Recognizing Revenue

Kamaria Smith-Frayer

Strayer University

ACC 562

December 7, 2021

Dr. John Yvelvington

Recognizing Revenue

In an accrual accounting system, revenue recognition is a key component in determining

what accounting period revenue should be recognized. Realizable and earned are 2 important

factors in accurately recognizing revenue according to GAAP. Properly identifying revenue in

the correct accounting period is essential in examining the financial position of a company.

Because of the attention that investors, lenders and other interested parties give to revenue, this

area is often where fraudulent accounting actives could take place. Understanding the revenue

recognition guidelines issued by FASB, interpreted by SEC and enforced by the Auditors is

important in maintaining financial reporting integrity.

Realizable & Recognizable

Revenue in general is recognized when the earnings are realized or realizable. Revenue

is realizable when goods or services are exchanged for cash or the claims to cash (The Financial

Accounting Standards Board [FASB], 2009). For example, when a company sells a product and

receives cash or a credit arrangement is made in exchange for the product the seller have

realizable earnings at that exchange. Therefore, that revenue should be recognized in the

accounting period that transaction took place. However, not all product or service transactions

are that straight forward. Depending on the industry and the company normal business practices

can determine when a product or service exchange can be realizable.

In certain industries the general product and service exchange is not possible in their

normal business activities. The Financial Accounting Standards Board addresses various

industries and gives guidelines on the proper revenue recognition standards. Such as in the

collection of revenue in the healthcare service industry, in general service revenue should be

recorded in the accounting period when service was provided at the established service rate
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regardless if full payment is expected (FASB, 2009). Provisions are provided to account for

contractual agreements between third party payers. According to FASB ASC 954-605-25,

contractual adjustments and discounts are recorded on an accrual basis and should be subtracted

from the gross service revenue. This determines the net service revenue and is ultimately the

amount that is recognized as revenue. Applying this concept, a healthcare center provides

service to Patient A. The normal rate of service is $100.00; this is the amount that will be

recorded as service revenue in the accounting period that the service was provided. However the

healthcare provider has a contractual agreement with ABC insurance company and the service

provider has agreed to only charge $75.00 for patients that are covered by ABC insurance

company. Therefore, the healthcare provider will record the $25 difference as a service revenue

discount. The $75.00 net service revenue is the amount that is considered the recognizable

revenue.

Recognizing Revenue in the Proper Accounting Period

As with determining the proper amount of revenue to recognize on the financial

statements, determining the appropriate period revenue should be recognized is not always clear

either. The combination of realized or realizable and earned is necessary to recognize revenue

(No. 101, 1999). In general a customer purchases an item by paying the seller and in return the

seller releases ownership to the customer at the time of the payment exchange. In situations such

as this it is clear that the revenue earned from the transaction should be recognized in the

accounting period the transaction took place. Often businesses enter into contractual purchase

agreements to constitute their sales. In these circumstances, accounting standards give

organizations guidelines to operate under their normal business practices. Applying this

principle, Company A has an agreement to sell widgets to Customer B. The customary business
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practice between the 2 organizations is the sale of the widgets are initiated by a Purchase Order

and finalized by a sales agreement signed by Customer B’s authorized personnel. In this

particular situation Customer B issues a PO for 5000 widgets near the end of Company A’s fiscal

quarter. Customer B has been a client of Company A for several years and because the order

was ready Company A ships the widgets prior to receiving the signed sales agreement. After

being out on vacation, Customer B authorized personnel signs and returns the sales agreement to

Company A, after Company A’s fiscal quarter ends. Even though the products were shipped and

received in the prior fiscal period, the revenue is not recognizable until the fiscal period the sales

agreement is received. This is because of the established business practices and sales agreements

negotiated between the 2 organizations

Auditors View

SAS No. 99 points out that certain accounts; transactions and assertion are more prone to

manipulation than others because of the degree of attention and subjectivity during the recording

and reporting of the financial information. Auditors are instructed to automatically assume that a

high risk of improper revenue recognition exist (Hopwood, Leiner, Young, 2008). The Revenue

recognition principle depending on the situation can rely strongly on the judgment of the

company’s accounting professionals. With this assumption the auditor should take the proper

steps in addressing these high risk activities and take a higher degree of professional skeptism.

This is done by assigning audit personnel who have experience in examining the audit trail for

revenue activities. The auditor must determine if the management choice of accounting

principles are appropriate and consistently followed throughout the company’s transactions.

Especially paying close attention to complex transactions that occur at the end and beginning of

fiscal periods. The testing procedures used by the auditors to review revenue should not follow a
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sense of time and should have a level of unpredictability to make it difficult for individuals being

audited to anticipate transactions that will be tested.

Conclusion

Revenue recognition can be a challenge to many businesses in a variety of industries. It

is important to keep in mind the 2 key factors in the process of deciding whether certain revenue

can be recognized. Is it realized or realizable and has it been earned? Relying on the guidelines

set by authoritative sources and qualified accountants with good judgment, management should

trust that what they are reporting is accurate. Questionable ethical decisions taint the integrity of

the organization and the reliability of the financial reporting of a company, therefore the revenue

principles outlined by FASB should be taken seriously and applied. With that assurance the

information that is provided to management, investors and lenders will enable all parties to make

wise financial decisions.

References

Hopwood, W., Leiner, J., Young, G.. (2008). Forensic Accounting (1st ed). McGraw-Hill

Education/MBS

No. 101 – Revenue Recognition in Financial Statements. (1999, December). Security Exchange

Commission Staff Accounting Bulletin. Retrieved January 15, 2010 from,

http://www.sec.gov/interps/account/sab101.htm

The Financial Accounting Standards Board. (2009, June). Accounting Standards Codification

605-10-25-1. Retrieved January 15, 2010 from, http://asc.fasb.org