Revenue Recognition Essay

The final dedicatement of tax in father reference practices is an ara that has authentic a lot of circumspection from regulators. Whenever in that respect is a report of financial re narratives or negative earnings, regulators pay extra attention to review the financial statements in tell apart to confirm that that there be non any indications of financial put-on or that the organization over timbreped their boundaries in the bea of managed earnings. The reason that regulators hurl taken a supernumerary interest in financial news report and potential fraud is due to the collapses of companies such as Enron, WorldCom and Tyco. Regulators and those in the accounting profession are focalisation their efforts on the causes of fraud as well as the step that squeeze out be taken to effectively detect and pr eventidet a possible reoccurrence of fraudulent behavior especi every last(predicate)y in the area of tax gross recognition and the overstatement of assets. gros s recognition refers to the time when transactions are recorded on the books, Per Generally Accepted Accounting Principles (GAAP), tax incomes, and gains, are generally recognized when1. Revenues are realized or are realizable2. They drop been earned the substantial completion of the activities complex in the earnings process. two of these items are typically met at the point of sale, which generally occurs when goods are delivered or when draw are rendered to the client. Usually receiptss and assets are recognized simultaneously. However, assets can be received before the conditions of receipts recognition are met. One pattern would be if a node pays in advance for goods or services which will be received at a later date. compensate though the cash is received and is recorded as an asset in the familiaritys books, the taxation has not been earned. Typically the revenue is not recognized prior to a sale because either the guest has not paid for the goods yet or becaus e the goods bring in not been delivered to the customer. The main expulsion to not recognizing revenue prior to a sale would be when a shove exists that guarantee the sale or that the customer has promised a juristic promise of payment such as when both the seller and the emptor are legally obligated to fulfill the term of a contract (Parizek & Findley, 2008).Another exception to the revenue recognition rule occurs when a result or service whitethorn be provided to the customer without receiving a legitimate promise of payment. This typically occurs with a family dentist who provides services to ease a patients pain and then tries to collect thepayment later. Also, if a company has a substantial amount of services to provide even though the customer has provided a substantial payment, the company must(prenominal) arrest to recognize the revenue. It is not enough that iodin of the criteria for recognizing revue is met both items must be satisfied in order for the recogniti on of revenue.Because e very(prenominal) income statement begins with total revenue, how revenue is measured is a fundamental concept in the field of accounting and as such, the head of revenue recognition has received a lot of attention over the course of the past a few(prenominal) years. The American Institute of Certified Public Accountants (AICPA) has produced specific guides to help with the publication of revenue recognition in specific situations in certain industries. The AICPA education of Position (SOP) 97-2, Software Revenue Recognition contained the representing four items (Parizek & Findley, 2008) 1. glib-tongued evidence of an arrangement exists2. Delivery has occurred.3. The vendors fee is hardened or determinable.4. Collectability is probable.These four items were used as the framework in the sec Staff Accounting Bulletin No. ci. The SAB 101 is a very unique and interesting bulletin because it provides specific typefaces and then proceeds with a questions and rejoinder remainsat. SAB was created in large part to the comebacks that the stave had encountered in piece conducting a review. Because SAB 101 addresses specific situations, it cannot be used as an answer to every instance of revenue recognition, but it does provide a blanket(prenominal) guide for companies to use as a form of direction when go about with dealing with a complicated situation such as when there is persuasive evidence of an arrangement, delivery of goods has already occurred or services switch been rendered or when the price is fixed or determinable (SEC, 1999). researchs 1 and 2 of SAB address the topic of Persuasive Evidence of an Arrangement and highlight how a seller could be tempted to bend the rules of revenue recognition in order for a more favorable time in which the sale is report. The number 1 question exhibited the shell in which Company A required for to from each ace one one sale to be supported by a written gross gross revenue agreem ent signed by an authorized representative of both the customer and Company A. This issue was if Company A could recognize the revenue in the current quarter even if thesales agreement would not be signed until a few days after the quarter had ended. This question highlighted the shoot for companies to have squiffy internal controls and the need to a accepted system to be in place for processing contracts. Without a strong internal control structure as well as distinctly text fileed procedures, there is a possibility of managers becoming tempted to adjust how revenue is recognized base on the needs of the quarter. Questions 3 and 4 reviewed the issue of ownership of goods and when the transfer had effectively taken place.Question 4 reviews the case of Company R that is a retailer that offers layaway sales to its customers. For the layaway option, a customer pays a portion of the sales price and Company R holds onto the ware until the customer returns to pay the balance remain ing on the deal. Once the mathematical product is paid in full, the customer can take possession of the ware. This case is an example of what is referred to as a bill and hold arrangement where the customer is billed for the merchandise but the merchandise is held by the company for liberate or shipment at a later date. Question 4 is also an example of how around companies could manipulate their inventories at the end of a quarter. A company could increase revenue by pushing some of its merchandise in the warehouse aside and claim that it has already been change but were being held for the customer. In order for the company to recognize the revenue they must be able to show that the merchandise is completely crack up from its other merchandise and cannot be used for any other order.The company also must be able to show that the customer specifically requested in writing that the company hold the merchandise. Questions 5 and 6 reviewed revenue recognition when the company must perform several(prenominal)(prenominal) activities. Question 5 asks the question as to when Company H should recognize the revenue from an upfront, nonrefundable fee for an extended service contract along with regular, monthly payments. SAB 101 illustrates how the nonrefundable fee cannot be hard-boiled separately and must be treated as a part of the overall unit because no one would pay a deposit without expecting additional goods or services to follow (SEC, 1999). The questions 7, 8 and 9 in SAB 101 describe situations where the price may not fixed or determinable in the transaction. Question 8 describes how Company A owns a building and meshs it to a retailer. The annual lease payment is $1.2 million plus one percent of all the retailers sales in excess of $25 million. It is probable thatsales during the year will exceed $25 million. Should Company A evaluate and recognize revenue associated with the one percent of the sales over $25 million on a straight-line basis throughou t the year?Because the purchaser does not have any fixed or determinable indebtedness to make a payment until the $25 million sales take has been reached, none of the extra revenue can be estimated and recognized in advance. Question 10 in SAB 101 does not deal with when revenue should be recognized but sort of how the revenue should be reported on the income statement. Question 10 discusses the situation where Company A operates an internet site where customers can order the products of another company, Company T. Company T ships directly to the customers and Company A never has any ownership of the merchandise but company A does receive a portion of each sale that Company T makes. Since Company A never takes legal ownership of the merchandise, it would be inappropriate for them to use the gross revenue describe method where they would report $175 in revenue and $150 in cost of goods sold.Instead Company A should report the money that it earns from each sale as commission rev enue. SAB 101 is not the only work that has tried to address the issue of revenue recognition. The Financial Accounting Standards gore (FASB) and the world-wide Accounting Standards Board (IASB) are working together on roast project that would create a single standard for revenue recognition. The project is intended to solve issues in the differences between U.S. GAAP and International Financial Reporting Standards (IFRS). FASB has listed the following six for the project (FASB,2012) 1. Converging U.S. and external standards on revenue recognition 2. Eliminating inconsistencies in the existing conceptual commission on revenue recognition.3. Providing conceptual guidance that would be useful in addressing prox revenue recognition issues. 4. Eliminating inconsistencies in existing standards-level authoritative books and accepted practices. 5. Filing voids in revenue recognition guidance that have developed over time 6. Establishing a single, comprehensive standard on revenue rec ognition In creating a new revenue recognition standard, the FASB and the IASB have adjusted their focus to realization and earnings approach instead of focusing on an asset and liability approach. To assist companies with the changes, FASB issued a proposal of marriage that broke down the revenue recognition process into five steps.The setoff step would be to match thecontract with the customer. The second step would be for the company to identify each step of the transaction with the customer. Third, the company would have to identify the transaction price of each separate act or obligation. In the fourth step, the company reviews how much it expects to receive for preforming each step with the company recognizing the revenue in the final step once the merchandise has been transferred to the customer (FASB, 2012). The work between FASB and IASB is still a work in progress but has strong support from several groups in the accounting community some of which have already laid a ori gin to work from.In 1998 former SEC Chairman Arthur Levitt delivered what is now considered to be a famous speech titled The Numbers Game in which he expressed great concern over how many companies withdraw in the practice of earnings caution. In his speech Mr. Levitt identified several major accounting techniques that he thought were being used to neutralize the integrity of financial insurance coverage(Levitt, 1998). Mr. Levitt stressed how accounting involves significant judgment and he expressed concern that this judgment was being pushed aside by management due to the pressure that they were encountering to meet the numbers. Mr. Levitt mentioned the standards of objectivity, integrity and judgment in reporting accounting number and stressed that it was these standards that remain an integral part of the common accounting professions enter of headmaster Conduct and form the foundation by which financial statements are compiled, audited and interpreted.He went on the decl are that the ethical dilemmas facing businesses and their accountants often revolve around the pressure placed upon companies by investors and creditors. These pressures can sometimes cause management to become involved in accounting hocus pocus (Levitt, 1998). Additionally, because accounting involves judgment, the reported accounting numbers can be significantly different depending on the assumptions made by those that are preparing the financial statements.Mr. Levitt declared that accounting principles Allow for flexibility to adapt to changing circumstances and it was this flexibility that creates many of the ethical issues that accountants are faced with. As companies come under pressure to reportfavorable results, accountants also come under pressure to flex those rules almost to the point of breaking. Mr. Levitt gave credit to the Code of Professional Conduct for providing guidance to the public accounting profession members when they are faced with difficult issues (Levitt, 1998).Addressing the issues and establishing new policies and procedures is not enough in ensuring that companies are adhering to changes in methods. Communication must be maintained with those that work in the accounting profession so that they are also complying with the la runnel methods. In October of 2000, the Chief Accountant of the SE, Lynn Turner, wrote a letter to Ms. Arlene Thomas, the Vice President of the Professional Standards and Services office of the AICPA in order to inform auditors of topics that the SEC had been focusing their attentions on. Amount several topics that Ms. Turner included in her letter was the topic of revenue recognition.The letter discussed the issue of revenue fraud and how over fractional of the revenue frauds that were identified were due to companies that overstated their revenue because that had reported revenue either too early of deceptively (U.S., 2000). Ms. Turner stressed the greatness for auditors to test cut off dates and stressed how auditors must place special focus and conduct examen that is above and beyond the reviewing of a few transactions. Ms. Turner also wanted to bring to of Ms. Thomas the issue that was elevated with companies having side agreements with their customers which could alter the terms and conditions of the original contract. These adjustments could result in revenue being im rightly recorded and that auditors should conduct thorough testing of contracts. This testing is important because it could assist the auditor with identifying if and side agreements exists and then can test the revenue accordingly.Ms. Turner went on to give praise to the AICPA for a catalogue that they issued entitled Audit Issues in Revenue Recognition and stated how this document should be used by auditors for guidance when it comes to properly auditing revenue. Ms. Turner stated how some organizations can be quite complex and conduct several complex revenue transactions and by reading the terms and condition s of the contracts, auditors would be able to determinethe best course of action for conducting a proper and thorough audit (U.S., 2000).The topic of financial reporting fraud is one that will continue to remain the focus of the SEC, FASB and ISAB for some time to come. Revenue recognition will play a large role in the process as it encompasses two primary factors management will need to use their own judgment in determining how their revenue should be recognized and that management should be prepared to have their judgments analyzed and questioned. By maintaining focus of the issues that have been identified, and keeping an eye out for possible future issues, the authorities can be certain that investors are making decisions based on accurate information. Constant training and communication between all agencies will ensure that the scandals and financial collapse of companies will not be repeated.ReferencesAmerican Institute of Certified Public Accountants Accounting Standards Exec utive direction Statement of Position 97-2, (1997) Software revenue recognition, p.08. FASB. (2012, October 13). Revenue recognitionjoint project of the fasb and iasb. Retrieved from http//www.fasb.org/project/revenue_recognition.shtml Levitt, A. (1998, September 28). The numbers game. Retrieved from http//www.sec.gov/news/speech/speecharchive/1998/spch220.txt Parizek, G., & Findley, M. (2008). Charting a course revenue reconition practices for todays business environment. Journal of Accountancy, 20(3), 15-22. SEC. (1999, December 3). Sec staff accounting bulletin No. 101 revenue recognition in financial statements. Retrieved from http//sec.gov/interps/account/sab101.htm U.S., SEC. (2002, October 13). Letter 2000 audit risk alert to the American institute of certified public accountants. Retrieved from http//www.sec.gov/info/accountantts/staffletters/audrsk2k.htm