REVENUE RECOGNITION
AND MEASUREMENT
MADE BY
PIYUSH PALIWAL
What is Revenue?
Generally revenue is the sum of the
selling prices or the fees of all the
products sold and services provided to
customer during the current period,
whether the sales are cash sales or
credit sales. It also includes gains from
the sale or exchange of assets other
than stock in trade, interest and
dividend earned on investments.
Activities from which Revenue is derived
Revenue is derived from 3 main
activities:-
1. Selling products or raw materials, as the case
may be.
2. Rendering services and permitting others to
use enterprise resources which result in
interest, rent, royalty fees etc.
3. Disposing of resources other than products or
raw materials e.g. sale of plant and machinery
or investment.
Guidelines for Revenue Recognition
The problem of revenue recognition is
related to timing of revenue recognition
and is directly governed by the realisation
principles.
It may be stated that, based upon
realisation principle, atleast four
guidelines are found in the accounting
literature and have been followed in
practice. Accordingly revenue should be
recognised as soon as:
1. The business enterprise has performed a
substantial portion of its production or sales
effort.
2. The revenue can be objectively measured.
3. The major portion of costs has been incurred
and the remaining costs can be estimated with
reasonable precision.
4. The amount ultimately collectable in cash,
receivables or some other assets has been
received, an estimate can be make of the
portion of cash that will prove to be
uncollectable.
REVENUE
RECOGNITION
METHODS
[Link] at the point of sale: In most
of the cases where the firms are engaged
in manufacturing and selling goods &
services, revenue is recognised at the
time of sale of products or delivery of the
services. This method of revenue
recognition is known as complete sale or
market test or in some contexts
completed contact method of revenue
recognition.
2. Recognition during period of production:
This method is also known as production basis
and it is more common in long term construction
project such as ship building in which production
cycle is very long and production is initiated only
on receipt of definite order. The buyer and seller
agree in advance on the contract price. The
construction company must also have some
reasonable basis for estimating the cost to be
incurred under the contract so as to obtain
satisfactory return on the investment.
Recognition during period of production is done
by following method:
A. Percentage of completion Method: This is the method
that probably makes the most sense to investors. Under
the sales basis method, revenue is recognized at the
time of sale (defined as the moment when the title of the
goods or services is transferred to the buyer.) The sale
can be for cash or credit (i.e.,accounts receivable.) This
means that revenue is not recognized even if cash is
received before the transaction is complete. A magazine
publisher, for example, that receives Rs.1200 a year for
an annual subscription, will only recognize Rs.100 of
revenue every month. The reason is simple: if they went
out of business, they would have to return a pro-rated
portion of the annual subscription price to the customer
since it had not yet delivered the merchandise for which
it had been paid
B. Completed contract method: The third type of
production basis is the completed contract method in
which the firms involved in the construction projects
postpone the revenue recognition until the project and
sale are completed. Though similar to the completed
sale basis, it is often referred to as the completed
contract method of revenue recognition. The primary
reason for not using the percentage of completion
method when a contract exists is the uncertainty of
total costs to be incurred in carrying out the project. If
total costs cannot be reasonably estimated, the
percentage of total costs incurred by a given date also
cannot be estimated and the percentage of the
services already rendered cannot be determined.
3. Recognition upon collection of cash: In some
situation there may be some uncertainty as to
collectability of cash or other assets of the
customer. Therefore an objective measure of the
services rendered and benefits to be received
cannot be made at the time of sale.
Installment method: The best known application
of the collection basis is in the installment method.
In installment sale the purchaser makes a down
payment and agrees to pay the balance price of
the article in specified amounts at specific interval
over a period of time. The seller may retain the
right of possession of goods in the event the
purchaser defaults on the payment.
4. Recognition at completion of production
process: Such in the case when firms are
engaged in the production of precious metal
(e.g. gold, diamond etc) having a fixed
monetary value with no or negligible cost of
marketing. Revenue may be recognised
when the goods are produced and sale may
not be the controlling factor.
Revenue Measurement
The amount of revenue is generally calculated
by cash or cash equivalent value of other
assets(e.g. bills receivable) received from
customers. This amount represents the agreed
price between the buyer and the seller at the
time of sale.
This is, however, subject to certain adjustments
in those cases where revenue is recognised
prior to the collection of cash. The adjustments
are in respect of bad debts and interest on
delayed payments.
Regarding bad debt, logic suggests that this adjustment
should be made in the period when the revenue is
recognised and not in the later period when debtors are
declared bad.
Secondly in installment sale where the cash collection
extends over several years the selling price include the
element of interest too. Under the accrual basis of
accounting this interest element should be recognised as
interest revenue during the periods between sale and
collection.
Thus, when cash collection is to be delayed the measure
of calculation of current revenue should be the selling
price reduced to the account for the interest element
applicable to future periods.
