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Wednesday 18 January 2012

Guidelines for Revenue Recognition


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

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)

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.

Tuesday 17 January 2012

Timing issues

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


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

The Ledger


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


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

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


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?

The purpose of accounting is to:
 identify, record, and communicate the economic events of an  organization to 
interested users.