Financial Accounting

(PGDM- 2015-16)

Session -12: Revenue Recognition

Sriranga Vishnu
Faculty ( F&A Area)

Revenue Recognition
-Introduction
Accrual Concept of Accounting
Revenue Recognition When and How Much
Normal Operating Cycle
Revenue is recognized at a single point in the
Cycle
Objectivity- Not influenced by personal bias/
judgment; verifiable, reliable.

Revenue Recognition
-Introduction
Revenues are inflows or other enhancements of
assets of an entity or settlement of its Liabilities (or
both) from delivering or producing goods,
rendering services or other activities that
constitute the entitys ongoing major or central
operations (FASB Concept Statement 6)
Expenses are outflows or other using up of assets
or incurrence of Liabilities (or both) from delivering
or producing goods, rendering services or other
activities that constitute the entitys ongoing major
or central operations (FASB Concept Statement 6)

Revenue Recognition
-Introduction
Characteristics of Revenues:
Revenues represent actual or expected cash inflows
The assets increased by revenue can be of various kinds
cash, claims, other goods /services received, increased value
of a product resulting from production
Transactions can be of different kinds output, delivery, fee,
interest, dividend, rent, etc.

Characteristics of Expenses:
Expenses represent actual or expected cash outflows
The liabilities incurred can be of various kinds units of
products delivered/ produced, employees services used,
electricity used, taxes on income, etc.
Transactions can be of different kinds cost of goods sold, cost
of services provided, depreciation, interest, rent, etc.

Timing of Revenue Recognition

Revenue Recognition Criteria:
Entity has substantially performed the income earning
activities
The amount of Income can be reliably measured
The assets received can be readily converted into cash

Since inappropriate revenue recognition has been

found in most of the financial frauds, SEC suggests
that Revenue should be earned and realized when:
(SAB 101)

Persuasive evidence of an order arrangement exists;

Delivery of goods occurred/services rendered
The sellers price to the buyer is fixed or determinable
Collectability of the sales proceeds is reasonably assured

Timing of Revenue Recognition

Methods of Revenue Recognition:
Delivery Method Revenue is recognized in the period
when goods are delivered or when services are
rendered
If certain, the income may be recognized after delivery
If uncertain, income is recognized proportionately or only after
receiving the complete payment

Consignment Shipments- The consignor retains the title

of the goods until they are sold. Hence, mere transfer of
goods should not be treated for revenue recognition
Franchises: Revenue is to be recognized by Franchisors
when services is provided rather than when fee is
received

Timing of Revenue Recognition

Percentage-of-Completion Method Long term
projects take several years to complete. Hence, in
such cases revenue is recognized differently:
Payment of predetermined amounts at certain periods of time
Through a predetermined formula which includes cost+ profit

When there is reasonable certainty of getting

payments, revenue can be recognized as per the
percentage of work that has been completed. Income
is recognized similarly
When the profit to be earned can not be estimated
reliably, revenue must be recognized when the project
has been completed

Timing of Revenue Recognition

Percentage-of-Completion Method Main advantages are:
Periodic Income is recognized currently rather than at the
completion of the contract
Status of incomplete projects is made clear through the current
estimates of cost to complete it.

Success of Percentage-of-Completion Method lies in the

reliable estimation of ultimate costs. In order to accrue
income, it is necessary. However, future related
uncertainties make such estimation difficult
Cash flows (payments) might be irrelevant in
determining the amount of revenue recognized during
each period

Timing of Revenue Recognition

Production Method For agriculture produce
subjected to MSP, revenue can reliably be
recognized when the crops are harvested
For precious metals like gold and silver,
revenue can be recognized as soon as they are
produced (unearthed), even before being sold
However, during periods of large sales price
fluctuations, production method might not give
proper figures

Timing of Revenue Recognition

Installment Method When sales are made on
installment basis, if the payments are high on
reliability, revenue may be recognized at the time
sale is made
If the amount of income to be realized cannot be
measured reliably, revenue is recognized when all
the installment payments are received
Cost Recovery Method In this method, the amount
of cost of sales is equated with the amount of
installment payments. Any excess is reported as
income