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Revenue Recognition Under IFRS (IAS -18)

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)

02 June 2009

Why there is so much attention on Revenue Recognition

“Companies try to boost earnings by manipulating the recognition of revenue…

• before a sale is complete,

• before the product is delivered to a customer, or

• at a time when the customer still has options to terminate, void or delay the sale”

SEC Chairman Arthur Levitt, “Numbers Game” Speech, September 28, 1998

Enron:- Admitted it improperly inflated revenues and hid debt through business partnerships.

Global Crossin:- Mis-stated revenues through the use of reciprocal transactions

AOL Time Warner:- The company employed fraudulent round-trip transactions that boosted its online advertising revenue to mask the fact that it also experienced a business slow-down. AOL time Warner paid $ 300 million to SEC.

Bristol-Myers:- The company improperly inflated revenues by as much as $1.5 billion through use of channel stuffing.

Computer Associates (CA):- CA routinely kept its books open to record revenue from contracts executed after the quarter ended in order to meet Wall Street quarterly earnings estimates. CA prematurely recognized $2.2 billion in revenue in FY2000 & 01. Paid $225 million as penalty

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

What is Revenue ?

What is Income :- The IASB’s Framework for the preparation and presentation of Financial Statements define income as :-

“….increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contribution from equity participants”

What is Revenue:- Revenue is subset of Income and is defined in IAS 18

“… the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants”

Revenue includes only economic benefits arising in the ordinary course of an entity’s activities, whereas income include such benefits that arise from all activities whether ordinary or otherwise

Revenue should be recorded based on the substance, not the form, of a transaction. The substance will not only be based on the transaction’s visible economic effects; it will also have to be analysed based on all the transactions' contractual terms, or the combination of the contractual terms of linked transactions.

Revenue excludes revaluation gain as well as contribution from equity participation and income from non-ordinary activities.

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

Timing of Revenue Recognition

IAS-18 distinguishes between revenue from sale of goods, revenue from the rendering of services and revenue from the use by others of the entity’s assets. But the principal beside all the categories are same

Sale of Goods:- Revenue arising from the sale of goods should be recognized when all of the following criteria have been satisfied:

• the seller has transferred to the buyer the significant risks & rewards of ownership;

• the seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

• the amount of revenue can be measured reliably;

• it is probable that the economic benefits associated with the transaction will flow to the seller;

• the costs incurred or to be incurred in respect of the transaction can be measured reliably.

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

Rendering of Services :- For a transactions involving the rendering of services when the outcome of the transaction can be estimated reliable, revenue should be recognised by reference to the transaction’s stage of completion at the balance sheet date.

The transaction’s outcome can be estimated reliably when all the following conditions are satisfied

• the amount of revenue can be measured reliably;

• it is probable that the economic benefits will flow to the seller;

• the stage of completion at the balance sheet date can be measured reliably;

• the costs incurred, or to be incurred, in respect of the transaction can be measured reliably.

When the above criteria are not met, revenue arising from the rendering of services should be recognised only to the extent of the expenses recognised that are recoverable (a "cost-recovery approach". )

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

Revenue from the use by others of the entity’s assets:- Revenue arising from the use by others of the entity’s assets yielding interest, royalties and dividends should be recognised when:

• Its probable that the economic benefits associated with the transaction will flow to the entity

• The amount of the revenue can be measured reliably

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

The standard clearly states that when the expenses cannot be measured reliably, revenue cannot be recognised and any consideration received should be recognised as a liability.

One of the condition for revenue recognition is that it is probable that the economic benefits relation to the transactions will flow to the entity. In some situation, it may not be probably that the economic benefits will flow to the entity until the consideration is received by the entity or until an uncertainty is removed. In this situation we can’t recognised the revenue until consideration is received of uncertainty is removed.

Where uncertainty arises about the collectibility of an amount that has already been included in revenue, any provision required as result of that uncertainty is recognised as an expenses and not as a reduction of revenue.

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

The principle set out in IAS 18 is that revenue should be measured at the fair value of the consideration received or receivable.

Where goods are sold or services provided in return for consideration in the form of cash or cash equivalents receivable at the time of the transaction or shortly thereafter, the fair value is generally the amount receivable.

However, even then the following factors still require consideration in determining the revenue to be recognised:

• If principal/agency relationship exists and entity is acting as an agent , Revenue should be recognised to the extent that it represents payment for acting as an agent.

• The existence of trade discounts, volume rebates and other incentives which should be taken into account in measuring the fair value of the consideration received

• If transaction forms part of a multiple element transaction, the total consideration should be allocated to each separable element of the transaction.

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

Measurement of Revenue

The principle set out in IAS 18 is that revenue should be measured at the fair value of the consideration received or receivable.

Where goods are sold or services provided in return for consideration in the form of cash or cash equivalents receivable at the time of the transaction or shortly thereafter, the fair value is generally the amount receivable.

However, even then the following factors still require consideration in determining the revenue to be recognised:

• If principal/agency relationship exists and entity is acting as an agent , Revenue should be recognised to the extent that it represents payment for acting as an agent.

• The existence of trade discounts, volume rebates and other incentives which should be taken into account in measuring the fair value of the consideration received

• If transaction forms part of a multiple element transaction, the total consideration should be allocated to each separable element of the transaction.

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

If payment is deferred, the substance of the arrangement is that there is both a sale and a financing transaction. In this case, its necessary to discount the consideration to present value in order to arrive at fair value. IAS-18 requires that the rate of discount should be whichever of the following is more clearly determinable

• the prevailing rate for a similar instrument of an issuer with a similar credit ratin or

• a rate of interest that discounts the nominal amount of the instrument to the current cash sales price of the goods or service

Example:- An entity sells good on extended credit. The goods are sold for $1,200 ON 1ST Jan 2007, receivable on 31st Dec 2008. The customer can borrow at 4.5%

On transaction date, Revenue of $1,099 will be recorded.

The discounted receivable should be updated at each balance sheet date to reflect the passage of time. The resulting increase in the receivable represents interest income and should be recognised from the date of sale to receipt of cash.

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

Sale of Goods

Example:- Goods costing $ 5000 purchased in year 1

1.Sold in same year at $ 8,000

2.Sold in subsequent year at $8000

3.Customer orders the goods and paid $2000 in advance for the goods in year 2, In the year 3 goods are delivered and the balance of $6000 is paid.

Goods purchased are sold in the year

Treatment :- Recognised Revenue of $ 8,000 and cost of sales $ 5000

Goods purchased are sold in the subsequent year

Treatment:- Year-1:- $5000 Inventory will be recorded.

Year-2:-Revenue recognised of $ 8000, cost of sales $ 5000 & inventory will be derecognized.

Goods purchased and paid for in advance are sold in subsequent year

Treatment:- Year-1:- $5000 Inventory will be recorded.

Year-2:- No revenue will be recognised, $2000 will be recognised as liability and inventory will be continue in the books

Year-3:- Delivery has occurred, So Revenue of $8000 will be recognised. Inventory will be derecognized, liability of $2000 will be remove, and cost of sale $5000 will be recorded in books.

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

Risk and Reward of Ownership

The transfer of risk and reward of ownership of goods usually occurs when legal title or possession is transferred to the buyer. IAS-18 notes that in some circumstances the transfer of the significant risks and rewards of ownership may occur before or after delivery.

The timing of the transfer will depend on the contracts specific terms and conditions. i.e. When the entity retains and obligation for unsatisfactory performance not covered by normal warranty provisions

§ When the receipt of the revenue from the sale is contingent on the buyer deriving revenue from its sale of the goods

§ When the goods are shipped subject to installation and such installation is a significant part of the contract that has yet to be completed by the entity.

§ Sale or return basis

§ The seller retains the risk of physical damage to the product.

§ There is a significant doubt as to buyer’s intention or ability to take delivery of goods

§ The seller has a repurchase option at a fixed price

If any of above condition is included in the agreement may indicate the risks and rewards of ownership have not passed and, hence, revenue should not be recognised

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

Example:-

Entity A operates in a country where its commonplace to retain the title to goods sold as protection against non-payment by a buyer.

The retention of the title will enable entity A to recover the goods if the buyer default on payment.

In this case, Once entity A sold the goods to entity B can recognised the revenue, provided buyers controls the goods and its free to use of dispose of them as it wishes.

The most significant risk of ownership, product risk, has been transferred to entity B.

Entity A’s retention of legal title does not affect the substance of the transaction

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CA Tilak Raj Sharma (Practising CA in Solan (H.P.)) (6374 Points)
Replied 02 June 2009

Thanks Amit........

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

Tilak yar i want participation but sorry to say no body is participating in the ifrs discussion.. i am putting so much effort but at the end of the day always result is zero. So far i started so many discussion form on ifrs and put lots of information but no body is participating. I dont know why I bel there can be two reasons only Either Others are smart Or i can say i am the duffer Amit

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CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. ) (9017 Points)
Replied 02 June 2009

Bill and hold sales

Bill and hold sales occur where a customer obtains title to goods, but request that the goods are held by the supplier until the customer requests delivery or collects the goods. In this case, Revenue recognition depends on whether there has been substantive performance under the contract. A key factor to consider is inventory risk. If the seller retains the risk of damages to inventory, it will not be appropriate to recognise the sale. i.e. there are some other conditions which need to be fulfilled before recognition of revenue.

§ The buyer must have taken title to the goods and accepted billing

§ It must be probable that delivery will take place

§ The goods must be on hand, identified and be ready for delivery to the buyer

§ The buyer must specifically acknowledge the deferred delivery instruction.

§ The usual payment term must apply

Revenue is not recognised when there is simply an intention to acquire or manufacture the goods in time for delayed delivery.

Example:- Entity A entered into a contract during 2008 to supply video games to customer in the year 2009, as per instruction of the customer. Usual Payment terms apply. At the year end video games was ready to sale and buyer accepted the billing. As in this case all conditions are fulfilled as on 31st Dec 2008., Therefore Entity A can recognise the revenue in the year 2008 itself.

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