BUS 251 Lecture Notes - Lecture 4: Cash Flow, Net Income, The Seller

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251-4
REVENUE
Why Is Revenue Important To Users?
Revenues are defines as inflows of economics benefits (cash or A/R) from a company’s
ordinary operating activities. There does not have to be a receipt of cash in order for a
company to recognize revenue
Assessing Revenues:
When losses occur (net loss) its important for the management and user to evaluate both
the size and cause of the loss. Financial statement user must evaluate both the quantity
and quality of the revenue.
Quantity: refers to the amount of revenue and whether or not the trend shows an
increase or decrease over a number of accounting periods.
Quality: refers to the source(s) of revenue and the company’s ability to sustain
the revenue over the long term.
Another way quality of earning is measure is to compare the cash flow from
operations (from statement of cash flows) with net income – if these two
amounts are moving together (both up or down) and if the cash flow from
operating activities is greater than the net income we consider the earning to be
of higher quality. If the two amount don't move together and cash flow is less
than the net income then its lower quality
REVENUE RECOGNITION
Users need to be aware of a company’s RR policy so that they can make informed
judgments about reported revenues. Many companies have different ones and the info
about their RR policy can be found on the notes in the financial statements. Standards
require companies to disclose the amount of revenues for each significant category or
stream of revenue.
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When Are Revenues Recognized?
Revenues are recognized when they have been earned — to help determine when
revenues are earned accounting standards have developed two general revenue
recognition criteria:
1. It is probable that economic benefits will flow to the company
2. The amount of these benefits can be reliably measured.
In most cases this will be straightforward but for other professional judgment is required
and to assist with this process standard setters have establish specific revenue
recognition criteria:
Criteria developed that specify the conditions under which revenue should be
recognized by the 3 common categories of revenue generating activities
The three common categories of revenue-generating activities are:
1. The sale of goods
2. The provision of services
3. The receipt of interest, royalties and dividends
The two general criteria is common to all three categories.
SALE OF GOODS
There are 5 revenue recognition criteria that must be met before a company selling
goods can recognize revenue. Most cases revenue is recognized at the time of sale,
which is what will focus on in this course. There are 5 specific criteria for revenue
recognition for sale of goods.
1. The significant risk and rewards of
ownerships of the good have been
transferred to buyer
Customer either takes the good away or
the good are shipped to them. When the
title of the good transfers to customer the
risk and rewards have also been shift
2. The seller has no continuing
involvement or control over good
When customer takes the good away or
good have been shipped and company has
no control over goods
3. The amount of revenue can be Selling price has normally been agreed to
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reliably measured by the seller and buyer so company can
quantify the amount of benefits flowing in
4. It is probable that the economic
benefit from the transaction will flow
to the seller
Customer will pay cash, which provides
immediate economic benefits. Also if they
sell in credit, a company will only do that
if they trust they will receive money
5. The cost incurred or that will be
incurred to complete the transaction
can be reliably measured
These cost can normally be estimated
using either historical data or industrial
date
PROVISION OF SERVICES
Companies that earn revenue from the delivery of services have 4 recognition criteria
that must be met before a company can recognize revenue:
The
1. Amount of revenue can be
easily measured
At the time of entering into an agreement to
sell/purchase services the price is agreed to by the
seller and buyer
2. It is probable that the
economic benefits from
transaction will flow to seller
Cash or credit will flow to seller
3. The cost incurred or that
will be incurred to complete
a transaction can be easily
measured
The seller must be able to estimate the total cost
that will be incurred to provide the contracted
services. Seller will be able to determine this with
sufficient reliability because these estimated would
have been prepared prior to contract
4. The portion of the total
services completed can be
reliably measured (if services
are ongoing
The seller must be able to reliably quantify the
portion of the services that has been provided for
that account period - known as percentage of
completion method — 4 weeks out of 13 is 30.8%
instead revenue can be recognized as cost to
date relative to the total expected cost or based on a
survey of the work completed
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