Revenue Recognition Under IFRS (IAS -18)

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 03 June 2009

Volume or Settlement Discounting

Suppliers may offer customers discounts for either achieving a minimum threshold of purchases (Volume discount) or for prompt settlement of outstanding receivables (Settlement discount).

In order to calculate the appropriate revenue to be recognised, it may be necessary for an entity to estimate the volume of sales or the expected settlement discounts for an entity to estimate the volume of sales, or the expected settlement discounts to be taken.

The revenue recognised would then be reduced by this estimate, such that the revenue recognised represents the fair value of the right to consideration.

The need to estimate the amount of discounts expected to be taken does not preclude the reduction of revenue for these discounts.

However, if no reliable estimate can be made then the revenue recognised on the transaction should not exceed the amount of consideration that would be received if the maximum discounts were taken

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 03 June 2009

Example:-

A food manufacturer sells canned food and has 100 customers. The delivery of the goods is made on the last day of each month.

Standard payment terms requires settlement within 45 days of delivery.

The entity’s policy is to grant a settlement discount of 2% to customers who pay with in 15 days of delivery.

Experience shows that 50% of customers normally pay within 15 days .

Invoice value $1000

In this case food manufacturer should recognise revenue of $990.

The amount is calculated by deducting from the total invoiced value the expected amount of discounts to be take of $10 ($1000 x 50% x 2%)

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 03 June 2009

Barter Transactions

Companies usually trade for cash or the right to receive cash. Sometimes, however, transactions are undertaken that involve the swapping of goods or services. These are known as Barter Transactions. IAS 18 does not permit revenue to be recognised in an exchange or barter of similar goods or services. Where goods or services are exchanged for goods or services of a dissimilar nature, the revenue is measured at the fair value of the goods or services received. In terms of determining the point at which a sale should be recognised, the accounting for barter transactions is no different from accounting for transactions that are settled in cash.

Example:- A travel agency sells low-price holidays, The agency has entered into an advertising agreement with a radio broadcaster. The agreement provides for the travel agency to place radio advertisement to the value of $15000 and in return the radio broadcaster advertise on the travel agency’s web page. The travel agency has previously sold similar web-site advertising space to others for cash of $10,000

In this case the travel agency should recognise advertising revenue of $10,000 and advertising expenses, also of $10,000. This is calculated by reference to the value of advertising services provided and not by reference to the value of the value of services received. The medium of the advertisement is dissimilar in nature.

SIC 31 states that the seller can only reliably measure the fair value of advertising services it provides in the exchange by reference to non barter transactions.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 03 June 2009

Capacity Transaction

In some network- based industries, such as telecommunications and electricity, entities enter into transactions for the sale or purchase of network capacity. For example, a telecommunication entity may sell excess capacity on its trans- Atlantic cables. The entity would probably retain ownership of the network assets, but would convey and Indefeasible Right of Use (IRU) to the buyer for an agreed period of time. Occasionally, an entity may sell capacity to another party in exchange for receiving capacity on that other party’s network.

Example:- Entity A has network capacity on a route from London to New York, but it needs to increase its capacity between London and Paris (a similar route). Entity B, on the other hand, has capacity between London and Paris, but needs to increase its capacity between London and New York. Entity A agrees to grant a 20 Years IRU to entity B over the route between London to New York in consideration for a one off payment of $10M. In addition, entity B agrees to grant to entity A an IRU of equivalent term over the route from London to Paris also for one off payment of $10M

This transaction’s commercial substance must be considered. To the extent that the swap does not have substance, entity A and entity B should not record revenue or costs, in respect of the capacity exchanged. To the extent that the transaction has substance, it may be appropriate to recognise revenue.

Where there is no valid commercial purpose, exchange transactions have come to be known as ‘Hollow swaps’ or ‘Rounding Tripping’.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Share for Service

Revenue recognition issues can arise where entities accept shares in consideration for services provided.

This most commonly occurs when the services are provided to start-up entities.

But in this case one of the conditions need to be satisfied before revenue in relation to provision of services is recognised is that the amount of revenue can be measured reliably.

The key difficulty with these sorts of arrangements is whether the value of the shares can be reliably measured.

Where shares are listed and there is sufficiently liquid market, the consideration can be reliably measured and the revenue should be recognised.

In case of Non- Marketable securities value is determined according to IAS 39.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Free Products

Some sales promotions i.e. “buy one, get one free” or “two for the price of one”. Or a vendor may price products below cost to attract volume.

The revenue on such transaction is the actual sales proceeds and the purchase or production cost of the ‘free’ product and ‘loss leader’ is a cost of sale.

In this case, The additional cost from offering the second box at a discount to the normal price is recorded as a cost of sales, not as a marketing expenses.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Customer loyalty Programmes

Some companies offer point schemes or award credits. Example are airlines that offer free air miles and supermarkets that offer loyalty cards that accumulate points that can then be used to reduce the cost of future purchase or may sometimes be redeemable for cash. A variety of loyalty programmes are currently available in the market place, of which there are 3 main type.

§ Schemes where points earned through the purchase of goods or services can only be redeemed for goods and services provided by the issuing entity.

§ Schemes where points earned through the purchase of goods or services cannot be redeemed for goods or services sold by the issuing entity.

§ Schemes whereby points earned through the purchase of goods or services can be redeemed either at issuing entity or at other entities that participate in the loyalty programme.

Historically, certain entities were accounting for the provision of loyalty award credits as marketing expenses. But later on IFRIC-13 clarified the accounting of loyalty awards. According to IFRIC-13 marketing costs are incurred independently of a sale transaction, so any vouchers, allowance and discounts or other incentives offered to a customer as part of a sales and deducted from revenue.

The fair value of the consideration received or receivable in respect of the initial sales is allocated between the award credits and the other components of the sale. Fair value of population of award credits also to take into consideration the proportion of incentives expected to be redeemed.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Example:- An entity buys a particular product for $5 and normally sells it for $8. It issues a voucher for 50% off a second item of a customer buys one.

If the fair value of the voucher is ignored, there is a gain on the first sale of $3. and Loss on second sale of $1. However, a part of the consideration from the first sale, representing the fair value of the voucher, should be differed and recognised as revenue when the second sale is made. If the fair value of the voucher is $2, the revenue on first sale would be $6 and second sale is also be $6.

IFRIC 13 requires an entity issuing award credits to determine whether it is collecting revenue on its own account or on behalf of the third party. When the entity is collecting revenue on behalf of a third party it earns commission income. This income will be deferred until the third party is obliged to supply the awards and is entitled to receive consideration for doing so.

Where vouchers are distributed free of charge and independently of another transaction, such voucher do not give rise to a liability, except where redemption of the vouchers will result in products (or services ) being sold at a loss.

In this kind of case, seller has to entered into an onerous contract and provision need to be created as per IAS 37. When the vouchers are redeemed the seller should recognise revenue at the amount received for the product, that is, after deducting the discount granted on exercise of the vouchers from the normal selling price.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Dividends

Dividend income should be recognised when the shareholders right to receive payment is established. IAS-10 states that dividends payable to holders of equity instruments that are declared after the balance sheet should not be recognised as a liability at the balance sheet date. Similarly, dividends should not be recognised as receivable if they have not been declared by the balance sheet date.

The situation for parent companies investments in subsidiaries is no different from that where this shareholding is held as a trade investment.

Where dividends on equity investments are received that have been paid out of the investee’s pre-acquisition income they should be set against the cost of the investment and not treated as revenue. When its difficult to allocation, the amt received from investment is taken as revenue.

Bonus issue of shares by a subsidiary to its parent do not transfer any value from the subsidiary to the parent. There are more shares in issue, but there is no economic significance to the transactions. Therefore, a bonus issue does not give the parent a reason to recognise a gain by increasing the carrying value of its investment in the subsidiary.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Licensing

In Licensing agreements when performance under the contract has occurred than revenue will be recognised.

Example.:- Entity A grants a license to a customer to use its web-site for next 2 yrs. License fees is $60,000.

In this case, The substance of the agreement is that the customer is paying for a service that is delivered over time.

Although entity A will not incur incremental costs in serving the customer, it will incur costs to maintain the web site.

Therefore in this case each month he has to recognise the revenue of $2500.

Where licensing fees is one time non-refundable fees:- Revenue will be recognise when the fee is received. Since the licensor has no control over the products further use or distribution and has no further action to perform under the contract, the licensor has effectively sold the rights details in the licensing agreement.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Royalties

Royalties include other fees for the use of assets such as trademarks, patents, software, copyright, record masters, films etc.

IAS-18 requires that royalties should be recognised on an accrual basis in accordance with the relevant agreement’s substance. (When revenue has earned).

In general, the application of the accruals basis means that revenue is recognised on a straight line basis over the agreement’s life or another systematic basis such as in relation to sales to which the royalty relates.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Franchise Fees

In the case of Franchise fees, revenue such as initial franchise fees, profits and losses from the sale of fixed assets and royalties.

In general, Franchise fees should be recognised on a basis that reflects the purpose for which they were charged.

Where the franchise agreement provides for the franchisor to supply equipment, inventory or other assets at a price lower than that charged to others, or at a price that does not allow the franchisor to make a reasonable profit on the supplies, part of the initial franchise fee should be deferred.

The deferred income will be recognised over the period of goods are likely to be provided.

The balance of initial fee should be recognised when performance of the initial services and other obligations has been substantially accomplished.

This approach is based on the fact that the initial fee in these circumstances is unlikely to be capable of being treated as a separable component.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Similarly, if there is no separate fee for the supply of continuing services after the initial fee or if the separate fee is not sufficient to cover the cost of providing any subsequent services together with a reasonable profit, then part of the initial fee should also be deferred and recognised as the subsequent services are provided

The initial services and other obligations under and area franchise may be based on the number of outlets established in the area.

If so, revenue from franchise fees attributable to the initial services is recognised in proportion to the number of outlet

If the initial fee is collectable over an extended period and there is significant uncertainty as to whether it will be collected in full, revenue should be recognised as collection of the fee is made.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Financial Services fees

Financial Services arise in many forms, including transactions such as loan origination fees, commitment fees, management fees, performance fees in relation to funds and unit trusts. Determining the revenue relation to financial services can be challenging because of the interrelationship between IAS 18 and IAS 39.

The appropriate accounting for financial service fees is primarily determined by whether the fees are:

§ An integral part of the financial instrument’s effective interest rate.

§ Earned as a result of services being provided

§ Earned upon the execution of a significant act.

It may be difficult to determine in which of these categories a fee should be included. In addition, a fee may be cover more than one service by the financial institution.

Fees that are an integral part of the effective interest rate are normally treated as an adjustment to the effective interest rate.

In case of Earned as a result of services being provided revenue will be recognise when services are provided.

In the Earned upon the execution of a significant act, Revenue will be recognised when the act has been performed.

CA. Amit Daga

Finance Controller CA. CS. CFA. CIFRS.

9017 Points Posted on 04 June 2009

Recognising Costs

Reliable measurement of costs incurred is one of the criteria to be satisfied before revenue can be recognised for the sale of goods or rendering of services. The IASB’s framework is based on a balance sheet approach.

IAS 18 refers to the matching of revenue and expenses, stating that revenue and expenses that relate to the same transaction are recognised at the same time.

In certain situations, the timing of costs can vary significantly from the profit of revenue recognition. i.e. in outsourcing contracts where the service provider may incur costs before revenue will be received.

. IAS -11 is clear that, for constructions contracts, direct costs of the contract can be deferred on balance sheet when certain criteria are satisfied.

In contrast, no specific guidance exists in IAS 18. IAS-18 states that, for the rendering of services, the requirement of IAS 11 generally apply to recognising revenue and associated expenses. (POC).

However, IAS 11 would not override any of the IAS 18 guideline.

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Revenue Recognition Under IFRS (IAS -18)

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