Income Concept and Revenue

Vilgia Delarhoza ( 1110534016 )

Hanna Deseasari ( 1110534003 )
The Purpose of Income Reporting
Income is used
1. as the basis of one of the principal forms of taxation.
2. in public reports as a measure of the success of a corporations
operations.
3. as a criterion for the determination of the availability of dividends.
4. by rate-regulating authorities for investigating whether those rates are
fair and reasonable.
5. as a guide to trustees charged with distributing income to a life tenant
while preserving the principal for a remainderman.
6. as a guide to management of an enterprise in the conduct of its affairs.
Importance of Income Reporting
The EMH and stock prices
Economic Vs. Accounting Income
Related sciences
concerned with the activities of business firms
use similar variables
differences over the timing and measurement of income
Relative importance of income statement (accounting) and
balance sheet (economics)

The Nature of Income
Three possibilities
Psychic
Satisfaction of human wants
Real
Increase in economic wealth
Money
Increases in monetary value
The concept of well-offness or capital maintenance
Problems
Because of the difficulties in measuring real income - Accountants have
adopted a transactions approach to income recognition
Capital Maintenance Concepts
Financial
capital
maintenance -
money
amount -
transactions
based
Physical capital
maintenance -
productive
capacity
Difference is in the treatment of holding gains
Current Value Accounting
The concept of physical capital maintenance
requires assets and liabilities to be stated at
their current values
Approaches:
1 Entry price or replacement cost
2 Exit value or selling price
3 Discounted present value
Income Recognition
Criticisms of the transactions approach
Possible alternatives
Edwards and Bell
1 Current operating profit
2 Realizable cost savings
3 Realized cost savings
4 Realized capital gains
Sprouse
The concept of measurable change
Accounting for Inflation
Instability of the accounting
measuring unit is due to the
effects of inflation or
deflation
General purchasing power
adjustments
Revenue Recognition
The income producing activities cycle
Revenue recognition criteria
1. The revenue has been earned
2. The revenue has been realized or is realizable
SAB No. 101 criteria
1. Persuasive evidence of an arrangement exists
2. Delivery has occurred
3. The vendors fee is fixed or determinable
4. Collectibility is probable.
Recognition Realization
Matching
Cost
Leads to or
Results In
Asset
Used up
Resulting in
Revenue
Used up Resulting
in No Revenue
Expense Loss
Earnings Quality, Earnings Management and
Fraudulent Financial Reporting
Assessing earnings quality:
1 Compare the accounting principles employed by the
company with those generally used in the industry and
by competitions.
Do the principles used by the company inflate earnings?
2 Review recent changes in accounting principles and
changes in estimates to determine if they inflate
earnings.
3 Determine if discretionary expenditures,
such as advertising, have been postponed
by comparing them to previous periods.
4 Attempt to assess whether some expenses, such as
warranty expense, are not reflected on the income
statement.

Earnings Quality, Earnings Management and
Fraudulent Financial Reporting
5 Determine the replacement
cost of inventories and other
assets. Assess whether the
company generating sufficient
cash flow to replace its assets?
6 Review the notes to financial
statements to determine if loss
contingencies exist that might
reduce future earnings and
cash flows.
7 Review the relationship between sales
and receivables to determine if
receivables are increasing more
rapidly than sales.
8 Review the management discussion
and analysis section of the annual
report and the auditor's opinion to
determine management's opinion of
the company's future and to identify
any major accounting issues
Earnings Quality, Earnings Management and
Fraudulent Financial Reporting
Earnings management
The attempt to influence short-term reported income
Arthur Levitt has outlined five earnings management
techniques that he described as threatening the integrity of
financial reporting:
1. Taking a bath
2. Creative acquisition accounting
3. Cookie jar reserves
4. Abusing the materiality concept
5. Improper revenue recognition


Distinction Between Conservative, Neutral,
Aggressive and Fraudulent Earnings Management
1. Conservative accounting



2. Neutral
earnings

3. Aggressive accounting

4. Fraudulent accounting

Overly aggressive recognition of loss or
reserve provisions
Overvaluation of acquired in process research
and development activities

Earnings that result from using a neutral
perspective

Understating loss or reserve provisions

Recording sales before they satisfy the earned
and measurability criteria
Recording fictitious sales
Backdating sales invoices
Overstating inventory