Revenue

1
Revenue
2
Problems in the Concept

• There is a gap between theory and practice
  between of the concept of accounting income
• This is due to having different concepts of
  income in accounting literature
• Hence, following criticisms are brought forward
• The concepts of Accounting Income has not been
  clearly formulated
• No long-term theoretical basis for computation
  and presentation of Accounting Income
• Accounting Standards permit choices in
  measurement of different firms/ periods income

3
Definitions

• There are several definitions
• IASC Definition
• Income is increase in economic benefits during
  the accounting period in the form of inflows or
  enhancements of assets or decrease in liabilities
  that result in increase in equity, other than
  those relating to contribution from equity
  participants.
• United Kingdom Framework Definition
• Gains are increases in ownership interest, other
  than those relating to contributions from owners.

4
Definitions

• FASB Definition
• Revenues are the inflows or other enhancements
  of assets of an entity or settlements of its
  liabilities (or a combination of both) during a
  period from delivering or producing goods,
  rendering services, or other activities that
  constitute the entitys ongoing major or central
  to operations

5
Definitions

• The Nature of Revenue
• Two approaches to revenue can be found in
  accounting literature
• Inflow of assets resulting from the operational
  activities of the firm (traditional view)
• Creation of goods and services by the enterprise
  and the transfer of these to consumers or other
  producers (revenue is a product of the
  enterprise)
• I.e. Revenue is either considered as an inflow of
  net assets or an outflow of goods and services

6
Definitions

• The first view confuses the measurement of and
  timing of revenue with the revenue process. The
  revenue process is very broad in nature. But, the
  traditional view is narrow in measurement and
  timing of revenue.
• Also, assets may increase and liabilities may
  decrease for many reasons, of which revenue is
  only one.
• The second view is much broad. It recognizes that
  revenue is a flow process. Here the measurement
  and timing aspects are not restricted as in the
  first view.

7
Definitions

• Several similar definitions also state that
  revenue is the product of the enterprise (flow
  concept), but the product should leave the entity
  (outflow concept).
• AAA (1957) Revenue is the monitory expression
  of the aggregate products or services transferred
  by an enterprise to its customers during a period
  of time
• Hence, it can be safely concluded that revenue as
  a product of the enterprise is superior to the
  outflow concept, and the outflow concept is
  superior to the inflow concept.

8
Definitions

• In Summary
• The Views of Revenue
• Inflow Concept The Product of the
  (Traditional) Enterprise
  View
• Product Should Leave the
  Enterprise (Outflow View)
• Ranking
• The Product of the Enterprise View
• The Outflow View the product should leave the
  enterprise
• The Inflow View (Traditional View) inflow of
  net assets
• (Pls adjust the diagram you have taken in the
  lecture as above)

9
ICASL (IASC) Framework

• The definition of income encompasses both revenue
  and gains.
• Revenue arises in the course of the ordinary
  activities of an enterprise and is referred to by
  a variety of different names including sales,
  fees, interest, dividends, royalties and rent
• Gains represent other items that meet the
  definition of income and may, or may not, arise
  in the course of the ordinary activities of an
  enterprise. Gains represent increases in economic
  benefits and as such are no different in nature
  from revenue. Hence, they are not regarded as
  constituting a separate element in this framework.

10
ICASL (IASC) Framework

• Gains include, for example, those arising on the
  disposal of non-current assets. When gains are
  recognized in the income statements, they are
  usually displayed separately because knowledge of
  them is useful for the purpose of making economic
  decisions. Gains are often reported net of
  related expenses.

11
What Should be Included in Revenue ?

• There is no common agreement
• One view is that all changes in the net assets of
  the firm, other than capital transactions, should
  be considered as revenue
• An another view is that there should be a
  distinction between revenue producing activities
  of the firm and other gains/losses
• Literature available do not give a clear
  difference between revenue and gains
• Prof. Hendriksen has suggested that for a better
  understanding a distinction between the wealth
  producing activities and other forms of
  unexpected transfers to wealth arising from
  gifts/grants.
• SLAS 29 Income Revenue Gains

12
What Should be Included in Revenue ?

• Edwards Bell identifies four types of income
• Current operating profit the excess of sales
  revenue over the current cost of inputs used in
  the production of output sold
• Realizable cost savings the increase in the
  prices of assets held during the period
• Realized cost savings the difference between
  historical costs and the current purchase price
  of the goods sold
• Realized capital gains the excess of sales
  proceeds over historical costs on the disposal of
  long term assets

13
Measurement of Revenue

• Measurement of revenue must precede recognition
  of it
• The traditional or conventional approach used by
  accountants is the transactions approach
• Here both internal and external transactions are
  taken in to account
• The events approach is an alternative. This
  approach (according to Prof. Hendriksen) focuses
  on the description of the activities rather than
  merely on reporting transactions.
• Under events approach income is assumed to arise
  when certain activities/ events takes place
  rather than as a result of specific transactions

14
Measurement of Revenue

• Should be measured at the Exchange Value of the
  product/ service of the enterprise
• EV represents the cash equivalent or the present
  discounted value of the money claims to be
  received eventually from the revenue transaction
• In many cases this is equivalent to the price
  established in the transaction with the customer
• But, appropriate allowance must be made for the
  necessity to wait for the final collection
• All returns, trade discounts and other reductions
  of billed prices should be deducted according to
  the above EV concept
• Cash discounts and bad debts are also reductions
  of revenue. They do not have the basic
  characteristics of expenses.

15
Recognition of Revenue

• General Rule
• Income is recognized in the income statement when
  an increase in future economic benefits related
  to an increase in an asset or a decrease of a
  liability has arisen that can be measured
  reliably.
• This means, in effect, that recognition of income
  occurs simultaneously with the recognition of
  increases in assets or decreases in liabilities
• Revenue recognition procedures are generally
  directed at restricting the recognition as income
  to those items that can be measured reliably and
  have a sufficient degree of certainty.

16
SLAS 29 - Revenue

• The primary issue in accounting for revenue is
  determining when to recognize revenue. Revenue is
  recognized when it is probable that future
  economic benefits will flow to the enterprise and
  these benefits can be measured reliably
• SLAS 29 should be applied in accounting for
  revenue arising from the following transactions
  and events
• (a) the sale of goods
• (b) the rendering of services and
• (c) the use by others of enterprise assets
  yielding interest, royalties and dividends.

17
SLAS 29 - Revenue

• Revenue is the gross inflow of economic benefits
  during the period arising in the course of the
  ordinary activities of an enterprise when those
  inflows result in increases in equity, other than
  increases relating to contributions from equity
  participants.
• Measurement of Revenue
• Revenue should be measured at the fair value of
  the consideration received or receivable.
• The amount of revenue arising on a transaction is
  usually determined by agreement between the
  enterprise and the buyer or user of the asset. It
  is measured at the fair value of the
  consideration received or receivable taking into
  account the amount of any trade discounts and
  volume rebates allowed by the enterprise.

18
SLAS 29 - Revenue

• Sale of Goods (Recognition)
• Revenue from the sale of goods should be
  recognized when all the following conditions have
  been satisfied
• the enterprise has transferred to the buyer the
  significant risks and rewards of ownership of the
  goods
• the enterprise retains neither continuing
  managerial involvement to the degree usually
  associated with ownership nor effective control
  over the goods sold
• the amount of revenue can be measured reliably
• it is probable that the economic benefits
  associated with the transaction will flow to the
  enterprise and
• the costs incurred or to be incurred in respect
  of the transaction can be measured reliably.

19
SLAS 29 - Revenue

• Rendering of Services (Recognition)
• When the outcome of a transaction involving the
  rendering of services can be estimated reliably,
  revenue associated with the transaction should be
  recognized by reference to the stage of
  completion of the transaction at the balance
  sheet date. The outcome of a transaction can be
  estimated reliably when all the following
  conditions are satisfied
• the amount of revenue can be measured reliably
• it is probable that the economic benefits
  associated with the transaction will flow to the
  enterprise
• the stage of completion of the transaction at the
  balance sheet date can be measured reliably and
• the costs incurred for the transaction and the
  costs to complete the transaction can be measured
  reliably.