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REVENUE RECOGNITION AS-9
Top lines do matter
Prof. Ramkesh Gupta
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WHAT IS REVENUE ?
THE NEW DRESSINGCODEPROFITS DO NOT MATTER BUT TOP
LINES (REVENUES DO)
For companies Absolute Sales Growth
Matter
The DOTCOMS example
Sales of a travel agent - Should sales
includes the cost of the fare collected or
only the commission
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AS 9
WHAT IS REVENUE ?
Revenue is gross inflow of cash, receivables or
other considerations in the ordinary course ofbusiness from sale of goods, rendering of service
FASB Concept statement 6 Defines Revenue
Inflows or other enhancements of assets of an
entity or settlement of liabilities form delivering or
producing goods, rendering services or other
activities that re entities major or central operation
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REVENUE RECOGNITION
ABC LTd. signed a contract on December 15,
2005 to supply special equipment to BPL LTd.
The sale value of the equipment was Rs.2 lacs.
The production was completed on 28 Feb 06, and
ready for despatch. The goods were despatched
to the BPL 18th Mar and the same were received
by the company on 1st April. The company
received full payment on 30th Apr, 2006 There
was a warranty clause of 6 months from the dateof receipt. What is the Revenue for the y.e.
31.03.06?
Dec05 Jan 06 Feb.06 Mar.06 April 06
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The Revenue Recognition problem ?
Dec. Jan. Feb Mar Apr Sep
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Revenue Recognition
One option might be to record the revenue in the month
the production is complete.
Jan FEB
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Revenue Recognition
Another option might be to record the revenue when
goods are received by customer or finally when cash is
received in April
Dec Jan Feb Mar Apr
Another option might be to record the revenue when
goods are received by customer or finally when cash is
received in April
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The Revenue Recognition
A third option might be to record the revenue when
goods are despatched ( March) or Still, when the
warranty period is over.
Dec Jan Feb Mar April 6 m later
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Revenue Recognition
Conceptually revenue can be recognized
incrementally and continuously at different
points in the earning process
For accounting purpose we choose one
event which will reduce the risk of
ultimately receiving the revenue tominimum
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REVENUE RECOGNITION AS 9
REVENUE IS RECOGNISED FROM SALES
WHEN
All significant risks and rewards of ownership
have been transferred to the buyer (Ref: Sale ofGoods Act)
The seller has not retained any control over the
goods transferred
There is no uncertainty about the amount of
consideration from the sale
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Broad frame work for recognition
Different points in RR
Sale is complete on Delivery *
Subject to certain conditions eg: allowing
customer to test the product, additional
services, other works before accepting the
product
Sale complete only when cash is received
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Broad frame work for recognition
Eg:ABC makes equipment and installs them in thefactory on firm orders from parties. The
installation time is about an hour.At the year end ABC produces 10 equipments and
ships it to the customer and promises to to install
the same as soon as some cables were available.
Can the company recognize the sale on delivery ?
Ans: No
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Broad frame work for recognition
Two criterion must be followed:
Is it realized or realizable
Is it earned through substantial completion of theactivities involved in completion
The best practice is to select one point in the cycle
that meets both the criteria for recognition.
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Broad frame work for recognition
Principle of Conservatism
Principle of Substance over Form
Principle of Accrual
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REVENUE RECOGNITION
Revenue is recognized at the point of Sale
It has to satisfy the three conditions:
Risks and Rewards are transferred to the
buyer Seller has no control over the goods
There is no uncertainty over the collectibles
Substantial Performance of the contract
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Recognition Criteria
A Renttoown stores in the US, sellsConsumer durables on a installment basis .
Ie. Pay rent and own after yearsTheir experience is only 25 % of thecustomers complete the full term of theagreement.
They recognize revenue as and when cash iscollected.
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REVENUE RECOGNITION :
The number Game
RELIANCE INDUSTRIES
SALES CROSS 50000 cr
!!
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Reliance Industries
The real sales: year ended 31/3/2002
Sales Rs. 57,119 cr
Inter Divisional Transfers Rs. 11,715Excise Duty Rs. 3,314
=========
Rs 42088 cr
International accounting standards/US GAAP, do notallow the inclusion of inter divisional transfers,Excise duties etc.
ICAI, has now come out with this clarification
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WHAT IS REVENUE ?
THE NEW DRESSINGCODEFor a company to include Gross Amount as sales
It must be the primary obligor.
It must have general inventory risk.
It must have latitude in establishing prices
Changes the product or performs part of theservice.Determines product/service specifications.
Bears risk for physical loss of inventory.
(eg: A travel agent cannot do all this)
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Recognition Policies followed by
companiesMicrosoft: Not all revenues are recognised
at the time of sale. 20 % of the sale price is
reported as unearned revenue (office )and(35% for windows). This is recognised over
a 18 month period which is the product life
cycle.- Perceived by SEC as the income smoothing
technique used by MS.
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Revenue Recognition
How to recognize revenue ?
For services
Long Contracts
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Rendering of Services
Revenue is normally recognized by
Completed contract Method or
Percentage of completion method
The Question is is there really a choice ?
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Revenue Recognition:
Construction Contracts AS - 7Usually take long time to complete
Ex: Construction of Roads, Bridges, dams, buildings.
Two methods for recognizing revenues in suchcases
Percentage of Completion Method
Completed Contract method (eliminated)
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Revenue Recognition: Contracts
Percentage Completion Method
Based on Completion of the Stage (Mile
stone event)Stage can be determined by,
-Cost incurred / Total cost
-Survey of work performed-Completion of physical proportion of thecontract work
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Revenue Recognition:
Construction ContractsPercentage Completion Method
Steps 1: Determine the stage of completion
Step 2: Estimate the total revenue
Step 3:Estimate the total contract cost
(Completed and balance)
Step 4: Take proportionate Profits or
Account for the losses
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Yr 1 Yr 2 YR 3
Contract Price 800 880 880Cum. Actual
Cost210 450 750
Estimate cost
to Complete490 300 -
Total Cost 700 750 750
% completed 30 % 60% 100%
Rev (Cu, CY 240 , 240 528, 288 880, 352
Cost(CU, CY 210, 210 450, 240 750, 300
Profit(CU,CY 30, 30 48 52
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RR: Construction Contracts
Completed Contract Method:
Revenue and costs are recognised only
when the entire contract is completed
This method is not recognised as per the
Accounting Standards
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Thats all