How and when do companies recognize revenues?
In our general post on sales analysis we offered the example of a bookstore. It seemed easy enough to understand that when a customer bought a book it counted as a sale. However, suppose the customer paid by check. Can the store count the sale as revenue before the check clears? How about a layaway sale? In this case the store has received a portion of the eventual purchase price. Does that portion count as revenue?
These are two simple examples of timing issues that businesses must consider when reporting their financial performance. Accounting rules (called Generally Accepted Accounting Principles, or GAAP, in the US) have developed to answer those questions. These rules have their foundation in what is known as the matching principle: financial statements should be prepared so that revenues earned and the expenses associated with those revenues should be reported in the same period.
There are also specific rules governing when a company can report revenue. According to Financial Statement Analysis: A Global Perspective, revenue can be recognized when all of the following criteria are met:
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For goods |
For services |
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The significant risks and rewards of ownership have been transferred to the buyer |
The amount of revenue can be measured reliably |
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The seller no longer retains managerial involvement typically associated with ownership nor effective control of the goods |
It is probable that the economic benefits of the transaction will flow to the service provider |
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The amount of revenue can be measured reliably |
The stage of completion of the transaction can be reliably measured as of the financial statement reporting date |
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It is probable that the economic benefits of the transaction will flow to the seller |
The related costs incurred or to be incurred can be reliably measured |
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The related costs incurred or to be incurred can be reliably measured |
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In the case of layaway sales, the sale cannot be recognized until the buyer takes the product. In the case of checks that have not cleared, as long as it is likely to clear the revenue can be reported at the time of sale. There are a number of other considerations the company must factor into a report of revenue, which are addressed by a number of ways the company can choose to report sales. In their financial documents a company must disclose the method it uses for reporting revenue. Investors should be on the lookout for any of the following terms, which require additional understanding:
Gain on sale
Multiple deliverables
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when do cell phone companies recognize revenues? At the sale of a cell phone? or at end of a contract period? for example: if ABC Cell phone company makes and sell phone and provides service .Customers generally sign two separate contracts, one governing the sale of the devices and the other governing the provision of the service. Once the phone is sold to a customer the same cell phone provides contracts for 12 months and billed on a monthly basis. The services are priced at standard rates, although discounts are offered depending on the number of devices sold. The devices also have been sold at a discount. However, the discount is based on the number of units purchased (or to be purchased) and does not appear to be unreasonable.
The ABC Cell phone devices are made to be used exclusively with the ABC company services and, currently, there are no other competitors making devices that work with the ABC services. Customers may cancel the service at any time. However, amounts paid related to the devices are non-refundable. Payments for the devices are due upon completion of the installation and final acceptance by the customer.
How should revenue be recognized for sales of both the Phone and service?
thanks,
I’m guessing this is related to Apple’s iPhone and their decision to pro-rate the revenue over the life of the contract rather than recognize it up front.
Normally the phone portion would be treated as a sale and revenue recognized when the customer takes the phone. In this case, Apple is treating it as a lease, in which the customer is paying for the phone over the term of the service contract.
It is possible - depending on their contract with AT&T, that this is the case. For example, Apple may have an agreement to accept returns or have some other contingent liability that suggests it shouldn’t be recognized as a sale.