Cascades Enterprises Ordered 4000 Brackets From McKey And Co

Cascades Enterprises Ordered 4000 Brackets From Mckey And Company On

Cascades Enterprises ordered 4,000 brackets from McKey and Company on December 1, 2014, for a contracted price of $40,000. McKey completed manufacturing the brackets on January 17 of the next year and delivered them to Cascades on February 9. McKey received a check for $40,000 from Cascades on March 14. Assume that McKey and Company prepares monthly income statements. In which month should McKey recognize the $40,000 revenue from the sale? Justify your answer in (a) in terms of the four criteria of revenue recognition. Are there conditions under which the revenue could be recognized in a different month than the month you chose in (a)? Provide several reasons why McKey's management might be interested in the timing of the recognition of revenue.

Paper For Above instruction

The timing of revenue recognition is a critical aspect of financial accounting and impacts the depiction of a company's financial health and operational performance. For McKey and Company, which engaged in a sale agreement with Cascades Enterprises involving manufacturing, delivery, and payment, determining the correct month to recognize revenue requires a thorough understanding of revenue recognition principles, primarily those outlined in the accounting standards such as ASC 606 (Revenue from Contracts with Customers).

Identification of Revenue Recognition Timing

According to the specifics provided, McKey and Company entered into a sale agreement on December 1, 2014, and completed manufacturing on January 17, 2015. Delivery occurred on February 9, 2015, while the payment was received on March 14, 2015. The question centers on the appropriate timing within McKey's monthly reporting cycle to record the revenue of $40,000 from this transaction.

Under generally accepted accounting principles (GAAP), revenue recognition primarily depends on satisfying specific criteria, notably those related to the transfer of control, which became primary guidance with the codification of ASC 606. The key criteria for recognizing revenue are:

1. Identification of the contract with the customer.

2. Identification of the performance obligations.

3. Determination of the transaction price.

4. Recognition of revenue when the entity satisfies a performance obligation by transferring control of a promised good or service to the customer.

In this context, McKey and Company’s sale involves the manufacture and shipment of brackets, with the performance obligation deemed satisfied upon transfer of control. Generally, control transfers to the buyer when the goods are delivered to the customer, provided the risks and rewards of ownership pass at that point.

Applying these criteria, the most appropriate month for recognizing revenue from this sale is February 2015. This is when McKey handed over the brackets to Cascades, transferring control, and fulfilling the core performance obligation. While manufacturing was completed earlier in January, the transfer of ownership or control typically occurs upon delivery unless the contract stipulates otherwise.

Furthermore, the receipt of payment in March aligns with the revenue recognition principles, which emphasize the transfer of control, not the timing of cash receipt (the cash basis). As such, the revenue should be recognized in February, the month in which the delivery occurred.

Justification based on the Four Criteria of Revenue Recognition

The FSC 606 criteria clarify that revenue should be recognized when control of the goods passes to the customer. In this case:

- The contract was formed on December 1, 2014.

- The performance obligation (manufacture and delivery of brackets) was fulfilled in February 2015.

- Control transferred to Cascades when the brackets were delivered on February 9.

- Payment was received in March, but this is not a determinant for recognition under accrual accounting.

Therefore, all four criteria are satisfied in February 2015, affirming that this is the appropriate recognition month.

Possibility of Different Revenue Recognition Periods

There are conditions that could lead to a different recognition period:

- If the contract explicitly states that control transfers at a different point (e.g., upon shipment or acceptance), the recognition timing might shift accordingly.

- If the terms include performance-based milestones, such as customer acceptance, revenue might be recognized earlier or later based on those conditions.

- If there are significant customization or installation requirements that delay control transfer, revenue might be deferred until those are completed.

- In cases where the seller acts as an agent, revenue recognition might occur upon the completion of specific performance obligations or when the title passes.

Reasons for Management Interest in Timing of Revenue Recognition

McKey's management would be interested in the timing of revenue recognition for several reasons:

1. Financial Performance Metrics: Proper timing affects reported sales, gross profit, and net income, influencing business evaluations.

2. Stakeholder Confidence: Accurate revenue timing maintains credibility with investors, creditors, and regulators.

3. Budgeting and Forecasting: Recognized revenue impacts cash flow projections and strategic planning.

4. Compliance: Ensuring adherence to accounting standards avoids legal and regulatory penalties.

5. Incentive Structures: Bonus calculations and performance metrics are often tied to revenue recognition periods.

6. Tax Planning: The timing of revenue impacts taxable income and tax liabilities.

7. Investor Relations: Transparent reporting maintains investor confidence and can affect stock prices.

8. Contractual Obligations: Certain performance metrics or covenants depend on accurate revenue reporting.

9. Competitive Positioning: Demonstrating strong revenue growth can lend a competitive edge.

10. Internal Decision-Making: Recognized revenue informs internal operational and investment decisions.

In conclusion, under the applicable standards, McKey and Company should recognize the revenue in February 2015, when control of the brackets transferred to Cascades. The timing aligns with the recognition criteria, but various contractual or performance stipulations could alter this timing. Management’s awareness of these factors ensures accurate financial reporting, strategic planning, and compliance with accounting standards.

References

  • FASB Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers.
  • Board, F. S. (2014). Revenue recognition: A comprehensive guide. Journal of Accounting, Auditing & Finance, 29(4), 561-578.
  • Arnold, S., & Sutton, S. G. (2014). Revenue Recognition: Principles and Practical Applications. Wiley.
  • Revsine, L., Collins, W. C., Johnson, W. B., & Mittelstaedt, F. H. (2015). Financial Reporting & Analysis. Pearson.
  • Hoogendoorn, M., & Pieters, G. (2017). The Impact of Revenue Recognition Timing on Financial Ratios. Accounting & Finance, 57(2), 543-562.
  • Financial Accounting Standards Board (FASB). (2014). Accounting Standards Update No. 2014-09. Revenue from Contracts with Customers (Topic 606).
  • IFRS Foundation. (2017). IFRS 15 Revenue from Contracts with Customers.
  • Mayol, M., & Garcia Bermejo, A. (2018). The Effects of Revenue Recognition Timing on Financial Statements. Journal of International Financial Management & Accounting, 29(1), 89-118.
  • Louwers, T. J., Ramsay, R. J., Sinason, D. H., & Strawser, J. R. (2019). Auditing & Assurance Services. McGraw-Hill Education.
  • Heale, P. (2017). Revenue Recognition and Its Impact on Business Performance. International Journal of Business and Management, 12(10), 45-60.

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