Session Outline

Issues concerning revenue recognition

Realisation convention
Accounting for revenues
Bad debt provisions
Examples

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Issues concerning revenue recognition

When in which accounting period should revenue

be recognised?
How much revenue should be recognised?

Revenue recognition fraud has been called one of the

major accounting issues in the U.S.
>40% of Securities Exchange Commission (SEC)
enforcement actions concern incorrect revenue
recognition

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Revenue examples in accounting equation

1.Sales/ Revenue for cash

2.Sales/ Revenue on credit trade receivables
to be converted to cash

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Impact on (this year): Cash? Revenue?

Cash sales made this year 1,000 +1000 +1000

Credit sales made last year 2,000

cash received this year

Credit sales made this year 2.500

cash received this year

Credit sales made this year 1,500

cash received next year

Credit sales made this year 4,000

50% collected this year and 50% next year

LECTURE 4 Aditi Gupta (SMN 135 2014)

 When should revenue be recognized?

At the time the goods are produced?

At the time the order is placed by the customer?
At the time the goods are delivered to the
customer?
At the time cash is received from the customer?

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Realisation convention

Realisation is considered to have occurred when:

The enterprise has transferred to the buyer the
significant risks and rewards of ownership of the
goods.
The enterprise retains no control over the goods
sold.
The amount of revenue can be measured reliably.
The costs incurred or to be incurred in respect of the
transaction can be measured reliably.

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Examples of special cases.
1. Travel agency (date of departure)
2. Airlines (date of departure)
3. Construction contracts (multi-year broken down into
stages that can be measured reliably)
4. Gift cards
5. Plot of land selling Christmas trees
6. Bundled sales- database, database training,
upgrades, customer support
7. Publishing company- yearly subscriptions (when
published and delivered)

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Deferred/ unearned revenue
When the amount
received during the DEFERRED
year is more than OR UNEARNED
the full revenue for
the period REVENUE

When the revenue

for the period is
more than the cash
received during the
period

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Realisation convention
and
Publishing companies sell subscriptions for their
magazines that the subscribers pay for in advance.
If the subscription money, EUR 70, is received this
year for magazine to be delivered next year, the
revenue relates to the next year

LECTURE 4 Aditi Gupta (SMN 135 2014)

 How much revenue should be recognised?

Net sales are reported net of any cost needed

to achieve them:
volume rebates OR trade discounts
allowances, i.e. reductions in price for damaged
or unsatisfactory merchandise
returns of sold goods by the customers

LECTURE 4 Aditi Gupta (SMN 135 2014)

 How much revenue should be recognised?

Suppose a local outlet has EUR 500,000 gross sales on

credit and EUR 50,000 sales return and allowances.

LECTURE 4 Aditi Gupta (SMN 135 2014)

 How much revenue should be recognised

The income statement extract would be as follows:

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Bad debt provisions
Trade receivables arise when an enterprise agrees to
accept payment in the future for goods or services
delivered today.
Advantages and disadvantages of granting credit:
It boosts sales and profit.
BUT, due to the delay in receiving payment, the
seller must finance activities in other ways while
awaiting payment.
Bad debt expenses may arise when some credit
customers are unable to pay.

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Bad debt provisions
At the end of each accounting period, the accounting
records are adjusted to reflect the estimate of
uncollectible receivables:
By writing off the specific trade receivables identified
as uncollectible actual bad debts (matching
concept)
By estimating the total amount of uncollectible
receivables. This estimate is based on the historical
experience of bad debts- provision for doubtful debts
(prudence or conservatism)

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Bad debt provisions
For example if the bad debts for the year are 15,000. It
will reduce 15,000 from trade receivable and 15,000
will be the expense for that year.

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Example: Revenue recognition: when and how
much
Butterfly Distributors, sold 10 wood stoves to Lumberside
Condominiums, Inc.
The sale contract was signed on April 20, 2012. The list price of
each wood stove was 2400 but a 5% quantity discount was
allowed.
The wood stoves were to be delivered on May 3, and a cash
discount of 2% of the amount owed was offered if payment was
made by June 3.
Butterfly Distributors, delivered the wood stoves as promised and
received the proper payment on June 2.

How much revenue should be recognised in April, in May, and in

June? Explain why.

LECTURE 4 Aditi Gupta (SMN 135 2014)

 All discounts are not deducted from gross sales

Trade discounts are traditional ways of

determining net sales prices. They often
reward high volume customers. deduction
from gross sales

Cash discounts are relatively small reduction

of selling prices that are intended to spur
prompt payment- operating expense

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Income statement for the period 1st-31st May
When

Gross Sales 24,000

Less 5% trade/volume discount -1,200

Net Sales 22,800

How
much

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Income statement for the year

Gross Sales 24,000

Less 5% trade/volume discount 1,200
Net Sales 22,800
Cost of sales x..
Gross profit x
Less Admin, Marketing, Distribution x
Less cash discount 2% 456
Operating Profit

LECTURE 4 Aditi Gupta (SMN 135 2014)

 5.1

LECTURE 4 Aditi Gupta (SMN 135 2014)

 5.3
Assets = Liabilities + Equity
Assets = Liabilities + Capital +Profit
Assets = Liabilities + Capital +Profit (Revenue- expenses)

LECTURE 4 Aditi Gupta (SMN 135 2014)

 5.4
Assets = Liabilities + Equity
Assets = Liabilities + Capital +Profit
Assets = Liabilities + Capital +Profit (Revenue- expenses)

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Class assessment after reading week.
1. Test on 4th November, 2014 from 11.10-12.15 in B5.
2. Please bring
ANY Calculator (no phones, laptops, ipads etc.)
Candidate number I cannot mark tests with
names on it.
Yourselves by 11.05 latest.
3. I aim to start the test by 11.10 and expect to finish by
12.15.

LECTURE 4 Aditi Gupta (SMN 135 2014)

 On the day

Leave ALL your belongings at the door

Bring ONLY a calculator and stationary with you
to the seat (no sheets of paper)
You will be provided with answer booklets.
Occupy the first 4 rows as you come in.
From the 5th row onwards please leave a seat in
between you and the person sitting next to you
If I see anyone talking they will be asked to
leave immediately and awarded a zero.

LECTURE 4 Aditi Gupta (SMN 135 2014)

 Topics for exam

Weeks 1-5
Lecture notes
Do at home questions
Tutorial questions
Text book chapters

You will be asked to put transactions through the

accounting equation and prepare a balance sheet
and income statement.
one short discursive question

LECTURE 4 Aditi Gupta (SMN 135 2014)