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Meetings Summary Financial AccountingMeeting 1: Revenue Recognition and Provisions, Contingent liabilities & Contingent assets
IFRS 15 is a new standard specifying the accounting treatment for all revenue arising from contracts with customers. It
applies to all entities that enter into contracts to provide goods or services to their customers, unless the contracts are
within the scope of other IFRS standards (e.g. lease contracts).
The standard outlines the principles an entity must apply to measure and recognize revenue and the related cash flows. An
entity applies the five-step model to recognize revenue at an amount that reflects the consideration to which the entity
expects to be entitled in exchange for transferring goods or services to a customer.
1. Identify the contract(s) with a customer
- Any contracts that create enforceable rights and obligations fall within the scope of the standard
Dependents on the facts and customers
o The contract is approved by all parties
o The entity can identify the rights of each contract under the contract
o The entity can identify the payment terms
o The contract has commercial substance
o Collectability is probable
- Entities are required to continue assessing the criteria throughout the term to determine if they are
subsequently met
2. Identify the performance obligations in the contract
- Promised goods or services are accounting for as separate performance obligations if they are distinct or if
they are part of a series of distinct goods and services that are substantially the same and have the same
pattern of transfer to the customer.
3. Determine the transaction price
- This is the amount of consideration to which an entity expects to be entitled in exchange for transferring
promised goods or services to a customer, which excludes amounts collected on behalf of a third party.
4. Allocate the transaction price to the performance obligations in the contract
- An entity allocates the transaction price to each identified performance obligation based on the proportion
of the stand-alone selling price of that performance obligation to the sum of the total stand-alone selling
prices of all performance obligations. This is known as the relative stand-alone selling price method. Using
this method, any discount within the contract will be allocated proportionally to all of the separate
performance obligations in the contract (assignment 1.2)
5. Recognise revenue when (or as) the entity satisfies the performance obligation(s)
- Under IFRS, revenue can only be recognized when an entity satisfies an identified performance obligation by
transferring a promised good or service to a customer.
o Performance obligations satisfied over time: An entity has to meet one of the following criteria in
order to recognize revenue over time
a. The benefits provided by the entity’s performance are simultaneously received and consumed
by the customer;
b. The customer controls an asset that is being created or enhanced by the entity’s performance;
c. The asset created has no alternative use to the entity and there is an enforceable right to
payment for the work performed to date
o Performance obligation satisfied at a point in time: To help entities determine the point in time
when a customer obtains control of a particular good or service, the standard provides a list of
indicators of the transfer of control:
a. The entity has a present right to payment for the asset
b. The asset’s legal title is held by the customer
c. Physical possession of the asset has been transferred by the entity
d. The significant risks and rewards of ownership of the asset reside with the customer
e. There is customer acceptance of the asset
An entity is required to capitalize as an asset two types of costs relating to a contract with a customer
- Any incremental costs to obtain the contract that would otherwise not have been incurred, if the entity
expects to recover them
, - Costs incurred to fulfil a contract with a customer, if certain are criteria are all met
o They are directly related to a specific contract or to a specific anticipated contract (e.g. direct
labour and materials)
o They generate/enhance resources of the entity that will be used in satisfying performance
obligations in the future; and
o They are expected to be recovered
Principal versus agent considerations
- In arrangements that three of more parties, an entity will have to determine if it is acting as a principle or an
agent in order to determine the amount of revenue to which it is entitled. When the entity is the principal,
the revenue is the gross amount to which the entity expects to be entitled. When the entity is the agent, the
revenue is the net amount that the entity Is entitled to retain in return of its services as agent (e.g.
commission)
- Given that the identification of the principal and agent in a contract is not always straightforward, IFRS 15
provides the following indicators to help entities asses if there is an agency relation
o Entity does not have the primary responsibilities of fulfilling the contract
o Entity has no inventory risks over the goods transferred
o Entity does not have discretion in establishing prices
o Entity’s consideration is in the form of a commission
o The entity is not exposed to customer credit risk for the amount due in exchange for the other
party’s goods or services
Assignment 1.1. REVENUE RECOGNITION – SALE OF GOODS
In each of the following situations, state at which date, if any, revenue will be recognized:
1. A contract for the sale of goods is entered into on 1 May 2016. The goods are delivered on 15 May 2016. The
buyer pays for the goods on 30 May 2016. The contract contains a clause that entitles the buyer to rescind the
purchase at any time. This is in addition to normal warranty conditions.
- Answer: In this case, there is no revenue recognition. The contract contains a clause that the buyer can
rescind the purchase at any time. Consequently, the significant risks of ownership of the asset are not
transferred to the customer. Hence, there is no control transfer and as a result no revenue recognition. The
seller of the good continues to have control.
2. A contract for the sale of goods is entered into on 1 May 2016. The goods are delivered on 15 May 2016. The
buyer pays for the goods on 30 May 2016. The contract contains a clause that entitles the buyer to return the
goods up until 30 June 2016 if the goods do not perform according to their specification.
- Answer: In this case, the transfer of control happens on the June 30 2016, as the customer no longer holds
the rights to return the goods and receives legal title of the asset on this date. As the control transfer is on
June 30, 2016, the seller can recognize the revenue on this date.
3. A contract for the sale of goods is entered into on 1 May 2016. The goods are delivered on 15 May 2016. The
contract contains a clause that states that the buyer shall only pay for those goods that it sells to a third party for
the period ended 31 August 2016 (or earlier when notified of sale). Any goods not sold to a third party by that
date will be returned to the seller.
- Answer: The goods are firstly put into a provision for unsold goods when delivered on the 15 th of May.
Revenue will be recognized as the goods are sold by the buyer to a 3 rd party (gross amount). The amount not
yet sold remains in the provision for unsold goods in the financial statements of the seller
4. 4. Retail goods are sold with normal provisions allowing the customer to return the goods if the goods do not
perform satisfactorily. The goods are invoiced on 1 May 2016 and the customer pays cash for them on that date.
- Answer: A right of return is not a separate performance obligation but it affects the estimated transaction
price for transferred goods. The estimate of expected returns should be calculated in the same way as other
variable consideration. Consequently, only recognize revenue for the expected amount the entity does not
expect to be returned on the 1st of May. The additional revenue follows when the customers loses ‘the right
of return’.
Assignment 1.2. MULTIPLE-ELEMENT ARRANGEMENT
Company A provides a bundled service offering to Customer B. It charges Customer B $38,000 for initial connection to its
network and two ongoing services — access to the network for 1 year and ‘on-call trouble-shooting’ advice for that year.
,Customer B pays the $38 000 upfront, on 1 July 2015. Company A determines that, if it were to charge a separate fee for
each service if sold separately, the fee would be:
- Connection fee $ 6,000
- Access fee $ 13,000
- Troubleshooting $ 24,000
The end of Company A’s reporting period is 30 June. Prepare the journal entries to record this transaction in accordance
with IFRS 15 for the year ended 30 June 2016, assuming Company A applies the relative fair value approach. Show all
workings.
Answer:
The aggregate of the stand-alone selling prices ($6,000+$13,000+$24,000 = $43,000) exceeds the total transaction price of
$38,000, indicating there is a discount inherent in the contract. That discount must be allocated to each of the individual
performance obligations based on the relative stand-alone selling price of each performance obligation. Therefore, the
amount of the $38,000 transaction price is allocated to each performance obligation as follows:
- Connection fee 6,000/43,000*38,000 = $5,302
- Access fee 13,000/43,000*38,000 = $11,488
- Troubleshooting fee 24,000/43,000*38,000 = $21,209
- Total relative stand-alone selling price = $38,000
The connection fee is a performance obligation recognized at a point in time (1 st of July, 2015). However, the access fee and
troubleshooting fee are performance obligations recognized over a time (1 year period). Consequently, the following
journal entries are made on July 1st, 2015 and June 30th, 2016 respectively.
Date Name account Debit Credit
July 1st, 2015 Cash $38,000
Revenue (connection) $5,302
Unearned revenue access $11,488
Unearned revenue $21,209
troubleshooting
Date Name account Debit Credit
June 30, 2016 Unearned revenue access $11,488
Unearned revenue $21,209
troubleshooting
Revenue $32,697
Assignment 1.3. REVENUE RECOGNITION – RENDERING OF SERVICES
In each of the following situations, state at which date/s, if any, revenue will be recognized:
1. A contract for the rendering of services is entered into on 1 May 2016. The services are delivered on 15 May 2016.
The buyer pays for the services on 30 May 2016.
- Answer: Services are delivered on 15th May 2016. Hence this is the date that the control transfers from the
seller to the buyer, and consequently, revenue is recognized at this date.
2. A contract for the rendering of services is entered into on 1 May 2016. The services are delivered continuously
over a 1-year period commencing on 15 May 2016 (every month). The buyer pays for all the services on 30 May
2016.
- Answer: As the performance obligations are delivered continuously over the 1 year period, the revenue
should also be recognized continuously over this one year period.
3. A contract for the rendering of services is entered into on 1 May 2016. The services are delivered continuously
over a 1-year period commencing on 15 May 2016. The buyer pays for the services on a monthly basis,
commencing on 15 May 2016 (every month).
- Answer: As the performance obligations are delivered continuously over the 1 year period, the revenue
should also be recognized continuously over this one year period
, 4. Company A is an insurance agent and provides insurance advisory services to Customer B. Company A receives a
commission from Insurance Company I when Company A places Customer B’s insurance policy with Insurance
Company I, on 1 April 2016. Company A has no further obligation to provide services to Customer B.
- Answer: Company A is an agent, so they should recognize the net amount the company is expected to retain
in return for its services as an agent. Consequently, revenue should be recognized when the performance
obligation is satisfied, which is on the 1st of April 2016.
5. Company A is an insurance agent and provides insurance advisory services to Customer B. Company receives a
commission from Insurance Company I when Company A places Customer B’s insurance policy with Insurance
Company I, on 1 April 2016. Company A is required to provide ongoing services to Customer B until 1 April 2017
(every month starting 1 April 2016). Additional amounts are charged for these services. All amounts are at market
rates.
- Answer: Company A is an agent, so they should recognize the net amount the company is expected to retain
in return for its services as an agent. As it is an ongoing services, revenue should be recognized continuously
as performance obligations are satisfied continuously until March 2017.
6. Company A receives a non-refundable upfront fee from Customer B for investment advice on 1 March 2016.
Under the agreement with Customer B, Company A must provide ongoing management services until 1 March
2017. An additional amount is charged for these services. the upfront fee is higher than the market rate for
equivalent initial investment advice services.
- Answer: This is an ‘it depends’ situation. If the investment advice given on 1 March 2016 is a separate
performance obligation, you have to recognize a stand-alone selling price and recognize revenue for the
investment advice, and the management services fees would be recognized over the 1-year period. However,
if the investment advice is not a separate performance obligation, you have to recognize the entire upfront
fee for both the investment advice and management services over the 1-year period until March 1, 2017.
Whether the initial investment advice is a separate performance obligation depends on the usefulness of the
report. If the initial investment advice is a useful report, one should recognize revenue. However, if the initial
investment advice is useless (without the management services), one should recognize the entire upfront fee
over the 1-year time period.
IAS 37 deals with the recognition, measurement, and presentation of provisions and contingent assets and contingent
liabilities. The standard contains specific requirements regarding the recognition of restricting provisions and onerous
contracts.
A provision is a subset of liabilities which is uncertain timing or amount. It is this uncertainty that distinguishes provisions
from other liabilities. A constructive obligation is defined as an obligation that derives from an entity’s actions where an
established pattern of past practice indicates to other parties that the entity will accept certain responsibilities,
consequently creating reasonable expectations from those parties that the entity will discharge those responsibilities. A
present obligation would come into existence when the decision was communicated publicly to those affected by it. This
would result in the valid expectation that the entity would fulfil the obligation; thus leaving the entity with little or no
discretion to avoid the outflow of economic benefits.
IAS 37 requires a provision to be recognized when:
a. The entity has a present obligation (legal or constructive) as a result of past event;
b. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation
c. A reliable estimate can be made of the amount of the obligation
A contingent liability is defined as:
a. A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence
or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or
b. A present obligation that arises from past events but is not recognized because:
- It is not probable that an outflow of resources embodying economic benefits will be required to settle the
obligation
- The amount of the obligation cannot be measured with sufficient reliability
On that basis, a contingent liability under IAS 37 means on the following:
a. An obligation that is estimated to have less than a 50% likelihood of existing
b. A present obligation that has less than 50% likelihood of requiring an outflow of economic benefits
c. A present obligation for which a sufficiently reliable estimate cannot be made
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