Revenue_slides.pptx - Revenue Analysis Why Care about Revenue Plays a critical role in forecasting financial performance Revenue is arguably the most

Revenue_slides.pptx - Revenue Analysis Why Care about...

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Revenue Analysis
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Why Care about Revenue? Plays a critical role in forecasting financial performance. “Revenue is arguably the most important line item in the financial statements of most companies. It is critical to investors in performing their analysis and evaluation of companies.” (Bob Herz, “Revenue Recognition Standard Will Level the Playing Field”) 2
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Revenue Recognition Revenue recognition in theory . Accrual versus cash basis accounting Revenue recognition principle Revenue recognition in practice . SAB 101 Creative revenue recognition practices New revenue recognition rules 3
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Under cash basis accounting? Exchange of cash Under accrual basis accounting? When it’s earned and realizable Why not use cash basis accounting? Easier to manipulate Worse predictor of future cash flows than accruals basis Why? Cash basis accounting destroys information by eliminating management forecasts embedded in the financial statements (i.e., accruals) 4 What Triggers Revenue Recognition?
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Two components of the revenue recognition principle 1. Earned Critical event in the earnings process has taken place. The firm has performed all (or a substantial portion of) the services, or conveyed the asset to the buyer 2. Realizable (or Realized) Amount to be collected (i.e., price) is measurable and collection is reasonably assured, or firm has already received cash 5 Revenue Recognition
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When Should a Company Recognize Revenue? Long-term construction industry (shipbuilding, highway construction etc.) Natural resources (oil, mining) Agricultural products Most retail and manufacturing industries Real estate development
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Why? SEC study of financial reporting frauds found over half of the frauds involved overstating revenue SAB 101 did not change the revenue recognition principle Just clarified it Issued as a warning 7 SEC S taff A ccounting B ulletin ( SAB 101 )
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How Did SAB 101 Clarify Revenue Recognition Principle? Critical event in the earnings process has taken place Evidence of arrangement Delivery or rendering of services has occurred Amount to be collected is measurable and collection is reasonably assured Price is fixed or determinable Collectability is reasonably assured 8
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What Was the Impact of SAB 101?
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