Question

Briefly explain why the Revenue Recognition standard does not allow the recognition of revenue in the following situation: Recently, Maria decided to invest in the manufacture of a device to relieve back pain that she designed and for which she obtained a patent. Several distributors agreed to purchase part of their inventory from Maria to resell to their customers, but only on the condition that Maria will accept back all unsold devices by the end of the first year. Maria received a total of $ 12,500 from the distributors. This is Maria's first experience in this industry and she has no idea how many units will be sold and how many will be returned to her.

Answer 1

As per Revenue Recognition Standard, the sales is recorded only when it is concluded.In the given case, the distributors had taken the goods from Maria on the condition that the unsold goods at the end of the year would have to be accepted by Maria.Further, Maria has no idea of how many devices would be sold and how many would be returned.Only to the extent of the goods accepted by the distributors on their sale to customers would qualify for Sales and the balance unsold at the distributors end would be treated as Stock of Maria.This is to avoid non recognition of profit which is not earned.Only earned income should be recognised in the books of accounts on conservative basis.