Revenue Recognition Essay

The issue of tax income cognizance practices is an scope that has catchd a down of attention from regulators. Whenever there is a identify of fiscal restatements or oppose boodle, regulators pay extra attention to review the financial statements in state to verify that that there be non any indications of financial device or that the organization over billped their boundaries in the atomic number 18a of managed earnings. The reason that regulators have interpreted a special interest in financial method of accounting and authority fraud is due to the resolves of companies such as Enron, WorldCom and Tyco. Regulators and those in the accounting affair ar heightening their efforts on the ca designs of fraud as well as the steps that stick out be interpreted to effectively detect and foresee a possible reoccurrence of fraudulent behavior especially in the area of tax tax enhancement apprehension and the overstatement of pluss. gross recognition refers to the sentence when proceeding are recorded on the books, Per Generally Accepted Accounting Principles (GAAP), tax incomes, and gains, are generally recognized when1. Revenues are realized or are tangible2. They have been earned the substantial completion of the activities involved in the earnings process. Both of these items are typically met at the point of sale, which generally occurs when goods are delivered or when operate are rendered to the client. Usually receiptss and assets are recognized simultaneously. However, assets rotter be received before the conditions of gross recognition are met. impartiality example would be if a client pays in advance for goods or service which will be received at a after date. Even though the cash is received and is recorded as an asset in the beau mondes books, the revenue has not been earned. Typically the revenue is not recognized prior to a sale be beat either the customer has not paid for the goods yet or because the goods have not bee n delivered to the customer. The master(prenominal) exception to not recognizing revenue prior to a sale would be when a set about exists that guarantee the sale or that the customer has promised a valid promise of payment such as when both the seller and the buyer are legally obligated to fulfill the term of a deal (Parizek & Findley, 2008).Another exception to the revenue recognition linguistic rule occurs when a product or service may be provided to the customer without receiving a valid promise of payment. This typically occurs with a family dentist who provides services to ease a patients pain and then tries to cumulate the payment later. Also, if a caller has a substantial amount of services to provide even though the customer has provided a substantial payment, the company moldiness wait to recognize the revenue. It is not enough that whiz of the criteria for recognizing reexamination is met both items must be satisfied in articulate for the recognition of re venue.Because every income statement begins with total revenue, how revenue is measured is a of import concept in the field of accounting and as such, the topic of revenue recognition has received a lot of attention over the kind of the past few years. The Ameri stand Institute of Certified existence Accountants (AICPA) has produced limited guides to help with the topic of revenue recognition in specific spaces in current industries. The AICPA Statement of Position (SOP) 97-2, Software Revenue Recognition contained the pursuit four items (Parizek & Findley, 2008) 1. Persuasive evidence of an arrangement exists2. Delivery has occurred.3. The vendors fee is hardened or determin competent.4. Collectability is probable.These four items were utilize as the framework in the instant Staff Accounting Bulletin no ci. The SAB one hundred one is a very unique and interesting bulletin because it provides specific cases and then proceeds with a questions and answer format. SAB w as created in large area to the issues that the staff had encountered in while exacting a review. Because SAB hundred and one addresses specific office staffs, it cannot be used as an answer to every instance of revenue recognition, provided it does provide a comprehensive guide for companies to use as a form of direction when faced with dealing with a complicated situation such as when there is persuasive evidence of an arrangement, delivery of goods has already occurred or services have been rendered or when the harm is fixed or definable (SEC, 1999).Questions 1 and 2 of SAB address the topic of Persuasive evince of an Arrangement and highlight how a seller could be tempted to bend the rules of revenue recognition in bon ton for a more favorable time in which the sale is account. The first question exhibited the case in which telephoner A required severally sale to be obligeed by a written gross sales agreement signed by an veritable representative of both the custom er and confederacy A. This issue was if accompany A could recognize the revenue in the current quarter even if the sales agreement would not be signed until a few eld after the quarter had ended. This question highlighted the need for companies to have strong inner(a) controls and the need to a reliable system to be in built in bed for processing contracts. Without a strong internal control structure as well as clearly documented procedures, there is a disaster of managers becoming tempted to adjust how revenue is recognized based on the demand 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 production until the customer returns to pay the balance rest on the merchandise. Once the merchandise is paid in full, the customer can take possession of the merchandise. This case is an example of what is referred to as a flower and hold arrangement where the customer is billed for the merchandise but the merchandise is held by the company for release or shipment at a later date. Question 4 is also an example of how some companies could see to it their inventories at the end of a quarter. A company could increase revenue by pushing some of its merchandise in the warehouse deflection and claim that it has already been sold but were be held for the customer. In order for the company to recognize the revenue they must be able to come out that the merchandise is completely separate 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 activities. Question 5 ask s 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 treated singly and must be treated as a part of the boilers suit unit because no one would pay a deposit without expecting surplus 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 structure and leases it to a retailer. The annual lease payment is $1.2 million plus one share of all the retailers sales in extra of $25 million. It is probable that sales during the year will exceed $25 million. Should Company A estimate and recognize revenue associated with the one percent of the sales over $25 million on a straight-line origination throughout the year?Because the buyer does not have any fixed or det erminable obligation to make a payment until the $25 million sales level 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 preferably 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 other 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 reporting 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 revenue. SAB 101 is not the only work that has tried to address the i ssue of revenue recognition. The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are working together on joint 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 6 for the project (FASB,2012) 1. Converging U.S. and international standards on revenue recognition 2. Eliminating inconsistencies in the existing conceptual way on revenue recognition.3. Providing conceptual direction that would be useful in addressing future revenue recognition issues. 4. Eliminating inconsistencies in existing standards-level authoritative literature and accepted practices. 5. Filing voids in revenue recognition guidance that have developed over time 6. Establishing a single, comprehensive standard on revenue recognition In creating a new revenue recognition standard, the F ASB and the IASB have adjusted their focus to acknowledgment and earnings approach instead of focusing on an asset and liability approach. To assist companies with the changes, FASB issued a proposal that broke down the revenue recognition process into five steps.The first step would be to match the contract 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(prenominal) it expects to receive for preforming each step with the company recognizing the revenue in the utmost step once the merchandise has been transferred to the customer (FASB, 2012). The work between FASB and IASB is exempt a work in progress but has strong support from several groups in the accounting community some of which have already laid a foundation to work from.In 1998 former SEC Chairman A rthur Levitt delivered what is now con casered to be a famous speech coroneted The Numbers Game in which he expressed great disturbance over how many companies engage in the practice of earnings management. In his speech Mr. Levitt identified several major accounting techniques that he prospect were being used to undermine the integrity of financial reporting(Levitt, 1998). Mr. Levitt emphasize 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 total. Mr. Levitt mentioned the standards of objectivity, integrity and judgment in reporting accounting number and stressed that it was these standards that uphold an integral part of the universe accounting professions mark of Professional Conduct and form the foundation by which financial statements are compiled, audited and interpreted.He went on the say that the honourable dilemmas facing contra stes and their accountants often wheel 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 stated that accounting principles lay off 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 report favorable results, accountants also come under pressure to flex those rules well-nigh to the point of breaking. Mr. Levitt gave credit to the Code of Professional Conduct for providing guidance to the populace 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 latest methods. In October of 2000, the Chief Accountant of the SE, Lynn Turner, wrote a earn 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 include in her letter was the topic of revenue recognition.The letter discussed the issue of revenue fraud and how over half of the revenue frauds that were identified were due to companies that exaggerated their revenue because that had reported revenue either too early of misleadingly (U.S., 2000). Ms. Turner stressed the importance for auditors to test cut off dates and stressed how auditors must place special focus and conduct testing that is higher up and beyond the reviewing of a few transactions. Ms. Turner also wanted to act upon to of Ms. Thomas the issue that was raised 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 improperly 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 retort praise to the AICPA for a document 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 conditions of the contracts, auditors wou ld be able to determine the best furrow 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(a) factors management will need to use their own judgment in determining how their revenue should be recognized and that management should be active to have their judgments analyzed and questioned. By maintaining focus of the issues that have been identified, and keeping an warmheartedness out for possible future issues, the authorities can be certain that investors are making decisions based on accurate information. Constant readiness 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 Executive Co mmittee 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). earn 2000 audit risk alert to the american institute of certified public accountants. Retrieved from http//www.sec.gov/info/accountantts/staffletters/audrsk2k.htm