Revenue Recognition

MANAC I

Issues involved
When to recognize?

Timing

How much to recognize?

Amount
Determinants
Operating Cycle

Accounting System
Accrual accounting system
AS 1

Realization, Conservatism, Matching
Concepts


Readings
Accounting Standard 9

HBS-Revenue Recognition and Reporting

AHM Chapter 5
What is revenue?
All the receipts are not revenue

It is the gross inflow of cash, receivables or
other considerations arising in the ordinary
course of business
It is charge made to customers
Revenue
Sale of goods

Services

Others Interest, Royalties and dividends


Note: Assume that company follow Accrual Accounting System

AS9 - Does not include revenue from
Construction contracts (AS 7)

Hire-purchase and lease agreements (AS 19)

Government grants and subsidies (AS 12)

Insurance contracts (partly AS 30, 31)

Changes in foreign exchange rates (AS 11)

Revenue Recognition Methods
1. Sales
2. Installment Sales
3. Production
4. Long-term contracts I
5. Long-term contracts II
6. Cost recovery
7. Delivery
Revenue Recognition Methods
1. Sales Method recognition at the time
services are rendered or goods shipped

2. Installment Sales Method recognition at
the time the sale price is collected

3. Production Method recognition at the
time the product is completed but before
delivery
Revenue Recognition Methods
4. Percentage-of-completion method
recognition proportionally over the
performance of a long-term contract
5. Completed contract method recognition
at the completion of a long-term contract
6. Cost recovery method recognition after
the buyers cumulative cash payments
exceed the sellers total costs
7. Delivery method recognition at time of
delivery if the sale is made and cash is
received prior to delivery or production
Event Revenue Recognition Revenue
at this time Recognition Method
1 Sales order received NO NONE
2 Deposit or advance payment received NO NONE
3 Goods are produced For certain long-term contracts Percentage of completion
4 Production completed; goods stored For precious metals and certain Production
agrrcultural products
5 Goods shipped or services provided Usualy Delivery
6 Customer pays account receivable Collection is uncertain Installment
Timing of Revenue Recognition
Sale of goods
Seller has transferred the property in the
goods to the buyer for a consideration
Transfer of significant risks and rewards of
ownership
Physical delivery is due or done
Either both or one

Services
When service is performed
Proportionate completion method
Multiple acts

Completed service contract
Single acts
Others
Interest due but not received

Royalties accrue and either paid or due

Dividends right to receive payment is
established

Effect of Uncertainties on Revenue
Recognition
It should be measurable
Adjust for sales discount, bad debts, provision for
bad debts, allowance for returns,

Reasonably certain consider

If not certain postpone
Format
Turnover (Gross) XXX
Less: Excise Duty XX

Turnover (Net) XXX
Cash and Trade Discounts
Trade discounts reductions to the gross
selling price for a particular class of
customers

Cash discounts reductions of invoice prices
awarded for prompt payment
Cash and Trade discount
Credit terms Meaning
n/30 The full billed price (net price) is ude on thirtieth day after the invoice date
1/5, n/30 A 1% discount can be taken for payment within 5 days of the invoice date;
othewise, the full billed price is due in 30 days
15 E.O.M. The full price is due within 15 days after the End Of the Month of sale
an invoice dated January 20 is due February 15
Illustration ..
A manufacturer sells 30000 of computer
equipment to IBM on terms 2/10, n/60

Ans..
Illustration ..
A manufacturer sells 30000 of computer
equipment to IBM on terms 2/10, n/60

Ans..
IBM may remit 30000 less a cash discount of
0.02 X 30000 and pay 29400, if it makes
payment within 10 days after the invoice date
Otherwise it must pay the full 30000 within 60
days
WHAT IS THE ENTRY FOR THIS

Transaction analysis or Journal entries
1. Accounts receivables Dr 30000 and
Sales Cr 30000
2. Cash Dr 29400; Cash discounts on sales
Dr 600 and Accounts receivables Cr
30000
OR
1. Cash Dr 30000 and Accounts
receivables - 30000
Question to think / discuss
Sale of goods
Delivery is delayed at buyers request and
buyer takes title and accepts billing
Sale of goods
What is delivery subject to conditions ?

Installation and inspection
On approval
Guaranteed sales
Provide allowance for the same
Consignment sales
Cash on Delivery




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HUL AR 2008-09 page 112
Infosys AR 2007-08 page 73
Jindal Steel and Power AR-2007-08
AXIS bank AR-2007-08
Cost of Sales and Inventory
:

Issues involved
What is inventory?

What costs are included in inventory?

How do we separate CGOS and closing
inventory?


Resources
AS 2
AS-2 deals with determination of value of
inventory

HBR-The Question of LIFO and FIFO

AHM Chapter 6

What is inventory?
Asset items held for sale in the ordinary
course of business or goods that will be used
or consumed in the production of goods to be
sold
Types of Companies
Merchandising company
Sells goods in same form as acquired.

Manufacturing company
Converts raw material into finished goods.

Service company
Provides intangible services.

Merchandising company

Merchandising
Sells goods in same form in which they are
acquired.
Inventory costs (and costs of goods sold) =
acquisition costs.

Manufacturing company

Manufacturing company converts raw
materials and purchased parts into finished
goods.
3 types of inventories;
Raw Materials.
Work-in-process.
Finished goods.

Service company

Service organizations (hotels, beauty parlors,
plumbers)
May have materials inventories.

Professional Service Inventories
Professional service firms (accounting firms,
legal firms)
Intangible inventory costs are costs incurred for
client but not yet billed called jobs-in-progress or
unbilled costs.

Example: law and accounting firms.
Labor , overhead, and incidental product costs but no
materials cost.
Expensed in period billed (i.e., when revenues are
recognized).

Terminology
Inventories: are assets
a. held for sale in the ordinary course of business
b. in the process of production for such sale
c. in the form of materials or supplies to be
consumed in the production process or in the
rendering of services

Net Realizable Value:
Measurement
Inventories should be valued at the lower of
cost and net realizable value (as per AS 2)
Cost Formulas
FIFO
LIFO
Weighted Average
Average
Inventory valuation Method
What is the value of inventory? Under
.
FIFO

LIFO

Average

Weighted Average
What is the value of inventory? Under
.
FIFO 4500

LIFO 3800

Average 4141

Weighted Average
Question to all?
The Question of LIFO or FIFO: Which is
Preferable?

Ans: . . .
Answer this .
Sales 100000
Less: Cost of goods sold
Op inventory 20000
Purchases 30000
Cost of goods available 50000
Less: Cl. Inventory 14000
Cost of goods sold 36000
Gross Profit 64000
Operating Exp 29000
Net Income 35000
If Cl inventory is overstated by 2000
What is the impact on
a. Cost of goods sold
b. Net income
Advantages for FIFO
Usually follows physical flow of goods.
If prices are based on oldest cost, results in
best matching.
More accurate balance sheet valuation.
Non-theoretical/practical argument:
Results in highest income during periods of rising
prices.

Advantages for LIFO
If prices are based on current costs, results in
best matching of revenues and costs and
therefore most useful income statement.
Closest to reflecting current or replacement
costs of goods sold.
However, it is still historical costs and could differ
from current costs
Advantages for LIFO (Cont.)
During periods of price increases:
Higher costs of goods sold.
Lower taxable income.
Lower income taxes.
Higher cash flows.
If LIFO for tax purposes than also financial reporting.

Relationship of Inventory and Cost of
Goods Sold
Beginning inventory + net purchases = goods
available for sale
Goods available for sale = cost of goods sold
+ ending inventory.
Equivalently: Beg. inventory + net purchases
-ending inventory = cost of goods sold.
Net purchases = gross purchases -purchase
returns and allowances + freight-in

Calculate value of inventory for reporting in
Financial Statements on ITEM by ITEM
Item Units Cost per unit NRV per unit
Z 200 4.00 4.50
Y 250 5.00 5.50
X 300 6.00 5.00
W 350 7.00 6.00
Calculate value of inventory for reporting in
Financial Statements on ITEM by ITEM
Lower of
Item Units Cost per unit NRV per unit Cost or MV
Z 200 4.00 4.50 800 COST
Y 250 5.00 5.50 1250 COST
X 300 6.00 5.00 1500 MV
W 350 7.00 6.00 2100 MV
5650 total
Calculate value of inventory for reporting in FS
on TOTAL INVENTORY basis
Item Units Cost per unit NRV per unit COST MV
Z 200 4.00 4.50 800 900
Y 250 5.00 5.50 1250 1375
X 300 6.00 5.00 1800 1500
W 350 7.00 6.00 2450 2100
6300 5875
Why lower of cost or market price
Market price may be below cost due to:
Physical deterioration.
Change in consumer tastes.
Technological obsolescence.
LCM is a reflection of conservatism concept.
Market is defined as replacement cost.

AS - 2
In India, as per AS 2 Valuation of
Inventories,
the cost of inventories should be assigned by
using
First-in, First out (FIFO) method or
Weighted Average Cost of method
Disclosure Requirements
The financial statements should disclose:
a. the accounting policies adopted in measuring
inventories, including the cost formula used and
b. the total carrying amount of inventories and its
classification appropriate to the enterprise
Like: raw materials and components, work in progress,
finished goods, stores and spares and loose tools.
Jindal AR- 2007-08
Infosys AR 2007-08
Inventory value will be.

?
Infosys AR 2007-08 page no. 64
TCS AR 2010-11
Inventory as a part of CA (Scheduled H)


HUL AR- 2008-09 page no. 64
Revise ..
1. Inventory is reported in the Balance Sheet as
an ___________

2. The inventory method which assumes that
goods are sold in the reverse order of their
acquisition is know as ________ method

3. A company should select the ____ inventory
method if it wishes to keep its taxes to
minimum
Revise ..
1. Inventory is reported in the Balance Sheet as
an _CURRENT ASSET

2. The inventory method which assumes that
goods are sold in the reverse order of their
acquisition is know as _LIFO_ method

3. A company should select the _LIFO_ inventory
method if it wishes to keep its taxes to
minimum