One area of aggressive accounting was in revenue recognition for franchise reven
ue. Explain how companies were being aggressive with franchise revenue. How did
current Canadian GAAP solve this problem area?
Franchise revenue - franchisors were recognizing the franchise fee upfront once
paid before performing services for the franchisee. As such, Canadian accounting
standards have provided a specific guideline for recognizing franchise fee reve
nues -- once the franchisor had no remaining obligation and had performed all su
bstantial initial services for the franchisee and there were no unfulfilled cond
itions, then they could recognize the revenue.
Related party transactions - IFRS vs. Canadian GAAP
Related party transactions is when a firm engages in a transaction where one of
the parties has the ability to influence the actions and policies of the other.
Under Canadian GAAP, there are specific criteria for recording related party tra
nsactions at either exchange value or carrying value. If the the transaction is
monetary and a part of normal business operations, or if it's not a part of norm
al operations without a substantive transfer in ownership but has evidence of re
asonable value, then it would be recorded at exchange value under Canadian GAAP
(i.e. what each party paid for it). for all other circumstances, it would be rec
orded at carrying value, or the actual value of the transaction. Related party t
ransactions also require note disclosure in the financial statements. IFRS has a
similar definition of "related party transactions" as Canadian GAAP, and note d
isclosure is also required, but there are no guidelines for measuring the transa
ction at either exchange value or carrying value, which can allow for some finan
cial statement manipulation.
GREEN INCORPORATED CASE
Memo to: Green Incorporated Board of Directors
From: Accounting policy analyst
Re: Accounting policies on 2008 events and IFRS impact
- users & objectives:
1. shareholders/board of directors - performance evaluation, cash flow p
rediction, satisfy the debt-to- equity ratio
2. bank - cash flow prediction, high liquidity, collateral
3. Green Power (new subsidiary) - concerned about parent's ability to su
stain itself, cash flows
MOST IMPORTANT USER: you, GI since you will want to evaluate the perform
ance of the company and comply with the bank's requirements
CONFLICTS: Not too much of a conflict between the objectives, all users
are concerned with cash flow prediction. GI may be more inclined to capi
talize expenses, but that remains the only conflict of interest.
1. since you are a private company and the bank requires audited financi
al statements from you, i will assume that you are constrained by
ASPE standards when preparing your financial statements.
2. the debt-to-equity ratio required by the bank is also a major constra
int as you are limited in the amount of debt you can have in proportio
n to your equity.
Issues: 1) revenue recognition of 3-year contracts - when to recognize?
school signs contract --> pays deposit equal to normal fee --> GI inspects them
--> deposit is offset against future purchases
GI can only recognize revenue when the transaction is complete, that is:
1. the risks and rewards of the contract have been transferred to the or
2. the organization has accepted the risks and rewards of the contract.
3. GI can reliably measure all costs related to the contract
4. the amount of revenue from the contract can be measured reliably
5. GI retains no continuing managerial influence over the final product(
thus, GI cannot recognize revenue upon signing of the contract, nor when the dep
osit is paid to them. the earliest point when GI can recognize revenue is after
they have provided the free "Go Green" assessment of the organization.
alternative 1: recognize revenue after GI has inspected the school. - this is th
e earliest point for recognizing revenue in GI's business cycle. GI has performe
d their part of the deal, but the organization still has the ability to order pr
oducts from GI over the three years of the contract. this means that GI will hav
e to estimate the number of recycled products the organization will purchase as
well as the costs associated with these products. since this is a new program, t
here will be no historical basis for these estimates, and it would be difficult
to justify the use of this alternative.
alternative 2: recognize revenue as each recycled pro