Revenue Recognition

Revenue recognition is one of the principles of accounting that are recognized by the International financial reporting standards. The principle operates on the premise that the business acknowledges revenue at the time when it is earned, usually at the time of rendering services or transferring goods to the buyer. The point of sale is used as a basis for the timing of revenue recognition due to several considerations. In particular circumstances, however, bases other than the point of purchase are used for the timing of revenue recognition.

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At the point of sale, the seller is assumed to have done all that is supposed to be done on the goods or services thus getting the entitlement of the payment from the buyer. At this point, the risks and rewards concerning the good or service in question are transferred from the seller to buyer. After the transfer has been made the buyer takes full control of the goods which is an equivalent of ownership. Also, at the point of sale, the liabilities and obligations of the parties are clearly spelled out. The transaction creates the period of expectation for the payment and the reasonable amount that is attributable to the goods or services being exchanged. And since the risks and rewards change at this point, the seller can apply the Matching Principle where expected revenues and expenses associated with the transferred good or service, can be tallied to come up with the profit. Furthermore, the point of sale is critical in managerial accounting as it recognizes the dynamics in the business world. For instance, businesses engage in credit facilities to the customers and, therefore, payment cannot be made forthwith. In the same breath, the point of sale accommodates the principle of Double Entry which is essential in instituting appropriate internal controls so as to minimize frauds and forgeries in the business transactions (Kimmel, Weygandt, Kieso, & Kimmel, 2010)

However, there are some objections to the point of sale principle of revenue recognition. One of the objections is that it is too conservative because revenue is earned throughout the entire period of production. The cases where income is earned based on long-term contracts makes it difficult to recognize revenue based on the propositions of the principle. The earnings continue as long as the party involved in the construction is undertaking the services required by the customers. Also, the revenues from rent, interests and commissions are recognized given the existence of a prior agreement specifying the gradual increase in the claim against the customer, rendering the point of sale approach unrealistic in qualifying the revenues involved at the point of engagement(Riahi-Belkaoui,2008 ). Moreover, costs such as advertising may have future benefits that are not relevant to the period incurred. The point of sale might not reflect the actual picture of the revenue generated during a particular accounting period (Bragg, 2010).

Another objection to this principle is that it is not conservative enough as it does offer the solution to the problems associated with the change in the value of the good or service exchanged for credit. Such transaction results in accounts receivables that do not represent real funds that can be utilized by the company. Goods may be transferred to the customers, but there are cases where the customer may return due to inadequate adherence to the specifications ordered. In the event of sales returns, the measurement of the value of the goods presents an awkward situation of ascertaining the revenues and the effects on earlier transactions. Also, the company may incur extra expenses on the goods exchanged as a result of the contracting other institutions to collect accounts receivables from its customers (Gibson, 2012). The point that is being made by these arguments is that the point of sale is supposed to generate disposal funds but fails to meet this objective since there is a difference, regarding monetary gains, when cash is paid for the goods being sold and when the consideration for the goods is settled at a later date.

Revenue may be recognized during production. An example of such a case is the revenue generated from construction activities. Construction contracts, for instance, recognize revenue based on the progress of the construction process or the amount of work that has been completed as at a particular accounting period. For example, if 40% of the road is complete as at a specified accounting period, 40% of gross profit can be recognized from this particular project. Recognizing revenue through this approach is advantageous because the company uses the data obtained for a given period to control the budget of the long-term construction contract. As a result, the use of resources such as money and manpower can be optimized and regulated to the benefit of the company. Also, the method enables the company accountants to report final results rather than estimates. It is not necessary to make provisions for bad debts, for instance, as in the case of point of sale approach (Gibson, 2012). The realized revenue can be accurately quantified.

Recognition of income when cash is received entails documenting the receipt of money consideration in exchange for a good or service. According to Gibson (2012), the method employs a single entry system in recording the transactions that have taken place during a particular period, and the balance that remains after settling the expenses is considered as the profit for the organization. The business does not engage in giving credit facilities, and therefore, payment is the method through cash, bank transfers, credit cards or cheque. The approach enables the business to run efficiently due to the availability of disposable funds generated from sales. Also, it controls spending and adherence to the enterprise budgets. Moreover, there are no future expenses incurred in regards to individual sales due to bad debts and other related expenses.

References

Bragg, S. M. (2010). Wiley revenue recognition: Rules and scenarios. Hoboken, NJ: Wiley.

Gibson, C. H & Gibson. H. (2011). Financial reporting and analysis: Using financial accounting information. Cincinnati, OH: South-Western College Pub.

Gibson, C. H. (2012). Financial reporting and analysis. Cincinnati, OH: South-Western College Pub.

Kimmel, P. D., Weygandt, J. J., Kieso, D. E., & Kimmel, P. D. (2008). Accounting: Tools for business decision making. Hoboken, NJ: John Wiley & Sons, Inc.

Riahi-Belkaoui, A. (2010). Accounting theory. New York: Harcourt Brace Jovanovich.