Accounting for Revenue Accounting for Revenue and Expensesand Expenses

–Accounting BasesAccounting Bases–Cash BasisCash Basis–Accrual BasisAccrual Basis

–Recognition of RevenuesRecognition of Revenues–Recognition of ExpensesRecognition of Expenses–Matching of Revenues and ExpensesMatching of Revenues and Expenses–Gross Profit MarginGross Profit Margin–Net Profit MarginNet Profit Margin

Accounting BasisAccounting Basis

Cash Basis of AccountingCash Basis of Accounting

Accrual Basis of AccountingAccrual Basis of Accounting

Cash BasisCash Basis

Revenue is recorded only when Revenue is recorded only when the cash is received and an the cash is received and an expense is recorded only cash expense is recorded only cash is paidis paid..

The cash basis of accounting is not The cash basis of accounting is not accordance withaccordance with

Generally Accepted Accounting Generally Accepted Accounting Principles(GAAP) – Principles(GAAP) –

violating the revenue recognition concept.violating the revenue recognition concept.

Accrual BasisAccrual BasisAn enterprise should prepare its financial An enterprise should prepare its financial statements except for cash flow information statements except for cash flow information under under accrual basis of accountingaccrual basis of accounting

The effects of transactions and other events The effects of transactions and other events are are recognised when they occurrecognised when they occur ( (notnot as as cash or its equivalents is cash or its equivalents is received or paidreceived or paid) ) and they are and they are recorded in the accounting recorded in the accounting records and reported in the financial records and reported in the financial statements of the period to which they statements of the period to which they relaterelate

IllustrationIllustrationExample:Example:Given below is the summary of transactions of Given below is the summary of transactions of

Salma Enterprise for the month of June Salma Enterprise for the month of June 2005.2005.

RMRMSales (70% on credit)Sales (70% on credit) 60,00060,000Advertising expenses (cash)Advertising expenses (cash) 1,0001,000Rent expense (cash)Rent expense (cash) 1,5001,500Depreciation ExpenseDepreciation Expense 1,2001,200Salary expense (unpaid)Salary expense (unpaid) 18,00018,000Collection from customerCollection from customer 8,000 8,000(from May credit sales)(from May credit sales)

Calculate the profit by using both accrual and Calculate the profit by using both accrual and cash basis.cash basis.

Accrual Basis:Sales (total) 60,000Less:Advertising 1,000Depreciation 1,200Rent 1,500Salary 18,000 (21,700)Net Profit 38,300

Cash Basis:Sales:Cash Collection 8,000

Cash Sales 18,000Less:Advertising 1,000Rent 1,500 (2,500)Net Profit 23,500

RecognitionRecognition

The process of incorporating in the balance The process of incorporating in the balance sheet or income statement an item that meets sheet or income statement an item that meets the definition of an element and satisfies the the definition of an element and satisfies the following criteria for recognition:following criteria for recognition:

it is probable that any it is probable that any future economic benefit future economic benefit associated with the item will flow to or from associated with the item will flow to or from the entity;the entity; and and

the item has a the item has a cost or valuecost or value that can be that can be measured with reliabilitymeasured with reliability..

Revenue recognitionRevenue recognition

Sale of goodsSale of goods

Rendering of servicesRendering of services

RevenueRevenue

The gross The gross inflow of economic benefitsinflow of economic benefits during the period arising in the course of during the period arising in the course of the the ordinary activitiesordinary activities of an entity when of an entity when those those inflows result in increases in inflows result in increases in equityequity, other than increases relating to , other than increases relating to contributions from equity participantscontributions from equity participants

Revenue recognitionRevenue recognition

Revenue is recognised when Revenue is recognised when

(a)(a) it is probable that it is probable that future economic future economic benefits will flow to the entitybenefits will flow to the entity and and

(b)(b) these benefits can be these benefits can be measured measured reliablyreliably. .

Revenue recognitionRevenue recognition

Goods includes Goods includes goods produced by the goods produced by the entity for the purpose of saleentity for the purpose of sale and and goods goods purchased for resale, such as purchased for resale, such as merchandise purchased by a retailermerchandise purchased by a retailer or or land and other property held for resale.land and other property held for resale...

Recognition criteria: Sale of goodsRecognition criteria: Sale of goods

Revenue from the sale of goods shall be recognised when Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied:all the following conditions have been satisfied:

(a) the entity has transferred to the buyer the (a) the entity has transferred to the buyer the significant riskssignificant risks and rewards of ownership of the goods;and rewards of ownership of the goods;

(b) the entity retains neither continuing managerial (b) the entity retains neither continuing managerial involvement to the degree usually associated with involvement to the degree usually associated with ownership nor effective control over the goods sold;ownership nor effective control over the goods sold;

(c) the amount of revenue can be (c) the amount of revenue can be measured reliablymeasured reliably;;

(d) it is probable that the (d) it is probable that the economic benefitseconomic benefits associated associated with the transaction will flow to the entity; andwith the transaction will flow to the entity; and

(e) the costs incurred or to be incurred in respect of the (e) the costs incurred or to be incurred in respect of the transaction can be transaction can be measured reliablymeasured reliably..

Measurement of RevenueMeasurement of RevenueRevenue shall be measured at the Revenue shall be measured at the fair valuefair value of the of the consideration received or receivableconsideration received or receivable.*.*

Fair valueFair value is the amount for which an asset is the amount for which an asset could be exchanged, or a liability settled, could be exchanged, or a liability settled, between knowledgeable, willing parties in an between knowledgeable, willing parties in an arm’s length transactionarm’s length transaction

In most cases, the In most cases, the considerationconsideration is in the is in the form of form of cash or cash equivalentscash or cash equivalents and the and the amount of revenue is the amount of cash or amount of revenue is the amount of cash or cash equivalents received or receivable.cash equivalents received or receivable.

Revenue recognition:Revenue recognition:Rendering of servicesRendering of services

When the outcome of a transaction involving When the outcome of a transaction involving the rendering of services can be estimated the rendering of services can be estimated reliably, revenue associated with the reliably, revenue associated with the transaction shall be recognised by reference transaction shall be recognised by reference to to the stage of completion of the transaction the stage of completion of the transaction at the balance sheet date.at the balance sheet date. The outcome of a The outcome of a transaction can be estimated reliably when transaction can be estimated reliably when all the following conditions are satisfied:all the following conditions are satisfied:

Revenue recognition:Revenue recognition:Rendering of services (cont..)Rendering of services (cont..)

((a) the amount of revenue can be a) the amount of revenue can be measured reliablymeasured reliably;;

(b) it is probable that the (b) it is probable that the economic benefitseconomic benefits associated with the transaction will flow to the associated with the transaction will flow to the entity;entity;

(c) the (c) the stage of completion of the transactionstage of completion of the transaction at the at the balance sheet date can be measured reliably; andbalance sheet date can be measured reliably; and

(d) the (d) the costs incurred for the transactioncosts incurred for the transaction and the and the costs to complete the transactioncosts to complete the transaction can be can be measured measured reliablyreliably. * . *

Rendering of services: methods to Rendering of services: methods to determine stage of completiondetermine stage of completion

The stage of completion of a transaction may be determined by a The stage of completion of a transaction may be determined by a variety of methods. An entity uses the method that measures reliably variety of methods. An entity uses the method that measures reliably the services performed. Depending on the nature of the transaction, the services performed. Depending on the nature of the transaction, the methods may include:the methods may include:

(a) surveys of work performed;(a) surveys of work performed;

(b) services performed to date as a percentage of total services to be (b) services performed to date as a percentage of total services to be performed; orperformed; or

(c) the proportion that costs incurred to date bear to the estimated (c) the proportion that costs incurred to date bear to the estimated total costs of the transaction. total costs of the transaction. Only costs that reflect services performed to date are included in costs Only costs that reflect services performed to date are included in costs incurred to date. Only costs that reflect services performed or to be incurred to date. Only costs that reflect services performed or to be performed are included in the estimated total costs of the transaction.performed are included in the estimated total costs of the transaction.

Progress payments and advances received from customers often do Progress payments and advances received from customers often do not reflect the services performed.not reflect the services performed.

ExpensesExpenses

Decrease in economic benefitsDecrease in economic benefits during during the accounting period in the form of the accounting period in the form of outflows or depletions of assetsoutflows or depletions of assets or or incurrence of liabilitiesincurrence of liabilities that result in that result in decreases in equitydecreases in equity, other than those , other than those relating to distributions to equity relating to distributions to equity participantsparticipants

Expense recognitionExpense recognition

An expense should be recognised An expense should be recognised when and only when:when and only when:

(a)(a)It is probable that the It is probable that the consumption or loss of future consumption or loss of future economic benefits resulting in a economic benefits resulting in a reduction in assets and/or an reduction in assets and/or an increase in liabilities has increase in liabilities has occurred; andoccurred; and

(b)(b)The consumption or loss of The consumption or loss of future economic benefits can be future economic benefits can be measured reliably.measured reliably.

Expense recognitionExpense recognitionBasis for recording expenses is the matching Basis for recording expenses is the matching principleprincipleExpenses are the costs of operating a Expenses are the costs of operating a businessbusinessExpenses are costs of assets that are used up Expenses are costs of assets that are used up in the earning of revenuein the earning of revenueMatching principle requires:Matching principle requires:– Identify all expenses during the accounting periodIdentify all expenses during the accounting period– Measure the expensesMeasure the expenses– MatchMatch the the expensesexpenses against the against the revenues earnedrevenues earned

during the same periodduring the same period

Matching of Revenues and Matching of Revenues and ExpensesExpenses

Revenue and expenses that relate to the Revenue and expenses that relate to the same transaction or other events are same transaction or other events are recognised simultaneously.recognised simultaneously.

Example – If the company estimated Example – If the company estimated that sales commission paid to the that sales commission paid to the salesman must be at 10% of their total salesman must be at 10% of their total sales example total salessales example total sales

is RM1000.is RM1000. Matching concept:Matching concept: Expense: sales commission RM100Expense: sales commission RM100 Revenue: Total sales RM1000.Revenue: Total sales RM1000.

Methods of matchingMethods of matching1) Cause and effect1) Cause and effect

Direct link between expense and Direct link between expense and revenue. Eg services rendered by revenue. Eg services rendered by employees (such as commission, employees (such as commission, cost of goods sold).cost of goods sold).

2) Systematic and rational 2) Systematic and rational allocation of cost eg depreciationallocation of cost eg depreciation

3) Immediate recognition eg 3) Immediate recognition eg advertising expenseadvertising expense

Gross Profit MarginGross Profit Margin

Net sales – Cost of salesNet sales – Cost of sales

Net sales = Gross sales – sales Net sales = Gross sales – sales returns –sales discountreturns –sales discount

Cost of sales = cost of goods soldCost of sales = cost of goods sold

Net Profit MarginNet Profit Margin

Gross Profit minus operating expensesGross Profit minus operating expenses

Operating expenses:Operating expenses:– Distribution expensesDistribution expenses– Selling expensesSelling expenses– Administrative expensesAdministrative expenses– Finance costsFinance costs