As-9 Revenue Recognition

REVENUE RECOGNITION

Accounting Standard - 9

- Vishnu Sahu

What is RevenueWhat is Revenue

Gross inflow of consideration (cash / receivables / others) Gross inflow of consideration (cash / receivables / others) arising in the course of ordinary business activities from:arising in the course of ordinary business activities from:

Sale of goodsSale of goods Rendering of services andRendering of services and Use of enterprise resources yielding interest, royalties and Use of enterprise resources yielding interest, royalties and

dividendsdividends

Revenue RecognitionRevenue Recognition

Recognition is the process of recording and reporting an Recognition is the process of recording and reporting an item as an element of financial statementsitem as an element of financial statements

The revenue recognition principle provides that revenue The revenue recognition principle provides that revenue is recognized:is recognized: when it is earned, andwhen it is earned, and when it is realized or realizablewhen it is realized or realizable

Revenue RecognitionRevenue Recognition Earned-Earned- when the earnings process is substantially when the earnings process is substantially

complete.complete.

Realized-Realized- when goods and services are exchanged for cash when goods and services are exchanged for cash or claims to cash.or claims to cash.

Realizable-Realizable- when assets received are convertible into a when assets received are convertible into a known amount of cash.known amount of cash.

Revenue TransactionsRevenue Transactions

Basically there are four types of transactions through Basically there are four types of transactions through which a firm earns revenueswhich a firm earns revenues

Sale of GoodsSale of Goods Rendering of ServicesRendering of Services Use of Enterprise’s assetsUse of Enterprise’s assets Disposal of assets (other than inventory)Disposal of assets (other than inventory)

AS-9 does not deal with….AS-9 does not deal with….

Revenue arising from construction contracts (AS-7)Revenue arising from construction contracts (AS-7)

Revenue arising from hire-purchase, lease agreements Revenue arising from hire-purchase, lease agreements (AS-19)(AS-19)

Revenue arising from government grants and other Revenue arising from government grants and other similar subsidies (AS-12)similar subsidies (AS-12)

Revenue of insurance companies arising from insurance Revenue of insurance companies arising from insurance contracts (IRDA Regulations)contracts (IRDA Regulations)

Items not included in the definition Items not included in the definition of revenueof revenue

Realised gains resulting from the disposal of, Realised gains resulting from the disposal of, and unrealised gains resulting from the holding and unrealised gains resulting from the holding of, non-current assets e.g. appreciation in the of, non-current assets e.g. appreciation in the value of fixed assets;value of fixed assets;

Unrealised holding gains resulting from the Unrealised holding gains resulting from the change in value of current assets, and the natural change in value of current assets, and the natural increases in herds and agricultural and forest increases in herds and agricultural and forest products;products;

Contd…Contd… Realised or unrealised gains resulting from Realised or unrealised gains resulting from

changes in foreign exchange rates and changes in foreign exchange rates and adjustments arising on the translation of foreign adjustments arising on the translation of foreign currency financial statements;currency financial statements;

Realised gains resulting from the discharge of an Realised gains resulting from the discharge of an obligation at less than its carrying amount;obligation at less than its carrying amount;

Unrealised gains resulting from the restatement of Unrealised gains resulting from the restatement of the carrying amount of an obligation.the carrying amount of an obligation.

Basic Principles of Revenue Basic Principles of Revenue RecognitionRecognition

TimingTiming MeasurementMeasurement

Timing and MeasurementTiming and Measurement

Timing:Timing: Revenue Recognition at Point of SaleRevenue Recognition at Point of Sale Revenue Recognition before Delivery (e.g. Long Revenue Recognition before Delivery (e.g. Long

term contracts)term contracts) Revenue Recognition after DeliveryRevenue Recognition after Delivery

Measurement:Measurement: Should we recognize entire revenue at the same Should we recognize entire revenue at the same

time or in partstime or in parts

Revenue Recognition Classified by Revenue Recognition Classified by Nature of TransactionNature of Transaction

Sale of GoodsSale of Goods Delivery is delayed at buyer’s request and buyer takes title and Delivery is delayed at buyer’s request and buyer takes title and

accepts billingaccepts billing

Delivered subject to conditionsDelivered subject to conditions Installation and inspectionInstallation and inspection On approvalOn approval Guaranteed sales (e.g. money back if not completely satisfied)Guaranteed sales (e.g. money back if not completely satisfied) Consignment salesConsignment sales Cash on delivery salesCash on delivery sales

Installment Sale and the seller delivers the goods only when Installment Sale and the seller delivers the goods only when the final payment is receivedthe final payment is received

Sale of GoodsSale of Goods Special order and shipments (i.e. where payment is received Special order and shipments (i.e. where payment is received

for goods not presently held in stock)for goods not presently held in stock)

Sale / Repurchase agreementsSale / Repurchase agreements

Sales to intermediate partiesSales to intermediate parties

Subscriptions for publicationsSubscriptions for publications

Installment salesInstallment sales

Trade discounts and volume rebatesTrade discounts and volume rebates

Rendering of ServicesRendering of Services Installment feesInstallment fees

Advertising and Insurance agent commissionsAdvertising and Insurance agent commissions

Financial service commissionsFinancial service commissions

Admission feesAdmission fees

Tuition feesTuition fees

Entrance and membership feesEntrance and membership fees

Use of Enterprise AssetsUse of Enterprise Assets

Interest: Charges for the use of cash resources or amounts due Interest: Charges for the use of cash resources or amounts due to the enterpriseto the enterprise

Royalties: Charges for the use of such assets as know-how, Royalties: Charges for the use of such assets as know-how, patents, trade marks and copyrightspatents, trade marks and copyrights

Dividends: Rewards from the holding of investment in sharesDividends: Rewards from the holding of investment in shares

Use of Enterprise AssetsUse of Enterprise Assets Revenue should be recognized when no significant uncertainty Revenue should be recognized when no significant uncertainty

as to measurability or collectibility existsas to measurability or collectibility exists

Interest: on a time proportion basis Interest: on a time proportion basis taking into account the taking into account the amount outstanding and the rate applicableamount outstanding and the rate applicable

Royalties: Royalties: on an accrual basis in accordance with the terms on an accrual basis in accordance with the terms of the relevant agreementof the relevant agreement

Dividends: Dividends: when the owner’s right to receive payment is when the owner’s right to receive payment is establishedestablished

Types of TransactionsTypes of Transactions

Transactions

Long TermContracts

Installment Sales

BarterTransactions

Methods of Revenue RecognitionMethods of Revenue Recognition

Long Term ContractsLong Term Contracts Percentage (%) of Completion MethodPercentage (%) of Completion Method Completed Contract MethodCompleted Contract Method

Installment SalesInstallment Sales Installment MethodInstallment Method Cost Recovery MethodCost Recovery Method

Barter TransactionsBarter Transactions

Percentage of Completion MethodPercentage of Completion Method

Appropriate when the project’s cost and revenue can be Appropriate when the project’s cost and revenue can be reliably estimatedreliably estimated

Revenue, Expense and Profit is recognized as the work is Revenue, Expense and Profit is recognized as the work is performedperformed

Formula = Formula = Total cost incurred till dateTotal cost incurred till date

Total Expected CostTotal Expected Cost

Percentage of completion: StepsPercentage of completion: Steps

Costs incurred to date = Percent completeMost recent estimated total costs

11

Estimated total revenue x Percent complete = Revenue to be recognized to date

22

Total revenue to be recognized to date less Revenue recognized in PRIOR periods = Current period revenue

33

Current Period Revenue less current costs = Gross profit44

Data: Contract price: $1,000 Estimated cost: $800Start date: Jan, 05 Finish: Dec, 07Balance Sheet date: Dec. 31

Given: 2005 2006 2007

Costs incurred $400 $300 $100

To Find: Revenue and Net Income (Profit) to be recognized each yearin the company’s Income Statement

Percentage of Completion Percentage of Completion Method: ExampleMethod: Example

500 – 400 375 - 300 125 - 100= 100 = 75 = 25

Net Income recognized

Revenue recognized

1,000 * 50% 1,000 * 37.5% 1,000 * 12.5%= 500 = 375 = 125

2005 2006 2007

% Exp incurred each year

400 = 50% 300 = 37.5% 100 = 12.5%800 800 800


Income Statement 2005 2006 2007 Total

Revenues $500 $375 $125 $1,000

Expenses $400 $300 $100 $800

Net Income $100 $75 $25 $200

Solution:


Completed Contract MethodCompleted Contract Method

Appropriate when the outcome of a project cannot be reliably Appropriate when the outcome of a project cannot be reliably measuredmeasured

When the project is comparatively short in durationWhen the project is comparatively short in duration

Revenue, Expense and Profit is recognized only when the Revenue, Expense and Profit is recognized only when the contract is completecontract is complete



Revenues $0 $0 $1,000 $1,000

Expenses $0 $0 $800 $800

Net Income $0 $0 $200 $200

To Find: Expenses, Revenue and Net Income to be recognized each year

Completed Contract Method: Completed Contract Method: ExampleExample

Installment MethodInstallment Method Installment Sale occurs when a firm finances a sale Installment Sale occurs when a firm finances a sale

and payments are received over an extended periodand payments are received over an extended period

If collectibility cannot be reasonably estimated, this If collectibility cannot be reasonably estimated, this method is usedmethod is used

Revenue and Profit is recognized as the cash is Revenue and Profit is recognized as the cash is collectedcollected

Profit = Cash Collected during the period * Profit = Cash Collected during the period * Expected Profit Percentage Expected Profit Percentage

Installment Sales Method: Installment Sales Method: ExampleExample


To Find: Expenses, Revenue and Net Income to be recognized each year in the company’s Income Statement

Given 2005 2006 2007 Total

Collections $400 $400 $200 $1,000

400 – 80 400 - 80 200 - 40= 320 = 320 = 160

Expenses recognized

ProfitRecognized

400 * 20% 400 * 20% 200 * 20%= 80 = 80 = 40

2005 2006 2007

Profit: 1,000 – 800 = 200Profit %: 200 = 20% 1,000




Revenues $400 $400 $200 $1,000

Expenses $320 $320 $160 $800

Net Income $80 $80 $40 $200

Solution:

Cost Recovery MethodCost Recovery Method

Under Installment Sales, if collectibility is highly Under Installment Sales, if collectibility is highly uncertain, the cost recovery method is useduncertain, the cost recovery method is used

Revenue is recognized as cash is collectedRevenue is recognized as cash is collected

Profit is recognized only when cash collected exceeds Profit is recognized only when cash collected exceeds costs incurredcosts incurred

Very conservativeVery conservative



Revenues $400 $400 $200 $1,000

Expenses $400 $400 $0 $800

Net Income $0 $0 $200 $200

Cost Recovery Method: Cost Recovery Method: ExampleExample

To Find: Expenses, Revenue and Net Income to be recognized each year

Barter TransactionsBarter Transactions

Barter TransactionBarter Transaction Two parties exchange goods or services without Two parties exchange goods or services without

cash paymentscash payments

Round-trip transactionRound-trip transaction Involves the sale of goods to one party with the Involves the sale of goods to one party with the

simultaneous purchase of identical goods from the simultaneous purchase of identical goods from the same partysame party

E.g. Internet cos. buy advertising space on each E.g. Internet cos. buy advertising space on each other’s websiteother’s website

Common ways of Manipulating Common ways of Manipulating RevenueRevenue

Objectives of manipulating revenues:Objectives of manipulating revenues: Overstatement of revenues: To boost company Overstatement of revenues: To boost company

valuationsvaluations Understatement of revenues: To save on tax, thereby Understatement of revenues: To save on tax, thereby

increasing savings increasing savings

3 common ways…....3 common ways….... Fraudulent reporting of fictitious salesFraudulent reporting of fictitious sales Inaccurate timing of revenue recognitionInaccurate timing of revenue recognition Improper valuation of revenueImproper valuation of revenue

FraudsFrauds In late ‘93, In late ‘93, Bausch & Lomb Bausch & Lomb made an offer to 32 distributorsmade an offer to 32 distributors

To pick ~2 yrs inventory at prices lower than normalTo pick ~2 yrs inventory at prices lower than normal Dec 24th deadline for sales, i.e., before the closing of ‘93 booksDec 24th deadline for sales, i.e., before the closing of ‘93 books Distributors will not have to pay unless the lenses were soldDistributors will not have to pay unless the lenses were sold Final payments would be renegotiated if the program floppedFinal payments would be renegotiated if the program flopped

Distributors purchased almost $25mn during this periodDistributors purchased almost $25mn during this period

In ‘94 B&L announced that “high distributor inventories” will hurt In ‘94 B&L announced that “high distributor inventories” will hurt 1994 sales. Stock slides from $50 to the low $30s1994 sales. Stock slides from $50 to the low $30s

10 months after sales, 85% of money was still to be collected10 months after sales, 85% of money was still to be collected

Implications for Financial AnalysisImplications for Financial Analysis

Points to be consideredPoints to be considered

Conservativeness / Aggressiveness of the firm’s revenue Conservativeness / Aggressiveness of the firm’s revenue recognition policiesrecognition policies

Extent to which the firm’s policies rely on judgment and Extent to which the firm’s policies rely on judgment and estimatesestimates

QQ’s’s

Mr. Hey Amey has received Rs.1 Crore in Feb 07 as contract Mr. Hey Amey has received Rs.1 Crore in Feb 07 as contract

fees for his Rock concert to be held in Hilton Towers fees for his Rock concert to be held in Hilton Towers

(Mumbai) during October 07. When would the income be (Mumbai) during October 07. When would the income be

recorded?recorded?

QQ’s’s

Mr. Gaurav Gundawar has invested in securities and mutual Mr. Gaurav Gundawar has invested in securities and mutual

funds of Shraddha Telecom. The company proposed a funds of Shraddha Telecom. The company proposed a

dividend on 10dividend on 10th th March 07. but the dividend was declared on March 07. but the dividend was declared on

1515thth June 07. When should be the income recognised in the June 07. When should be the income recognised in the

books of Mr. Gundawar?books of Mr. Gundawar?

Q’sQ’s Mr. Gaurav Patil has an agency for Jigar products. Jigar sends Mr. Gaurav Patil has an agency for Jigar products. Jigar sends

24 Televisions to Mr. Gaurav’s showroom on consignment 24 Televisions to Mr. Gaurav’s showroom on consignment

basis on 1basis on 1stst March 2007. But till 31 March 2007. But till 31stst March 2007 none of the March 2007 none of the

televisions have been sold to any customer. Should Jigar televisions have been sold to any customer. Should Jigar

record the TVs sent as sales?record the TVs sent as sales?

QQ’s’s Mr. Vivek Doubts Kabra is the subscriber of a journal by Mr. Mr. Vivek Doubts Kabra is the subscriber of a journal by Mr.

Ravish Chupa Rustam. Mr. Ravish Chupa Rustam received Ravish Chupa Rustam. Mr. Ravish Chupa Rustam received

Rs.50,000 as subscription under a special scheme for next five Rs.50,000 as subscription under a special scheme for next five

years. Mr. Chupa Rustam would like to know whether the years. Mr. Chupa Rustam would like to know whether the

entire income should be recorded for the current year or not?entire income should be recorded for the current year or not?

THANKS……..THANKS……..

As-9 Revenue Recognition

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