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Revenue Recognition

The issue of when to recognize revenue is one of the constant dilemmas in accrual accounting. In fact, it is one of the few projects for converging U.S. GAAP and IFRS still left to be agreed upon. When accounting is done on a cash-basis, revenue is recognized when cash is received, regardless of when the sale of goods occurs. However, most accounting is done on an accrual basis. Under accrual accounting, according to the revenue recognition principle, revenues are recognized when they are realized, or realizable and earned (FASB ASC 605-10-25-1).

This means that under the revenue recognition principle, revenue can be recognized, even if no cash has changed hands. Revenue can be recognized as either accrued revenue (when it is earned before cash is received) or deferred revenue (when cash is received before the revenue is earned). The following definitions relate to different consideration for the sale of goods. 

Discrete earnings process: Often there is one main act or critical event in the earnings process that signals substantial completion or performance. For the sale of goods, this usually occurs at the point of delivery. Therefore, while some uncertainty will still exist, the risk is low enough to justify recognizing the revenue from the sale at this point. This is because we can say the risks and rewards of ownership pass. 

Risks and rewards of ownership: In order to recognize an asset on the balance sheet, a company must prove that it assumes the risks of ownership, and has the right to the asset's future benefits. 

F.O.B. shipping point means that the legal title passes to the buyer when the goods leave the shipping docks. F.O.B. destination means that the legal title will not pass to the buyer until they physically receive the goods. 

Non-refundable fees: Fees that are paid upfront, even if non-refundable typically are not earned until some performance obligation, good or service is provided. For example, a nonrefundable gym membership fee is not recognized as revenue until the time the service is provided. Similarly, set-up fees for contract etc. do not represent a benefit to the consumer, so our not recognized as earned immediately. The entity should evaluate whether the costs incurred to set-up a contract should be treated as a liability.

Sale and buyback: If a company sells inventory in one period, with an express agreement to buy it back in another, is it really a sale? In this case, the customer is limited in their ability to direct the use of and obtain substantially all of the remaining benefits of the asset. As a result, these arrangements should be accounted for either as a lease or a financing agreement. IG40

Bill-and-hold transactions: A bill and hold transaction is one where a company sells revenue to a customer but does not ship it right away. The main concern about bill and hold transactions is they might result from aggressive selling practices, which raises the question of whether it is a real sale. A customer may request to enter into such an agreement because of lack of warehouse space or delays in the customer's production schedule. To recognize a bill-and-hold sale, the customer must have control of the goods, even though physical posession remains with the seller, who is now the goods custodian. This means:
     (a) The reason for the bill-and-hold arrangement must be substantive. 
     (b) The product must be identified separately as belonging to the customer. 
     (c) The product currently must be ready for physocal transfer to the customer. 
     (d) The entity cannot have the ability to use the product of to direct it to another customer (IG 51). 

Consignment arrangements: Consignment sales occur when inventory is delivered to another party such as a dealer or distributor for sale to end customers. If the other party does not obtain control fo the product at this point, the entity would recognize revenue on the final sale of the goods to the customer, not upon the delivery of the products to the dealer. 

Transactions with customer accceptance provisions: Customer accepteance clauses allow the customer to cancel a contract of requre an entity to take remedial action if a good or service does not meet agreed-upon specifications. An entity should onsider such clauses when evaluating when a customer obtains control of a good or service. 

Acceptance Provision:

Accounting Treatment:

Acceptance provision is for trial or evaluation purposes and customer is not committed to pay.

The sale should not be recognized until the customer accepts the product or the trial period lapses.

The right of return is based on subjective criteria (such as whether or not the buyer likes the color). The seller cannot easily determine whether these criteria will be met.

The sale should not be recognized until the customer’s acceptance is received.

The right of return is based on objective criteria like size or other requirements. The seller can determine whether or not it is likely to have met these criteria before receiving the customer’s acceptance.

The seller can recognize the sale at delivery (as long as there are no more performance obligations such as installation.


Disposition of assets other than inventory: When assets are disposed of outside of the normal course of business, such as income earning assets, a gain (instead of revenues) is typically recognized. If the buyer doesn't pay, title will simply stay with the seller. In order to record the sale, some level of consideration must typically be exchanged as a down-payment. 

Licensing and rights to use: licensing refers to when the entity grants the customer the right to use, but not to own, its intellectual property. Revenue is recognized at the point in time that the customer takes control of the right. If the entity has othe performance obligations in the contract, these obligations might be accounted for seperately, or might require the delaying of recognizing all revenue until satisfied. 

Categories within Revenue Recognition

Sales Revenue

Postings: 450

In bookkeeping, accounting, and finance, sales are a subset of revenue that is garnered from the sale of goods or merchandise during the normal course of business.

Percentage of Completion Method

Postings: 20

In accounting for contracts, the basic accounting policy decision is the choice between two generally accepted methods: the percentage-of-completion method including units of delivery and the completed-contract method.

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