Measurement of Revenue

Issues covered

• Deciding the timing of revenue

• Measuring the amount of revenue in a particular period

• Measuring expenses related to revenue recognized in a particular period.

Deciding the timing of revenue

Operating cycle of a product:– Purchase order by customer 2008– Production of units 2009– Delivery of units to customers 2010 and

collection of cash 2010– Post sale free service period 2011

Revenue is recognized in _________ year

Deciding the timing of revenue

Operating cycle of product:– Purchase order by customer 2007– Advance collection from customers 2008– Production of units 2009– Delivery of units to customers 2010– Post sale free service period 2011

• Revenue is recognized in _________ year

First Requirement for Revenue Recognition

• Transfer of goods along with ownership, title and significant risk in case of sale of goods

Deciding the timing of revenue

Operating cycle of product:– Purchase order by customer 2008– Production of units 2009– Sale of units to customers on credit 2010– Collection from customers in 2011– Post sale free service period 2011 and 2012

Revenue is recognized in _________ year

Second Requirement for Revenue Recognition

• In case of credit sales, the credit sales amount should be realizable or collectable. The risk of collection should be insignificant.

Summary

• Two requirements for revenue recognition:

– Shipment of goods in case of sale of goods or completion of service in case of service

AND

– Insignificant risk of realization or collection

Revenue from services rendered

• ABC Ltd entered into a contract with one of its clients in 2010 to provide software services during 2011 to 2015.Contract price was Rs 7.50 Cr

• Completed Service Contract Method

Or• Proportionate Completion Method

– Price is pre-determined– Cost of entire service can be reliably measured

Measuring Expenses in case of sale of goods

Operating cycle of product:– Received order in 2008– Production of units 2009– Sale of units to customers on credit 2010– Collection from customers in 2011– Post sale free service period 2011 and 2012

• Inventory used for credit sales (COGS) in 2010• Estimated bad debts (Provision for bad debts)

related to credit sales of 2010.• Estimated cost of (Provision) post sale free

service related to credit sales in 2010

Measuring Expenses in case of services rendered

• ABC Ltd entered into a contract with one of its clients in 2010 to provide software services during 2011 to 2015.Contract price was Rs 7.50 Cr. The estimated cost is Rs 1 Crore in each year.

• Completed Service Contract MethodOr

• Proportionate Completion Method– Price is pre-determined– Cost of entire service can be reliably measured

Case 1 - Other revenue

• Interest Income: total amount of interest earned till reporting date

• Royalties Income: total amount of royalties charged till reporting date

• Dividend Income: Amount of dividend declared by company till reporting date

Case 2

• In Dec 2011, Manufacturer A sold goods to Wholesaler B. B used this inventory as collateral for a bank loan of Rs 10,00,000 and sent the Rs 10,00,000 to A. Manufacturer A agreed to repurchase the goods on or before 1st July, 2012 for Rs 12,00,000.

• Does Manufacturer A have revenue in 2011? Why?

• Product Repurchase Agreement.

Case 3:

• Manufacturer A found that Afghanistan is a potential market for his product. In 2011,”A” made credit sales to a customer from Afghanistan on credit basis for Rs 30 Cr. The amount is yet to be collected on accounting closing date. The customer financial condition is strong and he has strong willingness to make payment. In 2011, it has been observed that Central Bank of Afghanistan rejected 60% of requests for INR by local importers.

• Does manufacturer A have revenue in 2011? Why?

Case 4

• In December 2011, Manufacturer A sold goods to B on cash basis for Rs 4 Cr. The delivery is delayed at the buyer’s request and buyer takes title and accepts billing. The goods will be delivered in 2012.

• Does manufacturer A have revenue in 2011? Why?

Case 5:

• In Oct 2011, Manufacturer A sold goods to B on cash basis for Rs 5 Cr. As per the Terms and Conditions of sales contract guarantee period is 6 months. During this period, B will have the right to return the goods to A and ask for cash.

• Does manufacturer A have revenue in 2011? Why?

• Goods sent on sale-or-return basis• Sales including installation and inspection• Consignment sales

Case 6:

• In 2011, Manufacturer A sold goods to B on installment basis for Rs 5 Cr. B will make down payment of Rs 1 Cr and balance will be paid in four equal annual installments. A will release the goods to B only after payment of all the installments.

• Does manufacturer A have revenue in 2011?

Case 7

• When an electric utility customer uses electricity, the electric company has earned revenues. It is obviously impossible, however, for the company to read all of its customers’ meters on the evening of 31 March 2012.

• How does the electric company know its revenue for financial year 2011-12?

Case 8

• A bank sells a customer $500 of American Express traveler’s checks, for which the bank collects from the customer $505. (The bank charges a 1 per cent fee for this service).

• How does the bank record this transaction?

Case 9

• Sales on barter system

• Sales within the group companies etc.

Accounting for Bad Debts

• Provision for Bad Debts (liability)

• Bad Debts (expense)

• Collection of debtors written off as bad debts (income)

Accounting for revenue and expense at Microsoft Corporation – 1990s

• In case of listed companies, the general accounting practice of manipulation is overstating the revenues and understating the expenses.

• Microsoft Corp continuously understated its revenue and overstated expenses.

• No separate accounting standard for IT sector in 1990s• Entire industry was expected to follow the accounting

policies of Microsoft Corp• What was the Financial Reporting Strategy of Microsoft

Corp?

Summary

• The biggest individual item• The critical part in accounting is revenue• No accounting standard covers different issues of

revenue recognition• The Revenue Recognition is the most popular

scheme accounting manipulation• The users of financial statements should be extremely

careful with respect to Revenue Recognition• The users of financial statements should be extremely

careful with respect to WIP in case of construction companies.

Readings

1.Chapter 3 from the prescribed text book

2. Accounting Standard 9 http://www.icai.org/post.html?post_id=8660