Revenue Recognition Under IFRS (IAS -18)

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Payment in advances of sale of goods

Payment received in advance of performance do not represent revenue because they have not been earned. Until the selling entity completes its contractual performance, the increase in cash is matched by an increase in liabilities.

In a situation, Where goods are delivered only when the buyer makes the final payment in a series of installments. It states that revenue from such sales is recognised when the goods are delivered as the supplier in general is not certain of the flow of economic benefit.

However, where experience indicates that the vast majority of such sales are completed, revenue may be recognised when a significant deposit is received, provided that the goods are on hand identified and ready for delivery to the buyer.

One further condition that we consider should be met before revenue can be recognised is that the seller must not be able to dispose of the goods to any party other than that buyer.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Example:- Entity A enters into a sale agreement to sell 10 TV sets at a total price of $15000 to a customer.

They already have 5 TV in inventory. They collects a cash deposit of $1000 from the customer.

The TV sets are not released to the customer until the full price is paid and it should be completed within 3 Months otherwise deposit will be forfeits by Entity A.

If prior to delivery TV is damaged or lost than Entity must either refund the cash deposit or replaced the TV.

In this case as Entity A retains the risk of ownership of TV. Therefore, it should be recognised as Inventory until they are delivered.

As not all the goods are on hand, identified and ready for delivery and there is no restriction on entity A selling the goods to another party.

Therefore, Entity A should recognise $15000 as revenue only when 10 TV sets are delivered to the customer.

Till that time $1000 will be recognised as a liability of the company.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Sale or return/Consignment

Sale or return is a contracts, where contract may give the customer the right to return goods they have purchased and obtain a refund of release from the obligation to pay.

In this case, the entity may expect that there will be few returns and that the level of return can be reliably estimated.

In other situations, the entity may expect that there will be a high level of returns. Where the entity can estimate the level of returns reliably, the liability recognised for the expected level of returns will be measured in accordance with IAS-37. The liability is not a financial liability as the contract for return is executory and no cash will be paid unless the goods are returned.

The liability should be measured at the best estimate of the expenditure necessary to settle the obligation. The ‘best estimate’ will be the amount to be paid back to the customer plus any direct incremental costs of the return net of the value of the returned goods.

In many cases, the value of the return goods may be their original cost. However, if a reliable measurement of net realisable value is available and its lower than original cost, NRV should be used when determining the liability to be recognised.

In assessing the value of the returned goods, management will need to consider whether the returned goods will be impaired for damage or obsolescence.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Example:- A clothing retailers sells T-Shirts to Customers have the right to return T-Shirts within 28 days of purchase, provided that the T-Shirts are unworn and undamaged. Based on historical evidence, the retailer is able to reliably estimate the level of T-Shirts that will be returned. In this case, as retailer can reliable measure the level of retunes, revenue should be recognised when the sale is made and adjusted for the expected level of returns. Thus for each T-Shirt sold, an element of the consideration will be recognised as revenue with the remaining element of consideration being recognised as a provision. Cost of sales recognised on each sale would also be adjusted to reflect the impact of returned goods, with the reduction in inventory partially offsetting the provision for returns

balaji

senior exe

26 Points Joined December 2007

In case of multi-year contracts can the revenue be recognised based on the porjected cost rather than going by the actual cost incurred?

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Balaji Muti-year contracts normally covers under IAS-11 (Construction Contract) so you have to follow the Percentage of Completion method..

In the IAS-11 , they prescribed three methods

• Surveys of work performed

• Percentage of Completion method

• Proportion of the estimated total costs

But POC is always advisable

If you are not able to estimated projected cost reliably.

Revenue is only recognised to the extent of recoverable contract costs. This approach is necessary to avoid recognising profit on a contract before its probable that a profit will be earned on the overall contract.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Balaji Thanks for participating

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Warranties

A Warranty is often provided in conjunction with the sale of goods, Warranties represents guarantees made by the seller that a product will perform as specified for a period of time. A Warranty only permits a customer to return of exchange a product if the product does not meet the specified performance criteria.

Initial Warranty :- When a warranty is not a separate element and represents an insignificant part of the transaction, the seller has completed substantially all the required performance and can recognise the full consideration received as revenue on the sale. The cost of warranties should be determined at the time of the sale, and a corresponding provision for warranty costs recognised.

If such cost cannot be measured reliably, revenue should not be recognised until the warranty period has expired and the related warranty costs are identified.

Extended Warranty:- An extended warranty is an agreement to provide warranty protection in addition to the scope of coverage, of a manufacturer’s original warranty, or to extend the period of coverage provided the manufacturer’s warranty. In this case revenue will be deferred and recognised over the period covered by the warranty.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Example:- Entity A sells electrical goods with 12 Months Initial warranty and offers 2 to 5 yrs Extended Warranty.

The initial warranty cannot be separately identified. Thus, on the sale of goods, the manufacturer should recognised full revenue and make a necessary provision as per historical record.

In case of Extended Warranty sale price is $100. The average cost of repairing or replacing the goods under the warranty is $ 600 per valid claim.

In this case, Entity A defer the revenue and recognise it on a straight line basis. The cost incurred under the warranty should be charged to cost of sales as incurred and management should not recognise a provision of the expected warranty costs, but should monitor that warranty cost does not exceed the amount of revenue allocated to the warranty.

If its occur the warranty contract will be onerous and it may be necessary to recognise an onerous contract provision.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Sale of Services

The percentage of completion method is used to recognise revenue for rendering services. Accordance with IAS 18, various methods may be used to determined the stage of completion.

• Surveys of work performed

• Percentage of Completion method

• Proportion of the estimated total costs

When a contract contains a specific act which is much more significant than any other acts to be performed under the contract, the recognition of revenue is postponed until the significant act is executed. Some contracts contain “trigger events” before the occurrence of which the customer would pay nothing. In such a situation, the seller should not recognise any revenue until the trigger event occurs.

Example:- A professional services entity provides advice to a bidder in a take-over situation. Fees are charged on time basis, but will not be payable unless the bid is declared unconditional. The entity normally bills in monthly basis.

In this case trigger point is bid being declared unconditional. Until that point, no revenue should be recognised by the professional services entity, even though it may have provided services. This is because until the bid is declared unconditional, revenue is not receivable and if this does not occur, no economic benefits will flow to the entity.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Sale of Software

In the Software industry, revenue recognition poses a number of issues, Software houses normally earn their revenue from a combination of the following

§ Sale of off-the-shelf software where the licensing arrangement gives the customer the right to use the software for a specified period.

§ Sale of customized software developed for a specific application

§ Sale of software support services

Selling software is different from selling a tangible product, since what is being sold is the right to use intellectual property. In this case, recognition may need to be delayed until after delivery and acceptance by the customer. Fees from the development of customized software are recognised as revenue by reference to the developments stage of completion, including of services provided for post-delivery service support. In this case, the outcome cannot be assessed with reasonable certainty before the contracts conclusion, revenue should be recognised only to the extent that the expenses recognise are recoverable.

Where a software house provides maintenance services or other after sales support with the initial contract for hardware and software, it is necessary to determine of this can be regarded as a separable component. If it can, then revenue relating to the maintenance component is recognised as performance of the maintenance service occurs. Maintenance revenue will generally be recognised on SLM basis

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Multiple element Transactions

IAS 18 says its necessary to apply the revenue recognition criteria to each separately identifiable component of a single transaction in order to reflect the transaction’s substance. In assessing the transaction’s substance, the transaction should be viewed from the perspective of the customer and not the seller.

Example:- A mobile phone network packages within a single contract a handset, line rental and prepaid calls, These three products and services are also available separately and their stand alone retail prices are a good guide to determine the fair value of the consideration received for each component. At the start of the contract, the handset is delivered, but provision of the line rental and pre-paid calls will be outstanding. Thus revenue is recognised immediately for the provision of the handset, but revenue for line rental and prepaid calls is deferred. The revenue from line rental will be recognised over the rental period and revenue from the calls will be recognised on a usage basis. If entity are not selling components separately but other vendors in the market are selling separately, Still separation of component is required.

IFRS does not define identifiable components of a single transaction. The assessment of components and future obligation is a matter of judgment of management. The revenue in respect of each separable component of transaction is measured at its fair value.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Linked Transaction

Where two or more transactions are linked they should be treated as a single transaction like where and entity sells goods but, at the same time, enters into an agreement to repurchase the goods at a later date. The agreement terms need to be analyzed to ascertain whether, in substance, the seller has transferred the significant risk and rewards of ownership to the buyer.

Example:- The management of entity A is considering the following to alternative transactions

• Sale of inventory to bank for $ 5M with an obligation to repurchase at a later stage

• Option to repurchase any time up to 12 Months.

In the first case, Management should not recognise the revenue on the transfer of inventory to bank. It should be remain as a inventory with entity book and the proceeds from the bank should be recognised as a collateralised borrowing, Once entity paid the amount from balance sheet they will remove the collateralised borrowing

In the second case, management should not recognise revenue unless and until the repurchase option is allowed to lapse, The inventory should remain on entity A’s balance sheet and proceeds recognised as collateralised borrowing until the entity A’s right to repurchase the inventory is lapsed.

If two transactions are not connected no problem arises.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Contracts with milestone payments

Contracts in certain industries, like Pharmaceutical, are often structured to provide for the payment of cash upon the achievement of certain ‘milestones” identified in the contract. Accounting for such contracts can be complex and the appropriate revenue recognition will vary depending on the substance of the arrangements.

• The reasonableness of the payments compared to the effort, time and cost to achieve.

• Where royalty or agreements are in place, a component of the payment made under the contract may relate to the royalty or license fees rather than the provision of services and should be accounted for accordingly.

• Contracts may include cancellation clauses requiring the repayment of amounts received under the contract to date upon cancellation by either party. Such cancellation clauses may indicate that recognition of revenue for amounts received under the contract is not appropriate

• If payments are dependent upon the achievement of certain milestones, and there is doubt as regards the achievement of the milestones, then revenue should not be recognised until the relevant milestone has been achieved.

• All obligations under a contract must be considered in assessing the extent to which an entity has performed. The existence of penalty clauses for failure to deliver may reduce the revenue that can be recognised

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Joined October 2007

Sales Tax

When an entity sells a product, sales taxes that are collected on behalf of a government body should be excluded from the revenue recognised. These taxes are remitted to the government in full and do not increase equity. Revenue should, therefore, be presented net of sales taxes.

The treatment of sales taxes differs from that of production taxes which are treated as cost of sales, It may be necessary to analyse, for each jurisdiction in which the entity operates, whether certain taxes are sales taxes or production taxes to determine the accounting treatment for the tax in each jurisdiction. For example, excise duty payable by manufacturers of tobacco and alcoholic products, is a sales tax in some jurisdictions and a production tax in others. In some jurisdictions it may be difficult to determine the exact nature of the tax. The treatment of excise duty in one jurisdiction may, therefore, be different from that in another.

When determining whether revenue, should be presented gross or net of excise tax, the key consideration is whether the entity is acting as agent or principal . Indicator that the entity is acting as principal include but are not limited to

• Risk and rewards of the transaction

• Ability to choose the selling price

• Basis of Calculation

• Point of Payment