Revenue Recognition: Fundamental Principles (Portfolio 5100)

Portfolio 5100-2nd, Revenue Recognition: Fundamental Principles (Accounting Policy and Practice Series), represents the first of a series of Portfolios on revenue recognition.

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This Portfolio is part of the Accounting Policy and Practice Series, an essential resource including more than 70 accounting Portfolios and the latest news and developments.



Portfolio 5100-2nd, Revenue Recognition: Fundamental Principles (Accounting Policy and Practice Series), represents the first of a series of Portfolios on revenue recognition. This Portfolio analyzes general principles governing revenue recognition. A number of revenue recognition principles apply to all types of transactions, whether they involve products or services and whether they are completed in one step or involve a long-term contract. This Portfolio refers to these principles as “fundamental principles.”
The Portfolio surveys the concept of revenue recognition, the relevant accounting literature, and the methodology of researching a revenue recognition issue. The Portfolio discusses in detail the four basic recognition criteria – persuasive evidence of an arrangement; delivery of goods or performance of services; fixed or determinable sales price; and reasonably assured collectibility. The Portfolio also discusses accounting for nonmonetary transactions; reporting revenue gross v. net; measuring revenue when the consideration is stock; determining whether certain amounts collected by a vendor should be included in revenue; determining whether certain types of discounts or sales incentives should be recorded as a reduction in revenue; and principles related to financial statement disclosure.
In addition, the Portfolio analyzes multiple-element arrangements. Transactions involving multiple elements must be analyzed to identify the deliverables (if any) that must be examined separately with respect to revenue recognition. This Portfolio analyzes when a transaction is considered a multiple-element arrangement; how to determine the separate units of accounting within a multiple-element arrangement; and how to allocate the total arrangement consideration among the units of accounting.
This Portfolio may be cited as BNA Tax and Accounting Portfolio 5100-2nd, Starczewski, Mallek, and Beil, Revenue Recognition: Fundamental Principles (Accounting Policy and Practice Series). Within the Accounting Policy and Practice Portfolio Series, however, references to the Portfolios will include only the Portfolio numbers and titles.

Note: Various FASB documents, copyright by the Financial Accounting Standards Board, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116, U.S.A., are reprinted with permission.

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Lisa Marie Starczewski, J.D. (summa cum laude), Villanova University School of Law; B.A. (magna cum laude), Smith College. Ms. Starczewski served as Editor-in-Chief of the Villanova Law Review (1987-88) and has practiced law with Morgan, Lewis & Bockius and Schnader, Harrison, Segal & Lewis. She has also taught at the Villanova University School of Law. Ms. Starczewski has coauthored, in addition to this work, several other Accounting Policy and Practice Portfolios: 5101, Revenue Recognition: Product Sales and Services; 5114, Accounting for Leases: Fundamental Principles. She has also authored numerous Tax Management Portfolios and Tax Practice Series Chapters (also published by BNA). She has received the Tax Management Distinguished Author Award and is a member of the Tax Management U.S. Income Advisory Board.

J. Randolph Mallek, CPA, Ph.D. (Accounting), The University of Texas at Austin; MPA (Master in Professional Accounting), The University of Texas at Austin; MS (Information Systems), American University; MS (Administration), University of California at Irvine. Licensed as a CPA in the state of Texas, Dr. Mallek has taught undergraduate and graduate financial, managerial, and accounting information courses at the Leventhal School of Accounting at the University of Southern California and was an Associate Professor of Accounting at Al Akhawayn University in Morocco and an Assistant Professor of Accounting at American University in Washington, D.C. Dr. Mallek works as a Professor of Accounting at Stevenson University in Baltimore. M.D.

Frank J. Beil, CPA, MS (Accounting), University of North Dakota, consults for the FASB in the areas of Revenue Recognition for Products, Services, Multiple Element Transactions, Contractor Accounting, and Accounting for Software Transactions. He is a Senior Lecturer in Accounting and Adjunct Professor of Management at the Carlson School of Management, University of Minnesota. Mr. Beil conducts seminars on Revenue Recognition, Accounting for Pensions, Accounting for Leases, and FASB Update and consults for public and private companies on applying accounting standards.


Detailed Analysis

I. Overview

A. Concept of Revenue Recognition

B. Nature of Accounting Literature on Revenue Recognition

C. Significance of Revenue Recognition

D. Methodology for Researching a Revenue Recognition Issue

1. In General

2. Steps Summarized

3. Steps Detailed

E. Fundamental Principles of Revenue Recognition-In General

F. Multiple Element Arrangements

G. Generally Accepted Accounting Principles and the GAAP Hierarchy

H. Principles-Based Accounting Standards

1. In General

2. The Proposed FASB Revenue Recognition Project

3. Sarbanes-Oxley Act of 2002 and SEC Study

a. In General

b. Revenue Recognition

I. SEC Guidance on Revenue Recognition

1. Staff Accounting Bulletins

2. SEC AAERs and LRs

a. In General

b. Need for Adequate System of Internal Accounting Controls

J. Topics Addressed in Other Portfolios

1. Product Sales

2. Service Revenues

3. Long-Term Contracts

4. Software

5. Specialized Industries

6. Accounting Fraud

II. Fundamental Principles of Revenue Recognition

A. Role of Fundamental Principles

B. Definitional Guidance-"Revenue" and "Recognition"

1. In General

2. What is "Revenue"?

3. What is the Definition of "Recognized Revenue?"

4. Conflict Between FASB CONs 5 and 6

C. The SEC's Four-Pronged Revenue Recognition Test

1. In General

2. Persuasive Evidence of an Arrangement

a. In General

(1) Effect of Pre-Sale Negotiations and/or Anticipatory Inventory Shipments

(2) Non-Binding or Incomplete Agreements

b. Indicia of an Arrangement

(1) Written and/or Authorized Sales Agreements

(a) Written Sales Agreement and Authorized Signature Requirement

(b) Approval by Seller's Management Committee or Board of Directors Requirement

(c) Effect of "Side Agreements"

(d) Absence of Formal Continuation Provisionâ€"Effect on Current Revenue Recognition

(2) E-Commerce Issues

3. Fixed or Determinable Price

a. General Rule

(1) Factors in the Customer's Control

(2) Factors in Seller's Control

(3) Factors in Control of a Third Party

(4) Factors Based on an Index

4. Performance and Delivery

a. Accounting for Advance Payments and Unearned Revenue

5. Reasonable Assurance of Collectibility

a. Credit Card Sales

b. Sales Returns and Allowances

D. Fundamental Principles Related to Measuring Revenue

1. Accounting for Nonmonetary Transactions (Barter Transactions)

2. Reporting Revenue Gross Versus Net

a. Emerging Issues Task Force-Background

b. Analysis of EITF Issue 99-19

(1) In General

(2) How Indicators Are Evaluated

(3) Sample Disclosure

3. Accounting by a Grantee For an Equity Instrument to be Received in Conjunction With Providing Goods or Services

4. Income Statement Characterization of Reimbursements Received for "Out-of-Pocket" Expenses Incurred

5. Accounting for Consideration Given by a Vendor to a Customer (Including Resellers of the Vendor's Products) or to a Third-Party Manufacturer or Reseller

a. General Application

b. Scope

c. Issues

(1) EITF Issue 01-9

(2) EITF Issue 06-1

d. Income Statement Characterization-Reduction in Revenue or Expense?

(1) Application

(2) Examples

(a) Exchanges That Do Not Represent Identifiable Benefits

(b) Exchanges That Represent Identifiable Benefits

e. Accounting for "Negative Revenue"

f. Up-Front Nonrefundable Consideration

g. Measuring the Cost of Consideration

h. Application of EITF Issue 01-9 to Gift Cards and Gift Certificates

i. Application of EITF Issue 01-9 to Below-Market Financing

6. Accounting for "Points" and Other Time-Based or Volume-Based Sales Incentive Offers for Free Products or Services to be Delivered in the Future

7. Accounting by a Customer (Including a Reseller) for Certain Consideration Received From a Vendor

a. In General

b. Reasonable Estimates of Future Refunds and Rebates

c. Up-Front Nonrefundable Consideration

III. EITF Issue 00-21, "Revenue Arrangements with Multiple Deliverables"

A. In General

B. Scope of EITF Issue 00-21

1. EITF Issue 00-21 Does Not Establish New Revenue Measurement Rules

2. EITF Issue 00-21 Excludes Open-Ended Contracts Involving Future Benefits and Award Credit Sales

3. Relationship Between EITF Issue 00-21 and Other Accounting Literature

C. Application of EITF Issue 00-21

1. Existence of an Arrangement

2. Tripartite Methodology

a. Issue 1: Identifying Units of Accounting

b. Issue 2: Determining the Total Arrangement Consideration

c. Issue 3: Allocating the Total Arrangement Consideration to the Separate Units of Accounting

3. Limitations on Consideration Allocated to Delivered Items

D. Examples of Accounting for Revenue Arrangements With Multiple Deliverables

1. Identifying the Deliverables

2. Unit of Accounting

a. First Condition of Separation: Stand-Alone Value Requirement

b. Second Condition of Separation: Evidence of Fair Value Requirement for Undelivered Item(s)

c. Third Condition for Separation: General Right of Return for Delivered Item(s)

3. Determining the Total Arrangement Consideration

4. Allocating the Total Arrangement Consideration to the Units of Accounting

a. Fair Value Method

5. Effect of Contingencies on Revenue Recognition

a. Effect of Contingency-Limitation on Consideration Allocation

b. Effect of Contingency-Postponement of Revenue Recognition

c. Residual Method

6. Revenue Recognition-Accounting Illustrations

a. Equipment Sales With Installation

b. Service Contracts and Ancillary Product Sales

c. Limitation on Revenue Recognition Per Period, Effect of Arrangement Cancellation, and Amounts Reported as Assets

E. Conclusion

IV. Financial Disclosures and Income Statement Presentation

A. In General

B. Required Disclosure of Revenue Recognition Accounting Policies and Income Statement Presentation

1. Footnote Disclosure of Accounting Policies

2. Income Statement Presentation

3. Accounting Changes-APB Opinion No. 20

4. Disclosure of Gain Contingencies

5. Disclosure of Risks and Uncertainties

6. Related Party Disclosures

C. Management's Discussion & Analysis

1. Critical Accounting Estimates and Assumptions

2. Revenue and Sales Trends


Working Papers


Worksheet 1 Relevant History of Generally Accepted Accounting Principles

Worksheet 2 Hierarchy of Generally Accepted Accounting Principles

Worksheet 3 EITF Issue No. 00â€"21, Revenue Arrangements with Multiple Deliverables

Worksheet 4 EITF Issue 00â€"10, Accounting for Shipping and Handling Fees and Costs

Worksheet 5 EITF Issue 99â€"19, Reporting Revenue Gross as a Principal versus Net as an Agent

Worksheet 6 EITF Issue 00â€"08, Accounting by a Grantee for an Equity Instrument to be Received in Conjunction with Providing Goods or Services

Worksheet 7 EITF Issue 01â€"14, Income Statement Characterization of Reimbursements Received for "Out-of-Pocket" Expenses Incurred

Worksheet 8 EITF Issue 01â€"9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)

Worksheet 9 Excerpts from Annual Report of Black & Decker Corp. on Form 10â€"K (Dec. 31, 2004)

Worksheet 10 Excerpts From Annual Report of Nucor Corp. on Form 10-K (Dec. 31, 2004)

Worksheet 11 Excerpts from Annual Report of Wal-Mart Stores Inc. on Form 10-K (Dec. 31, 2004)

Worksheet 12 Excerpts from Annual Report of BearingPoint, Inc. on Form 10-K (Dec. 31, 2004)

Worksheet 13 Excerpts from Annual Report of Perot Systems Corp. on Form 10-K (Dec. 31, 2004)

Worksheet 14 Principal Acronyms and Abbreviations Used in Portfolio

Worksheet 15 EITF Issue 06-1, Accounting for Consideration Given by a Service Provider to a Manufacturer or Reseller of Equipment Necessary for an End-Customer to Receive Service from the Service Provider

Worksheet 16 List of Significant Accounting Pronouncements Principally Discussed



Securities and Exchange Commission:

Accounting and Auditing Enforcement Releases

Staff Accounting Bulletins

Court Cases:

American Institute of Certified Public Accountants:

Accounting Principles Board Opinions

Accounting Research Bulletins

Audit and Accounting Guides

Statements on Auditing Standards

Statements of Position

Emerging Issues Task Force

Financial Accounting Standards Board:

Concepts Statements

Statements of Financial Accounting Standards

Proposals, Reports, Updates


Textbooks, Handbooks, and Articles:

BNA Tax and Accounting Portfolios: