Suzie's Sweater: The New Paradigm in Accounting: Revenue Recognition Is the #1 Problem in Financial and Accounting Fraud

By King, Alfred M. | Strategic Finance, August 2005 | Go to article overview

Suzie's Sweater: The New Paradigm in Accounting: Revenue Recognition Is the #1 Problem in Financial and Accounting Fraud


King, Alfred M., Strategic Finance


Here is a Pop Quiz, students: At 11:30 p.m. on Dec. 31, Suzie comes into a store and buys a sweater for $100. She pays cash but is then apologetically told that her size is temporarily out of stock so she should come back on Tuesday; the store will then have the sweater in her size and she can pick it up.

You are the accountant for the store, and, unfortunately, business was slow that day so Suzie's sweater sale was the only transaction. You now have to make the accounting entries for day's business.

What are the correct entries? I'll give you one You should debit cash for $100, so only problem is what is or are the offsetting credit(s)?

If you answered that the correct credit entry should be to credit deferred revenue for $100, you would flunk the test--at least if the Financial Accounting Standards Board (FASB) were doing the grading that day. The "correct" entry, assuming the cost to the store for the sweater is $80, is to recognize $20 of income on Dec. 31 and have a liability (to deliver the sweater) of $80.

REVENUE RECOGNITION IS THE PROBLEM

Most observers of financial and accounting fraud have identified revenue recognition as the country's number-one problem. When should revenue be recognized, and in what amounts, is far more complex an issue than is generally accepted. Just a simple example will suffice.

A software company sells a customer software, which includes services to help the customer install the system, access to a help desk for the next two years, and promised upgrades to the software as and when they are available. How much of the single total selling price relates to the software and can be recognized upon delivery, and how much has to be deferred for future services?

The answer to this conundrum is complex and beyond the scope of this article. Suffice it to say that a lot of time and effort have been spent on this issue over the past 10 or more years, and there is as yet no consensus as to the correct answer. The FASB, Emerging Issues Task Force (EITF), and Securities & Exchange Commission (SEC) have all weighed in on the issue, perhaps even with seemingly conflicting advice. This example could be multiplied 100-fold, and some observers have stated that there are more than 200 separate approaches to revenue recognition in today's accounting literature.

THE FASB SOLUTION

The FASB has tackled the problem of revenue recognition and is attempting to resolve it starting from a conceptual approach. This approach has been referred to as an "Asset-and-Liability Approach" and starts with the premise that you must look at and evaluate the liability the seller assumes when the customer places an order.

Put in its simplest terms, the FASB believes that the seller of Suzie's sweater only has a liability for $80 after Suzie has paid her cash. The logic is that the store owes her a sweater, and the cost to provide the sweater (perhaps including normal operating costs) is $80.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Suzie's Sweater: The New Paradigm in Accounting: Revenue Recognition Is the #1 Problem in Financial and Accounting Fraud
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.