Revenue Recognition Effects on Cash Flows and Financial Ratios

CFA Level 1 - Financial Statements

Both methods - the percentage-of-completion and completed-contract methods - produce the same net cash flow effect.

Cash Flow Effects

• Percentage-of-completed contract method
  • Net income (NI) will be higher in the first years and lower in the last year.
  • Net Income will be less volatile.
  • Total assets will be greater.
  • Liabilities will be lower. 

• Completed contract method
  • Net income will be nonexistent in the first years and higher in the last year.
  • Net income will be very volatile.
  • Total assets will be smaller.
  • Liabilities will be higher (no recognition of retained earnings).
  • Stockholders equity will be lower.
  • Stockholders equity will be more volatile.

Impact on Financial Ratio

Ratio	Formula	% of Completion Method	Reason	Completed Method
Current Ratio	Current Assets Current Liabilities	Higher	Construction in progress includes portion of estimated profits	Lower
Revenue Turnover	Revenues Average Receivables	Higher	Revenues are reported	Lower - Not measurable prior to completion
Assets to Equity	Total Assets Equity	Higher	Retained earnings are reported	Lower - Not measurable prior to completion
Total Debt Ratio	Total Liabilities Total Liabilities + Total Equity	Lower	Liabilities are smaller and the denominator includes equity which is higher	Higher

| | Print This! | No comments

Do you like this post?