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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~60 views
Financial Analysis Post 3: Importance of understanding revenue recognition policy of different business models& how it impacts financial analysis. 3 case studies covered: Eros International, Asian paints & Just dial (1/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
We know that revenue is a consideration a company has received or expects in rendering services or selling a product to customers. Let’s take a couple of examples: (3/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
If a company created a product which it hasn't delivered yet to the customer for which the company may have received advance and its non-refundable, should it be considered as revenue? Would the answer change if the company has not yet received advance for the same? (4/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
Well thankfully, we don't have to worry about these things, as we have Accounting Standards setting up rules on what should be recognized/ recorded as revenue by companies and what shouldn’t. (5/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
These accounting policies are set by Accounting Standards which every company has to stick to post customizing it to their business environment and model. (6/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
That’s a really imp. catch for an analyst. We are not trying to say that companies will cheat by putting up a policy which suits them & keeps changing it every yr,but a changing business model/changing accounting standards may demand change in the revenue recognition policy.(7/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
What an analyst should always keep an eye out for is a change in these revenue recognition policies, understand the reason behind the same & see if they lead to any impact on financials & should he or she make any changes to the data before hitting the ground for analysis. (8/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
Let’s take examples of Revenue recognition policies of different models.

First step-let’s learn where to find how companies record revenue? You will find this under the Accounting Policies section just after Financial statements, mostly under the title- Revenue Recognition (9/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~20 views
One may observe that since a company may engage into different natures of product & service rendering to customers, the same company may have different revenue recognition policies for each of these revenue generating activities. Let’s take couple of examples-Asian Paints (10/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~30 views
Asian Paints defines revenue to be recognized for sale of paint products upon shipment of the product to its customer, that's when the company loses control of their product to the customer! (11/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
This is a simple format which the majority of the companies have to follow while analyzing what to report as revenues. Even here subtle changes can be present in the definition of control. (12/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
Whereas for rendering of services, it recognizes revenue based on milestones which are achieved. Such contracts tend to have milestones where, service renderer is entitled to a payment upon achievement of a pre decided and agreed upon milestone. (13/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
Example: Contract states explicitly that the customer would be liable to pay 25% of overall contract value upon reaching a particular stage of the project.

Example 2 - EROS. It engages in multiple activities & below are the revenue recognition policies for these activities(14/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
1) Theatre sales: Upon ticket sales of movies & if there are any minimum contracted guarantees provided by any exhibitors, recognize it upon release. (15/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
E.g if there is a minimum contractual guarantee provided by an exhibitor of lets say 1 Cr, They are liable to pay that amount to EROS as soon as they get movie screening rights even if they may or may not be able to sell the tickets for whatsoever reasons. (16/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~20 views
2) Sale of film rights: Upon delivery of rights (In this segment, the company sells its movie rights/ exclusivities to different distributors/networks). One may also notice the term, pre-agreed transfer pricing norms. We will discuss this topic in detail later. (17/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~30 views
3) Sale of satellite rights: Same as above
4) Production fee: Milestone approach which we discussed in Asian Paints

Taking another example of Just dial: (18/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
Just Dial Recognizes revenues across multiple segments using different recognition policies.

Search related services are basically long term arrangements for digital presence of customers on Just Dial’s website for lead generation.(19/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
It's a fixed cost paid by customers to JD for a tenure of 1 year or more. Just Dial is known to sell 1-5 year contracts to their customers to avail this digital presence service on JD’s website. This payment is usually made upfront or in a periodical manner by the customer.(20/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
As a result, sometimes this leads to items such as Contract Assets/ Contract Liabilities on JD’s b/s. More on these items would be covered in our next post where we teach you how to analyze Revenues of such companies which engage in long term contracts with their customers.(21/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
Meanwhile, focusing on the issue at hand, to understand how JD recognizes the revenue for such long term contractual arrangements? Answer is pro-rata basis over the contract period.(22/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
E.g-On 1/4/18- 5 yr contract is sold for 3 lakh rs by JD. After 1 year the firm would be able to recognize 1/5th of 3 lakh RS i.e. 60 thousand.

FY19 End, the remaining 2.4 lakh rs (if paid in advance) would sit in the Contract Liabilities/ Deferred Revenue account (23/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views
When you look at the Income statement, you would notice, Revenue from contract with customers instead of sale of goods & you will find very high Contract Liabilities/ Deferred revenue figures on JD’s B/S. More than 75% of liabilities are these Deferred Revenues. (24/n)
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Finnacle Shah Classes

@finnacle_shah_classes
4 years ago ~10 views

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