Cost Behavior: Analysis and Use UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee.
Revenue Recognition UAA ACCT 650 Seminar in Executive Uses of Accounting Dr. Fred Barbee.
-
Upload
justine-enzor -
Category
Documents
-
view
228 -
download
6
Transcript of Revenue Recognition UAA ACCT 650 Seminar in Executive Uses of Accounting Dr. Fred Barbee.
Marketing the product
Receiving customers’ order
Negotiating and signing production contracts.
Ordering materials
Manufacturing 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
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 6
APB, FASB, AICPA, EITF,
SEC, SAB
Conceptual Guidance
Authoritative Literature
Sig
nifi
can
t Gap
FASB Concept Statements
5 and 6
APB, FASB, AICPA, EITF,
SEC, SAB
Conceptual Guidance
Authoritative Literature
Revenue
Revenues are inflows of assets and/or settlement of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.
Statement of Financial Accounting Concepts No. 6 “Elements of Financial Statements”
Paragraph 78
Revenue
Essential Characteristics
Inflows of assets or settlements of liabilities
Result of some productive activity of the firm
Major or central operation
Recognition
The 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
Recognition Essential Characteristics
Depiction in both words and numbers
Included in financial statements and statement totals
Disclosure by other means is not recognition
Statement 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 element
It must be measurable
It must be relevant
It must be reliable
Principle of Revenue Recognition
To recognize a revenue it must be:
1. Realized (or realizable)
2. Earned
Principle of Revenue Recognition
Realized
When cash or claims to cash are received.
Realizable
When assets received are readily convertible to known amounts of cash or claims to cash.
Realization Criterion The 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 Criterion
The 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?
The Timing of Revenue Recognition
The 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 Recognition
The point at which goods are delivered to a customer.
The point at which the customer is billed
The point at which payment is received from the customer.
Revenue RecognitionClassified by Nature of Transaction
Revenue RecognitionClassified by Nature of Transaction
Timing of RecognitionTiming of Recognition
Date of Sale(Date of Delivery)
Date of Sale(Date of Delivery)
Type of TransactionType of Transaction
Sale of ProductFrom Inventory
Sale of ProductFrom Inventory
RevenueRevenue
SalesSales
Revenue RecognitionClassified by Nature of Transaction
Revenue RecognitionClassified by Nature of Transaction
Timing of RecognitionTiming of Recognition
Services Performedand Billable
Services Performedand Billable
Type of TransactionType of Transaction
Rendering aService
Rendering aService
RevenueRevenue
Fees or ServicesFees or Services
Revenue RecognitionClassified by Nature of Transaction
Revenue RecognitionClassified by Nature of Transaction
Timing of RecognitionTiming of Recognition
As time passes orassets are used
As time passes orassets are used
Type of TransactionType of Transaction
Permitting useof an Asset
Permitting useof an Asset
RevenueRevenue
Interest, Rent,and Royalties
Interest, Rent,and Royalties
Revenue RecognitionClassified by Nature of Transaction
Revenue RecognitionClassified by Nature of Transaction
Type of TransactionType of Transaction
Sale of asset otherthen inventory
Sale of asset otherthen inventory
RevenueRevenue
Gain or loss ondisposition
Gain or loss ondisposition
Timing of RecognitionTiming of Recognition
Date of Saleor Trade in
Date of Saleor Trade in
Figure 2.2 The Revenue Recognition Process: Industries Recognizing Revenue at Indicated Phases
Revenues may also be recognized at other times besides thepoint of sale.
The SEC & Revenue Recognition
SABs 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 Recognition
SAB 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 SEC
Persuasive 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 SEC
The seller’s price to the buyer is fixed or determinable; and
Collectibility (payment) is reasonably assumed.
SEC Staff Accounting Bulletin No. 101 http://www.sec.gov/interps/account/sab101.htm
Revenue Recognition Per the SEC
SAB 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
Should a company that acts as a distributor or reseller of products or services record revenue as gross or net?
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 – Land’s End . . .
Land’s 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
For 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 prices
Changes 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.
Why Study This Case
Examine revenue recognition issues
Process used by FASB
Substance over form
Communications with Shareholders
Why is Mike Disturbed?
Reported income will be reduced and Circuit City growth rate will appear slower.
He believes that Circuit City’s present accounting policy is correct.
Why is Mike Disturbed?
Full recognition of revenue from extended warranty sales is justifiable; and
Deferral will not match revenues and expenses for the substance of the transaction.
What Could Mike Do?
Present his case to the FASB
Rally the industry to lobby FASB
Estimate the effect of the possible change.
Full Revenue Recognition
Stereo Contract Total
Revenue $1,000 $100 $1,100
Cost 900 20 920
Profit $100 $80 $180
At date of Sale
Recognize total revenue $1,100
Recognize total costs 920
Profit $180
Deferral of Revenue Sale of Stereo and Warranty
are two separate transactions
At date of Sale
Recognize total revenue $1,000
Recognize total costs 900
Profit $100
Defer $100 contract revenue and allocate over 2 year period.
Partial Revenue Recognition
Transactions are linked
At date of Sale
$900/$920 x $1,100 $1,076
$20/$920 24
Total Revenue $1,100
Defer $24 and recognize over 2-year period.
Concluding Thoughts
FASB sought to improve financial disclosure by limiting diversity in accounting practice.
Good matching of revenues and expenses is not always easy.
Concluding Thoughts
The job of determining, supporting and sustaining financial reporting policies within a company in a changing environment can be a difficult one.