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Department
Management and Organizational Studies
Course
Management and Organizational Studies 3370A/B
Professor
Baldwin Wallace
Semester
Fall

Description
Objectives – Income measurement  Apply the revenue recognition principle  Apply the matching principle to recognize expenses  Describe the basic format and the contents of the income statements  Explain additional items on the income statement  Explain the effects of sales on the cash flow statement Income Measurement aka Revenue Recognition  In a recent survey, o top three concerns  42% great risk of errors  35% most complex to manage  57% errors in revenue – highest level of material impact to f/s o 92% of public companies use manual processes/spreadsheets o Difficult to internally control processes for revenue recognition We care – why?  Method of recognition can affect: o Revenue & Expenses o Net Income/Loss o Balance sheet accounts such as A/R, deferred revenue  Which affects financial ratios such as Gross Margin, Return on SE, other profitability ratios  May lead stakeholders such as investors, regulators, management, customers and others to make an “incorrect” decision Revenue Recognition Principle  Revenues are recognized when they are earned  How do we know when revenue has been earned? Criteria o Performance has occurred o Amount of revenue can be reasonably measured o Collection of payment is reasonably assured o Costs required to earn revenue can be reasonably measured Critical Event Approach  Revenue & related expenses recognized when the critical event occurs  Critical event can occur when: o Goods & services delivered (walk out of store with groceries) o Order received and terms of sale finalized o Production is completed – even if the buyer has not taken delivery o Cash is collected  What is the critical event at Enron? Revenue Recognition at Enron (Selling gas 20 years forward) 1. Performance has occurred – delivery of gas would not take place for 20+ years. No cash exchange prior to that date. 2. Amount of revenue can be reasonably measured – no active trading in the 20 year forward market – therefore not possible to reasonably measure revenue (no one else was selling gas 20 years in advance) 3. Collection of payment is reasonably assured – Did anyone know? 4. Costs required to earn revenue can be reasonably measured – can you determine the costs to earn revenue 20 years from now? Gradual Approach  Revenue & related expenses recognized over some period of time  Appropriate for long term projects (like construction – to give you revenue to pay workers and
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