Module 5
Reporting and
Analyzing
Operating Income
Revenue Recognition
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Revenue recognition criteria
1.
2.
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realized or realizable, and
earned
Realized or realizable means primarily that
cash is collected or a receivable is collectible.
Earned means that the seller has performed
its duties under the terms of the sales
agreement.
Revenue may be questioned, when…
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Rights of return exist
Continuing involvement by seller in product
resale
Contingency sales
Revenue Recognition Challenges
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Case 1: Channel stuffing
Case 2: Barter transactions
Case 3: Mischaracterizing transactions as
arm’s-length
Case 4: Pending execution of sales agreements
Case 5: Gross versus net revenues
Case 6: Sales on consignment
Case 7: Failure to take delivery
Case 8: Nonrefundable fees
Percentage-of-Completion
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Method appropriate for sales made with longterm contracts: construction, defense contracts,
project services
The percentage-of-completion recognizes
revenue by the proportion of costs incurred to
date compared with total estimated costs.
Subject to manipulation of the estimated costs.
Percentage-of-Completion
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Assume that Bayer Construction signs a $10 million
contract to construct a building. Bayer estimates
construction will cost $4,500,000 the first year and
$3,000,000 for the second year.
Research and Development (R&D) Expenses
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Expense all R&D costs as incurred unless those
assets have alternative future uses (in other R&D
projects or otherwise).
For example, a general research facility housing
multi-use lab equipment is capitalized and
depreciated like any other depreciable asset.
However, project-directed research buildings
and equipment with no alternate uses must be
expensed.
How is R&D Reported by Cisco?
13% of
sales
Restructuring Expenses
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Restructuring costs typically consists of three components:
 Employee severance or relocation costs
 Asset write-downs
 Other (i.e., contract termination costs, legal expenses, etc.)
Accounting standard requires:
 formal restructuring plan approved by its board of directors
 identify the relevant employees and notify them of the plan.
Each year, the company must disclose in its footnotes liability
(accrual), liability amount settled this period and any changes in
estimates.
Income Tax Expenses
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Companies maintain two sets of accounting
records,
one for preparing external financial statements
 another for reporting to tax authorities.
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Two sets of accounting records are necessary
because the U.S. tax code is VERY different
from GAAP.
Income Tax Differences
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Timing Differences
Depreciation
 Bad debts expense
 Warranties
 % completion vs completed contract on revenues
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Permanent Differences
Life insurance of officers
 Entertainment above limits
 Income from state and local bonds
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Deferred Tax Liabilities and Assets
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Deferred tax liabilities
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Arise when reported income is higher than taxable income.
Example: Depreciate faster for tax return than fin. report
Deferred tax assets
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Arise when reported income is lower than taxable
income.
Unearned revenues are revenues for tax return
Bad debt expenses are projected in fin. report, but only
write-offs allowed for tax return
Loss Carryforwards
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When a company reports a loss for tax
purposes, it can carry back that loss for up to
two years to recoup previous taxes paid.
Any unused losses can be carried forward for up
to twenty years to reduce future taxes.
This creates a benefit (an “asset”) on the tax
reporting books for which there is no
corresponding financial reporting asset and thus
the company records a deferred tax asset.
Income Tax Footnotes
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Income tax expense reported in its income
statement (called the provision) consists of the
following two components (organized by
federal, state and foreign):
Current tax expense - the amount payable (in cash)
to tax authorities
 Deferred tax expense - the effects on tax expense
from changes in deferred tax liabilities and deferred
tax assets
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Pfizer’s Income Tax Footnote
Income tax expense (provision) is the sum of
1. Taxes currently payable
2. Deferred income taxes
Earnings Per Share
Global Accounting – R&D
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U.S. GAAP expenses all R&D costs
IFRS allows capitalization and subsequent amortization
of certain development costs that meet a list of
requirements.