Revenue Recognition

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revenue recognition accounting standard as per DS Rawat

Transcript of Revenue Recognition

  • Revenue RecognitionUAA ACCT 650 Seminar in Executive Uses of Accounting Dr. Fred Barbee

  • Marketing the productReceiving customers orderNegotiating and signing production contracts.Ordering materialsManufacturing the product.Delivering the product.Collecting the cash from customers.Consider a Manufacturing Firm . . .

  • The fundamental revenue recognition concept is that revenues should not be recognized by a company until realized or realizable and earned by the company.Lynn E. Turner, Chief Accountant, SEC Speech by SEC Staff: Revenue Recognition May 31, 2001

  • Revenue RecognitionAt the Financial Accounting Standards Board (FASB)

  • In an effort to provide better and more comprehensive guidance as to when companies should record revenues, the FASB has added a project on revenue recognition to its agenda.www.fasb.org May 22, 2002

  • Revenue usually is the largest item in financial statements, and revenue recognition issues top the list of reasons for financial reporting restatements. L. Todd Johnson FASB Senior Project Manager www.fasb.org/news/nr052002.shtml

  • A top down approach focusing on conceptual guidance.A bottom up approach that provides an inventory of existing revenue recognition guidance and accepted practices.

  • . . . Issues involving revenue recognition are among the most important and the most difficult that standard setters and accountants face. www.fasb.org/project/revenue_recognition.shtml

  • FASB Concept Statements 5 and 6APB, FASB, AICPA, EITF, SEC, SAB

  • FASB Concept Statements 5 and 6APB, FASB, AICPA, EITF, SEC, SAB

  • RevenueRevenues are inflows of assets and/or settlement of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entitys ongoing major or central operations.Statement of Financial Accounting Concepts No. 6 Elements of Financial Statements Paragraph 78

  • RevenueEssential CharacteristicsInflows of assets or settlements of liabilitiesResult of some productive activity of the firmMajor or central operation

  • RecognitionThe process of formally recording or incorporating an item into the financial statements of an entity as an asset, liability, revenue, expense, or the like.Statement of Financial Accounting Concepts No. 5 Recognition & Measurement in Financial Statements of Business Enterprises - Paragraph 6

  • RecognitionEssential CharacteristicsDepiction in both words and numbersIncluded in financial statements and statement totalsDisclosure by other means is not recognitionStatement of Financial Accounting Concepts No. 5 Recognition & Measurement in Financial Statements of Business Enterprises - Paragraph 6

  • To be recognized . . .An item must meet the definition of an elementIt must be measurableIt must be relevantIt must be reliable

  • Principle of Revenue RecognitionTo recognize a revenue it must be:Realized (or realizable)Earned

  • Principle of Revenue RecognitionRealized When cash or claims to cash are received.RealizableWhen assets received are readily convertible to known amounts of cash or claims to cash.

  • Realization CriterionThe revenue the amount the customers will pay can be objectively measured.The eventual collection of cash (or cash-equivalents) can be reasonably assured.Any remaining fulfillment costs can be estimated with reasonable reliability and accuracy.

  • The Earned CriterionThe company has completed a substantial portion of the production and sales effort.The risks of ownership have been shifted to the customer.

  • Whoa . . . Wait a Minute!This all sounds so incredibly easy!So . . . Why do we have so many problems with revenue recognition?

  • Lets Approach This From a Different Perspective

  • Criteria for Revenue RecognitionThe amount of revenue that will be collected is reasonably assured and is measurable with a reasonable degree of certainty.The critical event in the process of earning the revenue has taken place.

  • Timing of Revenue Recognition

  • The Timing of Revenue RecognitionThe point at which an order is obtained from a customer.The point at which an order is accepted and the terms of the sale are finalized.

  • The Timing of Revenue RecognitionThe point at which goods are delivered to a customer.The point at which the customer is billedThe point at which payment is received from the customer.

  • Revenue RecognitionClassified by Nature of Transaction

  • Revenue RecognitionClassified by Nature of Transaction

  • Revenue RecognitionClassified by Nature of Transaction

  • Revenue RecognitionClassified by Nature of Transaction

  • Figure 2.2 The Revenue Recognition Process: Industries Recognizing Revenue at Indicated PhasesRevenues may also be recognized at other times besides thepoint of sale.

  • Revenue RecognitionAt the Securities and Exchange Commission (SEC)

  • The SEC & Revenue RecognitionSABs do not represent rules or interpretations of the Commission but rather represent the interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the Federal securities laws.SEC Staff Accounting Bulletin No. 101 - FAQs http://www.sec.gov/info/accountants/sab101faq.htm

  • The SEC & Revenue RecognitionSAB 101 . . . Reflects the basic principles of revenue recognition in existing GAAP.Does not supersede any existing authoritative literature.Summarizes in one location the existing guidance on revenue recognition.SEC Staff Accounting Bulletin No. 101 - FAQs http://www.sec.gov/info/accountants/sab101faq.htm

  • Revenue Recognition Per the SECPersuasive evidence of an arrangement exists;Delivery has occurred or services have been rendered;SEC Staff Accounting Bulletin No. 101 http://www.sec.gov/interps/account/sab101.htm

  • Revenue Recognition Per the SECThe sellers price to the buyer is fixed or determinable; andCollectibility (payment) is reasonably assumed.SEC Staff Accounting Bulletin No. 101 http://www.sec.gov/interps/account/sab101.htm

  • Revenue Recognition Per the SECSAB 101 observes that judgment is the key factor in deciding the timing and amount of revenue to recognize.SEC Staff Accounting Bulletin No. 101 http://www.sec.gov/interps/account/sab101.htm

  • Lets look at . . .

  • Should a company that acts as a distributor or reseller of products or services record revenue as gross or net?

  • Motivations for Reporting at GrossTypical e-Commerce firm had negative earnings and P/E multiplesInvestors substitute revenue reports for earnings reports, especially revenue growth.Companies that report at gross may inflate market share proportions.

  • Example Priceline.com . . .Priceline.com brokered airline tickets online and included the full price of the ticket as Priceline.com revenues. This greatly inflated revenues relative to traditional ticket brokers and travel agents who only included commissions as revenue.

  • Example eBay.com . . .eBay.com included the entire price of auctioned items into its revenue even though it had no ownership or credit risk for items auctioned online.

  • Example Lands End . . .Lands End issued discount coupons (e.g., 20% off the price), recorded sales at the full price, and then charged the price discount to marketing expense.

  • Resolution (EITF 99-19)

  • Resolution EITF 99-19For gross reporting of a transaction price, a company should meet the following tests regarding the product or service being sold . . .

  • The Company . . .Is the primary obligor.Has general inventory risk.Has latitude in establishing pricesChanges the product or performs part of the service.

  • The Company . . .Determines product/service specifications.Bears risk for physical loss of inventory.Bears credit risk.Cash and price discounts must be deducted from revenue rather than be reported as expenses.

  • The Case: Circuit City Stores, Inc. (A)Why Study This Case?

  • Why Study This CaseExamine revenue recognition issuesProcess used by FASBSubstance over formCommunications with Shareholders

  • Why is Mike Chalifoux Disturbed?

  • Why is Mike Disturbed?Reported income will be reduced and Circuit City growth rate will appear slower.He believes that Circuit Citys present accounting policy is correct.

  • Why is Mike Disturbed?Full recognition of revenue from extended warranty sales is justifiable; andDeferral will not match revenues and expenses for the substance of the transaction.

  • What Actions Could Mike Chalifoux Take

  • What Could Mike Do?Present his case to the FASBRally the industry to lobby FASBEstimate the effect of the possible change.

  • Three Possible Methods

  • Three Possible MethodsFull Revenue RecognitionDeferral of RevenuePartial Revenue Recognition

  • Full Revenue Recognition

    StereoContractTotalRevenue$1,0