ras Fat Semester Pinan Asm 6 REVENUE RECOGNITION 5. REVENUE RECOGNI 5.1.1. Introduction issues involving revenue reco Revenue is usualy the largest single item in financial statements, and the issues involving revere ran ‘ong the most important and difficult ones that standard-stters and accountant ; seamen tin a ie tac Sus at hi, sinifcanly. Quite often, companies end up tweaking the revenue numbers, Besides some other reir, Recording revenue improperly is also a commonly used “earnings management technique’. The ever evolving business models andthe growing online economy have only compounded the issue. Revene as been defined dtferemly by different authorities. Reveve is defines a receipts oF returns fom ay source. Receipts from any source are very broad and if adopted, without restraint, may distort the very pupo of preparing final accounts. Receipts on isue of shares, bonos or debentures or deposits or loans ar mt revenue, Receipts in dicharge of the obligation already created tothe business eg, payments received fom debtors or receipts onsale of od ase or investments arent revenes, iN ‘of an enity of set 2 a ‘goods, rendering services or other activities, that constitute the entity's ongoing major or central operations revenue. The Institute of Chartered Accountants of India (ICAI) defines revenue as the gross inflow of exh, receivables or other consideration, aa ‘out of activities of 5 amine eof om 5.1.2. Revenue Recognition Principles ‘The revenue recognition principle isa comerstone of accrual accounting together with matching principle: They both determine the accounting period, in which revenues and expenses are recognized, According to he ‘when they ar: ferred or services rendered, no matter When cash is received. In cash accounting ~ in contrast ~ revenues are recognized when cash d goods a cc "n cash is received no matter when goods at shevees are sold, Received advances are not recognized as revenues, but as liabilities (deferred incom), uitl the; (1) and (2) are met. p (receivat i Polis eee ae (receivable) are received in exchange for goods © Teceived in such exchange are readily convertible to cash &t 2) s oth, such ad inal delivery completion (with a provision for retums, warrant Payment assurance revenue recognition Sete), are required, because of Recognition of revenue from four types of transactions: 1) Revenves from selling inventory are recognized at the dat of ste often 2 fees am nine cee ee ee a aoe: 3)_ Revenue from permission to use company’s assets (eg, interests for ners on tiled. assets, and royalties for using intangible assets) is recognized as time pasa ‘money, rent for using fixed 4) Revene om ling an ase ter an veri expe athe pin gan ae EE When it takes place = SARS REN, SES SN, \" = ¥ AEE: BE be: LLIIES,Revenue Recognition (Module 5) 447 5.1.3. Revenue Measurement JAS-18, Revenue, stipulates that revenue should be measured at the Fair Value (FV) of the consideration received. [Link]. Consideration in the Form of Cash ‘When the consideration received is in the form of cash or cash-equivalents, the amount of revenue is the amount of cash or cash-equivalents received or receivable. However, when the inflow of cash or cash equivalents is deferred, the FV of the consideration may be less than the nominal amount of cash received or receivable. ‘A sales transaction that allows credit for a significant period @ORGSEIMIAHMOMMAINGRGIEBEHiod allowed to customers) is in ‘substance’ a combinati s transaction and financing transaction. Therefore, the amount receivable from the Cust ti . Usually when an entity ‘grants credit for a significant period, it obtains an in: ‘su ‘note’ from the customer to its claim. When the transaction is identified as a composite transaction constituted of sales and financing, the FV of the consideration is determined by discounting all future receipts using an imputed rate of interest. The difference between the FV and the nominal amount ofthe consideration is recognized as interest income. [Link]. Consideration in the Form of Other than Cash ‘When a firm receives consideration in a form other than cash or cash-eguivalent, revenue is recognized at the Fair ‘Value (FV) of the consideration received or receivable. For example, shares issued by the buyer as consideration, revenue should be recognized at the FV of equi seller. Grant date is the date on which the equity shares are granted to the seller. ‘Vesting date is the date on which the performance necessary to earn the equity is completed by the seller and seller's tights have vested. pita 2 j In a situation when the FV of the consideration received cannot be measured reliably, the enterprise should ‘apply the well accepted accounting principle that a transaction involving exchange of non-monetary considerations should be recorded at the FV of the consideration given or consideration received, whichever is more clearly evident. Therefore, in a sale transaction, if the FV of the consideration received cannot be measured e FV of the goods or servi all ciple, ly, 5.13.3. Barter Transaction ‘When goods or services are exchanged or swapped for goods or services, which are of a similar nature or value, the se is not seas ‘asa transaction which generates revenues. Therefore, exchange of similar items Standard Interpretation Committee (SIC) of IASB issued SIC-31, which discusses barter transact advertising services, Ik concludes that revenue from a barter transaction iavolving @AveRsemEnEReannot be measured at the FV of advertising services received. However, a seller can dete services provided reliably with reference to non-barter transactions. 5.1.4. Collectability of Revenue Under generally accepted accounting principles, revenue recognition customarily does not depend on the collection of cash. Accrual accounting techniques normally record revenue at the point of a credit sale by establishing a receivable. When uncertainty arises surrounding the collectability of this amount, the receivable is appropriately adjusted by establishing a valuation allowance. In some cases, however, the collection of the sales price may be so uncertain that an objective measure of ultimate collectability cannot be established. When such circumstances exist, the seller uses either the instalment method or the cost recovery method to recognize —=: (APB 10). Both of these methods allow for a feral of gros pri ntl cat a been Accounting Principles Board specifically noted se inst acceptable” if revenues and a provision for Non-collectible accounts can be reasonably estimated.8 MMs ar ae 5.1.5. Sale of Goods ‘eventue from the sale of goods is recognized when: Significant risks and rewards of ownership are transferred tothe buyer. ‘The seller has no continuing managerial involvement or control over the goods: | ‘The amount of revenue can be measured reliably; Itis probable that economic benefits will flow to the seller; and ; ‘The costs of the transaction (including future costs) can be measured reliably. [Link]. Transfer of Risks and Rewards ‘The transfer of risks and rewards is evaluated by comparing the entity's exposure, before and after the trans, ‘with the variability in the amounts and timing of the net cash flows of the transferred asset. An entity by retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variably in the present value of the future net cash flows from the financial asset does not change significantly as areqy of the transfer (e.g., because the entity has sold a financial asset subject to an agreement to buy it back ata fied price or the sale price plus a lender's return). [Link]. Bill and Hold Revenue Transactions | ‘When a company is striving to reach difficult revenue goals, sometimes resort to bill = under which it completes a product, tote | customer, (who may not want it yet). Thous jumber of situations where this treatment i legitimate (perhaps the customer has no storage space available), there have also been a number of cases where bil and hold transactions have subsequently been proven to be a fraudulent method for recognizing revenue ‘Consequently, the following rules must now be met before a bill and hold transaction will be considered valid: 1) Completion: The product being stored under the agreement must be ready for shipment. This means that | the seller cannot have production staff in the storage area making changes to the product subsequent tote | billing date. 2) Delivery Schedule: The products cannot be stored indefinitely. Instead, there must be a schedule in place for the eventual delivery of the goods to the customer. 3) Documentation: The buyer must have signed a document in advance clearly stating that it is buying the products being stored by the seller, 4) Origination: The buyer must have requested that the bill and hold transaction be completed, and have & ‘good reason for doing so. . 5) Ownership: The buyer must have taken on all risks of ownership, so the seller is now simply the provider of storage space. ©) Performance: The terms of the sales agreement must not state that there are the part of the seller at the time when revenue is recognized. 7) Segregation: The-products involved in the transaction must have beer | 8 ust have been split awa invent tnd sede Thy a tuo ae ade vals ere nga oe ee any unfulfilled obligations [Link]. Installment ; ‘The primary source of accounting for real estate sales is the FASB’: for recognizing revenue under varying conditions. * Statement 66, which establishes a scheme ‘The threshold question in a real estate transaction is whether there has been a is a two-part conjunctive test “sale”. Under Statement 66, thet » [ean Any such post-sale obligation will invalidate the sale for revenue recognition purposes | ‘When the actual collection of cash is suspect, a company should t recognition. This is primarily used in some real estate transactions where thes ust@umeRt method of revem™ cash collection is subject to the risk of the buyer’s financing sale may falling iy be agreed upon but calculated in proportion to cash received. EHO, AS areal oe pet