Case 5-5 Revenue Recognition

Revenue is usually recognized at point of sale.

Under special circumstances, however, bases other
than the point of sale are used for the timing of
revenue recognition.

Required: 
a. Why is the point of the sale generally used as
the basis for the timing of revenue recognition? 
Because the point of sale is usually the most common case when the
revenue has been earned and realized. For the revenue to be recognized the
two requirements has to be met. Earned means that the seller finished their
duty (delivering goods or performing services). And, realized means that the
goods or services are exchanged with cash. Based on the two requirements,
the point of sale is viewed as a reliable timing in the business course of
action.

b. Disregarding the special circumstances when

bases other than the point of sale are used,
discuss the merits of each of the following
objections to the sale basis of revenue recognition:

1. It is too conservative because revenue is earned

throughout the entire process of production.
Revenue is earned throughout the entire process of production, not
because it is really generating revenue, but because the process of
 production creates the value of the products that can create revenue
in the future. But it is really difficult to accurately measure the amount
of value or revenue generated by process. Also there will be no
revenue generated unless the product is sold. Thus the point of sale is
clearer and better timing to use for revenue recognition and the period
of time before the point of sale would not be considered for revenue
recognition with a few exceptions.

2. It is not conservative enough because accounts

receivable do not represent disposable funds , sales
returns and allowances may be made and collection
and bad debt expenses may be incurred in later
period.
For revenue recognition the amount of revenue has to be measured in
reliable manner. Also the net income depends only on the generated
cash during the year and it is because collection of receivables is
important for profit earning and periodic revenue measurements. At
the point of sale account receivables amount is an important measure
to record the sale the most accurately because disposal funds, sales
returns and allowances, collection and bad debt expenses are possible
factors in the future, but not the fact at the time of sale.

c. Revenue may also be recognized ( 1 ) during

production and ( 2 ) when cash is received. For
each of these two bases of timing revenue
recognition, give an example of the circumstances
in which it is properly used and discuss the
accounting merits of its use in lieu of the sales
basis.
- 1. Percentage of completion method: This is usually used for a project
or things that take long time to build. ( Usually more than a year) then,
they calculate the percentage of completion in the year or period, and
calculate relative revenue and expenses to report.
- 2. This is used when ultimate collectability of the revenue is doubt.
- Example are: The installment method and the cash-recovery method.