Case-Study-Four

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ACC271 – Intermediate Financial Accounting

Case Study Four

Revenue Recognition

Dajana Kristic, Marija Kristic, Justin Archibald

Revenue recognition is the increase in economic resources resulting from ordinary operations of the entity. There is three different types of revenue recognition: before delivery, at the point of delivery, and after delivery. There are four criteria that have to be met in order for revenue to be recognized:

Performance is achieved

Reasonable measure

Reasonable assurance of collectability

Can match in material expense.

Why is the point of delivery usually used as the basis for the timing of revenue recognition?

The point of delivery is usually used as the basis for the timing of revenue recognition because it is the most commonly used form. It is what is used for most product sales. The most important part of recognizing the profits is meeting all four of the criterion, and the point of delivery does that right then and there, rather than before or after delivery.

Why could point of delivery be considered “too conservative” when revenue is earned throughout the process? Please provide an example.

Point of delivery could be considered too conservative because under some circumstances, other things have to be taken into consideration. This form of recognition just might not work, and a lot of the time it does not. If revenue has to be collected before it is earned, then other factors may need to be taken into account – what if the contract is not finished when it needs to be? What if other extreme expenses come into play that had not originally been discussed? This and many other things need to be taken into consideration.

An example of this would be not having policies in place for before or after delivery revenue recognition, specifically something like The Brick has to offer their clients. With their option to not pay for five years, there are recognizing revenue long after delivery. If they did not have this option for customers and enforced the point of delivery revenue recognition, this would require people to immediately pay for their purchases so that they could record them. For point of delivery to take place, after all, all four criteria must be met right away. This is a circumstance where this is too conservative, because without this after delivery policy, they would probably lose a lot of their

business. They would have far less revenues to even record! People choose this option because it is practical for them; although they may not be able to afford something they need now, this gives them the option to pay for it when they are financially able.

The only recommendation for it being “too conservative” is to take into consideration the other forms of recognition and use them when appropriate. If long term construction contracts changed from before delivery recognition to point of delivery recognition, it would mess with everyone’s systems and the company’s book keeping. Companies need to stick to what works for them, and for some point of delivery may be too conservative; that is why the other forms of recognition are accepted.

Why could point of delivery be “not conservative enough” when recognizing revenue recognition? Please provide an example.

Point of delivery might possibly be considered “not conservative enough” because of aggressive revenue recognition. Any form of breaking the rules of recognizing real revenues is considering aggressive revenue recognition, and although it is unfortunate, it happens.

An example of this would be a company skewing their books to make it appear that their profits were higher than they actually were, even by a small amount. When meeting all four criteria of recognizing revenue, whoever is responsible for the books has to record this sale. Say their profits were $10.00, but they recorded them as $10.50; they continued to do this every time that they sold that product, even though their profits were $10.00 every time. Although $0.50 does not seem like much, it is a significant difference in identifying real profits. This might happen for a number of different reasons. Maybe the individual who is recording this dishonestly and incorrectly has an incentive; maybe they will receive a bonus. Maybe they did not reach their targeted quota for the month. Whatever the reason, it is a problem.

The manager, or bookkeeper, or whoever is recording this is guilty of aggressive revenue recognition, and that is definitely not conservative enough.

The recommendation for this would be to honestly identify profits; to record revenues as they actually are, not “cook the books”.

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