Discuss about the Issues in Revenue Recognition for Accounting Principles.
This paper aims at providing exhaustive analysis on the current issues affecting revenue recognition. It looks at the factors relevant for policy selection and the importance of following accounting principles in accounting policy selection.
Factors influencing accounting policy selection in connection with Slater and Gordon’s decision to have early adoption of new revenue standards
To select accounting policy, firms must consider accounting standards and principles defined by various bodies in line with Accounting. According to Accounting Professional and Ethical Standards (APES), an entity is required to follow the defined standards of accounting practices to identify a right accounting policy. Apart from the standards and principles, a firm should have guidance on how to implement a selected policy. The factors and principles for consideration are;
The consistency of the policy. A firm should verify on the police selected whether it withstand the test of consistency in application over similar transactions. In case the policy fails to portray similarity of operation in a similar transaction, it is termed not appropriate for implementation (APES 110). A good accounting policy should not change its reaction on similar transactions in a firm. However, in the case of change, there should be an elaborative reason of the need for the change.
Ability to recognize revenue collected. A policy should follow the revenue recognition procedure defined by International Financial Reporting Standards (IFRS) which requires a firm to record a revenue after it has been earned. A Firm should not involve in practices of recording revenues before being earned. Or recording can also happen when there is a high probability of earning revenue.
Ability to recognize gain and loss. A policy should recognize gains and losses realized by a firm at the end of the operation. Gains are recorded after they have been realized while losses are recorded once identified. A good policy should comply with the principle. This helps to avoid confusions arising on records that are not well organized on the gains and losses encountered in an entity.
Cost principle. This is applicable where there is a transaction between or among parties. While selecting a policy, cost concept should be considered to comply with the set expectations of accounting bodies.
The principle of matching. The principle defines the need to record expenditure once realized in operation. It entails recording on time the costs incurred to help in revenue calculation. Good policy does provide appropriateness of applying the matching principle to facilitate firm’s ability to accrue revenue.
Disclosure principle. Accounting policy should entail a disclosure policy defining an effectiveness of disclosing entity status regarding liabilities, assets and other particulars important to users of financial statement (EY 2015).
It too should provide a stable guidance on how changes to be done on a policy implemented by an entity. Strong and convincing disclosure needs are to be catered for in the policy. While selecting a policy, a disclosure policy should follow the trends dictated by IFRS and AASB. Disclosure policy has to accommodate clarity of materiality needs, appropriate guidance on the use of the accounting policies and flexible ways to present orders by an entity. Based on this principle, a firm should provide an elaborative explanation behind the change of a policy if the need arises to change policy.
Having an insight concern on Slater and Gordon’s case on the revenue recognition, it looks appropriate for them to record revenue as cases progressed. They had challenges in recording revenues due to challenges in a time of payment, a situation that could not go tally with the disclosure policy. The disclosure principle and revenue recognition principle demanded the firm only to record revenue after it has been realized thus there existed need to change the policy (EY 2015).
To be competitive and adaptive in the market regarding the accounting operation requirements, the firm sort for work in progress method to record its revenue. This allowed them to project their income collection before payment is realized (Savage et al. 2013). However, the method had different computation compared to a method of recording that considers only realized and revenues with high probability to accrue. In the process of trying to deal with revenue recognition criteria like other firms, they came in compliance with the new revenue standards of IFRS 15 though of a slightly different condition (EY 2015).
The cause of sharp drop in the firm’s revenue in 2015 in connection with new revenue standards IFRS 15
Before 2015, the firm has been in growth over revenue collection per year. This is overestimated due to the following reasons;
The inclusion of unpaid revenue. The firm considered all revenues to be paid in the books of account as revenues are collected. This inflated the revenue collection regardless of the payments that were not met after their periods of promise.
Double counting problem. Among the cases solve by this law firm were to get paid in the span between 18 months to 2 years. However, the books of accounts are always prepared at the end of a year (Elliot and Elliot 2007). Therefore, due to unreliable dates of payment, though already recorded as revenue collected, they end up re-recording some revenue collections with no notice. This is a behavior that contributed to a large percentage of the drastic changes in the rate of revenue collection noted in 2015.
Overestimation of figures. The firm’s interest in having control over market shares and control of small law firms motivated the need to overestimate the work in progress value. The firms included revenue not yet collected in their final books of accounts and went further to illustrate a higher sum of revenue collected with no clear accounting concepts (Wagenhofer 2014). Therefore, following appropriate accounting guidelines on the records done within the period operation, the research group realized a lot of gaps in the firms accounting techniques. Blocking the gaps necessitude this drastic drop.
Implementation of a new revenue recognition policy (IFRS 15). A new revenue standards by IFRS contributed largely to the sharp drop in firm’s revenue collection levels. This is true as per the definition of a new revenue recognition policy which required a firm only to record revenues already collected or those with a higher possibility of being collected. Comparing the scenario with the latter, a sharp reduction was appropriately registered (Savage, Douglas and Barra 2013).
Before IFRS 15, the firm could record all expectations on revenue regardless of outcomes. The unpaid revenue was captured in books of accounts as collected. The firm depended on possibilities than on the real revenue collection scenarios (Peach 2016). This policy blocked possibilities of giving unreliable and hiked information to the users of the accounting statements. Therefore, implemented work in progress policy eliminated the likelihood concept of recording revenue estimates.
The practices demonstrated by the firm has breaches on fundamental principles of accounting ethics. Overestimating figures, recording unpaid revenue, and double counting are among the behaviors breaching accounting principles and ethics. These are the breached principles and ethics;
Integrity. Integrity requires an entity to remain honest and trustworthy on to professional roles defined by accounting practices (APES 110). It confines both an entity and its employees to remain upright on facts in the business. Members are expected to provide a report, returns or other relevant information with no mislead or false statement (CPA Australia 2012). The information should not be contradictory to ethics and carelessly placed. Also, members are not to create omissions or unclear communication with intended mind (Deegan and Unerman 2007). However, the company and its employees have violated the integrity concept by providing misleading information in the market; an intention meant to lure investors and wore other small law firms (Fyfe 2016). Their information has misled and carelessly omit a lot of relevant true information decisive to investors and other users.
Objectivity of the firm. The principle of objectivity defines that an entity should ensure professionalism on its operations without allowing biases or personal interest to jeopardize its operation (APES 110). This firm’s objective has not followed the objectivity concept thereby it end up operating for self-interest gains instead of professional operations (Fyfe 2016).
Professional level of competency and care. Employees of an entity should portray a high level of competence and care to their clients through their services (APES 110). They are to show diligent behavior when providing services as well as attain and maintain professionalism incompetence. In Slater and Gordon’s firm, employees mind not of clients. Thus their behaviors contradict professional competence. Instead, they, offer clients with disastrous information on the growth rate of their revenue, an act that only subjected users to market uncertainty (Fyfe 2016).
Regarding accounting principles and ethics, Slater and Gordon have breached the defined standards by both the IFRS and APES. The firm went contrary to demonstrate its self-vested needs on the preparation of its financial statements. It aimed not in providing truthful and straightforward information but to capture the perception of the best performing law firm in the market (Collins and McKeith 2010). Even though it enjoyed a lead for some years, the policy on revenue recognition and disclosure policy helped to sort the problem out by filling the gaps it used to manipulate while preparing financial statements.
References
APES 110 Code of Ethics for Professional Accountants. Retrieved from: https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf
Australia Accounting Standard Board. 2016. Application of Materiality to Financial Statement.
Collins, B. and McKeith, J., 2010. Financial Accounting and Reporting. McGraw Hill.
CPA Australia. 2012. Accounting Concepts and Principles. Publisher: BPP Learning Media Ltd.
Deegan, C. and Unerman, J. 2007. Financial Accounting Theory. European edition, McGraw Hill
Elliot, B. and Elliot, J, 2007. Financial Accounting and Reporting. FT Prentice Hall, 12th Ed.
Fyfe, M., 2016.The Undoing of Slater and Gordon, the Age, 24 June
IAS 18 Revenue and IFRS 15. Retrieved from: www.ifrs.org (alternatively, AASB118 Revenue and AASB 15 Revenue from contracts with customers, available for download atwww.aasb.gov.au)
IASB Framework. Retrieved from: www.ifrs.org
Peach, K., 2016. Australia Accounting Standards Board.
Savage, A., Douglas, C., and Barra, R., 2013. Accounting for the Public Interest: A Revenue Recognition Dilemma. Issues in Accounting Education, Vol. 28, No. 3, pp. 691-703.
Slater and Gordon annual reports. Retrieved from: https://www.slatergordon.com.au/investors/reports-and-presentations
Wagenhofer, A., 2014. The role of revenue recognition in performance reporting. Accounting and Business Research, 44(4), pp.349-379.
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