Measurement of Revenue

Dr.Rachappa Shette
 Issues covered
• Deciding the timing of revenue
• Measuring the amount of revenue in a
particular period
• Measuring expenses related to revenue
recognized in a particular period.
 Deciding the timing of revenue
Operating cycle of a product:
– Purchase order by customer 2008
– Production of units 2009
– Delivery of units to customers 2010 and
collection of cash 2010
– Known post sale free service period 2011

Revenue is recognized in _________ year

 Deciding the timing of revenue
Operating cycle of product:
– Purchase order by customer 2007
– Advance collection from customers 2008
– Production of units 2009
– Delivery of units to customers 2010
– Known post sale free service period 2011

• Revenue is recognized in _________ year

 First Requirement for Revenue
Recognition
• Transfer of goods along with ownership,
title and significant risk in case of sale of
goods
 Deciding the timing of revenue
Operating cycle of product:
– Purchase order by customer 2008
– Production of units 2009
– Delivery of units to customers on credit 2010
– Collection from customers in 2011
– Known post sale free service period 2012
Revenue is recognized in _________ year
 Second Requirement for Revenue
Recognition
• In case of credit sales, the credit sales
amount should be realizable or collectable.
The risk of collection should be
insignificant.
 Deciding the timing of revenue
Operating cycle of product:
– Purchase order by customer 2008
– Production of units 2009
– Delivery of units to customers on credit 2010
– Collection from customers in 2011
– Unknown post sale free service period 2010-
2012
Revenue is recognized in _________ year
 Summary
• Two requirements for revenue recognition:

– Shipment of goods in case of sale of goods or

completion of service in case of service

AND

– Insignificant risk of realization or collection

 Revenue in case of Contruction
Industry
• ABC Ltd entered into a contract with one of its
clients in 2010 to provide software services
during 2011 to 2015.Contract price was Rs 7.50
Cr
• Completed Service Contract Method
Or
• Proportionate Completion Method
– Price is pre-determined
– Cost of entire service can be reliably measured
 Measuring Expenses in case of
sale of goods
Operating cycle of product:
– Received order in 2008
– Production of units 2009
– Delivery of units to customers on credit 2010
– Collection from customers in 2011
– Known post sale free service period 2011 and 2012
In which year revenue recognised?
What are the expenses incurred for the year 2010?
• COGS i.e. Inventory is used for credit sales in
2010
• Estimated bad debts (Provision for bad debts)
related to credit sales of 2010.
• Estimated cost of (Provision) post sale free
service related to credit sales in 2010
 Case 1 - Other revenue
• Interest Income: total amount of interest
earned till reporting date
• Dividend Income: Amount of dividend
declared by company till reporting date
 Case 2:
• Manufacturer A found that Syria is a potential
market for his product. In 2015,”A” made credit
sales to a customer from Syria on credit basis for
Rs 30 Cr. The amount is yet to be collected on
accounting closing date. The customer financial
condition is strong and he has strong willingness
to make payment. In 2011, it has been observed
that Central Bank of Syria rejected 60% of
requests for INR by local importers.
• Does manufacturer A have revenue in 2015?
Why?
 Case 3
• In December 2015, Manufacturer A sold
goods to B on cash basis for Rs 4 Cr. The
delivery is delayed at the buyer’s request
and buyer takes title and accepts billing.
The goods will be delivered in 2016.
• Does manufacturer A have revenue in
2015? Why?
 Case 4:
• In Oct 2015, Manufacturer A sold goods to B on cash
basis for Rs 5 Cr. As per the Terms and Conditions of
sales contract guarantee period is 6 months. During this
period, B will have the right to return the goods to A and
ask for cash.

• Does manufacturer A have revenue in 2015? Why?

• Goods sent on sale-or-return basis

• Sales including installation and inspection
• Consignment sales
 Case 5:
• In 2015, Manufacturer A sold goods to B
on installment basis for Rs 5 Cr. B will
make down payment of Rs 1 Cr and
balance will be paid in four equal annual
installments. A will release the goods to B
only after payment of all the installments.
• Does manufacturer A have revenue in
2015?
 Case 6
• When an electric utility customer uses
electricity, the electric company has
earned revenues. It is obviously
impossible, however, for the company to
read all of its customers’ meters on the
evening of 31 March 2016.
• How does the electric company know its
revenue for financial year 2015-16?
 Case 7
• A bank sells a customer $500 of American
Express traveler’s checks, for which the
bank collects from the customer $505.
(The bank charges a 1 per cent fee for this
service).
• How does the bank record this
transaction?
 Case 8
• In Dec 2015, Manufacturer A sold goods to
Wholesaler B. B used this inventory as collateral
for a bank loan of Rs 10,00,000 and sent the Rs
10,00,000 to A. Manufacturer A agreed to
repurchase the goods on or before 1st July, 2016
for Rs 12,00,000.
• Does Manufacturer A have revenue in 2015?
Why?
• Product Repurchase Agreement.
 Case 9
• Sales on barter system
• Sales within the group companies etc.
Accounting for revenue and expense at
Microsoft Corporation – 1990s
• In case of listed companies, the general accounting
practice of manipulation is overstating the revenues and
understating the expenses.
• Microsoft Corp continuously understated its revenue and
overstated expenses.
• No separate accounting standard for IT sector in 1990s
• Entire industry was expected to follow the accounting
policies of Microsoft Corp
• What was the Financial Reporting Strategy of Microsoft
Corp?
 Summary
• The biggest individual item
• The critical part in accounting is revenue
• No accounting standard covers different issues
of revenue recognition
• The Revenue Recognition is the most popular
scheme accounting manipulation
• The users of financial statements should be
extremely careful with respect to Revenue
Recognition
• The users of financial statements should be
extremely careful with respect to WIP in case of
construction companies.
 Readings

1.Chapter 5 from the prescribed text book

2. Accounting Standard 9
http://www.icai.org/post.html?post_id=8660
3. Revenue Recognition and Reporting
(HBS)