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Unformatted text preview: Chapter 18: Revenue Recognition Revenue Recognition principle – companies should recognize revenue when it is realized or realizable and when it is earned • Revenues are realized when a company exchanges goods and services for cash or claims to cash (receivables) • Revenues are realizable when assets a company receives in exchange are readily convertible into known amounts of cash or claims to cash • Revenues are earned when a company has substantially accomplished what it must do to be entitled to the benefits represented by the revenues- that is, when the earnings process is complete or virtually complete Four revenue transactions are recognized in accordance with this principle: • Companies recognize revenue from selling products at the date of sale (the date of delivery to customers) • Companies recognize revenue from services provided, when services have been performed and are billable • Companies recognize revenue from permitting others to use enterprise assets, such as interest, rent, and royalties, as time passes or as the assets are used • Companies recognize revenue from disposing of assets other than products at the date of sale Revenue Recognition at Point of Sale (Delivery) • Companies usually meet the two conditions for recognizing revenue (being realized/realizable and being earned) by the time they deliver products or render services to customers • Therefore, companies commonly recognize revenues from manufacturing and selling activities at point of sale (usually meaning delivery) • Sales with Buyback Agreements – when a repurchase agreement exists at a set price and this price covers all cost of the inventory plus related holding costs, the inventory and related liability remain on the seller’s books (a.k.a. no sale) • Sales When Right of Return Exists – certain companies experience such a high rate of returns – a high ratio of returned merchandise to sales – that they find it necessary to postpone reporting sales until the return privilege has substantially expired o FASB has concluded that if a company sells its product but gives the buyer the right to return it, the company should recognize revenue from sales transactions at the time of sale only if the following size conditions have been met: The seller’s price to the buyer is substantially fixed or determinable at the date of sale The buyer has paid the seller, or the buyer is obligated to pay the seller, and the obligation is not contingent on resale of the product The buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product The buyer acquiring the product for resale has economic substance apart from that provided by the seller The seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer The seller can reasonably estimate the amount of future returns o If all six of these conditions are not met, the company must recognize sales revenue and costs of...
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