Monday, August 13, 2012


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The possible revenue recognition points are the signing of the contract, the beginning of construction, the progress stages of the construction (gradually over the life of the contract), the completion of the project to the satisfaction of the customer, and collection of the cash. To postpone taxes, you would want to delay recognition of revenue until the next year, even though you have completed more than half of the project. Of the four criteria, the strongest argument might be that the costs will not be fully known until the customer has indicated that the work is satisfactory. Collectibility of the payment may also be somewhat uncertain. The Income Tax Act allows completed contract accounting on contracts of less than 4 months so at a minimum, this revenue could be recognized when the contract is complete.

b. The gain on the portfolio could be recognized in the year in which it occurs or when the shares are sold. To postpone taxes, revenue should be recognized when the shares are sold. That can be supported based on the fact that the selling prices of the shares are quite volatile and may very well fall back to, or even below, the original cost. In other words, the amount earned is not known until the sale actually takes place. This treatment is consistent with the requirements of the Income Tax Act which only requires that income from investments be recognized on disposition.

c. Revenue could be recognized when the passes are sold, over the 60 days from the initial usage, when the travelers actually use the passes to ride on the bus, or when they expire. To postpone taxes, revenue would be recognized as late as possible. The preferred time would be when the pass expires because this is the latest possible point. While preferable, recognition on expiry is probably not acceptable since it is very conservative. In addition, since most of the costs associated with the pass will be expensed as they incur (it will be difficult to match fuel and the cost of the driver, for example, to the specific pass), deferring recognition until expiry would result in mismatching of expenses and revenue (which would be good for tax purposes). Probably, the most realistic time would be evenly over the life of the pass. On the other hand, expiry of the pass can be viewed as equivalent to when the contract is completed, which would be allowable for tax purposes.

d. Revenue could be recognized at the original sale, could be allocated partially to the technical support and to the three versions of the product, and conceivably could be recognized when the support period expires. To postpone taxes, the company would want to recognize revenue as late as possible. Waiting until the end of the support period would be unduly conservative, especially given that the initial product is delivered and paid for by the customer long before the 18 month service period has expired. It could be argued that instead of one bundle of goods being sold (which would argue for recognition on delivery), four products are being sold�the initial software plus the technical support plus the two upgrades. In this case revenue would be recognized separately for each component (upgrades when delivered to the customer, technical support over the life of the service contract).

e. Revenue could be recognized when the fee is paid, which presumably is in advance, it could be recognized over time, on the basis that the fee is compensation for being available, not for actually providing any services, or at the completion of the period of coverage. If the firm was not going to be compensated additionally for any work that was provided, an argument could be made that the costs of providing the services are not known until the time expires. Given the facts of the situation, the latest alternative that could be defended for tax postponement purposes is a monthly recognition of the revenue as it is earned. At this point the revenue is earned since the client has had access to a lawyer if and when required, the amount of revenue is known and costs (which would be mainly period costs) would have been incurred and expensed in the period.

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