Case 1.10 Gemstar-TV Guide International, Inc.
1. What fundamental principles dictate when a company should recognize or record
revenue in its accounting records? Revenue recognition issues can be particularly complex for
companies that sell software and/or license technology. Identify specific rules or concepts in the
professional standards that accountants and auditors can rely on to make proper revenue
recognition decisions for such companies.
Revenues are recognized when realized or realizable and earned. Revenues are not
recognized until realized or realizable and not recognized until earned. Revenues are realized
when products are exchanged for cash or claims to cash. Revenues are realizable when related
assets received are readily convertible to cash to claims to cash. Revenues are earned when the
products are delivered or services are performed. Recognition is the process of recording an item
in the financial statements. Realization is the process of converting non-cash resources into cash.
Revenues are inflows of assets or settlements of liabilities (or both). Also, revenues are from
activities of the entity’s central operations. Gains are increases in net assets and from peripheral
or incidental transactions of an entity.
In keeping with accrual basis bookkeeping, the Revenue Recognition Principle dictates
that revenue must be recorded at the time it has been fully earned, not when it is received. With
Accrual Accounting revenue is recorded when it is earned and costs and expense are recorded
when they are incurred. Accrual accounting requires the use of payable and receivable accounts
and is also used in payroll accounting for recording payroll liabilities. This method of accounting
can also track sales tax liabilities that are reported on an accrual basis.
AICPA Statement of Position (SOP) 97-2 applies to all entities that license, sell, lease, or
market computer software. It also applies to “hosting” arrangements in which the customer has
the option to take possession of the software. Hosting arrangements occur when end users do not
take possession of the software but rather the software resides on the vendor’s or a third party’s
hardware, and the customer accesses and uses the software on an as-needed basis over the
Internet or some other connection. It does not, however, apply to revenue earned on products