Question

a) What is the differences between hardware and software revenue recognition? Based on this, what pieces of information are important for an accountant to know before they can recognize revenue?

b) Describe the revenue cycle - from the point in time when a sales person closes a deal, to that becoming revenue, AR and eventually cash on a company's financials.

Answer 1

a) Software Revenue Recognition-

Certain arrangement to deliver software or software systems may include both software and service element. The services may include training or installation services. If an arrangement includes such services, a determination must be made as to whether the service element can be accounted for separately as the services
are performed. Generally, for determining whether the service element may qualify for separate accounting as a service certain indicative factors may have to be established. These include determination of fair value of the service element, services not being essential to the functionality of any other element of the arrangement and the contract being described in such a manner such that the total price of the contract would be expected to vary as a result of the exclusion of such services. If an arrangement includes services that may qualify for
separate accounting based on the indicative factors given above then revenue should be allocated between the software and service element. Revenue allocated to the service element may be recognised as and when the services are performed or, if no pattern is discernable then on a straight line basis over the period during which the services are performed.

Hardware Revenue Recognition-

Some contract manufacturers produce goods for their customers over time but do not deliver the manufactured product until a later point in time.
Under today’s U.S. GAAP, revenue would be recognized only after the manufactured items are delivered to the customer. Under the new standard, it is possible that revenues may be recognized earlier in some cases. Specifically, the new rules require that revenue be
recognized over time, rather than at a point in time such as product delivery when certain criteria are met.
For example, assume Windy Inc. receives an order to produce 100 portable CT scanners that are significantly customized for this specific customer. The contract indicates that legal title to the scanners passes at the moment they are loaded on the freight carrier’s truck and depart Windy’s warehouse. Under the new standard, revenue may need to be recognized over time as the scanners are being produced, even though title of the product or equipment does not transfer until the end of the contract period. For instance, this outcome would be appropriate if:
• The asset Windy is building has no alternative use – i.e., it can’t be sold to any other customers, and
• Windy has an enforceable right to recover its cost, plus a reasonable profit margin, at any time throughout the contract in the event that the order is cancelled.
If Windy is required under the new standard to recognize revenues over time, it must select an appropriate way of measuring progress towards completion of its performance obligation. Likely, Windy would use input measures, such as comparing actual costs incurred to date relative to total expected costs to fulfill the contract.

Pieces of information that are important for an accountant to know before they can recognize revenue are as follows-

Timing of approval for sales agreements.

“Side” arrangements to the master contract.

Consignment/financing arrangements.

Criteria for delivery (bill and hold sale).

Layaway programs.

Nonrefundable, up-front fees.

Cancellation or termination provisions.

Membership fees/services.

Contingent rental income.

Right of return.

b) THE REVENUE CYCLE

A recurring set of business activities and related information processing operations associated with providing goods and services to customers and collecting cash in payment for those sales. All accountants need to know something about the revenue cycle. The revenue cycle is one of many processes used in an effective accounting information system (AIS). If a company is to stay in business, their accountants need to be able to implement a way of keeping track of the sales and profits. Technology is also changing the face of the revenue cycle, and the AIS in general.

These are The Four Basic Revenue Cycle Business Activities that all accountants should know something about.

1. Sales Order Entry
2. Shipping
3. Cash Collections
4. Billing

Many aspects of each step in the revenue cycle are listed below.

SALES ORDERS

• The main employees involved in this step work in the sales order department.
• Responses are made to customer inquiries.
• The customer's credit is then checked before a purchase can be made.
• Finally, the inventory must be checked to see if the item is available.

SHIPPING

• Customer orders are filled by the warehouse workers.
• The shipping department then sends out the merchandise.

BILLING

• The workers in the billing department send out invoices to customers.
• Employees in the accounts receivable division are in charge of maintaining customer accounts.

CASH COLLECTIONS

• The cashier takes the remittances from the customers and deposits them in the bank.
• The accounts receivable employees then credit the customers' accounts when the payment is received.