CHAPTER 5 Revenue Recognition

CHAPTER 5 Revenue Recognition - Income Measurement and...

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Income Measurement and Profitability Analysis REVENUE RECOGNITION Revenue Recognition Principle Revenues are recognized when: (1) It is realized or realizable a) Revenue is realized when goods or services are exchanged for cash or receivables b) Revenue is realizable when assets received are convertible to cash or receivable (2) It is earned a) Revenues are earned when the earnings process is complete Quality of Earnings Some publicly traded companies have had a tendency to recognize revenue prematurely. This affects the quality of earnings and the transparency of overall financial reporting. To combat this problem the SEC issued Staff Accounting Bulletin No. 101 that provides additional criteria that must be followed in determining when revenue should be recognized. The additional criteria are as follows: 1) Persuasive evidence of an arrangement exists. 2) Delivery has occurred or services have been rendered. 3) The seller’s price to the buyer is fixed or determinable. 4) Collectibility is reasonably assured. REVENUE RECOGNITION AT A POINT IN TIME The recognition of revenue depends of the type of business transaction involved. The following is a table that lists the types of business transactions that might occur and the timing of revenue recognition. This assumes that collectibility is reasonably certain. Transaction Products Services Use of Assets Disposition of Assets Source Sales Fees Interest, rents Gain or loss Timing Date of sale (date of delivery) Services performed Passage of time Date of sale or trade-in Completion of the Earnings Process within a Single Reporting Period Revenue is normally recognized when a product is delivered (title transfers to the buyer) or the service is performed. This is assuming that the two revenue recognition criteria above are satisfied and that collectibility is reasonably certain. Completion of Production Basis Under certain circumstances revenue is recognized at the completion of production even though the product has not been sold. The circumstances that would make this possible are: 1) The sales price is reasonably assured 2) The units of product are interchangeable 3) There are no significant costs involved in product distribution Products that normally qualify for this type of accounting treatment are the harvesting of agricultural crops and the mining of metals. E:\Teaching\3321\web\module2\c5\tnotes\c5a.doc 1/31/2007 1
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Income Measurement and Profitability Analysis Installment Sales Accounting Method The recognition of revenue is based on the collection of cash rather than the completion of the sale. It is used in industries where collection is relatively uncertain. To accomplish this we use a separate set of accounts to record “Installment Receivables” and “Deferred Gross Profit.” Year of Installment Sale: (1) Record all transactions as follows: ACCOUNT DEBIT CREDIT Installment receivables $XX,XXX Inventory $XX,XXX Deferred gross profit, (current year) $X,XXX To record installment sales and related deferred gross profit for the year. (2)
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CHAPTER 5 Revenue Recognition - Income Measurement and...

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