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Revenue is reported on the top line of the income statement. Accrual accounting allows revenue to be recognized, i.e., reported on the income statement when it is earned, and not necessarily when cash is received. Companies disclose their revenue recognition policies in the notes to their financial statements. It is useful to review these policies to understand how and when a company recognizes revenue, especially when making comparisons with other companies. According to IFRS, a company should recognize revenue from the sale of goods whenever the following conditions are satisfied:
IFRS also specifies similar criteria for recognizing revenue from the services rendered once the outcomes of the transactions can be reliably estimated. Revenue will be recognized by reference to the stage of completion of the transaction as at the balance sheet date. The outcome of the transaction may be reliably estimated when all the following conditions have been satisfied:
IFRS recognizes interest, royalties, and dividends when it is probable that the economic benefits associated with a transaction will flow to a company and the revenue can be reliably measured. According to US GAAP, revenue is recognized when it is “realized or realizable and earned”. The guidance provided by US GAAP lists four criteria to determine when revenue is realized or realizable and earned:
Specific Revenue Recognition ApplicationsIn some instances, revenue recognition is more difficult to determine than it appears to be based on the general principles outlined. This is especially the case whenever revenue is recognized before or after goods are delivered or services rendered. This is the case for long-term contracts, installment sales, and barter. Long-term ContractsLong-term contracts span several accounting periods and present challenges concerning when the earning process has been completed and revenue recognition should therefore occur. Installment SalesInstallment sales are sales in which proceeds are to be paid in installments over an extended period of time. IFRS separates the installments into the sale price, which is the discounted present value of the installment payments, and an interest component. The revenue which is attributable to the sale price is recognized at the date of sale, and revenue attributable to the interest component is recognized over time. BartersUnder IFRS, revenue from barter transactions must be measured based on the fair value of revenue derived from similar non-barter transactions with unrelated parties. US GAAP, on the other hand, states that revenue can be recognized at fair value only if a company has historically received cash payments for such services and can, therefore, use this historical experience as a basis for determining fair value. Otherwise, the revenue should be recorded at the carrying amount of the asset surrendered. Gross versus Net ReportingUS GAAP regulates the gross versus net reporting of revenue. Precisely, US GAAP determines when revenue should either be reported on a gross or net basis. Before revenue is reported on a gross basis, US GAAP states that it should be established that the company: (i) is the primary obligor under the contract; (ii) bears credit risk and inventory risk; (iii) can choose its supplier; and (iv) has reasonable latitude to establish prices. If these criteria are not met, the company should report net revenues. Financial Analysis ImplicationsWhen conducting a financial analysis on a company’s financial statements, it is important to note whether the company’s revenue recognition policy results in the recognition of revenue sooner rather than later. In addition, it is equally important to pay attention to the extent to which the policy requires the company to make estimates. It is also important to understand any differences in the revenue recognition policies when comparing one company’s financial statements with those of another. This makes it possible to characterize the relative conservatism of a company’s revenue recognition policy. Besides, it facilitates quantitative assessment of how differences in policies might affect financial ratios.
What conditions must be met for revenue to be recorded?According to generally accepted accounting principles, for a company to record revenue on its books, there must be a critical event to signal a transaction, such as the sale of merchandise, or a contracted project, and there must be payment for the product or service that matches the stated price or agreed-upon fee.
What are the 5 criteria for revenue recognition?5 Criteria for Revenue Recognition. Identify the Contract with Your Customer. ... . Identify Your Performance Obligations. ... . Determine Your Transaction Price. ... . Allocate the Transaction Price to the Performance Obligations in the Contract. ... . Recognize Revenue When Your Business Satisfies a Performance Obligation.. When should revenue be recognized on the income statement?The revenue recognition principle, a feature of accrual accounting, requires that revenues are recognized on the income statement in the period when realized and earned—not necessarily when cash is received.
What are the conditions for revenue to be recognized under IFRS quizlet?For both IFRS and US GAAP, the first step in revenue recognition is to identify the contract with the customer. Both IFRS and US GAAP require that, for revenue to be recognized, it is "probable" that the seller will receive payment.
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