Subject 2. Revenue Recognition
#cfa #cfa-level-1 #financial-reporting-and-analysis #understanding-income-statement
There are two revenue and expense recognition issues when accrual accounting is used to prepare financial statements:
- Timing: when should revenue and expense be recognized?
- Measurement: how much revenue and expense should be recognized?
Revenue is generally recognized when it is (1) realized or realizable, and (2) earned.
The general rule for revenue recognition includes the "concept of realization." Two conditions must be met for revenue recognition to take place:
1. Completion of the earnings process
The company must have provided all or virtually all the goods or services for which it is to be paid, and it must be possible to measure the total expected cost of providing the goods or services. No remaining significant contingent obligation should exist. This condition is not met if the company has the obligation to provide future services (such as warranty protection) but cannot estimate the associated expenses.
2. Assurance of payment
The quantification of cash or assets expected to be received for the goods or services provided must be reliable.
These conditions are typically met at the time of sale, but there are many exceptions, which will be discussed next.
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