REVENUE RECOGNITION AS-9 Top lines do matter

Prof. Ramkesh Gupta

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WHAT IS REVENUE ? THE NEW DRESSINGCODE

PROFITS DO NOT MATTER BUT TOP LINES (REVENUES DO) For companies Absolute Sales Growth Matter The DOTCOMS example Sales of a travel agent - Should sales includes the cost of the fare collected or only the commission
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AS 9
WHAT IS REVENUE ? Revenue is gross inflow of cash, receivables or other considerations in the ordinary course of business from sale of goods, rendering of service FASB Concept statement 6 Defines Revenue Inflows or other enhancements of assets of an entity or settlement of liabilities form delivering or producing goods, rendering services or other activities that re entities major or central operation
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REVENUE RECOGNITION
ABC LTd. signed a contract on December 15, 2005 to supply special equipment to BPL LTd. The sale value of the equipment was Rs.2 lacs. The production was completed on 28 Feb 06, and ready for despatch. The goods were despatched to the BPL 18th Mar and the same were received by the company on 1st April. The company received full payment on 30th Apr, 2006 There was a warranty clause of 6 months from the date of receipt. What is the Revenue for the y.e. 31.03.06?
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Dec05 Jan 06

Feb.06

Mar.06

April 06

The Revenue Recognition problem ?

Dec. Jan. Feb Mar Apr Sep

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Revenue Recognition
Jan FEB

One option might be to record the revenue in the month the production is complete.
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Revenue Recognition
Dec Jan Feb Mar Apr

Another option might be to record the revenue when goods are received by customer or finally when cash is received in April
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The Revenue Recognition

Dec Jan Feb Mar April 6 m later

A third option might be to record the revenue when

goods are despatched ( March) or Still, when the warranty period is over.
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Revenue Recognition
Conceptually revenue can be recognized incrementally and continuously at different points in the earning process For accounting purpose we choose one event which will reduce the risk of ultimately receiving the revenue to minimum
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REVENUE RECOGNITION AS 9
REVENUE IS RECOGNISED FROM SALES WHEN All significant risks and rewards of ownership have been transferred to the buyer (Ref: Sale of Goods Act) The seller has not retained any control over the goods transferred There is no uncertainty about the amount of consideration from the sale
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Broad frame work for recognition

Different points in RR Sale is complete on Delivery * Subject to certain conditions eg: allowing customer to test the product, additional services, other works before accepting the product Sale complete only when cash is received
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Broad frame work for recognition

Eg:ABC makes equipment and installs them in the
factory on firm orders from parties. The installation time is about an hour. At the year end ABC produces 10 equipments and ships it to the customer and promises to to install the same as soon as some cables were available. Can the company recognize the sale on delivery ? Ans: No
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Broad frame work for recognition

Two criterion must be followed:

Is it realized or realizable Is it earned through substantial completion of the activities involved in completion

The best practice is to select one point in the cycle that meets both the criteria for recognition.

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Broad frame work for recognition

Principle of Conservatism Principle of Substance over Form Principle of Accrual

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REVENUE RECOGNITION
Revenue is recognized at the point of Sale It has to satisfy the three conditions: Risks and Rewards are transferred to the buyer Seller has no control over the goods There is no uncertainty over the collectibles Substantial Performance of the contract

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Recognition Criteria
A Rent to own stores in the US, sells Consumer durables on a installment basis . Ie. Pay rent and own after years Their experience is only 25 % of the customers complete the full term of the agreement. They recognize revenue as and when cash is collected.
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REVENUE RECOGNITION : The number Game

RELIANCE INDUSTRIES

SALES CROSS 50000 cr !!

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Reliance Industries
The real sales: year ended 31/3/2002 Sales Rs. 57,119 cr Inter Divisional Transfers Rs. 11,715 Excise Duty Rs. 3,314 ========= Rs 42088 cr International accounting standards/US GAAP, do not allow the inclusion of inter divisional transfers, Excise duties etc. ICAI, has now come out with this clarification Ramkesh.Christ @

WHAT IS REVENUE ? THE NEW DRESSINGCODE

For a company to include Gross Amount as sales

It must be the primary obligor. It must have general inventory risk. It must have latitude in establishing prices Changes the product or performs part of the service.Determines product/service specifications. Bears risk for physical loss of inventory.
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(eg: A travel agent cannot do all this)

Recognition Policies followed by companies

Microsoft: Not all revenues are recognised at the time of sale. 20 % of the sale price is reported as unearned revenue (office )and (35% for windows). This is recognised over a 18 month period which is the product life cycle. - Perceived by SEC as the income smoothing technique used by MS.
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Revenue Recognition
How to recognize revenue ? For services Long Contracts

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Rendering of Services
Revenue is normally recognized by Completed contract Method or Percentage of completion method
The Question is is there really a choice ?

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Revenue Recognition: Construction Contracts AS - 7

Usually take long time to complete
Ex: Construction of Roads, Bridges, dams, buildings. Two methods for recognizing revenues in such cases Percentage of Completion Method Completed Contract method (eliminated)

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Revenue Recognition: Contracts

Percentage Completion Method Based on Completion of the Stage (Mile stone event) Stage can be determined by, -Cost incurred / Total cost -Survey of work performed -Completion of physical proportion of the contract work
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Revenue Recognition: Construction Contracts

Percentage Completion Method Steps 1: Determine the stage of completion Step 2: Estimate the total revenue Step 3:Estimate the total contract cost (Completed and balance) Step 4: Take proportionate Profits or Account for the losses
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Yr 1 Contract Price 800

Cum. Actual Cost Estimate cost to Complete

Yr 2 880

YR 3 880

210
490

450
300

750
-

Total Cost
% completed

700
30 %

750
60%

750
100% 880, 352 750, 300 52

Rev (Cu, CY 240 , 240 528, 288 Cost(CU, CY 210, 210 450, 240 Profit(CU,CY 30,
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30

48

RR: Construction Contracts

Completed Contract Method: Revenue and costs are recognised only when the entire contract is completed This method is not recognised as per the Accounting Standards

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Thats all

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