Revenue RecognitionRevenue recognition practices are one of the most common reasons for accounting restatements. Many would believe that it is a basic principle: when a sales transaction occurs, revenue is recorded. Unfortunately, there are many different sales and services that make revenue recognition a much more complex issue. It is difficult to develop guidelines applicable to all industry transactions to record revenue. There are two basic guidelines to follow when decided if a company should recognize revenues. “According to GAAP, revenue is recognized at the earliest moment in time that both of the following conditions are satisfied: The critical event in the process of earning the revenue has taken place, and the amount of revenue that will be collected is reasonably assured is measurable with a reasonable degree of reliability.”
There are two main ways companies recognize revenue. Most companies meet the requirements for recognizing revenues at the point of sale, or delivery. The other method used is called revenue recognition before delivery, and there are two methods used: Percent-of-Completion Method and Completed-Contract Method.
“At the point of sale” seems like a simple concept when you deliver a service or item and you recognize revenue. This is not always the case. There are a few departures that can occur from the sales basis of recognizing revenue. One is to recognize revenue earlier than the time of the sale or service, which is appropriate if you have a high degree of certainty of the exact amount of revenue. Another is to not recognize revenue until after the time of the sale. This is only justifiable if extreme uncertainty exists when it comes to the amount of cash to be collected, Other situations that arise and effect revenue recognition are sales with buyback agreements, sales when right of return exist, and trade loading and channel stuffing. These situations impose problems when dealing with the appropriate time to realize revenues with...