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. Persuasive evidence that an arrangement exists
2. Delivery has occurred
3. The vendor's fee is fixed or determinable
4. 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