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Auditing Special Purpose Frameworks: Auditing Revenues—Part 1

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Oct 16th 2014
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Read more from Larry Perry here and in the Today's World of Audits archive.

Because of the importance of revenue recognition auditing procedures, and because of the breadth of the principles for the FRF for SMEs, this article will review accounting principles; part 2 will discuss auditing procedures.

Recognizing Revenues

Recognizing revenue under the FRF for SMEs requires completion of performance of a transaction and reasonable assurance of collection of invoices and billings. Similar to the way it's done under U.S. GAAP, revenue must be earned or realizable to be recognized.

Specifically for the sale of goods, performance is achieved when the seller has transferred ownership of the goods to the buyer and the seller retains no continuing involvement in the goods transferred.

When services are provided under long-term contracts, determine performance under the percentage-of-completion method or the completed-contract method. Use the method that best relates the revenue to the work performed.

Achievement of performance occurs when:

  • There is persuasive evidence of an arrangement.
  • Goods have been delivered or services have been provided.
  • The seller's price is fixed or determinable.

Generally, performance of a transaction determines when revenue is earned and recognized. For the sale of goods or providing services, performance is considered achieved when a seller has transferred goods to a buyer or provided services, such as when a point of sale or delivery has occurred, when the buyer assumes the risks and rewards of ownership of a product or accepts the services, when there is reasonable assurance a specified amount of consideration will be received (collectability) in return, and when an appropriate allowance for returns of products has been determined. A sale would not be recorded when the seller retains significant risks of ownership, such as in the case of consignment sales. An appropriate allowance for uncollectible accounts should be provided based on the evaluation of collectability.

For long-term contracts or rendering services, determine performance under either the percentage-of-completion method or the completed-contract method, whichever best presents revenues in relationship to the work that has been accomplished. Recognize revenue under the percentage-of-completion method based on something systematic, rational, and consistent, such as sales value, related costs, and extent of progress or number of acts. Amounts billed are an appropriate basis only if they are indicative of work completed.

The completed-contract method normally should be used when the extent of progress cannot be reasonably estimated. Management may elect to use the completed-contract method when it is used for income tax reporting or when the financial position and results of operations are similar to the percentage-of-completion method. This may occur when an entity performs numerous short-term contracts or in other situations.

Contract claims may be recorded when amounts have been awarded or received or at times when it becomes probable the claims will result in additional contract revenue (if amounts can be reasonably estimated). In the latter case, revenue should be recorded only to the extent related costs are incurred.

Multiple Deliverable Arrangements

For multiple deliverable arrangements, consider performance of transactions separately in accordance with the recognition criteria above. An example would be the sale of software with separately priced installation, training, maintenance, and warranty agreements. Revenue from elements such as maintenance and warranty agreements will normally be recognized on a straight-line basis over the term of the agreement unless the services are provided in an identifiable, significantly different pattern.

Under the FRF for SMEs, when a sales transaction includes the delivery or performance of multiple products, services, or rights to use assets, and the delivery or performance occurs at different times, apply revenue recognition criteria to each of the deliverables. A vendor of large appliances, for example, will ordinarily sell the product, charge additionally for delivery, and make warranty and/or maintenance agreements available for separate purchase. Apply separate revenue recognition criteria to each of these deliverables. For fixed-fee warranty or maintenance agreements, revenue would be recognized over the term of the agreement, ordinarily on a straight-line basis.

Other Income

Investment income is recognized in a manner similar to U.S. GAAP. Interest is recognized over time, royalties are recognized as they accrue under an agreement, and dividends are recognized when a shareholder has the right to receive payment.

Principal vs. Agent

Also as with U.S. GAAP, an agent in a transaction will report only commissions as revenues. Companies that conduct business as agents rather than as principals sometimes face a dilemma as to how to record revenues, gross amount of billings or net amounts of commissions. Judgment based on facts and circumstances should guide resolution.

Other Resource Materials

For live and on-demand two-hour webcasts on this and other accounting and auditing subjects, click on the applicable box on the left side of my home page, www.cpafirmsupport.com . Registered users on my website receive a 20 percent discount on all live and on-demand webcast courses offered by a major publisher on all functional topics from many qualified authors and presenters. Also, check the Webinars page on AccountingWEB.com for free one-hour live and on-demand webcasts presented by myself and other presenters.

These two resource books with numerous illustrative attachments are also available on my website:

  • Small Audits Made Easy and Profitable
  • Performing Tests of Balances Auditing Procedures

Tables of Contents for both books are available by making requests under the "Contact Us" tab.

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