Lane,Thanks.1. Accrual
2. COGS has two components:
a. A one time use launch vehicle that we purchase in advance, and is used up in the launch.
b. Launch related expenses that are paid at the time of launch.Thanks,
Paul
Financial Professional: Lane, JD, CFP, MBA, CRPS replied 9 months ago

The yes, simply becasue of the accrual method, advance revenue is a liability (not necessarily a payable, but rather Customer Advances or Unearned Revenues, maybe? - something that doesn't label it as a payable to a vendor.

...

But yes, in cases where payment is received prior to services being provided, accrual accounting dictates that the payment be initially recorded as a liability. The company then recognizes the payment as revenue only after the good or service is provided.

...

Then as the amount received in advance is earned, the current liability account will be debited for the amount earned and the Revenues account reported on the income statement will be credited

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Customer reply replied 9 months ago
Thanks. Understood about the general idea of not recording it as revenue until it's earned. But here there are COGS that occur before the launch, before the revenue is earned. So would I also not reflect these as COGS until the launch, and refer to them as something like Prepaid COGS / Expenses?
Financial Professional: Lane, JD, CFP, MBA, CRPS replied 9 months ago

That's right. Expense is recognized in the period in which related revenue is recognized (Matching Principle).

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Customer reply replied 9 months ago
do I then start recognizing revenue when I start spending money on COGS in advance of the launch?
Financial Professional: Lane, JD, CFP, MBA, CRPS replied 9 months ago

One or the other. What's the contract say. If you never launch, is the money refunded?

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Customer reply replied 9 months ago
I believe the contract does provide for a refund in the case of no launch.
Financial Professional: Lane, JD, CFP, MBA, CRPS replied 9 months ago

I think i'd err on the side of % of completion rather than completion of contract, becasue it sounds like the costs are a known.

...

The accounting for long term contracts using the percentage of completion method is an exception to the basic realization principle. This method is used wherein the revenues are determined based on the costs incurred so far.

...

With completion of contract, revenue is recognized when the contract is fulfilled. The contract is considered complete when the costs remaining are insignificant.

...

The percentage of completion method is used when:

  • Collections are assured
  • The accounting system can:
  1. Estimate profitability
  2. Measure progress toward completion.
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Financial Professional: Lane, JD, CFP, MBA, CRPS replied 9 months ago

As per IAS 11.42-43, an entity shall present:

(a) the gross amount due from customers for contract work as an asset; and

(b) the gross amount due to customers for contract work as a liability.

(These should be separate line-items on the face on the balance sheet.)

The gross amount due from/to customers for contract work is the net amount of:

(a) costs incurred plus recognized profits; less

(b) the sum of recognized losses and progress billings

for all contracts in progress

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Customer reply replied 9 months ago
Thanks for that.I was looking more at those Wikipedia entries and some other ones. I don't think there's a reliable way to estimate the percentage of completion. We could use the costs we expend, but that doesn't really capture it either. I understand that Completion of Contract allows us to defer tax payments, but in a situation like this where we really haven't completed anything partial at all until the launch, it seems like it might be appropriate. Or do you think we just use our cost schedule, and apportion revenues based on that as a percentage of completion?
Financial Professional: Lane, JD, CFP, MBA, CRPS replied 9 months ago

This is really getting to be more art than science. That is to say, you'd qualify for either, because the costs ARE know and progress is measurable.

...

If you DO use % of completion, the formula there works.

...

I think I'd err on the side of % of completion because Completing of contract considers all income and expenses directly related to a long-term contract as received when work is completed. And with % completion, there's less risk for fluctuation and a more frequent reporting of revenues and expenses.

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Customer reply replied 9 months ago
I see what you're saying. So then I guess what I'll do is apportion revenue pro-rata based on the advance expenditures we make. Thanks.
Financial Professional: Lane, JD, CFP, MBA, CRPS replied 9 months ago

Wish there were a more definitive answer. But I think apportioning as you spend still defers somewhat, allows for matching, and keeps changes in tax law from making what happens in the end a complete surprise.

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Financial Professional: Lane, JD, CFP, MBA, CRPS replied 9 months ago

As always ... Your positive rating … (by using those the stars or faces on your screen, and then clicking “submit”) …is thanks enough!

That's the only way I'll be compensated by JustAnswer for the work here

...

Thank you, Paul.

Lane

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