revenue recognition uaa acct 650 seminar in executive uses of accounting dr. fred barbee

Revenue Recognition

UAA ACCT 650 Seminar in Executive Uses of

Accounting Dr. Fred Barbee

Marketing the product

Receiving customers’ order

Negotiating and signing production contracts.

Ordering materials

Manufacturing the product.

Delivering the product.

Collecting the cash from customers.

Consider a Manufacturing Firm . . .

“The fundamental revenue recognition concept is that revenues should not be recognized by a company until realized or realizable and earned by the company.”

Lynn E. Turner, Chief Accountant, SEC Speech by SEC Staff: Revenue Recognition

May 31, 2001

Revenue Recognition

At the Financial Accounting Standards Board (FASB)

In an effort to provide better and more comprehensive guidance as to when companies should record revenues, the FASB has added a project on revenue recognition to its agenda.

www.fasb.org May 22, 2002

http://www.fasb.org/

“Revenue usually is the largest item in financial statements, and revenue recognition issues top the list of reasons for financial reporting restatements.”

L. Todd Johnson FASB Senior Project Manager

www.fasb.org/news/nr052002.shtml

A top down approach

focusing on conceptual guidance.

A bottom up approach

that provides an inventory of

existing revenue

recognition guidance

and accepted practices.

“. . . Issues involving revenue recognition are among the most important – and the most difficult – that standard setters and accountants face.”

www.fasb.org/project/revenue_recognition.shtml

FASB Concept Statements

5 and 6

APB, FASB, AICPA, EITF,

SEC, SAB

Conceptual Guidance

Authoritative Literature

Sig

nifi

can

t Gap

FASB Concept Statements

5 and 6

APB, FASB, AICPA, EITF,

SEC, SAB

Conceptual Guidance

Authoritative Literature

Revenue

Revenues are inflows of assets and/or settlement of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.

Statement of Financial Accounting Concepts No. 6 “Elements of Financial Statements”

Paragraph 78

Revenue

Essential Characteristics

Inflows of assets or settlements of liabilities

Result of some productive activity of the firm

Major or central operation

Recognition

The process of formally recording or incorporating an item into the financial statements of an entity as an asset, liability, revenue, expense, or the like.

Statement of Financial Accounting Concepts No. 5 “Recognition & Measurement in Financial

Statements of Business Enterprises” - Paragraph 6

Recognition Essential Characteristics

Depiction in both words and numbers

Included in financial statements and statement totals

Disclosure by other means is not recognition

Statement of Financial Accounting Concepts No. 5 “Recognition & Measurement in Financial

Statements of Business Enterprises” - Paragraph 6

To be recognized . . .

An item must meet the definition of an element

It must be measurable

It must be relevant

It must be reliable

Principle of Revenue Recognition

To recognize a revenue it must be:

1. Realized (or realizable)

2. Earned

Principle of Revenue Recognition

Realized

When cash or claims to cash are received.

Realizable

When assets received are readily convertible to known amounts of cash or claims to cash.

Realization Criterion The revenue – the amount the

customers will pay – can be objectively measured.

The eventual collection of cash (or cash-equivalents) can be reasonably assured.

Any remaining fulfillment costs can be estimated with reasonable reliability and accuracy.

The Earned Criterion

The company has completed a substantial portion of the production and sales effort.

The risks of ownership have been shifted to the customer.

Whoa . . . Wait a Minute!

This all sounds so incredibly easy!

So . . . Why do we have so many problems with revenue recognition?

Timing of Revenue Recognition

The Timing of Revenue Recognition

The point at which an order is obtained from a customer.

The point at which an order is accepted and the terms of the sale are finalized.

The Timing of Revenue Recognition

The point at which goods are delivered to a customer.

The point at which the customer is billed

The point at which payment is received from the customer.

Revenue RecognitionClassified by Nature of Transaction


Timing of RecognitionTiming of Recognition

Date of Sale(Date of Delivery)

Date of Sale(Date of Delivery)

Type of TransactionType of Transaction

Sale of ProductFrom Inventory

Sale of ProductFrom Inventory

RevenueRevenue

SalesSales




Services Performedand Billable

Services Performedand Billable


Rendering aService

Rendering aService

RevenueRevenue

Fees or ServicesFees or Services




As time passes orassets are used

As time passes orassets are used


Permitting useof an Asset

Permitting useof an Asset

RevenueRevenue

Interest, Rent,and Royalties

Interest, Rent,and Royalties




Sale of asset otherthen inventory

Sale of asset otherthen inventory

RevenueRevenue

Gain or loss ondisposition

Gain or loss ondisposition


Date of Saleor Trade in

Date of Saleor Trade in

Figure 2.2 The Revenue Recognition Process: Industries Recognizing Revenue at Indicated Phases

Revenues may also be recognized at other times besides thepoint of sale.

Revenue Recognition

At the Securities and Exchange Commission (SEC)

The SEC & Revenue Recognition

SABs do not represent rules or interpretations of the Commission but rather represent the interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the Federal securities laws.

SEC Staff Accounting Bulletin No. 101 - FAQs http://www.sec.gov/info/accountants/sab101faq.htm

The SEC & Revenue Recognition

SAB 101 . . .

Reflects the basic principles of revenue recognition in existing GAAP.

Does not supersede any existing authoritative literature.

Summarizes in one location the existing guidance on revenue recognition.

SEC Staff Accounting Bulletin No. 101 - FAQs http://www.sec.gov/info/accountants/sab101faq.htm

Revenue Recognition Per the SEC

Persuasive evidence of an arrangement exists;

Delivery has occurred or services have been rendered;

SEC Staff Accounting Bulletin No. 101 http://www.sec.gov/interps/account/sab101.htm


The seller’s price to the buyer is fixed or determinable; and

Collectibility (payment) is reasonably assumed.



SAB 101 observes that “judgment” is the key factor in deciding the timing and amount of revenue to recognize.


Let’s look at . . .

Should a company that acts as a distributor or reseller of products or services record revenue as gross or net?

Example – Priceline.com . . .

Priceline.com brokered airline tickets online and included the full price of the ticket as Priceline.com revenues. This greatly inflated revenues relative to traditional ticket brokers and travel agents who only included commissions as revenue.

Example – eBay.com . . .

eBay.com included the entire price of auctioned items into its revenue even though it had no ownership or credit risk for items auctioned online.

Example – Land’s End . . .

Land’s End issued discount coupons (e.g., 20% off the price), recorded sales at the full price, and then charged the price discount to marketing expense.

Resolution (EITF 99-19)

Resolution – EITF 99-19

For gross reporting of a transaction price, a company should meet the following tests regarding the product or service being sold . . .

The Company . . .

Is the primary obligor.

Has general inventory risk.

Has latitude in establishing prices

Changes the product or performs part of the service.

The Company . . .

Determines product/service specifications.

Bears risk for physical loss of inventory.

Bears credit risk.

Cash and price discounts must be deducted from revenue rather than be reported as expenses.

The Case: Circuit City Stores, Inc. (A)

Why Study This Case?

Why Study This Case

Examine revenue recognition issues

Process used by FASB

Substance over form

Communications with Shareholders

Why is Mike Chalifoux Disturbed?

Why is Mike Disturbed?

Reported income will be reduced and Circuit City growth rate will appear slower.

He believes that Circuit City’s present accounting policy is correct.

Why is Mike Disturbed?

Full recognition of revenue from extended warranty sales is justifiable; and

Deferral will not match revenues and expenses for the substance of the transaction.

What Actions Could Mike Chalifoux Take

What Could Mike Do?

Present his case to the FASB

Rally the industry to lobby FASB

Estimate the effect of the possible change.

Three Possible Methods

Three Possible Methods

Full Revenue Recognition

Deferral of Revenue

Partial Revenue Recognition

Full Revenue Recognition

Stereo Contract Total

Revenue $1,000 $100 $1,100

Cost 900 20 920

Profit $100 $80 $180

At date of Sale

Recognize total revenue $1,100

Recognize total costs 920

Profit $180

Deferral of Revenue Sale of Stereo and Warranty

are two separate transactions

At date of Sale

Recognize total revenue $1,000

Recognize total costs 900

Profit $100

Defer $100 contract revenue and allocate over 2 year period.

Partial Revenue Recognition

Transactions are linked

At date of Sale

$900/$920 x $1,100 $1,076

$20/$920 24

Total Revenue $1,100

Defer $24 and recognize over 2-year period.

How should the change be implemented?

Implementation . . .

Restate prior years?

One-time cumulative adjustment?

Phase in?

Some Concluding Thoughts

Concluding Thoughts

FASB sought to improve financial disclosure by limiting diversity in accounting practice.

Good matching of revenues and expenses is not always easy.

Concluding Thoughts

The job of determining, supporting and sustaining financial reporting policies within a company in a changing environment can be a difficult one.

What did Circuit City Do?

revenue recognition uaa acct 650 seminar in executive uses of accounting dr. fred barbee

Documents

revenue recognition

revenue revenues

inventory revenue sales

recognition measurement

revenue recognition

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