Professional Documents
Culture Documents
ON
INSTITUTE OF MANAGEMENT
D.A.V COLLEGE, CHANDIGARH
ACKNOWLEDGEMENT
The successful completion of any task would be incomplete without mentioning the
names of persons who helped to make it possible. I take this opportunity to express my gratitude
in few words and respect to all those who helped me for the completion of this summer project
Finally, I express our sincere thanks and deep sense of gratitude to my parents and friends
for giving timely advice in all the ways and in all aspects for doing the project.
Shivesh Kuthiala
REVENUE RECOGNITION AND MEASUREMENT
The revenue recognition principle is a cornerstone of accrual accounting together with the
matching principle. They both determine the accounting period, in which revenues and expenses
are recognized. According to the principle, revenues are recognized when they are realized or
realizable, and are earned (usually when goods are transferred or services rendered), no matter
when cash is received. In cash accounting – in contrast – revenues are recognized when cash is
Cash can be received in an earlier or later period than obligations are met (when goods or
services are delivered) and related revenues are recognized that results in the following two types
of accounts:
The Critical-Event Approach: IFRS provides five criteria for identifying the critical event for
1. Risks and rewards have been transferred from the seller to the buyer
The first two criteria mentioned above are referred to as Performance. Performance occurs
when the seller has done most or all of what it is supposed to do to be entitled for the payment.
E.g.: A company has sold the good and the customer walks out of the store with no warranty on
the product. The seller has completed its performance since the buyer now owns good and also
all the risks and rewards associated with it. The third criterion is referred to as Collectability.
The seller must have a reasonable expectation of being paid. An allowance account must be
created if the seller is not fully assured to receive the payment. The fourth and fifth criteria are
referred to as Measurability. Due to Matching Principle, the seller must be able to match
expenses to the revenues they helped in earning. Therefore, the amount of Revenues and
General rule[edit]
Received advances are not recognized as revenues, but as liabilities (deferred income), until the
1. Revenues are realized when cash or claims to cash (receivable) are received in exchange
for goods or services. Revenues are realizable when assets received in such exchange are
2. Revenues are earned when such goods/services are transferred/rendered. Both such
payment assurance and final delivery completion (with a provision for returns, warranty
1. Revenues from selling inventory are recognized at the date of sale often interpreted as the
date of delivery.
2. Revenues from rendering services are recognized when services are completed and billed.
3. Revenue from permission to use company's assets (e.g. interests for using money, rent for
using fixed assets, and royalties for using intangible assets) is recognized as time passes
4. Revenue from selling an asset other than inventory is recognized at the point of sale,
Accrued revenue (or accrued assets) is an asset such as proceeds from a delivery of goods or
services, at which such income item is earned and the related revenue item is recognized, while
cash for them is to be received in a later accounting period, when its amount is deducted
from accrued revenues. It shares characteristics with deferred expense(or prepaid expense,
or prepayment) with the difference that an asset to be covered later is cash paid out to a
counterpart for goods or services to be received in a later period when the obligation to pay is
actually incurred, the related expense item is recognized, and the same amount is deducted
from prepayments
Deferred revenue (or deferred income) is a liability, such as cash received from a counterpart for
goods or services which are to be delivered in a later accounting period, when such income item
is earned, the related revenue item is recognized, and the deferred revenue is reduced. It shares
characteristics with accrued expense with the difference that a liability to be covered later is an
obligation to pay for goods or services received solo from a counterpart, while cash for them is
to be paid out in a later period when its amount is deducted from accrued expenses.
For example, a company receives an annual software license fee paid out by a customer upfront
on the January 1. However the company's fiscal year ends on May 31. So, the company using
accrual accounting adds only five months worth (5/12) of the fee to its revenues in profit and
loss for the fiscal year the fee was received. The rest is added to deferred income (liability) on
Advances[edit]
Advances are not considered to be a sufficient evidence of sale, thus no revenue is recorded until
the sale is completed. Advances are considered a deferred income and are recorded
as liabilities until the whole price is paid and the delivery made (i.e. matching obligations are
incurred).
Exceptions[edit]
The rule says that revenue from selling inventory is recognized at the point of sale, but there are
several exceptions.
Buyback agreements: buyback agreement means that a company sells a product and agrees
to buy it back after some time. If buyback price covers all costs of the inventory plus related
holding costs, the inventory remains on the seller's books. In plain: there was no sale.
Returns: companies which cannot reasonably estimate the amount of future returns and/or
have extremely high rates of returns should recognize revenues only when the right to return
expires. Those companies that can estimate the number of future returns and have a
relatively small return rate can recognize revenues at the point of sale, but must deduct
Long-term contracts[edit]
This exception primarily deals with long-term contracts such as constructions (buildings,
stadiums, bridges, highways, etc.), development of aircraft, weapons, and space exploration
hardware. Such contracts must allow the builder (seller) to bill the purchaser at various parts of
The percentage-of-completion method says that if the contract clearly specifies the price
and payment options with transfer of ownership, the buyer is expected to pay the whole
amount and the seller is expected to complete the project, then revenues, costs, and gross
profit can be recognized each period based upon the progress of construction (that is,
percentage of completion). For example, if during the year, 25% of the building was
completed, the builder can recognize 25% of the expected total profit on the contract. This
method is preferred. However, expected loss should be recognized fully and immediately due
calculating the percentage of completion for comparing budgets and actuals to control the
cost of long-term projects and optimize Material, Man, Machine, Money and time (OPTM4)
.The method used for determining revenue of a long-term contract can be complex. Usually
two methods are employed to calculate the percentage of completion: (i) by calculating the
percentage of accumulated cost incurred to the total budgeted cost. (ii) by determining the
is accurate but cumbersome. To achieve this, one needs the help of a software ERP package
which integrates Financial, inventory, Human resources and WBS (Work breakdown
structure) based planning and scheduling while booking of all cost components should be
done with reference to one of the WBS elements. There are very few contracting ERP
applicable or the contract involves extremely high risks. Under this method, revenues, costs,
and gross profit are recognized only after the project is fully completed. Thus, if a company
is working only on one project, its income statement will show $0 revenues and $0
construction-related costs until the final year. However, expected loss should be recognized
This method allows recognizing revenues even if no sale was made. This applies to agricultural
products and minerals.There is a ready market for these products with reasonably assured prices,
the units are interchangeable, and selling and distributing does not involve significant costs.
Sometimes, the collection of receivables involves a high level of risk. If there is a high degree of
uncertainty regarding collectibility then a company must defer the recognition of revenue. There
Installment sales method allows recognizing income after the sale is made, and
proportionately to the product of gross profit percentage and cash collected calculated. The
unearned income is deferred and then recognized to income when cash is collected.[2] For
example, if a company collected 45% of total product price, it can recognize 45% of total
Cost recovery method is used when there is an extremely high probability of uncollectable
payments. Under this method no profit is recognized until cash collections exceed the seller's
cost of the merchandise sold. For example, if a company sold a machine worth $10,000 for
$15,000, it can start recording profit only when the buyer pays more than $10,000. In other
words, for each dollar collected greater than $10,000 goes towards your anticipated gross
profit of $5,000.
Deposit method is used when the company receives cash before sufficient transfer of
ownership occurs. Revenue is not recognized because the risks and rewards of ownership
On May 28, 2014, the FASB and IASB issued converged guidance on recognizing revenue in
contracts with customers. The new guidance is heralded by the Boards as a to think major
achievement in efforts to improve financial reporting.[4] The update was issued as Accounting
Standards Update (ASU) 2014-09. It will be part of the Accounting Standards Codification
(ASC) as Topic 606: Revenue from Contracts with Customers (ASC 606), and supersedes the
existing revenue recognition literature in Topic 605 issued by FASB.[5]ASC 606 is effective for
public entities for the first interim period within annual reporting periods beginning after
disclosure requirements
Simplify the preparation of financial statements by reducing the number of requirements to
The new revenue guidance was issued by the IASB as IFRS 15. The IASB’s standard, as
amended, is effective for the first interim period within annual reporting periods beginning on or
Measurement of Revenue:
Revenue is properly measured either by the exchange value of the product or services of the
firm. This exchange value actually reveals the cash equivalent or the present discounted value of
the money which is received from the revenue transaction. This may be similar to the price
For this purpose, proper allowance must be made in order to wait for final collection. For
example, a cash sale of Rs. 1,000 will produce a revenue of Rs. 1,000 but if the payment is made
after a year, it produces a revenue which will be less than Rs. 1,000, since question of discount
will appear in the latter case. If the waiting period is very short, naturally, the discount factor
may be ignored.
The above criterion for the purpose of measurement of revenue relates to the present value of
money or its equivalent which is finally received from the revenue transaction since all returns,
trade discounts and other reductions are subtracted from the revenue so earned. Cash discounts
It is to be noted that cash discounts are allowed to customers for two purposes:
money value (which will be received under the granted credit terms at a later date).
Practically, if the rate of cash discount was fixed rationally, the sellers would be less interested in
whether they received the net amount or gross price minus certain amount of expected bad debt
losses. In this context, cash discounts and expected bad debt losses are to some extent similar.
After reading this article you will learn about: 1. Meaning of Expense 2. Measurement of
Expense 3. Recognition.
Meaning of Expense:
The term ‘expenses’ is a flow concept. It represents both favourable and unfavorable changes
made in an accounting period. The favourable one represents revenue whereas the unfavorable
In short, the consumption or use of goods and services in order to earn revenue is the expense.
Thus, Hendriksen opines- ‘expenses are the using or consuming of goods and services in the
ADVERTISEMENTS:
‘Expense is the expired cost, directly or indirectly related to given fiscal period, of the flow of
goods or services into the market and of related operations’. The primary objective of all costs is
to earn revenue from the customers in exchange of goods and services produced by the firm at a
given period. As such, the amount which is spent in anticipation of earning revenue, no doubt,
constitutes cost.
Needless to mention that all sacrifices are not expenses. The sacrifices which are directly or
indirectly related to the production are included with expenses. At the same time, such sacrifices
are losses against which neither any benefit has been realised nor is there any chance of realising
the same in future. Thus, the benefits which are received in excess of the sacrifices are incomes
Expenses are defined in terms of cost expirations or cost allocations frequently. They are the
structural model for the measurement of accounting income and they do not reflect real world
situations. Expense valuation in that context is a problem which differs from the definition of
expense.
Expenses are measured in terms of valuation of goods or services used or consumed, but
the said measurement does not define it. Therefore, the difference between the two is that
activity or a process.
Measurement of Expense:
The conventional method of measuring expenses is the historical cost concept measurement. The
primary reason is that they are assumed to be verifiable since they represent cash outlays by the
enterprise. They also represent the exchange value of goods and services while they were
(i) Under this method only, the expenses can be objectively determined and ascertained.
ADVERTISEMENTS:
(iii) Personal bias of the valuer is neglected here, so, manipulation of reports and statements may
be avoided.
(i) It does not represent a relevant measurement of the goods and services used in order to meet
(ii) It does not permit a separation of operating activity from gains and losses arising from
(iii) The impact of price level changes between purchase of raw material and the sale of finished
Revenue is generally measured in terms of the current price received against the product sold.
Therefore, the expenses matched should also be measured in terms of the current price of goods
or services used or consumed. Because, income which arises from sale transaction is the excess
income which arises from the transactions and the gains or losses which arise from the holding of
The gains and losses which occur before the use may arise either from price changes, or from
deterioration, or from obsolescence, or other factors. At the same time, when the acquisition of
goods and services before the use is necessary along with loss or deterioration, this reduction in
Current price may be taken either from current liquidation/sale price or from a replacement cost.
expenses since it expresses the opportunity cost of a firm for using such specific asset.
Moreover, this measurement does not make any speculation about the future replacement. In
other words, the liquidation price/current cash equivalent is particularly significant when there is
Recognition of Expenses:
(i) A direct relation with the revenue earned during that period, e.g., selling expenses and
(ii) An indirect relation with revenue earned during that period, e.g., indirect operating expenses;
(iii) A measurable expiration of some assets which are not directly and/or indirectly related with
revenue for the said period, e.g., losses which arise from pilferage/theft or accidents etc.
In short, the expenses will be recognised in a particular accounting period if they relate to:
Accounting is a mathematical discipline designed to collect, record and then compile financial
information into more accessible formats intended for its end users. In sum, accounting is
intended to be a language that can be used to communicate financial information to its users in
an efficient and effective manner. Accrual basis is a set of guidelines designed to guide certain
Purpose of Accounting
Accrual and cash bases are the two most popular accounting bases although accrual basis is more
advantageous and thus more popular than its main competitor. The main difference between the
two accounting bases lies in when they choose to record a transaction. Cash basis accounting
only records transactions when cash and cash equivalents are either received or paid out. By
contrast, accrual basis accounting records most transactions at the times of their occurrence.
Accrual basis accounting is more popular than cash basis accounting because it produces more
accurate, more faithful financial statements that constitute better representations of actual
circumstances than its main competitor. Since accrual basis accounting records revenues and
expenses together in the same time periods based on their causal relationships, it produces more
accurate gauges of entities' performance in any time period. By contrast, the use of cash basis can
lead to distortions due to the collection of cash and cash equivalents not aligning with the actual
timing of sales.
The single most important issue in accrual basis accounting is that it requires transactions to
be recorded at the times of their occurrence. Since invoices do not coincide with actual events,
this approach necessitates some estimation and guesswork on the part of accountants working
under accrual basis accounting. Furthermore, an entire set of rules and regulations have grown
up and around these uncertainties in order to guide their accounting, which means that accrual
For accounting to be helpful to its end users, it must be presented in a format that manages to
communicate the relevant financial information to them in an effective and efficient manner.
Furthermore, the financial information must be the right financial information – it is much less
useful if it is inaccurate and not a faithful depiction of actual circumstances. Under most
situations, the financial information must also be compiled in time for it to be relevant to