Carl Warren: Hello, I'm Carl Warren.
I would like to discuss with you today the new revenue recognition standard, which was
issued by the Financial Academy Standards Board in May of 2014.
This new standard deal with businesses of all types, and I'd like to discuss the impact
upon teaching introductory accounting.
First of all, the standard was issued in 2014 -- May of 2014 -- and is effective for accounting
periods ending in 2016 and 2017.
However, what we need to understand is that's when most of your students will be entering
the business world.
So it's important for your students to understand the impact of this new financial accounting
standard as they continue their education and enter the business world.
In addition to that, many of our intermediate textbooks have been updated to the new revenue
recognition standards.
So it's important that we be consistent between how we teach introductory accounting and what
the students will find when they reach intermediate accounting, that is, we want to make sure
it's the same coverage and it's up to date.
It would not be good if, in fact, an introductory course taught the old method of accounting
and then the students entered into intermediate accounting and had to unlearn what they learned
in introductory accounting.
So that's why it's important to teach the new standard to our students.
Now, the impact in introductory accounting, first of all, in the accounting cycle chapters
-- introductory chapters of financial accounting -- it doesn't have really much impact.
We have to tweak the accounting definition slightly because the new standard uses a different
kind of framework for recognizing revenue, specifically for accountants, they use the
asset liability kind of approach to measurement of revenue.
But it just required a small tweak in the definition -- of our definitions in Chapters
1 through 4.
The real impact is when we cover merchandising businesses; specifically it impacts how we
cover and how we teach sales discounts and sales returns allowances.
Now, in addition to that, this new standard has a five-step revenue recognition process.
We've placed that into an appendix at the end of our text.
In introductory accounting, the transactions we present automatically meet the criteria
for the five-step process.
However, you may want to make your students aware of this five-step process and how it
might affect more complex transactions that they might encounter in the business world.
The five-step process really deals with products that are bundled together where you basically
have to divide up the revenue between two products.
For example, if you upgrade your cell phone, you typically will also have to sign a two-year
cell phone service contract.
Well, what's really happening there is the revenue that's being received by the company
is really with respect to two products -- the cell phone itself and the service contract.
And so this new standard requires you to divide up that revenue as you account for it between
these two products.
That is dealt with in the appendix, which you may or may not want to cover in your introductory
accounting class.
Now, let's look at the impact on sales discounts and sales returns and allowances.
Here we have the old presentation method, which appeared in our last edition, 25E.
And you can see here that in this old method, if you have a sale for $18,000, that you're
going -- with a 2 percent discount that you record the account receivable at the gross
amount of $18,000, and then we record a sales discount, it was paid with the discount period
of $360.
Under the new approach, this changes.
Specifically, the new standard requires you to recognize revenue in the amount of consideration
that you expect to receive.
And the implication of that is we want to record our initial receivable not at $18,000,
but at the amount net of the discount because that's the amount we typically would expect
to receive.
So in this case we would record our account receivable at $17,640, net of the $360 sales
discount, which is not shown under the new method.
Sales are simply credited for $17,640.
And then, of course, when we receive the cash, you simply debit and credit for $17,640.
Now, those of us who have taught accounting over the years know this is typically referred
to as the "gross method of accounting for sales discounts," and this method over here
is typically referred to as the "net method."
Now, with respect to sales returns allowances, it gets much more complex.
Under the old method we simply debited sales returns allowances, credited account receivable
for the amount of the return.
Under the new method, as I said, it becomes much more complex.
The new method under the standard requires us to recognize an adjusting entry at the
end the accounting period for any returns that we expect to receive in the future.
And so in this case, we're recording customer refunds payable of $40,000 since we expect
that customers -- two percent of the customers -- may return the merchandise.
And at the same time, we have to then debit our [inaudible] returns inventory for the
amount of inventory we expect to come back from those customers.
And then when the returns actually come back, we end up crediting cash because we're paying
customers cash.
And also, then, we reinstate the inventory that does come back into merchandise inventory.
So this is much more complex, and it is specifically stated in the standard that this is how we
should account for it.
Basically the logic, again, is that what we want to do is record sales in the amount revenue
-- record revenue in the amount that we expect to receive.
And so if we accept returns, we're actually expecting that some merchandise will be returned.
And so we have to net that out when we record our sales.
Now, if we go to the income statement, under the old method we would actually show gross
sales, less sales discounts, sales returns allowances to a net method.
Under the new standard we just have sales.
So sales is simply recorded at the net amount you expect to receive.
And so this is go to affect our merchandise inventory discussions and teaching of merchandise
inventory.
Sales returns allowances are dealt with throughout that chapter in almost all textbooks.
And throughout it is commingled throughout the chapter materials.
So it's not really a case where effectively you can say, "I don't want to cover one or
the other."
Basically you have to go to the new method, and this is what we've done in our new textbook
in the new edition.