Chapter 6 - Revenue and Inventories

Question 1

What is the definition of revenue?

Answer 1

Revenue is defined as ‘income arising in the course of an entity’s ordinary activities’. (IFRS 15, Appendix A)

If you see the term ‘ordinary activities’ used within a scenario, this simply means normal trading or operating activities.

Question 2

What are the steps to revenue recognition?

Answer 2

• Identify the contract
• Identify the separate performance obligations
• Determine the transaction price
• Allocate the transaction price to the performance obligations
• Recognise revenue as or when a performance obligation is satisfied

Question 3

What criteria must a contract fulfil in order for an entity to account for revenue from it?

Answer 3

An entity can only account for revenue from a contract if it meets the following criteria:

• the parties have approved the contract and each party’s rights can be identified
• payment terms can be identified
• the contract has commercial substance
• it is probable that the selling entity will receive consideration.

Question 4

What is a contract?

Answer 4

An agreement between two or more parties that creates rights and obligations

Question 5

What are the different forms of performance obligations? How do these affect revenue recognition?

Answer 5

An entity must also decide if the nature of a performance obligation is:

• to provide the specified goods or services itself (ie: it is the principal - this is the case if it controls the good or service before it is transferred), or
• to arrange for another party to provide the goods or service (ie: it is an agent).

If an entity is an agent, then revenue is recognised based only on the fee or commission to which it is entitled rather than the full amount.

Question 6

What is a performance obligation?

Answer 6

Performance obligations are promises to transfer distinct goods or services to a customer. A good or service is distinct if it can be sold separately and has a distinct function

Question 7

Which warranties fall under IFRS 15?

Answer 7

An extra additional service is provided to the customer.

If so, this falls within the scope of IFRS 15 and should be treated as a separate performance obligation.

It’s important to also be aware that purchasing extended warranties always falls under IFRS 15.

Question 8

Which warranty falls under IAS 37?

Answer 8

An assurance is provided that the item will work (as intended).

Guaranteeing to repair an item (if it stops working), is recognised as a provision under IAS 37.

Question 9

What is the transaction price? What should you consider?

Answer 9

The transaction price is the consideration that the selling entity will be entitled to once it fulfills its obligations in the contract

You should consider:

• variable consideration
• financing
• non-cash consideration

Question 10

What is variable consideration within determining the transaction price?

Answer 10

IFRS 15 states that if a contract includes variable consideration (e.g. a bonus or a penalty) then the entity must estimate the amount it expects to receive

Question 11

When should the estimate of variable consideration be included?

Answer 11

The estimate of variable consideration will only be included in the transaction price if it is highly probably that a significant reversal in the amount of revenue recognised will not occur when the uncertainty is resolved

The estimate can only be included in the transaction price if it is:

• highly probable
• that a significant reversal (in revenue amounts) will not occur.

Question 12

Which IFRS standards relate to financing?

Answer 12

IFRS 15 (paragraph 60) covering adjusting promised amounts for the time value of money and significant financing components.

IFRS 15 (paragraph 63) covering circumstances where the promised consideration does not need adjusting.

Question 13

How do you treat non-cash consideration in determining the transaction price?

Answer 13

Always remember that any non-cash consideration (for example other assets, products or shares) is measured at fair value at the date of transfer. If fair value cannot be determined, the stand-alone selling price of the goods / services should be used.

Question 14

How do you allocate the transaction price?

Answer 14

The total transaction price should be allocated to each performance obligation in proportion to standalone selling prices.

If a standalone selling price is not directly observable then it must be estimated.

Question 15

When must revenue be recognised?

Answer 15

Revenue is recognised when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer

Question 16

When must an entity determine whether is satisfies the performance obligation?

Answer 16

An entity must determine at contract interception whether it satisfies the performance obligation over time or at a point in time.

If the performance obligation is satisfied over time, then the revenue must be recognised over time, otherwise, the revenue is recognised at a point in time, which is when control of the asset transfers to the customer

Question 17

How does IFRS 15 classify a performance over time?

Answer 17

IFRS 15 Revenue from Contracts with Customers states that an entity only satisfies a performance obligation over time if one of the following criteria is met:

• the customer simultaneously receives and consumes the benefits from the entity’s performance
• the entity is creating or enhancing an asset controlled by the customer
• the entity cannot use the asset for ‘an alternative use’ and the entity can demand payment for its performance to date

Question 18

What if the outcome of the contract cannot be reliably determined?

Answer 18

Then the revenue recognised is restricted to the costs incurred that are recoverable from the customer

Question 19

What if a performance obligation is not satisfied over time?

Answer 19

Then it is satisfied at a point in time. This is normally when the customer obtains control of the promised asset.

An entity controls an asset if it can direct its use and obtain its remaining benefits

Question 20

What are some indicators that control has passed to the customer?

Answer 20

• the customer has physical possession of the asset
• the customer has accepted the asset
• the customer has the significant risks and rewards of ownership
• the customer has legal title
• the seller has a right to payment

Question 21

How do you treat consignment sales?

Answer 21

Where the buyer of the goods undertakes to sell them on behalf of the original seller. The original seller only recognises the sale when the buyer sells them on to a third party (IFRS 15, para B.77)

Question 22

How do you treat bill and hold arrangements?

Answer 22

An entity bills a customer but delivery is delayed with agreement of the customer.

The entity must determine whether control has been transferred to the customer (IFRS 15, para B.79)

Question 23

How do you treat sales with a right of return (refunds)?

Answer 23

Recognise revenue for the goods transferred and a liability for refunds (IFRS 15)

Question 24

What is the main disclosure requirement of IFRS 15?

Answer 24

The main disclosure requirement of IFRS 15 Revenue from contracts with customers is:

• revenue from contracts with customers disclosed separately from other sources of revenue.

Question 25

What does inventory consist of?

Answer 25

• raw materials: components and consumables (such as oil) used in the production process
• work in progress: partly finished goods
• finished goods: completed items manufactured by the business or goods purchased for resale

Question 26

How are inventories valued?

Answer 26

At the lower of cost and net realisable value for each separate product line

Question 27

What is ‘cost’?

Answer 27

Cost is the cost of bringing items of inventory to their current location and condition

Cost = cost of purchase + conversion costs

Question 28

What is cost of purchase?

Answer 28

Purchase price plus directly attributable costs such as import duties, delivery costs

Question 29

What are conversion costs? How do you allocate overheads?

Answer 29

• Costs directly related to producing inventory units e.g. labour, materials
• Allocation of overheads that are incurred in converting materials into finished goods:
  Variable production overheads e.g. electricity: allocated based on actual units of production
  Fixed production overheads e.g. factory rent: allocated based on budgeted normal levels of production

Question 30

What is NRV?

Answer 30

Net realisable value is actual or estimated selling price less all future costs to complete the sale (including all costs to be incurred in marketing, selling and distribution)

Question 31

What are the main disclosure requirements of IAS 2 Inventories?

Answer 31

• the accounting policy which has been adopted (including the cost formula used)
• the total carrying amount included (classified appropriately)
• the amount of inventories that have been carried at NRV
• the amount of inventories that are recognised as an expense during the period
• the details of any circumstances that may have led to the write­down of inventories to their NRV.