The Importance of How You See Your Revenue

January 19, 2008

Accounting & Finance, Business

Not too many accountants realize that there are a number of methods written and established to change the way your company looks on paper.  Revenue recognition is a simple way to have your company look vastly different in the eyes of an outsider.  The basic rule is that there are either cash or accrual accounting methods.  Cash accounting shows the cash when received.  With accrual accounting, when you receive the cash is completely irrelevant.  So this leaves the method in how you recognize the revenue open.

USSEC’s SAB104 states that revenue generally is realized or realizable and earned when all of the following criteria are met:

  1. Persuasive evidence of an arrangement exists;
  2. Delivery has occurred or services have been rendered;
  3. The seller’s price to the buyer is fixed or determinable; and
  4. Collectability is reasonably assured

The beauty of GAAP are the many exceptions that are allowed.  Some of the various exceptions can be varied due to time of delivery of the product (before of after completion), percentage of completion, deposits, and even by the expiration of a return period.  Yes, with companies that have a very high rate of return, there is a revenue recognition principal that allows companies to take the revenue when the return period expiration expires.

Concerns related to the recognition of revenue have increased.  Fraudulent acts of recording revenue improperly through sham transactions, but subtler practices, such as recognizing revenue before it is earned, have drawn more intense regulatory scrutiny.  Also, revenue recognition does not have to be a permanent fixture for a company.  If a company is having a particular bad year, it may choose to recognize revenue that has yet to be collected in order to vastly increase its sales revenue for the year.  New, less obvious issues involving revenue recognition in the growing online economy have also come to light. Not surprisingly, these problems have caught the attention of both the SEC and FASB.

Thankfully though, it’s like a living breathing creature.  Constantly evolving and being changed to benefit industries and various scenarios.  Even now, the IASB and the FASB are conducting a project to develop new concepts and for revenue recognition and new general standards that will be based on those concepts.  These would replace the existing standards already set in place. 

The CPA Journal has written several recommendations for improving accounting practices as follows:

  1. Individuals recording and auditing revenue should have a high level of knowledge of GAAP for revenue recognition. In addition, audit committees should be keenly aware of subtler issues and make appropriate inquiries.
  2. All relevant individuals should be knowledgeable about recent revenue recognition guidelines, including SAB 101 and EITF 99-17 and 99-19.
  3. Where revenue recognition may be questioned—such as in the above cases—the financial statements should make the appropriate disclosures and inform users of the “grossing up” of the transactions if the transactions are not reported net of revenue earned.

Hopefully after a few years and the comfort zone increases, we’ll all be able to use these methods practically and have another level of accounting that both benefits the companies involved as well as the economy.  We all know they need the help!

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