Lecture 6 - Revenue Recognition Flashcards
Revenue Recognition
5 Step Model
1) Identify the Contract
2) Separate POs
3) Determine Transaction Price
4) Allocate Transaction Price
5) Recognize Revenue
Step 1: Identify the Contract
Definition of Contract & Customer
An entity shall apply IFRS 15 to a contracts only if the counterparty is a customer.
Contract = agreement between two or more parties that creates enforceable right and obligations
Customer = Party that has contracted with an entity to obtain G&S that are an output of the entity’s ordinary activities in exchange for consideration
Step 1: Identify the Contract
5 Criteria Contract
Must be met at the commencement.
a. Agreed by all
b. Rights are identifiable
c. Payments terms are identifiable
d. Commercial substance
e. Collectability is probable
Step 1: Identify the Contract
Special Circumstances
When a contract with a customer does not meet thre criteria for a revenue contract and an entity receives consideration from the customer, the entity can only recognize the consideration received as revenue when such amounts are non-refundable and either of the following has occurred:
a. the entity has completed performing all of its obligations and has received all, or substantially all, consideration
b. the contract has been terminated
Step 1: Identify the Contract
Combination of Contract
Entities have to combine individual contracts entered into at, or near, the same time with the same customer if they meet on or more of the following:
Step 2: Separate Performance Obligations (SPO)
SPO Definition
According to IFRS 15, a performance obligation is a promise in a contract to transfer a distinct good or service to the customer. A good or service is distinct if both of the following criteria are met:
- The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer.
- The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.
If a promised G&S is not distinct, an entity is required to combine that G&S with other promised goods or services until it identifies a bundle that is distinct.
Step 2: Separate Performance Obligations (SPO)
Customer Options
(e.g. sales incentives, customer award credits, contract renewal options or other discounts) is a separate perfroamnce obligation onyl if it provides the customer with a material right that the customer would not have received without entering the contract.
Step 2: Separate Performance Obligations (SPO)
It’s an SPO if…
**It is Distinct **
- The item can be sold separately and provides a standalone benefit.
It is a Customer Option that Provides a Material Right:
- The option offers a significant benefit or discount not available without the contract.
Step 3: Determine Transaction Price
Definition
= Amount of consideration to which an entity expects to be entitled in exchange for transferring promised G&S to a customer, which excludes amounts collected on behalf of thrid parties
Effect of:
a) Variable Consideration
b) Constraining estimated
c) Existence of significant financing component
d) Non-Cash consideration
e) Consideration payable to a customer
Step 3: Determine Transaction Price
Variable Consideration
= If an entity’s settlement to a consideration is contingent on the occurence or non-occurence of a future event, the transaction price is considered to be variable.
(e.g. dicounts, penalties, refunds, credits, price concesions, etc.)
You need to ESTIMATE! But how? 2 manners.
- “Expected Value” Approach: weighted probability (large nmb of similar contracts)
- “Most Likely” Appoach: most probable option (limited number of possible amounts)
Step 3: Determine Transaction Price
Constraining Estimates
After estimating the amount of variable consideration, an entity must apply the “constraint” to the estimated amount to prevent the revenue to be overstated.
- “highly probable” that a significant revenue reversal will not occur
- assess whether it is significant relative to the total contract revenue or only the variable consideration
Step 3: Determine Transaction Price
Significant Financing Component
For some transactions, customers may pay in advance or in arrers of the transfer. The entity is required to adjust the transaction price for the effect of time value of money IF
- either benefit signifivantly to the timing
- period is greater than a year
Step 3: Determine Transaction Price
Non-Cash Consideration
An entity is required to include the fair value of any non-cash consideration it receives in the transaction price.
Step 3: Determine Transaction Price
Payable to Customer
Payments can be in the form of cash or non-cash items (e.g. discounts, coupons, vouchers) that a customer can apply against amounts owed to the company.
Define the purpose of the payment to the customer!
Distinct Goods or Services: If the payment is for a distinct good or service provided by the customer, it is accounted for separately.
Reduction of Transaction Price: If the payment is to incentivize the customer or reduce the price of the goods or services being sold, it reduces the transaction price and thus the recognized revenue.
Combination Payments:
Excess over Fair Value: If the payment exceeds the fair value of the goods/services received from the customer, the excess reduces the transaction price.
Uncertain Fair Value: If the fair value cannot be estimated, the entire payment reduces the transaction price.
Step 4: Allocate Transaction Price
2 Methods
Relative Stand-Alone Selline Price Method: allocation the TP to each identified PO based on the proportion of the stand-alone selling price to the sum (i.e. on a pro-rate basis)
Stand-alone selling price: Price at which the G&S is, or would be, sold separately by the entity
- if not observable, estimated with market assessment approach, expected cost plus margin, or residual approach
