Analyzing revenue
Running head: ANALYZING REVENUE
Analyzing Revenue
Chinomnso Benedict Owen
Colangelo College of Business, Grand Canyon University
ACC-502: Accounting Practices
Ronald Perry
30 June, 2021
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Analyzing Revenue
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Managers and executives strive to deliver results in the form of profits for their
corporations mainly by making more sales. As such, revenue sits at the top of the income
statement and serves as a fundamental drive for business success. However, before revenue is
recorded, it must be recognized. The FASB and IASB (Financial Accounting Standard Board
and International Accounting Standard Board) have formulated steps for revenue recognition
under GAAP and IFRS which could be grouped into a 5-step framework. This paper seeks to
discuss those steps in depth, providing examples on how Starbucks utilizes this model for
recognizing revenue and how the 5-step revenue recognition model could be used to prevent
financial statements fraud.
Revenue simply refers to the income generated after the transfer of control of goods &
services. Young, Bens & Cohen (2018) argue that for revenue to be recognized, it must meet 3
criteria: there should be a reasonable basis for determining the amount of revenue earned
(measurable), the seller should expect payment for revenue earned (realizable) and the control of
the product must be transferred to the buyer. Under the ASC Topic 606 issued by the Financial
Accounting Standards Board (FASB), there was a convergence on how revenue must be
recognized by corporations in a 5-step model (Wang, Chiu & Chiu, 2020). This model works to
identify the contract with the customer(s), the performance obligations in the contract, determine
the transaction price, allocate the transaction price to the obligations of performance in the
contract and eventually, recognize the revenue when the contract obligations have been fulfilled
(Young et. al, 2018). First, the contract is identified with the client. A contract could be oral,
implied or written, but all parties involved must understand and agree upon its terms and
conditions for it to be valid. The terms of payment and transfer of direct control of goods and
services are also identified in the step. Next, the performance obligations (PO) should be
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identified within the contract. The obligation is typically a promise to deliver the goods/services
(Young et. al, 2018). There could be several performance requirements within a contract. For
instance, each product that the seller promises to transfer direct control of, or a bundle of
indistinguishable products and services is a separate performance obligation (Zarzycki, 2020).
The third step involves determining the price that the seller is entitled to in exchange for the
goods/services transferred. Biermeier (2018) writes that when determining the price, a few things
and their effects should be considered: an estimate of the amount received after discounts or
refunds, fair value of the items versus the historical cost and amount payable to the customer,
that is anything that is owed the customer. The next step is to ensure that the price determined
matches the separate performance obligations. This step is a 2-step process: determining the
standalone selling price and allocating the transaction price to the performance obligations
(Joanne, 2017). Standalone selling price refers to the amount a seller charges separately for the
goods/services. Finally, when all parties have satisfied the performance obligations within the
contract, the revenue can be recognized and recorded in the income statement. At this time, the
customer obtains control of the product, which means they can direct the use of that asset and
have the right to deploy that asset as they see fit (Young et. al, 2018). Within the contract should
be specified whether the transfer of control occurs at a “point in time” or “over time”.
Starbucks is an American multinational coffee company headquartered in Seattle,
Washington, and trades on the NASDAQ Global Select Market (“NASDAQ”) under the symbol
“SBUX. Like every other multinational corporation within the US, are required to adhere to the
accounting standards of the FASB and IASB. In the last financial year of 2020, the company
generated a total net revenue of $23.52 billion. Starbucks typically includes their criteria and
steps taken for revenue recognition in the notes to the consolidated financial statement. They
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generate most of their income through royalties from company-operated and license stores. A
written contract is drafted and agreed upon by the entities involved, with the rights of all parties
clearly defined. Also, via transactions with everyday consumers of Starbucks products, there is
an oral identifiable contract where customers understand that the control of that product can be
transferred under certain performance obligations and transaction price. Under the second step of
revenue recognition, the Starbucks value cards provide an opportunity for the company to
recognize revenue when the clients redeem the cards as a performance obligation. In the last
fiscal year, the company recognized breakage revenue of $130.3 million from company-operated
stores in states where escheatment laws do not apply (Starbucks, 2020). The company considers
the terms of the contract and their customary business practices to determine the transaction price
(Young et. al). If a client receives a 25% discount based on the loyalty program, the transaction
price would be determined based off the 25%. Standalone prices are allocated per performance
obligation. For instance, the average cost of a cup of Starbucks coffee is $5. If a client were to
make an order for 3 cups of coffee worth $3.5, $6 and $4, these various prices per cup would be
printed in the receipt giving a total of $13.5 for that transaction. Finally, the last step involves
recognizing the revenue when performance obligations have been satisfied and the control of the
goods have been transferred to the client. To illustrate, when cash payments are approved and the
control of that cup of coffee has been handed to the customer, revenue can be recognized as all
entities have fulfilled their obligations.
Pre-existing GAAP guidelines allowed for revenue recognition even before fulfilment of
performance obligations and that created loopholes for financial statement fraud. The new
revenue recognition model has created a more airtight seal in preventing such fraud. The mere
fact that revenue cannot be recognized until a contract has been drawn up and identified goes a
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long way in preventing. It helps filter invalid contracts that do not represent genuine transactions
fraud and prevents contracts’ manipulation (Carmichael, 2019). For instance, the licensing stores
and the Starbucks corporations are made aware of their rights within the control and the
transaction can be carried out with the knowledge that no side bears the unilateral decision of
terminating the contract. This new model seeks to identify the performance obligations within
the contract and ensure they are satisfied to prevent premature revenue recognition. ASC Topic
606 dictates that revenue should be recognized based on the allocated transaction price approach.
In previous guidelines, recording of variable consideration are measurable revenue gave rise to
malpractices such as channel stuffing. However, with the 5-step revenue recognition model,
public companies like Starbucks would have to carefully consider every element when drafting
contract in order to prevent fraud.
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References
Biermeier, C. (2018). Revenue recognition – A five step approach. Retrieved from
Carmichael, D. R. (2019). New Revenue Recognition Guidance and the Potential for Fraud and
Abuse. CPA Journal, 89(3), 36–43
Joanne, M. F. (2017). Wiley revenue recognition: Understanding and implementing the new
standard. John Wiley & Sons Inc
Starbucks Corporation (2020). Starbucks fiscal 2020 annual report: Form 10-k. Retrieved from
https://s22.q4cdn.com/869488222/files/doc_financials/2020/ar/2020-Starbucks-AnnualReport.pdf
Wang, Y., Chiu, T., & Chiu, V. (2020). Redesigning business process to comply with the new
revenue recognition standard using process mining. Journal of Emerging Technologies in
Accounting, 17(1), 149–163. https://doi-org.lopes.idm.oclc.org/10.2308/jeta-52663
Young, S. D., Cohen, J., & Bens, D. A. (2018). A Brief overview of GAAP and IFRS: The
framework for financial accounting. V. Visentin, L. Johnson (Eds.), Corporate financial
reporting and analysis: A global perspective (4th ed, pp. 45-51). John Wiley & Sons Inc
Zarzycki, N. (2020). Revenue recognition: A simple guide. Retrieved from
https://bench.co/blog/accounting/revenue-recognition/
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