Textbook Notes (270,000)
CA (160,000)
UOIT (400)
BUSI (200)
Chapter 4

BUSI 2150U Chapter Notes - Chapter 4: Revenue Recognition, Financial Statement, The Seller

Course Code
BUSI 2150U
Michael Konopaski

This preview shows pages 1-3. to view the full 9 pages of the document.
Income Measurement and the Objectives of Financial Reporting
Chapter 4 – Income Measurement and the Objectives of
Financial Reporting
Recognition refers to revenues and expenses appearing in the income statement
Different ways of recognizing revenue and expenses
Methods chosen can affect the amounts reported in an entity’s financial statements
Revenue Recognition
For there to be revenue, there has to be a corresponding increase in assets or decrease in
Critical – event approach is a revenue recognition approach where an entity recognizes
revenue at a specified instant in the earnings process called the critical event – when the
critical event occurs, 100% of the revenue is recognized
Gradual approach is a revenue recognition approach that results in revenue being
recognized gradually over a period of time
The Critical – Event Approach
IFRS provides 5 criteria for identify the critical even for recognizing revenue on the sale
of goods:
1. Significant risks and rewards of ownership have been transferred from the seller
to the buyer
2. The seller has no involvement or control over the goods sold
3. Collection of payment is probable
4. The amount of revenue can be reasonably measured
5. Costs of earning the revenue can be reasonably measure
First two criteria, called performance criteria, meaning the seller has done most or all of
what it’s supposed to do to be entitled payment
Performance has occurred when a customer purchases merchandise and take delivery
Performance might not have occurred on delivery if, for example:
The buyer has to resell the merchandise before the seller gets paid
The seller has to install the goods and installation is significant part of the
Third criteria is if payment isn’t probable or if the seller can’t make a reasonable estimate
of how much won’t be collected, revenue shouldn’t be recognized
The fourth and fifth criteria deal with measurability
For revenue to be recognized the entity must be able to estimate the amount it has earned
and the cost incurred to earn it
Often costs are incurred after the critical event and there must be recorded in the same
period as the revenue
The criteria are fairly conservative because they tend to delay revenue recognition until
fairly late in the revenue – generating process

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

Income Measurement and the Objectives of Financial Reporting
The critical event selected should provide a reasonable and fair representation of the
entity’s activates, given the needs of the stakeholders
Some Critical Events
Delivery occurs when the buyer takes possession of the goods or receives the service
being sold
Most retail, manufacturing, and service businesses use delivery as their critical event
There is too much uncertainty before delivery
Completion of Production
Revenue recognition criteria can be met as soon as the product is produced, even if it
hasn’t been delivered to the customer, if the same of the product is assured and the costs
of selling and distributing it are minor
Revenue Recognition
Some cases, revenue recognition is delayed after goods have been delivered or services
provided to customers
Delay is appropriate if the risk and rewards of ownership haven’t transferred at the time
of deliver or if there are significant uncertainties about costs, revenue or collection
Following are some examples of uncertainties
Warranty Costs
Warranty is a promise by a seller or producer of a product to correct
specified problems with the product
If a company isn’t able to make a reasonable estimate of its warranty
costs it should wait until the end of the warranty period to recognize
If a company can’t estimate the amount of goods customers will return it
should wait until the end of the return period to recognize revenue
Cash Collection
The third criterion requires a reasonable expectation that payment will be
If a reasonable estimate of the amount that will be collected isn’t
possible, collection becomes the critical event
In any of these cases, delaying revenue recognition results from too much uncertainty
If reasonable estimates can be made of warranty costs, returns, or uncollectible amounts,
it’s appropriate to recognize revenue
Consignment sale is a transaction in which the producer or distributer of goods transfers
the goods to another entity for sale but for which risk and rewards of ownership do not
transfer – the producer or distributor recognizes revenue when the other entity actually
sells the merchandise to somebody else

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

Income Measurement and the Objectives of Financial Reporting
Why Does it Matter When a Company Recognizes Revenue?
An entity’s accounting choices don’t change the underlying economic activities being
Stakeholders can be affected by these alternative events
The president’s bonus based on net income
May pay less tax if revenue recognized on delivery
Unionized employees might feel more confident about seeking wage increases if
production is the critical event
While an accounting choice doesn’t affect an entity’s underlying economic activity, it
may have economic consequences for stakeholders
Google Inc.
Prospectus is a legal document that provides detailed information about a company that
is offering its shares for public sale
Why Do Mangers Have So Much Choice?
While eliminating choice may make all financial statements consistent in when they
recognize revenue, a consistent critical event may not result in comparable statements
Not all sale transactions are identical and the terms of sale can vary enough that the same
critical event wouldn’t make sense for every sale
Allowing choice for recognizing revenue and other accounting issues is sensible because
the economic activities of the Canadian and world economies are too complex for
precisely defined accounting rules that suit every situation
The Gradual Approach to Recognizing Revenue
Recognizes revenue bit by bit over the entire earnings process rather than when a
particular critical event occurs
This approach is consistent with the conceptual nature of the revenue – earning process
because it reflects earnings as continuous ran than a one – time event
Gradual approach is appropriate for delivery of services and long – term construction
projects such as dams and large buildings
Since revenue recognition criteria usually lead to later rather than earlier revenue
recognition, the early years of long – term contracts would have no revenue or income
and the final year will have it all
The Percentage – of – Completion Method
You're Reading a Preview

Unlock to view full version