Ahmad Ismail What is IAS 18 Revenue? Measurement of revenue Recognition of revenue Identification of transaction Income definition per framework : Increases economic benefits assets / = liabilities equity ( other than contribution ) Income includes Revenue & Gains Revenue – ordinary activity of business Gains – not ordinary , profit on sale Gross inflow economic benefit (cash, receivables, other assets) During the period Ordinary activity other than increases relating to contributions from equity participants. Chain of 10 bicycle shops sells new and used bicycles and rents bicycles. This year it sold the land and building for one of its shops, which was closed. It has 3 types of revenue: Sale of new bikes, Sale of used bikes, and Rentals. The proceeds from selling the land and building are not revenue (not ‘ordinary’); instead, this is presented net as a gain or loss. Revenue is usually determined by agreement between the entity and the buyer or user of the asset. Revenue is measured at the fair value taking into account the amount of any trade discounts and volume rebates allowed by the entity. Fair value is the amount for which an asset could be exchanged between willing parties in a transaction. Fair value of consideration Delayed payment (deferral, discounting, collection risk) Exchanges/barter transactions Similar items - no revenue Otherwise dissimilar - fair values Agent/principal relationship Amounts collected on behalf of principal are not revenue Revenue = commission 1. The entity has substantially performed what is required in order to earn income 2. The amount of income can be reliably measured 3. The related assets received can readily be converted to cash or claims for cash Revenues are recognized to the extent that it is probable that economic benefits will flow to the entity and the amount of revenue can be measured reliably. Revenues are stated net of discounts, allowances and returns. During production At completion of production Time of sale Over period receivables outstanding At the time cash is collected We sell goods costing 1,500,000 for 2,000,000 due in 2 years interest free. Current cash price would have been 1,652,893. ◦ Financing transaction. Up front revenue is 1,652,893. Profit is 152,893. ◦ PV = (FV) / ((1+int)^periods) ◦ 1,652,893 = (2,000,000) / ((1+int)^2) ◦ Int = 10 (10%) by solving the equation Example, continued: ◦ Interest income year 1 = 1,652,893 x 10% = 165,289, unpaid, bringing receivable up to 1,818,182. ◦ Interest income year 2 = 1,818,182 x 10% = 181,818, bringing receivable up to 2,000,000, which is then repaid 1 Jan 01 Account receivable Revenue 31 Dec 01 Account receivable Interest revenue 31 Dec 02 Account receivable 1,652,893 1,652,893 165,289 165,289 181,818 Interest revenue 31 Dec 02 Cash Account receivable 181,818 2,000,000 2,000,000 IAS 18 specifies revenue recognition criteria for 3 basic revenue generating scenarios: 1) Sale of goods 2) Rendering of services 3) Interest, Royalties and Dividends The recognition criteria are usually applied separately to each transaction. In certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. When the selling price of a product includes amount for subsequent servicing, that amount is deferred and recognized as revenue over the period during which the service is performed. . The recognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole. . 1. 2. 3. 4. 5. Revenue should only be recognized when all of the following conditions are satisfied : transferred the significant risks and rewards of ownership of the goods to the buyer The seller no longer has management involvement or effective control over the goods The amount of revenue can be measured reliably, It is probable that the economic benefits associated with the transaction will flow to the entity The costs incurred in respect of the transaction can be measured reliably Examine the circumstances of the individual transaction. In most cases, the transfer of the risks and rewards of ownership coincides with the transfer of the legal title or the passing of possession to the buyer. Common for most retail sales 1. 2. 3. 4. The outcome of a transaction can be measured reliably when all of the following conditions are met: The amount of revenue can be measured reliably; It is probable that economic benefits associated with the transaction will flow to the entity; The stage of completion of the transaction at the end of the reporting period can be measured reliably; The costs incurred for the transaction and the costs to complete the transaction can be measured reliably. Example: Security firm receives 10,000 to respond to alarms for 2-year period ◦ Service contract stage of completion is even over two years. 10,000 / 24 = 417 revenue recognized per month. Revenue is recognized only when the economic benefits associated with the transaction will flow to the entity. Reliable estimates after it has agreed to the following with the other parties to the transaction: each party’s enforceable rights regarding the service to be provided and received by the parties the consideration to be exchanged the manner and terms of settlement. In most cases, the consideration is in the form of cash or cash equivalents and the amount of revenue is the amount of cash or cash equivalents received or receivable. However, when the inflow of cash or cash equivalents is deferred, the fair value of the consideration may be less than the nominal amount of cash received or receivable. For example, an entity may provide interest-free credit to the buyer or accept a note receivable bearing a below-market interest rate from the buyer as consideration for the sale of goods. Amounts collected on behalf of third parties such as sales taxes, goods and services taxes and value added taxes They are not economic benefits which flow to the entity and do not result in increases in equity. 1. Interest revenue should be recognised on the effective interest’ basis. 2. Dividend when the right to receive payment is established. Often this does not happen in the case of dividends until the shareholder actually receives the dividend. 3. Royalties should be recognised on an accruals basis in accordance with amounts receivable as a result of ‘asset use’ up to the reporting date. Example: We buy zero coupon bond for 100,000, redeemable at 134,010 in 6 years. •PV = (FV) / ((1+int)^periods) 100,000 = (134,010) / ((1+int)^6) → int = 5% Year Interest at 5% x Receivable Bond Receivable Debit Bond, Credit Int. Revenue 100,000 1 5,000 105,000 2 5,250 110,250 3 5,513 115,763 4 5,788 121,551 5 6,078 127,629 6 6,381 134,010 Standard IAS 18 undergoes major revision as a part of the convergence project between IASB (setter of IFRS) and FASB (setter of US GAAP). The new IAS 18 is expected to be applicable from 1 January 2017 or later. So the current IAS 18 in the financial statements will stay in force till 1 January 2017.