ASSIGNMENT

ON

REVENUE RECOGNITION AND MEASUREMENT

(ACCOUNTING)
Submitted

In partial fulfillment of the requirement of the degree of

MASTERS OF BUSINESS ADMINISTRATION

SESSION 2018-2020

SUBMITTED TO: SUBMITTED BY:

MR. ABHISHEK SHIVESH KUTHIALA
DAV COLLEGE, SECTOR 10, ROLL No. 1013
CHANDIGARH MBA - 1st Sem.

INSTITUTE OF MANAGEMENT
D.A.V COLLEGE, CHANDIGARH
 ACKNOWLEDGEMENT

The successful completion of any task would be incomplete without mentioning the
names of persons who helped to make it possible. I take this opportunity to express my gratitude
in few words and respect to all those who helped me for the completion of this summer project

I express a deep sense of gratitude to my guide Mr. Abhishek Mishra, Faculty,

Department of Management studies, for his encouragement, support and guidance to complete
this project work successfully.

Finally, I express our sincere thanks and deep sense of gratitude to my parents and friends
for giving timely advice in all the ways and in all aspects for doing the project.

Shivesh Kuthiala
 REVENUE RECOGNITION AND MEASUREMENT

The revenue recognition principle is a cornerstone of accrual accounting together with the

matching principle. They both determine the accounting period, in which revenues and expenses

are recognized. According to the principle, revenues are recognized when they are realized or

realizable, and are earned (usually when goods are transferred or services rendered), no matter

when cash is received. In cash accounting – in contrast – revenues are recognized when cash is

received no matter when goods or services are sold.

Cash can be received in an earlier or later period than obligations are met (when goods or

services are delivered) and related revenues are recognized that results in the following two types

of accounts:

 Accrued revenue: Revenue is recognized before cash is received.

 Deferred revenue: Revenue is recognized after cash is received.

Revenue realized during an accounting period is included in the income.

International Financial Reporting Standards criteria[edit]

The Critical-Event Approach: IFRS provides five criteria for identifying the critical event for

recognizing revenue on the sale of goods:[1]

1. Risks and rewards have been transferred from the seller to the buyer

2. The seller has no control over the goods sold

3. Collection of payment is reasonably assured

4. The amount of revenue can be reasonably measured

5. Costs of earning the revenue can be reasonably measured

The first two criteria mentioned above are referred to as Performance. Performance occurs

when the seller has done most or all of what it is supposed to do to be entitled for the payment.
E.g.: A company has sold the good and the customer walks out of the store with no warranty on

the product. The seller has completed its performance since the buyer now owns good and also

all the risks and rewards associated with it. The third criterion is referred to as Collectability.

The seller must have a reasonable expectation of being paid. An allowance account must be

created if the seller is not fully assured to receive the payment. The fourth and fifth criteria are

referred to as Measurability. Due to Matching Principle, the seller must be able to match

expenses to the revenues they helped in earning. Therefore, the amount of Revenues and

Expenses should both be reasonably measurable

General rule[edit]

Received advances are not recognized as revenues, but as liabilities (deferred income), until the

conditions (1.) and (2.) are met.

1. Revenues are realized when cash or claims to cash (receivable) are received in exchange

for goods or services. Revenues are realizable when assets received in such exchange are

readily convertible to cash or claim to cash.

2. Revenues are earned when such goods/services are transferred/rendered. Both such

payment assurance and final delivery completion (with a provision for returns, warranty

claims, etc.), are required for revenue recognition.

Recognition of revenue from four types of transactions:

1. Revenues from selling inventory are recognized at the date of sale often interpreted as the

date of delivery.

2. Revenues from rendering services are recognized when services are completed and billed.
 3. Revenue from permission to use company's assets (e.g. interests for using money, rent for

using fixed assets, and royalties for using intangible assets) is recognized as time passes

or as assets are used.

4. Revenue from selling an asset other than inventory is recognized at the point of sale,

when it takes place.

Revenue versus cash timing[edit]

Accrued revenue (or accrued assets) is an asset such as proceeds from a delivery of goods or

services, at which such income item is earned and the related revenue item is recognized, while

cash for them is to be received in a later accounting period, when its amount is deducted

from accrued revenues. It shares characteristics with deferred expense(or prepaid expense,

or prepayment) with the difference that an asset to be covered later is cash paid out to a

counterpart for goods or services to be received in a later period when the obligation to pay is

actually incurred, the related expense item is recognized, and the same amount is deducted

from prepayments

Deferred revenue (or deferred income) is a liability, such as cash received from a counterpart for

goods or services which are to be delivered in a later accounting period, when such income item

is earned, the related revenue item is recognized, and the deferred revenue is reduced. It shares

characteristics with accrued expense with the difference that a liability to be covered later is an

obligation to pay for goods or services received solo from a counterpart, while cash for them is

to be paid out in a later period when its amount is deducted from accrued expenses.

For example, a company receives an annual software license fee paid out by a customer upfront

on the January 1. However the company's fiscal year ends on May 31. So, the company using

accrual accounting adds only five months worth (5/12) of the fee to its revenues in profit and
loss for the fiscal year the fee was received. The rest is added to deferred income (liability) on

the balance sheet for that year.

Advances[edit]

Advances are not considered to be a sufficient evidence of sale, thus no revenue is recorded until

the sale is completed. Advances are considered a deferred income and are recorded

as liabilities until the whole price is paid and the delivery made (i.e. matching obligations are

incurred).

Exceptions[edit]

Revenues not recognized at sale[edit]

The rule says that revenue from selling inventory is recognized at the point of sale, but there are

several exceptions.

 Buyback agreements: buyback agreement means that a company sells a product and agrees

to buy it back after some time. If buyback price covers all costs of the inventory plus related

holding costs, the inventory remains on the seller's books. In plain: there was no sale.

 Returns: companies which cannot reasonably estimate the amount of future returns and/or

have extremely high rates of returns should recognize revenues only when the right to return

expires. Those companies that can estimate the number of future returns and have a

relatively small return rate can recognize revenues at the point of sale, but must deduct

estimated future returns.

Revenues recognized before sale[edit]

Long-term contracts[edit]

This exception primarily deals with long-term contracts such as constructions (buildings,

stadiums, bridges, highways, etc.), development of aircraft, weapons, and space exploration
hardware. Such contracts must allow the builder (seller) to bill the purchaser at various parts of

the project (e.g. every 10 miles of road built).

 The percentage-of-completion method says that if the contract clearly specifies the price

and payment options with transfer of ownership, the buyer is expected to pay the whole

amount and the seller is expected to complete the project, then revenues, costs, and gross

profit can be recognized each period based upon the progress of construction (that is,

percentage of completion). For example, if during the year, 25% of the building was

completed, the builder can recognize 25% of the expected total profit on the contract. This

method is preferred. However, expected loss should be recognized fully and immediately due

to conservatism constraint. Apart from accounting requirement, there is a need for

calculating the percentage of completion for comparing budgets and actuals to control the

cost of long-term projects and optimize Material, Man, Machine, Money and time (OPTM4)

.The method used for determining revenue of a long-term contract can be complex. Usually

two methods are employed to calculate the percentage of completion: (i) by calculating the

percentage of accumulated cost incurred to the total budgeted cost. (ii) by determining the

percentage of deliverable completed as a percentage of total deliverable. The second method

is accurate but cumbersome. To achieve this, one needs the help of a software ERP package

which integrates Financial, inventory, Human resources and WBS (Work breakdown

structure) based planning and scheduling while booking of all cost components should be

done with reference to one of the WBS elements. There are very few contracting ERP

software packages which have the complete integrated module to do this.

 The completed-contract method should be used only if percentage-of-completion is not

applicable or the contract involves extremely high risks. Under this method, revenues, costs,
 and gross profit are recognized only after the project is fully completed. Thus, if a company

is working only on one project, its income statement will show $0 revenues and $0

construction-related costs until the final year. However, expected loss should be recognized

fully and immediately due to conservatism constraint.

Completion of production basis[edit]

This method allows recognizing revenues even if no sale was made. This applies to agricultural

products and minerals.There is a ready market for these products with reasonably assured prices,

the units are interchangeable, and selling and distributing does not involve significant costs.

Revenues recognized after Sale[edit]

Sometimes, the collection of receivables involves a high level of risk. If there is a high degree of

uncertainty regarding collectibility then a company must defer the recognition of revenue. There

are three methods which deal with this situation:

 Installment sales method allows recognizing income after the sale is made, and

proportionately to the product of gross profit percentage and cash collected calculated. The

unearned income is deferred and then recognized to income when cash is collected.[2] For

example, if a company collected 45% of total product price, it can recognize 45% of total

profit on that product.

 Cost recovery method is used when there is an extremely high probability of uncollectable

payments. Under this method no profit is recognized until cash collections exceed the seller's

cost of the merchandise sold. For example, if a company sold a machine worth $10,000 for

$15,000, it can start recording profit only when the buyer pays more than $10,000. In other

words, for each dollar collected greater than $10,000 goes towards your anticipated gross

profit of $5,000.
 Deposit method is used when the company receives cash before sufficient transfer of

ownership occurs. Revenue is not recognized because the risks and rewards of ownership

have not transferred to the buyer.[3]

 Generally accepted accounting principles

 Comparison of cash and accrual methods of accounting

 Vendor-specific objective evidence

New Revenue Recognition Standard[edit]

On May 28, 2014, the FASB and IASB issued converged guidance on recognizing revenue in

contracts with customers. The new guidance is heralded by the Boards as a to think major

achievement in efforts to improve financial reporting.[4] The update was issued as Accounting

Standards Update (ASU) 2014-09. It will be part of the Accounting Standards Codification

(ASC) as Topic 606: Revenue from Contracts with Customers (ASC 606), and supersedes the

existing revenue recognition literature in Topic 605 issued by FASB.[5]ASC 606 is effective for

public entities for the first interim period within annual reporting periods beginning after

December 15, 2017 (nonpublic companies have an additional year).[6]

The new standard aims to:

 Remove inconsistencies and weaknesses in revenue requirements

 Provide a more robust framework for addressing revenue issues

 Improve comparability of revenue recognition practices across entities, industries,

jurisdictions, and capital markets

 Provide more useful information to users of financial statements through improved

disclosure requirements
 Simplify the preparation of financial statements by reducing the number of requirements to

which an entity must refer[5]

The new revenue guidance was issued by the IASB as IFRS 15. The IASB’s standard, as

amended, is effective for the first interim period within annual reporting periods beginning on or

after January 1, 2018, with early adoption permitted.[7]

Measurement of Revenue:

Revenue is properly measured either by the exchange value of the product or services of the

firm. This exchange value actually reveals the cash equivalent or the present discounted value of

the money which is received from the revenue transaction. This may be similar to the price

established in the transaction.

For this purpose, proper allowance must be made in order to wait for final collection. For

example, a cash sale of Rs. 1,000 will produce a revenue of Rs. 1,000 but if the payment is made

after a year, it produces a revenue which will be less than Rs. 1,000, since question of discount

will appear in the latter case. If the waiting period is very short, naturally, the discount factor

may be ignored.

The above criterion for the purpose of measurement of revenue relates to the present value of

money or its equivalent which is finally received from the revenue transaction since all returns,

trade discounts and other reductions are subtracted from the revenue so earned. Cash discounts

and bad debt, if any, are also to be deducted.

It is to be noted that cash discounts are allowed to customers for two purposes:

(i) To reduce the amount of bad debt losses, and

(ii) To equate the money-value received within the discount period with the present discounted

money value (which will be received under the granted credit terms at a later date).

Practically, if the rate of cash discount was fixed rationally, the sellers would be less interested in

whether they received the net amount or gross price minus certain amount of expected bad debt

losses. In this context, cash discounts and expected bad debt losses are to some extent similar.

Expenses Incurred by a Firm: Meaning, Measurement and Recognition

After reading this article you will learn about: 1. Meaning of Expense 2. Measurement of

Expense 3. Recognition.

Meaning of Expense:

The term ‘expenses’ is a flow concept. It represents both favourable and unfavorable changes

made in an accounting period. The favourable one represents revenue whereas the unfavorable

one represents the expense.

In short, the consumption or use of goods and services in order to earn revenue is the expense.

Thus, Hendriksen opines- ‘expenses are the using or consuming of goods and services in the

process of obtaining revenues’.

ADVERTISEMENTS:

The American Accounting Association, Committee on Concepts and Standards, defines:

‘Expense is the expired cost, directly or indirectly related to given fiscal period, of the flow of

goods or services into the market and of related operations’. The primary objective of all costs is

to earn revenue from the customers in exchange of goods and services produced by the firm at a
given period. As such, the amount which is spent in anticipation of earning revenue, no doubt,

constitutes cost.

Needless to mention that all sacrifices are not expenses. The sacrifices which are directly or

indirectly related to the production are included with expenses. At the same time, such sacrifices

are losses against which neither any benefit has been realised nor is there any chance of realising

the same in future. Thus, the benefits which are received in excess of the sacrifices are incomes

which are accrued to the proprietors.

Expenses are defined in terms of cost expirations or cost allocations frequently. They are the

structural model for the measurement of accounting income and they do not reflect real world

situations. Expense valuation in that context is a problem which differs from the definition of

expense.

Expenses are measured in terms of valuation of goods or services used or consumed, but

the said measurement does not define it. Therefore, the difference between the two is that

the measurement of an expense is based on cost and the definition of an expense is an

activity or a process.

Measurement of Expense:

The most common measurements of expense are:

(a) Historical Cost;

(b) Current Measurement (e.g., Replacement Cost); and

(c) Opportunity Cost or Current Cash Equivalent.

(a) Historical Cost:

The conventional method of measuring expenses is the historical cost concept measurement. The

primary reason is that they are assumed to be verifiable since they represent cash outlays by the

enterprise. They also represent the exchange value of goods and services while they were

acquired by the firm.

Arguments for Historical Cost:

(i) Under this method only, the expenses can be objectively determined and ascertained.

(ii) The measurement is verifiable since it is based on exchange prices.

ADVERTISEMENTS:

(iii) Personal bias of the valuer is neglected here, so, manipulation of reports and statements may

be avoided.

Arguments against Historical Cost:

(i) It does not represent a relevant measurement of the goods and services used in order to meet

the objectives of the external users of financial reports and statements.

(ii) It does not permit a separation of operating activity from gains and losses arising from

favourable purchases and unpredictable price changes.

(iii) The impact of price level changes between purchase of raw material and the sale of finished

product is not recognised here.

(b) Current Measurement (e.g., Replacement Cost):

Revenue is generally measured in terms of the current price received against the product sold.

Therefore, the expenses matched should also be measured in terms of the current price of goods

or services used or consumed. Because, income which arises from sale transaction is the excess

of cash or claims received over the amount of the resources used.

As such, the measurement of expenses in terms of current price has the advantages between the

income which arises from the transactions and the gains or losses which arise from the holding of

assets before the use.

The gains and losses which occur before the use may arise either from price changes, or from

deterioration, or from obsolescence, or other factors. At the same time, when the acquisition of

goods and services before the use is necessary along with loss or deterioration, this reduction in

value should be included in the measurement of expenses.

(c) Opportunity Cost or Current Cash Equivalent:

Current price may be taken either from current liquidation/sale price or from a replacement cost.

Current cash equivalent or a current liquidation/sale price is significant while measuring

expenses since it expresses the opportunity cost of a firm for using such specific asset.

Moreover, this measurement does not make any speculation about the future replacement. In

other words, the liquidation price/current cash equivalent is particularly significant when there is

a favourable market for purchase or sale for the item.

Recognition of Expenses:

An expense is recognised for an accounting period provided there is:

(i) A direct relation with the revenue earned during that period, e.g., selling expenses and

commissions which are incurred with cost of goods sold;

(ii) An indirect relation with revenue earned during that period, e.g., indirect operating expenses;

(iii) A measurable expiration of some assets which are not directly and/or indirectly related with

revenue for the said period, e.g., losses which arise from pilferage/theft or accidents etc.

In short, the expenses will be recognised in a particular accounting period if they relate to:

(a) The direct cost of goods sold;

(b) The indirect cost of operating exposes; and

(c) The exceptional losses incurred, if any.

What Are the Advantages and Disadvantages

Accounting is a mathematical discipline designed to collect, record and then compile financial

information into more accessible formats intended for its end users. In sum, accounting is

intended to be a language that can be used to communicate financial information to its users in

an efficient and effective manner. Accrual basis is a set of guidelines designed to guide certain

important concepts in accounting, in particular when to record transactions.

Purpose of Accounting

Accrual and Cash Bases

Accrual and cash bases are the two most popular accounting bases although accrual basis is more

advantageous and thus more popular than its main competitor. The main difference between the

two accounting bases lies in when they choose to record a transaction. Cash basis accounting

only records transactions when cash and cash equivalents are either received or paid out. By

contrast, accrual basis accounting records most transactions at the times of their occurrence.

Advantages of Accrual Basis Accounting

Accrual basis accounting is more popular than cash basis accounting because it produces more

accurate, more faithful financial statements that constitute better representations of actual

circumstances than its main competitor. Since accrual basis accounting records revenues and

expenses together in the same time periods based on their causal relationships, it produces more

accurate gauges of entities' performance in any time period. By contrast, the use of cash basis can
lead to distortions due to the collection of cash and cash equivalents not aligning with the actual

timing of sales.

Disadvantages of Accrual Basis Accounting

The single most important issue in accrual basis accounting is that it requires transactions to

be recorded at the times of their occurrence. Since invoices do not coincide with actual events,

this approach necessitates some estimation and guesswork on the part of accountants working

under accrual basis accounting. Furthermore, an entire set of rules and regulations have grown

up and around these uncertainties in order to guide their accounting, which means that accrual

basis accounting is harder to perform than cash basis accounting.

For accounting to be helpful to its end users, it must be presented in a format that manages to

communicate the relevant financial information to them in an effective and efficient manner.

Furthermore, the financial information must be the right financial information – it is much less

useful if it is inaccurate and not a faithful depiction of actual circumstances. Under most

situations, the financial information must also be compiled in time for it to be relevant to

decision-making on financial matters.