BUS 251 Chapter Notes - Chapter 4: Canadian Dollar, Subledger, Interest
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Chapter 4 – Revenue Recognition and Statement of Earnings
- Corporate managers engage in three general types of activities: financing,
investing, and operating. We will focus on operating: the ones that generate most
of the revenue.
- Operating activities include all the normal, day-to-day activities of every business
that almost always involve cash.
- The typical business operations involves an outflow of cash that is followed by an
inflow of cash, a process commonly called cash-to-cash cycle.
- The initial amount of cash in a company comes from the original investment by
shareholders and from any loans that the company may have received as start-up
Acquisition of Inventory
- Before the company acquires the inventory that it will sell to customers or will
use to provide its services, it must undertake the investing activities of acquiring
property, plant, and equipment.
- Company hires labour and purchases the first shipments of inventory (or signs
contracts to acquire them).
- All activities that promote and sell the product.
- Pricing, advertising, hiring and managing sales force, establishing retail sales
Delivering of Product
- Collection of the sales price in cash or it could take place later in time called
- Credit risk: the risk that the buyer won’t pay for the service/product.
- There can be an interest charge (but usually not for shorter period) and
sometimes the seller may ask for the product back (repossession) or may try
other methods to collect on the account.
- Goods may be returned, which means no cash collections. May be due to
damaged in shipment or price allowance (adjustment).
- Cash discount: less than the full amount will be accepted as full payment.
- Some goods carry a written or implied guarantee of quality.
Summary of the Cash-to-Cash Cycle
- Net amount left in cash after this cycle is completed is then available to purchase
more goods and services in the next cycle.
- If the cash inflows are less than the cash outflows, the amount of cash available is
reduces, and the company may be unable to begin a new cycle without getting
additional cash from outside the company in form of an equity or debt.
- If the cash inflows exceed cash outflows, the company can expand its volume of
activity, add another type of productive activity, or return some of the extra cash
to shareholders in the form of dividends.
- To measure operating performance as accurately as possible, accountants divide
normal operating activities in two groups, called revenues and expenses.
- Revenues are inflows of cash or other benefits from the business’s normal
operating activities when these inflows result in an increase in equity that did not
come from contributions from equity holders.
- Expenses are the costs incurred to earn revenues.
- The difference between revenues and expense called net earnings (or net
- Matching: requires the simultaneous recognition of all costs that are or will be
incurred (in past, present, or future) to product the revenue.
- Revenue can be easy to be recognized at a certain, but some are more difficult.
- Revenue recognition criteria have been developed with IFRS to resolve this
conflict and produce a measure of performance that is intended to balance the
need for timely information with the need for timely and reliable information.
Two basic criteria:
Probability that economic benefits will flow to the company. (Normally met
when the activity that generated the revenue (performance) is
Requirement that the revenue can be reliably measured. When the goods
or services are sold for cash or an agreed selling price (account receivable),
the measurement is easy to determine.
- Earnings Management: management deliberately chooses how and when to
recognize revenues and costs so that net earnings are higher or lower in
particular accounting periods.
- External users usually have difficulties in determining whether earnings
management takes place.
- Sometimes, Ontario Securities Commission or Securities and Exchange
Commission (SEC) in the United States, question a company’s revenue
- Users of financial statements rely on auditors to determine whether accounting
standards have been applied appropriately or not.
Applications of Revenue Recognition
Revenue Recognition for the Sale of Goods
- For the sales of goods, there are five specific revenue recognition criteria that
must be met before revenue can be recognized:
There has been a transfer of the risks and rewards to the buyer.
The company no longer has managerial involvement or control over the
The revenue can be measured reliably.
It is probable that economic benefits from the transaction will flow to the
The costs incurred or to be incurred with respect to the transaction can be
- Recognition at the time of sale
The most common point at which sales revenues are recognized is the time
of sale and/or shipment of the goods to the customer.
Usually the company has completed everything they have to do for the
The title to the goods has been transferred, which transfers the risk and
rewards to the buyer, and the company no longer has control over the
Cash: economic benefits, A/R: measurable. However, the company will
have to be reasonably assured of collection of the A/R before revenue can
If doubtful, an estimate of potential uncollectability must be made and an
allowance for uncollectable accounts established.
Sometimes they might do a deposit, in that case, we call it “unearned
Cash (A) 500
Unearned Revenue (L) 500
When goods are delivered, the deposit can then recognized as a revenue
Unearned Revenue (L) 500
Sales Revenue (S/E) 500
- Recognition at the time of contract signing
Usually retail land sales companies recognize revenue right wen they sign