GAAP is a set of specific common guidelines, provided by the institutions such as the Financial Accounting Standards Board, the American Institute of Certified Public Accountants and the Securities and Exchange Commission, about "acceptable accounting practices"
These acceptable practices should not necessarily be regarded as a set of ground rules. In fact, it is a common denominator, useful when foreign firms, especially auditing companies, proceed to financial verifications. The GAAP provide for an easier task from the auditing companies and anybody else who interprets the financial statements.
In the case of Legal Plan Services, the GAAP guidelines will provide the necessary information that will permit a common evaluation, a common ground on which revenue and expenses can be considered. Besides being interpretable by more than one side, the GAAP guidelines are, in this case, rules which allow for the company's accounting methods to be understood by others and would permit, in the future, an IPO preparation. We will be using Financial Accounting Standards Board documents in order to be able to identify the best and most suitable means by which the company can account for its revenues and expenses.
The first part of the essay will be a presentation of the different issues concerning the revenue and expense recognition, as identified by the Financial Accounting Standards Board in several documents over the past couple of years. This will be the theoretical base on which we can thereafter develop a discussion around the type of revenue and expense, as related to the company's specific area of expertise. In the second part of the assignment, we will be explaining and summarizing our findings for the company's president, with a series of conclusions thereafter.
Part 1 -- Revenue and Expense Recognition
Because of the issues concerned with revenue recognition and its importance within the company, the standards proposed and used for revenue recognition in the financial statements are among the most important and the most difficult to agree upon. Besides the FASB propositions, there are several other authorities that have laid opinions related to revenue recognition, among these the Accounting Principles Board, the American Institute of Certified Public Accountants or the Security and Exchange Commission through its Staff Accounting Bulletin (SAB).
As the Legal Plan Services company we are analyzing is planning an IPO in the near future, we should hereby state that the SAB lists two different criteria that should be used in the case of revenue. If "a transaction falls within the scope of specific authoritative literature on revenue recognition, that guidance should be followed"
. However, if this does not occur, SAB recommends "the use of the revenue recognition criteria in FASB Concepts Statement No.5, Recognition and Measurement in Financial Statements of Business Enterprises"
In my opinion, the FASB concepts are very important and refer to the fact that a revenue should not be recognized until it is realized or realizable and earned. The SAB methodology is not as applicable at this point for our company, mainly because it generally addresses companies that are already listed on the Stock Exchange and not necessarily those that are preparing for an IPO.
As such, referring to the FASB statements seems closer to our company's reality. The FASB Concepts Statement No.6, Elements of Financial Statements, refers to revenues as "changes in assets and liabilities"
. As we can see from the previous paragraph, we are already faced with two somewhat different types of revenue recognition. One refers to revenues as earnings, where earnings would be a similar concept to net income, while in the other case, revenue includes an operational change in assets and liabilities.
Given these introductory concepts of revenue recognition, it may be the proper time to have a brief look at the nature of the company's service, in order to be able to fit the company's revenues into one of the statements described previously. As we have seen from the case study, the company is designs, underwrites and markets legal service plans. These are obviously intangible products and their underwriting would probably place us closer to the first concept, where a revenue is recognized as it is realized or realizable and earned. Let's further examine these two key concepts.
The realized criterion refers to "changes in assets (in the form of receipts of cash or claims to cash or transformations into readily convertible assets)"
. The earned criterion refers to the fact that the company must have "substantially accomplished" what it must do to be entitled to the benefits."
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