Revenue Recognition Case Studies under IFRS

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) 26 June 2009

Revenue Recognition—Case Study-1

On 29 February, Vendor enters into a contract with a customer to provide, deliver and install manufacturing equipment for 15,000 due on delivery.

Vendor delivers the equipment on 31 March and installs it during April. Title to the equipment passes to the customer at delivery.

Vendor separately sells the equipment (inclusive of the delivery service) and installation service for 14,000 and 2,000 respectively.

Vendor does not sell delivery services separately from equipment. The allocation of the transaction price of 15,000 would be as follows:

Stand-alone Allocation of Measurement of

selling price discount Performance obligation

(A) (B) (A) - (B)

Machine and deliver 14,000 875 (a) 13,125

Installation 2,000 125 (b) 1,875

Total 16,000 1,000 15,000

(a)1,000 × (14,000 ÷ 16,000)

(b)1,000 × (2,000 ÷ 16,000)

Vendor satisfies the equipment and delivery services obligation on 31 March when the equipment is transferred to the customer.

Vendor satisfies the installation service obligation in April as installation progresses.

Therefore, Vendor’s net contract position and revenue recognition are as follows:

Net contract position at end of month Revenue recognition during month

February --- ----

March 1,875 (a) 13,125

April ---- 1,875

(a)Because the customer paid on delivery of the equipment, there are no remaining rights at 31March.

Therefore, Vendor’s net contract position at 31 March is a contract liability of 1,875 (the amount allocated to the remaining performance obligation).

Aditi Kaur (Practising CA) 27 June 2009

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) 26 June 2009

Revenue Recognition– Case Study-2

Entity A has an existing manufacturing customer, entity B, who has recently announced that it expects to have to restructure its debt with current creditors, including entity A, in order to ensure sufficient operating liquidity to avoid bankruptcy.

Subsequent to the announcement, Entity A ships an order of replacement parts to entity B based on a purchase order received from entity B prior to announcement

In this case, Entity A should not recognise revenue for the latest shipment to entity B as its not probable that the economic benefit related to the products shipped will flow to the entity.

Entity A may record revenue when entity B pays for the shipment of replacement parts, which is when it becomes probable that the economic benefit will flow to entity A and when the amount of revenue can be measured reliably.

In contrast, any allowance recorded against any existing receivable balance as a result of entity’s B announcement of its need to restructure debts should be recorded as an expenses not as a reversal of revenue

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) 26 June 2009

Revenue Recognition– Case Study-3

Entity A is a retailer and offers interest-free credit to a customer as part of its marketing strategy. The interest-free credit is provided by a finance company.

The legal form of the transaction is that entity A sells the goods to the customer at $100 and simultaneously the customer enters into a finance arrangement with the finance company .

This arrangement results in the finance company settling the customer’s account with the retailer and receiving $100 from the customer over 2 Years.

Current Interest rate is 10%.

The finance company does not have any recourse to entity A for bad or slow payment by the customer. How much revenue should entity A recognise and when ?

Entity A will receive $81 from the finance company in respect of the sale at, or close to, the time of the sale, Entity A should, therefore, recognise revenue of $81 immediately.

A should derecognise the receivable of $81 on receipt of the consideration form the finance company.

The finance company does not have recourse to entity A in respect of slow payment or non-payment by the customer.

Assuming all the arrangement’s other term support the conclusion that entity A has transferred substantially all the risk and rewards of ownership of the receivable to the finance company.

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) 26 June 2009

Revenue Recognition– Case Study--4

Entity A sells materials for making door profiles to a manufacturer who assembles the frames and puts glass in the door.

Entity A then repurchases the doors and sells them to a house builder for installation in homes.

Should the sale of the materials for the door profiles to the manufacturer be accounted for separately from the purchase of doors from the same manufacturer or should the transactions be regarded as linked and conditional on each other for accounting purpose ?

In this case, the indicate that the transactions are not conditional for each other, Because

§The manufacturer buys profile material and he has other markets too where he can sells the assembled doors.

§Entity A is not committed to buy doors from the manufacturer

§The price of the door is not fixed at the time of the profile material is sold and so the manufacturer bears the risks of price fluctuations and obsolescence.

However, if the facts had been different then the accounting might have been different too.

For example, if entity A sold the materials (Cost $5) for $10 per profile with the agreement that they will buyback finished door at $100. then this two transactions would be linked.

This is because the sale carries a corresponding commitment to repurchase the materials in the future at a fixed price.

In this case, $5 will be recorded as inventory and $10 will be recorded as liability .

When the door is purchased than inventory will be at $95 ($90 +$5) and liability will be $90. ($100-$10).

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) 26 June 2009

Revenue Recognition– Case Study -5

A Construction contractor has a fixed price contract for $11,500. The initial estimate of costs is $7,500 and the contract is expected to take four years. Cost will be incurred in the following manner,

In 1st yr its $3000, 2nd Yr it will be $1,500,

3RD yr it will be 1,875, 4th yr it will be $1,125.

In year two the contractor’s estimate of total costs increases to $8000. ($300 will be increased in the 3rd year and remaining in the last yr.

The contracts determines the stage of completion of the contract by comparing the costs of work performed to date with the estimated total costs.

Year-1 Year-2 Year-3 Year-4

Revenue agreed in contract 11,500 11,500 11,500 11,500

Contract costs incurred to date 3,000 4,500 6,675 8,000

Total Estimated Costs 7,500 8,000 8,000 8,000

Stage of Completion 40% 56.3% 83.4% 100%

To Date Prior yr Current Yr. Profit Margin

Year-1

Revenue(11,500 X 40%) 4,600 ------- 4,600

Costs (7,500 X 40%) 3,000 ------- 3,000 35%

Year-2

Revenue(11,500 X 56.3%) 6,475 4,600 1,875

Costs (8,000 X 56.3%) 4,500 3,000 1,500 20%

Year-3

Revenue(11,500 X 83.4%) 9,591 6,475 3,116

Costs (8,000 X 83.4%) 6,675 4,500 2,175 30%

Year-4

Revenue(11,500 X 100%) 11,500 9,591 1,909

Costs (8,000 X 200%) 8,000 6,675 1,325 30%

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) 26 June 2009

Revenue Recognition– Case Study -6

An IT company is developing a specialised IT platform for a customer. Work commenced 1 January 2005. At 31 December 2005, the hardware (which the IT company also sells separately) has been installed and the software is 50% completed.

The IT company does not anticipate any problem with the software development, which should take another 6 months to complete.

The customer has the right to return the hardware if the software does not work according to the customer’s specifications.

The contract as a whole is approximately 70% completed based on the costs incurred, which is a reliable measure of the services performed.

Costs incurred to date and costs to complete can be measured reliably for the hardware and software separately and in total.

The hardware and software account for 30% and 70% of the total consideration respectively.

Which revenue recognition guidance should be applied to this transaction?

A. Hardware: Sale of goods under IAS 18; Software: Rendering of services under IAS 18

B. Hardware and software : Rendering of services under IAS 18

C. Hardware and software : Construction contract under IAS 11

ANSWER

C. Hardware and software: Construction contract under IAS 11

The contract for the construction of the IT platform meets the IAS 11definition of a construction contract: “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 or their ultimate purpose or use.”

Revenue should be recognised using the percentage of completion method

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) 26 June 2009

Revenue Recognition– Case Study -7

Mr. Xyz is the manufacture and sale of machinery. A machine in inventory has a value of $800 and is sold for $1000, in exchange for a promissory note payable in one year from now. The marginal borrowing cost is 7%.

The present value of Revenue=$934 ($1000 x 1/1.07). Revenue of $934 is recognised at date of sale and the $66 is recognised as income spread over the life of the promissory note.

Journal Entry

1… Promissory Notes A/c Dr.. 1000

To Revenue A/c 934

To Deferred Interest Receivable 66

2… Cost of sales A/c Dr.. 800

To Inventory A/c 800

3… Deferred Interest Receivable A/c Dr. 5.5

To Interest Receivable A/c 5.5

4… Cash A/c Dr. 1,000

To Promissory Notes A/c 1,000