Revenue Recognition & Profitability Analysis.pdf

ACCT 301

Revenue Recognition & Profitability Analysis

Matthew Ecoff

Liberty University

ACCT 301-B07 LUO

ACCT 301 2

Abstract:

This research paper is intended to (1) define and analyze revenue recognition and profitability

analysis, as well as discuss how the two concepts work alongside each other, (2) evaluate the

importance of implementing revenue recognition into the workplace so that accountants,

managing members, and associates can fully understand the specific requirements to

absolute necessities in order for the business to strive financially and evolve past a few key

dependencies.

Keywords: revenue, profit, operations, processes, business, analysis

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Revenue Recognition & Profitability Analysis

The definitions and applications of revenue recognition and profitability analysis are so

extensive, that in order to fully cover both topics completely, an encyclopedia-size paper would

need to be written. Instead, this paper will cover the broad ideas of each concept and connect the

two ideas together. Along with basic principles of each theory, this paper will cover key

precise circumstances in which income is realized as revenue. Contracts concerning a seller and

a customer cover one or more performance commitments, which are promises by the seller to

allocate goods or services to a customer. The seller recognizes revenue when it fulfills a

performance obligation by shifting the promised good or service (Spiceland, 233). Income and

that differ in many ways. This can be confusing if there is disconnect between how income and

how revenue are defined, as they are not the same thing. Revenue, sometimes defined as net

sales, is the total amount of cash produced by the sale of services or products associated with the

company's operations, less any returns or discounts. Since both income and revenue are terms

associated to positive cash flow, they become confusing to the laymen. Income, also referred to

as net income or net profit, is represented as the bottom line and is the total amount of residual

cash from the original amount of revenue, after realizing all expenses. Now that income and

revenue are differentiated, let’s move on to the importance of revenue recognition.

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Someone does not need to have a college degree in accounting or MBA from a

distinguished university in order to understand the importance of organizational revenue.

Revenue can be recognized numerous ways, depending on the organization and the people who

operate it. In an article titled Business Model Innovation, the author writes, “The company's

values should have a block on the business model canvas. Of course, every company must

revenue, the authors of Intermediate Accounting write that, “Its pivotal role in the picture painted

by the financial statements makes measuring and reporting revenue one of the most critical

aspects of financial reporting” (Spiceland, 231). One of the most important aspects of revenue is

not only knowing how much to report, but when it needs to be reported.

recognizing revenue is not always the same for all companies. Companies like Chick-fil-a are

going to recognize revenue differently than construction contractors that take months, sometimes

years, to complete a job. Since Chick-fil-a generates revenue on an hourly basis and the

construction company will most likely get paid in intervals throughout the project, revenue

recognition will not be accounted for the same way. In an article written in the Journal of

Accountancy, the author writes, “For all contracts with customers, revenue will be recognized

when control of the promised goods or services is transferred to the customer as a whole, not

when risks and rewards pass” (Berchowitz, G. & Whitehead, 2014). This can be a difficult task

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for the construction company that has to delegate resources accordingly to maintain appropriate

funds to cover for the work needed to be performed. With experience and a vision, it can be

accomplished successfully. Flexible Business Models, in an accounting journal, the authors

wrote, “Upper management describes and explains the flexibility offered by different business

models adopted by different firms as they strive to achieve higher levels of business

Rules and regulations by governing bodies, such as the U.S. Securities and Exchange

Commission (SEC), the International Financial Reporting Standards (IFRS), or Generally

Accepted Accounting Principles (GAAP), are going to have strict criteria in respects to how

revenue is recognized and reported. In regards to how accounting rules impact the public interest

auditors, the SEC, and international accounting standard setters may have differing opinions

about the accounting treatment” (Savage, Cerf, & Barra, 2013). The SEC has become much

more strict to revenue recognition, being that many managers are evaluated and rewarded based

off how much revenue was produced. Revenue recognition accounting standards help warrant

that the applicable amount of revenue appears in each period's income statement, immediately or

over time. Now we will look at the differences between revenue and profit.

Revenue and profit are both extremely important to the success or failure of an

organization. Just like the true definitions of income and revenue get confused and mixed up,

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revenue and profit have the many of the same defining problems. Revenue is defined as the total

income a company receives without including expense, whereas profit is defines as total revenue

minus expenses. This, of course, is just the broad and general definition, as there are numerous

ways to define profit, such as operating profit or gross profit. Things like cost of goods sold,

interest, and taxes all play significant factors in which form of profit is used. However, profit is

models and insights from a variety of theories as the basis for the development of ideas on the

design of business and future growth (Cavalcante, 2014). So, although one cannot happen

without the other, both revenue and profit play vital roles in most all establishments.

One quintessential factor to profitability is how well a company controls and utilizes its

(Spiceland, 269). Turnovers, or activity ratios, are of the upmost importance when evaluating

assets; these ratios include assets turnover, receivable turnover, and inventory turnover. The

asset turnover ratio is a measure of how proficiently a company’s assets produce revenue. The

receivable turnover ratio, also sometimes referred to as accounts receivable turnover, offers an

suggestion in the company’s ability to collect receivables. Lastly, inventory turnover ratio

specifies how quickly inventory is sold and helps determine the average time it takes for

inventory to produce revenue. The combinations of the three listed turnover ratios are the major

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keys to verifying how well a company is established and financially successful. These ratios will

determine, alongside of profitability ratios, the success or failure of most companies.

Profitability ratios make an effort to calculate a company's means to earn an acceptable

return, for managers, investors, and owners, in relation to sales or resources dedicated to

operation. Essentially, it is used to determine a company’s bottom-line. Resources dedicated to

income divided by net sales. It indicates the portion of each dollar of revenue that is available

after all expenses have been covered and offers a measure of the company's ability to withstand

either higher expenses or lower revenue (Spiceland, 270). Return on assets conveys income as a

percentage of the average total assets accessible to produce that income. An organization’s

investors is return on shareholders’ equity. It is deemed to be the amount of return the

shareholders receive on their investment in the business, or how much the business is generating

for each of their participating dollar. All three figures are required, with the possible addition of

a few others depending on the type of business, to maintain the success and growth of an

organization.

The fundamental theme of this research paper is to point out the correlation between

revenue recognition and profitability analysis and, although they are two different concepts, they

work hand-in-hand to establish the success or failure of most companies. Crude accounting

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figures alone mean little to the people who make the decisions. However, the figures increase in

value when considered in relation to other data. In addition, the economic ratios made by those

connections stipulate an even better viewpoint when associated with comparable ratios of other

organizations. Accounting information is always useful in making operational decisions. The

saying, “numbers never lie,” could not be more truthful when concerning the ideas of revenue

better managing the overall operation and accountancy of the business.

In conclusion, to ensure that hard work and aptitude are not discounted when speaking of

successful organizations, Jesus Biblically speaks about monetary competence and faithfulness in

the parable of the bags of gold. Matthew 25:14-30 says, “Again, it will be like a man going on a

gold, to another two bags, and to another one bag, each according to his ability. Then he went on

his journey. The man who had received five bags of gold went at once and put his money to

work and gained five bags more. So also, the one with two bags of gold gained two more. But

the man who had received one bag went off, dug a hole in the ground and hid his master’s

money. After a long time the master of those servants returned and settled accounts with them.

The man who had received five bags of gold brought the other five. ‘Master,’ he said, ‘you

entrusted me with five bags of gold. See, I have gained five more.’ His master replied, ‘Well

done, good and faithful servant! You have been faithful with a few things; I will put you in

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charge of many things. Come and share your master’s happiness!’ The man with two bags of

gold also came. ‘Master,’ he said, ‘you entrusted me with two bags of gold; see, I have gained

two more.’ His master replied, ‘Well done, good and faithful servant! You have been faithful

with a few things; I will put you in charge of many things. Come and share your master’s

happiness!’ Then the man who had received one bag of gold came. ‘Master,’ he said, ‘I knew

with interest. So take the bag of gold from him and give it to the one who has ten bags. For

whoever has will be given more, and they will have an abundance. Whoever does not have, even

what they have will be taken from them. And throw that worthless servant outside, into the

darkness, where there will be weeping and gnashing of teeth.’

References:

Spiceland, J. D., Sepe, J., Nelson, M., & Thomas, W. (2016). Intermediate accounting (8th ed.).

Boston, MA: McGraw-Hill Custom.