bus 251 4 - H Chapter 4 8/21/08 9:11 AM Page 69 chapter...

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CHAPTER OVERVIEW This chapter continues the discussion begun in Chapter 2 on revenue recognition and performance measurement. The importance of revenue to an organization’s financial health is discussed, leading to the need for criteria to determine just when revenue should be recognized in various situations. The criteria consist of three general concepts: (1) the revenue must be earned, (2) the amount must be measurable, and (3) there is a reasonable assurance of collectibility of the amount earned. If a transaction meets all of these con- ditions, revenue should be recognized. The cash-to-cash cycle is introduced as a model for understanding a company’s performance and for relating the measurement of this performance to the recognition of revenue. This cycle outlines the steps involved in converting cash into inventory, selling the inventory, and then converting the receivables back into cash. Performance can be measured at various points within this cycle. Revenue recognition during the cash-to-cash cycle can be determined (1) at the time of sale, (2) at the time of contract signing, (3) at the time of production, and (4) at the time of collection. In long-term construction contracts, various methods, including the completed contract method and the percentage of completion method, can be used, depending on the circumstances. In situations where it is not possible to estimate the probability of collection with sufficient certainty, the instalment method can be used. Understanding the various ways that revenue can be recognized leads to a common measure of performance— return on investment (ROI). Two other specific kinds of ROI are: return on assets (ROA) and return on equity (ROE). chapter 4 REVENUE RECOGNITION H Chapter 4 8/21/08 9:11 AM Page 69
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Finally, performance measurement is discussed by considering the role of Net Income as a measurement of the change in shareholders’ wealth. LEARNING OBJECTIVES 1. Describe the cash-to-cash cycle of a retail company. 2. Explain the relationship between performance and revenue recognition. 3. List and explain the criteria for revenue recognition. 4. Define earnings management and explain why and how it can occur. 5. Describe various applications of the revenue recognition criteria. 6. Explain the impact various revenue recognition methods have on earnings recognition. 7. Calculate amounts to be recognized under the completed contract method and the percentage of completion method. 8. Describe how return on investment can give you one measure of performance. 9. Calculate the return on investment under some basic scenarios. CHAPTER REVIEW The cash-to-cash cycle is a model that describes the process of converting cash into inventory, selling the inventory, and converting the subsequent receivables back into cash. The steps for a retail firm include the following: the initial investment of cash, the purchase of merchandise inventory, selling activity, delivery of the product (including any warranty service), and the
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This note was uploaded on 05/13/2010 for the course BUS 251 taught by Professor Stevegibson during the Spring '08 term at Simon Fraser.

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bus 251 4 - H Chapter 4 8/21/08 9:11 AM Page 69 chapter...

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