bg financial accounting 2 chapter 11 5595

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CHAPTER 11: REVENUE

11.1 Overview of Revenue 11.2 Accounting requirement for Revenue 11.3 Presentation and Disclosure

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 The Five-Step Model

 Other Revenue Recognition Issues

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11.1 Overview of Revenue 11.1.1 Definition of Revenue 11.1.2 Types of Revenue

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11.1.1 DEFINITIONS OF REVENUE

The income generated from sale of goods or services, or any other use of capital or assets, associated with the main operations of an

organization before any costs or expenses are deducted Revenue is

shown usually as the top item in an income (profit and loss) statement

from which all charges, costs, and expenses are subtracted to arrive at

net income Also called sales, or (in the UK) turnover

Or

Revenues or revenue in business is the gross income received by anentity from its normal business activities before any expenses have beendeducted Income may be received as cash or cash equivalent and istypically generated from the sale of goods or the rendering of services

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11.1.1 DEFINITIONS OF REVENUE

- The amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise It is the "top line" or

"gross income" figure from which costs are subtracted to determine net income."

- From the business point of view revenue can be understood as a gross increase in owners’ capital resulting from the operations of a business

- The price of goods sold and services rendered during a given accounting period

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11.1.1 DEFINITIONS OF REVENUE

Other Revenue: Revenue that a company derives from any source

other than its operations For example, if a company sells one of its factories or receives income from interest payments, it is considered other revenue Most (though not all) other revenue is non-repetitive and, as such, is excluded from many calculations of profit"

Net revenue: Net revenue describes the gross revenue minus any

product returns, allowances and any discounts for the early payment of invoices

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Sale of

Goods

Services provided

Lending fees

and investments

Others (Sales of assets etc)

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 Sale return

 Sale Allowances

11.1.2 TYPES OF REVENUE

(11.2.2 Other Revenue Recognition Issues)

Sale return

A sales return is merchandise sent back by a buyer to the seller, usually for one of the following reasons:

 Excess quantity shipped

 Excess quantity ordered

 Defective goods

 Goods shipped too late

 Product specifications are incorrect

 Wrong items shipped

 of goods sold

Sale Allowances

of goods sold A sales allowance is a reduction in the price charged by a seller, due to a problem with the sold product

or service, such as a quality problem, a short shipment, or an incorrect price Thus, the sales allowance is created after the initial billing to the buyer, but before the buyer pays the seller The sales allowance is recorded as a deduction from gross sales , and so is incorporated into the net sales figure in the income statement

The sales allowance account is a contra account , since it offsets gross sales The result of the pairing of the gross sales and sales allowance accounts is net sales There is normally a debit balance in the sales allowance account.

Management usually wants to record sales allowances in a separate account, so that the aggregate amount of allowances given is clearly visible A large balance in this account is an indicator that a business has considerable problems with its products, or damage to those products while in transit.

Trade discount Allowances

of goods Trade discount allowances is a discount which is referred to as, discount given by the seller to the buyer at the time of purchase of goods It is given as a deduction in the list price or retail price of the quantity sold This is usually allowed by the sellers to attract more customers and receive the order in bulk i.e.

to increase the number of sales.

This is a discount allowed on a product as a reduction to the retail price It is the amount by which a manufacturer or wholesaler reduces the price of a product when it sells the product to a reseller.

It usually varies with the quantity of the product purchased It is a reduction in the published price of the product.

For example, a high-volume wholesaler might be entitled to a higher trade discount compared to a medium or low-volume wholesaler.

Usually, a retail customer will not receive any discount and will have to pay the entire published price.

Cash discount Allowances

A cash discount allowances is a reduction in the amount of an invoice that the seller allows the buyer This discount is given in exchange for the buyer paying the invoice earlier than the normal payment date of the invoice There are two reasons why a seller might make this offer:

 To obtain earlier use of cash, which may be necessary if the seller is short of cash; or

 To offer a discount for an immediate cash payment in order to entirely avoid the effort of billing the customer.

The amount of the cash discount is usually a percentage of the total amount

of the invoice, but it is sometimes stated as a fixed amount.

The typical format in which cash discount terms are recorded on an invoice is as follows:

Consignment Sales

Consignment occurs when goods are sent by their owner (the consignor ) to an agent (the consignee ), who undertakes to sell the goods The consignor continues to own the goods until they are sold, so the goods appear as inventory in the accounting records of the consignor, not the consignee

Principal-Agent Relationships,e.g., Consignment

Sales

• Principal’s performance obligation is to provide goods/services to a customer , while

agent’s performance obligation is to arrange for principal to provide goods or services to

a customer

• Examples:

• Travel Company (agent) facilitates booking of cruise for Cruise Company (principal)

• Priceline (agent) facilitates sale of various services such as car rentals at Hertz (principal)

• The principal recognizes revenue when the goods/services are sold to a customer

• The agent recognizes revenue in the amount of the commission that it receives

• Amounts collected on behalf of the principal are not revenue of the agent

Consignment Sales

• Consignments: A type of principal-agent relationships

• Consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer), who is to act as an agent for the consignor in selling the merchandise

• Consignment sales

One party (consignor) ships goods to another party (consignee) for sale

• Consignor (e.g., manufacturer or wholesaler) earns a profit on consignment sales

• Consignee (e.g., dealer) earns a commission on consignment sales

• Possession has transferred; however legal title remains with the consignor

 Question: Goods on consignment should be reported as inventory by the consignor or

consignee? Consignor

Revenue Recognition for Consignment Sales

 Consignor carries goods to consignee and makes a profit on the sale

 Separately classified as Inventory (consignments)

 The consignor recognizes revenue only after receiving notification of sale and the cash remittance from the consignee

 Consignee sells goods for consignor and makes a sales commission.

 The consignee does not record the product as an asset

 The consignee remits to the consignor cash received from customers, after deducting a sales commission and any chargeable expense: recognizes commission revenue while notifying sales and remitting cash to consignor

11.2 Accounting requirement for Revenue 11.2.1 The Five-Step Model

11.2.2 Accounting for Revenue

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REVENUE FROM CONTRACTS WITH CUSTOMER

Step 1:

Identify the contract with the customer

Step 2:

Identify the performance obligations in the contract

Step 3:

Determine the transaction price

Step 4:

Allocate the transaction price to the performance obligations in the contracts

Step 5:

Recognise revenue when or as the entity

satisfies a performance obligation

CORE PRINCIPLE

11.2.1 The Five-Step Model

•the contract has been APPROVED by the parties to the contract;

•each party’s RIGHTS in relation to the goods or services to be transferred can be

identified;

•the PAYMENT TERMS for the goods or services to be transferred can be identified

•the contract has COMMERCIAL SUBSTANCE

•it is PROBABLE that the CONSIDERATION to which the entity is entitled to in exchange for the goods or services will be COLLECTED

[Source: IFRS 15:9]

written, oral or implied by customary business practices, but must be

enforceable, have commercial substance and be approved by the parties to the

Step 1: Identify Contract with the Customer

Contract: Agreement between two or more parties that creates enforceable rights &

obligations

Essentials of a Contract:

- has commercial substance

- has been approved by the parties (Written, Oral or Implied) & commitment to perform obligations

- each party’s right regarding goods/services can be identified

- payment terms can be identified

Apply proposed revenue requirements to each contract unless specified criteria met

for combination of contracts

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 Contract Criteria for Revenue Guidance

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Apply Revenue Guidance to Contracts If: Disregard Revenue Guidance to

Contracts If:

 The contract has commercial

substance;

 The parties to the contract have

approved the contract and are

committed to perform their

respective obligations;

 The company can identify each party’s

rights regarding the goods or

services to be transferred; and

 The company can identify the

payment terms for the goods and

Company applies the revenue guidance to a contract according to the criteria in the

following Illustration

Step 2: Identify separate performance obligations

Performance Obligation: Promise in a contract with a customer to transfer a good or

service to customer

Customer: Party that has contracted with entity to obtain goods/services that are

output of entity’s ordinary activities

- IFRS to apply only to contract when counterparty is Customer

- IFRS not to apply when counterparty might not be customer but rather a collaborator or partner that shares with entity, risks & benefits of developing a product to be marketed

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Transaction price is “the amount

of consideration that a company

expects to receive from a

customer” in exchange for

transferring goods and services

Implementation

1 In a contract , transaction price is often easily determined because customer agrees to pay a fixed amount

2 In other contracts, companies must consider:

(1) variable consideration, (2) time value of money, (3) noncash consideration, and (4) consideration paid or payable

to customer

Step 3: Determine the Transaction Price

Other issues

• Time Value of Money

- When contract (sales transaction) involves a significant financing component

• Fair value determined either by measuring the consideration received

or by discounting the payment using an imputed interest rate

• Company reports interest expense or interest revenue

• Noncash Consideration

- Companies generally recognize revenue on the basis of the fair value of what is received (transactions with commercial substance ).

If that cannot be determined, the selling price of what was given up

- Receive Donation: Contribution Revenue

• Consideration Paid or Payable to Customers

- May include discounts, volume rebates, coupons, or free products

- In general, these elements reduce the consideration received and the revenue

to be recognized

Step 3

If more than one performance

obligation exists, allocate the

transaction price based on

relative fair values

Implementation

The best measure of fair value is what the good service could be sold for on a standalone basis

(standalone selling price)

Estimates of standalone selling price

can be based on 1) adjusted market assessment, 2) expected cost plus a margin approach, or

3) a residual approach

Separate Performance Obligations

STEP 5:

RECOGNISE REVENUE WHEN

OR AS THE ENTITY SATISFIES

A PERFORMANCE OBLIGATION

• The customer SIMULTANEOUSLY RECEIVES

and consumes the benefits provided by the entity’s performance

• The entity’s performance CREATES OR ENHANCES an asset that the customer

controls as the asset is created or enhanced

RECOGNISE

OVER TIME

• -the entity has A PRESENT RIGHT TO

PAYMENT for the asset

• -the customer has LEGAL TITLE to the

asset

• -the entity has TRANSFERRED PHYSICAL

POSSESSION of the asset

• -the customer has the SIGNIFICANT RISKS

AND REWARDS related to the ownership

A company satisfies its

performance obligation

when the customer

obtains control of the

Change in Control Indicators

1.Company has a right to payment for asset.

2.Company has transferred legal title to asset.

3.Company has transferred physical possession of asset.

4.Customer has significant risks and rewards of ownership.

5.Customer has accepted the asset.

Recognizing Revenue When Each Performance Obligation

is Satisfied

• Recognize revenue over a period of time (in a more rigorous manner) if:

(1) The customer controls the asset as it is created or enhanced or

(2) (i) the company does not have an alternative use for the asset created or enhanced and

(ii) either (a) the customer receives benefits as the company performs and therefore the task would not need to be re-performed, or (b) the company has a right to payment and this right is enforceable

• Recognizes revenue over time by measuring the progress toward completion

• Method for measuring progress should depict transfer of control from company to customer

• The most common method is the cost-to-cost method

• percentage-of-completion method

APPLYING THE IFRS FIVE-STEP MODEL

CORE PRINCIPLE: REVENUE FROM CONTRACTS WITH CUSTOMER

recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services

CONCLUSION

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11.2.2 Accounting for Revenue

11.2.2.1 Increase in Revenue 11.2.2.2 Decrease in Revenue

DOUBLE ENTRY FOR REVENUE

• PRINCIPLE:

• An increase of revenue is a credit entry in the revenue account

• An decrease of inventory is a debit entry in the revenue account

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Sales Returns:

1 Dr: Sales Returns

Cr: Accounts Receivable

2 Dr: Inventory

Cr: Cost of Goods Sold

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DOUBLE ENTRY FOR REVENUE

Cash Discount Allowances:

Dr: CashDr: Cash Discount Allowances

11.3 PRESENTATION AND DISCLOSURE

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