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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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A friend of yours who is not an accounting major states, “I always thought that a company recognizes revenues at the time of sale. Recently, however, I heard chat there are five specific steps for revenue recognition and that included in the steps is something about performance obligations to customers (whatever that means). Does that mean companies only recognize revenue when they get paid? But then I also heard that revenue may be recognized before or after the sale. I am confused. Please explain revenue recognition to me.”

Required:

Prepare a written response for your friend and explain the revenue recognition criteria. Also include a discussion of the reasons for, and alternative methods of, recognizing revenue in a period other than the period of sale.

To determine

Write a memo to your friend explaining about the criteria of revenue recognition, and state the alternative methods of revenue recognition.

Explanation

MEMO

From:

ABC

To:

XYZ

Re: The revenue recognition principle and its alternative methods

Dear Sir,

Revenues: Revenues are earnings from operations of a business. The operating activities are sale of goods and services, and rent revenue.

Revenues are the earnings that a company receives for transferring the goods or services to the customers. Revenues arise only when companies fulfills the performance obligations (transferring the goods or performing services) to the customers.

  • Revenues causes the following:
  • It increases the value of assets.
  • It  reduces the liabilities of the company by delivering the goods or providing service during a period, or
  • The other activities that the company includes are the ongoing major or central operations for customers.

The five key steps to apply the revenue recognition principle are as follows:

  1. Identify the best contract with a customer,
  2. Identify the requirements of the contract,
  3. Compute the transaction price,
  4. Assign the transaction price to the performance obligation, and
  5. Recognize the revenue, when (or as) each performance requirement is satisfied.

Under the accrual basis of accounting, if the company generates assets or pays off liabilities through the revenue generating process, then the accrual accounting measures and report them, even though the cash flows associated with the revenues may occur in a different period. The revenue recognition can occur after the receipt of cash flows from customers, or simultaneously with, prior to cash flows from customers...

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