Auditing Case: Revenue Recognition

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Revenue Recognition
Revenue is the electricity that drives business. Revenue has been the starting point on every income statement generated, every sales meeting conducted, and is on every entrepreneur’s wish list. The basic concept for revenue recognition is that revenue should not be recognized until it is realized or realizable and earned. There are also four criteria must be met in order to recognize revenue: 1) persuasive evidence of an arrangement exists: Consider the substance of the transaction and not merely its form. Because the SEC believes that a sale has not taken place if a "sale" is only intended for demonstration purposes, or if the seller is obligated to repurchase the product at specific prices, or if the buyer can return the goods and the buyer has no specific payment obligation; 2) delivery has occurred or services have been rendered: Ownership and risk must have been transferred to the buyer. The SEC does not consider delivery to have occurred unless the product has been delivered to either the customer or another site specified by the customer. This also means that the goods have been accepted by the customer; 3) the seller’s price to the buyer is fixed or determinable: This occurs when the customer does not have the unilateral right to terminate or cancel the contract and receive a cash refund. If you cannot reliably estimate the amount of any future cash refunds, then you must defer revenue recognition. If a price is conditional on a future event, then it is not fixed or determinable, so revenue recognition cannot occur; 4) collectability is reasonably assured: If you cannot reasonably estimate an allowance for doubtful account, then you cannot recognize revenue until you can make such an estimation. Revenue Recognition Scenarios:

1. Overall, AOL is selling two things in a one-year contract: software and Internet services. Let’s look at the software first. When AOL sells software to a customer, there is a contract between AOL and the...
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