Chapter 15
Revenue recognition issues
Opening questions
15.1
‘Income’ is often subdivided into ‘revenues’ and ‘gains’, but is there a difference
between them?
Traditionally, it has been considered that there is a difference. Generally speaking, revenues
relate to the ordinary income-generating activities of an entity—for example, from sales or
rental receipts—whereas gains relate to ‘other income’, which does not necessarily constitute
part of the ordinary activities of an entity. This is consistent with how revenue is defined
within AASB 15, which is ‘income arising in the course of an entity’s ordinary activities’.
15.2
What is the general rule in terms of when revenue shall be recognised from contracts
with customers?
The general rule is stated at paragraph 31 of AASB 15:
An entity shall recognise revenue when (or as) the entity satisfies a performance obligation
by transferring a promised good or service (i.e. an asset) to a customer. An asset is
transferred when (or as) the customer obtains control of that asset. (AASB 15)
Transfer of ‘control’ of the asset is a central requirement in the recognition of revenue under
the accounting standard.
15.3
If a customer pays for a product or service provided by an organisation with a payment
that is not in the form of cash, on what basis will that revenue be measured?
Where non-cash consideration is received, the consideration shall be measured at its fair value.
15.4
Organisations often sell products to customers with a ‘right of return’. What is a ‘right
of return’, and how, if at all, shall the right of return be accounted for at the point of
sale?
A ‘right of return’ exists when an entity transfers control of a product to a customer and also
grants the customer the right to return the product for various reasons (such as dissatisfaction
with the product) and receive any combination of the following:
(a) a full or partial refund of any consideration paid
(b) a credit that can be applied against amounts owed, or that will be owed, to the
entity, and
(c) another product in exchange.
Where a sale with a right of return is provided to a customer, revenue, a refund liability and
an asset relating to the right to recover the product will generally be recognised. The revenue
to be recognised will be based on the sale of products that are not expected to be returned
multiplied by their sales price, and the refund liability will be based on the products expected
to be returned multiplied by their sale price.
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15.5
If an organisation is constructing a building, and that building will take a number of
years to complete, can the organisation recognise revenue throughout the contract, or
does the construction-based organisation have to wait until project completion before it
recognises the revenue associated with the construction contract?
Yes, as long as certain conditions are satisfied, the revenue can be recognised over a period
of time. AASB 15, paragraph 31, states:
An entity shall recognise revenue when (or as) the entity satisfies a performance
obligation by transferring a promised good or service (ie an asset) to a customer. An
asset is transferred when (or as) the customer obtains control of that asset. (AASB 15)
Therefore, transfer of ‘control’ of the asset is a central requirement in the recognition of
revenue under the accounting standard. Revenue can be recognised over a period of time if
transfer of control of the good or service occurs over time. Where performance obligations
are satisfied over time and do not relate to a service, paragraph 35 of AASB 15 permits
revenue to be recognised to the extent that:
• the reporting entity’s performance creates or enhances an asset (for example, work in
progress in the form of a building) that the customer controls while the asset is being
created or enhanced, or
• the entity’s performance creates an asset with no alternative use to the entity and the entity
has an enforceable right to payment for performance completed to date.
15.6
AASB 15 identifies five steps that need to be taken when recognising revenue from
contracts with customers. What are these steps?
These five steps, which would be addressed sequentially, are:
1. Identify the contract(s) with customers.
2. Identify the performance obligation(s) in the contract.
3. Determine the transaction price of the contract.
4. Allocate the transaction price to each performance obligation.
5. Recognise revenue when each performance obligation is satisfied.
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Review questions
15.1
Would it be appropriate to recognise revenue at completion of production rather than
at the point of sale?
‘Control’ is central to the recognition of revenue. That is, pursuant to AASB 15, revenue
recognition is directly linked to the transfer of the control of the underlying goods and
services.
Adopting a view that revenue recognition should be consistent with the Conceptual
Framework, the IASB has – through AASB 15/IFRS 15 - embraced the view that revenue
recognition should be a direct function of whether goods and services have been transferred
to the control of the customer (and not be a function of who holds the risks and rewards of
ownership of the asset). That is, under the ‘new’ thinking of the IASB as reflected in AASB
15, revenue recognition from contracts with customers is very much linked to the transfer of
control of assets and not to the transfer of the risks and rewards of ownership as has been the
accepted position for many years. This is quite a significant shift in thinking.
Therefore, in this case, revenue recognition would not be recognised at the completion of
production, but rather, when control of the asset has passed to the customer.
15.2
If there was a constant and repetitive series of transactions then once a point was chosen in
the production/sales cycle, the revenue to be recognised each year at that point would be
equivalent to the revenue recognised at any other point—that is, there is a constant flow
through the system. Hence, beyond the first (and last) year, the choice of points in the revenue
recognition cycle would make little difference.
15.3
A bad debt occurs when a specific debtor is deemed unlikely to pay its debts and as a result
the reporting entity recognises a bad debts expense and also reduces the balance of the debtors’
ledger (with a corresponding reduction in the debtors’ subsidiary ledger). It is also possible
that a debtor that goes ‘bad’ was anticipated and that a sufficient amount was previously
recognised as a doubtful debts expense, with a corresponding increase in the allowance for
doubtful debts. If this is the case, there would be a debit to the allowance for doubtful debts
and a credit to accounts receivable (also called debtors).
A doubtful debt is recognised when it is considered, perhaps on the basis of past experience,
that not all debtors will pay the amounts that are due. No specific debtors are identified as
being unlikely to pay. Rather, a general allowance is created (an allowance for doubtful debts)
which is offset against accounts receivable. That is, the allowance for doubtful debts is a
contra account. When a doubtful debts expense is recognised, no adjustments are made
directly to the debtors’ ledger or the associated subsidiary ledgers.
15.4
What it means is that different approaches to asset and income recognition and measurement
will directly impact the quantum of revenues reported by an entity. For example, if an entity
values its assets at fair value, then the increase in the value of the assets could—depending
upon the category of assets—be treated as revenue. Alternatively, if an entity strictly applies
historical cost accounting then, although there may be an increase in the market or fair value
of its assets, this increase may be ignored until such time as a sale occurs. Consequently, prior
to the sale, less revenue will be reported by the historical cost organisation relative to an entity
that adopts a ‘mark to market’ approach to valuation.
As a further example, some forms of current cost accounting value all assets at market value,
but where the increase in market value is simply due to changing price levels in the economy,
the change in value is treated as a capital reserve, rather than as part of profits.
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Some entities adopt a modified version of historical cost in which, consistent with AASB 116
Property, Plant and Equipment, they elect to perform asset revaluations. However, under the
AASB 116 approach to revaluing property, plant and equipment, any gain is not treated as
part of profit or loss (unless it reverses a previous revaluation decrement), but is to be treated
as part of other comprehensive income, thereby increasing the reserves of the reporting entity,
but not increased retained earnings. This can be contrasted with investments in financial assets
that are shares. If these shares are held for trading, then in accordance with AASB 9 they are
to be measured at fair value with any changes therein to be included within profit or loss.
Hence, as can be seen from the above discussion, how assets are measured will have direct
implications for the reported profits of an entity.
15.5
AASB 15 does not apply to income derived from financial instruments. In relation to the scope
of AASB 15, paragraph 5 (the Scope section) states:
An entity shall apply this Standard to all contracts with customers, except the following:
(a) lease contracts within the scope of AASB 16 Leases;
(b) insurance contracts within the scope of AASB 4 Insurance Contracts;
(c) financial instruments and other contractual rights or obligations within the scope
of AASB 9 Financial Instruments, AASB 10 Consolidated Financial Statements,
AASB 11 Joint Arrangements, AASB 127 Separate Financial Statements and AASB
128 Investments in Associates and Joint Ventures; and
(d) non-monetary exchanges between entities in the same line of business to facilitate
sales to customers or potential customers. For example, this Standard would not
apply to a contract between two oil companies that agree to an exchange of oil to
fulfil demand from their customers in different specified locations on a timely basis.
Therefore, AASB 15 applies to only a subset (or part) of the income-generating activities of
an entity.
15.6
Identifying the contracts with customers is the first elements in the five elements that AASB
15 identifies as important in accounting for contracts with customers. A review of the contract
will identify a number of important factors that are necessary for determining whether to
recognise revenue, when to recognise it, and the amount of revenue to be recognised as
particular performance obligations are satisfied. Therefore, this is a necessary first step in the
process of recognising revenue.
15.7
These five steps, which would be addressed sequentially, are:
1. Identify the contract(s) with customers.
2. Identify the performance obligation(s) in the contract.
3. Determine the transaction price of the contract.
4. Allocate the transaction price to each performance obligation.
5. Recognise revenue when each performance obligation is satisfied.
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15.8
F.o.b. stands for free on board. An item may be sold f.o.b. shipping point, or f.o.b. destination.
Destination or shipping point refers to the point at which title and control of the goods passes
to the purchaser. If the goods are shipped f.o.b. destination, control does not pass until the
buyer receives the goods at the destination. In this case, revenue would not typically be
recognised until the goods reach their destination whereby they come under the control of the
buyer.
15.9
If an organisation received non-cash consideration from a customer in return for providing a
good or service then the consideration shall be measured at fair value. As paragraphs 66 and
67 of AASB 15 state:
66
67
To determine the transaction price for contracts in which a customer promises
consideration in a form other than cash, an entity shall measure the non-cash
consideration (or promise of non-cash consideration) at fair value.
If an entity cannot reasonably estimate the fair value of the non-cash consideration,
the entity shall measure the consideration indirectly by reference to the stand-alone
selling price of the goods or services promised to the customer (or class of
customer) in exchange for the consideration.
15.10 When the first Exposure Draft Revenue from Contracts with Customers was released in June
2010 it was proposed that reporting entities should recognise revenue at the amount of
consideration that the company expects to receive from the customer. Thus, it was initially
proposed that when determining the ‘transaction price’ the entity would consider the effect of
the customer’s credit risk and record only the net expected amount as revenue. This would
have represented quite a departure from traditional accounting practice. However, when the
second Exposure Draft was released in November 2011, the requirement was changed back
to the traditional approach and this approach has been incorporated within AASB 15. That is,
a reporting entity shall recognise revenue at the amount of consideration to which the entity
considers it is ‘entitled’. An entity shall exclude expectations of collectability when
determining the amount of the transaction price (and thus the amount to be recognised as
revenue).
15.11 If the promised amount of consideration in a contract is variable, an entity shall estimate the
total amount to which the entity will be entitled in exchange for transferring the promised
goods or services to a customer. There are two main ways to make this estimate—the expected
value, and the most likely amount. Paragraph 53 of AASB 15 requires:
An entity shall estimate an amount of variable consideration by using either of the
following methods, depending on which method the entity expects to better predict the
amount of consideration to which it will be entitled:
(a)
The expected value—the expected value is the sum of probability-weighted
amounts in a range of possible consideration amounts. An expected value may be
an appropriate estimate of the amount of variable consideration if an entity has a
large number of contracts with similar characteristics.
(b)
The most likely amount—the most likely amount is the single most likely amount in
a range of possible consideration amounts (ie the single most likely outcome of the
contract). The most likely amount may be an appropriate estimate of the amount of
variable consideration if the contract has only two possible outcomes (for example,
an entity either achieves a performance bonus or does not).
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15.12 We allocate the transaction price to each performance obligation on the basis of the selling
price of each distinct good or service. With knowledge of all of the stand-alone selling prices,
the organisation can then allocate the transaction price in proportion to the respective standalone selling prices. When estimating the stand-alone selling prices, paragraph 78 of AASB
15 states:
an entity shall consider all information (including market conditions, entity-specific
factors and information about the customer or class of customer) that is reasonably
available to the entity. In doing so, an entity shall maximise the use of observable inputs
and apply estimation methods consistently in similar circumstances.
15.13 Unearned income is the term used to represent situations in which assets are received by an
organisation for services to be performed at a future date.
Common examples of ‘unearned income’ (also referred to as ‘revenue received in advance’)
would include rent or interest received in advance, the receipt of consulting fees in advance
of the provision of services, or payments made in advance in relation to construction
contracts.
Since the services or resources have not been provided to the customer (and hence ‘control’
of the related good or service has not passed to the customer), the cash or other asset receipts
have not been earned and the customer would not be deemed to be in control of the goods or
services. In such a scenario, the receipts do not constitute revenue but instead are considered
as liabilities. They represent obligations to customers to satisfy particular performance
obligations. The entity would be under a present obligation to transfer future economic
benefits at a future date (see paragraph 106 of AASB 15).
15.14 Dividend revenue would be derived from investments in financial assets, which are financial
instruments. Financial instruments are not addressed within AASB 15. Rather, they are
addressed in AASB 9 Financial Instruments.
A dividend from pre-acquisition earnings/profits will typically occur when an investor
acquires an interest in another company and the shares have been acquired ‘cum div’—the
term used to refer to shares being bought with an existing dividend entitlement. If an entity
pays dividends out of profits earned before the acquisition, it is, in effect, returning part of
the net assets originally acquired by the acquirer. Therefore, if dividends are received from
pre-acquisition earnings, they shall be treated as a reduction in the cost of the investment
rather than being treated as revenue.
15.15 Multiple performance obligations could be bundled within one contract. A distinct
performance obligation can arise even if the related promise is incidental or part of a broader
marketing campaign. We identify the performance obligations at the commencement of the
contract. This requires us to identify each contractual promise to deliver goods and/or
services to the customer. This is required so that we can subsequently allocate amounts of
the ‘transaction price’ to each ‘performance obligation’ as it is satisfied.
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15.16 (a) In this case there are three performance obligations that need to be accounted for
separately and Surfside Ltd must allocate the total contract price between the surfboard,
wetsuit, and surfing lessons. Each of these separate components could be supplied
individually.
(b)
On the assumption that the discount of $200 relates to the three performance
obligations, then the discount shall be allocated to each performance obligation as follows:
Good or service
Surfboard
Wetsuit
Lessons
Stand-alone price
$850
$250
$200
$1,300
Discount allocation
Allocated amount
850/1300 x $200 = $131
$719
250/1300 x $200 = $38
$212
200/1300 x $200 = $31
$169
$200
$1,100
15.17 When amounts to be received from customers are to be discounted (for example, the amount
is to be received beyond 12 months), then the discount rate to be applied is discussed at
paragraph 64 of AASB 15, which states:
when adjusting the promised amount of consideration for a significant financing
component, an entity shall use the discount rate that would be reflected in a separate
financing transaction between the entity and its customer at contract inception. That rate
would reflect the credit characteristics of the party receiving financing in the contract, as
well as any collateral or security provided by the customer or the entity, including assets
transferred in the contract. An entity may be able to determine that rate by identifying the
rate that discounts the nominal amount of the promised consideration to the price that
the customer would pay in cash for the goods or services when (or as) they transfer to the
customer. After contract inception, an entity shall not update the discount rate for
changes in interest rates or other circumstances (such as a change in the assessment of
the customer’s credit risk).
15.18 A put option gives its holder the right to sell an asset, at a specified exercise price, on or before
a specified date. The writer (or seller) of the put option agrees to buy the asset at a future date,
for the exercise price, if the put option holder (buyer) should request it. The holder of the put
option (who may also be in possession of the underlying asset) would typically only exercise
the option (that is, require the other party to buy the underlying asset) if the exercise price was
above the market price.
Where a transaction involves the use of a financial instrument such as an option, it is necessary
to evaluate the conditions attaching to the transaction to establish whether, in substance, the
transaction is a financing arrangement rather than a sale.
In considering whether to recognise revenue when there are associated options, the probability
of the exercise of the options must be considered. Where it is probable that the put option will
be exercised and Eddie is required to repurchase the equipment, revenues should not be
recognised by Eddie since the requisite degree of certainty that the inflow of economic
benefits has occurred will not have been attained. The higher the price recorded on the put
option, the greater the probability that Mass Marketer will require Eddie to re-acquire the
assets. Hence the greater the price recorded on the option (which increases the differential
between the fair value, and the option price at the exercise date) the lower the justification for
recording the sales revenue.
Hence, if an entity sells an asset to another organisation and the other organisation (customer)
has a put option that requires the entity to acquire the asset at a price in excess of the original
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sale price, then no revenue shall be recognised. However, should the option lapse, then
revenue can be recognised. As paragraphs B66 to B69 of AASB 15 state:
B66 If an entity has an obligation or a right to repurchase the asset (a forward or a
call option), a customer does not obtain control of the asset because the customer is
limited in its ability to direct the use of, and obtain substantially all of the remaining
benefits from, the asset even though the customer may have physical possession of the
asset. Consequently, the entity shall account for the contract as either of the following:
(a) a lease in accordance with AASB 16 Leases if the entity can or must repurchase
the asset for an amount that is less than the original selling price of the asset;
or
(b) a financing arrangement in accordance with paragraph B68, if the entity can
or must repurchase the asset for an amount that is equal to or more than the
original selling price of the asset.
B67 When comparing the repurchase price with the selling price, an entity shall
consider the time value of money.
B68 If the repurchase agreement is a financing arrangement, the entity shall continue
to recognise the asset and also recognise a financial liability for any
consideration received from the customer. The entity shall recognise the
difference between the amount of consideration received from the customer and
the amount of consideration to be paid to the customer as interest and, if
applicable, as processing or holding costs (for example, insurance).
B69 If the option lapses unexercised, an entity shall derecognise the liability and
recognise revenue.
15.19 If an entity recognises the revenue associated with a contract over time, then this would be
considered to be less conservative than an approach that defers profit recognition until the end
of the contract. A conservative approach to profit recognition would be to wait until such time
that all necessary requirements pertaining to the construction have occurred. This would
ensure, with high certainty, that all expected revenue has actually been earned. Generally,
such high levels of certainty are not required.
15.20 To the extent that the benefactor does not have any rights to make a claim to have the donation
returned, then the donation would be treated as income, as it would satisfy the definition and
recognition criteria of income as provided in the Conceptual Framework. The donation
represents an inflow of economic benefits in the form of an increase in assets, which is not a
contribution from the owners of the entity. Further, the inflow has occurred and is for a
specific amount—hence the inflow satisfies the ‘probable’ test as well as being capable of
reliable measurement. Whether it would be treated as ‘revenue’ or a ‘gain’ (remember, the
conceptual framework divides income into revenues and gains) would be dependent upon the
nature of the business. If the entity was the sort of entity that relied upon donations to support
its business (for example, if it is a registered charity) then the donation might be treated as
revenue. Otherwise it might be treated as a gain.
15.21 When a reporting entity has entered into a contract with a customer—including a long-term
construction contract—then when either party to the contract has performed, the reporting
entity might present the contract in the statement of financial position as either a contract
liability, a contract asset or a receivable depending on the relationship between the entity’s
performance and the customer’s payment. In explaining this, paragraph 106 of AASB 15
identifies when a contract liability should be recognised. It states:
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If a customer pays consideration, or an entity has a right to an amount of consideration
that is unconditional (i.e. a receivable), before the entity transfers a good or service to
the customer, the entity shall present the contract as a contract liability when the payment
is made or the payment is due (whichever is earlier). A contract liability is an entity’s
obligation to transfer goods or services to a customer for which the entity has received
consideration (or an amount of consideration is due) from the customer.
Therefore, if progress billings exceed the gross amount of construction work in progress (the
contract asset), the net amount should be shown as a liability; otherwise it is disclosed as an
asset. Conversely, if the reporting entity transfers control of an asset to a customer before the
customer pays, then an asset shall be recognised which might be either a ‘contract asset’ or a
receivable.
15.22 Pursuant to AASB 15, a performance obligation would be considered to have been satisfied
‘over time’ when at least one of the following criteria is met:
 the customer receives and controls the benefits of the entity’s performance as the entity
performs (examples include routine or recurring services—such as a cleaning
service—in which the receipt and simultaneous consumption by the customer of the
benefits of the entity’s performance can be readily identified);
 the entity’s performance creates or enhances a customer-controlled asset (for example,
a work-in-progress asset, such as a building being constructed that is under the control
of the customer);
 an asset with no alternative use to the entity is being created and the entity has a right
to payment for performance completed to date.
AASB 15 requires than an entity shall measure progress towards satisfaction of a performance
obligation that is satisfied over time by using a method that best depicts the transfer of goods
or services to the customer. Methods for recognising revenue when control of the asset
transfers over time include:
 output measures that recognise revenue on the basis of direct measurement of the value
to the customer of the entity’s performance to date (for example, by surveys of goods
and services transferred to date, or by appraisals of results achieved);
 input measures that recognise revenue on the basis of the entity’s efforts or inputs to
the satisfaction of a performance obligation (for example, perhaps measured by the
proportion that contract costs incurred for work performed to date bear to the estimated
total contract costs).
When using the cost basis (an input measure) for a construction contract, the extent of contract
completion is measured by comparing costs incurred to date with the most recent estimate of
the total costs to complete the contract. Care must be taken in recognising when costs are
incurred and which costs are attributable to a specific project. When the extent of contract
completion is measured using the cost basis, adjustments have to be made to include only
those costs that reflect work performed. When the stage of completion is determined by
reference to the contract costs incurred to date, only those contract costs that reflect work
performed are included in costs incurred to date.
The costs incurred on construction contracts can be divided into:
i.
costs related directly to a specific contract such as direct materials, direct labour,
depreciation of plant and equipment used on a contract, costs of moving plant and
equipment to and from a site, expected warranty costs, costs of design and technical
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ii.
iii.
assistance that are directly related to the contract, costs of securing a contract, and
costs of hiring plant and equipment used in the construction activity;
costs that are attributable to contract activity in general and are capable of being
allocated on a reasonable basis to specific contracts such as tender preparation,
insurance, design and technical assistance, and project overheads;
costs that relate to the activities of the reporting entity generally, or that relate to
contract activity generally and are not normally related to specific contracts such as
general administrative and selling costs, finance costs, research and development costs
that are not directly related to the contract, and depreciation of idle plant and
equipment that is not used in the contract concerned.
Costs of the type described in (i) and (ii) above are normally included as part of accumulated
contract costs, whereas costs of type (iii) are usually excluded from accumulated contract
costs—and treated as costs of the period—because they do not relate to reaching the present
stage of completion of a specific contract. Further, any costs that are considered to be ‘wasted’
would also be excluded from being recognised as part of the contract costs carried forward.
Under the cost method, which is an example of an input measure of performance, the extent
of completion of a contract is measured by comparing costs incurred to date—which satisfy
the criteria for recognition—with the most recent estimate of the total costs to complete the
contract as shown in the following formula:
Percentage complete = costs incurred to the end of current period divided by the most recent
estimate of total cost.
15.23 Entities may enter into transactions whereby non-monetary assets are ‘sold’ and
simultaneously leased back to the vendor, frequently by way of a long-run, non-cancellable
lease. The substance of these sale and leaseback transactions is that, although legal ownership
of the leased property has been transferred to the purchaser/lessor, the vendor/lessee would
normally retain control of the future economic benefits embodied in the leased property by
virtue of the lease agreement. Because control of the asset has not been transferred, it would
be inappropriate to recognise revenue. The vendor/lessee has, in effect, entered into a
financing arrangement whereby the leased property has been used as collateral for a loan.
Payments made by the vendor/lessee under the lease will ensure that the purchaser/lessor
recoups the investment in the lease and receives an appropriate return on the investment. The
transaction does not constitute a sale and does not give rise to revenue, since the inflow of
economic benefits in the form of the proceeds from disposal has resulted from an equivalent
increase in liabilities (a lease payable), with the result that there has been no increase in equity.
Consistent with this, any gain on a sale and leaseback transaction, where the lease is deemed
to be a financial lease, should be amortised to the statement of comprehensive income over
the term of the lease rather than recognising the profit at the point of sale. Hence, given the
requirements identified above, Noosa Ltd would not record a profit of $300 000 in the year of
sale, but rather, would recognise an amount ($300 000 ÷ life of the lease) each year for the
duration of the lease.
Challenging questions
15.24 Some reasons for the lengthy time period associated with the development of this accounting
standard can be tied back to its perceived importance. Because of the importance of the
issues covered in the Exposure Draft on revenue recognition, and the fact that it would have
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widespread implications for most reporting entities, there were many (approximately 1000)
written submissions. With so many views, many of which would be competing, there is
obviously a need to take greater time to assimilate the various thoughts.
The recommendations relating to recognition of revenue (based on passing of ‘control’
rather than the previously accepted ‘risks and rewards of ownership’) have major
implications for when revenue would be recognised (in general, it would require revenue
recognition to be delayed), and therefore when receivables (assets) would be recognised.
Because the sums involved could be significant, and because various contractual
arrangements (for example, management bonuses, debt covenants) rely on profit and asset
measurements, there could be various concerns about the impacts on such contracts, both
from an efficiency as well as from an opportunistic perspective.
Whenever there is a major change in required accounting treatments the experience
generally is that the accounting standard will take a long time to develop. At the same time
that the accounting standard on revenue recognition has been developed, an accounting
standard on leases was also being developed. This accounting standard has the prospect of
creating major changes (by requiring many more leases to be included within the statement
of financial position), and consistent with the revenue recognition accounting standard, the
accounting standard on leases took a great deal of time to be developed.
15.25 The choice of accounting method should be dictated by considerations of what method is
appropriate in given circumstances and not by what method will provide management with
their preferred results. That is, a reporting entity should adopt accounting methods on an
objective basis. With that said, if a firm is currently being scrutinised because of its high
accounting profits (perhaps by employee unions attempting to secure increased wages for their
members), then researchers adopting the central tenets of Positive Accounting Theory (for
example, that all individual action is driven by self-interest and not issues such as objectivity,
fairness, etc.) would argue that the firm may prefer to adopt a method which defers income
recognition to future periods. This could be accomplished by demonstrating that the
organisation cannot reliably measure the stage of completion on a particular project, or that
control of the asset has not effectively been passed to the customer, and consistent with AASB
15, the firm will then only recognise revenue to an amount equal to the costs incurred. That
is, no net profit would be recognised until the project is complete.
15.26 (a) Assuming stage of completion can be reliably determined.
2023
$10 000 000
2024
$10 000 000
2025
$10 000 000
2 500 000
6 500 000
8 000 000
Estimated costs to complete
5 500 000
1 500 000
_________
Estimated total cost
8 000 000
8 000 000
8 000 000
Estimated total gross profit
$ 2 000 000
$ 2 000 000
$2 000 000
31.25%
81.25%
100%
Contract price
less Estimated cost
Costs to date
Per cent complete
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Gross profit recognised pursuant to the percentage-of-completion method (assuming
that the stage of completion can be reliably estimated).
2023
$2 000 000 × 31.25%
$625 000
2024
$2 000 000 × 81.25%
$ 1 625 000
Less gross profit already recognised
Gross profit in 2024
$2 000 000 × 100%
2025
625 000
$ 1 000 000
$ 2 000 000
Less gross profit already recognised
1 625 000
Gross profit in 2025
$ 375 000
Journal entries
2023
(i)
(ii)
(iii)
(iv)
2024
2025
4.0
1.5
To record costs incurred:
Dr
Construction in progress (contract asset) 2.5
Cr
Cash, accounts payable, accum. deprec.
2.5
4.0
1.5
To record billings to customers:
Dr
Accounts receivable
Cr
Construction in progress (contract asset)
2.0
5.0
2.0
3.0
5.0
3.0
To record cash collections:
Dr
Cash
Cr
Accounts receivable
2.0
5.0
2.0
3.0
5.0
3.0
To record periodic income recognised:
Dr
Construction in progress (contract asset) 0.625
1.0
0.375
Dr
Construction expenses
4.0
1.500
Cr
Revenue from long-term contracts
2.500
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15–12
3.125
5.0
1.875
(b)
Stage of completion cannot be reliably determined. In this case, contract costs must be
recognised as an expense in the financial year in which they are incurred and, where
it is probable that the costs will be recovered, revenue must be recognised only to the
extent of costs incurred.
2023
2024
2025
(i)
To record costs incurred:
Dr Construction in progress (contract
2.5
4.0
1.5
asset)
Cr
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
Cash, accounts payable, etc.
2.5
4.0
1.5
To record billings to customers:
Dr
Accounts receivable
Cr
Construction in progress (contract
asset)
2.0
5.0
2.0
3.0
5.0
3.0
To record cash collections:
Dr
Cash
Cr
Accounts receivable
2.0
5.0
2.0
3.0
5.0
3.0
To record periodic expenses and revenues:
Dr
Construction expenses
Cr
Revenue from long-term contracts
2.5
4.0
2.5
1.5
4.0
1.5
Because the 'contract asset' has a credit balance
a contract liability needs to be recognised:
Dr
Construction in progress (contract asset)
Cr
Contract liability
0.5
0.5
Reversal of adjusting entry in 2024:
Dr
Contract liability
Cr
Contract in progress (contract asset)
0.5
0.5
To record the profit on the project:
Dr
Construction in progress (contract
asset)
Cr
Revenue from long-term contracts
—
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15–13
—
—
2.0
—
2.0
15.27 (a)
Assuming stage of completion can be reliably determined
2023
$10 000 000
2024
$ 10 000 000
2025
$10 000 000
Costs to date
2 500 000
8 000 000
11 000 000
Estimated costs to complete
5 500 000
3 000 000
__________
Estimated total cost
8 000 000
11 000 000
11 000 000
$ 2 000 000
$(1 000 000)
$(1 000 000)
31.25%
72.73%
100%
Contract price
less Estimated cost
Estimated total gross profit/(loss)
Per cent complete
Gross profit recognised in:
2023
$2 000 000 × 31.25%
2024
$625 000
Expected loss
$ (1 000 000)
less Profit already recognised
2025
625 000
Loss recognised in 2024
$ (1 625 000)
Expected loss
$(1 000 000)
less Profit (loss) already recognised
(1 000 000)
Profit/loss recognised in 2025
$ nil
Journal entries: POC method
(i)
(ii)
(iii)
2023
2024
2025
2.5
5.5
3.0
To record costs incurred:
Dr
Construction in progress (contract
asset)
Cr
Cash, accounts payable, etc.
2.5
5.5
3.0
To record billings to customers:
Dr
Accounts receivable
Cr
Construction in progress (contract
asset)
2.0
5.0
2.0
3.0
5.0
3.0
To record cash collections:
Dr
Cash
Cr
Accounts receivable
2.0
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15–14
5.0
2.0
3.0
5.0
3.0
(iv)
To record periodic income recognised:
Dr
Construction in progress (contract
asset)
0.625
—
—
Dr
Construction expenses
2.5
5.5
3.0
Cr
Revenue from long-term contracts
3.125
3.875
3.0
Cr
Construction in progress (contract
asset)
—
1.625
—
Following the above journal entries, the total expenses recognised on the contract will be $11
million, and the total revenues $10 million, giving a total loss on the contract of $1 million.
These numbers are reconciled as follows:
Construction
expenses
Construction
revenues
2023
2.5
3.125
2024
5.5
3.875
2025
3.0
3.0
11.0
10.0
(b)
(i)
(ii)
(iii)
(iv)
Assuming stage of contract completion cannot be reliably determined.
2023
2024
2025
2.5
5.5
3.0
To record costs incurred:
Dr
Construction in progress (contract
asset)
Cr
Cash, accounts payable, etc.
2.5
5.5
3.0
To record billings to customers:
Dr
Accounts receivable
Cr
Construction in progress (contract
asset)
2.0
5.0
2.0
3.0
5.0
3.0
To record cash collections:
Dr
Cash
Cr
Accounts receivable
2.0
5.0
2.0
3.0
5.0
3.0
To recognise revenues and expenses and
foreseeable losses:
Dr
Construction expense
2.5
Cr
Construction revenue
2.5
4.5
3.0
Cr
Construction in progress (contract
asset)
—
1.0
—
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15–15
5.5
3.0
15.28 (a)
2024
2025
2026
$40 000 000
$40 000 000
$40 000 000
Costs to date
10 000 000
26 000 000
32 000 000
Estimated costs to complete
22 000 000
6 000 000
__________
Estimated total cost
32 000 000
32 000 000
32 000 000
$ 8 000 000
$ 8 000 000
$ 8 000 000
31.25%
81.25%
100%
Contract price
less Estimated cost:
Estimated total gross profit/(loss)
Per cent complete
Gross profit recognised in:
2024
$8 000 000 × 31.25%
$2 500 000
2025
$8 000 000 × 81.25%
$6 500 000
less Profit already recognised
2 500 000
Profit recognised in year
4 000 000
$8 000 000 × 100%
$8 000 000
less Profit already recognised
6 500 000
Profit recognised in year
$1 500 000
2026
(b)
Where stage of contract completion cannot be reliably determined.
(i)
(ii)
(iii)
2024
2025
2026
10.0
16.0
6.0
To record costs incurred:
Dr
Construction in progress (contract
asset)
Cr
Cash, accounts payable
10.0
16.0
6.0
To record billings to customers:
Dr
Accounts receivable
Cr
Construction in progress (contract
asset)
8.0
20.0
8.0
20.0
12.0
12.0
To record cash collections:
Dr
Cash
Cr
Accounts receivable
8.0
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15–16
20.0
8.0
20.0
12.0
12.0
(iv)
(v)
(vi)
(c)
To recognise a contract liability as amount
invoiced exceeds the construction in progress:
Dr
Construction in progress (contract
asset)
Cr
Contract liability
2.0
2.0
To reverse the entry made in previous year:
Dr
Contract liability
Cr
Construction in progress (contract
asset)
2.0
2.0
To record periodic income recognised:
Dr
Construction in progress (contract
asset)
—
—
8.0
Dr
Construction expenses
10.0
16.0
6.0
Cr
Revenue from long-term contracts
10.0
16.0
14.0
Journal entries assuming stage of completion can be reliably determined.
(i)
(ii)
(iii)
(iv)
2023
2024
2025
10.0
16.0
6.0
To record costs incurred:
Dr
Construction in progress (contract
asset)
Cr
Cash, accounts payable, etc.
10.0
16.0
6.0
To record billings to customers:
Dr
Accounts receivable
Cr
Construction in progress (contract
asset)
8.0
20.0
8.0
12.0
20.0
12.0
To record cash collections:
Dr
Cash
Cr
Accounts receivable
8.0
20.0
8.0
12.0
20.0
12.0
To record periodic income recognised:
Dr
Construction in progress (contract
asset)
2.5
4.0
1.5
Dr
Construction expenses
10.0
16.0
6.0
Cr
Revenue from long-term contracts
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Copyright © 2020 McGraw-Hill Education (Australia) Pty Ltd
15–17
12.5
20.0
7.5
15.29 (a)
2024
2025
2026
$40 000 000
$40 000 000
$ 40 000 000
Costs to date
10 000 000
31 000 000
46 000 000
Estimated costs to complete
22 000 000
15 000 000 ___________
Estimated total cost
32 000 000
46 000 000
46 000 000
Estimated total gross profit/(loss)
$ 8 000 000
($ 6 000 000)
($ 6 000 000)
31.25%
67.39%
100%
Contract price
less Estimated cost
Per cent complete
Gross profit recognised in:
2024
$8 000 000 × 31.25%
$2 500 000
2025
Expected loss
$(6 500 000)
2026
less Profit already recognised
2 500 000
Loss recognised in year
(8 500 000)
Expected loss
$(6 000 000)
less Loss already recognised [2 500 000 + (8 500 000)]
(6 000 000)
Profit recognised in year
(b)
0
Where stage of contract completion cannot be reliably determined.
(i)
(ii)
2024
2025
2026
10.0
21.0
15.0
To record costs incurred:
Dr
Construction in progress (contract
asset)
Cr
Cash, accounts payable, accum. deprec.
10.0
21.0
15.0
To record billings to customers:
Dr
Accounts receivable
Cr
Construction in progress (contract asset)
8.0
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Copyright © 2020 McGraw-Hill Education (Australia) Pty Ltd
15–18
20.0
8.0
20.0
12.0
12.0
(iii)
(iv)
(v)
(vi)
To record cash collections:
Dr
Cash
Cr
Accounts receivable
8.0
20.0
8.0
12.0
20.0
12.0
To recognise a contract liability as the
construction in progress account has a credit
balance:
Dr
Construction in progress (contract asset)
Cr
Contract liability
3.0
3.0
Reversal of adjustment in previous year:
Dr
Contract liability
Cr
Construction in progress (contract asset)
3.0
3.0
To record periodic income recognised:
Dr
Construction expenses
Cr
Revenue from long-term contracts
Cr
Construction in progress
10.0
21.0
15.0
10.0
15.0
15.0
—
6.0
—
2025
2026
21.0
15.0
(b) Journal entries assuming stage of completion can be reliably determined.
2024
(i)
(ii)
(iii)
(iv)
To record costs incurred:
Dr
Construction in progress (contract asset) 10.0
Cr
Cash, accounts payable, accum. Deprec.
10.0
21.0
15.0
To record billings to customers:
Dr
Accounts receivable
Cr
Construction in progress (contract asset)
8.0
20.0
8.0
12.0
20.0
12.0
To record cash collections:
Dr
Cash
Cr
Accounts receivable
8.0
20.0
8.0
12.0
20.0
To recognise a contract liability as the construction
in progress account has a credit balance:
Dr
Construction in progress (contract asset)
Cr
Contract liability
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Copyright © 2020 McGraw-Hill Education (Australia) Pty Ltd
15–19
3.0
3.0
12.0
(v)
(vii)
To reverse the adjustment made in the previous
year:
Dr
Contract liability
Cr
Construction in progress (contract asset)
3.0
3.0
To record periodic income recognised:
Dr
Construction in progress (contract asset) 2.5
—
—
Dr
Construction expenses
21.0
15.0
Cr
Revenue from long-term contracts
Cr
Construction in progress (contract asset)
10.0
12.5
12.5
15.0
—
8.5
—
15.30 (a) If management was rewarded in terms of accounting profits then it would be reasonable
to assume that the management would prefer to have non-volatile profits such that they
would receive a more uniform series of cash flows. Also, it would be reasonable to assume
that they would prefer that accounting profits not be deferred to future periods, given that
the present value of the future receipts would be lower than those received in earlier years.
With this in mind, management rewarded by profit-based schemes would probably prefer to
adopt the percentage-of-completion method. In adopting this accounting method they would
necessarily need to ensure that the requirements associated with recognising revenue over
time, as noted in AASB 15 (such as the requirement that the customer has control of the
asset; revenue can be reliably measured; and the contract costs to complete the contract and
the stage of completion can be measured reliably), are satisfied.
(b) If a firm is subject to a debt-to-asset constraint, a debt-to-equity constraint or an interest
coverage constraint then we may expect that the management would prefer to adopt an
approach that recognises revenue over time. If we recognise revenue throughout the term of
the contract we take the income to profit or loss and we increase the asset, ‘construction in
progress’ by the amount of profit recognised. This has the effect of loosening the
aforementioned accounting ratios.
15.31 (a)
To provide the journal entries for part (b), we need to determine the interest component
of each $6000 payment. The easiest way to do this is to draw up a table, as shown
below. The interest element is calculated by multiplying the opening receivable for a
period by the rate of interest implicit in the arrangement.
To determine the interest rate, we can divide the fair value of the asset at the date of
sale by the periodic payment.
$19 019  $6000 = 3.1699. Reviewing our present value tables for four years, we find
that this equates to an interest rate of 10 per cent.
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15–20
Date
Cash
payment
Interest
revenue
Principal
reduction
1 July 2023
Outstanding
balance
19 019
30 June 2024
6000
1902
4098
14 921
30 June 2025
6000
1492
4508
10 413
30 June 2026
6000
1041
4959
5454
30 June 2027
6000
545
5455
0
24 000
4981
19 019
Interest revenue equals the outstanding liability at the beginning of the financial
period, multiplied by the interest rate implicit in the agreement, which in this question
is 10 per cent.
The reduction in the principal is calculated by subtracting the interest revenue from
the cash payment.
(b)
Journal entries using the net-interest method:
Journal entry to record the initial sale on 1 July 2023
Dr
Note receivable
Cr
Sales
19 019
19 019
(to recognise the sale of a caravan)
Journal entry to record the receipt of $6000 on 30 June 2024
Dr
Cash
6000
Cr
Note receivable
4098
Cr
Interest revenue
1902
(to recognise periodic cash receipt pertaining to
note receivable)
Journal entry to record the receipt of $6000 on 30 June 2025
Dr
Cash
6000
Cr
Note receivable
4508
Cr
Interest revenue
1492
(to recognise periodic cash receipt pertaining to
note receivable)
15.32 The general expectation was that because revenue recognition is now dependent upon the
customer having control of the asset under construction (pursuant to AASB 15), this will mean
that for many contracts revenue recognition will need to be delayed until such time as control
has passed to the customer. This will have implications in terms of deferring the recognition
of revenue and therefore profits, and in deferring the recognition of assets.
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15–21
Many debt covenants include restrictions that are directly tied to measures of assets and
liabilities, and measures of profits. For example, an organisation might have borrowed funds
and as part of the borrowing agreed to restrict the total amount of debt it can borrow to a
specified maximum fraction of assets. It might also have agreed that its profits shall cover
total interest expenses by at least a minimum number of times. If revenue recognition is
deferred, this might impact both of these restrictions and at the extreme, might place the
organisation into technical default of its loan agreements. With this in mind, organisations
might need to renegotiate their agreements with lenders in light of the new accounting
requirements.
Managers often receive some form of bonuses tied to some measure of performance.
Accounting profits are often used in such plans—for example, a manager might be offered
1% of reported profits. Deferring revenue recognition will have implications for reported
profits, and therefore for remuneration plans that use some measure of accounting
earnings/profits.
15.33 Upon transfer of control of the products, the entity would not recognise revenue for the three
products that it expects to be returned. Consequently, the entity would recognise:
(a) revenue of $147 500 ($50 × 2950 products expected not to be returned)
(b) a refund liability for $2500 ($50 refund × 50 products expected to be returned)
(c) an asset of $1000 ($20 × 50 products) for its right to recover products from customers
on settling the refund liability.
Hence, the amount recognised in cost of sales for 2950 products is $59 000 ($20 × 2950).
The accounting entries would be:
Dr
Cash
150 000
Cr
Revenue
Cr
Refund liability
147 500
2500
(to recognise the initial sale)
Dr
Cost of goods sold
59000
Dr
Right to recover (an asset)
1000
Cr
Inventory
60 000
(to recognise transfer of inventory to the customer)
Dr
Refund liability
Cr
Cash
Dr
(to recognise the refund provided to the customer
when the goods are ultimately returned)
Inventory
Cr
Right to recover
2500
2500
1000
1000
(to place the returned assets back into inventory)
15.34 Because the artworks have been given irrevocably as a gift, and not as a loan, it becomes an
asset of the National Gallery of Australia. Because there has been an inflow of economic
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15–22
benefits which is not of the nature of a contribution by an owner, the donation is to be treated
as income. In determining the amount to be recorded for the asset, and therefore for the
income, the inflow should be recorded at its fair value. Because it did not go to sale, the
amount will need to be determined by somebody with expertise in valuing such works of art.
A valuation might be obtained from an independent ‘market analyst’.
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