Ch4 Revenue

8/13/2019 Ch4 Revenue

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Chapter 4 Revenue Recognition

1. Objectives

1.1 Define the meaning of revenue.

1.2 Determine the measurement of revenue.

1.3 Discuss the revenue recognition criteria for sale of goods.

1.4 Explain the various types of service transactions and their criteria for revenue

recognition.

1.5 Discuss the revenue recognition criteria for interest, royalties and dividends.

1.6 Descrie the disclosure re!uirements under "#$% 1&.

% a l e o f

' o o d s

( e n d e r i n g

o f % e r v i c e s

) n t e r e s t ,

( o y a l t i e s *

D i v i d e n d s

D i s c l o s u r e

) d e n t i f i c a t i o no f

+ r a n s a c t i o n

e a s u r e m e n t

D e f i n i t i o n

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2. Introduction

2.1 $ccruals accounting is ased on the matching of costs with the revenue they

generate. )t is crucially important under this convention that -e can estalish

the point at -hich revenue may e recognised so that the correct treatment can

e applied to the related costs. or example, the costs of producing an item of

finished goods should e carried as an asset in the statement of financial

position until such time as it is sold/ they should then e -ritten off as a

charge to the trading account.

2.2 Income, Revenue and ain

0a Income is increases in economic benefits during the accountingperiod in the form of inflo-s or enhancements of assets or decreases of

liailities that result in increases in e!uity, other than those relating to

contriutions from e!uity participants.

0 Revenue is defined as the gross inf!ow of economic benefits during

the period arising in the course of the ordinary activities of an

enterprise -hen those inflo-s resu!t in increases in e"uity, other

than increasesrelating to contriutions from e"uity participants.

0c ainsrepresent other items that meet the definition of income. 'ains

represent increases in economic benefits and as such are no

different in nature from revenue. "o-ever, they are often reported

net of related expenses, e.g. net exchange gains, gain on disposa! of

non#current assets. +hey also inc!ude unrea!i$ed gains, for example,

arising from the revaluation of investment in securities.

2.3 +his %tandard covers the follo-ing areas

0a sale of goods

0 rendering of services

0c interest, royalties and dividends

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%. &easurement of Revenue

3.1 &easurement of Revenue

0a (evenue should e measured at fair va!ue of the consideration

received or receivab!e.

0 'air va!ue ( ) is the amount for -hich an asset -ould eexchanged, or a liaility settled, et-een no-ledgeale, -illing

parties in an arms length transaction.

0

3.2 ased on the entity concept, revenue includes only the gross inf!ows of

economic benefits received and receivab!e y the enterprise on its o-n

account.

3.3 $mounts collected on beha!f of third parties such as sales taxes are not

counted. %imilarly, in an agency relationship, any amounts collected y an

enterprise on ehalf of the principal are also not accounted for. (evenue is

reduced y trade discounts and volume reates ut not reduced y suse!uent

ad dets and sales returns.

(*) +eferred payment of revenue

3.4 hen the inflo- of cash or cash e!uivalents is deferred, the fair value of the

consideration -ill e less than the nominal amount of cash received or

receivale. +his happens -hen an enterprise provides interest free credit to the

uyer or accepts a note receivale -hich is elo- the maret interest rate.

%uch an arrangement in fact constitutes a financing transaction. +he fair

va!ue of the considerationhas to e determined by discounting a!! future

receipts at an imputed interest rate. +he difference between the fair va!ueand the nomina! amount of the consideration is recogni$ed as interest

revenue.

3.5 -RCI 1

$7 8td ought a machine from 9:; 8td at


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$7 8td any interest for the deferred payment. +he orro-ing rate at that

time -as 1=>.

Re"uired/

7ompute the present value of the consideration and the interest income.

o!ution/

(0) change of assets

3.6 +he revised "#$% 16 specifies that exchange of items of property, plant and

e!uipment, regard!ess of whether the assets are simi!ar , aremeasured at

fair va!ue of the goods or services received , ad?usted y the amount of any

cash or cash e!uivalents transferred.

3.@ amp!e 1

ree 7onstruction 8td contracted -ith Arinting 8td -here it -ill supply a fixed

!uantity of -all paper to Arinting 8td and in return, Arinting 8td -ill deliver acertain amount of in as consideration. ree 7onstruction 8td should record

revenue for the fair value of the in received.

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4. a!e of oods

4.1 Recognition of a!e of oods

(evenue from the sale of goods should e recogniBed -hen all the follo-ing

conditions have een satisfied

0i the enterprise has transferred to the uyer the significant riss and

rewards of ownershipof the goods/

0ii the enterpriseretains neither continuing manageria! invo!vementto

the degree usually associated -ith o-nership nor effective contro!

over the goods sold/

0iii the amount of revenuecan e measured re!iab!y/

0iv it is probab!y that the economic benefits associated -ith thetransaction -ill f!ow to the enterprise/ and

0v the costs incurred or to be incurredin respect of the transaction can

e measured re!iab!y.

4.2 +o assist -ith the decision of revenue recognition, the %tandard provides an

appendix -ith various examples

3ransactions Critica! vent

1. Cill and hold sales Delivery is

delayed, ut the uyer taes title

and accepts illing.

(evenue is recogniBed -hen the uyer taes

title. (evenue is not recogniBed -hen there is

simply an intention to ac!uire or manufacture

the goods in time for delivery.

2. 'oods shipped su?ect to

conditions

a. )nstallation and inspection. (evenue is normally recogniBed -hen the

uyer accepts delivery, and installation and

inspection are complete.. Fn approval -hen the uyer

has negotiated a limited right of

return.

)f there is uncertainty aout the possiility of

return, revenue is recogniBed -hen the

shipment has een formally accepted y the

uyer or the goods have een delivered and

the time period for re?ection has elapsed.

c. 7onsignment sales under -hich

the recipient 0uyer undertaes

to sell the goods on ehalf of

(evenue is recogniBed y the shipper -hen

the goods are sold y the recipient to a third

party.

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the shipper 0seller.

d. 7ash on delivery sales. (evenue is recogniBed -hen delivery is made

and cash is received y the seller or its agent

3. 8ay a-ay sales under -hich thegoods are delivered only -hen the

uyer maes the final payment in a

series of instalments.

(evenue is recogniBed -hen the goods aredelivered

4. Frders -hen payment is received

in advance of delivery for goods

not presently held in stocs.

(evenue is recogniBed -hen the goods are

delivered.

5. %ales and repurchase agreements )n sustance, the seller has transferred the

riss and re-ards of o-nership to the uyer

and hence revenue is recogniBed.

6. %ales to intermediate parties, e.g.

distriutors, dealers, etc. for resale.

(evenue is recogniBed -hen the riss and

re-ards of o-nership have passed.

@. %uscriptions to pulications and

similar items.

(evenue is recogniBed -hen the items

involved are despacted.

&. )nstallment sales, under -hich the

consideration is receivale in

installments.

(evenue attriutale to the sales price,

exclusive of interest, is recogniBed at the date

of sale.

G. Aroperty of sales. (evenue is normally recogniBed -hen legal

title passes to the uyer. )f the seller is

oliged to perform any significant acts after

the transfer of the e!uitale andHor legal title,

revenue is recogniBed as the acts are

performed.

. Rendering of ervices

5.1 Recognition of Rendering of ervices

hen the outcome of a transaction involving the rendering of services can e

measured relialy, revenue associated -ith the transaction should e

recogniBed y reference to the stage of completion of the transaction at the

statement of financial position. +he outcome of a transaction can e estimated

relialy -hen all the follo-ing conditions are satisfied

0i the amount of revenuecan e measure re!iab!y/

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0ii it is probab!e that the economic benefits associated -ith the

transaction -ill f!ow to the enterprise/

0iii the stage of comp!etionof the transaction at the statement of financial

position date can e measured re!iab!y/ and0iv the costs incurred for the transaction and the costs to comp!ete the

transaction can e measured re!iab!y.

5.2 hen the outcome of the transaction involving the rendering of services

cannot be estimated re!iab!y, revenue should e recogni$ed on!y to the

etent of the epensesrecogniBed that are recoverale.

5.3 &ethods of &easuring the Revenue of Rendering of ervices

0a 5ercentage of comp!etion method ith service industries, revenue

is recogniBed y reference to the stage of completion of a transaction

-hich is often referred to as the percentage of completion method.

+he stage of completion of a transaction can e determined y various

means depending on the nature of the transaction. +hese include

0i surveys of -or performed/

0ii services performed to date as a percentage of total services to

e performed/

0iii the proportion that costs incurred to date ear to the estimated

total costs of the transaction.

0 traight !ine basis hen services are performed y an indeterminate

numer of acts over a specified period of time, revenue is recogniBed

on a straight line asis over the specified period unless some other

etter method is availale. or example, a fitness clu -hich provides

unlimited use of its facilities to its memers offers a threeIyear

memership suscription at a discount. or such memership fees,

revenue should e recogniBed over the three year period on a straightI

line asis.

0c Comp!eted performance method hen a specific act is much more

significant than any other acts, the recognition of revenue is postponed

until the significant act is executed. or example, a moving company

may pac, load, store and deliver goods to destinations designated y

customers. +he act of delivery, the last of a series of acts, is so

significant that revenue can only e recogniBed -hen delivery is

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completed.

5.2 Examples from %tandard

3ransactions Critica! vent

1. )nstallation fees (evenue is recogniBed y reference to the

stage of completion of the installation.

2. %ervicing fees included in the price

of the product

+he identifiale amount included in the

selling price, i.e. service fees, is deferred and

recogniBed over the period during -hich the

service is performed.

3. $dvertising commissions edia commissions are recogniBed -hen the

related advertisement or commercial appears

efore the pulic.

4. )nsurance agency commissions (evenue is recogniBed on the rene-al date of

the policy provided that the agent -ill not e

re!uired to perform further services.

5. inancial services fees (ecognition of revenue for financial service

fees depends on the purposes for -hich the

fees are assessed and the asis of accounting

for any associated financial instrument.6. $dmission fees (evenue from artistic performance, other

special events is recogniBed -hen the event

taes place.

@. +uition fees (evenue is recogniBed over the period of

instruction.

&. )nitiation, entrance and

memership fees

)f fees permit only memership, the fee is

memership fees. (ecognised as revenue

-hen no significant uncertainty as to theircollectiility exists. )f fees include other

services or facilities provided, revenue is

recogniBed on a asis reflecting the timing,

nature and value of the enefits provided.

G. ranchise fees (evenue is recogniBed on a asis that reflects

the purpose for -hich the fees are charged.

1=. ees from the development of

customiBed soft-are

(evenue is recogniBed y reference to the

stage of completion.

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6. Interest, roya!ties and dividends

6.1 +efinitions

0a Interest is the charge for the use of cash or cash e!uivalents or

amounts due to the entity.

0 Roya!tiesare charges for the use of nonIcurrent assets of the entity,

e.g. patents, computer soft-are and trademars.

0c +ividendsare distriutions of profit to holders of e!uity investments,

in proportion -ith their holdings, of each relevant class of capital.

6.2 Recognition of Interest, Roya!ties and +ividends

0a Interest is recognised on a time proportion basis that taes into

account the effective yie!don the asset.

0 Roya!tiesare recognised on an accrua!s basisin accordance -ith the

sustance of the relevant agreement.

0c +ividends are recognised -hen the shareho!der7s right to receive

payment is estab!ished.

8. +isc!osure Re"uirements

@.1 $n enterprise should disclose

a the accounting policies adopted for the recognition of revenue

including the methods adopted to determine the stage of completion of

transactions involving the rendering of services/

0 the amount of each significant category of revenue recogniBed during

the period including revenue arising from

0i the sales of goods/

0ii the rendering of services/

0iii interest/

0iv royalties/

0v dividends/ and

0c the amount of revenue arising from exchanges of goods or services in

each significant category of revenue.

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amination ty!e 9uestions

9uestion 1

0a )n accordance -ith "#$% 1& C(evenue,

0i define Crevenue, and 02 mars

0ii explain ho- revenue should e measured -hen goods are sold in

exchange for dissimilar goods. 03 mars

0 )n accordance -ith "#$% 1& C(evenue, discuss -hen and ho- revenue

should e recogniBed in the follo-ing transactions.

0i est $dvice 8td is a consulting firm that has received a t-oIyear

engagement from a client. +he company -ill assign differing numers of

personnel to the pro?ect depending on the pro?ects needs and the

availaility of personnel. +he company maes periodic illings ased on

the hours -ored y the personnel, plus 2=> profit. 04 mars

0ii +he ar 8ost "ealth 7lu has t-o types of memerships oneIyear and

t-oIyear. Each type of memership re!uires an initial fee as -ell as

monthly fees for unlimited use of the clus facilities. 04 mars

0iii rancisco 8td o-ns &=> and 2=> of the e!uity shareholdings in ed 8td

and +ed 8td respectively. $ll three companies are unlisted and their

accounting year ends 31 Decemer. Fn 1 $pril 2==1 and 15 $pril 2==1,

final dividends in respect of the year ended 31 Decemer 2=== -ere

declared and approved at the general meetings of ed 8td and +ed 8td

respectively. 04 mars

0$dapted "#$$+ Aaper @ inancial $ccounting )) Decemer 2==1 J6

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9uestion 2

"#$% 1& C(evenue re!uires revenue to e recognised -hen it is proale that future

economic enefits -ill flo- to the enterprise and these enefits can e measured

relialy. :ou are the accountant of $+ 8imited. :our ?unior ass you to explain the

accounting treatments, according to the re!uirements of "#$% 1&, of the follo-ing

t-o transactions

0i Fn 1 Kanuary 2==4, $+ 8imited sold a machine for per annum.

0ii $+ 8imited o-ns the right to a retail shop franchise. Fn 1 Kanuary 2==4 it sold

the right to open a ne- outlet to r 8ee/ the franchise is for three years. $+

8imited received an initial fee of 1 =.&G3

2 =.@G@

3 =.@12

0@ mars

0c Arepare ?ournal entries to record the revenue earned from the franchise in 2==4

and 2==5. 06 mars

0+otal 25 mars

0$dapted "#$$+ Aaper @ $dvanced $ccounting Kune 2==4 71

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9uestion %

est-or 8imited, -hich is an entertainment programme producer and distriutor,

has the follo-ing transactions occurred during the year ended 3= %eptemer 2==5

01 est-or 8imited entered into a franchise agreement -ith 8ine 8imited and

sold the right of a franchise to 8ine 8imited for a period of 4 years on 1 Fctoer

2==4. est-or 8imited received an initial fee of


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9uestion 4

Meir 8imited sells furniture and fixtures from several retail outlets. )n previous years,

the company has undertaen responsiility for fitting the furniture and fixtures in

customers premises. 7ustomers pay for the furniture and fixtures at the time they are

ordered. +he average length of time from customer ordering furniture and fixtures to

its fitting is 1= days. &=> of the sales invoice value relates to the goods and 2=> of

the fitting services for the furniture and fixtures.

)n previous years, Meir 8imited had recogniBed sales revenue only -hen the

furniture and fixtures had een successfully fitted as the rectification costs of any

fitting error -ould e difficult to estimate. Fne of the directors of Meir 8imited, r.

an, is proposing to recogniBe sales revenue -hen customers order and pay for the

goods, rather than -hen they have een fitted.

Re"uired/

0a Explain ho- should revenue associated -ith the rendering of services

transaction e recogniBed in accordance -ith "#$% 1& C(evenueN 06 mars

0 Do you thin that 0i the existing accounting policy, 0ii the accounting policy

proposed y r. an, or 0iii oth of them for recogniBing revenue isHare LF+

correctN 0:ou should ignore the information given in part 0c -hen ans-ering

this part 01= mars

0c rom the next accounting year on-ard, Meir 8imited is going to change its

trading practice y outsourcing the fitting of furniture and fixtures at customers

premises to approved contractors ecause the cost involved in such fitting

services -ill e less than maintaining a service team in the company for this

purpose. Meir 8imited -ill pay a fixed account to the contractors for each ?o

and the contractors -ill e responsile for the fitting of furniture and fixtures

and also paying compensation for any errors in the fitting. "o- to recogniBeand measure sales revenue in the next accounting yearN 0G mars

0:our ans-er should e in line -ith the re!uirements of Crame-or for the

Areparation and Aresentation of inancial %tatements and "#$% 1&

C(evenue.

0+otal 25 mars

0$dapted "#$$+ Aaper @ $dvanced $ccounting Kune 2==@ 73

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9uestion

it 8imited, -hich is engaged in manufacturing and selling of office e!uipments, has

an accounting yearIend of 31 Decemer. Fn 1 Kanuary 2==@, it 8imited sold goods

to a customer in four e!ual instalments of per annum.

Re"uired/

0a )n accordance -ith "#$% 1& (evenue, explain -hen and ho- to recognise the

revenue from sale of goods. 0@ mars

0 "#$% 1& states that Cif the entity retains significant riss of o-nership, the

transaction is not a sale and revenue is not recognised. Arovide t-o examples

of situations in -hich the entity may retain significant riss and re-ards of

o-nership in the context of sale of goods. 02 mars

0c Arepare ?ournal entries to record the transactions of instalment sales from years

to 31 Decemer 2==@ to 2=1=. %ho- all your -orings. 016 mars

0:our calculation should e rounded up to the nearest dollar.

0+otal 25 mars

0"#)$$+ Aaper @ inancial $ccounting Ailot Aaper 2==& 72

9uestion 6

"#$% 1& (evenue -as issued -ith a vie- to standardising the recognition and

measurement of revenue. +he principles of the standard are ased around the concept

of income that -as developed in the "#)7A$s rame-or for the Areparation and

Aresentation of inancial %tatements.

Re"uired/

0a Explain ho- the "#)7A$s frame-or defines income and ho- this definitioncompares to the definition of revenue given in "#$% 1&. 04 mars

0 Futline the re!uirements of "#$% 1& regarding the recognition and

measurement of revenue from

0i +he sale of goods/

0ii +he rendering of services/

0iii +he use of entity assets. 0G mars

)ota prepares financial statements to 3= %eptemer each year. During the year ended

3= %eptemer 2==5 )ota engaged in the follo-ing transactions

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1. Fn 1 Fctoer 2==4 )ota sold a plot of land to a an for


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05 mars

0 #appa is an entity that prepares financial statements to 31 arch each year.

During the year ended 31 arch 2=1= the follo-ing transactions occurred

0i Fn 2G arch 2=1= #appa delivered t-o machines to a customer. Details

relating to the machines are as follo-s

achine 7onstruction cost )nvoiced price

< , -hen the final

purchaser paid Fmicron for them. +he invoiced value of these goods 0the

price payale y the final purchaser -as


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maintenance. +he maret value of the property on 1 $pril 2==G -as

deposit is re!uired on

ooing and the alance of the holiday must e paid six -ees efore the travel date.

)n previous years Aart-ay has recognised revenue 0and profit from the sale of its

holidays at the date the holiday is actually taen. rom the eginning of Lovemer

2==5, Aart-ay has made it a condition of ooing that all customers must have

holiday cancellation insurance and as a result it is unliely that the outstanding

alance of any holidays -ill e unpaid due to cancellation. )n preparing its financial

statements to 31 Fctoer 2==6, the directors are proposing to change to recogniBing

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revenue 0and related estimated costs at the date -hen a ooing is made. +he

directors also feel that this change -ill help to negate the adverse effect of comparison

-ith last years results 0year ended 31 Fctoer 2==5 -hich -ere etter than the

current years.

Re"uired/

7omment on -hether Aart-ays proposal to change the timing of its recognition of its

revenue is acceptale and -hether this -ould e a change of accounting policy.

06 mars

0$77$ 2.50"#' inancial (eporting Decemer 2==6 J500ii

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Documents

Ch4 Revenue