Question

A company thought they were going to win a legal settlement. The believed is was "likely and estimable" so they recognized an Accounts Receivable. Does this mean that they must have booked a Credit Sale also? Does this mean they have already recognized revenue from the legal settlement eventhough they could still lose? Follow up question: The company lost in court. They now have to take an after tax charge of $100 million. Do they also have to reverse the Revenue recognition?

Answer 1

A company thought they were going to win a legal settlement. The believed is was "likely and estimable" so they recognized an Accounts Receivable. Does this mean that they must have booked a Credit Sale also? Does this mean they have already recognized revenue from the legal settlement eventhough they could still lose?

As per new accounting standard relates to Revenue Recognition as per IFRS 15 & USGAAP ASC- 606, Company before recognition of revenue , need to pass 5 step model – like- Identify the contract with customer , identify teh performance of obligation , determine transaction price , allocate the transaction price to the performance obligation and finally recognised revenue .

Most important part is Contract with customer – Under this model revenue will recognised after fulfilment of following points :

1. It has been agreed by its parties , who are committed to perform their respective obligation
2. Each party’s rights regarding the goods and services to be transferred
3. Identify payment terms
4. It has commercial substance
5. Its is probable that the entity will collect the consideration to which it will be exchanged for goods and services that will be transferred to customer.

Meaning of commercial substances mean – risk in the contract and timing of the entity’s future cash flow are expected to change

Most important factor relates to collectability / collection probable – it is probable that the entity will collect the consideration , to which it will be entitled in exchange for the goods and services that will be transferred to the customer . Only the customers ability and intention to pay are considered in evaluating whether collectability

So before recognising revenue, company has to see collection visibility and high probable that entity will collect cash in future and no challenge / risk involved in it .

Above case ( as per question ) , company thought they will they were going to win legal settlement . They believed is was likely and estimable . In this situation , we are not sure about how much surety or probability to win the case and no risk to turn negative . Only on likely and estimate basis , it is difficult to recognised revenue and account credit sales . Company has to do more risk + probability analysis in this matter , before recognising revenue

Second part – Assume company recognised revenue and account credit sales but finally they lost on court . After lost in court , matter is quite certain and distinct and company needs to reversal of revenue recognised and account corresponding loss of provision in financial .