Suitable Revenue Recognition Policy in Finance

This article discusses the suitable revenue recognition policy in finance and its importance in reflecting the substance of underlying transactions. It also covers the guidelines provided by ASIC and AASB15/IFRS15 for revenue recognition. The article emphasizes the importance of correctly classifying assets as financial or non-financial and checking the necessary elements of a sale to recognize it as revenue.

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3. CPA Australia believes that ‘a suitable revenue recognition policy’ requires the appropriate
application of ‘the timing of recognition’, therefore ‘reflecting the substance of underlying
transactions’. This belief of CPA Australia is in line with the ASIC.
A ‘suitable revenue recognition’ policy is that by way of which revenue was arising from
transactions can be accurately and fairly determined and that too at the correct time. This is
why ‘the timing of recognition’ is being given so much importance. If revenue arising from
transactions are recognised pre-maturely, the essence of the underlying transactions (if any) is
not reflected. And if the revenue from a particular transaction is recognised after the
‘appropriate time’, the essence of the entire transaction can get lost. This can lead to disparity
between accounting policies followed for preparation of financial statements of companies
which can, in turn, lead to investors getting mislead (Hamilton, Hyland & Dodd, 2011).
Hence, to prevent such situations, the Australian Securities and Investments Commission
(ASIC) on 7 November 2014 announced its areas of focus for 31 December 2014 financial
reports of listed entities. The ASIC announced that the directors and auditors should ensure
that the company’s revenue recognition policies are such that the revenue is recognised in
such a way that the substance of underlying transactions is appropriately and adequately
taken into account. The ASIC had mentioned the below-mentioned points that should be kept
in mind by the directors and auditors while framing their entity’s ‘suitable revenue
recognition policy.’
Revenue can be earned either from the sale of goods or provision of services. The entity
should recognise the revenue relating to services only after the said services have been
performed. When the income relates to the sale of goods, the income should be accepted just
after the title of products that is the control of the said goods has been passed to the buyer.
And when the revenue is arising out of both the sale of products and the provision of related
services, care should be taken to ensure that the revenue is appropriately allocated to the
goods component and the service component and recognised accordingly (Carcello, 2012).
Also, the ‘suitable revenue recognition policy’ should take care that the assets of the
organisation are appropriately classified as financial or non-financial assets. A non-financial
asset is an asset which commands value by itself that is, it possesses amount in its self. Land,
gold, oil, etc., are examples of non-financial assets. These possess value in themselves.
Financial assets, on the other hand, are assets which have value based on one/more

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contractual claim(s). Stocks, bonds, bank deposits are examples of financial assets. Financial
assets are more comfortable to sell than non-financial assets. If the assets are not correctly
classified as commercial or non- economic, it might mislead investors and lead them into bad
investment decisions (Petty et. al, 2012). This is why it is necessary for an entity to classify
its assets as financial or non- financial correctly.
Also, ASIC specified that the appropriate class of the instrument should recognise the
revenue on financial instruments.
Thus, CPA Australia believes that ‘a suitable revenue recognition policy’ requires the
‘appropriate application’ of ‘the timing of recognition’ therefore ‘reflecting the substance of
underlying transactions’.
4. AASB15/IFRS15 clearly states when and when not to recognise revenues. There are clear
indications of transactions which fall into the category of income when they match the
substance of underlying operations. When ownership of goods is passed to the buyer, when
goods are sold, and all terms related to the sale have been performed to ensure revenue from
the sales, also, sales are said to have affected only if the goods are those which are classified
as good in the company’s operating senses. Financial assets, investments etc. cannot be
classified as goods and their sale cannot be classified as sales. Also, there should be no clause
attached to the sales. If there is, it cannot be treated as sales. No contingency should be
connected to recognise revenue (Gowthrope, 2011). So once a transaction is affected, its
recognition implies checking of five things. Firstly the customer has to be understood. There
has to be approval from both parties for the customer contract, then secondly, performance
obligations have to be identified, as discussed earlier, then thirdly the transaction price has to
be ascertained. Fourthly, transaction price has to be allocated to performance obligation, and
fifth is that revenue is recognised when a performance obligation is recognised (Gay &
Simnet, 2015).
Where on the one hand IFRS states that the revenue has to be recognised when there is
assurance that a future economic benefit shall flow to the entity and that benefit is measurable
in money terms, revenue can be appreciated, whereas CPA requires income recognition only
on realisation. However, they both recognise revenue on recognition.
The timing of recognition is the point in a sale where a transaction is successfully considered
as a sale for the reporting period. The deal is not a small activity. It is a prolonged activity
with different stages. In the stage where the sale can be successfully treated as a part of

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reporting period’s income is explained by CPA or ASIC, and this is also approved and
applied by AASB 15 or IFRS 15. A sale contract is generally and mostly treated as a contract
with the customer. Any agreement with the customer which is measurable in monetary terms
which is in the course of business, and in which there is an obligation on each party to fulfil,
is termed as a customer contract (IASB, 2010).
In accountancy, there is a concept of substance over form. What appears cannot always be the
same. So to recognise any transaction as a sale in a contract from a customer, its underlying
transaction also needs to be thoroughly checked. An accounting transaction may appear to be
a sales transaction whereas, in reality, it may not be. For example, sales are made by one
party on behalf of another party, if not clearly explained and recognised, can be misleading
and revenue might take a hit in case of malicious intentions of the other party (Porter &
Norton, 2014). Hence all the necessary elements if a sale needs to be sought to recognise the
same as revenue. This point is the point when there is no obligation pending, and the
ownership of goods has been successfully passed.

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References
Carcello, J. (2012). What do investors want from the standard audit report? CPA Journal 82
(1), 7. Doi: http://dx.doi.org/10.2139/ssrn.2930375
Gay, G. & Simnet, R. (2015) Auditing and Assurance Services. McGraw Hill
Gowthrope, C. (2011) Business accounting and finance for non specialists (3rd ed.). South
Western
Hamilton, K., Hyland, B. and Dodd, J. L. (2011) Impairment: IASB-FASB Comparison.
Drake Management Review. [online]. 1(1), p. 55–67. Available from:
https://pdfs.semanticscholar.org/8d8f/5fd070193d6fa52e79d1dee9cc6632159d8a.pdf
[Accessed 1 October 2018]
IASB. (2010) Conceptual Framework for Financial Reporting. Available from:
http://www.aasb.gov.au/admin/file/content102/c3/Oct_2010_AP_9.3_Conceptual_Framewor
k_Financial_Reporting_2010.pdf [Accessed 26 January 2019]
Petty, J. W, Titman, S., Keown, A. J., Martin, J. D., Burrow, M. and Nguyen, H. (2012)
Financial Management: Principles and Applications, 6th ed. Australia: Pearson Education
Australia.
Porter, G. and Norton, C. (2014) Financial Accounting: The Impact on Decision Maker.
Texas: Cengage Learning