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Revenue Recognition & Reporting Financial Performance
Stephenie Fox CA
Principal, CICA
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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
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Section 3400
Addresses timing of revenue recognition
(not measurement)
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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.
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Revenue Recognition
¶.06 – recognize when performance requirements (¶ 07&08) are satisfied and ultimate collection is reasonably assured
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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
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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
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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
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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
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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
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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
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Transfers of Risks and Rewards
Completion of significant acts Not always easy to assess E.g. bill and hold sales, contracts with
multiple elements
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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
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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
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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
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Persuasive Evidence of an Arrangement
Arrangement:
final understanding between the parties as to the specific nature and terms of the agreed upon transaction
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Determining Whether an Arrangement Exists
Customary business practices Side arrangements Consignment arrangements Title passes but revenue recognition
precluded
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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
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Fixed or Determinable Sales Price
Cancellable sales arrangement Right of return Price protections/inventory credit
arrangements Refundable fee for service arrangements
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Disclosure of accounting policies
Always disclose revenue recognition policy Policy for each type of transaction If multiple elements, policy for each element
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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
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EIC 143 Extended warranty and product maintenance contracts
Defer and recognize over life of contract Costs incurred should be deferred
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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?
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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
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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.
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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
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Presentation
Net income Other comprehensive income Total One or two statements Terms may vary
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Statement of Comprehensive Income
20X2 20X1
Net income 651 22
Other comprehensive income net of tax
2102 702
Comprehensive Income
2753 724
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Reporting Financial Performance
Convergence project
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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
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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
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Reporting Financial Performance
Work in process International convergence a goal by all
standard setters