Revenue Recognition
Chapter 8
Recognition refers to the time when transactions are recorded in the books.
Per FASB Concepts Statement No. 5, revenues and gains are usually
recognized when:
1. They are realized or realizable
2. They have been earned through substantial completion of the activities
involved in the earnings process.
Both criteria are usually met when goods are delivered or services are
rendered, that is, at the point of sale. At that time both assets and
revenues are recognized at the same time. However, there are many
exceptions to point of sale revenue recognition. In Exhibit 8-1, Page 387,
the authors provide a time line revenue recognition table which shows that
depending on the circumstances revenue may be recognized before and after
the point of sale.
The AICPA has compiled specific guidelines relating to revenue recognition
including Statement of Position (SOP)
97-2 which relates to high-tech companies (but which has been followed by
many other industries). It expands on the FASB's revenue recognition
criteria with a check list of the following four factors:
1.
2.
3.
4.
Persuasive evidence that an arrangement exists
Delivery has occurred
The vendor's fee is fixed or determinable
Collectibility is probable
Addressing numerous revenue recognition abuses, in 2002 SEC issued Staff
Accounting Bulletin (SAB) 101. This document is structured in question and
answer format and offers ten specific revenue recognition questions and ten
answers. Carefully study these questions and the authors’ answers which
are detailed in Pages 389-398 of the text.
Responding to the many abuses of income reporting in the 1990's and
beyond, the SEC takes a very conservative approach relative to revenue
recognition in SAB 101.
Next, Chapter 8 discusses revenue recognition prior to delivery of goods or
performance of services. As the authors note, in some cases revenue may
be recognized prior to the actual delivery of goods or services. Accounting
for long-term construction-type contract is discussed using the completed
contract method and the percentage of completion method. Whereas in the
completed contract method all income and all expense are recognized in the
year of completion, in the percentage of completion method income and
expense are recognized year by year as the contract progresses toward
completion. Carefully study Pages 402-5. Complications including revision
of cost estimates and the reporting of anticipated contract losses are also
discussed in subsequent pages.
In a section entitled “Accounting for Long-Term Service Contracts: The
proportional Performance Method”, the authors describe how revenue may
recognized prior to the completion of a service contract. The same methods
of determining the percentage of completion may be used for service
contracts as were used for construction contracts.
Revenue recognition after delivery of goods or performance of services is
discussed on Pages 411-416. Under some circumstances, the uncertainty of
cash collection suggests that revenue recognition should await the receipt of
cash. Three revenue recognition methods are discussed including:
1. Installment sales
2. Cost recovery
3. Cash