Accounting for Business: Income Recognition and Revenue Recognition

This article discusses income recognition and revenue recognition in accounting for business. It explains which financial items of an ant-virus software company are considered income and how to recognize revenue as per AASB 15. It also compares the loan credential and acquisition criteria for ABC and XYZ. The article includes relevant ratios and factors based on balance sheet information.

Accounting for Business
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Answer to question 1
Income Recognition
There are five financial items of the ant-virus software company namely: earning from sales of
software, from update download, interest from investing in short- term money market, discount
arising out of early settlement of liability and issuance of equity for cash. We have to find out
which of them are to be considered as income for the year by the company as per definition
cited. Income is defined as those inflows of funds which contribute to the profit generation of the
company.
Income from software sales of anti-virus is income, as it is the sales proceeds of the product the
company deals in. Sales of such anti-virus software are the products licensed under the company
to be sold.
Update download is also an income as this is a licensed service of the company to be offered to
the clients after regular intervals. It is also to be reckoned as one of the products of the company
to be offered to the clients.
Interest from investing in short-term money market is income as it increases the money value of
the company by investment. .
Discounting of liability is income as it reduces the value of liability of the company. As liability
is a balance sheet item and cannot be adjusted, this amount of discount is to be shown as other
comprehensive income, as it contributes to the profit of the company.
The amount collected from market by issuance of share is not an income, as it will be
accumulated in company capital for further use by the company in its business process and will
directly feature in the balance sheet under the head capital.
Revenue recognition
To recognise revenue as per AASB 15: Recognition of Revenue- Contract and customers,
following five-step model is to be followed:
a) If any contract exists
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b) The declared and implied conditions of the contract to deliver goods or services to any
intended customer;
c) The negotiated price to be paid by the customer;
d) Fixed system to allocate the transaction price to the goods and services;
e) The time of recognition as revenue depends on the time control transfer to the customer.
With these pre-set conditions for revenue recognition, sales of anti-virus software and update
download will be treated as revenue as per AASB 15: Revenue recognition – contract and
customers. (Australia, 2019)
Earning form interest generated from short term money market will be treated in
interest/dividend revenue as per AASB 9 –Financial Instruments. (Ridley, 2019) (AASB, 2007)
As per IAS 18 paragraph 10, rebates allowed by creditors are to be considered as revenue in
general standard of revenue. (IASPlus, 2019)
Only share issue is not considered as revenue as it adds to the capital of the company and
features in balance sheet.
Answer to Question 2
a) Loan credential of ABC and XYZ
The case study of loan availing power of two companies is compared through the derivation of
different factors and ratios. It is observed that out of the three ratios, only Loan to value ratio is
favorable for ABC, where as for all other factors, XYZ is way ahead in credential of getting loan
of $ 6,000.
Particulars ABC XYZ
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Amo
unt
Amo
unt
Ra
tio Remarks Amo
unt
Amo
unt
Ra
tio Remarks
Working
Capital:
Current Assets 7200 2600
0
less Current
Liabilities
5280
0
1200
0
Working Capital
-
4560
0
weak financial
condition
1400
0
Strong Financial
Condition
Current ratio:
current asset/
current
liabilities
7200 5280
0
0.
14
anything <1 is not
desirable, hence
not good
2600
0
1200
0
2.
17
as it is >1, proved
good
Debt to Equity
ratio:
total
liabilities/share
holder's equity
5280
0 8400 6.
29
high ratio shows
weakness in cash
management
1200
0
3420
0
0.
35
<1 shows good
condition in
respect of ratio
Debt to asset
ratio
Total liabilities/
total assets
5280
0
6120
0
0.
86
not favorable for
loan sanction
1200
0
4620
0
0.
26
favorable for loan
sanction
Loan to value
ratio:
Loan/ value of
assets 6000 5400
0
0.
11
this ratio is
favorable due to
high collateral
value
6000 2020
0
0.
30
this ratio is not
favorable due to
collateral value
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b) Acquisition factor-ABC and XYZ
For acquisition choice of these two companies, some relevant information like ROI cannot be
calculated due to insufficient data in the form of absence of Profit and loss account. Still, with
the available financial information in the form of balance sheet provides the view that acquisition
of XYZ will cost more to the buyer in comparison to that of ABC. Considering the factors like
working capital management, net assets and other relevant ratios based upon balance sheet
information, if the buyer wants to go for a safe business acquisition, he should go for XYZ; but if
he has ability to ensure professional risk management, he can go for ABC too with lesser amount
of investment than that of XYZ.
Acquisition criteria for ABC and XYZ
ABC XYZ
Particulars Amo
unt
Amo
unt
Ra
tio Remarks Amo
unt
Amo
unt
Ra
tio Remarks
Working Capital:
Current Assets 7200 2600
0
less Current
Liabilities
5280
0
1200
0
Working Capital
-
4560
0
weak financial
condition
1400
0
Strong Financial
Condition
Net Asset value 8400 financially weak 3420
0
financially
strong
Current ratio:
current asset/
current
liabilities
7200 5280
0
0.
14
anything <1 is not
desirable, hence
not good
2600
0
1200
0
2.
17
as it is >1,
proved good
Debt to Equity
ratio:
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total
liabilities/shareh
older's equity
5280
0 8400 6.
29
high ratio shows
weakness in cash
management
1200
0
3420
0
0.
35
<1 shows good
condition in
respect of ratio
Debt to asset
ratio
Total liabilities/
total assets
5280
0
6120
0
0.
86 not favorable 1200
0
4620
0
0.
26 favorable
c) If the owners of both companies agree to the take over of liabilities, the net asset value of the
companies will change as follows:
ABC = $ 61,200
XYZ = $ 46, 200
This situation will change the working capital by following:
ABC = $ 7,200
XYZ = $ 26,000
Due to more non-current assets, the credential of ABC will increase than XYZ; but considering
the working capital condition, the scenario will not be changed.
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Bibliography
AASB, 2007. Compiled Accounting Standard; AASB 118- Revenue. [Online] Available at:
https://www.aasb.gov.au/admin/file/content105/c9/AASB118_07-04_%20COMPapr07_07-07.pdf
[Accessed 13 May 2019].
Australia, P., 2019. New standard - Revenue recognition. [Online] Available at:
https://www.pwc.com.au/ifrs/new-standard-revenue-recognition.html [Accessed 13 May 2019].
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Canada, B.D.B.o., nd. 4 ways to assess your business performance using financial ratios. [Online]
Available at: https://www.bdc.ca/en/articles-tools/money-finance/manage-finances/pages/financial-
ratios-4-ways-assess-business.aspx [Accessed 13 May 2019].
IASPlus, 2019. Revenue recognition: Key differences between U.S. GAAP and IFRSs. [Online] Available at:
https://www.iasplus.com/en-us/standards/ifrs-usgaap/revenue [Accessed 13 May 2019].
Ridley, C., 2019. How to Account for Revenue from Interest and Dividend. [Online] Available at:
https://www.caseware.com.au/2019/01/how-to-account-for-interest-and-dividends-under-the-new-
revenue-regime/ [Accessed 13 May 2019].
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