New Accounting Standard in China- Revenue Recognition | A New Revenue Standard
- Why do we need a new revenue standard?
Before the new revenue standard was formulated, some small-scale enterprises, in particular, were unable to recognize revenue in a standardized and reasonable manner.
They would usually recognize or adjust revenue by whether the enterprise issued VAT invoices, received payments from banks, etc.
This way will be mixed with temporal differences and the influence of various uncertain factors, which cannot reflect the true revenue of the enterprise, and at the same time, in the financial statements, the users of the statements cannot grasp and understand the revenue of the enterprise.
So based on the accrual principle, in order to standardize the recognition and measurement of revenue as well as the disclosure of related information, the Ministry of Finance revised it in 2017, and on January 1, 2018, it formally took effect the Accounting Standard for Enterprises No. 14 – Revenue, which guides enterprises if they standardize the recognition and measurement of revenue and how to truly reflect in the financial statements the corporate revenue. It requires listed companies and some large enterprises to implement the new revenue standard on a priority basis from January 1, 2020.
- How is revenue recognized?
An enterprise should recognize revenue when it has fulfilled its performance obligations under the contract, which can also be understood as when the customer obtains control of the relevant goods. In this case, the acquisition of control of the relevant goods means the ability to dominate the use of the goods (control the goods) and derive substantially all of the economic benefits from them.
Normally, companies should evaluate and identify the contract at the contract start date to understand each individual performance obligation included in the contract, and determine whether each individual performance obligation is to be performed in a certain period of time or at a certain point in time, and finally, recognize revenue separately when each individual performance obligation has been performed.
- What is a certain point in time and what is a certain time period?
A certain point in time is a point in time in the course of a transaction at which a business recognizes revenue, usually when the customer obtains control of the relevant goods. The following factors are also taken into consideration:
- Whether the customer has a present obligation to pay for the merchandise
- Whether the customer has taken possession of the merchandise and has legal title to the merchandise
- Whether the enterprise has transferred the risk of the commodity to the customer, etc.
A certain time period is the period during which an enterprise should recognize revenue in accordance with the progress of performance. This can be done by determining the progress of performance based on the percentage of goods that have been transferred to the customer according to the contract, or by determining the progress of performance using the enterprise’s input to fulfill the performance obligation.
In conjunction with the above, we can use a diagram to better understand the basic process of revenue recognition.
- Case Study: I am a business owner; how will my company recognize revenue?
- A point in time to: the epidemic is raging around the world, company A is a medical mask manufacturer, company B and company A signed a sales contract, the contract agreed that company B purchase 100,000 masks from company A, the total value of the contract 100,000 yuan. company B paid company A in full in January, company A produced and delivered the contracted masks in full in February, and issued an invoice of 100,000 yuan to company B in March of the same year.
We conclude that this is a contract that recognizes revenue at a certain point in time based on the content of the transaction at the contract start date according to the revenue recognition process. When Company A produces and delivers the masks to Company B, ownership of the masks has then been transferred to Company B and the masks are no longer under Company A’s control. Although Company A received the payment in January and invoiced Company B in March, which can be interpreted as a kind of increase in equity, it is still not enough to prove that this is a certain point in time that can be recognized as sales revenue. The combined analysis shows that Company A should recognize sales revenue of $100,000 when the masks are produced and delivered in February.
- A certain point in time to: Company C is a renovation company that undertakes office renovation services for Company D. The total value of the contract is $1 million. Company D pays 60% of the purchase price when the contract is concluded and pays the remaining amount when the renovation is completed. After the payment arrives, Company C invoices Company D. Company C recognizes 30% of the input in January, 40% in February, and 30% in March and completes construction acceptance based on the input.
Again, based on the revenue recognition process, at the contract start date, we can conclude that this is a contract that recognizes revenue at a certain point in time based on the content of the transaction. company C completes the renovation services over a period of 3 months, and the service can be clearly measured by the percentage of inputs. If we follow the previous practice, Company C recognized 60% of the invoiced revenue before the business was carried out, which is seriously inconsistent with the actual situation and does not comply with the principle of accrual. From the above analysis, it is clear that Company C should recognize revenue of $300,000 in January, $400,000 in February and $300,000 in March in accordance with the input ratio.
In summary, through the new revenue standard, enterprises can recognize and measure sales revenue more scientifically and reasonably in their daily production and operation activities, and report users can effectively grasp the marketing situation and profit and loss data of the enterprise, which brings help to enterprise decision-making.
At the same time, the revenue recognition of enterprises is no longer unpredictable or high or low as before, providing economic vision, reliable and effective data support to report analysts.
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