The process of recognizing revenue in accounting may be done in multiple ways, but one must ensure that this process is carried out at the proper time. This report is intended to show various issues in the context of revenue recognition in order to prove that timing is a highly critical element of the process of determining income. Within this report, the writer will analyze the concepts of revenue collection and revenue generation.
Revenue collection is a significant activity that enables organizations both public and private to fund their operations in the recurrent and developmental categories. Revenue generation enables firms to make a profit and increase their equity levels which act as a positive indicator for stakeholders. The collection and generation of revenue inform the recognition process.
Revenue recognition is a vital accounting principle since it ensures that the conditions needed to account for funds generated are leading to enhanced bookkeeping and accountability. This critical accounting principle enables an entity to monitor contracts with customers which ensures that revenue generation is enhanced within organizations. One of the apparent benefits of revenue recognition is increased accountability both internally and externally leading to prudent utilization of resources. Broadly, revenue recognition is a critical practice that leads to the sensible use of resources in an organization.
Most of the commonly applied accounting principles are contingent upon planning and budgeting, which is the ability of an institution to structure its generated resources or funds in a manner that will result in the attainment of set objectives. In this regard, specific criteria must be present to facilitate revenue recognition. This criterion includes recognition of price, probability of the collection of revenue, evidence of prior arrangements, and the prior delivery of products (“Revenue Issues in Depth,” 2016).
Central to the planning process within accounting is the issue of timing. In order to ensure that revenue recognition is achieved according to acceptable standards of practice, it is necessary to ensure that the recognition of revenue occurs within a specific span of time. Specifically, recognition of revenue, as well as the recognition of expenses, should occur within the same time period. Firms may decide to carry out the recognition of the revenue process for monthly time periods, or they may carry them out on an annual basis. Regardless, it must be carried out within the same time period. If timing is improperly applied within the revenue recognition process, a distortion of the firm’s income statement may occur. This can lead to incorrect perceptions with regard to the financial performance of the firm.
For example, suppose a firm chooses to recognize its revenues based on expected sales for the next quarter and expenses based on the charges of the current quarter. In using this method, the firm may recognize revenues of $10 million and expenses of $9.5 million in a given quarter, which results in a profit of $500,000. However, if sales prove to be less than estimated in the next quarter, then the company's financial statements will show profits that do not exist. As such, it is essential that revenues and expenses are recognized in the same time period, as this practice allows financial statements to best reflect the actual performance of a company.
In equal measure, investors can evaluate the viability of the investment since revenue recognition surmises the overall stability of a firm. Moreover, the management of an entity can be determined through revenue recognition which demonstrates the importance of the principle in the administration of organizations. Equally important, revenue recognition can provide an overall assessment of a sector, especially if the policies employed have been standardized throughout the industry.
Revenue recognition has proved crucial in fighting crime, especially fraud since it is now possible to ascertain the income generated by an organization. Therefore, investigators can use revenue recognition principles to determine if an entity has engaged in any illegal activity regarding finance (McMahon, Pence, Bressler, & Bressler, 2016). At the company level, the management can prevent fraud since they are aware of the expected income since revenue recognition principles have been used to set the price.
In relation, taxes can be easily calculated using the revenue recognition principles which improves the collection of funds owed to the government (McMahon et al., 2016). In fact, the new standards developed are holistic since they are market driven rather than industry-specific which means the authorities can determine the amount of taxes due leading to proper fiscal management at the national level. The old system was limited to specific industries which limited the amount of data available. Equally important, revenue recognition acts as deterrence of fraud since employees tasked with accounting are aware of the risks involved (McMahon et al., 2016). Ideally, it is now easy to determine any funds expected within an entity due to improved accountability that can be attributed to the principles of revenue recognition.
The management of assets and liabilities are a fundamental activity in any organization since they influence the planning and future growth of an institution. Notably, entities can undertake more obligations to fund their operations if revenue generation is constant and easy to monitor since they will be able to structure repayment of the liability (Henry & Holzmann, 2009). Towards this end, management can manage its assets and liabilities in a manner that will not affect the operations of the institution negatively. Again, equity will remain constant due to the planning element that is reinforced by revenue recognition since the administration is aware of its overall financial state which minimizes the need for external capital to fund company activities.
My personal stance on the issue of revenue recognition is that companies must complete revenue recognition in a timely manner. Revenue recognition plays a vital role in any firm since it enables the institution to structure its operations in an organized manner. However, I strongly believe that there is not one perfect method of revenue recognition that can be applied across the board, because what may work best for one company could potentially be detrimental to another. The new standard of revenue recognition moves away from rules-based revenue recognition of the past to more principles or judgment-based approach which allows for a global standard (Tysiac, 2017). I believe the new standard is much more efficient than the old standard as it allows for the timing and method used to be decided at the company level. For example, take two companies that would fall into the category of retail and offer the exact same products to customers. One company does not offer delivery services, and the other company does. It would be safe for the company that does not offer delivery services to use the sales-basis method (revenue recognized at the time of sale) because at that time the transaction is truly complete. For a company that does provide delivery services, this method would not work because the transaction is not fully complete until the goods have been delivered by the company and accepted by the customer. For this company, the accrual method (initially recorded as prepaid assets and later classified as an expense when goods have been delivered and accepted) of revenue recognition would be more beneficial. Therefore, I am of the opinion that the timing of revenue recognition should be reinforced at the company level and should also be heavily based on the type of service that an individual company provides. Recognizing revenue and expenses in the same time period is extremely important, and research shows the method used to ensure this is equally important.
The recognition of revenue has been shown to be vital in the management of organizations since it facilitates the planning element. Even further, the evidence collected has demonstrated that revenue recognition is influenced by several variables that include proof of prior arrangements, and price determination (Henry & Holzmann, 2009). According to Karina Kasztelnik (2015), the elements mentioned above are fundamental to the success of an organization due to the consistency availed to the institution.
The analysis of scholarly work on the subject has shown that revenue recognition, as well as its timing, is an important accounting practice which is regulated by various professional organizations to improve accountability in management. Traditionally, the revenue recognition principles have been based on industry-specific rules-based approaches, but a new alternative solution to revenue recognition is a shift to principles or judgment-based contract specific methods to determine revenue recognition (“New Revenue Recognition…”, 2017). The shift is an effective alternative that aims to incorporate more sectors in revenue recognition which will facilitate inter-industry comparability (“New Revenue Recognition…”, 2017). Furthermore, this alternative solution to the timing of revenue recognition would provide a global standard in which entities are able to use sound judgment, based on the specific type of service provided, to determine what methods of revenue recognition fit their specific needs.
In conclusion, the timing of revenue recognition is an integral part of accounting for entities spanning all industry sectors, but choosing the appropriate revenue recognition method is just as important as the practice itself. Of course, the value of revenue recognition is entirely dependent on the ability of the firm to conduct its recognition activities within a viable timespan so as to prevent financial distortion. As previously stated, recognizing revenues from different periods can cause the firm to show profits that do not exist. This misinformation can heavily distort the company's performance causing investors, employees, and managers alike will orient their future decisions around incorrect information. Thus, it is vital for firms to select appropriate methods, based on the types of services provided, to recognize revenues and expenses within the same period so that stakeholders can operate with the most accurate information possible.
New revenue recognition accounting standard—Learning and implementation plan. (2017). Retrieved from https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/revenuerecognition/downloadabledocuments/2014-09_liplan.pdf
Henry, E., and Holzmann, O. (2009). Contract-based revenue recognition. Wiley Periodicals, Inc.
Kasztelnik, K. (2015). The value relevance of revenue recognition under international financial reporting standards. Sciedu Press.
Revenue issues in depth. (2016). Retrieved from https://home.kpmg/content/dam/kpmg/pdf/2016/05/IFRS-practice-issues-revenue.pdf
McMahon, R., Pence, D., Bressler, L., & Bressler, M. (2016). New tactics in fighting financial crimes: Moving beyond the fraud triangle. Journal of Legal, Ethical and Regulatory Issues.
Tysiac, K. (2017). Revenue recognition: A complex effort. Journal of Accountancy.