SAB 101's Requirements for Revenue Recognition
Moody, Lailani, The CPA Journal
A PREREQUISITE FOR REVENUE RECOGNITION IS that delivery has occured or services have been rendered.
Staff Accounting Bulletin 101, Revenue Recognition in Financial Statements, is the third in a series of SABs issued in response to SEC Chair Arthur Levitt's concerns over financial reporting abuses and earnings management. It provides registrants and their auditors with the staff's position on the requirements for revenue recognition under generally accepted accounting principles: The revenue must either be realized or realizable and earned. This generally does not occur until all of the following criteria are met:
* Persuasive evidence of an arrangement exists,
* Delivery has occurred or services have been rendered,
* Price is fined or determinable, and Collectibility is reasonably assured.
SAB 101 presents the staff s position on various revenue recognition issues related to those four criteria, such as cancellation and termination clauses, bill-and hold transactions, determination of delivery, up-front fees, side agreements, contingent rental income, and consignment-like arrangements. The SAB also stipulates disclosures pertaining to revenue recognition the staff expects registrants to provide in their financial statements and management's discussion and analysis. Moreover, the SAB states the staffs opinion that application of SAB 101 will require some registrants to change their revenue recognition methods, which they should report as changes in accounting principle, unless the changes are corrections of errors. Application is required no later than the first quarter of the fiscal year beginning after December 15, 1999.
Recently issued SAB lOlA delays the implementation date of SAB 101 for registrants with fiscal years beginning between December 16, 1999, and March 15, 2000. Registrants should report any change in accounting principle resulting from the adoption of SAB 101 no later than the second quarter of their fiscal year.
Persuasive Evidence of an Arrangement
For purposes of SAB 101, an arrangement is "the final understanding between the parties as to the specific nature and terms of the agreed-upon transaction." Persuasive evidence that an arrangement exists is needed before revenue recognition can occur. Depending on a registrant's business practice, evidence may be in the form of a written sales agreement or other written or electronic evidence, such as a purchase order or online authorization. A registrant may have different business practices for dif ferent types of transactions, depending on the class of customer or nature of the product.
Written agreements. If the registrant normally would be limited to a written sales agreement, persuasive evidence requires a final agreement signed by both parties. If the arrangement requires approval, say, of the board of directors, revenue recognition is not appropriate until that approval is obtained.
The staff provides the following illustration of how it applies the persuasive evidence criterion: A customer places an order near the end of a registrant's fiscal quarter, and the registrant delivers the product the day before its quarter ends. The registrant uses written sales agreements, but the customer cannot obtain written approval of the contract until a few days after the end of the quarter. Persuasive evidence of an arrangement in this situation would be a final agreement properly executed by the customer's authorized personnel. The sale is therefore considered a transaction of the subsequent period.
Side Agreements. Entities sometimes enter into side agreements that amend the sales contract, for example, by including a cancellation or termination provision. A subsequently executed side agreement could mean the original agreement was not final and revenue recognition would be inappropriate.
Consignment Arrangements and Financings. Certain "sales agreements" are in substance consignments or financings and do not qualify for revenue recognition until a sale occurs. …