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Transcript of REVENUE RECOGNITION
REVENUE RECOGNITIONAccounting Day 2008Wayne R. PinnellManaging PartnerHaskell & White LLPMay 12, 2008
The Value of Experience
Revenue RecognitionRevenue Recognition OverviewBasic Revenue Recognition CriteriaMultiple Elements in Revenue Recognition Other Revenue Recognition ConsiderationsCompany Internal Control ConsiderationsFrauds Involving Revenue RecognitionAuditor ConsiderationsUS GAAP vs. IFRSConclusion and Q & A
1. Revenue Recognition OverviewThere are hundreds of references in authoritative guidance and interpretations under US GAAP covering revenue recognition. There are general standards and numerous standards written to apply to specific industries or situations.Codification from FASB came out Q1-2008. (http://asc.fasb.org) You can register and access the website for free.
1. Revenue Recognition OverviewSome of the more common revenue criteria include:FASB Concepts Statement No. 5 (the foundation)SEC Staff Accounting Bulletin (SAB) 104 applies to public companies, but is generally considered applicable to all companiesSFAS 66 applies to real estateSOP 97-2 and its related interpretations applies to softwareSOP 81-1 applies to contract accountingEITF 99-19 applies to gross revenue as principal vs. net as agentEITF 00-10 guidance on accounting for shipping & handling feesEITF 00-21 applies to multiple deliverable arrangements
2. Basic Revenue Recognition CriteriaFASB Concepts Statement No. 5 (December 1984):Revenues of an enterprise during a period are generally measured by the exchange values of the goods or services. Recognition of revenues in a given period requires that the revenues meet two criteria. The revenues must be:
Realized or realizable, andEarned
2. Basic Revenue Recognition CriteriaWhen is revenue realized or realizable?
Revenue is realized when products, merchandise or services or other assets are exchanged for cash or claims to cashRevenue is realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash
When is revenue earned?
Revenue is earned when the entity has substantially accomplished what it must do to be entitled to benefits represented by the benefits of the revenue. In other words, the earnings process has been completed.
2. Basic Revenue Recognition CriteriaMajor recent revenue recognition standards:In October 1997, the AICPA issued Statement of Position 97-2 on Software Revenue Recognition to address the evolving practices in the software industry.In December 1999, the SEC issued Staff Accounting Bulletin No. 101 on Revenue Recognition to summarize existing GAAP on the subject adopting the basic principles from SOP 97-2. The SEC later amended SAB 101 with the issuance of SAB 104.
2. Basic Revenue Recognition CriteriaSAB 104 and SOP 97-2 indicate that revenue is generally realized or realizable and earned when ALL of the following four criteria are met in:
Persuasive evidence of an arrangement existsDelivery has occurred or services have been renderedSellers fee is fixed or determinableCollection is reasonably assured
2. Basic Revenue Recognition CriteriaPersuasive evidence of an arrangement is based on the Companys customary and agreed upon business practice which may require a:
Signed contractPurchase orderElectronic communicationCredit card authorization
2. Basic Revenue Recognition CriteriaPersuasive evidence of an arrangement exists
Complete = contract is signed by both parties before period end. If contract is not signed by either party, terms and conditions are not final, revenue cannot be recognized.Does contract include all terms and conditions?Are there any side letters/agreements? Such agreements may include cancellation, termination, or return provisions that could affect revenue recognition
No revenue can be recognized unless persuasive evidence of an arrangement exists, even if delivery has occurred.
SAB 104 Discussion Question (summarized)Is there Persuasive Evidence of an Arrangement?Facts: Company A delivers product to Company B prior to quarter end. Company As normal and customary business practice for this class of customer is to enter into a written sales agreement that requires the signatures of the authorized representatives of the Company and its customer to be binding. Company A prepares a written sales agreement which is signed by their authorized representative prior to quarter end. Company Bs purchasing department has orally agreed to the sale and stated the contract will be approved the first week of the next quarter.
SAB 104 Discussion Question (summarized)Question: Can Company A recognize revenue in the current quarter?Interpretive response: Revenue cannot be recognized in the current quarter. As a result of Company As business practice of requiring a written sales agreement for this class of customer, persuasive evidence of an arrangement would require a final agreement that has been executed. Company Bs execution of the sales agreement after the end of the quarter causes the revenue from the transaction to be recognized in the subsequent period.
2. Basic Revenue RecognitionDelivery has occurred or services have been rendered
Delivery can vary based on the nature of the productPhysical transferElectronic transmissionAvailability for downloadInstallation/Training requirementsCustomer acceptance
If the undelivered element(s) are essential to the functionality of the delivered element(s), delivery may not have occurred
2. Basic Revenue Recognition CriteriaDelivery has occurred or services have been rendered
Shipping terms impact revenue recognition, i.e. FOB shipping point vs. FOB destinationTitle and risk of loss must transferThe Companys policy of replacing goods damaged in shipment at no charge to the customer creates FOB destination terms for revenue recognition purposes
2. Basic Revenue Recognition CriteriaDelivery has occurred or services have been rendered (cont).:
Bill and hold arrangements should be uncommon. It must be requested by the customer and has several other conditions specified in SAB 104Revenue should not be recognized when customers have an unconditional right of return
SAB 104 Discussion Question (summarized)Has Delivery Occurred?Facts: Company Z has an arrangement to deliver its products to Company A on a consignment basis. Pursuant to the terms of the arrangement, Customer A is a consignee, and title to the products does not pass from Company Z to Customer A until Customer A consumes the products in its operations. Company Z delivers product to Customer A under the terms of their arrangement.
Question: May Company Z recognize revenue upon delivery of its product to Customer A?
SAB 104 Discussion Question (summarized)Interpretive Response: No. Products delivered to a consignee pursuant to a consignment arrangement are not sales and do not qualify for revenue recognition until a sale occurs. The staff believes that revenue recognition is not appropriate because the seller retains the risks and rewards of ownership of the product and title usually does not pass to the consignee.
SAB 104 Discussion Question (summarized)Has Delivery Occurred?Facts: Company A receives purchase orders for product. The customer is not ready to take delivery of the product for various reasons including lack of space and delays in customers production schedules. Company A ships the product to a third-party warehouse but retains title to the product and payment is dependent upon delivery to a customer specified site.
Question: Can company A recognize revenue when the product is shipped?
SAB 104 Discussion Question (summarized)Interpretive response: Revenue cannot be recognized. Delivery generally is not considered to have occurred unless the customer has taken title and assumed the risks and rewards of ownership of the product. This could be considered to be an inappropriate bill and hold transaction.
SAB 104 Discussion Question (summarized)Has Delivery Occurred?Facts: Company E is an equipment manufacturer whose main product is generally sold in a standard model. The contracts for sale of that model provide for customer acceptance to occur after the equipment is received and tested by the customer. The acceptance provisions state that if the equipment does not perform to Companys E published specifications, the customer may return the equipment for a full refund or a replacement unit. Title to the equipment passes upon delivery to the customer. Company E does not perform installation or other services on the equipment and tests each piece of equipment it sells before shipment.
SAB 104 Discussion Question (summarized)Question: Company E receives an order from a new customer for a standard model of its main product. When should Company E recognize revenue from sales of this piece of equipment?
Interpretive response: Revenue should be recognized upon delivery of the equipment. While the SEC staff presumes that customer acceptance provisions are substantive provisions that generally result in revenue deferral, that presumption can be overcome. Although the contract includes a customer acceptance clause, acceptance is based on meeting Company Es published specifications for a standard model.
SAB 104 Question (paraphrased)Have all conditions related to Delivery been met?Facts: Assuming the same facts as the previous example. Company E enters into an arrangement with a new customer to deliver a version of its standard product modified as necessary to be integrated into a customers new assembly line while still meeting all of the stan