Selected Revenue Recognition Issues 1. Revenue recognition — general The accounting literature on revenue recognition includes both broad conceptual discussions as well as certain industry-specific guidance. Based on these guidelines, revenue should not be recognized until it is realized or realizable and earned.
There are generally two types of customer acceptance. In the first type, some customer arrangements will allow for a trial period, or they may allow for customer acceptance based on subjective criteria, with satisfaction of the criteria determined by the customer.
While these provisions may seem different, they are treated similarly because in both cases the customer essentially has control over whether or not to accept the product.
In other cases, the customer or the contract may specify objective criteria that will result in the acceptance of the good to be delivered.
If an entity can objectively demonstrate that the specifications in the contract have been fulfilled, then control has effectively passed to the customer and the entity should recognize revenue on the sale. However, there is at least one question that may lead to diversity in practice.
This issue concerns the application of rights of return with the portfolio approach. How is the treatment different for a right of return at the contract level as opposed to the portfolio level? When an entity primarily engages in large contracts that include many goods to be delivered, it may be easy to apply an estimate of returns by applying the percentage expected to be returned across all products.
If an entity engages in a large number of transactions with customers who purchase only one or a few products at a time, it may become impossible to know which customers will return their products and which will not, even when the entity can predict with very high accuracy the aggregate number of returns it will receive.
In each contract with one product, there are only two possible consideration amounts. If all of the contracts are relatively homogenous from the point of view of the entity, then the entity would likely reach the same conclusions about the appropriate transaction price and the appropriate constraint for each of the contracts.
Either method could badly skew the amount of revenue recognized. For these reasons, there are still discussions about the appropriate treatment of variable consideration and rights of return at the contract level the reader is once again referred to our article on variable consideration.
As the guidance currently stands, the portfolio approach is best when possible. Using the portfolio approach, it is possible to account for an estimated percentage of contracts that will end in a return without knowing in advance which contracts will ultimately end in a return of the product.
Comparison to Under ASCa right of return that was generally available to all customers made it difficult to conclude that consideration was fixed or determinable, which made it difficult to recognize revenue on some transactions.
ASC required entities to meet each of five criteria to recognize any revenue at the point of sale, or recognize no revenue whatsoever until the return provision expires or until all of the criteria were met, whichever came first.
An entity was required to: Determine the price at the date of sale, Receive payment, or have the right to receive payment, Have no obligation to replace products in the event of theft or destruction, Meet certain economic substance tests, Be able to estimate the returns to be received.
These criteria, and particularly the criterion to be able to estimate the returns to be received, frequently led to companies being required to defer revenue that had substantially been earned. In comparison, ASC takes a more principles-based approach and treats general rights of return as variable consideration.
In many cases, this will lead to similar treatment under both standards. However, entities who have previously determined they could not make an estimate accurate enough to meet the requirements for earlier recognition under ASC may find that they will recognize revenue earlier as they apply the new revenue model to these transactions.
These transactions will recognize some revenue upfront, which was not permitted under ASC Summary The accounting for transactions which include a general right of return under the new revenue standard is a significant theoretical change from current practice, but many companies will find that the new treatment will result in a similar practical effect on financial statements.
One significant change will arise from the separate, gross presentation of refund assets and liabilities from inventory, which will reflect the goods expected to be returned and the consideration that will be refunded to the customer. Companies that currently have too much uncertainty to recognize revenue upfront under ASC will probably see the most significant changes to their financial statements as they will generally recognize much more revenue upfront under ASC than is currently allowed.
The accounting for customer-specific rights of return, or customer acceptance provisions, is not expected to undergo any major change.The landscaper can recognize the revenue immediately upon completion of the job, even if they don’t expect payment from that customer for a few weeks.
Maneuvering the right way to handle your accounting is always a critical process. It’s important as a business owner to begin understanding and preparing to apply the standard, or to work.
At issue is whether the five-step process for booking revenue mandated by the new FASB standard will diverge significantly from the way companies must recognize revenue in their tax returns.
Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
A company should apply the following five steps to achieve the core principle.
The Right Way to Recognize Revenue Learn the components of SAB and mistakes to look out for. BY THOMAS J. PHILLIPS, MICHAEL S.
LUEHLFING AND CYNTHIA M. DAILY. Related. TOPICS. Accounting and Financial Reporting EXECUTIVE SUMMARY Right of return. According to the SEC, SAB spells out the criteria for revenue recognition based on existing accounting rules, which say that companies should not recognize revenue %(1).
Learn the components of SAB and mistakes to look out for.
More than half of the financial reporting frauds among U.S. public companies from to involved overstating revenue, according to a study conducted by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).