Question

CA18-4 (Recognition of Revenue—Theory) Revenue is recognized for accounting purposes when a performance obligation is satisfied. In some situations, revenue is recognized over time as the fair values of assets and liabilities change. In other situations, however, accountants have developed guidelines for recognizing revenue at the point of sale.

Instructions

(Ignore income taxes.)

(a) Explain and justify why revenue is often recognized at time of sale.

(b) Explain in what situations it would be appropriate to recognize revenue over time.

Short answer

1. Revenue is recognized at the time of sale because thecontrol of assets is transferred to the buyer at this time only.
2. Revenue is recognized over time when one among three specified conditions is satisfied.

Step-by-step solution

Definition of Revenue Recognition

The principle reflecting the conditions under which the business entity must recognize the revenue is known as revenue recognition. It also provides information about how to account for revenue.

Justification for recognizing revenue at the time of sale

Revenue must be recognized at the time of sale because the control of assets is transferred to the buyer at the time of sale only. Time of sale is considered as deciding factor for the time when the performance obligation is satisfied. The asset is said to be controlled by the customer when they can use the asset and generate benefits from its use.

Situations under which revenue must Be recognized over time

The business entity must recognize revenue over time when one of the following conditions are met:

1. The customer receives the benefits as the seller completes the performance.
2. The customer controls the asset when the seller creates it.
3. The seller cannot use the created asset for other alternative purposes.