Why I Became a CPA Journal of Accountancy – October 2005Chapter 18 REVENUE RECOGNITION Sommers – ACCT 3311Guidelines for Revenue RecognitionDiscussion QuestionRevenue Recognition MattersMessing with RevenueRev Rec at Point of Sale (Delivery)Multiple-Deliverable ArrangementsOverview of New Revenue Rec StandardOverview of Revenue RecognitionNew Revenue Recognition StandardThe Five-Step ProcessThe Five-Step ProcessThe Five-Step ProcessRevenue Rec Articles – WSJ and CFODiscussion QuestionsDiscussion QuestionsRevenue Recognition Before DeliveryPercentage-of-Completion MethodPercentage-of-Completion MethodPercentage-of-Completion ExamplePercentage-of-Completion Example Cont.Percentage-of-Completion Example Cont.Percentage-of-Completion Example Cont.Completed Contract MethodCompleted Contract ExampleCompleted Contract ExampleCompleted Contract ExampleCompleted Contract ExampleLong-Term Contract LossesWhy I Became a CPAJournal of Accountancy – October 20051. No one can argue when you say, “I am a person who counts!”2. The opportunity to become a client’s #1 trusted advisor.3. Nobody gets an Academy Award until we say so.4. Your debits always equal your credits.5. You have Credentials People Admire.6. It’s the only profession directly connected to life’s inevitabilities: death and taxes.7. Mom wanted you to be a rock star and this is the way to rebel.8. You can work on Saturdays and Sundays while your friends are forced to watch the “March Madness” NCAA tournament.9. Only you know what a widget is.10. No one ever asks, “How do you spell that?”11. Red Sox wouldn’t give in to salary demand.12. All the free pencils you want.CHAPTER 18 REVENUE RECOGNITIONSommers – ACCT 3311Guidelines for Revenue RecognitionWhat are the two general criteria that must be satisfied before a company can recognize revenue?The realization principle requires that two criteria be satisfied before revenue can be recognized:1. When it is realized or realizable – there is reasonable certainty as to the collectibility of the asset to be received (usually cash).2. When it is earned– the earnings process is judged to be complete or virtually complete.Discussion QuestionQ18-2 What is viewed as a major criticism of GAAP as regards to revenue recognition?GAAP has numerous standards related to revenue recognition, but many believe the standards are often inconsistent with one another.Revenue Recognition Matters•Revenue recognition is a top fraud risk and regardless of the accounting rules followed (IFRS or U.S. GAAP), the risk or errors and inaccuracies in revenue reporting is significant.•Restatements for improper revenue recognition are relatively common and can lead to significant share price adjustments.Messing with Revenue“Trade loading is a crazy, uneconomic, insidious practice through which manufacturers—trying to show sales, profits, and market share they don’t actually have—induce their wholesale customers, known as the trade, to buy more product than they can promptly resell.”A similar practice is referred to as channel stuffing. When a software maker needed to make its financial results look good, it offered deep discounts to its distributors to overbuy, and then recorded revenue when the software left the loading.Rev Rec at Point of Sale (Delivery)•Companies usually meet the two conditions for recognizing revenue by the time they deliver products or render services to customers.•Implementation problems–Sales with Discounts–Sales When Right of Return–Sales with Buybacks–Bill and Hold Sales–Principal-Agent Relationships–Trade Loading and Channel Stuffing–Multiple-Deliverable ArrangementsMultiple-Deliverable Arrangements•MDAs provide multiple products or services to customers as part of a single arrangement. •The major accounting issues related to this type of arrangement are how to allocate the revenue to the various products and services and how to allocate the revenue to the proper period.•All units in a multiple-deliverable arrangement are considered separate units of accounting, provided that:–A delivered item has value to the customer on a standalone basis; and–The arrangement includes a general right of return relative to the delivered item; and–Delivery or performance of the undelivered item is considered probable and substantially in the control of the seller.Overview of New Revenue Rec Standard•In 2014, the FASB and IASB issued a converged standard on revenue recognition entitled Revenue from Contracts with Customers.Overview of Revenue Recognition•Revenue from Contracts with Customers, adopts an asset-liability approach. Companies:–Account for revenue based on the asset or liability arising from contracts with customers. –Are required to analyze contracts with customers•Contracts indicate terms and measurement of consideration. •Without contracts, companies cannot know whether promises will be met.New Revenue Recognition Standard•Key Concepts of Revenue RecognitionPerformance Obligation is SatisfiedThe Five-Step ProcessA contract is an agreement between two partiesthat creates enforceable rights or obligations. Inthis case, Boeing has signed a contract to deliverairplanes to Delta.Assume that Boeing Corporation signs a contract to sell airplanes to Delta Air Lines for $100 million.A Boeing has only one performance obligation—to deliver airplanes to Delta. If Boeing also agreed to maintain the planes, a separate performance obligation is recorded for this promise.Step 2: Identify the separate performance obligations in the contract.Step 1: Identify the contractwith customers.The Five-Step ProcessTransaction price is the amount of considerationthat a company expects to receive from a customer in exchange for transferring a good or service. In this case, the transaction price isstraightforward—it is $100 million.Step 3: Determine the transactionprice.In this case, Boeing has only one performanceobligation—to deliver airplanes to Delta.Step 4: Allocate the transaction price to the separateperformance obligations.LO 2The Five-Step ProcessBoeing recognizes revenue of $100 million for thesale of the airplanes to Delta when it satisfies itsperformance obligation—the delivery of theairplanes to Delta.Step 5: Recognize revenue wheneach performance obligationis satisfied.Revenue Rec Articles – WSJ and CFO•What is effective date?•What should firms be aware of?•What should investors be aware of?Discussion