MBA Module 3 PPT

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MBA Module 3 PPT Powered By Docstoc
					    Module 5
  Reporting and
Analyzing Operating
   Operating and Nonoperating
Components in the Income Statement
            Revenue Recognition
n    Revenue recognition criteria
    1.   realized or realizable, and
    2.   earned
n    Realized or realizable means that the seller’s
     net assets (assets less liabilities) increase.
n    Earned means that the seller has performed
     its duties under the terms of the sales
Arguments Against Revenue Recognition

 n   Rights of return exist
 n   Consignment sales
 n   Continuing involvement by seller in product
 n   Contingency sales
Pfizer’s Revenue Recognition Policy
n   Pfizer recognizes its revenues as follows:
    n Revenue Recognition—we record
      revenue from product sales when the
      goods are shipped and title passes to the
      customer. At the time of sale, we also
      record estimates for a variety of sales
      deductions, such as sales rebates,
      discounts and incentives, and product
Oracle’s Revenue Recognition Policy
    Risks of Revenue Recognition
n   Case 1: Channel stuffing
n   Case 2: Barter transactions
n   Case 3: Mischaracterizing transactions as arm’s
n   Case 4: Pending execution of sales agreements
n   Case 5: Gross versus net revenues
n   Case 6: Sales on consignment
n   Case 7: Failure to take delivery
n   Case 8: Nonrefundable fees
n   The percentage-of-completion recognizes revenue by
    the proportion of costs incurred to date compared with
    total estimated costs.
n   Assume that Abbott Construction signs a $10 million
    contract to construct a building. Abbott estimates
    construction will take two years and will cost
    $7,500,000. This means the contract yields an expected
    gross profit of $2,500,000 over two years.
n   The following table summarizes construction costs
    incurred each year and the revenue Abbott recognizes.

n   Revenue recognition policies for these types of contracts
    are disclosed in a manner typical to the following from the
    2005 10-K report footnotes of Raytheon Company:
Johnson Controls Revenue Recognition –
    Risks of Percentage-of-Completion
n   The percentage-of-completion method of revenue
    recognition requires an estimate of total costs.
n   If total construction costs are underestimated, the
    percentage-of-completion is overestimated (the
    denominator is too low) and revenue and gross
    profit to date are overstated.
n   This uncertainty adds additional risk to financial
    statement analysis.
    Recognition of Unearned Revenue
n   Deposits or advance payments are not recorded
    as revenue until the company performs the
    services owed or delivers the goods.
n   Until then, the company’s balance sheet shows
    the advance payment as a liability (called
    unearned revenue or deferred revenue) because
    the company is obligated to deliver those
    products and services.
    Recognition of Unearned Revenue
n   Assume that on January 1 a client pays Pfizer
    $360,000 for a guaranteed one year supply of a rare
n   Microsoft reports $10.9 billion of unearned revenue in
    2006. the company describes its recognition policy as

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