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10-54 Auditing (Revenue Recognition)

Judgments about whether revenue should be recognized are among the most contentious that an auditor faces. Following are a number of situations in which the auditor will be required to either acquire additional information or make decisions about the amount of revenue to be recognized.
Required:
a. Identify the primary criteria the auditor should use in determining revenue to be recognized.
b. For each of the scenarios:
? Identify the key issues to address in determining whether revenue should be recognized.
? Identify additional information the auditor may want to gather in making a decision on revenue recognition.

? Based only on the information presented, develop a rationale for either the recognition or nonrecognition of revenue.

Revenue Recognition Scenarios

1. AOL sells software that is unique as an Internet provider.The software contract
includes a service fee of $19.95 for up to 500 hours of Internet service each
month.The minimum requirement is a one-year contract.The company proposes
to immediately recognize 30 percent of the first-year's contract as revenue
from the sale of software and 70 percent as Internet services on a monthly
basis as fees are collected from the customer.

2. Modis Manufacturing builds specialty packaging machinery for other manufacturers.
All of the products are high-end and range in sales price from $5 million
to $25 million.A major customer is rebuilding one of its factories and has
ordered three machines with total revenue of $45 million.The contracted date
to complete the production was November and the company met the contract
date. The customer acknowledges the contract and confirms the amount.
However, because the factory is not yet complete, they have requested that
Modis hold the products in their warehouse as a courtesy to the company until
their building is complete.

3. Standish Stoneware has developed a new low-end line of bakeware products
that will be sold directly to consumers and to low-end discount stores (but not
Wal-Mart).The company had previously sold high-end silverware products to
specialty stores and has a track record for returned items from the high-end
stores. The new products tend to have more defects, but the defects are not
necessarily recognizable in production. For example, the products are more
likely to crack when first used in baking.The company does not have a history
of returns from these products but because the products are new, the company
grants each customer the right to return the merchandise for a full refund or
replacement within one year of purchase.

4. Omer Technologies is a high-growth company that sells electronic products to
the custom copying business. It is an industry with high innovation, but Omer's
technology is basic. In order to ensure growth, management has empowered
the sales staff to make special deals to increase sales in the fourth quarter of the
year.The sales deals include a price break and an increased salesperson commission.
However, it does not extend either the product warranty or the customer's
right to return the product.

5. Electric City is a new company in the Chicago area that has the exclusive right
to a new technology that saves municipalities a substantial amount of energy
for large-scale lighting purposes; for example, lighting ball fields, parking lots,
and shopping centers.The technology has been shown to be very cost effective
in Europe. In order to get new customers to try the product, the sales force
allows the customers to try the product for up to six months to prove the
amount of energy savings they will incur with the product.The company is so
confident that the customers will buy the product that they provide this pilot
period. Revenue is recognized at the time the product is installed at the customer
location with a small provision made for potential returns.

6. Jackson Products decided to quit manufacturing a line of its products and outsourced
the production.However,much of the manufacturing equipment they
had could be used by other companies. In addition, they had over $5 million
of new manufacturing equipment on order in a noncancelable deal. Jackson
decided to sell the new equipment ordered and their existing equipment. All
of the sales were recorded as revenue.

Solution Preview

a. Identify the primary criteria the auditor should use in determining revenue to be recognized.

Revenues are defined as inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities hat constitute the entity's ongoing major or central operations.

From an accounting standpoint, revenue is considered to be realized when two criteria are satisfied: -
1. Objective evidence exists as to the amount of the revenue.
2. All necessary cost of generating the revenue have been incurred or can be
reasonably estimated.

In the application of these criteria, revenue is generally considered to be earned when goods are sold or services have bee performed and are billable.

b. For each of the scenarios:

? Identify the key issues to address in determining whether revenue should be recognized.
? Identify additional information the auditor may want to gather in making a decision on revenue recognition.
? Based only on the information presented, develop a rationale for either the recognition or nonrecognition of revenue.

Revenue Recognition Scenarios

1. AOL sells software that is unique as an Internet provider. The software contract includes a service fee of$19.95 for up to 500 hours of Internet service each month. The minimum requirement is a one-year contract. The company proposes to immediately recognize 30 percent of the first-year's contract as revenue from the sale of software and 70 percent as Internet services on a monthly basis as fees are collected from the customer.

? Identify the key issues to address in determining whether revenue should be recognized.

The key issues that we have to determine are the actual month that AOL provides the internet service to the customers and the number of customers.

? Identify additional information the auditor may want to gather in making a decision on revenue recognition.

The auditor may want to know the actual month that AOL provides the internet service to each customer.

? Based only on the information presented, develop a rationale for either the recognition or nonrecognition of revenue.

Based on the information presented, the revenue will be recognized when the customer received the service for that certain month. The remaining ...

Solution Summary

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