lecture6 - Receivables and Revenue Recognition 15.501/516...

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1 Receivables and Revenue Recognition 15.501/516 Accounting Spring 2004 Professor S. Roychowdhury± Sloan School of Management Massachusetts Institute of Technology Feb 23 and 25, 2004±
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WHY DO WE CARE ABOUT ± REVENUE RECOGNITION?± ± Revenue has a BIG impact on bottom-line profitability ==> managers may be tempted to manage revenue ± Large Sample Evidence: over 40% of SEC enforcement actions on accounting issues deal with Revenue Recognition ± Sample of headlines from searching Dow Jones Newswire for 2004 and 2003: ± Ceridian Results for 2000-2003 to restated, Feb 18 ± Wolf Popper files Securities Class Action against Sonus Networks, Feb 13, 2004 ± Tripos postpones earnings release – will revise revenue recognition policies, Feb 12 ± Opsware expects 100% revenue growth, points out transparent revenue recognition policies , Feb 11 ± Agco Corp faces class action suit, Feb 6 2
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CRITERIA FOR REVENUE RECOGNITION ± Under accrual accounting, a firm recognizes revenue when it has: ± Performed all, or a substantial portion of, the services to be provided. ± Incurred a substantial majority of the costs, and the remaining costs can be reasonably estimated. ± Received either cash, a receivable, or some other asset for which ± a reasonably precise value can be measured ± collectibility is reasonably assured. 3
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Recognition Criteria Cash Basis vs Accrual Basis Accrual Cash± Revenue± Expense± 4
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Cash Basis vs Accrual Basis± Recognition Criteria Accrual Cash Revenue when $ rec’d± Expense when $ paid± 5
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Cash Basis vs Accrual Basis± Recognition Criteria Accrual Cash Revenue when earned when $ rec’d and realized Expense when incurred when $ paid 6
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EXAMPLES OF REVENUE RECOGNITION EVENTS z At the time of sale (This is, by far, most commonly ± encountered.) z Title passes to the buyer and delivery takes place z Reasonable estimate of uncollectibles z Reasonable estimate of sales returns z Reasonable estimation of all other material expenses representing uncertain future outflows (e.g., warranty costs). z Most common in retail, wholesale & manufacturing z Even when right of return exists? 7
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z Hardware z Revenue from hardware sales or sales-type leases is recognized when the product is shipped . z Recent experience of Sunbeam “…. .In the fourth quarter of last year Sunbeam recorded $50 million in sales of cooking grills under an ‘early buy’ program … [some $35 million] were categorized ‘bill and hold’ sales and never even left Sunbeam’s warehouses.” -- from Barron’s, 6/8/98 z Agco Corp “….Farm equipment company Agco announced that the Securities and Exchange Commission has launched an informal inquiry into its accounting practices…… Agco stated that in some instances it recognizes revenue when equipment remains on its premises after having been invoiced to the dealer.
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lecture6 - Receivables and Revenue Recognition 15.501/516...

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