Chapter 9 Revenue Flashcards
1.1 Revenue recognition
Revenue is defined as income arising in the course of an entity’s ordinary activities. An entity shall recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to.
The first step is to identify the contract, then the separate performance obligations, then the transaction price, allocate the price to the performance obligations and recognise revenue when a performance obligation is satisfied.
1.2 Identify the contract
An entity can only account for revenue from a contract if it meets the following:
- The parties have approved the contract and each party’s rights are identified
- Payment terms can be identified
- Contract has commercial substance
- Probable the selling entity will receive consideration
1.3 Identify the performance obligations
Performance obligations are promises to transfer distinct goods/services to a customer. A good or service is distinct if it can be sold separately and has a distinct function.
If another party is involved in providing a good or service, the entity must determine the nature of its performance obligation. This may be providing the good itself (principal) or arranging for goods/services to be provided by another party (agent). The agent is entitled to recognise commission only as revenue.
1.4 Determine the transaction price
The price is the consideration the selling entity is entitled to once it has fulfilled the performance obligations in the contract. The issues are variable consideration, financing and non-cash consideration.
Variable consideration: the entity must estimate the amount it expects to receive. The estimate will only be included in the transaction price if it is highly probable a significant reversal in the amount of revenue recognised will not occur when the uncertainty is resolved. An entity can use two methods:
- Expected value: sum of probability-weighted amounts in a range of possible consideration amounts. This is appropriate estimate if an entity has a large number of contracts with similar characteristics
- Most likely amount: this is the single most likely amount in a range of possible consideration. This is appropriate if the contract only has two possible outcomes.
Financing: entity shall adjust the consideration for the effects of time value of money. An entity does not need to adjust if it expects, at contract inception, that the period between the transfer of goods/services to a customer and the receipt of payment is less than a year.
Non-cash consideration: measured at FV.
1.5 Allocate the transaction price
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 it must be estimated.
1.6 Recognise revenue
Revenue is recognised when the entity satisfies a performance obligation. At contract inception it must determine if it satisfies the performance over time or at a point in time.
Satisfied over time: IFRS 15 states an obligation is met over time if:
- 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 other use and the entity can demand payment for its performance to date
Satisfied at point in time: normally when the customer obtains control of the promised asset. An entity controls an asset if it can direct its use and obtain the benefits. Indicators control has passed to customer include: physical possession, customer accepted asset, customer has risks and rewards of ownership, legal title and seller has right to payment.
1.7 Contract costs
Costs are recognised as an expense over the contract consistent with transfer of goods/services.
Costs to obtain contract: should be allocated to the contract if entity is expected to recover the costs, otherwise expensed immediately.
Costs of fulfilling a contract: an entity shall recognise an asset from the costs incurred to fulfil a contract only if those costs meet all of the following criteria:
- Relate directly to a contract that the entity can specifically identify
- Costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the future
- Costs are expected to be recovered
1.8 Practical application
- Consignment sales: buyer of goods undertakes to sell them on behalf of original seller. Original seller recognises the sale when the buyer sells to a third party
- Bill and hold arrangements: entity bills a customer but delivery is delayed until agreement. The entity must determine whether control has been transferred to customer
- Sale with a right of return: recognise revenue only for the goods transferred not expected to be returned. Recognise a liability for returns. Recognise an asset representing the cost for the goods expected to be recovered on return.
- Warranties: if separately purchased by the customer, should be recognised as a separate performance obligation. Otherwise, warranty is accounted for under IAS 37 Provisions.
1.9 Customer loyalty programmes
These include those where an entity grants loyalty award credits to customers. This results in obligation to provide free or discounted goods. Some of the proceeds from the initial sale should be allocated to award credits as a liability, effectively accounting for the award as a separate component of the sale transaction.
1.10 Construction contracts
A contract for the construction of an asset is a contract whose performance obligation is satisfied over time. Contract revenue is recognised over time based on degree of completion of the contract. It can be assessed by:
- Output method: work certified / total contract price x 100%
- Input method: costs incurred to date / total expected costs x 100%
1.11 Disclosure requirements
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.
2.1 Audit and assurance implications of revenue
Audit risks Audit tests
Identification of a contract Obtain copies of the contract. Inspect contracts to ensure all the conditions of step 1 are satisfied: 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
Identifying separate performance obligations Confirm the goods and services to be transferred under the contract, and ensure that they can be sold separately. Review contract to determine whether acting as a principal or as an agent.
Incorrect transaction price Agree the transaction price to the contract. If discounted, then recalculate the PV and confirm that the discount rate reflects the borrowing rate of the customer. For variable consideration, consider whether it is highly probable that it will be received and whether the estimation method is appropriate i.e. expected value or most likely amount. If non-cash consideration received confirm fair value against market prices or other evidence if that is unavailable.
Ensure that the contract price is appropriately allocated to each performance obligation Confirm stand-alone prices to price lists. If stand-alone price is an estimate consider the reasonableness of the assumptions used e.g. a mark-up.
Revenue is recognised over time if appropriate, or otherwise, when control is transferred Consider whether the criteria for recognising revenue over time is satisfied by reviewing the nature of the contract and the goods or service provided. With reference to the contract terms, consider when control is transferred to the customer.
Construction contracts: Incorrect measurement of contract revenue, Incorrect measurement of contract costs, Incorrect assessment of overall outcome of contract, Incorrect measurement of stage of completion, Asset may not be recoverable Agree total revenue to sales contract. Agree any contract variations to correspondence with customer. Obtain details of costs incurred and agree to supporting documentation such as timesheets and goods received notes. Check costs allocated to the appropriate contract. Review the calculation of costs to complete and assess the validity of any assumptions made by management. Where possible, compare the overall expected profitability with other similar projects. Recalculate the overall profit or loss expected from the project. If insufficient information exists, confirm that revenue is recognised only to the extent that costs are recoverable. Establish the way in which the stage of completion has been measured (e.g. by surveyor) and determine whether it appears reasonable – recalculate. Where the stage of completion is based on costs incurred to date assess whether they fairly represent the stage of completion (i.e. they do not represent inefficiencies). Assess the likelihood of recovery of revenue recognised but not yet received (may represent a bad debt).
