When is revenue recognized under gaap

More sales to a different class of customer, such as a reseller distribution channel that has a lower gross profit margin than existing sales principally made to end users. Also, increasing service revenue that has a higher profit margin than product sales. Seasonal trends or variations in sales. A gain or loss from the sale of an asset s. Finance executives typically implement a new accounting standard by discussing and analyzing its requirements with their auditors.

Besides reading SAB for guidance, a company should look to recent abstracts from the emerging issues task force EITF which have addressed not only when revenue should be recognized, but also classification questions on whether revenue should be recorded gross the sales price and the cost of the product or net just the gross margin. Some company executives say they do not know what is correct under the new standard. Some transactions become complex arrangements and could require reviewing authoritative accounting literature, and in the end, involve professional judgment of auditors and finance executives in the absence of clear-cut guidance.

Answers are organized under these topics: transfer of title; substantial performance and acceptance; nonrefundable payments; accounting for certain costs of revenues; refundable fees for services; estimates and changes in estimates; fixed or determinable fees; and implementing the guidance in SAB no.

Several recently settled SEC civil suits in federal courts involving alleged improprieties offer examples of how not to apply revenue recognition principles, some of which may seem obvious because companies intentionally made reporting misstatements. Recent allegations against companies and their officers include activities that violate good accounting:. Issuing press releases on the Internet regarding false and misleading projections of revenues.

Improperly reporting revenues on sales of software and improperly reporting revenues with side letters or material contingencies. Recording sham barter deals which resulted in material misstatement of revenue. Improperly recognizing revenue through fraudulent bill and hold transactions, recognizing revenue with material contingencies and issuing press releases which materially overstated revenues.

In the subsequent settlements, the courts ordered judgments ranging from the imposition of fines and disgorgement of ill-gotten gains to entry of temporary or permanent injunctions barring people from serving as officers of public companies or practicing before the SEC as accountants. The SEC brought a case that is significant because it included allegations against the external auditors for failure to take appropriate action after discovering possible illegal conduct.

The company, named in a federal suit over alleged overstatement of revenue for existing contracts, failed to announce termination of contracts and inappropriate recognition of fees subject to material contingencies. Further, the SEC alleged the company attempted to cover up these recognition problems.

The SEC amended the initial complaint to bring a civil injunction against one of the external auditors for violating Section 10A of the Securities and Exchange Act, which compels auditors to address possible illegal activity. Unfortunately the executives at another company did not act soon enough to ward off revenue recognition problems.

As a result, both the chief operating officer and the chief financial officer at the software maker were replaced when the company investigated improper accounting practices. Taking quick action, the company said it would file restated results of operations, although it did not indicate the extent of the restatement. For many companies, SAB need not be cause for alarm, but rather a call to take a good, honest look at their revenue recognition practices.

For example, Delta Air Lines recently changed its method of recognizing sales of frequent flier miles to credit card companies, hotels and other marketing partners. Previously, the company had recognized revenue as cash was received, but now Delta will show part of the revenue immediately and defer the rest until the consumer uses the miles. The change brought about a cumulative adjustment in the year it occurred. Some companies have complex business scenarios that may not have easy solutions.

The SEC questioned Priceline. In the s, the stock market encouraged less than conservative financial reporting from companies. In the absence of net income, market capitalization is based on revenues as an indicator of future earnings potential.

Essentially, many companies Wall Street scrutinized reported net losses and net cash outflows. These companies then tried to meet or exceed the Wall Street estimates or rumored numbers through creative accounting. Earnings management is not new, but it draws magnified media and investor attention in an environment where the market punishes companies that do not meet their earnings estimates.

Last spring software maker MicroStrategy, Inc. As a result, the company showed a net loss for that time period. In April, the company settled a shareholder class action suit alleging fraud arising from revenue overstatement. A similar fall in stock price at another company shows just how sensitive the market is to changes in revenue expectations.

Surprisingly, this drop occurred even though Apple still reported a net profit for the period. If companies choose questionable accounting practices to meet expectations of shareholders and analysts, then they will get the attention of the SEC, which has no tolerance for earnings management practices that become fraudulent financial reporting.

The cornerstone of investing is accrual or matching revenues with expenses. It is also the main difference between cash basis accounting and accrual basis accounting. In cash basis accounting, revenues are simply recognized when cash is received no matter when and how the services were performed or goods delivered. In accrual basis accounting, revenues are recognized when they are realized or realizable and earned no matter when cash is received.

US GAAP for revenue recognition consists of over pronouncements by various standard setting bodies that is hard to retrieve and sometimes inconsistent. Despite the large number of revenue recognition pronouncements, there is little guidance for service activities, which is the fastest growing part of the U.

Learn more about how private companies can get ready and what private companies need to know. A framework for revenue recognition In order to achieve the core principle and determine when to recognize revenue—and how much revenue to recognize—the FASB and IASB established a five-step framework. The five steps provide entities with a model to identify the contract to be evaluated under the new revenue standard, evaluate the performance obligations or units of account to which the recognition principles apply , and determine the amount of consideration to be recognized as revenue for each performance obligation.

A five-step model for recognizing revenue. The new revenue recognition ASC standard affects other accounting topics as well, including, but not limited to, contract modifications, licensing, contract costs, and presentation. It also creates additional quantitative and qualitative disclosure requirements. The new revenue standard also eliminates many of the revenue recognition rules prescribed under legacy US GAAP, replacing them with a principles-based framework outlined in the five-step model.

In some cases, applying the five-step model and recognizing revenue under the new standard will be straightforward. In other cases, however, applying the new guidance will require significant judgment, increasing the complexity of compliance. Click the tiles below for several examples. Subscribe and archives Subscribe to receive Roadmap series publications via e-mail. Archives are available on the Deloitte Accounting Research Tool website.

The Roadmap series contains comprehensive, easy-to-understand accounting guides on selected topics of broad interest to the financial reporting community. In this role, Chris consults with engagement teams and clients on complex accounting matters and wo She provides consultations to clients and audit practitioners on complex financia Fullwidth SCC.

Do not delete! This message will not be visible when page is activated. Latest news from DeloitteAcctg Share the latest research, events, and more. Please enable JavaScript to view the site. Viewing offline content Limited functionality available. My Deloitte.