Question

GAAP revenue recognition standards are based on broad principles rather than bright-line rules. This creates a certain amount of latitude in determining when revenue is earned. Assume a company that normally required acceptance by its customers prior to recording revenue as earned, delivers a product to a customer near the end of the quarter. The company believes customer acceptance is assured but cannot obtain it prior to quarter-end. Recording the revenue would assure “making its numbers” for the quarter. Although formal acceptance is not obtained, the salesperson records the sale, fully intending to obtain written acceptance as soon as possible.

a. What are the revenue recognition requirements in this case?

b. What are the ethical issues relating to this sale?

c. Assume you are on the board of directors of this company. What safeguards can you put in place to ensure the company’s revenue recognition policy is followed?

Answer 1

a. In order for revenue to be recognized on the income statement, GAAP specifies that 2 criteria should be met. One, revenue must be realized or realizable, and second, revenue must be earned.

b. I do not believe it is ethical for the salesperson to record this as a sale. Because the company has a policy that required acceptance by its customers prior to recording revenue as earned.

c. I would advise that the prior approval is taken well in advance before the quarter end so that revenue can be recognized correctly.