Introduction
Big Beans has entered into their transactions of stated sales. These transactions involve the accounting recognition of sales revenue. The accounting treatments of these three transactions have been reviewed in this write up taking into consideration the available Generally Accepted Accounting Principles (GAAP).
Sales with immediate delivery
Scenario: Immediately on harvesting 1,000,000 bushels of beans were sold to Grain Elevators at a price of $18 per bushel with immediate delivery.
1,000,000 bushels of beans have been @ $18 per bushel and the deliveries of bushels have been made immediately. Generally Accepted Accounting Principal (GAAP) with regard to recognition of revenue is covered by FASB Statement of Financial Accounting Concepts No.5.
As per paragraph 83 of said SFAC No.5, revenue “recognition involve consideration of two factors, a) being realized and realizable, and b) being earned, with some time one and sometimes the other being the most important consideration”. Both criteria are required to be accomplished before the revenue is recognized.
The revenue is treated as realized when cash is received for the sale of the product; and revenue is termed as realizable when a promise to pay is received and that be either verbal promise to pay or written in the shape of notes receivable. The transaction under consideration does not involve cash being received by Big Beans. That means revenue has not been realized at the occurrence of a transaction. Also, there is no indication of any written promise to pay as no notes receivable has been executed.
In the transactions, the bushels have been sold and transferred. Delivery plays an important role in the sale of goods transactions. On delivery of goods sales transaction gets completed and a claim to the realization of consideration arises. Accordingly, it can be said that on delivery of goods a non-written promise to pay accrues as the buyers accepted the delivery and have not paid cash. Therefore revenue is realized when the claim of recovery arose as a non-written promise to pay on acceptance of delivery of goods.
The second condition is that the revenue must be earned. Revenue is treated as earned when enforceable exchange takes place of considerations. That is to say, deliveries of goods have been given and a promise to pay has been received. In our transaction bushels have been transferred and a verbal promise to pay has been created on acceptance of delivery by Grain Elevators. Thus revenue can be said to be earned.
Again as per SFAC No.5 before recognition of a transaction four basic criteria namely, definition (meeting the basic element of asset or liability or change in equity), measurability, relevance, and reliability, are required to be fulfilled. As stated above on delivery of goods a claim to the recovery of consideration (which claim is an asset) has arisen. The transaction is measurable as its price is the current cost. The transaction is relevant as it can be evaluated in the context of financial reporting. We can calculate the value of the transaction. The transaction is reliable as it involves a debtor named Grain Elevators and thus representatively faithful. The transaction, therefore, meets all the four criteria of accounting recognition.
As all the four basic criteria of accounting recognition and the criteria of revenue recognition being realized and earned have been met, the transactions should be recognized immediately at the transfer of delivery bypassing the following Journal entry:
DR. CR.
Grain Elevators $18000000
Sales of Bean Bushels $18000000
Sales with delayed deliveries
Scenario: Sale of 500000 bushels @ 17.75 per bushel with delivery within next two months.
Looking from criteria provided under IAS 18 “revenue from sales of goods should be recognized when the following conditions have been satisfied:
The entity has transferred to the buyer the significant risks and rewards of ownership of the goods; b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; c)the amount of revenue can be measured reliably; d) it is probable that economic benefits associated with the transactions will flow to the entity; and e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.”(Technical Summary IAS 18)
In our transaction bushels have sold but deliveries of bushels will be made within two months. It may be noted that the transaction provides a specific number of bushels sold (500000 bushels) and also a specific sale price ($17.75 per bushel). Therefore the transaction is measurable reliably; it is also probable that economic benefits will flow to the buyer; and there are no other costs in respect of transactions. Accordingly, the transaction complies with criteria c), d), and e) mentioned above. But as the delivery of goods has not yet taken place. Therefore the seller Big Beans has not transferred risks and rewards of ownership to the buyer and also retains the usual managerial and effective control over bushels. That means criteria a) and b) are not immediately complied with; and those will comply with only on delivery of goods. Hence revenue cannot be recognized immediately. It will be recognized only at the time of the delivery of bushels to the buyer within two months.
Transaction without sale and delivery
Scenario: Recording revenue of unsold bushels at a current market price of $17.75 per bushel.
The revenue is not realized or realizable as there is no buyer. Also, revenue is not earned as there appears to be no enforceable exchange of considerations. Accordingly, the conditions of revenue recognitions as prescribed under SFAS no. 5 are not complied with.
The goods are lying with the owner and there is no contractual agreement of transfer of ownership, managerial, and/ or control rights. Therefore even the criteria prescribed under IAS 18 cannot be complied with.
As the transaction fulfills neither the rules framed under SFAS No. 5 nor it complies with the criteria of revenue recognition as stated under IAS 18, therefore it can be said that no sale or revenue transaction has taken place. There cannot be any accounting recognition, and the recording of revenue by Big Beans is uncalled for.