Judy Schaeffer is getting up to speed on the new guidance on revenue recognition
ID: 2455919 • Letter: J
Question
Judy Schaeffer is getting up to speed on the new guidance
on revenue recognition. She is trying to understand the revenue recognition principle as it relates to the
five-step revenue recognition process.
Instructions
(a) Describe the revenue recognition principle.
(b) Briefly discuss how the revenue recognition principle relates to the definitions of assets and liabilities.
What is the importance of control?
(c) Judy recalls that previous revenue recognition guidance required that revenue not be recognized
unless the revenue was realized or realizable (also referred to as collectibility). Is collectibility a
consideration in the recognition of revenue? Explain.
Explanation / Answer
(a)
The revenue recognition principle states (under accrual accounting method) that Revenue is to be recognized only when it has been earned. Revenue is earned when the revenue cycle has completed, that is, the good is produced and sold and/or the service is rendered.
(b)
This principle can result in creation of assets or liabilities.
When a sale is made on account (credit sale) such that the good or service is sold (rendered) but payment is yet to be received, it gives rise to a current asset called Accounts Receivable, that is payment due from customer.
On the other hand, if payment has been received for a good or service that is to be sold (rendered) later than the time when payment is received, it gives rise to a liability called Deferred Revenue.
Control is important to ensure that revenue is recognized in accordance with the matching principle, so that an Account Receivable or Deferred Revenue is not recognized as revenue.
(c)
Collectibility is not a consideration in revenue recognition. To provide an estimation for uncollectible revenue, a seaparate contra-asset account is created as Provision for Bad Debt (Uncollectible revenue), which is credited from Account Receivable.
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