Revenue Recognition Policy: Metropolitan - Case Study Example

? Audit Memorandum Revenue recognition Review policy The main aim of this memo is to show the result of the expenses and revenue recognition for Metropolitan environment service. The metropolitan provides cleaning services to his customers through collection, consolidation, treating and disposing off of the waste and hazardous waste materials. In this manner there is no physical product leaving the premise in order for revenue to be earned. Throughout the examination some of the major areas of revenue income recorded by the Metropolitan in their books of accounts include the following; Disposal non-hazardous and hazardous waste materials, the cost of transporting of the waste materials from the customer premises to where the waste are going to be disposed off, there are also cost of materials purchased to assist the job being done, labor cost is also reflected in the revenue income, allowances expenses of the employees like travelling expenses and lastly there are tax expenses which has to be paid in time. In order to analyses each and every scenario is in order to know at what point does the ownership of the waste material passes from the customer to Metropolitan and when is the contract is valid. In the first scenario, when the customer is transporting the materials to the disposal site, then the contract has not been performed substantially and the Metropolitan should not record any revenue since the contract is not fully done, the revenue should be recorded on 20th after the successful destruction of that waste. According to the accounting standards a service can be rendered as a single act or as continuous process over a period of time, charges of the same services can also be spread over the period through which the work is done. Where the contract is made the revenue is recognized when there is a substantial work performance which in our case has not been done they should record it using periodicity concept where revenue of any particular time is recorded at that time when they are realized. In the second scenario the contract is done in part and the Metropolitan is free to record the revenue as per the completion method of revenue recognition where one realized revenue over period of time. The part of collection and transportation has been done so the company can realized that part but should not recognize the whole revenue since the contract of destruction part has not been done and the whole revenue will be realized after the whole project is done. ASC 605-15-25-1: Being realized or realizable…states that revenue and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash.... Being earned…states that revenue is not recognized until earned.  That paragraph states that an entity's revenue-earning activities involve delivering or producing goods, rendering services, or other activities that constitute its ongoing major or central operations, and revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues… ASC 605-20-25-4, costs that are directly related to the acquisition of a contract and that would have not been incurred but for the acquisition of that contract (incremental direct acquisition costs) shall be deferred and charged to expense in proportion to the revenue recognized. All other costs, such as costs of services performed under the contract, general and administrative expenses, advertising expenses, and costs associated with the negotiation of a contract that is not consummated, shall be charged to expense as incurred. .605-20-S25-1 See paragraph 605-20-S99-2, SEC Observer Comment: Revenue and Expense Recognition for Freight and Services in Process, for SEC Staff views on recognition of revenue and expenses by freight service entities In my examination of the company product and in accordance with the international accounting standards, revenues should be recognized in the financial statements when they are realized and in the case of metropolitan there are various points or factors they need to consider before deciding which way to go, some of the guiding principles include; Persuasive evidence of an agreement exist, when the delivery of service has actually taken place, the price of the service can be easily determined and when the revenue collectability is for sure that is the risk has fully passed to the Metropolitan, matching principle will be important as the revenue earned is matched with the expenses used to generate them. Metropolitan should use periodicity revenue recognition principle concept. This case when the disposal of waste material has taken place from customers then revenue should be recognized as the service that has taken place substantively and the metropolitan can confidently say that it has delivered the service and can legally claim the rightful binding contract. For instance, there is persuasive evidence of arrangement and it has been accomplished so it is prudent for an accountant to recognize that. Meanwhile while the customer is still transporting waste material from his or her site to metropolitan, it is not prudent for revenue to be recognized at that point since the delivery of service has not taken place and the customer can easily change his mind of the contract or the place to dispose of the waste material. In billing the disaster waste by assuming all the risk, this is wrong because one cannot actually or substantially said that there are activities which has taken place to guarantee the revenue recognition but should wait until the waste are disposed off. In the fourth scenario the billing ought to have been done earlier has some of the contract had already been done to guaranteed payment so metropolitan need to look into the above areas to improve their revenue recognition points not so late but within reasonable time. (FASB Concept Statement No.5, Paragraph 86) states clearly that expenses are recognized when there is actual flow of cash that is to say the expense has actually occurred. Example is when the worker of Metropolitan as worked and the service is fully delivers the company should bill the expenses at that point. Other expenses like material associated with work been done should be recognized at the point in which they are used not at the point at which they are bought. The financial statement should recognized other accounting standards like matching concept where revenue is matched with the expenses incurred when realizing the revenue if some expenses are incurred but the work has not been done until future time then they should not be reflected in income statement but in balance sheet as liabilities to be included. Advance salary payment should also be reflected in balance sheet as assets which the company will spend in later date to realized revenue. In accounting for taxes the company needs to be very careful so as not to mix the time at which they report tax to the tax master. Different countries have different accounting years and time for tax remittance so it is important that these factors are carefully considered. In the above scenarios, the ownership of the waste changes when the signing contract form is completed and the waste has been taken over by the Metropolitan waste company at that point the goods that is, the waste has changed the ownership. The risk passes to the metropolitan immediate he takes the delivery of the waste and the agreement begin at the point when metropolitan will accept the contract of disposing off the waste. Generally in my view the company following the GAAP principles and only need to make few adjustment by consulting on how to account for its branches to reflect the entire company performance not as a single unit but as different parts so that the management can realized which branch does not give the company expected revenue and necessary adjustment will be made. Otherwise the company performance and adherence to international accounting standards is encouraging. Other factors which the finance manager needs to consider before changing the accounting policies include: He needs to assess the impact the change will bring to the company both directly or indirectly. This is very important as if the change will be too expensive to the company then should be avoided and if it is positive then should be embraced by all stake holders. There is need for the manager to figure out the person who will be in charge in implementing the changes in the company and the necessary skills needed. Proper analysis need to be considered in both external and internal effect of the financials users the principles and standards needs to conform with the required internationally. Changes need to be communicated to the right people and at the right time so that people implementing changes may not meet resistance from the staff. The company should embrace the use of financial footnotes in reporting the statement by fully disclosing the accounting principles and standards so that the users can make appropriate decision. Example of the financial report Income from services Disposal of hazardous and non-hazardous waste xxxx Transport income of waste xxxx xxxxxx Expenses Cost of materials purchased xxxx Labor cost xxxx Employee expenses xxxx (xxxxx) Profit Before Tax xxxxx Less tax xxx References Accountant's Guide to Fraud Detection and Control, (2nd Ed.) Federal Reserve Bank of Kansas City Jackson Hole Symposium, 261-312. Strong, R. (2009). Accounting Best Practices (6th Ed.) South-Western Cengage Learning. p. 527. Svensson, E.O. (2002). Brink's Modern Internal Auditing, (6th Ed.). Quarterly Journal of Economics, vol. 115. Read More