Revenue Recognition

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The issue of revenue recognition practices is an area that has received a lot of attention from regulators. Whenever there is a report of financial restatements or negative earnings, regulators pay extra attention to review the financial statements in order to verify that that there are not any indications of financial fraud or that the organization overstepped their boundaries in the area of managed earnings. The reason that regulators have taken a special interest in financial accounting and potential fraud is due to the collapses of companies such as Enron, WorldCom and Tyco. Regulators and those in the accounting profession are focusing their efforts on the causes of fraud as well as the steps that can be taken to effectively detect and prevent a possible reoccurrence of fraudulent behavior especially in the area of revenue recognition and the overstatement of assets. Revenue recognition refers to the time when transactions are recorded on the books, Per Generally Accepted Accounting Principles (GAAP), revenues, and gains, are generally recognized when: 1. Revenues are realized or are realizable

2. They have been earned the substantial completion of the activities involved in the earnings process. Both of these items are typically met at the point of sale, which generally occurs when goods are delivered or when services are rendered to the customer. Usually revenues and assets are recognized simultaneously. However, assets can be received before the conditions of revenue recognition are met. One example would be if a customer pays in advance for goods or services which will be received at a later date. Even though the cash is received and is recorded as an asset in the company’s books, the revenue has not been earned. Typically the revenue is not recognized prior to a sale because either the customer has not paid for the goods yet or because the goods have not been delivered to the customer. The main exception to not recognizing revenue prior to a sale would be when a contract exists that guarantee the sale or that the customer has promised a valid promise of payment such as when both the seller and the buyer are legally obligated to fulfill the term of a contract (Parizek & Findley, 2008). Another exception to the revenue recognition rule occurs when a product or service may be provided to the customer without receiving a valid promise of payment. This typically occurs with a family dentist who provides services to ease a patient’s pain and then tries to collect the payment later. Also, if a company has a substantial amount of services to provide even though the customer has provided a substantial payment, the company must wait to recognize the revenue. It is not enough that one of the criteria for recognizing revue is met; both items must be satisfied in order for the recognition of revenue. Because every income statement begins with total revenue, how revenue is measured is a fundamental concept in the field of accounting and as such, the topic of revenue recognition has received a lot of attention over the course of the past few years. The American Institute of Certified Public Accountants (AICPA) has produced specific guides to help with the topic of revenue recognition in specific situations in certain industries. The AICPA Statement of Position (SOP) 97-2, “Software Revenue Recognition” contained the following four items (Parizek & Findley, 2008): 1. Persuasive evidence of an arrangement exists

2. Delivery has occurred.
3. The vendor’s fee is fixed or determinable.
4. Collectability is probable.
These four items were used as the framework in the SEC Staff Accounting Bulletin No. 101. The SAB 101 is a very unique and interesting bulletin because it provides specific cases and then proceeds with a questions and answer format. SAB was created in large part to the issues that the staff had encountered in while conducting a review. Because SAB 101 addresses specific situations, it...
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