Module 3:

Revenue Recognition
1

INTERNATIONAL FINANCE
AND ACCOUNTING
 Some Basics on Revenue
2

— How important is revenue?

¡ Primary financial objectives
¡ Basis for Fortune’s annual ranking of companies: a measure of
economic size/political importance
¡ Key factor of executive compensation

— Timing of revenue recognition

¡ Transfer of legal title/ Provision of service
¡ Clear-cut situation:
÷ Goods are delivered (or service provided)
÷ Collection is probable and measurable
¡ How about less clear-cut situations?
 Some Basics on Revenue
3

• Over the year, the company sold $600,000 worth

of goods of which 80% was paid in cash and 20%
was on account
• The goods that were sold cost $400,000

Dr. Cash 480,000 Dr. COGS 400,000

Dr. A/R 120,000 Cr. Inventory 400,000
Cr. Sales revenue 600,000
 Five steps in the recognition of revenue
4

1. Identify the contract with a customer.

2. Identify the separate performance obligations in the
contract.
3. Determine the transaction price.
4. Allocate the transaction price to the separate performance
obligations.
5. Recognize the revenue allocated to each performance
obligation when the entity satisfies each performance
obligation.
 Revenue Recognition Criteria
5

Sale of goods
¡ Transferred the significant risks and rewards of ownership of
the goods

¡ Retains no control over the goods

¡ The amount of revenue can be measured reliably

¡ Inflow of the economic benefits is probable

¡ The costs incurred (or to be incurred) can be measured reliably

 Revenue Recognition Criteria
6

Provision of services
¡ The state of completion can be measured reliably

¡ The amount of revenue can be measured reliably

¡ Inflow of the economic benefits is probable

¡ The costs incurred and the costs to complete can be measured

reliably
 Expense Recognition
7

— Expenses are recognized when they are incurred

• The matching principle (match expense
incurred with revenue earned)
e.g. sales commissions, depreciation expenses
• For long-lived assets, expenses are recognized
over the life of the asset
• regardless of when the cash is paid
 Sale of Goods with a Right of return - Example
8

— Lighting, a manufacturer of lighting fixtures

— An agreement with a Mexican company that will import
and distribute its products locally
— Lighting ships $2,000,000 of lighting fixtures to the
Mexican distribution in Year 1
— The distribute has the right to return products over the
subsequent 3 months
— Old revenue recognition rules (IAS 18 & US counterparts):
sell-through accounting
¡ Revenue is not recorded & inventory not deducted until the
end
 Sale of Goods with a Right of return - Example
9

— Under IFRS 15, (assume 40% gross margin)

¡ Assume a 10% rate of returns
 Sale of Goods with a Right of return - Example
10

— Suppose the Mexican distributor returns 8% on Mar 15

— Suppose no additional return until Mar 31 (accountant’s

original forecast was too pessimistic by 2%)
 Special Situations
11

— Bill-and-hold sales
— Servicing fees included in the price of the product (multiple
deliverables)
— Consignment sale
— Customer Loyalty Programs
 Special Situations
12

— Bill-and-hold sales
¡ Delivery is delayed at the buyer’s request but the buyer takes title
and accepts billing
¡ Have been used by entities to shift sales from future to current
period
¡ Accounting fraud of Sunbeam
https://www.sec.gov/litigation/admin/33-
7976#:~:text=Also%20in%201997%2C%20Sunbeam's%20management,million%20cam
e%20from%20accounting%20fraud.
¡ Questions checklist for accountants make decisions:
1. Has the product been separately identified as belonging to the
customer?
2. Is the product ready for shipment to the customer?
3. Can the seller use the product or reallocate it to another customer?
4. Is there a substantive business reason for the bill–and–hold
arrangement, such as, that the customer’s warehouse is full?
 Special Situations
13

— Multiple deliverables (or multiple performance obligations)

¡ Deliver two or more goods and services as a bundle,
— Rogers, for example, sells a bundle of phone & service,
or internet service & TV
¡ Components in the bundle are delivered at different time
— Revenue sources, as well as timing of revenue recognition, for
components will differ
 Apple’s Multiple Deliverables
14
Apple has identified up to three deliverables regularly included in arrangements
involving the sale of these devices.

1. The first deliverable is the hardware and software essential to the

functionality of the hardware device delivered at the time of sale.
2. The second deliverable is the embedded right included with the purchase of
iOS devices, Mac and Apple TV to receive future unspecified software
upgrades and features relating to the product's essential software.
3. The third deliverable is the non-software services to be provided to qualifying
versions of iOS devices and Mac.

• Apple allocates revenue between these deliverables using the relative selling
price method.
• Revenue allocated to 2 and 3 is deferred and recognized on a straight-line basis
over the estimated period the software upgrades and non-software services are
expected to be provided for each of these devices, which ranges from two to
four years.
Special Situations-Multiple deliverables
15

Example:
— selling cars along with a package of services
—timing of revenue recognition for multiple components will differ

Stand-alone
Price
Car $45,000
Basic service package (2 years) 3,000
Extend service package to 4 years premium service 2,000
Total 50,000
Final negotiated price (car + premium service) 45,900
16
 Special Situations-Multiple deliverables
17

— Journal Entries for Revenue only (ignore expenses):

Upon Delivery
Accounts Receivable 45,900
Sales Revenue – Car in Bundle 41,310
Unearned (or Deferred) Revenue 4,590

Year 1 and Year 2 year-end:

Unearned Revenue 1,377
Service Revenue – Basic Service in Bundle 1,377

Year 3 and Year 4 year-end:

Unearned Revenue 918
Service Revenue – Extend Service in Bundle 928
 Special Situations-Multiple deliverables
18
Relative Fair Value Method
— when stand-alone selling prices for each component are available

Residual Method

— when the stand-alone selling price for one deliverable is not established

— First allocates the prices to specific components for which standard

market value has already been established, and then allocates the remaining
amount to the components for which prices are more difficult to establish.

Previous car example, what if stand-along price for service packages are not available?

Total Allocation to car: $45,000

price
$45,900 Allocation to service packages combined: $45,900 - $45,000=$900

How to prepare journal entries for revenue recognition? Ignore expenses here
 Special Situations-Multiple deliverables
19

The Miller-Porter Company sells powder coating equipment at a sales

price of $50,000 per unit. The sales price includes delivery, installation,
and initial testing of the equipment, as well as a monthly service call for
one year in which a technician checks to make sure that the equipment is
working properly and makes adjustments as needed.
After the first year, customers are given the opportunity to enter into an
extended service agreement; Miller-Porter prices these extended service
agreements to earn an expected gross profit of 50%. Given the wages paid
to technicians and the time required to make a service call, the company
estimates that the cost of providing each monthly service call is $200

— Develop a revenue recognition policy using the residual method for

company’s sales of powder coating equipment
— Prepare journal entries for the date of delivery and the date of service
(Revenue only; ignore expenses)
 Special Situations-Multiple deliverables
20

Revenue recognition policy

Revenue recognized at date of delivery, installation, and initial testing $45,200
Revenue recognized each month when service calls are made $400
Journal entries
Date of delivery – Accounts receivable (or Cash) $50,000
Revenue – Equipment in Bundle $45,200
Deferred revenue $4,800
Date of service call – Deferred revenue $400
Revenue – Service in Bundle $400
 Special Situations
21

— Consignment sales
¡ If goods sold, net proceeds remitted to consignor

¡ If goods not sold, they’d be returned to the consignor

--Thus the risks of ownership stay with the consignor

Consignment
Cynthia
Store
22
 Special Situations: Consignment
23

— Consignment sales
¡ Fail criteria #1 because the risks of ownership stay with the
consignor

¡ Therefore the consignor delays recording revenue until the

consignee successfully sell the goods
 Special Situations: Consignment
24

— Consignment sales
¡ Fail criteria #1 because the risks of ownership stay with the
consignor

¡ Therefore the consignor delays recording revenue until the

consignee successfully sell the goods

Sold to Customers
Special Situations: Customer Loyalty Programs
25

— IFRS 15: award credits should be treated as a

separately identifiable component of the sales
transaction in which they are granted.
— The revenue allocated between awards credits
(liability) and current sale is based on their fair
value.
• When credit is used, transfer from liability to
revenue.
 Special Situations: Customer Loyalty Programs
26
— Redjet airways has a frequent-flyer program, in which customers receive 1
point for each mile flown. Frequent-flyer program members can redeem
30,000 points for a free domestic flight, which would cost $600 on average.
— During Year 1, Redjet awarded 1,000,000 points to its customers on flights
with total ticket sales of $600,000. Frequent-flyer points expires two years
after they are awarded. By the end of Year 1, frequent-flyer program
members had redeemed 300,000 points for free tickets. Redjet expects that
only 10% of points will expire unredeemed. This 10% is termed breakage.
Special Situations: Customer Loyalty Programs
27

— The journal entry to recognize revenue from ticket sales

in Year 1:
Cash 600,000
Revenue 582,000
Unearned Revenue 18,000

— During Year 1, 300,000 points were redeemed for 10 free

flights, with a value of $6,000. The journal entry to
recognize revenue from providing free flights under the
awards program is:
Unearned Revenue 6,000
Revenue 6,000
 How big is the impact of revenue recognition?
28

— Enron’s revenue recognition

— Revenue $13.3 billion à $100.8 billion in 4 years!
— # 6 on the Fortune Global 500
• Mark-to-Market Accounting

• SPEs

$100.8 billion
$6.3
billion
 Case Discussion
29

Typical revenue fraud (Deloitte):

¡ https://deloitte.wsj.com/riskandcompliance/2018/06/18/clamping-
down-on-potential-revenue-recognition-fraud/
¡the two most common schemes identified were related to
fictitious sales or revenue timing issues, which together
accounted for 83 percent of the revenue recognition schemes
investigated by the SEC

Jumio, Inc. revenue fraud:

¡ https://www.jdsupra.com/legalnews/founder-fraud-case-study-
roundtrip-78323/
¡ See SEC case filing for more
details: https://www.sec.gov/litigation/complaints/2019/comp-pr2019-
50.pdf , points 12-19)
 Case Discussion
30

Jumio, Inc. revenue fraud:

¡ How did Jumio manipulate its revenue?
¡ Referring to the revenue recognition criteria we learned, how did
such accounting practice violate accounting standards?
¡ Besides manipulating revenue numbers, what else did Mattes do that
indicates he was intentionally misleading the market?
¡ How was the fraud uncovered?
¡ What’s the penalty brought by SEC on Jumio and Mattes?
¡ What are some corporate governance agencies that could reduce
fraud risk?

See SEC case filing for more

details: https://www.sec.gov/litigation/complaints/2019/comp-pr2019-
50.pdf , points 12-19)
 Revenue Recognition Criteria
31

Provision of services

¡ The state of completion can be measured reliably

¡ The amount of revenue can be measured reliably

¡ Inflow of the economic benefits is probable

¡ The costs incurred and the costs to complete can be measured

reliably
 Provision of Service:
Revenue Recognition Criteria
32

¡ The state of completion can be measured reliably

÷ provision of a service can occur over an extended period of time
÷ revenue be allocated according to the stage of completion
 Construction Contract
33

Confederation bridge:

— Year 1, start a contract to build the bridge at a fixed price of $12 billion
— Total estimated cost is $10 billion
— Actual costs incurred to date (cumulative) were Year 1: $3 billion, Year
2: $5 billion, Year 3: $8 billion, Year 4: $10 billion
— Determine the amount of revenue, gross profit to be recognized for
Year 1, 2, 3, and 4.
34
 Exercise
35

(in billion dollars) 2016 2017 2018 2019

Contract price 2.5 2.5 2.5 2.5
Costs incurred to date 0.5 1.1 1.5 2
Estimated total cost 2 2 2 2

¡ Percentage-of-completion method, cost-to-cost basis

¡ Compute revenue to be recognized for each of the four years