Chapter 16
Revenue recognition
issues
.
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Objectives of this lecture
• Understand some of the concepts of income and revenue
• Understand the points of an organisation’s operating cycle at
which income can be recognised
• Appreciate that the amount of income recognised in a particular
period will relate directly to the accounting measurement model
that has been adopted
• Understand how the existence of particular conditions
associated with a sale (such as attached put and call options, or
the right of return) will affect the timing of revenue recognition
• Understand the issues associated with recognising revenues
for long-term construction projects and be aware of the
requirements of AASB 111 Construction Contracts
.
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Definition of income and revenue
Income defined (par. 70 of the AASB Framework) as:
• Increases in economic benefits during the accounting period in
the form of inflows or enhancements of assets or decreases in
liabilities that result in an increase in equity, other than those
relating to contributions from equity participants
• Income is divided into ‘revenues’ and ‘gains’
.
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Definition of income and
revenue (cont.)
Revenues and gains (par. 74 of the AASB Framework)
• Revenue arises in the course of the ordinary activities of an
entity and is referred to by a variety of different names,
including sales, fees, interest, dividends, royalties and rent
Gains (pars 74 and 75, AASB Framework)
• Other items that meet the definition of income and may or may
not arise in the course of the ordinary activities of an entity.
Gains represent increases in economic benefits and as such
are not different in nature from revenue
.
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Definition of income and
revenue (cont.)
Revenues and gains (par. 75, AASB Framework)
• Gains include, for example, those arising on the disposal of
non- current assets. The definition of income also includes
unrealised gains, for example those arising on the revaluation
of marketable securities and those resulting from increases in
the carrying amount of long-term assets. When gains are
recognised in the income statement, they are usually displayed
separately because knowledge of them is useful in making
economic decisions. Gains are often reported net of related
expenses
.
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Definition of income and
revenue (cont.)
• Generally speaking, revenues relate to the ordinary
income-generating activities of an entity, e.g. sales
or rental receipts
• Gains relate to ‘other income’—not necessarily part
of the ordinary activities of an entity
• Differentiation based on some degree of professional
judgment
• What is an ‘ordinary’ activity for one business may
not be ‘ordinary’ for another—so the benefits might
be deemed ‘revenue’ in one entity and a ‘gain’ in
another
.
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Definition of income and
revenue (cont.)
• Differentiation between revenue and gains also
embraced by AASB 118 Revenue (par. 7)
– The gross inflow of economic benefits during the period
arising in the course of the ordinary activities of an entity
when those inflows result in increases in equity, other than
increases relating to contributions from equity participants
.
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Definition of income and
revenue (cont.)
Scope of AASB 118 Revenue is fairly restricted—
applies to accounting for revenue arising from
transactions and events relating to (par. 1):
a) the sale of goods
b) the rendering of services
c) the use by others of entity assets yielding interest,
royalties and dividends
Recognition criteria provided for each of the above
categories of revenue, e.g. sale of goods (par. 14)
.
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Definition of income and
revenue (cont.)
Revenue from the sale of goods is to be recognised
when all of the following conditions have been satisfied:
•
•
•
•
•
.
The entity has transferred to the buyer the significant
risks and rewards of ownership of the goods
The entity retains neither continuing managerial
involvement to the degree usually associated with
ownership nor 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 or to be incurred in respect of the
transaction can be measured reliably
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Definition of income and
revenue (cont.)
Where revenue has been recognised, AASB 118
requires that the revenue be measured at the fair
value of the consideration or contributions received or
receivable (par. 9)
–
–
.
If cash is not to be received for some period of time the
future amount to be received would need to be
discounted to its present value and the present value
recognised as revenue (refer to AASB 118, par. 11)
If cash is received for goods and services provided the
revenue recorded is equal to the cash received
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Income and revenue recognition—current
practice
AASB 118 (Appendix A) provides guidance in relation
to the recognition of different types of revenues. In
relation to the sale of goods, guidance is provided in
relation to:
–
–
–
–
–
–
.
goods sold subject to conditions
lay-by sales
orders when partial payment is received in advance
subscriptions to publications
instalment sales
real estate sales
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Income and revenue recognition—current
practice (cont.)
•
.
The earnings cycle (Coombes and Martin, 1982)
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Income and revenue recognition—current
practice (cont.)
•
.
Traditionally, revenue has been recognised at several
points in the earnings cycle (refer to Figure 16.1
reproduced on previous slide), for example:
(i) at point 5 (progressively throughout production) in the
building industry for long-term construction contracts
(ii) at point 7 (receipt of orders after completing
production) where it is the responsibility of the
purchaser to collect the goods
(iii) at point 8 (delivery of goods to customers)—in most
cases
(iv) at point 9 (receipt of cash) by some professional
practices and for instalment credit sales
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Income and revenue recognition—current
practice (cont.)
• Rarely, if ever, recognised prior to point 5
(progressively throughout production)
- Uncertainty surrounding the ultimate irrevocable and
unconditional claim to cash (or its equivalent) prior to
this point
• In practice, point 9 (receipt of cash) is considered too
conservative to be the general criterion
• At point 8 (delivery of goods to customers) any
uncertainty remaining is accounted for by creating a
‘provision for doubtful debts’
.
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Income and revenue recognition—current
practice (cont.)
• Currently, we have a system of accounting based
predominantly on a historical-cost, transaction-based system
of accounting
• We also make use of other approaches to valuation (e.g.
market values)
– Increases in market values of marketable securities are
recognised as part of income—a departure from
traditional historical accounting but still consistent with
the definition of income provided in the AASB Framework
Note
• Different measurement models of assets and liabilities, e.g.
historical cost vs the modified historical cost system, will
generate different calculations of income and hence profits
.
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Income and revenue recognition—
according to the AASB Framework
Paragraph 83 of the AASB Framework
An item that meets the definition of an element (e.g.
income) should be recognised if:
(a) the item has a cost or value that can be measured
with reliability
(b) it is probable that any future economic benefit
associated with the item will flow to or from the entity
.
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Income and revenue recognition—
according to the AASB Framework (cont.)
Note
• Probable refers to more likely than less likely
• AASB 118 ‘Revenue’ provides recognition criteria
for revenue items
–
–
.
Revenue that relates to sale of goods, rendering of
services, and interest, royalties and dividends
Revenue from sales of goods and services is to be
recognised when the entity has transferred to the buyer
the significant risks and rewards of ownership of the
goods (refer to pars 16 and 17 of AASB 118 for
additional guidance)
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Income and revenue recognition—at
completion of production
• At times, revenue may be recognised at the
completion of production, even when no sale has
been made
• Examples of such cases include the production of
precious metals or agricultural products
.
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Income and revenue recognition—at the
time of sale
• The two conditions (probable economic benefits
and reliable measurement) for recognising
revenue are usually met by the time the product or
merchandise is delivered, or the services are
rendered to customers
• Normally determined by shipping terms, i.e. time of
sale is commonly interpreted as when title passes
.
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Income and revenue recognition—at the
time of sale (cont.)
• F.O.B. shipping point
– Title passes to the buyer (and revenue is recognised)
when the seller delivers goods to a common carrier who
acts as an agent for the buyer
• F.O.B. destination
– Title does not pass (and revenue is not recognised) until
the buyer receives the goods from the carrier
.
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Income and revenue recognition—at the
time of sale (cont.)
In advance of cash receipt
• When revenue is recognised in advance of receipt of
cash, it is common to recognise a ‘provision for
doubtful debts’
– Determined on basis of past experience and industry
averages
– Journal entry
Dr
Doubtful debts expense
Cr
Provision for doubtful debts
– Provision for doubtful debts is contra account to debtors
.
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Income and revenue recognition—at the
time of sale (cont.)
In advance of cash receipt (cont.)
• If goods are sold or services provided on credit terms,
not all amounts due from debtors will ultimately be
collected
• To ignore this fact would lead to an overstatement of
receivables and assets in the statement of financial
position (balance sheet)
• This is consistent with the general principle provided in
par. 18 of AASB 118
.
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Income and revenue recognition—at
the time of sale (cont.)
In advance of cash receipt (cont.)
Accounting for bad and doubtful debts
• When actual debtor is identified as unlikely to pay when amount
was previously anticipated
Dr
Provision for doubtful debts
Cr Debtors
• When debtor is identified as unlikely to pay and amount was not
previously anticipated
Dr
.
Bad debts expense
Cr Debtors
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Accounting for sales with associated
conditions
• Transactions involving the sale of assets with
conditions attached should be reviewed to assess
whether:
– control of the future economic benefits has passed from
the seller to the purchaser, and
– it is probable that the inflow of economic benefits to the
seller has occurred
.
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Accounting for sales with associated
conditions—call and put options
Call option
• Provides the holder of the option with the right to buy an asset
at a specified exercise price on or before a specified date
• The party that writes the call option agrees to deliver a
particular asset to the call option buyer, if that buyer instructs
the other party to do so
• A call option is considered to have value when the value of the
underlying asset exceeds the option’s exercise price
• If at exercise date the exercise price is above or equal to the
market value of the asset, the option has no value and a sale
could be recorded
• However, if something is sold to another party, but as part of
the sales conditions the seller has a call option that enables
them to buy back the asset at a future date, then to the extent
that the market price is greater than, or likely to be greater than,
the option’s exercise price, no sale should be recorded
.
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Accounting for sales with associated
conditions—call and put options (cont.)
Put option
• Operates in reverse manner to a call option
• Holder has the right to sell an asset at a specified exercise price
on or before a specified date
• The writer or the seller of the put option agrees to buy the asset
at a future date for the exercise price if the put option holder
(buyer) so requests
• The holder of the put option would typically exercise the option
(require the other party to buy the asset) only if the exercise
price is above the market price
• Guarantees holders a minimum price for their assets
• If an asset is sold to another party, and the buyer has a put
option that enables that party to sell the asset back to the
original seller, then a sale should not be recognised if the
exercise price is, or is likely to be, above the market price
.
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Accounting for sales with associated
conditions—call and put options (cont.)
• Where a transaction involves concurrent use of a
financial instrument, it is necessary to evaluate the
conditions attaching to the transaction to establish
whether, in substance, the transaction is a financial
arrangement rather than a sale
• Probability of the exercise of an option must be
considered in recognising revenue
.
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Accounting for sales with associated
conditions—revenue recognition when right
of return exists
• Alternative treatments available when the seller is
exposed to continued risks of ownership through
return of the product
– Not recording the sale until all return privileges have
expired
– Recording the sale but reducing sales by an estimate of
future returns
– Recording the sale and accounting for the returns as they
occur
.
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Accounting for sales with associated
conditions—revenue recognition when right
of return exists (cont.)
• If a company sells its product but gives the buyer the right
to return the product, revenue from the sales transaction
may be recognised at the time of sale if all of the following
conditions have been met:
– The seller’s price to the buyer is substantially fixed or
determinable at the date of sale
– The buyer has paid the seller, or the buyer is obligated
to pay the seller and the obligation is not contingent on
the resale of the product
– The buyer’s obligation to the seller would not be
changed in the event of theft or physical destruction or
damage of the product
.
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Accounting for sales with associated
conditions—revenue recognition when right of
return exists (cont.)
• If a company sells its product but gives the buyer the right to
return the product, revenue from the sales transaction may
be recognised at the time of sale if all of the following
conditions have been met (cont.):
– The buyer acquiring the product for resale has economic
substance apart from that provided by the seller
– The seller does not have significant obligations for future
performance to directly bring about the resale of the
product by the buyer
– The amount of future returns can be reasonably
estimated
.
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Accounting for sales with associated
conditions—sale and leaseback
• Although ownership of the leased property has been
transferred to the purchaser/lessor, the
vendor/lessee normally retains control
• The vendor/lessee has in effect entered into a
financing arrangement—leased property used as
collateral for a loan
• Transaction does not constitute a sale and does not
give rise to revenue
– Inflow of economic benefits (proceeds from disposal) have
resulted in an equivalent liability (lease payable)
– Result is no increase in equity
.
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Interest and dividends—interest revenue
• Interest revenue is recognised over time as the borrower
has the benefit of the borrowings and the lender
establishes claims for interest earned
• Prepayment of interest is not regarded as revenue to
lender as lender has present obligation to provide finance
for the period to which the prepayment relates
• Interest revenue might be implicit in the terms of a
transaction
– For example, where goods are sold on extended credit,
vendor is effectively financing the purchaser
– Transaction gives rise to two forms of revenue:
1.Sales revenue—present value of future payments
2.Interest revenue from financing activities
.
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Interest and dividends—interest
revenue (cont.)
• To estimate the present value of the proceeds, an
applicable interest rate inherent in the agreement must be
determined
• AASB 118 (par. 11)
– When the arrangement effectively constitutes a financing
transaction, the fair value of the consideration is
determined by discounting all future receipts using an
imputed rate of interest. The imputed rate of interest is
the more clearly determinable of either:
(a) the prevailing rate for a similar instrument of an
issuer with a similar credit rating, or
(b) a rate of interest that discounts the nominal amount
of the instrument to the current cash sales price of the
goods or services
.
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Interest and dividends—interest
revenue (cont.)
• The difference between the fair value and the nominal amount
of the consideration is recognised as interest revenue
• Rate used for valuation purposes will normally be at least
equal to the rate at which the debtor can obtain financing of a
similar nature from other sources at the date of the transaction
• Objective is to approximate the rate that would have resulted if
an independent borrower and an independent lender had
negotiated a similar transaction on comparable terms and
conditions
Refer to Worked Example 16.1 on p. 516—Recognition of
interest inherent in a sales transaction
.
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Worked Example 16.1—Recognition of interest inherent in a
sales transaction
• On 1 July 2011, Cassie Ltd sells a computer to Ted Ltd
• The computer cost Cassie Ltd $9000
• Rather than selling the item for a cash price or a short-term
claim for cash of $12 009, Cassie Ltd accepts a promissory
note that requires Ted Ltd to make three annual payments of
$5000 each, the first one to be made on 30 June 2012
• The difference between the gross receipts and the current sales
price represents interest revenue to be earned by Cassie Ltd
over the period of the note
• The rate implicit in the arrangement is 12%
REQUIRED
• Provide the journal entries for Cassie Ltd for the years ended
30 June 2012, 2013 and 2014
.
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Worked Example 16.1—Solution
Date
1 July 2011
30 June 2012
30 June 2013
30 June 2014
Cash
payment
Opening
liability
5 000
5 000
5 000
15 000
12 009
8 450
4 464
Interest
revenue
at 12%
Principal
reduction
1 441
1 014
536
2 991
3 559
3 986
4 464
12 009
Outstanding
balance
12 009
8 450
4 464
0
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 example is 12%. This approach is often
referred to as the effective-interest method
The reduction in the principal is calculated by subtracting the
interest revenue from the cash payment
.
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Worked Example 16.1—Solution (cont.)
1 July 2011
Dr Note receivable
Cr Sales
Dr Cost of sales
Cr Inventory
30 June 2012
Dr Cash
Cr Note receivable
Cr Interest revenue
30 June 2013
Dr Cash
Cr Note receivable
Cr Interest revenue
30 June 2014
Dr Cash
Cr Note receivable
Cr Interest revenue
.
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12 009
12 009
9 000
9 000
5 000
3 559
1 441
5 000
3 986
1 014
5 000
4 464
536
16-37
Interest and dividends—dividend revenue
• Dividends do not accrue over time but usually result from a
decision of the board of directors
• Dividend revenue should be recorded once it is considered
probable that inflow of future economic benefits has occurred
and when these benefits can be measured reliably
• If a dividend needs final approval, perhaps at a meeting of
shareholders, then the dividend revenue should not be
recognised until such time as the dividend has been approved
(or ratified). As paragraph 30(c) of AASB 118 states:
dividends shall be recognised when the shareholder’s right
to receive payment is established
.
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Unearned revenue
• Recorded when payment is received in advance of
services or resources being provided
• The receipts have not been earned
• Considered to be liabilities
– under present obligation to transfer future economic benefits
at a future date
Refer to Worked Example 16.2 on p. 520—Revenue
received in advance
.
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Accounting for
construction contracts
• Accounting issues result from some construction
projects taking a number of financial periods to
complete
– Should revenue be recognised progressively throughout
the contract?
– If so, how would the amount of revenue be determined?
• Deferral of revenue recognition until completion of
project would result in greater volatility of reported
revenues and of related profits or losses
.
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Accounting for
construction contracts (cont.)
• Governed by AASB 111 Construction Contracts
• Applies to the accounting methods adopted by a
contractor for all construction contracts
• Construction contract defined (AASB 111, par. 3)
– a contract specifically negotiated for the construction of
an asset or a combination of assets that are closely
interrelated or interdependent in terms of their design,
technology and function of their ultimate purpose or use
• Refer also to AASB 111 (par. 4)
.
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Accounting for
construction contracts (cont.)
Accounting requirements
• Individual construction contracts must be accounted for
separately and the requirements of the standard must be
applied separately to each contract
• AASB 111 (par. 9)
– A group of contracts, whether with a single customer or
with several customers, is to be treated as a single
contract when:
(a) the group of contracts is negotiated as a single
package
(b) the contracts are so closely interrelated that they
are, in effect, part of a single project with an overall
profit margin, and
(c) the contracts are performed concurrently or in a
continuous sequence
.
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Accounting for
construction contracts (cont.)
Accounting requirements (cont.)
• AASB 111 requires (if certain criteria are satisfied)
that contractors use the percentage-of-completion
method to account for construction contracts
– Profit on construction contract is recognised in proportion
to the work performed in each reporting period in which
construction occurs
.
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Accounting for
construction contracts (cont.)
• Construction costs plus gross profit earned to date
accumulated in inventory account (construction in
progress)
• Progress billings accumulated in contra inventory
account (billings on construction in progress
account)
.
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Accounting for
construction contracts (cont.)
• Percentage-of-completion method should be used
provided that certain conditions are met that
enable the outcome of the contract to be reliably
estimated
AASB 111 (par. 22)
• When the outcome of a construction contract can
be estimated reliably, contract revenue and
contract costs associated with the construction
contract are to be recognised as revenue and
expenses, respectively, by reference to the stage
of completion of the contract activity at the
reporting date
.
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Accounting for
construction contracts (cont.)
• Types of construction contracts
– Fixed-price contracts
– Cost-plus contracts
• Type of contract determines the conditions that must
be satisfied to use the percentage-of-completion
method
• Defined in par. 3 of AASB 111
.
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Accounting for
construction contracts (cont.)
Conditions of use of percentage-of-completion method
(AASB 111, par. 23)
• With fixed-price contract
– Total contract revenue can be measured reliably
– It is probable that economic benefits arising from the
contract will flow to the contractor
– Both the contract costs to complete the contract and stage of
contract completion as at reporting date can be measured
reliably
– The contract costs attributable to the contract can be clearly
identified and measured reliably so that actual costs can be
compared with prior estimates
.
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Accounting for
construction contracts (cont.)
Conditions of use of percentage-of-completion
method (AASB 111, par. 24)
• With cost-plus contract:
– it is probable that the economic benefits arising from the
contract will flow to the contractor; and
– the contract costs attributable to the contract, whether or
not specifically reimbursable, can be clearly identified
and measured reliably
.
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Accounting for
construction contracts (cont.)
•
If conditions are not satisfied:
- no profit is to be brought to account until they are satisfied
- at the extreme, no profit to be recognised until project
completion
Note
• When outcome of construction contract cannot
be estimated reliably (AASB 111, par. 32):
(a) revenue is to be recognised only to the extent of
contract costs incurred that it is probable will be
recoverable, and
(b) contract costs are to be recognised as an expense
in the period in which they are incurred
.
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Accounting for
construction contracts (cont.)
Measuring progress towards completion
•
•
.
Percentage of completion can be measured in a number of
ways (per AASB 111, par. 30)
– The entity uses the method that measures reliably the
work performed. Depending on the nature of the
contract, the methods may include:
(a) the proportion that contract costs incurred for work
performed to date bear to the estimated total
contract costs
(b) surveys of work performed, or
(c) completion of physical proportion of the contract
work
Progress payments and advances received from customers
often do not reflect the work performed
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Accounting for
construction contracts (cont.)
Measuring progress towards completion (cont.)
Cost basis
•
The percentage of completion is measured by comparing
costs incurred to date with the most recent estimate of the
total costs to complete the contract
•
Only those contract costs that reflect the work performed are
included in costs incurred to date. Examples of contract
costs excluded are:
– contract costs that relate to future activity on the contract,
such as costs of materials delivered or set aside but as
yet not installed, used or applied
– payments made to subcontractors in advance of work
performed
.
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Accounting for construction
contracts (cont.)
Types of costs incurred by contractors
.
a)
Costs related directly to a specific contract, e.g. direct
materials, direct labour, depreciation of equipment,
costs of moving plant and equipment, expected
warranty costs, costs of design and technical assistance
directly related to contract, costs of securing contract,
costs of hiring plant and equipment
b)
Costs that are attributable to contract activity in general
and capable of being allocated on a reasonable basis to
specific contracts, e.g. tender preparation, insurance,
design and technical assistance
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Accounting for
construction contracts (cont.)
Types of costs incurred by contractors (cont.)
c)
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, e.g. general
administration and selling costs, finance costs and
research and development costs not directly related to
contract
Note
•
•
.
Costs a) and b) are normally included in accumulated
contract costs
Costs c) are usually excluded from accumulated contract
costs because they do not relate to reaching the present
stage of completion of a specific contract
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Accounting for
construction contracts (cont.)
•
Calculation of percentage of completion (cost
method)
Costs incurred to the end of the current period
Most recent estimate of total costs
•
Current period revenue or gross profit
–
.
Estimated total revenue or gross profit from
the contract multiplied by percentage
complete less total revenue or gross profit
recognised in prior periods
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Accounting for
construction contracts (cont.)
Journal entries for construction contract accounting
To record costs of construction
Dr
Cr
Construction in process
Materials, cash, payables, etc.
To record billings to customers
Dr
Cr
Accounts receivable
Billings on construction in process
To record collections of billings
Dr
Cr
.
Cash
Accounts receivable
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Accounting for
construction contracts (cont.)
Journal entries for construction contract accounting
(cont.)
To record contract revenue and contract expenses
Dr
Dr
Cr
Construction in process
Construction expenses (costs incurred)
Revenue from long-term contracts
To record final approval of contract
Dr
Cr
.
Billings on construction in process
Construction in process
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Accounting for
construction contracts (cont.)
Disclosure requirements
• AASB 111 requires that the statement of financial
position or accompanying notes disclose:
– the gross amount of work in progress (or contract costs
incurred)
– the related aggregate billings deducted from the work in
progress
.
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Accounting for
construction contracts (cont.)
Disclosure requirements (cont.)
• Work in progress will include the profit recognised throughout
the contract
• If progress billings exceed the gross amount of construction
work in progress, the net amount should be shown as a
liability or otherwise disclosed as an asset
• Disclosure requirements are outlined in AASB 111 (pars 39–
42)
• Appendix to AASB 111 provides an example of a disclosure
that might appear in an entity’s financial report
.
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Accounting for
construction contracts (cont.)
Application of percentage-of-completion method to
account for construction contracts
– Refer to Worked Example 16.3 on p. 526—Percentage-ofcompletion method
– Refer to Worked Example 16.4 on p. 527—Construction
contract where outcome cannot be reliably estimated
.
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Accounting for
construction contracts (cont.)
Accounting for long-term contract losses
When current estimates of total contract costs and revenues for
any contract indicate that a loss is probable:
– provision should be made for any foreseeable loss on the
contract regardless of the amount of work already
performed
– the loss is to be brought to account as soon as it is
foreseeable
AASB 111 (par. 36)
When it is probable that total contract costs will exceed total
contract revenue, the expected loss shall be recognised as
an expense immediately
.
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Accounting for
construction costs (cont.)
AASB 111 (par. 37)
Expected loss (excess of total contract costs over total
contract revenue) arising from a construction contract is
recognised as an expense irrespective of:
– whether work has commenced on the project
– the stage of completion of the activity, or
– the difference between total contract costs and total contract
revenue expected to arise from other construction contracts
Refer to Worked Example 16.5 on page 528—
Percentage of completion with recognition of a loss
.
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Illustration—Accounting for a construction
contract
XYZ signed a contract on 1 January 2011, agreeing to build a warehouse
for ABC at a contract price of $20 000 000. XYZ estimated that
construction costs would be as follows:
2011 $5 000 000
2012 $8 000 000
2013 $3 000 000
$16 000 000
The contact provided that ABC would make payments on 31 December
of each year as follows:
2011 $ 4 000 000
2012 $10 000 000
2013 $ 6 000 000
$20 000 000
The contract was completed and accepted on 31 December 2013.
Assume that actual costs and cash collections coincided with
expectations
.
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Illustration—Solution
(a) INCOME RECOGNISED EACH YEAR
YEAR
P.O.C.
2011
$1.25
2012
$2.00
2013
$0.75
$4.00
P.O.C.
Revenue
(5/16)x20
(13/16)x20-6.25
(16/16)x20-16.25
Expense
5/16 x 16
13/16 x 16 - 5
16/16 x 16 - 13
2011
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2013
6.25
10.0
3.75
(5)
(8.0)
(3.0)
1.25
.
2012
2.00
0.75
16-63
Illustration—Solution (cont.)
(b)
Journal entries POC method
2011 2012 2013
(i) To record costs incurred
Dr. Construction in process
5
8
3
Cr. Cash, accounts payable
5
8
3
(ii)To record billings to customers
Dr. Accounts receivable
4
Cr. Billings on contracts
4
in process
.
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10
10
6
6
16-64
Illustration—Solution (cont.)
(iii)To record cash collections
Dr. Cash
Cr. Accounts receivable
2011
4
4
2012 2013
10
6
10
6
(iv) To record periodic income recognised
Dr. Construction in process
1.25
2
0.75
Dr. Construction expenses
5.00
8.00 3.00
Cr. Revenue from LT contract
6.25
10
3.75
(or could separately show the revenue and expense)
(v) To record final approval and acceptance
Dr. Billings on contracts in process Cr. Construction in process
-
.
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-
20
20
16-65
Summary
• In this lecture the recognition of income and
revenue has been considered
• AASB Framework for the Preparation and
Presentation of Financial Statements requires that
for income to be recognised the associated inflow
of economic benefits or associated reduction in
liabilities must be both probable and measurable
with reasonable accuracy
• AASB 118 Revenue provides a number of
additional recognition criteria, e.g. for revenue to
be recognised, the risks and rewards of ownership
of the asset (for the sale of the goods) must be
transferred to the purchaser
.
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Summary (cont.)
• Sales transactions are often made with associated
conditions (e.g. call and put options or a right to
return the assets)
– It is necessary to consider whether they reduce the
probability that the inflow of resources will ultimately
occur
– If it appears that an option that will reduce the inflow of
resources will probably be exercised or that the right of
return will be exercised, the revenue should not be
recognised by the reporting entity until such time as the
requisite degree of certainty is attained that the inflow
of economic benefits will occur
– Determining whether revenue should be recognised
will also depend on the system of accounting being
used, i.e. measurement model being adopted
.
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Summary (cont.)
• Under historical-cost accounting the increase in the value
of marketable securities would not be considered as
revenue until such time as the securities are sold
• If a market values-based system is used increased
market prices of assets could be treated as part of the
period’s income
• Revenue and expenses related to a construction contract
are to be recognised by applying the percentage-ofcompletion method if the outcome and stage of
completion of the construction contract can be reliably
estimated
• Where percentage-of-completion method is applied,
revenue is brought to account with a corresponding
increase in construction in progress on the basis of
percentage of completion
.
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Summary (cont.)
• Percentage of completion is measured typically by
comparing costs incurred to date with the most recent
estimate of the total costs to complete the contract
• Revenue will be recognised throughout the life of the
contract, but if the percentage-of-completion method is
used and it becomes apparent that a loss will be made,
the entire loss must be recognised as soon as it is
foreseeable
• For disclosure purposes, billings on construction in
progress account is shown in the statement of financial
position (balance sheet) as a deduction from construction
in progress account—if billings account balance exceeds
construction in progress account the net amount
represents a liability
.
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