revenue recognition & reporting financial performance

Revenue Recognition & Reporting Financial Performance

Stephenie Fox CA

Principal, CICA

Revenue Recognition

CICA Handbook Section 3400 REVENUES Issued 1986 Revenue generating activities increasingly

complex Current environment – sales figures used as

indicator in evaluating stock prices

Section 3400

Addresses timing of revenue recognition

(not measurement)

Revenue Defined

Revenue is the inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise, normally from the sale of goods, the rendering of services and the use by others of enterprise yielding interest royalties or dividends. Revenue is net of items such as trade or volume discounts, returns and allowances, claims for damaged goods, and certain excise and sales taxes.

Revenue Recognition

¶.06 – recognize when performance requirements (¶ 07&08) are satisfied and ultimate collection is reasonably assured

Revenue Recognition (cont)

¶ .07 sale of goods – seller of goods has transferred to the buyer the significant risks and rewards of ownership in that all significant acts have been completed and the seller retains no continuing managerial involvement in or effective control of the goods transferred to a degree usually associated with ownership

Revenue Recognition (cont)

¶.08 rendering of services and long-term contracts – performance determined using percentage of completion or completed contract method – performance achieved when reasonable assurance exists regarding the measurement of the consideration that will be derived from rendering the service or performing the long-term contract

Recognition

Transferring risks and rewards of ownership Need to assess whether these have been

transferred – look at circumstances Usually coincides with transfer of legal title Do any significant acts of performance

remain to be completed

Recognition (cont)

Must have certainty of collection e.g. does payment depend on resale of

goods by the buyer Returns – are they significant and

unpredictable

Problems of interpretation

What does significant acts mean? OSC notice 52-701 – review of revenue

recognition to determine if appropriate application of Section 3400.

Revenue has direct effect on reported earnings- also becoming an indicator of value and performance especially in tech sector

OSC Findings

Need for significant improvement in nature and extent of disclosure

Referred to more detailed literature like SAB 101 – effectively makes this part of Canadian GAAP for public listed companies

Feeling that issuers have not looked at all existing sources of accounting literature when applying Canadian GAAP

Transfers of Risks and Rewards

Completion of significant acts Not always easy to assess E.g. bill and hold sales, contracts with

multiple elements

SAB 101 – U.S. SEC

General FASB principles – revenue recognized when realized or realizable and earned

Earned when substantially accomplished what it must do to be entitled to benefits represented by revenues

Problems of uncertainties and interpretation

CICA – New EIC’s

EIC 141 revenue recognition EIC 142 revenue arrangements with multiple

deliverables EIC 143 accounting for separately priced

extended warranty and product maintenance contracts

EIC 141 Revenue Recognition

Performance achieved under 3400.07 when: Persuasive evidence of an arrangement exists Delivery has occurred or service have been

rendered; and The seller’s price to the buyer is fixed or

determinable

Recognize revenue in the period in which all of these criteria are met

Persuasive Evidence of an Arrangement

Arrangement:

final understanding between the parties as to the specific nature and terms of the agreed upon transaction

Determining Whether an Arrangement Exists

Customary business practices Side arrangements Consignment arrangements Title passes but revenue recognition

precluded

Delivery and Performance

Revenue recognized when seller has substantially accomplished what it should do under terms of the arrangement – usually on delivery of product or performance of services

Fixed or Determinable Sales Price

Cancellable sales arrangement Right of return Price protections/inventory credit

arrangements Refundable fee for service arrangements

Disclosure of accounting policies

Always disclose revenue recognition policy Policy for each type of transaction If multiple elements, policy for each element

EIC 142 Multiple deliverables

Provides guidance for determining if arrangements with multiple deliverables consist of separate units of accounting

Presumption is that separate contracts with same entity entered into at same or near the same time are a package

EIC 142 looks at when these can be separated and accounted for separately

EIC 143 Extended warranty and product maintenance contracts

Defer and recognize over life of contract Costs incurred should be deferred

Reporting Financial Performance

Display and presentation of items in the operating statement

Cash flow statement Should certain items not recognized in

income statement be recognized in a statement of financial performance?

Background

Concerns with income statement including– Undue emphasis on bottom line– Classification of items– Transparency for gains and losses that don’t go

through the I/S– Gains and losses from changes in fair value

Comprehensive Income

Change in equity of an enterprise from transactions and events from non-owners.

All changes in equity except those from investments by owners and distributions to owners.

Other Comprehensive Income

Revenues expenses gains and losses required by primary sources of GAAP to be included in comprehensive income but excluded from net income

Presentation

Net income Other comprehensive income Total One or two statements Terms may vary

Statement of Comprehensive Income

20X2 20X1

Net income 651 22

Other comprehensive income net of tax

2102 702

Comprehensive Income

2753 724

Reporting Financial Performance

Convergence project

Reporting Financial Performance

Maximize predictive value with respect to forecasts of comprehensive income and its components

Bottom line not a useful number – aggregates a range of components of financial performance – goal is useful disaggregation

Ambiguity in definition of operational earnings – companies defining own measures of profit-lack of consistency and comparability between

Proposed Format of Performance Report (Preliminary)

Part A – Revenue, Cost of sales (excludes depreciation), Pension expense, Other (selling general and admin)

Part B - Investing (= changes in assets) e.g. Interest Dividends, Depreciation & amortization

Part C – Financing (=changes in liabilities) +/- Income taxes, Discontinuing operations, Other Total changes in net assets before transactions with

owners

Reporting Financial Performance

Work in process International convergence a goal by all

standard setters