Review of Revenue Recognition in Due Diligence: What to Look for? – In the world of business and finance, the due diligence process is a critical step before undertaking major transactions such as acquisitions, investments, or mergers. One of the main aspects of focus during this process is revenue recognition. Revenue recognition not only determines a company’s financial health but also influences strategic decisions and investor confidence. 

What Is Due Diligence and Why Is It Important?

Due diligence is an investigative process conducted before making significant business decisions. Its purpose is to ensure that all financial, legal, operational, and risk aspects are thoroughly examined. In financial terms, due diligence aims to verify that a company’s financial statements accurately reflect its real condition. Revenue recognition becomes a major focus because it directly relates to reported income and how it reflects the company’s sustainability.

What Is Revenue Recognition: Definition and Basic Principles

Revenue recognition is the process of acknowledging revenue in a specific period according to applicable accounting principles, such as IFRS (International Financial Reporting Standards) and GAAP (Generally Accepted Accounting Principles). The main principle is that revenue should be recognized when the company has fulfilled its primary obligations and has earned the right to the consideration.

For example, a service company recognizes revenue when the service is rendered, not necessarily when payment is received. Proper revenue recognition must be consistent and aligned with the relevant standards to ensure the accuracy of financial reports.

What Are the Focus Areas in Due Diligence Regarding Revenue Recognition?

During due diligence, auditors and analysts scrutinize how the company recognizes revenue in depth. The following are key aspects they focus on:

1. Compliance with Accounting Standards

Firstly, they verify that revenue recognition has been carried out in accordance with applicable accounting standards. If the company follows IFRS 15 or ASC 606, documentation supporting revenue recognition based on the five-step model is required: contract identification, performance obligations, transaction price, allocation, and revenue recognition when obligations are fulfilled.

2. Consistency in Policy Application

Consistent application of revenue recognition policies across periods is crucial. Inconsistencies may raise concerns about the accuracy of financial statements and potential manipulation.

3. Complex and Unusual Transactions

Auditors will examine complex transactions, such as long-term contracts, large discounts, or third-party transactions. They ensure revenue is recognized appropriately and not overstated.

4. Impact of Estimates and Discount Policies

Revenue recognition often involves estimates, such as discounts, returns, or rebates. During due diligence, understanding how the company accounts for these factors and assessing potential overstatement risks is vital.

5. Supporting Data Accuracy

Gathering supporting documentation like contracts, invoices, shipment records, and payment records is part of the verification process. Auditors match recognized revenue with these supporting documents.

6. Manipulation Risks

A primary concern is the potential for revenue manipulation to meet financial targets. Therefore, auditors look for signs of unethical practices such as early revenue recognition, deferred expenses, or booking revenue from incomplete transactions.

Why Deep Understanding of Revenue Recognition Is Critical in Due Diligence

A thorough understanding of revenue recognition during due diligence is vital because it can reveal hidden risks and opportunities. Overstated revenue may give investors or buyers an inaccurate picture of the company’s financial health, risking losses later on. Conversely, conservative and compliant revenue recognition provides a clearer, more reliable view for decision-making.

In addition, revenue recognition practices are linked to legal and regulatory compliance. Violations or improper practices can lead to sanctions, fines, and damage to reputation.

The Role of Technology and Data in Revenue Due Diligence

In the digital era, due diligence is increasingly supported by technology and data analytics. analytical software and AI can help auditors analyze large transaction volumes, detect suspicious patterns, and verify data automatically. These technological tools make the process more efficient, accurate, and capable of identifying potential risks that might be overlooked manually.

Revenue recognition is a critical aspect of due diligence that can significantly impact the assessment of a company’s overall financial health. Professionals conducting due diligence must examine compliance with standards, consistency, data accuracy, and potential manipulation risks. A deep understanding of this process will assist decision-makers in accurately assessing risks and opportunities.

For companies operating in Indonesia that require assistance with conducting thorough due diligence, risk assessment, and risk management in safety and security, Siema Konsultan offers trusted solutions.

Established and managed by multilingual Indonesian professionals with extensive knowledge and experience, supported by international advisors and contributors, Siema combines global capabilities with local insights to deliver real solutions. For consultations, please contact us via phone/WhatsApp at 0813 1114 2228.

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