CH 3. Revenue Flashcards
What is the objective of IFRS 15 Revenue from Contracts with Customers?
to establish the principles for reporting useful information to users of financial statements about:
Nature
Amount
Timing
Uncertainty of revenue
Cash flows
arising from a contract with a customer.
The core principle is that an entity recognises revenue to depict the transfer of promised goods or services to customers.
Define the Key terms-
Income
Revenue
Contract
Contract Asset
Receivables
Contract Liability
Customer
Performance Obligations
Stand-alone Selling Price
Transaction price
Income: Any form of asset that results in an increase of an inflow, or decrease of any form of liability outflow.
Revenue: Income arising in the course of an entity’s ordinary activities.
Contract: An agreement between two or more parties that creates enforceable rights and obligations.
Contract Asset: An entity’s right to consideration in a transfer for goods or services. when that right is conditioned on something other than the passage of
Receivables: An entity’s right to consideration that is unconditional.
Contract Liability: An entity’s obligation to deliver goods or services. for which the entity has received consideration.
Customer: A party of the contract with an entity to obtain goods or services that are an output of the entity
Performance Obligations: A promise in a contract with a customer to transfer to the customer a distinct good or service, or a series of distinct goods or service.
Stand-alone Selling Price: the price at which an entity would sell a promised good or service separately to a customer.
Transaction price: The amount of consideration to which an entity expects to be enti~ed in
exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties.
What are the 5 steps to revenue recognition?
- Identify the contract with the customer
- Identify the performance obligation(s)
- Determine the transaction price
- Allocate the transaction price to the performance obligations
- Recognise revenue when (or as) the performance obligations are satisfied
How do you identify a contract with the customer?
(A) A contract exists an agreement between two or more parties that creates enforceable rights and obligations
and
(B) All of the following criteria are met:
- Approved the contract in writing, orally or implied customary practices
- Identify each party’s rights
- Identify payment terms
- The contract has commercial substance (risk, timing or amount of future cash flows expected to change as a result of contract)
- Probable that the entity will collect the full consideration
If the criteria in (b) are not met, you must continue to assess the contract against the criteria. If they are met in the future, the entity must then apply the revenue recognition model.
If the criteria in (b) are not met (e.g unlikely to collect the full consideration) and substantially most of the consideration has already been received, you should recognise the consideration received as revenue/sales when:
- The entity has no remaining obligations to the customer and substantially all of the consideration has been received and is not refundable;
or
- The contract has been terminated and consideration is not refundable.
Otherwise, the entity should recognise a liability for the amount of the consideration received.
How do you Identify the separate performance obligations in the contract?
A promised good or service is distinct if:
- the customer can benefit from the good or service on its own or by using resources that are readily available.
- the promise to provide the good or service is separately identifiable from other contractual promises.
If a promised good or service is not distinct, an entity should combine that good or service until it identifies a bundle that is distinct
• A series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer.
How do you identify the transaction price?
- What can affect the T.P?
The transaction price is the amount to which the entity expects to be ‘entitled’ likely to receive.
In determining the transaction price, you must consider the effects of:
- (a) The existence of a significant financing component
- (b) Non-cash consideration
- (c) Consideration payable to a customer
- (d) Variable consideration
Discounting is not required if the consideration is due within a year.
If Discounting is applied, it must be presented separately from revenue as interest income.
How does a significant finance element determine the transaction price?
In determining the transaction price, you must consider the effects of:
(A) The existence of a SIGNIFICANT FINANCE ELEMENT
Consider if the timing of payments provides the customer or the entity with a financing benefit.
Measured by:
- The DIFFERENCE between the CASH SELLING PRICE and the PROMISED CONSIDERATION.
- The LENGHT OF TIME between the TRANSFER of the GOODS or SERVICES to the customer and the payment date.
Revenue should be split for the finance element and the service or good supplied by discounting T.P at the customers borrowing rate.
The unwinding of the discounting is recognised as finance income in the following years.
How does a Non-cash consideration affect the transaction price?
In determining the transaction price, you must consider the effects of:
(b) Non-cash consideration
- Any non-cash consideration is measured at FAIR VALUE.
If the fair value cannot be estimated reliably then:
- Measured using the stand-alone selling price of the good or
services promised.
How does a consideration payable (Incentive payments) determine the transaction price?
In determining the transaction price, you must consider the effects of:
(c) Consideration payable to a customer
- If consideration paid to a customer is in exchange for a distinct good or service, then it should be accounted for as a purchase transaction.
-
Assuming that the consideration paid to a customer is not in exchange for adistinct good or service, it is accounted as a REDUCTION of the transactionprice. e.g.
- Compensation payments
- Cashback rewards
How does a variable consideration determine the transaction price?
In determining the transaction price, you must consider the effects of:
(d) Variable consideration
- The entity must estimate the amount it will be entitled to.
’ Revenue can only be included in the T.P if it is highly probable that a significant reversal will not occur when the uncertainty is resolved’
-
Measure Variable consideration by:
- Probability-weighted expected values
- Most likely amount
Applies to Transactions:
- Revenue with a Refund policy
- Revenue with a bonus for meeting criteria
- Revenue with a clawback clause
- Sales with discount policy
3.1.7 How do you Allocate the transaction price to performance obligations?
The total transaction price should be allocated to each performance obligation in proportion to the stand-alone selling prices if sold separately.
If a stand-alone selling price is not directly observable then it must be estimated. Observable inputs should be maximised whenever possible.
If a customer is offered a discount or an incentive for purchasing a bundle of goods and services, then the discount should be allocated across all performance obligations within the contract in proportion to their stand-alone selling prices, (unless observable evidence suggests that this would be inaccurate).
3.1.8 How do you recognise revenue?
Revenue is recognised when a performance obligation is satisfied:
- When the entity transfers a promised good or service to a customer.
- An asset is considered transferred when the customer obtains control of that asset. Control of an asset refers to the ability to direct the use of and obtain substantially all of the remaining benefits from, the asset.
- The customer has Consumed or benefited from the service. if the service contract spans over a period, recognise the revenue for the service period provided and the remaining contract period is deferred income.
How do you recognise revenue, when the satisfaction of a performance obligation is over a period of time?
- (a) Customer receives and consumes the benefits provided by the entity’s e.g lease of property or I.T Maintainance.
- (b) The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced; (eg work in progress of construction contract)
- (c) The entity’s performance does not create an asset with an alternative use (internally) to the entity and the entity has an enforceable right to payment for performance completed to date.
For each performance obligation satisfied over time, revenue should be recognised by measuring:
- output methods (progress of outputs) using tools (such as surveys of performance, or time elapsed
- input methods (such as costs incurred as a proportion of total expected costs)
If progress cannot be reliably measured then revenue can only be recognised up to the recoverable costs incurred.
e.g Building project - A builder has completed the foundation of the building which is worth 10% of the full contract so it should recognise 10% of the full contract value. (output method)
What are the indicators for the satisfaction of a performance obligation at a point in time?
To determine the point in time when a customer obtains control of the asset or service provided.
The entity would consider indicators of the transfer of control that include, but are not limited to, the following (para. 38):
(a) A present right to payment for the asset.
(b} Customer has legal title to the asset.
(c) Transferred physical possession of the asset.
(d) The customer has the significant risks and rewards of ownership of the asset
(e) Customer has accepted the asset.
How should the cost obtain a contract be treat? (Contract costs)
Incremental costs of obtaining a contract are recognised as an asset if the entity expects to recover them.
e.g architectural firm tendering for a contract will incur nominal costs creating basic plans and drawings.
Journal’s
Dr - Contract asset
Cr - Cash
The asset should then be amortised over the life of the revenue contract.
