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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 Enterprise’s 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 buyer’s 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 owner’s right to receive payment is
established
Types of Transactions

Transactions

Long Term Installment Barter


Contracts Sales Transactions
Methods of Revenue Recognition
 Long Term Contracts
 Percentage (%) of Completion Method
 Completed Contract Method

 Installment Sales
 Installment Method
 Cost Recovery Method

 Barter Transactions
Percentage of Completion Method
 Appropriate when the project’s 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 company’s Income Statement
Percentage of Completion
Method: Example
2005 2006 2007

% Exp incurred 400 = 50% 300 = 37.5% 100 = 12.5%


each year 800 800 800

Revenue 1,000 * 50% 1,000 * 37.5% 1,000 * 12.5%


recognized = 500 = 375 = 125

Net Income 500 – 400 375 - 300 125 - 100


recognized = 100 = 75 = 25
Percentage of Completion
Method: Example

Solution:

Income Statement 2005 2006 2007 Total

Revenues $500 $375 $125 $1,000

Expenses $400 $300 $100 $800

Net Income $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 2006 2007 Total

Collections $400 $400 $200 $1,000

To Find:
Expenses, Revenue and Net Income to be recognized each year
in the company’s Income Statement
Installment Sales Method:
Example
Profit: 1,000 – 800 = 200
Profit %: 200 = 20%
1,000

2005 2006 2007

Profit 400 * 20% 400 * 20% 200 * 20%


Recognized = 80 = 80 = 40

Expenses 400 – 80 400 - 80 200 - 40


recognized = 320 = 320 = 160
Installment Sales Method:
Example

Solution:

Income Statement 2005 2006 2007 Total

Revenues $400 $400 $200 $1,000

Expenses $320 $320 $160 $800

Net Income $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
other’s 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 firm’s revenue


recognition policies

 Extent to which the firm’s policies rely on judgment and


estimates
Q’s
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?
Q’s
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?
Q’s
Mr. Gaurav Patil has an agency for Jigar products. Jigar sends
24 Televisions to Mr. Gaurav’s 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?
Q’s
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……..

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