Accounting Way

Guidelines for Revenue Recognition

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In general, the guidelines for revenue recognition are quite broad. On top of the broad

guidelines, certain industries have specific additional guidelines that provide further

insight into when revenue should be recognized. The revenue recognition

principle provides that companies should recognize revenue (1) when it is realized

or realizable and (2) when it is earned. Therefore, proper revenue recognition

revolves around three terms

Revenues are realized when a company exchanges goods and services for cash or

claims to cash (receivables).

Revenues are realizable when assets a company receives in exchange are readily

convertible to known amounts of cash or claims to cash.

Revenues are earned when a company has substantially accomplished what it must

do to be entitled to the benefits represented by the revenues—that is, when the

earnings process is complete or virtually complete.

Four revenue transactions are recognized in accordance with this principle:

1. Companies recognize revenue from selling products at the date of sale. This

date is usually interpreted to mean the date of delivery to customers.

2. Companies recognize revenue from services provided, when services have

been performed and are billable.

3. Companies recognize revenue from permitting others to use enterprise assets,

such as interest, rent, and royalties, as time passes or as the assets are used.

4. Companies recognize revenue from disposing of assets other than products

at the date of sale.

Who Uses Accounting Data

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The information that a user of financial information needs depends upon

the kinds of decisions the user makes.There are two broad groups of users

of financial information: internal users and external users.

INTERNAL USERS

Internal users of accounting information are those individuals inside a company

who plan, organize, and run the business. These include marketing managers, production

supervisors, finance directors, and company officers.

Managerial accounting
provides internal reports to help users

make decisions about their companies. Examples are financial comparisons of operating

alternatives, projections of income from new sales campaigns, and forecasts

of cash needs for the next year.

EXTERNAL USERS

External users are individuals and organizations outside a company who want financial

information about the company. The two most common types of external

users are investors and creditors. Investors (owners) use accounting information to

make decisions to buy, hold, or sell ownership shares of a company. Creditors (such

as suppliers and bankers) use accounting information to evaluate the risks of

granting credit or lending money.

Financial accounting
answers these questions. It provides economic and financial

information for investors, creditors, and other external users. The information

needs of external users vary considerably. Taxing authorities (such as the Internal

Revenue Service) want to know whether the company complies with tax laws.

Regulatory agencies, such as the Securities and Exchange Commission and the

Federal Trade Commission, want to know whether the company is operating within

prescribed rules. Customers are interested in whether a company like General

Motors will continue to honor product warranties and support its product lines.

Labor unions such as the Major League Baseball Players Association want to know

whether the owners can pay increased wages and benefits.

WHAT IS ACCOUNTING? (2)

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Why is accounting so popular? What consistently ranks as one of the top

career opportunities in business? What frequently rates among the most

popular majors on campus? What was the undergraduate degree chosen

by Nike founder Phil Knight, Home Depot co-founder Arthur Blank, former acting

director of the Federal Bureau of Investigation (FBI) Thomas Pickard, and numerous

members of Congress? Accounting.1 Why did these people choose accounting?

They wanted to understand what was happening financially to their

organizations. Accounting is the financial information system that provides these

insights. In short, to understand your organization, you have to know the numbers.

Accounting
consists of three basic activities—it identifies, records, and communicates

the economic events of an organization to interested users. Let's take a

closer look at these three activities.

Three Activities

To identify economic events, a company selects the economic events relevant to its

business. Examples of economic events are the sale of snack chips by PepsiCo,

providing of telephone services by AT&T, and payment of wages by Ford Motor

Company.

Once a company like PepsiCo identifies economic events, it records those

events in order to provide a history of its financial activities. Recording consists of

keeping a systematic, chronological diary of events, measured in dollars and cents.

In recording, PepsiCo also classifies and summarizes economic events.

Finally, PepsiCo communicates the collected information to interested users by

means of accounting reports. The most common of these reports are called

financial statements. To make the reported financial information meaningful,

Kellogg reports the recorded data in a standardized way. It accumulates information

resulting from similar transactions. For example, PepsiCo accumulates all sales

transactions over a certain period of time and reports the data as one amount in the

company's financial statements. Such data are said to be reported in the aggregate.

By presenting the recorded data in the aggregate, the accounting process simplifies

a multitude of transactions and makes a series of activities understandable and

meaningful.

A vital element in communicating economic events is the accountant's ability

to analyze and interpret the reported information. Analysis involves use of ratios,

percentages, graphs, and charts to highlight significant financial trends and relationships.

Interpretation involves explaining the uses, meaning, and limitations of

reported data. Appendix A of this textbook shows the financial statements of

PepsiCo, Inc.; Appendix B illustrates the financial statements of The Coca-Cola

Company. We refer to these statements at various places throughout the text. At

this point, they probably strike you as complex and confusing. By the end of this

course, you'll be surprised at your ability to understand, analyze, and interpret them.

You should understand that the accounting process includes the bookkeeping

function. Bookkeeping
usually involves only the recording of economic events. It is

therefore just one part of the accounting process. In total, accounting involves the

entire process of identifying, recording, and communicating economic events.

Timing issues

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Accountants divide the economic life of a business into artificial time periods

(Time Period Assumption)

Generally a month, a quarter, or a year.
Fiscal year vs. calendar year
Also known as the "Periodicity Assumption"

Accrual- vs. Cash-Basis Accounting

Accrual-Basis Accounting

Transactions recorded in the periods in which the events occur
Revenues are recognized when earned, rather than when cash is received.
Expenses are recognized when incurred, rather than when paid.

Cash-Basis Accounting

Revenues are recognized when cash is received.
Expenses are recognized when cash is paid.
Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP).

Posting

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Posting – the process of transferring amounts from the journal to the ledger accounts.

The Ledger

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A General Ledger contains the entire group of accounts maintained by a company.

The General Ledger includes all the asset, liability, owner’s equity, revenue and expense accounts.

Double entry

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Double-entry accounting system

Each transaction must affect two or more accounts to keep the basic accounting equation in balance.

Recording done by debiting at least one account and crediting another.

DEBITS must equal CREDITS

If Debits are greater than Credits, the account will have a debit balance.
If Credits are greater than Debits, the account will have a credit balance.

Accounting Career Opportunities

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Public Accounting

Careers in auditing and taxation serving the general public.

Private Accounting

Careers in industry working in cost accounting, budgeting,

accounting information systems, and taxation.

Opportunities in Government

Careers with the IRS, the FBI, the SEC, and in public

colleges and universities.

Forensic Accounting

Careers with insurance companies and law offices to conduct

investigations into theft and fraud.

Ethics In Financial Reporting

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Standards of conduct by which one’s actions are judged as right or wrong, honest or dishonest, fair or not fair, are Ethics.

* Recent financial scandals include: Enron, WorldCom, HealthSouth, AIG, and others.

* Congress passed Sarbanes-Oxley Act of 2002.

* Effective financial reporting depends on sound ethical behavior.

What is Accounting?

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The purpose of accounting is to:

identify, record, and communicate the economic events of an organization to

interested users.

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2009-09-08T09:18:00.000+01:00

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Theories & Further Information about Shareholder's Equity

2009-09-04T21:56:00.003+01:00

The shareholder's equity is often an important part of the capital that funds the net assets.

The share capital may be made up of both ordinary and preference shares, though preference shares are much less popular these days for tax reasons. However, in the notes to the accounts there may also be a figure for Authorised Share Capital. This may be very different to the Issued Share Capital. The authorised capital is the maximum amount of money that the shareholders have decided that the company can issue in shares and will usually be considerably larger than the issues share capital as the company wants to retain the option of issuing more shares in the future to raise more capital - perhaps to fund an expansion.

The reserves will include retained profit from the past. That is profits that the firm has kept for itself and not issued to shareholders in the form of a dividend. They may also include share premiums. As mentioned in the explanation of shareholder's equity, this is where shares are issued at more than their face value. The face value of the share may be, say £1, but they may be issued at £3.50 because the market has risen in the meantime and the shares are now worth much more. The £1 will be included as part of the issued share capital (see above), but the other £2.50 will be called a share premium. A final part of reserves may be something called revaluations. If the company's assets have risen in value - perhaps because of inflation - this is effectively a source of funds for the shareholders and so also needs to be recorded on the bottom half of the balance sheet. This situation can occur particularly with property companies such as hotel operators where the value of the properties rises with a booming property market.

The shareholder's equity is shown on the balance sheet as part of the balancing figure - the one that matches the net assets. It is therefore a key part of the capital financing of the business.

What is Shareholder's Equity?

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The shareholder's equity comes in the bottom half of the balance sheet and is part of the overall financing of the business. The shareholder's equity is a part of the overall level of capital that finances the net assets.
As well as the shareholder's equity the net assets may be financed by:

•Retained profit & reserves

•Loans & debentures

There may also be other more detailed sources of capital shown on a balance sheet. These may include the "share premium account". This is where the shares are issued at above their face value. The amount raised from the sale of shares is then split into two - the share capital (the face value of all the shares) and the share premium account (the surplus over and above the face value).

The shareholder's equity may also be known as the equity capital. The reward to the shareholders for investing this money in the business is a share of the profit - a dividend . The amount of the dividend clearly depends on the profitability of the business.

Theories & Further Information about Dividends Payable

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When it's considering how much of its profit to pay in dividends, the company is up against various conflicting interests. The shareholders clearly want a share of the profit in return for their investment in the shares, but they also (unless they're very short-sighted!!) want the company to grow in the future. To grow in the future, the company needs to invest a proportion of the profit. Whatever is invested can't then be paid to shareholders as dividends.
It is the job of the Board of Directors to try to take account of all these conflicting interests and to decide on the level of dividend they are going to recommend is paid. This recommendation is then considered at the Annual General Meeting of the company. The Directors should be in the best position to decide what needs to be re-invested and therefore how much can be spared to be paid out as dividends.

For more detail about how much of its profit a company is paying out in dividends, shareholders or potential investors could look at the DIVIDEND COVER or the DIVIDEND YIELD RATIOS. There is more detail on these in the reported earnings per share and the reported dividend per share pages.

Theories & Further Information about Dividends Payable

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What are Dividends Payable?

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Any profit that the firm makes belongs to the owners of that firm. They are the shareholders. The amount of the profit that each shareholder should receive depends on how many shares they own. The more shares they own, the larger the proportion of the company they own and therefore the more of the profit they should receive. This share of the profit is known as a dividend and to spread out fairly, the dividend is normally expressed as an amount per share.

The size of the dividend depends on two things. First it depends on the amount of profit that has been made, but secondly it depends on how much of the profit is distributed to the shareholders. Profit is a vital source of funds for investment for a company and so if they were to distribute too much to the shareholders, they would damage their long-term performance. However, at the same time the shareholders are entitled to a share as the reward for the risk they have taken in investing in the company.

The Board of Directors has to balance up these two demands on the total profit, and will then recommend the size of the dividend they think is appropriate. This will then be put to the firm's AGM for the shareholders to vote on.

Profit attributable to shareholders = Dividends paid + Retained profit

For further details about profit, you could look at the section on operating profit or the Financial Ratios section.

What is Interest Payable?

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When a firm borrows money, it has to pay interest. Interest is the return to the lender for the service of having lent money and the associated risk. The level of interest payable is therefore the total amount of interest the firm has to pay on all its borrowings, whether short-term or long-term.

The amount of interest payable will depend on how much money the firm has borrowed, and for how long it has borrowed it. The rate of interest will vary according to the level of risk (the higher the risk the higher the rate of interest) and the length of time the money is borrowed for (short-term, unpredictable borrowing such as overdrafts will command higher rates of interest).
Interest payable is usually subtracted from the operating profit to give the profit on ordinary activities before taxation. It is not considered to be a part of the trading profit, as this measures the profit the firm has made on its mainstream activity of selling its product or service.

What is Cost of Goods Sold?

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Cost of goods sold is also sometimes phrased as COST OF SALES.

The cost of goods sold is the costs actually incurred in producing the product or service. It is the direct costs of production. It does not include the indirect costs, which may be things like administration and marketing costs. These cannot be directly attributed to producing the product and so are not included.

The cost of goods sold for a production company will include things like raw materials, energy and labour used to produce the product. For a retail company such as Marks and Spencer it will be the total amount they have paid to their suppliers for the products they sell on the shelves.