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Strategies & Market Trends : BFT: Will the tulip craze ever break down?
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To: Pancho Villa who wrote (263)4/6/1998 9:17:00 PM
From: Pancho Villa  Read Replies (1) of 650
 
A short lesson on revenue recognition:

Answer to a friend's email on my revenue recognition post:

Hola Pancho:

>superb post.

>Can't a company recognize all the revenue when taken in and then carry as a
>liability the value of the unused portion of the prepaid services???

let me illustrate with two examples the principle of revenue recognition: in
general revenue is recognized (becomes part of the income statement) when
the services are provided, the goods delivered; or in the case of a project,
revenue may be recognized partially along the way as milestones in the
project are reached.

The example:
Suppose you sell an airline ticket for cash: $200 in December 97.ÿ You are
going to Paris Texas on January 17. 1997.ÿ The airline cannot recognize the
revenue in the income statement (IS) that closes on 12/31/97 because it has
not yet provided the services.

The transaction is recorded as follows:

Keep in mind that all accounting transactions must maintain:

Assets = liabilities + Stockholders equity:

Assets:
Cash goes up by $200

Liabilities:

Services to be rendered goes up by $200.

200 = 200 + 0ÿÿÿÿ (checks)

This transaction does not see the IS, thus is not part of 97 revenue.

Now ln the IS for the period 12/31/97-3/31/98 the airline can recognize the
revenue, because it took you to Paris, as follows:

Liabilities:

Services to be rendered goes down by $200 (The airline no longer owes you
any service)

Stockholders Equity:

retained earnings account goes up by $200 (the eairline now has the right to
cliam the revenue.ÿ of course there is a cost side also)

0 = - 200ÿ + 200 (checks) (the transaction only affected the left hand side)

Notice that the retain earnings account is actually linked to the bottom
line of the IS (i.e., if you zoom into the retained aernings account you are
looking at the IS). so the 200 bucks shows up as revenue in the IS.

If the ticket had been bought on credit.ÿ the transaction would have been
very similar, except that instead of increasing cash by $200, accounts
receivables increases by $200.ÿ When you finally pay the $200 the
transaction is posted as follows:

Cash account increases by $200

Accounts receivable decreases by 200 (you no lenger owe the money)

200 - 200 = 0

we see this transaction only affected asset accounts and is independent of
when the revenue was recognized.

Pancho
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