how to recognize revenue

1. Measurement of Revenue

2. Issues covered
• Deciding the timing of revenue
• Measuring the amount of revenue in a
particular period
• Measuring expenses related to revenue
recognized in a particular period.

3. Deciding the timing of revenue
Operating cycle of a product:
– Purchase order by customer 2008
– Production of units 2009
– Delivery of units to customers 2010 and
collection of cash 2010
– Post sale free service period 2011
Revenue is recognized in _________ year

4. Deciding the timing of revenue
Operating cycle of product:
– Purchase order by customer 2007
– Advance collection from customers 2008
– Production of units 2009
– Delivery of units to customers 2010
– Post sale free service period 2011
• Revenue is recognized in _________ year

5. First Requirement for Revenue
Recognition
• Transfer of goods along with ownership,
title and significant risk in case of sale of
goods

6. Deciding the timing of revenue
Operating cycle of product:
– Purchase order by customer 2008
– Production of units 2009
– Sale of units to customers on credit 2010
– Collection from customers in 2011
– Post sale free service period 2011 and 2012
Revenue is recognized in _________ year

7. Second Requirement for Revenue
Recognition
• In case of credit sales, the credit sales
amount should be realizable or
collectable. The risk of collection should
be insignificant.

8. Summary
• Two requirements for revenue recognition:
– Shipment of goods in case of sale of goods or
completion of service in case of service
AND
– Insignificant risk of realization or collection

9. Revenue from services rendered
• ABC Ltd entered into a contract with one of its
clients in 2010 to provide software services
during 2011 to 2015.Contract price was Rs 7.50
Cr
• Completed Service Contract Method
Or
• Proportionate Completion Method
– Price is pre-determined
– Cost of entire service can be reliably measured

10. Measuring Expenses in case of
sale of goods
Operating cycle of product:
– Received order in 2008
– Production of units 2009
– Sale of units to customers on credit 2010
– Collection from customers in 2011
– Post sale free service period 2011 and 2012
• Inventory used for credit sales (COGS) in 2010
• Estimated bad debts (Provision for bad debts)
related to credit sales of 2010.
• Estimated cost of (Provision) post sale free
service related to credit sales in 2010

11. Measuring Expenses in case of
services rendered
• ABC Ltd entered into a contract with one of its
clients in 2010 to provide software services
during 2011 to 2015.Contract price was Rs 7.50
Cr. The estimated cost is Rs 1 Crore in each
year.
• Completed Service Contract Method
Or
• Proportionate Completion Method
– Price is pre-determined
– Cost of entire service can be reliably measured

12. Case 1 - Other revenue
• Interest Income: total amount of interest
earned till reporting date
• Royalties Income: total amount of royalties
charged till reporting date
• Dividend Income: Amount of dividend
declared by company till reporting date

13. Case 2
• In Dec 2011, Manufacturer A sold goods to
Wholesaler B. B used this inventory as collateral
for a bank loan of Rs 10,00,000 and sent the Rs
10,00,000 to A. Manufacturer A agreed to
repurchase the goods on or before 1 st July, 2012
for Rs 12,00,000.
• Does Manufacturer A have revenue in 2011?
Why?
• Product Repurchase Agreement.

14. Case 3:
• Manufacturer A found that Afghanistan is a
potential market for his product. In 2011,”A” made
credit sales to a customer from Afghanistan on
credit basis for Rs 30 Cr. The amount is yet to be
collected on accounting closing date. The
customer financial condition is strong and he has
strong willingness to make payment. In 2011, it
has been observed that Central Bank of
Afghanistan rejected 60% of requests for INR by
local importers.
• Does manufacturer A have revenue in 2011?
Why?

15. Case 4
• In December 2011, Manufacturer A sold
goods to B on cash basis for Rs 4 Cr. The
delivery is delayed at the buyer’s request
and buyer takes title and accepts billing.
The goods will be delivered in 2012.
• Does manufacturer A have revenue in
2011? Why?

16. Case 5:
• In Oct 2011, Manufacturer A sold goods to B on cash
basis for Rs 5 Cr. As per the Terms and Conditions of
sales contract guarantee period is 6 months. During this
period, B will have the right to return the goods to A and
ask for cash.
• Does manufacturer A have revenue in 2011? Why?
• Goods sent on sale-or-return basis
• Sales including installation and inspection
• Consignment sales

17. Case 6:
• In 2011, Manufacturer A sold goods to B
on installment basis for Rs 5 Cr. B will
make down payment of Rs 1 Cr and
balance will be paid in four equal annual
installments. A will release the goods to B
only after payment of all the installments.
• Does manufacturer A have revenue in
2011?

18. Case 7
• When an electric utility customer uses
electricity, the electric company has
earned revenues. It is obviously
impossible, however, for the company to
read all of its customers’ meters on the
evening of 31 March 2012.
• How does the electric company know its
revenue for financial year 2011-12?

19. Case 8
• A bank sells a customer $500 of American
Express traveler’s checks, for which the
bank collects from the customer $505.
(The bank charges a 1 per cent fee for this
service).
• How does the bank record this
transaction?

20. Case 9
• Sales on barter system
• Sales within the group companies etc.

21. Accounting for Bad Debts
• Provision for Bad Debts (liability)
• Bad Debts (expense)
• Collection of debtors written off as bad
debts (income)

22. Accounting for revenue and expense at
Microsoft Corporation – 1990s
• In case of listed companies, the general accounting
practice of manipulation is overstating the revenues and
understating the expenses.
• Microsoft Corp continuously understated its revenue and
overstated expenses.
• No separate accounting standard for IT sector in 1990s
• Entire industry was expected to follow the accounting
policies of Microsoft Corp
• What was the Financial Reporting Strategy of Microsoft
Corp?

23. Summary
• The biggest individual item
• The critical part in accounting is revenue
• No accounting standard covers different issues
of revenue recognition
• The Revenue Recognition is the most popular
scheme accounting manipulation
• The users of financial statements should be
extremely careful with respect to Revenue
Recognition
• The users of financial statements should be
extremely careful with respect to WIP in case of
construction companies.

24. Readings
1.Chapter 3 from the prescribed text book
2. Accounting Standard 9
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