8 Aug 2022

193

Revenue Recognition: Revenue Recognition Principles

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Academic level: College

Paper type: Q&A

Words: 636

Pages: 2

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Q1: Why is revenue recognition considered a high fraud risk area? 

Revenue recognition is considered a high fraud risk area mainly because it is the easiest tool used for financial reporting fraud. The ease in which financial fraudsters can alter financial revenues has made it the most common tool used to conduct financial fraud. Revenue recognition can be altered quite easily in instances when revenue transactions are quite large and small alterations may not be found by external auditors. 

Another reason why revenue recognition is a high fraud risk area is because it is the most important indicator of a financial entity’s share price. A minor alteration of a company’s revenue can lure investors and can affect the company’s stocks. 

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Revenue recognition is also a high risk area because there are several techniques which revenues can be overstated and fabricated. Some techniques are well understood and available for use by financial reporting fraud. While the SEC and law enforcers are aware of most of the methods, fraudsters are constantly formulating new variations of ways to alter revenues. 

Q2: How might a fraudster inflate revenue? 

One basic way which a fraudster can inflate revenue is through adding fictitious sales to fake products that did not exist. This is achieved through recording deceiving revenues goods and services which were may not have been delivered. When recording financial information, fraudsters can do this by having sales journal entries recorded and those sales are not attributed to any specific customer. In case the sales are recorded, they can be attributed to fictitious customers. 

The second way fraudsters can inflate revenue is through reporting future revenue that may not have been received. When a large portion of this is credited as sales, it may not occur in the future period as stated. 

A third way fraudsters can inflate revenue is through reporting cancel orders as revenues. A firm can count all its orders as received revenue and when some of the orders are canceled do not alter the cancelations. 

Q3: Why might management overstate revenue? 

Management can decide to overstate revenue so as to show maximum productivity of a firm. A productive firm will appear to have higher earnings and the company can look more profitable than it actually is. 

Having an overstated revenue can also be done to influence investors into a company. With a larger number of investors looking to join the company, this can make the stock prices of the company to go up as the company will appear to be more profitable. 

In case a company is reporting very poor revenues, the management may want inflate revenues in order to hide its losses and to avoid negative outcomes. Some of the negative outcomes the management may want to avoid include losing key stakeholders and avoiding intervention by the public and the government. 

Q4: There is a new revenue recognition standard (Revenue from Contracts with Customers).  Briefly describe this new revenue recognition principle.  

The Revenue from Contracts with Customers is a new revenue recognition standard which was put in place in place by the FASB and LASB. The core principle used by the standard entails the recognition of when the control of the expected goods and services are allocated to customers. The amount that is allocated ought to reflect the consideration expected to be received by the entity in exchange. For the given scenario, control means having the ability to obtain benefits from an asset or to directly use it. 

The standard is applied through a five-step process that can be used to guide decisions for revenue recognition and to analyze revenue transactions. The first step one involves identifying the contract with the customer. The second step involves identifying the performance obligations. The third step involves determining the transaction price. The fourth step involves allocating the transaction price to the performance obligations and the fifth step involves allocating the transaction price to the performance obligations. The reason that the new standard was established was that it would provide a consistent revenue recognition principle to be applied in any geographic location or industry. Issues regarding revenue recognition would be addressed through a more robust framework. 

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StudyBounty. (2023, September 15). Revenue Recognition: Revenue Recognition Principles.
https://studybounty.com/revenue-recognition-revenue-recognition-principles-question-and-answer

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