Introduction
In most businesses income is accepted as revenue when the firm has received payment after selling a commodity or rendering a service. As an accounting principle that has been documented in the GAAP (Generally Accepted Accounting Principles), revenue recognition enables accountants to determine the point at which the income that a business entity earns turns into revenue (All Business, 2010, para. 1-6). Nonetheless, according to the GAAP, revenue should be recognized after a service is rendered or a commodity is sold but not when payment is received. This, therefore, means that when a transaction is taking place at the POS (point of sale), this is also the time to declare revenue acru8ng from such a product.
Revenue can be recognized from four types of transactions. They include revenue from, sale of stock, offering a service, sale of an asset other than the inventory and renting of a fixed asset. In each of these transactions, revenue is recognized differently. For example revenue from the sale of inventory is recorded or recognized on delivery. Revenue from a transaction is recognized depending on the type of transaction. On the other hand, revenue from the rendering services is recognized after the completion of the service. Moreover, Revenue from renting a fixed asset is recorded in the books of accounts when the asset is being used (All Business, 2010, para. 1-6).
There are also some exceptional cases in revenue recognition. Accounting principles state that stock sales revenue needs to be declared upon the purchase of a product or service. Nevertheless, there are some cases where the business may agree to sell a product and get the payment later. These are called buyback agreements. However, it is also possible to recognize revenue even before the actual product has been delivered, although this is a rarity. This occurs mostly in long-term contracts such as roads or building constructions. Sometimes the seller may realize that the purchaser is not credible enough, (there is a high level of risk). In such a case, the seller should use some methods such as deposit, installment or cost recovery methods to deal with this situation. In the deposit method, the seller receives money before a complete ownership transfer has occurred (Levitt, 1998, p.1-14). However, under the installment method, a relative amount of gross profit is collected in cash.
In this research, the main aim is to discuss revenue recognition, its requirements and ethics and governance issues relating to sales with reference to the generally accepted accounting principles (GAAP).
Revenue recognition requirements
According to the accounting principles, the matching principle and accrual accounting determine the accounting period. Moreover, the time of recording expenses and revenues also depends on the accounting principles. Therefore, once revenue has been realized, there is the need to declare it. The case of cash is however different because revenue is recognized when money is received.
According to the case, the seller recorded or recognized revenue before the buyer had accepted the commodity. This leads to the income of that year being higher than the way it should be ( it is unrealistic). However, according to the accounting principles, the revenue of a product should be recognized after the consumer has accepted the good, therefore, although the salesperson was assured of acceptance he would have not recorded the revenue prior to the quarter-end. This is because the consumer still had the option of delaying the sale, avoiding it or even terminating it.
Ethical issues relating to this sale
When the salesperson records revenue before the acceptance by the consumer, it leads to the financial statement of that quarter being overstated. It is unethical according to the accounting principles for the financial statement to have the incorrect figure for example the figure may be overstated or understated. This leads to an increase or decrease of income of that financial year. Levitt (1998, p.1-14).
The financial statement of a business should be reliable meaning that it should have the correct figure. This is because it is of great importance to the investors and the shareholders who may have an interest in the firm. Investors would always wish to invest in those firms or companies that make high profits. In that case, if the financial statement is overstated it may influence investors to invest in that company and they may later lose their money. When the financial statement is overstated it will not give the real image of the business to the creditors who would be wishing to offer credit to those marketers that have big profit margins. Most customers also always want to associate with those businesses that are profitable. In addition, employees mostly seek employment in those firms which make big profits rather than losses because they are assured of high pay.
Safeguards that can be put in place to provide assurance
As a member of the board of directors of this company the safeguards to use or put in place to provide assurance is to ensure that the accountants and the auditors follow the accounting principles. For the accountants to be well prepared in the area of revenue recognition they should be aware of the common contract terms. They should also find out whether there is a side agreement to the contract. In addition, accountants should determine whether there is a possibility of loss that has passed to the customer. They should also find out whether there are associated parties involved in the contract. In addition, they should decide whether there are major prices or concessions that are related to the contract. Moreover, the accountants should discuss the contract with the buyers and assess its terms and conditions. If there is a need they should also assess the creditworthiness of the buyers. This helps to ensure that business returns can be reasonably estimated and revenue is recognized.
Another safeguard to put in place to provide assurance is to ensure that the internal audit review on sale contracts and transactions complies with the accounting principles. On particular transactions that need to be emphasized the audit committee should plan with independent accountants. The sales records should be examined to check on their originality. This means transactions should be well supported. In big companies or organizations, an external auditor should be employed to check on the financial records.
Conclusion
According to (All Business, 2010, para. 1-6) the accountants and auditors of a company should apply the accounting principles when recording their business transactions. In addition, they should be familiar with the various accounting principles such as the matching principle. Therefore for every business to run efficiently it should keep its books of accounts following the accounting principles. The management should ensure that books of accounts or transactions are audited after every business financial year. The accounting and auditing process should be done by professionals (Certified Public Accountants) so as to provide assurance to the public.
Reference List
All Business. (2010). what are generally accepted accounting principles. Web.
Levitt, A. (1998). The numbers game. New York: NYU Center for Law and Business. Web.