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Accounting 2 - D249 Unit 4, Module 5 - Revenue Recognition questions and answers
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Accounting 2 - D249 Unit 4, Module 5 - Revenue Recognition questions and answers
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Accounting 2 - D249 Unit 4,Module 5 - Revenue
Recognition questions and
answers
It's Back - INTRO STORY
Sarbanes-Oxley Act of 2002 (SOX). Unfortunately, SOX did not solve
one of the classic accounting issues—how to properly account for
revenue - improper revenue recognition causes lots of
restatements, or possible fraudulent behavior by company
executives and employees.
because of revenue recognition problems - SEC increased
enforcement actions in this area. In some cases companies made
significant adjustments to previously issued financial statements.
Lynn Turner, a former chief accountant of the SEC, indicated, "When
people cross over the boundaries of legitimate reporting, the
Commission will take appropriate action to ensure the fairness and
integrity that investors need and depend on every day."
Examples of SEC claims filed
*charged former co-chairman and CEO of Qwest Comms.
International Inc. + 8 other former officers and employees with
fraud and other violations of the federal securities laws.
Fraudulently characterized nonrecurring revenue from one-time
sales as revenue from recurring data & Internet services. - used
transactions to fill the gap between actual
*claim against 3 former senior officers of iGo Corp., saying they
collectively caused improper revenue recognition on consignment
sales & products not shipped or shipped after end of fiscal quarter.
*complaint against both Homestore Inc.'s former CEO/Chairman &
Executive VP of business development for engaging in fraudulent
scheme's to overstate advertising & subscriptions -"round-trip"
transactions using 3rd party companies that allowed recognition of
own cash as revenue.
,*claims that Lantronix deliberately sent excessive product to
distributors, granted them generous return rights & extended
payment terms. (Channel stuffing), also loaned funds to a 3rd party
to purchase from distributors to prevent product returns. (3rd party
later returned the products) Improper revenue recognition practices
incl. shipping without a purchase order & contingent sale.
* Order issued finding Alere Inc.'s improperly inflated revenues by
prematurely recording sales for products still stored at warehouses/
not delivered yet.
It's Back CONT. - Consider some SEC actions:
*The SEC issued an order finding that a subsidiary of Alere
Inc. improperly inflated revenues by prematurely recording sales for
products that were still being stored at warehouses or otherwise
not yet delivered to customers. The SEC also cited Alere for
engaging in similar improper revenue recognition practices at
several other subsidiaries.
Revenue numbers are attracting more attention from investors
these days. In a recent survey, financial executives noted that the
revenue recognition process is increasingly more complex to
manage, more prone to error, and more material to financial
statements compared to any other area in financial reporting. The
report went on to note that revenue recognition is a top fraud risk
and that regardless of the accounting rules followed (GAAP or IFRS),
the risk of errors and inaccuracies in revenue reporting is
significant.
In response, the FASB and IASB issued a new standard on revenue
recognition to improve the reporting of revenue transactions. This
new standard provides a set of guidelines to follow in determining
when revenue should be reported and how it should be measured.
The new standard is comprehensive and applies to all companies. As
a result, comparability and consistency in reporting revenue should
be enhanced. After studying this chapter, you should have a good
understanding of the new revenue recognition concepts.
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Fundamentals of Revenue Recognition
Discuss the fundamental concepts related to revenue recognition
and measurement.
Background
Revenue is one of, if not the most, important measures of financial
performance that a company reports. Revenue provides insights
into a company's past and future performance and is a significant
driver of other performance measures, such as EBITDA, net income,
and earnings per share. Therefore, establishing robust guidelines
for recognizing revenue is a standard-setting priority.
Most revenue transactions pose few problems for revenue
recognition. That is, most companies initiate and complete
transactions at the same time. However, not all transactions are
that simple. For example, consider a cell phone contract between a
company such as Verizon and a customer. Verizon often provides a
customer with a package that may include a handset, free minutes
of talk time, data downloads, and text messaging service. In
addition, some providers will bundle that with a fixed-line
broadband service. At the same time, the customer may pay for
these services in a variety of ways, possibly receiving a discount on
the handset and then paying higher prices for connection fees and
so forth. In some cases, depending on the package purchased, the
company may provide free upgrades in subsequent periods. How,
then, should Verizon report the various pieces of this sale? The
answer is not obvious.
Both the FASB and the IASB indicated that the state of reporting for
revenue was unsatisfactory. IFRS was criticized because it lacked
guidance in a number of areas. For example, IFRS had one general
, standard on revenue recognition—IAS 18—plus some limited
guidance related to certain minor topics. In contrast, GAAP had
numerous standards related to revenue recognition (by some
counts, well over 100), but many believed the standards were often
inconsistent with one another. Thus, the accounting for revenue
provided a most fitting contrast of the principles-based (IFRS) and
rules-based (GAAP) approaches.1
Recently, the FASB and IASB issued a converged standard on
revenue recognition entitled Revenue from Contracts with
Customers [Global View - The converged revenue recognition
standard represents a significant milestone in the FASB/IASB
convergence project.] [1] (See the FASB Codification References
near the end of the chapter.) To address the inconsistencies and
weaknesses of the previous approaches, a comprehensive revenue
recognition standard now applies to a wide range of transactions
and industries. The Boards believe this new standard will improve
GAAP and IFRS by:
a. Providing a more robust framework for addressing revenue
recognition issues.
b. Improving comparability of revenue recognition practices across
entities, industries, jurisdictions, and capital markets.
c. Simplifying the preparation of financial statements by reducing
the number of requirements to which companies must refer.
d. Requiring enhanced disclosures to help financial statement users
better understand the amount, timing, and uncertainty of revenue
that is recognized.
New Revenue Recognition Standard
The new standard, Revenue from Contracts with Customers, adopts
an asset-liability approach as the basis for revenue recognition.
The asset-liability approach recognizes and measures revenue
based on changes in assets and liabilities. The Boards decided that
focusing on (a) the recognition and measurement of assets and
liabilities and (b) changes in those assets or liabilities over the life
of the contract brings more discipline to the measurement of
revenue, compared to the ”earned and realized” criteria in prior
standards.
Under the asset-liability approach, companies account for revenue
based on the asset or liability arising from contracts with
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