CHAPTER 5

REVENUE AND MONETARY ASSETS

Changes from Eleventh Edition

The chapter has been updated.

Approach
The sequence of transactions for accounts receivable and bad debts often causes difficulty; indeed, the
time that one is sometimes forced to spend on this topic is all out of proportion to its importance. Students
often do not understand why an Allowance for Bad Debts account is necessary at all; they do not grasp
the notion that although we feel reasonably sure that some accounts will go bad, we do not know which
ones they will be. Even when they do understand this, the chain of transactions involved in estimating bad
debts, writing off specific accounts, and booking bad debts recovered, is complicated and not easy to
follow.

If experience is any guide, it is quite likely that at the time this chapter is taught the press will be
describing a company that has gotten into trouble for overstating its revenue or understating its bad debt
or warranty allowance. Discussion of such a situation would be interesting

Cases
Stern Corporation (A) is a straightforward problem in handling accounts receivable and bad debts.

Grennell Farm, by contrast, has few technical calculations but provides an excellent opportunity for a
realistic discussion of alternative ways of measuring revenue and of valuing assets.

Joan Holtz (A) is a different type of case. It is a device for raising several discrete, separable problems
about the subject matter of the chapter, from which the instructor can pick and choose those he or she
wishes to take up in class. (It probably is not feasible to discuss all of them.)

Bausch & Lomb, Inc., is an actual case situation involving revenue recognition.

Boston Automation Systems, Inc. involves a review of the company’s revenue recognition practices in the
light of the SEC’s SAB 101 (a longer version of the case was included in the Eleventh Edition).

Problems

Problem 5-1
Sale Method Jan. Feb. Mar. April May June
Sales...................................................................................................................................................................................
$12,000 $ 8,000 $13,000 $11,000 $9,000 $13,500
Cost of goods sold..............................................................................................................................................................
7,800 5,200 8,450 7,150 5,850 8,775
Gross margin......................................................................................................................................................................
$ 4,200 $2,800 $ 4,550 $ 3,850 $3,150 $ 4,725

Installment Method Jan. Feb. Mar. April May June

Sales...................................................................................................................................................................................
$11,000 $10,000 $11,500 $10,500 $10,500 $9,500
Cost of goods sold..............................................................................................................................................................
7,150 6,500 7,475 6,825 6,825 6,175
$ 3,850 $ 3,500 $ 4,025 $ 3,675 $ 3,675 $3,325

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Problem 5-2
Completed Contract Percentage of Completion
This Year Next Year This Year Next Year
Income excluding motel (000)........................................................................................................................................................
$1,250 $1,250 $1,250 $1,250
Income from motel project..............................................................................................................................................................
0 750 450 300
Income before taxes........................................................................................................................................................................
$1,250 $2,000 $1,700 $1,550
Problem 5-3
To record the write-off:

If Alcom uses the direct write-off method—

dr. Bad debt Expense.................................................................. $3,000
cr. Accounts Receivable......................................................... $3,000
If Alcom uses the allowance method:
dr. Allowance for Doubtful Accounts......................................... $3,000
cr. Accounts Receivable................................................ $3,000
To record the partial payment:

If Alcom uses the direct write-off method:

Cash........................................................................................... $950
Bad Debts Recovered............................................................ $950
(or Bad Debt Expense............................................................ $950)
If Alcom uses the allowance method:
Either of the above two entries or:
Cash........................................................................................... $950
Allowance for doubtful accounts........................................... $950

Problem 5-4
The Allowance for Doubtful Accounts should have a balance of $51,750 on December 31. The supporting
calculations are shown below:

Days Account Expected Percentage Estimated

Outstanding Amount Uncollectible* Uncollectible
0-15 days $450,000 .01 $ 4,500
16-30 days 150,000 .06 9,000
31-45 days 75,000 .20 15,000
46-60 days 45,000 .35 15,750
61-75 15,000 .50 7,500
Balance for Allowance for Doubtful Accounts $51,750

The accounts that have been outstanding over 75 days ($15,000) and have zero probability of collection
would be written off immediately and not be considered when determining the proper amount of the
Allowance for Doubtful Accounts.

*
(1-Probability of collection.)

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b.
Accounts Receivable....................................................................... $735,000
Less: Allowance for Doubtful Accounts.......................................... 51,750
Net Accounts Receivable.................................................... $683,250

c. The year-end bad debt adjustment would decrease the year’s before-tax income by $29,250, as
shown below:

Estimated amount required in the Allowance for Doubtful $51,750

Accounts....................................................................................
Balance in the account after write-off of bad accounts but before
adjustment.................................................................................. 22,500
Required charge to expense.............................................................. $29,250

Problem 5-5
Green Lawn’s books:

dr. Inventory on Consignment........................................................... 8,400

cr. Finished Goods Inventory....................................................... 8,400

Note that at this point the $12,600 wholesale price (Green Lawn’s revenue when these goods are sold) is
irrelevant.

Carson’s books: No entry; the goods are not owned by Carson and hence are not inventory on Carson’s
books; similarly, Carson does not as yet owe Green Lawn for these goods.

Green Lawn’s books:

dr. Accounts Receivable................................................................... 5,040

Cost of Goods Sold...................................................................... 3,360
cr. Sales................................................................................... 5,040
Inventory on Consignment.................................................. 3,360
(This can be shown as two entries.)
Carson’s books:
dr. Cash or Accounts Receivable....................................................... 6,720
Cost of Goods Sold...................................................................... 5,040
cr. Sales................................................................................... 6,720
Accounts Payable................................................................. 5,040
(This also can be shown as two entries.)
Problem 5-6
20 x 4 20 x 5 20 x 6
Revenue..................... $980,000 $1,470,000 $2,205,000
Costs.......................... 721,000 1,190,000 1,715,000
Income....................... $259,000 $ 280,000 $ 490,000
Revenue equals percentage completed during the year times fixed price.

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Problem 5-7
The GRW Company’s current assets and current liabilities at year-end are shown below.

Current assets:
Cash......................................................................................... $ 23,100
Accounts receivable................................................................. $ 34,650
Less: Allowance for bad debts.................................................. 1,850
Net accounts receivable............................................................ 32,800
Beginning inventory................................................................. 46,200
Purchases.................................................................................. 184,800
Available inventory.................................................................. 231,000
Less: Cost of goods sold........................................................... 161,700
Ending inventory...................................................................... 69,300
Total current assets.............................................................. $125,200
Current liabilities:
Accounts payable...................................................................... $38,600
Current portion of bonds payable............................................. 7,700
Interest payable......................................................................... 25,000
Total current liabilities......................................................... $ 71,300
Current ratio = $125,200 / $71,300 = 1.76
Quick ratio = ($23,100 + $32,800) / $71,300 = .78

The above ratios measure GRW’s ability to meet short-term obligations. The current ratio indicates that
GRW has 76 percent more cash and relatively liquid assets that are expected to be converted to cash in the
short run than it has short-run obligations requiring cash for their satisfaction. This ratio does not
necessarily mean the amount of current assets is adequate, however. For example, the accounts payable
and interest payable could be obligations due within the next few days, and it may not be possible to
liquidate accounts receivable and inventories that quickly.

b. Cash Expenses:
Cost of goods sold.................................................................... $161,700
Other expenses......................................................................... 69,300
Total cash expenses............................................................................... $231,000

Days’ cash = $23,100 / ($231,000 / 365) = 36.5 days.

This ratio measures how many days of normal operating expenses can be paid without adding to the cash
balance. The above ratio indicates that GRW Company has an apparent stockpile of cash. This means
GRW is either planning unusual expenditures during the next period, or is not properly managing cash.
Cash does not generate a return. There is a trade-off between “instant” liquidity and the return on
marketable securities.

Some students may argue that purchases, rather than cost of goods sold, should be used in the calculation.
This would not reflect a true “steady state” of operations, since it happened that GRW built up its
inventory by $23,100 during the year. The argument for basing the ratio on purchases would be stronger if
the student explicitly assumes a long-term buildup of inventory each year (to support increasing sales);
but then, for consistency, some other cash expenses should probably be increased, too, thus resulting in
approximately the same 36.5-day figure. In any event, there is no implication that such ratio calculations

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are interpretable with great precision. They are most meaningful if calculated for the same company over
a period of years.

c. Days’ receivables = Net receivables / (Credit sales / 365) = $32,800 / ($323,400 x .77 / 365).
= 48 days.

This ratio measures the average collection period of receivables. Although some analysts use total sales
(often because the portion of credit sales is not disclosed), the above calculation is correct. The result
suggests that GRW’s customers are stretching the payment period.

Cases
Case 5-1: Stern Corporation (A)
Note: The case has been updated.

Approach
This case is designed to give practice in handling the various transactions for accounts receivable and bad
debts. There can be differences of opinion, particularly about the treatment of bad debts recovered, but the
objective is to understand the process, and I do not think it is important to get agreement as to the “one
best method” (if there is such a thing). This is not a full assignment by itself, but is if taken together with
study of the text.

Comments on Questions

Question 1
1. Accounts Receivable................................................................... 9,965,575
Sales........................................................................................ 9,965,575
2. Cash............................................................................................. 9,685,420
Accounts Receivable............................................................... 9,685,420
3. Allowance for Doubtful Accounts............................................... 26,854
Accounts Receivable............................................................... 26,854
(Entries would also be made to specific accounts receivable, assuming that the account on the balance
sheet is a control account.)

4. Debit Cash $3,674 ($2,108 for one account and $1,566 as partial payment on another). The rest of the
transaction could be handled in one of three different ways:

(a) Credit Allowance for Doubtful Accounts $4,594 ($2,108 for account collected in full and $2,486
for account collected in part with reasonable assurance of future collection of remainder), and debit
Accounts Receivables $920 (for balance of account partially collected). This is preferable.
(b) Credit Bad Debt Expense $3,674 ($2,108 + $1,566).
(c) Credit some “Other Income” account $3,674.
5. The calculation of the Allowance for Doubtful Accounts and Accounts Receivable depends upon
which of the alternatives was employed in handling the collection of written-off accounts in 4 above.

Under (a), the Accounts Receivable remaining on the books at the end of 2006 is calculated as
follows:

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Accounts Receivable, December 31, 2005.............................. $ 988,257

Add increase to A/R from sales on account during 2006........ 9,965,575
10,953,832
Less decrease to A/R for accounts for which payment was
received during 2006............................................................... 9,685,420
1,268,412
Less accounts written off in 2006............................................ 26,854
$ 1,241,558

Add that portion still due on previously written-off account

which was paid in part in 2006 with reasonable assurance of 920
future payment of the payment of the remainder.....................
$1,242,478

The bad debt expense is 0.3 percent * $1,242,478 = $37,274. The entry, therefore, would be:
Bad Debt Expense.............................................................. 29,886
Allowance for Doubtful Accounts......................... 29,886
The Allowance for Doubtful Accounts remaining on the books at the end of 2006 is
calculated as follows:
Allowance for Doubtful Accounts, December 31, 2005.......... $29,648
Less Accounts Receivable written off in 2006........................ 26,854
2,794

Add increase to Allowance for Doubtful Accounts for

previously written-off accounts which were collected during 4,594
the year or deemed collectible in the future.............................
Balance in account.................................................................. 7,388
Add additional bad debt expense needed................................. 29,886
Total allowance for Doubtful Accounts, December 31, 2006. . $37,274

The Allowance for Doubtful Accounts remaining on the books at the end of 2006 is calculated as follows:
Under (b) or (c), in the calculation of Accounts Receivable: the last step in the calculation above is
eliminated, thus leaving an Accountings Receivable balance of $1,241,558.
The Bad Debt Expense is calculated and recorded the same as shown above.
The Allowance for Doubtful Accounts remaining on the books as the end of 2006 is calculated as follows:
Allowance for Doubtful Accounts, December 31, 2005......... $29,648
Less Accounts Receivable written off in 2006........................ 26,854
Balance in account................................................................. $2,794
Add additional bad debt expense............................................ 34,453
Total Allowance for Doubtful Accounts, December 31, 2006 $37,247

Question 2
Using (a) Using (b) or (c)

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Balance of accounts as of December 31, 2006:

Accounts Receivable...................................................................... $1,242,478 $1,241,558
Less allowance for doubtful accounts............................................. 37,274 37,247
$1,205,204 $1,204,311
Question 3
In the ratios used for analysis of monetary assets listed below, the results are approximately the same
whether method (a), (b), or (c) is used.

2006
Current ratio.................................................................................. 2.7
Acid-test ratio............................................................................... 1.5
Days’ cash..................................................................................... N/A
Days’ receivables: method (a)....................................................... 44.1
method (b) or (c)...................................................................... 44.2

Case 5- 2: Grennell Farm

Note: This case has been updated from the Eleventh Edition.
Approach
This case is a good illustration of a situation where revenue recognition is not a cut-and-dried question. It
also provides excellent reinforcement of the matching concept and statement articulation. The alternatives
discussed are: (1) the production method, which recognizes inventory “holding gains” as revenue; (2) the
sales method, which is analogous to the financial accounting method of revenue recognition of most
manufacturers and retailers; and (3) the collection method, which recognizes revenues as collected, but is
not quite the same as cash-basis accounting (since costs are accrued). While either the production method
or sales method is acceptable under GAAP, that is really a moot point since Denise Grey is the sole owner
of the incorporated farm, and not bound by GAAP. Once the issue of how much revenue to recognize is
resolved, then how much expense to match can be dealt with. Together, these two issues determine how
much gross profit Grennell farm will be shown as earning.

Question 1
The calculations shown below for Question 1 show the range of sales figures under different recognition
methods. I start with the sales method, then do the collection method, and save the more unusual
production method until last. An issue is whether the entire $183,000 “annual costs not related to the
volume of production” should be treated as product or period expense. Unless the instructor for some
reason is using this case after Chapter 6, the students may not recognize this as an issue or, if they do, not
know how to deal with it in the financial statements. In any event, I think it worthwhile for the instructor
to note that these expenses are by definition fixed (do not vary with production volume), but that some
(especially a portion of salaries and wages) may be production costs and hence strictly speaking should be
used in valuing inventory. (Students often mistakenly use “fixed costs” and “period costs” as synonyms.)

Of course, the point of Question 1 is not just practice in revenue and expense matching calculations, but
thinking about which is the most appropriate method. For tax purposes, Grey will want to use the
collection method. For evaluating the performance of the farm in 2005, the production method would
seem most useful. This is because there is very little uncertainty concerning the eventual sale of the
30,000-bushel wheat inventory stored at the farm. This inventory exists, not because there are no
customers for it, but because the farm manager chose not to sell it, speculating that future prices will be
higher. This is the same reasoning that justifies this unusual revenue recognition method as GAAP; the
same method is also allowed for precious metals and other minerals where immediate marketability at

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quoted prices obtains. Also, many professional service firms (e.g., accounting firms) recognize revenue as
work is performed by recording jobs in progress at billing rates rather than at cost. The name Unbilled
Receivables is often used for this account to emphasize that the revenue has already been recognized,
even though it has not yet been billed.

Exhibit A
Collect the cash
from the customer

Customer acknowledges Collection Method Purchase raw material

receipt of the item

Ship the product to the Convert the raw material

customer and send a “Usual” Method to a finished product
sales invoice (Delivery Method)

Receive an order for the product Inspect the product

from a customer Production Method

Store the product in

a warehouse

To generalize the discussion, I put on the board a “cash cycle” diagram like the one in Exhibit A to this
note. Starting with purchases, I go around this wheel and add to its interior the three points at which
revenue can be recognized: these correspond to the three methods in the case, including the “usual”
method of recognizing revenue when goods are shipped. When is the “correct” point to recognize
revenue? This diagram points out that the answer is not clear-cut. “Conservatism” would say do not
recognize the revenue until there is very little uncertainty as to receipt of the cash proceeds, driving the
revenue recognition toward the collection point. “Timeliness” would argue for recognizing the revenue
when the “critical event” or “performance” has taken place, in this instance as soon as a certainly salable
product has been produced, i.e., the production method for Grennell. The measurability of income
criterion does not help select a method in this instance, as the Question I calculations are feasible for all
three methods.

Question 2
The original cost of the land was only $187.50 an acre: it is now appraised (for estate tax purposes) at
$1,050 per acre, or $2.1 million. The cost concept says that, at least prior to the transfer of ownership to
Grey (and possibly even afterwards), the balance sheet will show the land at its cost, $375,000. However,
again GAAP need not prevail here, for Grey is trying to assess the economic attractiveness of the farm.
Since she could sell the land for $2.1 million (or more, if the estate tax valuation was below market) and
invest the proceeds elsewhere, she will likely want to use the higher valuation in her assessment. (Again,
this is an argument often given for stating assets at current values: the asset is, in effect, tying up $2.1
million, not $375,000.) If Grey wants to think of selling only the 100 acres for the development, then she
may think of the land value as $2.22 million (1,900 * $1,050 plus $225,000). The point is that the
$375,000 historical cost is the least relevant for Grey’s purposes.

Question 3
Assuming Grey agrees that the combination of the production method of revenue recognition and the
$2.22 million land valuation best serve her appraisal purposes, then in 2005 we have $323,370 net income

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on an owner’s equity investment of $2,482,100 ($637,100 plus $1,845,000 write-up of land), or a 13

percent before-tax return on investment. When one considers future appreciation of the land, this may
well be a better investment than Grey would be able to make with the proceeds from selling the farm.

GRENNELL FARM
Income Statements
Method:
Sales Collection Production
Sales................................................................................. $522,000 $462,4001 $614,1005
Cost of goods sold
Beginning inventory............................................ 0 0 0
Production2.......................................................... 107,730 107,730 107,730
Less: Ending inventory........................................ 15,390 25,6503 06
Cost of goods sold............................................... 92,340 82,080 107,730
Gross margin.................................................................... 429,660 380,320 506,370
Other expenses ................................................................ 183,000 183,000 183,000
Net Income....................................................................... $246,660 $197,320 $323,370

Balance Sheets
Cash.................................................................................. $ 30,900 $ 30,900 $ 30,900
Accounts receivable.......................................................... 59,600 04 151,7007
Inventory.......................................................................... 15,390 25,650 0
Land................................................................................. 375,000 375,000 375,000
Buildings and machinery (net).......................................... 112,500 112,500 112,500
Total assets.......................................................... 593,390 544,050 670,100
Liabilities (current)........................................................... 33,000 33,000 33,000
Owners’ equity8................................................................
Common stock and APIC.................................... 457,500 457,500 457,500
Retained earnings................................................ 102,890 53,550 179,600
Total owners’ equity......................................................... 560,390 511,050 637,100
Total liabilities and owners’ equity................................... $593,390 $544,050 $670,100

Notes:
1
180,000 bushels @ $2.90 - 20,000 bushels @ $2.98 = 160,000 but @ $2.89.
2
210,000 bushels @ $.513 = $107,730.
3
30,000 bushels physically in inventory plus 20,000 bushels “inventory” at the elevator, reflecting
payment not yet received from the elevator operator.
4
Under the collection method, there ae no accounts receivable since sales revenues aer not recognized
until the collection is made.
5
30,000 bushels @ $3.07 + 180,000 bushels @ S2.90. Another approach is as follows:
210,000 bushels @ $2.80 = $588,000 (value at harvest)
180,000 bushels @ 0.10 = 18,000 (gain on sales to elevator)
606,000
30,000 bushels @ $0.27 = 8,100 (write-up to year-end value)
$614,100
Given the text’s description of the production method, I treat $606,000 as an acceptable answer, but point
out the logic of writing up the 30,000 bushels on hand for purposes of the year-end balance sheet.
6
Although there are 30,000 bushels physically in inventory, under the production method all wheat is
counted as sold, and hence is not in inventory in an accounting sense.

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7
This includes the $59,600 “real” receivable plus $92,100 recorded as revenue on the 30,000 bushels
produced but not physically sold. Students may create a different account for this $92,100, for example,
Unbilled Receivables, which is fine.
8
If you assume that the case statement “Grennell withdrew most of the earnings” means that Retained
Earnings at the beginning of the year was zero, then the 2005 drawings can be determined as follows:
Sales Collections Production
Beginning Retained Earnings........................................... $0 $0 $0
Plus: Net Income.............................................................. 246,660 197,320 323,370
Less: Ending Retained Earnings....................................... 102,890 53,550 179,600
Drawings............................................................. $143,770 $143,770 $143,770

Case 5- 3: Joan Holtz (A)

Note: This case has been updated from the Eleventh Edition.
Approach
These problems are intended to provide a basis for discussing questions about revenue recognition that
are not dealt with explicitly in the text and that are not sufficiently involved to warrant the construction of
a regular case. Instructors can pick from among those listed. Some of them can be used as a take-off point
for elaboration and extended discussion by adding “What if?” facts.

Answers to Questions
1. If electricity usage tended to be fairly constant from month to month, one could argue in this case for
basing reported revenues solely on the actual meter readings: the unreported usage in December
would be reported in January, and overall revenues for this year would not be materially misstated.
Stated another way, if revenues are based solely on meter readings, the December 2006 post-reading
usage (which is recorded in January 2007) is, in effect, assumed to be the same 2007 post-reading
usage. Prior to passage of the 1986 Tax Reform Act, this approach was permitted for income tax
purposes. The 1986 act requires the more acceptable (due to better matching) practice: estimating
actual usage for the part of December after meters are read and reporting that usage as part of the
revenues of that year. This is more sound accounting, in that with weather fluctuations and energy
conservation efforts, it is questionable whether the post-reading usage in December 2006 would in
fact not differ materially from the post-reading usage in December 2007. The same problem exists for
operators of vending machines. The postal service has the opposite problem: it receives cash from
stamp sales before all of the stamps are used. It carries a liability (unearned revenues) for this effect.
Both of these examples illustrate that even when cash is involved, the measurement of revenue is not
necessarily straightforward.

2. This is one of the problems whose “true” resolution depends on events that cannot be forseen at
the end of the accounting period. Some firms count the whole $10,000 as revenue in 2006 on the
grounds that it is in hand and that any specific services are undefined and/or separately billable.
Others take the more conservative approach of counting only $5,000 as revenue in 2006 on the
grounds that the service involved is “readiness to serve,” and that this readiness exists equally in each
year. I prefer the latter approach, based on the matching concept.

3. Many would argue that the service involved is the cruise and that no revenue has been earned
until the cruise has been completed. Others maintain that Raymond’s has completed its “service” of
arranging the cruise, that it is extremely unlikely that events will happen in 2007 that will change its
profit of $20,000, and that the amount is therefore revenue in 2006. Introduction of the possibility of a
refund lessens the strength of the argument of the latter group. This position can be weakened further

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by asking: (a) What if passengers are dissatisfied and demand (or sue for) a refund? (b) What if the
ship owner performs unsatisfactorily and Raymond’s, in order to protect its reputation, steps in and
incurs additional food or other cost to make the passengers happy? Students should be reminded to
consider two criteria: (1) that the agency has substantially performed its earning activities and (2) that
the income is reliably measurable.

4. This problem has been debated for many years. Some argue that the $4 per tree has already been
earned, as evidenced by the firm offer to buy the trees, and that it would be misleading to show no
revenues in 2006 and the full sales value when the trees are sold in 2007. The
percentage-of-completion method can be used as an analogy. Others argue that there has been no
transaction, and no assurance that the trees can be sold for more than $4 in 2007 because market
prices may decrease, or pests or fire may destroy them. Typically, firms facing this issue recognize no
revenue until harvesting the trees.

5. If a professional service firm (architects, engineers, consultants, lawyers, accountants, and so on)
values its jobs in progress at billing rates, then it is recognizing revenue as the work is performed
(time applied to projects) rather than waiting until the customer is billed. This is certainly defensible
if the firm has a contract (called a “time and materials contract”) that obligates the client to pay for all
time applied to the client’s project: the critical act of performance is spending the time on the project,
not billing that time. In fact, many such firms feel that even with fixed -fee contracts, the critical
performance task is spending time on a project as opposed to delivering some end item to the client;
they thus record jobs in progress at estimated fee, which would be the same as billing rates for the
time applied provided the project is within its professional-hour budget. Of course, whether the
revenue is recognized when the time is applied or when the client is billed does make a difference in
owners’ equity. Retained earnings will reflect the margin on the time applied sooner if the jobs in
progress inventory is valued at billing rates rather than at cost.

6. Numerous answers are acceptable. I argue that the coupon has nothing to do with the sale of
coffee. Its purpose is to promote the sale of tea. The 60 cent reimbursements made in 2006 and the 60
cent reimbursements made in 2007 are an expense of selling tea in 2007. Those who tie the coupons
with coffee would say that the entire 20 percent of coupons redeemed is an expense of selling coffee
in 2006 with the amount not yet redeemed being a liability as of December 31, 2006. It is customary
that the coupon issuer pay the store a handling fee in addition to the face value of each coupon; here
that fee is 10 cents. It is 60 cents per coupon that is the cost, not the 50 cent face value.

7. The bank would record the sale of $500 travelers checks for $505 as follows:

dr. Cash............................................................... 505

cr. Payable to American Express..................... 500
Commission Revenue................................ 5
After the bank remits the $500 cash to American Express, the latter will make the following entry:
dr. Cash............................................................... 500
cr. Travelers Checks Outstanding................... 500
The account credited is a liability account. This account had a balance of many billions of dollars,
which should help students understand why American Express does not itself levy a fee on the
issuance of travelers checks: the checks are a great source of interest-free capital to American
Express.
8. According to FASB Statement No. 49, Manufacturer A cannot record a sale at all under these
circumstances. The merchandise must remain as an asset on Manufacturer A’s balance sheet and a
liability should be recorded at the time the $100,000 is received from B. This statement precludes

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Manufacturer A from inflating its 2006 revenues and income by the sort of repurchase agreement
described. FASB 49 was issued to address the perceived abuse of treating such temporary title
transfers as sales.

9. FASB Statement No. 45 states that franchise fee revenue should be recognized “when all material
services or conditions relating to the sale have been substantially performed or satisfied by the
franchiser.” Amortization of initial franchise fees should only take place if continuing franchise fees
are so small that they will not cover the cost of continuing services to the franchisee. Since this
exception seems unlikely in this case, the $10,000 franchise fee should be recognized as revenue in
the year received, as soon as the training course has been completed. Investors will need to make their
own judgment as to what will happen when the market becomes saturated.

10. This item is designed to get students to think about (1) a condition that creates the need for a
change in revenue recognition policy, and (2) the potential need for multiple revenue recognition
policies for a firm.

Tech-Logic, a manufacturer of computer systems, normally recognizes revenue when its products are
shipped, a policy common among manufacturing firms. To adopt that policy, managers at Tech-Logic
must have concluded that the two criteria for revenue recognition were met at shipment: (1)
Tech-Logic would have substantially performed what is required in order to earn income, and (2) the
amount of income Tech-Logic would receive could be reliably measured.
With the sale of the computer systems to the organization in one of the former Soviet Union
countries, however, Tech-Logic’s ability to satisfy these two criteria changed. Although the first
criterion was still met, the uncertainty about whether (and how much) foreign exchange the customer
could obtain left the second criterion in doubt. Hence, Tech-Logic should not recognize revenue for
these computer systems at shipment or delivery. An alternative should be to wait until cash (in the
form of hard currency) was received to recognize revenue.
This item can also be used to discuss the fact that firms often have more than one revenue recognition
policy. Tech-Logic would not completely change its revenue policy to “cash receipt” for all sales at
the time it begins to sell computers to organizations in countries where the availability of foreign
exchange currency is in doubt. Rather, it would be likely to have two revenue recognition policies; at
shipment, for products sold to organizations in countries where the availability of foreign exchange
currency is not in doubt; and cash receipt, for products sold to organizations in countries where the
availability of foreign exchange currency is in doubt.
Because they manufacture products and provide a variety of services, computer manufacturers often
have a variety of revenue recognition policies. For example, a computer manufacturer might
recognize revenue for products when they are shipped; for custom software development, when the
customer formally accepts the software; and for maintenance services, ratably over the life of the
maintenance contract.
Item 10 was inspired by events that occurred at Sequoia Systems in 1992. Sequoia evidenced several
instances of aggressively booking revenue. One of these involved a Siberian steel mill. According to
The Wall Street Journal:
Executives signed off last year on the sale of a $3 million computer destined for a steel mill in
Siberia. But government approvals and hard currency to pay for the system got stalled, even
though $2 million of revenue was booked in the fiscal year ended June 30, and another $1 million
was going to be taken in the first quarter ended last month, insiders say. 1
Sequoia executives stated that they expected this ;obthe Siberian steel mill;cb and similar sales “will
1
The Wall Street Journal, “Sequoia Systems Remains Haunted by Phantom Sales,” October 30, 1992, p. B8.

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ultimately prove to be good business” and that the decision to book it as revenue “was supported by the
revenue recognition policy that we had in place.” 2 However, under investigation by the SEC and facing
lawsuits by shareholders, Sequoia twice restated revenues following the end of fiscal year 1992, reducing
originally reported revenues by more than 10 percent. 3

 Case 5­5: Boston Automation. Systems, Inc. *
Note: A shorter version of the Eleventh Edition case.

David   Fisher,   the   chief   financial   officer   of   Boston   Automation   Systems,   Inc.   a   capital   equipment
manufacturing and testing instrument supplier to a variety of electronic­based industries, including the
semiconductor   industry,   was   reviewing   the   revenue   recognition   practices   of   the   company’s   three
divisions. The review was undertaken in anticipation of disclosing in the company’s third quarter 2000
Form 10­Q filing with the Securities and Exchange Commission (SEC) and the possible impact on the
company of the revenue recognition and reporting guidelines set forth in the SEC’s Staff Accounting
Bulletin No. 101, “Revenue Recognition in Financial Statements” (SAB 101). SAB 101 had to be adopted
no later than the fourth quarter of 2000.

In   particular,   Fisher   was   concerned   about   the   effect   of   SAB   101’s   guidelines   covering   customer’s
acceptance and unfulfilled seller obligations on the company’s revenue recognition practices. Fisher’s
staff had been studying this aspect of SAB 101 and the company’s revenue recognition practices for
several   months.   As   a   test   of   his   own   understanding   of   the   issue,   Fisher   selected   from   each   of   the
company’s three divisions a limited number of representative sale transactions to review. In each situation
the question Fisher posed was,

Assuming   all   other   revenue   recognition   criteria   are   met   other   than   the   issues   raised   by   any
customer acceptance provisions, when should revenue be recognized?

Students are asked to assume the role of Fisher and reach conclusions as to the appropriate revenue
recognition decision in each of the sale transactions reviewed by Fisher. 1

Teaching Plan

The class discussion can open with a brief financial analysis of the company’s performance and then
proceed in the order of the questions listed at the end of the case.

The financial analysis should focus on the company’s high sales growth and its 1998 problems and 1999
recovery.   This   discussion   will   provide   some   insight   and   background   into   why   changing   revenue
recognition methods is so important to this company.

Question   1   is   designed   to   ensure   that   students   identify   the   company’s   current   revenue   recognition
accounting policies. This knowledge will be used later in the class to highlight the serious threat SAB 101
2
Ibid.
3
Ibid.
*

1
The Glendale Division and Advanced Technology Division sale transactions reviewed by Fisher and the teaching note’s
discussion of these sale transactions are based primarily on case examples included in Exhibit A of “the Securities and Exchange
Commission’s” Staff Accounting Bulletin No. 101: “Revenue Recognition in Financial Statements---Frequently Asked Questions
and Answers.”

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poses to the company. It may have to defer more revenue than it did before it adopted SAB 101.

Question 2’s  purpose is to give the  subsequent  class  discussion  of  the  individual  sale  transactions  a

managerial perspective, which should help to make what could be a dull accounting discussion more
relevant to the students. The revenue recognition decisions Fisher must make in the next quarter have
potentially significant adverse consequences for the company. The accounting decisions are important
managerial decisions.

Question 3 should take up the bulk of the class. As each sale transaction accounting issue is resolved, the
instructor should ask the class to explain the accounting entries required by the conclusion. To test the
students’ understanding of their conclusions, the instructor should ask the class to reconsider the facts of a
resolved   situation   with   modifications.   For   example,   in   the   Technical   Devices   Division   example   the
instructor might change the case facts by stating the division seldom, if ever in the past accepted product
returns from distributors. Then, the instructor should ask, “Does this fact change alter your decision?”

The  final  question should lead  to  an open  discussion,   which the  instructor  should focus   on whether
accounting standards should be stated in general principles (revenue should be recognized when earned
and realized) or detailed guides (SAB 101). This is a fundamental accounting standard setting issue. For
example, many believe the International Accounting Standards Committee’s (IASC) approach to writing
standards   is   preferable   to   the   Financial   Accounting   Standards   Board’s   (FASB)   approach.   The   IASC
writes standards in terms of general principles with some guidelines on their application and then leaves it
up to management to apply the standard in a way that reflects the particular facts of the situation. In
contrast, the FASB writes standards that are more like “cook books.” They are more like SAB 101, which
is very detailed in its guidance and much more restrictive in its permitted use of judgment.

SAB 101
The general rule governing revenue recognition is:

 Revenue should not be recognized until it is realizable and earned.

Because the general rule has been abused by some companies, more specific criteria for revenue
recognition have been prescribed by the SEC in SAB 101. As a result, revenue is now considered to be
realized and earned when:

 Persuasive evidence of an order arrangement exists,

 Delivery of the ordered goods has occurred or services have been rendered:
 The seller’s prince to the buyer is fixed or determinable, and,
 Collectibility of the sale proceeds is reasonably assured.

Persuasive Evidence
Purchase order and sale agreement documentation practices vary widely between customers, companies,
and industries. The SEC appears to be willing to accept as persuasive evidence of an agreement these
practices as long as there is some form of written or electronic evidence that a binding final customer
purchase authorization, including the terms of sale, is in the hands of the seller before revenue is
recognized.

Delivery

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Typically revenue is recognized when delivery has occurred and the customer has taken title and assumed
the risks and rewards of ownership of the goods specified in the customer’s purchase order or sales
agreement. More specifically,

 Delivery is not considered to have occurred unless the product has been delivery to the
customer’s place of business.
 If uncertainty exists about a customer’s acceptance of a product or service, revenue should not be
recognized even if the product is delivered or the service performed.
 Revenue should not be recognized until the seller has substantially completed or fulfilled the
terms specified in the purchase order or sales agreement.
 In licensing and similar arrangements, delivery does not occur for revenue recognition purpose
until the license term begins.

Performance

SAB 101 requires substantial performance of the sales arrangement by the seller and acceptance by the
customer of the product or services rendered before revenue can be recognized SAB 101 notes:

 A seller should substantially complete to fulfill the terms specified in the sales arrangements, and
 After delivery or performance, if uncertainty exists about acceptance, revenue should not be
recognized until after acceptance occurs.

There are two exceptions to the above requirement. Assuming all of the other recognition criteria are met,
the first exception is that revenue in its entirety can be recognized if the seller’s remaining performance
obligation is inconsequential or perfunctory. In this case, any related future costs must be accrued and
expensed when revenue is recognized.

A remaining performance obligation is not inconsequential or perfunctory if:

 The remaining performance obligation is essential to the functionality of the delivered products or
services.
 Failure to complete the activities would result in the customer receiving full or partial refund or
rejecting the product or services rendered to date.

In considering if a remaining performance obligation is or is not inconsequential or perfunctory, the SEC

staff has indicated that the following factors, which are not all-inclusive, would be considered.

 The seller does not have a demonstrated history of completing the remaining tasks in a timely
manner and reliably estimating their costs.
 The cost or time to perform the remaining obligations for similar contracts historically has varied
significantly from one instance to another.
 The skills or equipment required to complete the remaining activity are specialized or are not
readily available in the marketplace.
 The cost of completing the obligation or the fair value of that obligation is more than significant
in relation to such items as the contract fee, gross profit, and operating income.
 The period before the remaining obligation will be extinguished is lengthy. Registrants should
consider whether reasonably possible variations in the period to complete performance affect the
certainty that the remaining obligations will be completed successfully and on budget.

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 The timing of payment of a portion of the sales price is coincident with completing performance
of the remaining activity.

The second exception is a multiple-element deliverables sales arrangement. In this case, a portion of the
contract revenue may be recognized when the seller has substantially completed or fulfilled the terms of a
separate contract element. Pending additional accounting guidance, on multiple-element revenue
arrangements, the SEC indicated that it will accept any reasoned method of accounting for multiple-
element arrangements that is applied, consistently and disclosed appropriately. The SEC will not object to
a method that includes the following conditions.

 To be considered a separate element, the product or service represents a separate earnings

process.
 Revenue is allocated among the elements based on their fair value.
 If an undelivered element is essential to the functionality of a delivered element, no revenue is
allocated to the delivered element until the undelivered element is delivered.

In the case where a customer is not obligated to pay a portion of the contract price allocable to delivered
equipment until installation or similar service, recognition of revenue on the delivered equipment may be
recognized if the installation is not essential to the functionality of the equipment. Examples of indicators
that installation is not essential to the functionality of the equipment include:

 The equipment is a standard product.

 Installation does not significantly alter the equipment’s capabilities.
 Other companies are available to perform that job.

Conversely, examples of indicators that the installation is essential to the functionality of the equipment
include:

 The installation involves significant changes to the features or capabilities of the equipment or
building complex interfaces or connections.
 The installation services are unavailable from other vendors.
Contractual customer acceptance provisions must be satisfied before revenue can be recognized.

Customer acceptance provisions typically come in one of four forms:

1. Acceptance provisions in arrangements that purport to be for trial or evaluation purposes.

In substance, these transactions are consignment-type sales, and revenue should not be recognized until
earlier of acceptance or the acceptance provisions lapses.

2. Acceptance provisions that grant a right of return or exchange on the basis of subjective matters.
3. Acceptance provisions that grant a right of replacement on the basis of seller-specified objective
criteria.

Revenue can be recognized rather than deferred so long as a provision can be reasonably determined for
the amount of future returns based upon historical return experience of a similar sufficiently large volume
of homogeneous transaction.

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4. Acceptance provisions based on customer-specified objective criteria.

Formal customer sign-off provides the best evidence of acceptance. In its absence, revenue can be
recognized rather than deferred if the seller can reliably demonstrate that a delivered product meets the
customer-specified objective criteria.

Consignment-Type Transactions
Products shipped pursuant to a consignment arrangement should not be recorded as revenue since the
consignee has not assumed the risks and rewards of ownership. This is long-standing rule. SAB 101 goes
further. It states that the following characteristics in a transaction preclude revenue recognition even if
title to the product has passed to the buyer:

 The buyer has the right to return the product and

 the buyer does not pay the seller at the time of sale, and the buyer is not obligated to pay the
seller at a specified date or dates;
 the buyer does not pay the seller at the time of sale but rather is obligated to pay at a
specified date or dates, and the buyer’s obligation to pay is contractually or implicitly
excused until the buyer resells the product or subsequently consumes or uses the product;
 the buyer’s obligation to the seller would be changed (e.g., the seller would forgive the
obligation or grant a refund) in the event of theft or physical destruction or damage of the
product;
 the buyer acquiring the product for resale does not have economic substance apart from that
provided by the seller, or
 the seller has significant obligations for future performance to directly bring about resale of
the product by the buyer.
 The seller is required to repurchase the product (or a substantially identical product or processed
goods of which the product is a component) at specified prices that are not subject to change
except for fluctuations due to finance and holding costs, and the amounts to be paid by the seller
will be adjusted, as necessary to cover substantially all fluctuations in costs incurred by the buyer
in purchasing and holding the product (including interest). The indicators of the latter condition
include:
 The seller provides interest-free or significantly below market financing to the buyer
beyond the seller’s customary sales terms and until the products are resold.

 The seller pays interest cost on behalf of the buyer under a third-party financing
arrangement or
 The seller has a practice of refunding (or intends to refund) a portion of the original sales
price representative of interest expense for the period from when the buyer paid the seller
until the buyer resells the product.
 The seller guarantees the resale value of equipment to a purchaser, and the transaction
does not qualify for sale-type lease accounting. This transaction should be recorded as an
operating lease.
 The product is delivered for demonstration purposes.

Revenue Recognition Methods

Boston Automation Systems has adopted the following revenue recognition policies.

1. Recognize revenue upon product shipment

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Accounting: Text and Cases 12e – Instructor’s Manual Anthony/Hawkins/Merchant

2. Recognize service revenue ratably as service is provided over the period of the related contract.
3. Recognize long­term contract revenue using the percentage­of­completion accounting method
4. Revenue   from   multi­deliverables   contracts   is   allocated   to   each   deliverable   based   upon   the
amounts charged for each deliverable when sold separately.
5. The company provides estimated warranty costs when product revenue is recognized.

The instructor should ask students to explain the accounting entries for each revenue recognition policy as
it is identified by the class. At the end of this part of the discussion the instructor should ask a student to
explain the accounting entries the company will make to record the cumulative effect adjustment resulting
from the change in accounting principles.

The recognition policy most likely to be impacted by SAB  101 is “recognize  revenue upon product

shipment.”   In   particular,   those   sale   transactions   that   involve   customer   acceptance   and   unfulfilled
obligations subsequent to shipment.

While the students do not know it, the instructor should be aware that SAB 101 specifically excludes the
percentage­of­completion accounting method from its scope.

Fisher’s Concerns

An examination of Boston Automation System’s consolidated financial statements clearly shows that the
company has been growing both its sales and net income at a double­digit rate. If more revenue must be
deferred as a result of applying SAB 101, this high growth rate might be harder to manage or achieve in
the future. On the other hand, deferral of product sale revenue (when combined with the unearned service
revenue already on the balance sheet) may dampen some of the cyclical industry effect on the volatility of
its company’s revenues and earnings. A change in the revenue recognition methods may lead some to
question the company’s rebound from its 1998 problems (excess inventory and lower profits.)

The Advanced Technology Division appears to be the division that will most likely to be impacted by
SAB   101.   It   sales   transactions   involve   complex   equipment   and   appear   often   to   involve   significant
installation and equipment performance obligations.

The troubled Technical Devices Division’s sales strategy shift and the related inventory loading of its
distribution channels might lead to an adverse earning quality reaction by investors if the division booked
the mechanical testing device sales immediately and investors learned of it. Fisher should be concerned
about this possibility.

Fisher might find the cumulative effect adjustment troublesome. It will be a charge to earnings and a
credit  to deferred revenues.  Some investors  may  react  negatively  to this  one­time  charge   thinking  it
implies   the   company  had   been   too   aggressive   in   its   past   revenue   recognition  practices   by  recording
revenue (and earnings) prematurely.

Fisher should also recognize that the company’s general revenue recognition policy needs to change. In
the future revenue should be recognized upon delivery (not shipment) since title passes to the customer
upon delivery.

Sales Transactions

Fisher’s decisions on the appropriate revenue recognition accounting for each of the sales transactions he

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reviewed is presented below.

Trycom, Inc.

While   the   SEC   staff   presumed   that   customer   acceptance   provisions   are   substantive   provisions   that
generally result in revenue deferral, that presumption can be overcome. Although the contract includes a
customer acceptance clause, acceptance is based on meeting the division’s published specifications for a
standard model. The division demonstrates that the equipment shipped meets the specifications before
shipment, and the equipment is expected to operate the same in the customer’s environment as it does in
the   seller’s.   In   this   situation,   the   division   should   evaluate   the   customer   acceptance   provision   as   a
warranty. If the division can reasonably and reliably estimate the amount of warranty obligation, revenue
should be recognized upon delivery of the equipment with an appropriate liability for probable warranty
obligations.
White Electronics Company

Although the contract includes a customer acceptance clause that is based, in part, on a customer specific
criterion, the division demonstrates that the equipment shipped meets the objective criterion, as well as
the   published   specifications,   before   shipment.   Therefore,   the   division   should   evaluate   the   customer
acceptance provision as a warranty. If the division can reasonably and reliably estimate the amount of
warranty obligations, it should recognized revenue upon delivery of the equipment; with an appropriate
liability for probably warranty obligations.

Silicon Devices, Inc.

This contract includes a customer acceptance clause that is based, in part, on a customer specific criterion,
and the division cannot demonstrate that the equipment shipped meets that criterion before shipment.
Accordingly, the contractual customer acceptance provision is substantive and is  not  overcome  upon
shipment. Therefore, the division should wait until the product is successfully integrated at its customer’s
location and meets the customer­specific criteria before recognizing revenue. While this is best evidenced
by   formal   customer   acceptance,   other   objective   evidence   that   the   equipment   has   met   the   customer­
specific criteria may also exist (e.g., confirmation from the customer that the specifications were met).

Analog Technology, Inc.

While the division believes that its equipment can be made to meet the customer’s specifications, it is
unable to demonstrate that it has delivered what the customer ordered until installation and testing occurs.
Accordingly, it would be inappropriate for the division to recognize any revenue until it has demonstrated
that it has delivered equipment meeting the specifications set forth in the contract. This would normally
occur upon customer acceptance.

Specialty Semiconductor, Inc.

Upon delivery, the division has completed the earnings process and met the delivery criterion with respect
to the equipment because it has demonstrated that the equipment delivered to the customer meets the
requirements of the customer’s order. However, because the customer is not obligated to pay the division
if  installation of  the  equipment  is  not  completed,  no  revenue  may be  recognized  until  installation is
complete and the customer becomes obligated to pay. Conversely, if the division has an enforceable claim
at the balance sheet date through which it can realize some or all of the $20 million fee even if it failed to

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fulfill the installation obligation, deferral of a lesser amount, but not less than the estimated fair value of
the installation (i.e., $500,000), would be appropriate.

Alternatively, if the division’s policy is to defer all revenue until installation is complete, recognition of 
the $20,000,000 fee upon completion of installation would be appropriate. The division’s policy should 
be appropriately disclosed and consistently applied.

Micro Applications, Inc.

Upon delivery, the division has completed the earnings process and met the delivery criterion with respect
to the equipment because it has demonstrated that the equipment delivered to the customer meets the
requirements of the customer’s order. In addition, the buyer’s obligation to pay the fee is not contingent
upon completion of installation. Therefore, the division should recognize the revenue allocable to the
equipment,   $19,500,000,   as   revenue   upon   delivery.   The   remaining   $500,000   of   the   arrangement   fee
should be recognized when installation is performed.

Alternatively, if the division’s policy is to defer all revenue until installation is complete, recognition of
the   $20,000,000   fee   upon   completion   of   installation   would   be   appropriate.   This   policy   should   be
appropriately disclosed and consistently applied.

XL Semi, Inc.

The XL Semi, Inc., order is one unit for accounting purposes, rather than an equipment sale, and an
installation   sale.   Installation   of   the   equipment   would   affect   the   quality   of   use   and   the   value   to   the
customer   of   the   equipment.   Likewise,   the   equipment   is   essential   to   the   value   of   the   installation.
Additionally, because neither deliverable can be purchased from another unrelated vendor, the separate
deliverables in the arrangement do not meet the criteria for segmentation. Further, due to the specialized
skill involved in the installation of the equipment, installation is considered to be substantive, rather than
inconsequential or perfunctory. There is a strong presumption that the revenue recognition should be
delayed until customer’s acceptance is obtained following the completion of installation.

Technical Devices Division

The passing of title, the absence of evidence that the distributors do not have the capability to pay for the
devices and the product’s established market acceptance support immediate revenue recognition with a
provision for anticipated returns.  However, the  unsettled state  of  the  product market,  the  uncertainty
surrounding the future sales level, and the absence of historical return data for distributor sales to high
volume customers argues for revenue deferral on the grounds that return provisions cannot be estimated
reliably.

The distributor’s unusual extended payment terms, reflecting the expected sell­through of the mechanical
testing devices coupled with the division’s past generous unwritten return practices suggest that the so­
called sale is in substance a consignment­type transaction. Revenue should be recognized by the division
on a distributor sell­through basis.

The division’s excess inventory charge raises the question: “Was any of this written down inventory
resold during 1999 and, if so, what was the cost of goods sold?” Typically excess inventory is written
down to zero cost.

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Fisher should make this inquiry since the profit earned on the subsequent sale of written­down excess
inventory should be disclosed under GAAP.

Cookbook Rules Versus General Principles

There   are   two   basic   approaches   to   standard   setting:   Issue   detailed   rules   or   standards   that   set   forth
accounting principles in the form of general principles.

The   tendency   of   the   FASB   has   been   to   publish,   accounting   standards   with   detailed   implementation
requirements and guidelines. This approach to standard setting has been characterized as a “cookbook”
approach. It is the result of a need on the part of practicing public accountants, for guidance in the
application  of   accounting  standards,   investors   seeking  uniform   accounting  by  companies   to  facilitate
intercompany comparisons, and a general belief that this approach will produce financial statements that
are fair to all who rely upon them. Without detailed standards, the supporters of this approach claim,
some management will take advantage of the lack of guidance to issue misleading statements that will
lower the confidence of statement users in all financial statements.

The supporters of the proposition that accounting principles should embody principles rather than detailed
rules claim accounting rules cannot cover every situation. As a result there will always be some situations
that rules will miss but which would be covered by a well­stated general principle.

Accounting for Equity Transactions

If time permits, the instructor might want to use the company’s unusual accounting for equity transactions
to cover accounting for equity transactions. The unusual accounting includes accounting for a stock split
as a dividend­(debit common stock, credit paid in capital) like transaction (but no change to retained
earnings) to avoid changing the par value of the split stock and the reduction of common stock and paid­
in capital to reflect the acquisition of its own stock (no treasury stock account) as if it was canceled when
in fact the required stock is not cancelled (it is outstanding but not issued). The instructor may also want
to include in this discussion the accounting for the stock option tax benefits (a capital rather than an
income transaction.)

Summary

Clearly,  the SEC’s  experience  has  led  it  to conclude  after  reviewing  revenue  recognition accounting
practices in situations similar to those described in the case that the application of general principles, does
not   always   lead   to   the   appropriate   accounting   decision.   The   SEC’s   response   was   to   provide   more
guidance in the area of revenue recognition than was provided by the general principle that revenue
should be recognized when it is earned and realized. This SEC response had a profound impact on the
revenue recognition practices of many companies. For example, it ranged from retailers changing the way
they   accounted   for   lay­a­way   plans   (revenue   was   deferred   rather   than   recognized   immediately)   to
manufacturers like Boston Automation Systems with significant post­delivery obligations (they had to
defer rather than recognize income immediately).

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