By 2008, U.S. GAAP included more than 200 different revenue recognition guidelines, rules and regulations. The most straightforward sale is a retail sale for cash, such as a consumer paying cash for groceries. As business became more complicated, so did revenue recognition. Transactions involving multiple elements are common. A computer manufacturer may sell a package of hardware, software, warranties, and telephone support. It is unclear how a one-time initial payment should be allocated among these four elements and unclear how an initial payment - combined with a monthly fee over some period - should be allocated among the four elements.
In response to many questionable revenue recognition practices, in December 1999, the SEC issued Staff Accounting Bulletin (SAB) 100 to express their views on revenue recognition. In December 2003, the SEC issued a revised and expanded version of that bulletin, SAB 104, Revenue Recognition, Corrected Copy. SAB 104 includes four revenue recognition criteria that are widely quoted by U.S. firms in their revenue recognition note in Annual Reports. Based on these guidelines revenue should be recognized until it is realized or realizable and earned.
The SEC believes that revenue generally is realized or realizable and earned when all of the following criteria are met:
1. Persuasive evidence of an arrangement exists,
2. Delivery has occurred or services have been rendered, 3.The seller's price to the buyer is fixed or determinable, and
4.Collectability is reasonably assured.
The following are notes from two publicly traded U.S. firms which cover a few of the revenue recognition issues:
General Motors Automotive Revenue Recognition
We recorded an adjustment to correct deferred revenue related to data disks provided to customers to update their vehicle's navigational system. We did not compute deferred revenue using fair value as determined by vendor specific objective evidence as required by EITF 00-21, Revenue Arrangements with Multiple Deliverables, Additionally, we did not defer revenue on the correct number of 2006 models containing navigation systems. As part of our restatement, pre-tax earnings were decreased, through a reduction of Automotive sales, by $33.1 million ($21.5 million after tax) in 2005.
In addition, we incorrectly recognized revenue for our sponsorship of the GM Card program, which offers rebates that can be applied primarily against the purchase or lease of GM vehicles. We corrected this accounting by deferring and recognizing additional revenue over the average utilization period of points earned by retail customers. As part of our restatement, pre-tax earnings were increased, through an increase to Automotive sales, by $42.3 million ($27.5 million after tax) and $19.7 million ($12.8 million after tax) in 2005 and 2004, respectively, and retained earnings was decreased at January 1, 2004 by $147 million.
Target Corporation
Revenues
Our retail stores generally record revenue at the point of sale. Sales from our online business include shipping revenue and are recorded upon delivery to the guest. Total revenues do not include sales tax as we consider ourselves a pass through conduit for collecting and remitting sales taxes. Generally, guests may return merchandise within 90 days of purchase. Revenues are recognized net of expected returns, which we estimate using historical return patterns. Commissions earned on sales generated by leased departments are included within sales and were $16 million in 2007, $15 million in 2006 and $14 million in 2005.
Revenue from gift card sales is recognized upon redemption of the gift card. Our gift cards do not have expiration dates. Based on historical redemption rates, a small and relatively stable percentage of gift cards will never be redeemed, referred to as "breakage". Estimated breakage revenue is recognized over a period of time in proportion to actual gift card redemptions and was immaterial in 2007, 2006 and 2005.
Required:
For each note above:
1. Explain the revenue recognition rules used by the firm. As part of your explanation, prepare journal entries for each described method.
2. For each firm, are the revenue recognition methods described reasonable? Explain in detail.
3. In most cases, IFRS accounting rules provide only general revenue recognition guidelines. For the two firms above, discuss whether detailed revenue recognition rules are needed.