Revenue IFRS 15 Chapter 11 Revenue Recognition: A 5-step process 1. Identify the contract 2. Identify the separate performance obligations within a contract 3. Determine the transaction price 4. Allocate the transaction price to the performance obligations in the contract 5. Recognise revenue when (or as) a performance obligation is satisfied Example Solution 1. Agreement to provide goods (computer) & services (technical support for 12 months) 2. a. The supply of computer b. Technical support 3. Transaction Price $ 420 4. a. $300 on computer sale b. $120 for technical support 5. 1 Dec 20x1= $300 (risk & rewards/control transferred) 31 Dec 20x1 $120/12= $10 (Provision of technical support) revenue from technical support will be recognized over 12 months period ($10 in each subsequent month) 1. Identify the Contract What is a contract An agreement between two or more parties that creates enforceable rights and obligations Agreed in writing, orally or through other customary business practices Revenue can be recognized only when Contract should meet the following criteria: 1. 2. 3. 4. 5. Approval of the parties & their commitment to perform obligations Entity can identify each party’s rights regarding the goods or services to be transferred The entity can identify the payment terms for the goods or services to be transferred Commercial substance It is probable that the entity will collect the consideration (in exchange of g/s transferred to the customer) Example: Identify the contract • By 31 March 20X6, it was NOT probable that Mono will collect the consideration • So, Contract can’t be accounted for & no revenue recognition 2. Identifying the separate performance obligations Performance obligation is: Promises to transfer distinct goods or services to a customer Performance obligations are accounted for separately if the promise of goods/services are distinct i.e. could be sold separately Performance obligations may not be limited to the goods or services that are explicitly stated in the contract An entity must decide if the nature of a performance obligation is: • • To provide goods or services itself (principal) To arrange for another party to provide g/s (agent) Revenue recognition is based on entitled fee/commission • Hadrian is an agent and not the principal • Hadrian should not have included $45,000 in its revenue • Only the commission element of $4500 ($45000× 10%) can be recorded in revenue • Adjustment : Dr Revenue $40,500 Cr Cost of sales $ 40,500 Entitlement only 10% of sale value Revenue of 45000 Offa Principal Hadrian (Agent) Hadrian will provide goods to buyer on behalf of Offa Buyer If Hadrian has done correct entry initially: 1) Bank 45000 Commission 4,500 Payable to offa 40,500 2)Payable to offa Bank 40,500 40,500 Hadrian revenue should be 4500 They erroneously recognized 45000 How to correct Dr. Revenue(45000-4500) 40,500 Cr. Cost of sales 40,500 Impact of this entry would be Cost of sales nil & Revenue would be stated at correct amount of commission of 10% of 45000 i.e. $ 4500. Incorrect entry Hadrian 1)Bank 45,000 Revenue 45,000 2) Cost of sales 40,500 Bank 40,500 (Transfer to Offa) 3. Determining the transaction price Amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer Amounts collected on behalf of third parties (such as sales tax) are excluded Consideration may include fixed amounts, variable amounts, or both • Variable consideration- Included at its expected value or single most likely amount (performance bonuses) Adjustments of financing components – Transaction price should reflect the cash selling price at the time when control of g/s transfers (PV of consideration receivables) • Difference between the amount of promised consideration & cash selling price of promised g/s • Significant Time period between the transfer of promised g/s to customer & the payment date Consideration payable to customer (not in exchange for a distinct g/s) - Refunds/rebates reduce transaction price Payment is done 2 years after the transfer of equipment => Existence of financing component Consideration must be adjusted for the impact of financing transaction PV = $1,000,000/(1 + 10%)2 = $ 826,446 Refer to excel sheet for class solution Solution Consideration must be adjusted for the impact of financing transaction PV = $1,000,000/(1 + 10%)2 = $ 826,446 31 Dec 20X1 => Dr Revenue receivable Cr Revenue(Sales) $ 826,446 31 Dec 20X2 => Dr Revenue Receivable $ 82,645 Unwinding of interest Revenue recognition when performance obligation is satisfied $ 826,446 Total receivable = $ 909,091 Cr- Interest Income ($826,446 *10%) $ 82,645 Total receivable = $ 1 m 31 Dec 20X3 => Dr Revenue Receivable $ 90,909 Cr- Interest Income ($909,091 *10%) $ 90,909 Dr Cash $ 1,000,000 Cr Revenue receivable $ 1,000,000 • The total transaction price is being reduced by 5% ($1m/$20m). • Therefore, Golden Gate reduces the transaction price of each good by 5% as it is transferred. • By 31 December 20X1, Golden Gate should have recognised revenue of $3.8m ($4m × 95%). 4. Allocate the Transaction Price Transaction price is allocated in proportion to the stand-alone selling price of g/s that underlies each performance obligation Observable price of g/s when it’s sold separately in similar circumstances and to similar customers • If stand-alone price is not observable, there’s an estimation • Total transaction price < Buying the two performance obligations separately • Bundled sale/discounts => proportionately be allocated across each component Solution- Allocation of transaction price Machine Stand-alone Selling price = $ 95,000 Allocation of transaction price = $95,000 * 80% = $ 76,000 Performance Refer to excel sheet for class solution Total stand-alone prices = $ 125,000 vs Obligations Technical Support Stand-alone Selling price =Not Observable Estimation =Expected costs + margin = $20,000 + (50% * $20,000) = $30,000 Allocation of transaction price = $30000 * 80% = $ 24,000 Consideration Receivable = $ 100,000 So, discount = $25,000/$125,000 = 20% 5. Recognise Revenue Revenue is recognised when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer For each performance obligation identified, an entity must determine at contract inception whether it satisfies the performance obligation • at a single point in time, OR • Over a period of time Satisfying a performance obligation at a point in time Entity must determine the point in time at which a customer obtains control of a promised asset Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits (inflows or savings in outflows) from, the asset. Indicators 1. 2. 3. 4. 5. of transfer of control: The entity has a present right to payment for the asset The entity has transferred physical possession of the asset The customer has legal title to the asset The customer has the significant risks and rewards of ownership of the asset The customer has accepted the asset Illustration - discussion Control transferred Control not transferred • Dusty paying insurance & maintenance • Return can be made without penalty & Frod can recall • Purchase Price fixed @ date of delivery Price- no fluctuations Performance obligations over a period of time An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognises revenue over time Revenue recognition is by measuring the progress towards complete satisfaction of that performance obligation (Total price). Appropriate methods of measuring progress include: 1. Output methods – Revenue is based upon the value to the customer i.e. work certified OR time elapsed Work Certified to date Percentage of work completed = Total Contract Revenue × 100% 2. Input methods – Revenue is recognized based upon the amounts the entity has used i.e. costs incurred or labor hours. to date Percentage of work completed = TotalCosts × 100% estimated costs Presentation in Financial statements (4 steps) Step 1: Calculate overall profit/loss Step 2: Determine the progress of contract Step 3: Statement of profit/loss (Profitable) Step 4: Statement of Financial position Overall Profit/(loss) = Contract price ─ Costs to date ─ Costs to complete Input method / output method Revenue (total price × progress%) Less rev. recognised in previous years Cost of sales (Total costs × progress%) Less COS recognised in previous years Contract Asset/(liability) = Costs to date (Actual costs) Profit/(loss) to date less: amount billed to date Refer to excel sheet for class solution Example Alex commences a three year building contract during the year ended 31 December 20X4 and continued the contract during 20X5. The details of the contract are as follows: $m Total contract value 45 Costs incurred to date @ 20X5 20 Estimated costs to completion 12 Work certified as completed in 20X5 15 Stage of completion @ 20X5 70% Profit recognized to date @ 20X4 3.3 Progress billing to date 5 Show how this contract would be dealt with in the financial statements for the year ended 31 December 20X5. Solution Step 1: Calculate overall profit/loss $m Total revenue $m Total contract value 45 Costs incurred to date @ 20X5 20 Estimated costs to completion 12 Work certified as completed in 20X5 15 Stage of completion @ 20X5 70% Profit recognized to date @ 20X4 3.3 Progress billing to date 5 45 Total costs to date (20) to complete (12) Profit 13 . Step 2: Determine the progress of contract Recognise profit based upon 70% Profit recognition to 20X5 = 70% ×$ 13 m = $ 9.1 m Solution Step 3: Statement of profit/loss for the year ending 31 Dec 20X5 Revenue (total price × progress%) Less revenue recognised in 20X4 $m Total contract value 45 Costs incurred to date @ 20X5 20 Estimated costs to completion 12 Work certified as completed in 20X5 15 Stage of completion @ 20X5 70% Profit recognized to date @ 20X4 3.3 Progress billing to date 5 15 Cost of sales (Total costs × progress%) Less COS recognised in 20X4 (9.2) Profit (less recognized in 20X4) (9.1 ─ 3.3) Step 4: Statement of Financial position Costs to date (Actual costs) Profit/(loss) to date less: amount billed to date Contract Asset/(liability) 20 9.1 ( 5) 24.1 5.8 Bal. fig.
