Executive Summary
Revenue recognition is the principle that guides the specific conditions under which revenue is recognized in an organization. Revenue recognition is guided by the various situations that influence the recognition process. The conditions are grouped into performance, collectability, and measurability. An in-depth look at the performance-based condition reveals that the risks and rewards involved in goods and services have to be transferred from the seller to the buyer for revenue to be recognized. Also, the seller should not have control of the products already sold for the income to be recognized. A thorough consideration of the collectability principles indicates that the revenue in an organization is recognized when the collection of payment of the goods from the buyer's side is reasonably assured. A more careful focus on the measurability indicates that the revenue in a firm is recorded when the amount of revenue can be determined reasonably. Lastly, the costs of the revenue can also be measured adequately. The conditions guiding the recognition of revenue magnify the importance of timing in the revenue recognition process. According to the accounting and finance experts from the economic sector, the timing of the process adds on to the advantages that it has to the involved companies. Timing enables the companies to separate the payments from the money to be spent in a way that reduces confusion among the financial analysts. The timing of the revenue recognition also enables a given company to be in line with the conditions of the International Accounting Standards Board (IASB). Such a company is usually at the cutting edge of equitable accounting procedures. Timing also makes the work of the financial officers easier in accounting as they interact with the technological systems and equipment that help them with most of the accounting work such as revenue recognition and recording.
Importance of Different Methods of Revenue Recognition
The first method of revenue recognition is the sales method (Wagenhofer, 2014). The sales method of accounting recognizes the revenue earned from a particular sale after it is completed and the product or service exchanges hands (Wagenhofer, 2014). The sales method is relevant to the modern organizations in that it reduces the issue of confusion on the recognition and the recording of the revenue earned from the sales. Additionally, the fact that the revenue is not recognized when the cash has been received from a customer without the product or service exchanging from the seller to the buyer ensures that there is proper communication among the finance managers since the products have to be matched with the revenue they bring to the company (Wagenhofer, 2014). As for the sales method of revenue recognition, timing affects the recording of the revenue and ensures that it is not recorded inappropriately. The proper timing in the recording of the money collected from sales, therefore, ensures that the companies and their customers influence the process of accounting positively.
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The second method of revenue recognition is the percentage of completion method (Biondi et al., 2014). The percentage completion method is majorly used for projects that are undertaken in a given company. Under the percentage completion method, revenue is recorded after it has been generated. For instance, if a fashion based company, comes up with a project of manufacturing baseball caps, they are going to record the revenue made from the sales of the baseball caps after they have all been sold(Biondi et al., 2014). The percentage of completion method of revenue recognition enables a company to come up with the various targets that drive the projects forward. Also, the method leads to the near accuracy of the calculations regarding the costs involved which is essential to the facilitation of the budgeting process at the organizational level (Biondi et al., 2014). Timing chips in the percentage of completion process by ensuring that the accounting officials observe the completion of the project to recognize the generated revenue.
Quite different from both the sales method and the percentage of completion method is the cost recoverability method of revenue recognition (Zhang & Chen, 2017). The cost recoverability method is the most conservative revenue recognition method in the field of accounting. The method of recognition is relevant to a company, which cannot reasonably estimate the total expenses that would be expected to cover a project being undertaken in an organization (Zhang & Chen, 2017). The cost recoverability method is different from the other methods of revenue recognition in that it does not account for the profits earned from the project until all the expenses are covered. In other words, under the cost recoverability method of revenue recognition, the profits made by the company are not recorded on the income statement of the company (Zhang & Chen, 2017). The method of recognition enables a company to avoid the accounting errors that possibly come up in the allocation of the various resources to cover expenses against the profits earned.
The last method of recognizing revenue at an organizational level is the installment method (Chandra, Dutta & Marcinko, 2018). Under the installment method, a company records the profits earned after the money is received from the buyer. The actual collection of cash has to be seen for the revenue to be recognized under this method. The gross profit collected from the sales is calculated proportionally to the cash that has been received after the sales have been made at the organizational level (Chandra, Dutta & Marcinko, 2018). The installment method of revenue recognition works for the companies that want to record the income earned from their goods after the cash has been received physically or through the electronic cash means (Chandra, Dutta & Marcinko, 2018). For instance, if a land purchase paid a deposit followed by a 50% installment, the realty company selling the piece of land records it after the money has been received in either installment.
Summary Position
The selection of the best method of revenue recognition depends on the industry that a company is in and the type of service that a company renders to the target customers (McCarthy & McCarthy, 2014). The companies that are in both land and car dealership would use the installment method of revenue recognition where the income that has been earned from the sale of a piece of land or a particular car model is recorded after the installments have been made (McCarthy & McCarthy, 2014). Vice versa, a company that is categorized under the export industry in the manufacturing sub-sector can find the sales method of revenue recognition particularly helpful and especially in the recording of the company's receivables. Additionally, such a company may opt to use the cost recovery method of the revenue recognition process of an organization. Most of the customers in the manufacturing industries are retail (McCarthy & McCarthy, 2014). Therefore, there are sales recorded regularly within the business operation period of a firm. The payments are also received sooner compared to those of the car and land dealerships. The best method of revenue recognition, therefore, depends on the customers that the company serves, the frequency and number of payments made for the goods and services and the industry of the company (McCarthy & McCarthy, 2014).
Each company has various indicators for the revenue recognition process (Holzmann & Munter, 2014). The most common indicators are the cash positioning, cash available, and the time value of money (Holzmann & Munter, 2014). The three symbols justify the viability of the revenue recognition strategies that the management of a particular organization can implement in the process of identifying and classifying its various sources of revenue (Holzmann & Munter, 2014). A slight preview of the companies that sell most of their goods on credit indicates that the organizations have a high amount of revenue with corresponding low cash position. An in-depth review of all the methods of revenue recognition that have been highlighted as mentioned earlier the relevance of the installment method in cutting across all the sectors that are in the world (Holzmann & Munter, 2014). One of the merits of the installment method that makes it popular among the various companies is the conservativeness of the plan (Small & Kamdar, 2015). Its conservativeness enables the financial accounting managers to avoid the errors that are in the process of revenue recognition. The conservativeness of the installment method of revenue recognition also helps the companies to avoid other risks of recording and recognizing revenues generated from the products and services of the company (Small & Kamdar, 2015).
The installment method has also been said to have the capability to boost a company's revenue performance in the various sectors of growth and development (Small & Kamdar, 2015). Therefore, the installment method can be a measure of organizational efficiency. The method of revenue recognition, thus, provides a trend that can be followed regarding the revenue in a given company. The installment method of revenue recognition also provides sufficient time for an organization to calculate the overall revenue it receives from its financial operations rather than collect the partial payments that do not accurately account for the total revenue earned (Small & Kamdar, 2015). On the other hand, the installment method of revenue recognition may lead to the starvation of cash for the various projects of the company with the idea that the expenses involved in the project are supposed to be computed once the total revenue has been received. Hence, the installment method of revenue recognition may not work for the companies whose days of inventory turnover are short due to the need to replace and restock the inventory regularly. The installment method of revenue recognition may also lead to the company's indulgence in debts as it seeks to finance its operations, even after the intended cash has been depleted. The indulgence into debt may make the organization inefficient in its long-term operational aspects.
Recommendation
In spite of the various pitfalls that are brought about by the use of the installment method of revenue recognition, the plan is still the recommended one to be used in the various industries that are present in the various spheres of business (Small & Kamdar, 2015). Regarding timing, the revenue recognition method involving the use of the installments has proven to be one of the best plans that a modern company can have. The approach of the installment method in revenue recognition establishes the use of the payments made by the customers to particular products and services to cover the costs that have been used in the production of the items. The installment method of revenue timing has therefore proven to be one of the best programs in financial accounting that cater for the timing aspects, which are necessary for a business setup (Small & Kamdar, 2015). The installment method of revenue recognition is also advisable for the businesses of various sizes and financial capability since the revenues earned match the cash flows. Unlike both the sales methods and the cost recovery plan of recognizing the money that has been earned by a company, the installment method does not have an in-depth focus on the forecasts that are made on the income in the future aspects of the business. As a result, the financial accounting departments of the business ventures do not have to go through the strenuous and exhausting operations involving the forecasting of the revenues of the company (Small & Kamdar, 2015). Most of the company policies tend to favor the introduction of the installment method of revenue recognition to positively affect the productivity of the company and spearhead the effective conduction of the various business activities that translate into profits in the long run. The revenue recognition method also forms the foundation for the application of revenue recording methods.
The timing in the revenue recognition contributed to by the installment method leads to the improvement of the company's operations in the following aspects. The first area is the management of cash flows (Small & Kamdar, 2015). The management of cash flows by the organization is heavily dependent on the timing of the revenue recognition. Such timing enables the various parts of the statement of cash flows to be filled in good time to contribute to proper accounting and forecasting of the company's performance. The installment method of revenue recognition also takes advantage of the timing to determine the fixed billing schedules (Small & Kamdar, 2015). Each company has both fixed and variable bills to take care of during each accounting period. The fixed bills have a constant expense rate in each accounting period such as the rent of the premises that the business is located. Proper timing of the revenue recognition ensures that the business enterprise is timely in the payment of its bills. The other importance of timing as indicated by the installment method of revenue recognition is the acceleration of the billing cycles (Small & Kamdar, 2015). The billing cycles are the number of payments that a company makes to meet its financial obligations and especially the bills. The acceleration of the billing cycles is relevant to the increase in the revenue cycles as well for the company (Small & Kamdar, 2015). Proper timing as indicated by the installment method of revenue recognition leads to the proper appropriation of the revenues that are received by a business venture from its multiple operations. Furthermore, the installment method of revenue recognition leads to the effectiveness in the making of the managerial decisions in the various capacities at the organizational level (Small & Kamdar, 2015). Therefore, I would recommend organizations to make use of the installment method of revenue recognition due to its numerous advantages to a diversified business structure and its ability to integrate the use o technology in recognizing the revenues earned by an organization. Even though the method has some demerits, its merits outweigh them.
Conclusion
Revenue recognition has been described as one of the most critical managerial functions in an organization that targets to identify and record the various sources of income and the exact amount of money they give to the company. Timing has influenced the process of revenue recognition, which has been made more significant to the company scenarios. Methods of revenue recognition have been said to range from the sales method, cost recovery method, percentage of completion method and the installment methods. All the plans that facilitate the revenue recognition process have both advantages and disadvantages. The best method of revenue recognition that takes into consideration the issues of proper timing has been stated to be the installment method of revenue recognition. Under the program, the revenue earned from the sale of a product or service in an organization is recorded when the physical or electronic payment transfer has been effected. The installment method of revenue recognition has been able to ease the process for the cost accounting managers and the financial officers in the various parts of the organizations. Furthermore, the method of revenue recognition reduces the risks that could be incurred in the recognition and the recording of the revenues earned from the various operations of the company. Nonetheless, the installment revenue recognition method may not work effectively when a company has long-term and short-term debts due to the tendencies of such companies to pay their financial obligations before meeting the internal expenses of the company. All in all, the installment method of revenue recognition is still the best for many organizations.
References
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