4. revenue recognition
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Slide 1
Revenue Recognition
Slide 2
Revenue recognition landscape
Construction contracts
Multiple elements
1
2
34
5
6
IAS 18
IAS 11
IAS 18, 28, 39
IAS 18,39
IAS 18
IAS 18SIC 31
Revenue Recognition
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Slide 3
Definition and scope exclusion
Definition:
• Revenue is 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.
• Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.
Revenue Recognition
Scope exclusion:Does not apply to:• Lease agreements;• Dividends from investments accounted for
under the equity method (IAS 28 Investments in Associates);
• Insurance contracts within the scope of IFRS 4: Insurance Contracts;
• Changes in the fair value of financial assets and financial liabilities or their disposal (IAS 39 Financial Instruments: Recognition and Measurement);
• Changes in the value of other current assets;• Initial recognition and from changes in the fair
value of biological assets related to agricultural activity (IAS 41: Agriculture);
• The extraction of mineral ores
Slide 4
Timing of Recognition Sale of goods
SALE OF GOODS:
Revenue recognition criteria common under IFRS and Indian GAAP
1. Risks/rewards transfer
2. Probable inflow of benefits
3. Revenue measurable reliably
Additional revenue recognition criteria under IFRS
4. Costs measurable reliably
5. No continuing managerial involvement
Construction contracts
Probable benefits inflow
Measurable costs incurredMeasurable coststo complete
Multiple elements
1
2
34
5
6
Revenue Recognition
Slide 5
Timing of Recognition
No Continuing Managerial involvementIndicators of continuing managerial involvement or retention of effective control might include:
• Control over future price of the item.
• Responsible for the management of the goods subsequent to the sale.
• Transaction allows the buyer to compel the seller, or give an option to the seller, to repurchase the item.
• Guarantees the return of the buyer’s investment or a return on that investment for a limited or extended period.
Continuing Managerial
Involvement Exists!
No Sale!
No Revenue!
Revenue Recognition
Slide 6Slide 6
Handout 1
Continuing Managerial involvement
Continuing Managerial involvement
Revenue Recognition
Slide 7
Revenue recognition – Quick quiz
Revenue Recognition
Scenarios Revenue Recognition
1 Entity which does not retains an obligation for unsatisfactory performance not covered by normal warranty provisions can recognise the revenue immediately
2 When the receipt of the revenue from a particular sale is contingent on the derivation of revenue by the buyer from its sale of the goods, the seller can not recognised the revenue immediately.
3 Revenue can not be recognised when, the goods are shipped subject to installation and the installation is a significant part of the contract which has not yet been completed by the entity.
4 Revenue should not be recognised when the buyer has right to rescind the purchase for a reason specified in the sales contract and the entity is uncertain about the probability of return.
5 If an entity retains only an insignificant risk of ownership, the transaction is a sale and revenue is recognised.
6 Seller can recognise the revenue where transaction allows the buyer to compel the seller, or give an option to the seller, to repurchase the item.
7 If seller guarantees the return of the buyer’s investment or a return on that investment for a limited or extended period, revenue can not be recognised immediately.
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P
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Slide 8
Timing of Recognition – Sales on FOB/CIF terms
Revenue Recognition
Sold on FOB basis
No further performance obligations
Recognition on dispatch
is likely to be acceptable
Sold on CIF basis
Evaluate the exact terms
of arrangement
Recognise when risk of
loss is transferred
to buyer
Slide 9
Gross v/s Net reporting – Certain Items
Revenue Recognition
Particulars Reporting
Sales taxes Net off Sales
Excise Duty Gross / Net allowed (policy choice)
Rebates Reduced from Sales
Cash discounts Net
Product return Reduced from sales
Warranties Expensed off separately
Shipping and handling charges– Reimbursement– Otherwise
NetGross
Slide 10
Measurement of revenue
* The discount rate is the more clearly determinable of the following:• the prevailing rate for a similar instrument of an issuer with a similar credit rating; or
• a rate of interest that discounts the nominal amount of the instrument to the current cash sales price of the goods or services.
The difference between the fair value and the nominal amount of the consideration is recognised as interest revenue (as per IAS 39)
Revenue Recognition
Consideration is deferred
Revenue = Both a sale and financing transaction.
Discounted fair value of consideration*
Slide 11
Agency Arrangements
Revenue Recognition
Principal or Agent ?• expectation by the customer that the entity is acting as
the primary obligor in the arrangement.
• freedom to set the selling price with the customer.
• assumes inventory risk
• performs part of the services provided or modifies the goods supplied.
• assumes the credit risk
• discretion in selecting suppliers
Principal!
Gross Reporting!
If these conditions not satisfied – NET REPORTING !
Slide 12
Warranties Initial warranty
• Recognise the full consideration if warranty– not a separate element and – represents an insignificant part of the
transaction, the seller has completed substantially all the required performance
• Expected future cost relating to the warranty – not a reduction of revenue– but a cost of sale,
• Costs of warranties determined at the time of the sale - make a provision for warranty costs
• Costs cannot be measured reliably -recognise revenue when the warranty period expires; or cost can be measured reliably
Revenue Recognition
Extended warranty• The revenue from the sale of the extended
warranty should be deferred and recognised over the period covered by the warranty,
• No costs should be accrued at the inception of the extended warranty agreement
Rendering of services
Slide 14
Timing of recognition Services
Sale of goods
Probable benefits inflow
Measurable costs incurredMeasurable coststo complete
Interest
2
3
45
6
1
Revenue Recognition
Slide 15
Rendering of services – Revenue recognition
Revenue Recognition
Outcome cannot be estimated reliably
revenue recognised = recoverable expensesDuring the early stages of a transaction, it is often
the case that the outcome of the transaction cannot be estimated reliably.
Is it probable that the entity will recover the transaction costs incurred?
• Revenue is recognised only to the extent of costs incurred that are expected to be recoverable.
• No profit is recognised.
• Revenue is not recognised
• The costs incurred are recognised as an expense.
When the uncertainties that prevented reliable estimation no longer exist, revenue is recognised
YES NO
Outcome of a transaction estimated reliably
Stage of completion method
Outcome be estimated reliably if:
• Revenue measured reliably;• Probable that economic benefits
flow to the entity;• The stage of completion measured
reliably; and• The costs incurred for the
transaction and the costs to complete the transaction can be measured reliably
Slide 16
Rendering of services - Measurement
Revenue Recognition
Measurement of Revenue
by “Percentage of Completion method” depending on nature of transaction methods may include
• surveys of work performed;
• services performed to date as a percentage of total services to be performed; or
• the proportion that costs incurred to date bear to the estimated total costs of the transaction. Only costs that reflect services performed to date are included in costs incurred to date.
Progress payments and advances received from customers often do not reflect the services performed.
Slide 17
Rendering of services
Revenue Recognition
Treatment of certain specific services Revenue Recognition
1 Performance over Time• services are performed by an
indeterminate number of acts • over a specified period of time
Revenue is recognised on a straight-line basis unless a better method represents the stage of completion
2 Recognition of contracts containing significant acts
When significant act is executed (e.g. Loan origination fees for arranging loan)
3 Contracts with milestone payments -(payment of cash upon the achievement of certain ‘milestones’ identified in the contract
Revenue recognition will vary depending on the substance of the arrangements
4 Subscriptions Recognised on a straight-line basis over the period when the items are dispatched
5 Admission fees Admission fees for special events are recognised when the event takes place
6 Tuition fees Recognised as revenue over the period of instruction.
Slide 18
Sale of Software
Following points have to be considered• Physical delivery of the software - less indicative of when a sale should be recognised • Recognition delayed till acceptance by buyer• Depends on type of software
Revenue Recognition
Standard off the shelf
Customised software
Recognise revenue on delivery
Percentage of completion method
• Subject to installation
Process is substantial, Risk of non-acceptance
Installation process is simple upon the buyer's acceptance of delivery
recognition after >installation >Inspection >customer acceptance
Multiple Element Arrangement
Slide 20
Timing of recognition Multiple Elements
Multiple Elements
IAS 18 para 13:
In certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction to reflect substance.
• Identifying components of a transaction to reflect substance
• Combining if commercial effect cannot otherwise be understood
• linked transactions
Rendering of services
Dividends, royalties
3
4
56
1
2
Revenue Recognition
Slide 21
Multiple Element transactions
1. Separation of Elements
• A transaction may contain separately identifiable components that should be accounted for separately.
• Apply the revenue recognition criteria to each separately identifiable component of a single transaction to reflect the transaction's substance.
Customer’s Perspective
To assess the transaction's substance, view from
customers’ perspective
customer views the purchase as one
product
customer perceives there to be a
number of elements to the transaction,.
Apply recognition criteria to transaction as
whole
Apply recognition criteria to each element
separately.
Revenue Recognition
Slide 22
Multiple Element transactions
2. Allocation of Consideration
• Revenue in respect of each separable component of a transaction = its fair value.
• Fair value = price that is regularly charged for an item when sold separately
Total revenue > the sum of the fair value of the separable elements
additional revenue attributable to the activity of managing the two elements of
the contract
additional revenue recognised when full contract substantially complete
Total revenue < the sum of the fair value of the separable elements
Difference = discount
discount allocated between the separable components using:1. relative fair values 2. cost plus a reasonable margin
If overall loss on contract recognise immediately
Revenue Recognition
Slide 23Slide 23
Handout 3
Multiple Element Transactions
Multiple Element Transactions
Revenue Recognition
Slide 24
Measurement of revenue- Barter transactions
Revenue Recognition
Goods or services are exchanged or swapped for goods or services which are of a similar nature and value?
YES NO
NOT a transaction which generates revenue.
a transaction which generates revenue.
Can fair value of goods and services received be measured reliably?
YES NO
revenue is measured at the fair value of the goods or services received, adjusted by the amount of any cash or cash equivalents transferred.
the revenue is measured at the fair value of the goods or services given up, adjusted by the amount of any cash or cash equivalents transferred.
Slide 25
Interests, royalties and dividends
Revenue Recognition
Revenue arising form use by others of entity’s asset yielding interests royalties and dividends shall be recognised
when
on the following basis:
it is probable that the economic benefits associated with the transaction will flow to the entity.
the amount of the revenue can be measured reliably.
AND
Interests
Royalties
Dividends
using the effective interest method as set out in IAS 39.
on an accrual basis in accordance with the substance of the relevant agreement.
when the shareholder's right to receive payment is established
Slide 26
Thank You
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