Revenue Recognition and Contingent Liabilities - Essay Example

Revenue recognition is therefore a sensitive issue as it is open to the inflation of financial statement results, it is also important because it is the main base measure that is used to evaluate the performance of directors.

Theoretical Framework
The International Accounting Standards Board (IASB) has two main IAS which guide the recognition of revenue, these are IAS 18 Revenue and IAS 11 Construction Contracts (ACCA, 2014). Under these rules, revenue is to be defined as the gross inflow of income during a period due to normal activities. Therefore, revenue is the kind of reward a company gets from its normal trading activities.

IAS 18 identifies that revenue will be stated after the deduction of the cost of sale and sales tax and sales commissions. Revenue is recognized when ordinary activities or goods are made available to a consumer. The steps in recognizing a revenue are presented below:

1. The seller transfers significant risks and rewards of ownership to the buyer;
2. The seller has not retained significant control related to the ownership of the product;
3. The amount of the revenue can be measured reliably;
4. It is probable that the seller will gain the economic benefits related to the sale;
5. The cost incurred or to be incurred can be measured reliably (Weil, et al., 2014)

In construction contracts, revenue is to be recognized when it is possible to derive dependable estimates on work completed. Bill and hold transactions include transactions in which the seller executes a sale, holds it, and does not ship them but this transaction is recorded. This is a form of revenue recognition that is problematic because it gives room for creative accounting and fraudulent accounting techniques that can be abused by managers to meet their selfish and personal ends.

A bill and hold transaction is considered valid in most accounting contexts if and only if the buyer decides to sign and take significant responsibility for the loss and issues that happen with the item as it is being held by the seller. This means that the buyer undertakes to take the risk of allowing the seller to keep the products for him. Read More