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Resistance has been lodged by stakeholders regarding adjustment for time value of money. In 2011, FASB and IASB proposed that if a contract with a client has a momentous financing component, the company should adjust the amount consideration promised for the effect of time value of money. The inclusion of time value of money in revenue recognition has been met with opposition from some corporation and AICPA because of its complexity that its realistic challenges and cost would overshadow the benefits of the users. The principles of time value of money dictates that a particular amount of money has different buying power compared to the same amount in the future due to changes in inflation and interest. Where interest is earned on money, inflation will drive the prices high hence changing the value of money. Furthermore, complexity is detected when the letter proposes that in evaluating time value of money, a company shoulder consider how it manages its net cash inflows and outflows to accurately reflect the time value of money. General Motors, Chrysler and Boeing championed for modification or elimination of time value of money conditions because of its ability to deceive and generate operational challenges to implement. The board also proposed that a company to recognize revenue at the amount of consideration paid to which is entitled from the customer. Therefore the collectability would not openly influence the timing of revenue recognition but it is taken into consideration in deciding the contract price, hence affecting how much can be recognized. The condition to lessen the amount of revenue recognized for the projected portion that may be uncollectible comprises of circumstances in which an entity comes into agreements with customers and assumes a percentage of them to default, but unable to identify which exact customers will default. Assuming the company comes into agreement with a group of similar contracts in which the condition is obliged to be attuned to reflect the customer's credit risk, the company may recognize revenue on an individual contract basis in the sum of the invoiced total. The company would at that time amend the initial measurement of the receivables and identify a conforming reduction of revenue for the group of contracts. Even though credit risk has no impact on time value of money, the presentation of credit losses in a line of adjustments in the income statement as proposed by the board was met by a lot of resentment. In November 2012, the boards settle on the effects of customer credit risk that it presented as a separate line in expenses in the income statement, rather than adjacent to revenue (Tarantino & Cemauskas,2009)
What is IAS 18 Revenue Recognition?
Based on events and transactions, IAS 18 major goal is to explain the accounting treatment of revenue accrued from those transactions. The word revenue here means the economic gains whether in cash or asset form derived from the daily transactions of the business entity like sale of goods & services, interest and dividends. Measurement of revenue should be done at the fair value of consideration paid or to be paid, which means that barter trade of similar goods does not constitute a transaction that generates revenue. However, when the exchange happens with goods which are not similar it is said to be generating revenue. Recognition of revenue is basically the inclusion of items in the statement of income whose amount of revenue can be measure and the future benefits of the item can be traced back to the entity without much difficulty.
IAS 18 specifies the guidance when it comes to recognition of specified revenue generating activities namely:
In Sale of goods
Revenue arising should be recognized when the risk, reward of ownership and generally the economic benefits associated with the goods changes completely from the seller to the buyer
Amount of revenue can be reliably measured
Costs of the transaction can be measured according to the quantity of goods sold or services rendered
The seller no longer retains the right to participate in the management or in any form of control regarding the ownership of the products or goods sold. In rendering of services, if all the principle had been followed to the latter, revenue arising should be recognized when the transaction is finalized for example the time when closing the books of accounts and to the extent the expenses associated with rendering services can be recovered. The benefits realized are accrued to the person who renders the services or transfers to the seller. Also when rendering services the stage at which statement of financial position can be considered appropriately. (IAS 18.25) states that when the above procedures are not considered then the revenue accrued from providing services, only expenses that can be recovered should be recognized.
Epstein & Jermakowicz (2008) indicate that when it comes to royalties, interest and dividends, if it can be ascertained that all the benefits will flow to the firm and it can be measured with a great degree of absoluteness then royalties will be recognized on the accrual basis as specified in the agreement. Dividends are recognized when it is established that the shareholder has a right to the said dividends and the effective interest method is used to recognize the interest. A couple of things should be considered when it comes to recognizing revenue, reliable measurement of revenue, the flow of economic benefit from the transaction and the cost incurred in effecting the transaction (IAS 18.29-30)
Weaknesses of IAS 18 (Revenue Recognition)
Spreadsheet over automated
The weaknesses of revenue recognition as discussed in IAS 18 arise from the implementation of the accounting policies and from the sources of income which are: interest, royalties, dividends and sale of goods, which involve the exchange of services and goods. A survey done by Revenue Recognition and IDC about financial managers showed that the increase in companies' failure of compliance and financial statements is because 92% of public corporations employ spreadsheets to carry out their important accounting activities in revenue reporting processes. The fact that revenue recognition and reporting is not yet automated makes the use of spreadsheets more common. Because of the nature of risks involved with spreadsheets, managers, investors, auditors and finance department should be concerned if it fails to follow the basic principles of compliance. Spreadsheets sometimes don't follow procedure hence leading to financial restatements and violates basic rule and regulations in accounting policies. Some checks are avoided making the company prone to fraud. The three basic ways to improve Revenue Recognition and accounting process is to implement a business intelligent solutions which is used for analyzing revenue, financial systems should have augmented revenue recognition utility and establish a source revenue date that is clean and single. Revenue Recognition processes is always reliant on multiple sources of information and cannot be implemented in the obtainable enterprise system (Revenue Recognition, 2010). The requirement is automation across all borders of functions that will bestow numerous advantages.
Majority of the revenue transaction whether initiated and completed almost at the same time tend to pose several problems to revenue recognition. Nonetheless, not completely every transaction is that simple. For instance, clients might pay at a time which is not the same from that after they obtain goods or services, and the promised goods and services will be provided by the entity over many reporting periods. To take into consideration for those transactions, accountants have come about with an idea in which an entity distinguishes i) revenue when charge is received or receivable from a client and ii) the entity "earns" that revenue by the provision of goods or services that were promised to the customer. Thus meaning revenue will be recognized when the payment is realized or realizable and the "earnings process" is considerably completed.
Currently, weaknesses affecting revenue recognition are: the critical event or earnings process which are the current focus. This leads to lack of comparability in practice because it is difficult to identify. IFRS has failed to provide guides concerning multiple element arrangements. It is not clearly stated in the IAS 18 about how a company should distinct a solitary transaction into components. Taken from the official IAS 18 guide, the paragraph 17 and 19 is being interpreted as allowing the recognition of the all the revenue for multiple element arrangement upon distribution of the first element if all elements are sold together.
Example (taken from an article written by Lie Dharma Putra) for multiple-element arrangement would be:
ABC Company sells an mp3 player, which it calls the Liepod. ABC prefers to sell the Liepod with a bundled annual support package, which sells for $320. Without the service package, the Liepod retails for $250, and ABC sells the servicing package separately for $120 per year.
ABC splits apart the two revenue elements of the bundled annual support package by allocating revenue to the Liepod, based on the fair values of the Liepod and its support package, which it calculates as follows:
$250 product price
__________________________________ Ã- $320 bundled price = $216.22
$250 product price + $120 servicing price
ABC Company also allocates revenue to the support package in the same manner with the following calculation:
$120 servicing price
__________________________________ Ã- $320 bundled price = $103.78
$250 product price + $120 servicing price
Based on these calculations, ABC can recognize $216.22 of revenue every time it sells the bundled Liepod support package. However, because ABC must provide one year of service under the support package, the remaining $103.78 of revenue associated with the servicing contract can only be incrementally recognized on a monthly basis over the 12-month life of the service contract, which is $8.65 per month.
In spite of this, there are others who came up with an interpretation about the same paragraphs is to involve delay of revenue for the entire elements until transfer of the last elements has also been made thus creating confusion between which is the right path to follow. This clearly shows that IFRSs has failed to provide a proper guidance on the measuring of elements in the multiple-element arrangement. Without such guidance, there will be lost of objectivity for the left behind elements in such an arrangement, thus an increase in different measurement approaches to the same kind of transactions which results in reduction of comparability of revenue among companies.
Difference concerning the goods and services is another problem in IFRSs.
Revenue is recognized when a company agrees to transfer goods or service to the customer because when a company agrees to dispose something or provide services under contract, it is elevated to a contract position (IFRS, 2012)
The risks and rewards concept in IAS 18 may also be problematic when a transaction includes both a good and services associated to that good. In the absence of a clear understanding between goods and services, some companies were accounting for construction (service) contracts by recognizing revenue throughout the construction process. While we have other companies that were accounting for contracts for goods where recognizing revenue when the risks and rewards of possessing the property were transferred to the customer. As a result, revenue does not signify the outline of the transfer to the client of the entire goods and services listed in the agreement. Additionally, depending on how the accruals for the services are measured, an entity could realize the entire income in the agreement before the entity has satisfied all of its duties. The reduction of the comparability of revenue across entities is due to the absence of a clear difference between goods and services.
Uncertainties to recognize revenue at different cycles
Another weakness we can think of is that revenue is earned when the most important decisions are made or acts are performed in the operating cycle. In reality, revenue recognition may occur at different stages, at the time of delivery of items, at the time of sale or at the time when cash is collected. Revenue Recognition is prone to a number of inconsistencies that could occur as any stage of transaction or cycle. Since the uncertainties may fall at difference cycles, it is prudent for a manager to identify a point where the remaining uncertainties can be estimated with some degree of accuracy in order to recognize revenue (IFRS, 2012). Normally the decision is not accurate, complications usually arise in the case where transactions that involve many elements and the important post-delivery responsibilities. It is generally accepted practice in a couple of industries to recognize revenue at the stage when productions are finished; it is seldom that a sales contract has been agreed upon. This practice has been put into action in industries dealing with Agricultural and Mineral products which is basically supported by IAS 2 (inventories). When inventory is carried at net realizable value on one condition that this change would be reflected in the profit or loss account in that period that change occurred. Recognition and measurement in Financial Statement of Business entities suggest that revenue is only recognized when the production of a certain asset is completed. However, this occurs only when the assets involved are interchangeable unit, prices are quoted and they can easily be absorbed in the market without affecting the price of a company in terms of the quantities held by the same company (Tarantino .2008). There could be cases where consigned inventories remain in the seller's warehouse and have yet to be distributed to the buyer.
As a result, an entity may perhaps distinguish a good as inventory because majority of risks and rewards may not have been passed yet to the client even after the client has gained control over the good. That result is inconsistent with the IASB's description of an asset, which relies on control of the good but not the risks and rewards of owning the good.
There are some criticisms regarding the revenue recognition standards in IFRSs. This is because the standards applied by a certain entity might recognize the amounts in the financial statements that do no truthfully represent economic phenomena. That can take place since revenue recognition for the sale of a good rests mainly on when the risks and rewards for the rights of the good are passed to a purchaser.
Briefly, the main concern is the revenue recognition when recognizing the elements in financial statements, with the FASB's Concepts Statements offer conceptual regulation on the nature and significance of revenue recognition, there is no comprehensive and authoritative revenue recognition standard in most financial reporting standards or in accounting theory in general, which means there are always loopholes in the standard because it is only a guidance not a clear definite rule of the standard, it will always be changes and adjustments in the fore coming years. Other issues include a lack of consistency in recognition across different reporting standards and countries, the recognition of intangible assets, securitization, and conflict between recognition and disclosure in the financial statements. Thus, by applying the paragraph 13 of IAS 18, we take into account whether the goods are supplied by the entity itself or by a third party. If the goods are supplied by entity itself, consider the revenue recognized when the goods are redeemed and obligation to supply the goods has been completed.