Why So Many Methods? A survey of accounting recognition methods and its results provide a classic example of how complex commerce and the existing accounting systems have become. Staying within the norms or the standards has resulted in certain inadequacies in meeting the “matching principle” as criterion. There are about 10 methods of revenue recognition used, wherein each method aims to provide a standardized procedure for realizing profits, which are used according to the industry’s method of transacting its business. The present-day economy is so diverse that even the IRS and SEC are at loggerheads about revenue recognition methods. Considering the clamor for global competitiveness of US industries in the investment market, the International Financial Reporting Standards (IFRS) has likewise entered the scene, bringing another set of rules different to US GAAP’s revenue recognition rules. Observers are now describing this present situation as an accounting crisis, and the best advice they could give accountants-in-charge is to make a careful assessment of all accounting revenue recognition methods.
They have to decide on the most appropriate and applicable methods for their respective industry’s scenario. This is where simple buying and selling transactions transpire and accounting procedures for income realization are basic. Not all cash transactions, however, qualify under this method. The seller’s position as recipient of advance payment before delivery makes the seller liable until such time that the goods or services are delivered. As a liability, the Unearned Revenue account will be used and will be properly classified as income at point of delivery. There is also the side of the buyer who made the advance payment before the delivery of goods or services. The prepayment is initially recorded as a prepaid asset but will later be classified as expense when the goods are delivered or services are performed and accepted. Although this aspect refers to expenses, the latter is crucial in determining the amount of revenue gained from the incurrence or acquisition.
The act of accepting the goods or services consummates the transaction. This type of selling is where delivery of goods comes ahead of payment, and it creates a receivable instead of increasing cash. The receivable will be extinguished by a series of regular payments, and revenue recognition is allowed for every installment payment received. Only the paid portion of the receivable will be recognized as revenue from installment sales, and a distinction from revenue from cash sales should be maintained. The related expenses for installment sales will be assigned in proportion to the revenue actually gained, which could result in minimal profits or even loss at the time of reporting. An alternative method is to match the amount of monetary benefits earned against cost incurred until such time that the entire cost has been fully recovered. Thereafter, all succeeding installment payments received are recognized as purely revenues. This method is applicable for long-term projects where the amount of revenue gained by the service provider can be established only after the project has been completed. In this type of long-term projects, the costs incurred by the contractor cannot be matched against the advance payments received.
Materials purchased may still be held as assets; hence they cannot be appropriated to match the cash collected. Doing so could distort the presentation of income in future periods. This method is often preferred over the completed contract method since costs are properly identified and segregated to maintain proper monitoring. The aim is to make sure that the project is still operating within the projected budget. Any variables or losses suffered due to unforeseen economic events will be charged against the portion considered as unearned revenue. Hence the revenue subsequently recognized will be adjusted accordingly. In addition, the project performance is specifically identified and the corresponding revenue received will be protected by the agreement between the contracting parties. Any additions to the portion completed will cover another formal deed of agreement. There are brokers who handle all their customers’ transactions as if they all inure to the business, which tends to reflect substantial amounts in terms of Gross Sales but results to very little gross profit.