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This chapter continues the discussion begun in Chapter 2 on revenue
recognition and performance measurement. The importance of revenue to an
organization’s financial health is discussed, leading to the need for criteria to
determine just when revenue should be recognized in various situations.
The criteria consist of three general concepts: (1) the revenue must be earned,
(2) the amount must be measurable, and (3) there is a reasonable assurance of
collectibility of the amount earned. If a transaction meets all of these con-
ditions, revenue should be recognized.
The cash-to-cash cycle is introduced as a model for understanding a
company’s performance and for relating the measurement of this
performance to the recognition of revenue. This cycle outlines the steps
involved in converting cash into inventory, selling the inventory, and then
converting the receivables back into cash. Performance can be measured at
various points within this cycle.
Revenue recognition during the cash-to-cash cycle can be determined (1) at
the time of sale, (2) at the time of contract signing, (3) at the time of
production, and (4) at the time of collection.
In long-term construction contracts, various methods, including the
completed contract method and the percentage of completion method, can
be used, depending on the circumstances. In situations where it is not
possible to estimate the probability of collection with sufficient certainty, the
instalment method can be used.
Understanding the various ways that revenue can be recognized leads to a
common measure of performance—return on investment (ROI). Two other
specific kinds of ROI are: return on assets (ROA) and return on equity(ROE).
c h a p t e r
4
REVENUE
RECOGNITION
H Chapter 4 8/21/08 9: 11 AM Page 69
Financial Accounting Study Guide Chapter Four.pdf
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