Reference no: EM13903885

Recognising revenue: innovative practices

New revenue recognition practices emerge as companies seek to adapt traditional methods to new circumstances. The following are examples of new practice.

(a) A van hire company acquires a large number of vans for use in its business. The supplier gives it a discount in view of the number of vehicles purchased. The van hire company reports the bulk vehicle discount as revenue. In the year to 30 April 2001, revenue from bulk purchase discounts represents 48.8 million of the company's total revenues of 310.6 million.

(b) A biotechnology company undertakes substantial research to discover new drug compounds. To help finance its research efforts, it enters into drug delivery agreements with major pharmaceut- ical companies. In addition, it licenses to other drugs companies products and technology that it has developed in-house.

The drug delivery and licensing agreements result in substantial licensing income. Where the amounts received are non-refundable or the potential risk of repayment is remote, the company recognises income from licensing on the date the contract takes effect. Where the licensing income is receivable in stages, the company defers part of the licensing income until conditions specified in the contract have been met.

(c) Newtel is a recently established telecoms company that markets itself as an alternative carrier to existing national telecoms companies such as AT&T, Deutsche Telekom and NTT. It has invested heavily to build a ‘backbone' network to carry Internet traffic which is growing rapidly. In order to give customers global communications cover, it leases capacity on other companies' networks where there are gaps in its own. (These leases are known as IRUs or indefeasible rights of use.) It pays for the long-term leases through reciprocal arrangements in which other carriers lease capacity on its network to fill gaps in their networks. Although the exchanges are referred to as ‘swaps' in the business press, Newtel insists that they are separate transactions since each sale or purchase is priced individually and evaluated separately.
Newtel records capacity leased out as a sale and books the whole revenue from the long-term lease at the date of the contract. Other carriers account for Newtel's lease of capacity on their net- works in the same way.

Required

Is the method of revenue recognition used in each of the above situations acceptable in your opinion? Explain why (or why not). If the method is unacceptable, how should the company account for the transaction?