Revenue Recognition:

Revenue Recognition principle is one of the important principles of Accrual Accounting. According to this principle, revenue must be recognized when (1) They are realized or realizable and (2) They are earned Revenue is realized when products are exchanged for cash or claims to cash (Receivable). Revenue is realizable when related assets received are readily convertible to cash or claims to cash. Revenue is earned when the products are delivered or services are performed. Recognizing the revenue means recording the amount as revenue in the financial statements. Realization is the process of converting non-cash resources into cash. In the Revenue Recognition principle, it does not matter when cash is received. (In Cash Basis Accounting, revenue is recognized when cash is received no matter when goods or services are sold). For revenue to be recognized, both the above conditions must be met. In other words for revenue to be recognized, final delivery must be completed (of goods or services) and there has to be a payment assurance. Let us have a look at the timing of Revenue Recognition 1) For sale of finished goods (Inventory Items), revenue is recognized at the date of sale (some interpret this as the date of shipping or the date of delivery) 2) For sale of services (e.g. support services), revenue is recognized when the services are performed (delivered) 3) For sale of Asset Items (other than inventory items like finished goods), revenue is recognized at the point of sale (i.e. when the customer is invoiced) 4) For revenue from other activities like rent for using companys Fixed Assets, revenue is recognized as time passes or as assets are used.

Examples:
1) If a company invoices its customer for 100 units of item A, and ships (delivers) only 25 units, the company cannot recognize revenue for entire 100 items. It can only recognize revenue equivalent to the number of units delivered (Revenue is earned only when the products are delivered). Similarly, lets say you pay $120 in advance to company ABC for magazine subscription for one full year. The fact that company ABC received money for one full year does not mean that they can record the entire amount as Revenue. In-fact the amount received in advance is a Liability to the company because they have to deliver magazines to their customer every month and if they fail to do so, they are liable to refund the amount received in advance. In this scenario, the company will recognize 1/12th of the entire amount every month as earned revenue after they deliver the magazine. 2) Company ZXC signs a 3 year support contract with its client for a total amount of 3 million. This amount cannot be recorded as revenue unless the Company provides the support services to the client. Assuming the company is following a monthly calendar accounting period, the company will recognize 1/36th of the entire support contract deal amount every month. (Revenue is recognized when services are performed)

There are few exceptions to the timing of revenue recognition for sale of inventory items. Under normal scenario, revenue is recognizes at the point of sale, however if there are return policies, and if the company cannot reasonably estimate the amount of future returns, the revenue should be recognized only after the expiration of the return policy period.

Revenue Recognition Accounting:

If revenue is not recognized immediately, what is the accounting entry for the Sales Invoice? Lets have a look Lets say, you invoice the Customer in Advance for the annual support contract of $12000. Since, you are invoicing the customer in Advance, you debit your Receivables. But then if you are not crediting the revenue right away, where do you account for the credit side of the accounting entry? You credit, what is called as Deferred Revenue (or Unearned Revenue). Deferred Revenue is actually a liability for the company. (The company is liable to provide the goods or services for which cash is received or will be received in advance). As and when the goods or services are delivered, the Deferred Revenue is reduced (debited) and revenue is recognized. Accounting when the Invoice is created in Jan Date 1-Jan Accounting Class Receivables Debit 12000 Credit Comments The entire receivables is recognized in advance. How this receivable is collected will depend on the payment terms of the Invoice 12000

1-Jan

Deferred Revenue

End of Jan, Revenue is recognized for 1/12th of the entire amount, because the company has provided one months service to its client. To that effect, Deferred Revenue will be reduced and revenue will be recognized Date 31-Jan 31-Jan Accounting Class Deferred Revenue Earned Revenue Debit 1000 1000 Credit Comments Deferred Revenue reduced Earned Revenue amount for one month

End of Feb, another months revenue is recognized Date 28-Feb 28-Feb Accounting Class Deferred Revenue Earned Revenue Debit 1000 1000 Credit Comments Deferred Revenue reduced Earned Revenue amount for one month

The company will have similar accounting entry each month till Dec. At the end of Dec, the Deferred Revenue will be Zero and the entire amount will be reported as Revenue earned.

Revenue Recognition and Invoicing Rules explained

Revenue recognition principle is an important accounting principle, which is the main difference between cash basis accounting and accrual basis accounting. In cash basis accounting revenues are simply recognized when cash is received no matter when and how the services were performed or goods delivered. In accrual basis accounting revenues are recognized when they are (1) realized or realizable and (2) earned no matter when cash is received. Revenue recognition criteria according to US GAAP: USSEC's SAB104 states that revenue generally is realized or realizable and earned when all of the following criteria are met: 1. Persuasive evidence of an arrangement exists; 2. Delivery has occurred or services have been rendered; 3. The seller's price to the buyer is fixed or determinable; and 4. Collectability is reasonably assured Invoicing Rules and Accounting Rules: In Oracle AR, the invoicing and accounting rules help create invoices that span several accounting periods. Accounting rules determine the accounting period or periods in which the revenue distributions for an invoice line are recorded. Invoicing rules determine the accounting period in which the receivable amount is recorded.

Accounting Rules: Accounting rules determines revenue recognition schedules for invoice lines. Different accounting rules can be assigned to each invoice line. Using Accounting rules, the number of periods and the percentage of the total revenue to recognize in each period can be specified. Also accounting rules can be Fixed or Variable Duration. Clients can also create rules that will defer revenue to an unearned revenue account. This helps in the delay of specifying the revenue recognition schedule until the exact details are known. When these details are known, clients use the Actions wizard to recognize the revenue. Invoicing Rules: Invoicing rules determines when to recognize receivable for invoices that span more than one accounting period. Clients can only assign one invoicing rule to an invoice. Receivables provides the following invoicing rules: Bill In Advance: Use this rule to recognize your receivable immediately. Bill In Arrears: Use this rule if you want to record the receivable at the end of the revenue recognition schedule. Using Invoices with Rules:

Assigning Invoicing Rules: Invoicing rules determine whether to recognize receivables in the first or in the last accounting period. Once the invoice is saved, you cannot update an invoicing rule. If Bill in Arrears is the invoicing rule, Oracle Receivables updates the GL Date and invoice date of the invoice to the last accounting period for the accounting rule.

Assigning Accounting Rules To Invoice Lines: Accounting rules determine when to recognize revenue amounts. Each invoice line can have different accounting rule.

Creating Accounting Entries: Accounting distributions are created only after the Revenue Recognition program is run. For Bill in Advance, the offset account to accounts receivable is Unearned Revenue. For Bill in Arrears, the offset account to accounts receivable is Unbilled Receivables. Accounting distributions are created for all periods when Revenue Recognition is run. Running The Revenue Recognition Program: The Revenue Recognition program gives control over the creation of accounting entries. Submit the Revenue Recognition program manually through the Run Revenue Recognition window. The Revenue Recognition program will also be submitted when posting to Oracle GL. The program processes revenue by transaction, rather than by accounting period. Only new transactions are selected each time the process is run.
In R12 revenue recognition is based on Rules and Events, and they are:

Time-Based Revenue Recognition Upon Expiration of Contingencies Event-Based Revenue Recognition

o o o o

Ratably Over Time

Payment Customer Acceptance

Rule-Based Revenue Recognition o Payment Term Thresholds

o o

Refund Policy Thresholds Customer Credit worthiness

Lets take a quick look on some of the new changes:

Daily Revenue Recognition

Accuracy to the number of days in the accounting period. Enhanced Revenue Contingencies :

o o o o o o o o o o

Revenue distribution over full as well as partial accounting periods. Fulfills stringent accounting standards

Fully Supports US GAAP and IAS User definable contingencies User definable defaulting rules for contingencies assignment Supports parent-child (e.g. Product and Service) relationship Integration with Order Management and Service Contracts User Interface as well as Programming Interface (API) support

Access control through seeded Revenue Managers Responsibility Deferred Revenue Management

Event-Based Revenue Management in Oracle Receivables allows users to define revenue deferral reasons or contingencies and corresponding revenue recognition events. In Release 12, revenue contingencies for customer acceptance that are applied to goods sold in Order Management are now applied to services sold to cover those goods. Revenue is deferred for service ordered in both Order Management and Service Contracts. Acceptance contingencies associated with an item instance are automatically applied to service revenue associated with the item instance when it is covered in a Service Contract as a Covered Product. Revenue for services on other covered levels, subscriptions and usage is not impacted by contingencies applied to goods associated with those services.

R12 Revenue Recognition

Oracle Receivables, provides multiple methods by which revenue can be recognized for an invoice: Revenue Recognition Revenue Accounting Event-Based Revenue Management Enter an accounting rule Type. 1.Enter Fixed Schedule to prorate revenue recognition evenly over a predefined period of time. The revenue recognition schedule is always the same every time you choose this accounting rule. For example, if you have four schedules for your rule with this type, you will recognize twenty-five percent of your revenue at the end of each schedule. 2.Enter Variable Schedule to later specify, during invoice entry, the number of periods over which you want to recognize revenue for invoices to which you assign this rule. You can assign this type of accounting rule to invoices that you manually enter in the Transaction window or import into Receivables using AutoInvoice. The revenue recognition schedule changes for invoices that are assigned this type of accounting rule depending upon the value that you either pass through AutoInvoice or specify when you manually enter an invoice. 3.Enter Daily Revenue Rate, All Periods to have Receivables use a daily revenue rate to calculate the precise amount of revenue for each full and partial period in the schedule. Use accounting rules of this type to meet strict revenue accounting standards. 4.Enter Daily Revenue Rate, Partial Periods to have Receivables use a daily revenue rate to calculate the precise amount of revenue for only partial period in the schedule. This rule provides you with an even, prorated revenue distribution across the schedule's full periods. Enter Daily Revenue Rate, All Periods and Enter Daily Revenue Rate, Partial Periods. revenue recognition will work as below for these rules

In Advance Amount Partial period All Period Days

Total amount is =1000 Total Number of days= 154 For day=1000/154=6.49 All Period: Amount is equally divided for each bay Partial period : 17*6.49 (110.39 in first period) +15*6.49 (97.41 in last period) and remaining amount is equally distributed for remaining period irrespective on number of days in the periods . Note: If there are any rounding differences that will be adjusted in the last periods