Accounting Standard - 9

REVENUE
RECOGNITION
- Vishnu Sahu

What is Revenue

Gross inflow of consideration (cash / receivables / others)

arising in the course of ordinary business activities from:

Sale of goods
Rendering of services and
Use of enterprise resources yielding interest, royalties and
dividends

Revenue Recognition

Recognition is the process of recording and reporting an

item as an element of financial statements

The revenue recognition principle provides that revenue

is recognized:

when it is earned, and

when it is realized or realizable

Revenue Recognition

Earned- when the earnings process is substantially

complete.

Realized- when goods and services are exchanged for cash

or claims to cash.

Realizable- when assets received are convertible into a

known amount of cash.

Revenue Transactions

Basically there are four types of transactions through

which a firm earns revenues

Sale of Goods
Rendering of Services
Use of Enterprises assets
Disposal of assets (other than inventory)

AS-9 does not deal with.

Revenue arising from construction contracts (AS-7)

Revenue arising from hire-purchase, lease agreements

(AS-19)

Revenue arising from government grants and other

similar subsidies (AS-12)

Revenue of insurance companies arising from insurance

contracts (IRDA Regulations)

Items not included in the definition

of revenue

Realised gains resulting from the disposal of,

and unrealised gains resulting from the holding
of, non-current assets e.g. appreciation in the
value of fixed assets;

Unrealised holding gains resulting from the

change in value of current assets, and the natural
increases in herds and agricultural and forest
products;

Contd

Realised or unrealised gains resulting from

changes in foreign exchange rates and
adjustments arising on the translation of foreign
currency financial statements;

Realised gains resulting from the discharge of an

obligation at less than its carrying amount;

Unrealised gains resulting from the restatement of

the carrying amount of an obligation.

Basic Principles of Revenue

Recognition

Timing

Measurement

Timing and Measurement

Timing:

Revenue Recognition at Point of Sale

Revenue Recognition before Delivery (e.g. Long
term contracts)
Revenue Recognition after Delivery

Measurement:

Should we recognize entire revenue at the same

time or in parts

Revenue Recognition Classified by

Nature of Transaction

Sale of Goods

Delivery is delayed at buyers request and buyer takes title and

accepts billing
Delivered subject to conditions

Installation and inspection

On approval
Guaranteed sales (e.g. money back if not completely satisfied)
Consignment sales
Cash on delivery sales

Installment Sale and the seller delivers the goods only when
the final payment is received

Sale of Goods

Special order and shipments (i.e. where payment is received

for goods not presently held in stock)

Sale / Repurchase agreements

Sales to intermediate parties

Subscriptions for publications

Installment sales

Trade discounts and volume rebates

Rendering of Services

Installment fees

Advertising and Insurance agent commissions

Financial service commissions

Admission fees

Tuition fees

Entrance and membership fees

Use of Enterprise Assets

Interest: Charges for the use of cash resources or amounts due

to the enterprise

Royalties: Charges for the use of such assets as know-how,

patents, trade marks and copyrights

Dividends: Rewards from the holding of investment in shares

Use of Enterprise Assets

Revenue should be recognized when no significant uncertainty

as to measurability or collectibility exists

Interest: on a time proportion basis taking into account the

amount outstanding and the rate applicable
Royalties: on an accrual basis in accordance with the terms
of the relevant agreement
Dividends: when the owners right to receive payment is
established

Types of Transactions

Transactions

Long Term
Contracts

Installment
Sales

Barter
Transactions

Methods of Revenue Recognition

Long Term Contracts

Installment Sales

Percentage (%) of Completion Method

Completed Contract Method

Installment Method
Cost Recovery Method

Barter Transactions

Percentage of Completion Method

Appropriate when the projects cost and revenue can be

reliably estimated

Revenue, Expense and Profit is recognized as the work is

performed

Formula = Total cost incurred till date

Total Expected Cost

Percentage of completion: Steps

1

Costs incurred to date

= Percent complete
Most recent estimated total costs

2 Estimated total revenue x Percent complete

= Revenue to be recognized to date
3 Total revenue to be recognized to date less Revenue
recognized in PRIOR periods = Current period revenue
4 Current Period Revenue less current costs = Gross profit

Percentage of Completion
Method: Example
Data: Contract price: $1,000
Estimated cost: $800
Start date:
Jan, 05
Finish: Dec, 07
Balance Sheet date: Dec. 31
Given:

2005

2006

2007

Costs incurred

$400

$300

$100

To Find:
Revenue and Net Income (Profit) to be recognized each year
in the companys Income Statement

Percentage of Completion
Method: Example
2005

2006

2007

% Exp incurred
each year

400 = 50%
800

300 = 37.5%
800

100 = 12.5%
800

Revenue
recognized

1,000 * 50%
= 500

1,000 * 37.5%
= 375

1,000 * 12.5%
= 125

Net Income
recognized

500 400
= 100

375 - 300
= 75

125 - 100
= 25

Percentage of Completion
Method: Example
Solution:

Income Statement

2005

Revenues

$500

Expenses

Net Income

2006

2007

Total

$375

$125

$1,000

$400

$300

$100

$800

$100

$75

$25

$200

Completed Contract Method

Appropriate when the outcome of a project cannot be reliably

measured

When the project is comparatively short in duration

Revenue, Expense and Profit is recognized only when the

contract is complete

Completed Contract Method:

Example
Data: Contract price: $1,000
Estimated cost: $800
Start date:
Jan, 05
Finish: Dec, 07
Balance Sheet date: Dec. 31
To Find:
Expenses, Revenue and Net Income to be recognized each year

Income Statement

2005

2006

2007

Total

Revenues

$0

$0

$1,000

$1,000

Expenses

$0

$0

$800

$800

Net Income

$0

$0

$200

$200

Installment Method

Installment Sale occurs when a firm finances a sale

and payments are received over an extended period

If collectibility cannot be reasonably estimated, this

method is used

Revenue and Profit is recognized as the cash is

collected

Profit = Cash Collected during the period *

Expected Profit Percentage

Installment Sales Method:

Example
Data: Contract price: $1,000
Estimated cost: $800
Start date:
Jan, 05
Finish: Dec, 07
Balance Sheet date: Dec. 31
Given

2005

Collections

$400

2006
$400

2007

Total

$200

$1,000

To Find:
Expenses, Revenue and Net Income to be recognized each year
in the companys Income Statement

Installment Sales Method:

Example
Profit:
1,000 800 = 200
Profit %: 200 = 20%
1,000

2005

2006

2007

Profit
Recognized

400 * 20%
= 80

400 * 20%
= 80

200 * 20%
= 40

Expenses
recognized

400 80
= 320

400 - 80
= 320

200 - 40
= 160

Installment Sales Method:

Example
Solution:

Income Statement

2005

Revenues

$400

Expenses
Net Income

2006

2007

Total

$400

$200

$1,000

$320

$320

$160

$800

$80

$80

$40

$200

Cost Recovery Method

Under Installment Sales, if collectibility is highly

uncertain, the cost recovery method is used

Revenue is recognized as cash is collected

Profit is recognized only when cash collected exceeds

costs incurred

Very conservative

Cost Recovery Method:

Example
Data: Contract price: $1,000
Estimated cost: $800
Start date:
Jan, 05
Finish: Dec, 07
Balance Sheet date: Dec. 31
To Find:
Expenses, Revenue and Net Income to be recognized each year

Income Statement

2005

2006

2007

Total

Revenues

$400

$400

$200

$1,000

Expenses

$400

$400

$0

$800

Net Income

$0

$0

$200

$200

Barter Transactions

Barter Transaction

Two parties exchange goods or services without

cash payments

Round-trip transaction

Involves the sale of goods to one party with the

simultaneous purchase of identical goods from the
same party
E.g. Internet cos. buy advertising space on each
others website

Common ways of Manipulating

Revenue
Objectives of manipulating revenues:
Overstatement of revenues: To boost company
valuations
Understatement of revenues: To save on tax, thereby
increasing savings
3 common ways....
Fraudulent reporting of fictitious sales
Inaccurate timing of revenue recognition
Improper valuation of revenue

Frauds

In late 93, Bausch & Lomb made an offer to 32 distributors

To pick ~2 yrs inventory at prices lower than normal
Dec 24th deadline for sales, i.e., before the closing of 93 books
Distributors will not have to pay unless the lenses were sold
Final payments would be renegotiated if the program flopped
Distributors purchased almost $25mn during this period
In 94 B&L announced that high distributor inventories will hurt
1994 sales. Stock slides from $50 to the low $30s
10 months after sales, 85% of money was still to be collected

Implications for Financial Analysis

Points to be considered

Conservativeness / Aggressiveness of the firms revenue

recognition policies
Extent to which the firms policies rely on judgment and
estimates

Qs
Mr. Hey Amey has received Rs.1 Crore in Feb 07 as contract
fees for his Rock concert to be held in Hilton Towers
(Mumbai) during October 07. When would the income be
recorded?

Qs
Mr. Gaurav Gundawar has invested in securities and mutual

funds of Shraddha Telecom. The company proposed a

dividend on 10th March 07. but the dividend was declared on
15th June 07. When should be the income recognised in the
books of Mr. Gundawar?

Qs
Mr. Gaurav Patil has an agency for Jigar products. Jigar sends
24 Televisions to Mr. Gauravs showroom on consignment
basis on 1st March 2007. But till 31st March 2007 none of the
televisions have been sold to any customer. Should Jigar
record the TVs sent as sales?

Qs
Mr. Vivek Doubts Kabra is the subscriber of a journal by Mr.
Ravish Chupa Rustam. Mr. Ravish Chupa Rustam received
Rs.50,000 as subscription under a special scheme for next five
years. Mr. Chupa Rustam would like to know whether the

entire income should be recorded for the current year or not?

THANKS..