Revenue

Question 1

Revenue recognition 1.1 Revenue

Answer 1

Revenue is defined as ‘income arising in the course of an entity’s
ordinary activities’. (IFRS 15, Appendix A)
 Revenue results from:
– the sale of goods
– the rendering of services
– the receipt of interest, royalties and dividends.
 ‘Ordinary activities’ means normal trading or operating activities.

Question 2

Revenue recognition 1.2 Core principle

Answer 2

‘The core principle of this Standard is that an entity shall
recognise revenue to depict the transfer of promised goods or
services to customers in an amount that reflects the
consideration to which the entity expects to be entitled in
exchange for those goods or services’ (IFRS 15, para 2).

Question 3

Revenue recognition 1.3 A five step process

Answer 3

Step 1
Identify the contract
Step 2
Identify the separate performance obligations
Step 3
Determine the transaction price
Step 4
Allocate the transaction price to the performance obligations
Step 5
Recognise revenue as or when a performance
obligation is satisfied

Question 4

Revenue recognition 1.4 Step 1: Identify the contract

Answer 4

IFRS 15 Revenue from Contracts with Customers states that a contract
is an agreement between two parties that creates rights and obligations.
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 5

Revenue recognition 1.5 Step 2: Identify the performance obligations

Answer 5

IFRS 15 states that the distinct performance obligations within a
contract must be identified.
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.

ContractPerformance
obligation 1
e.g. The sale
of a motor
vehicle

Performance
obligation 2
e.g. The
provision of
servicing for
2 years

Question 6

Revenue recognition 1.5 Step 2: Identify the performance obligations Principal or agent?

Answer 6

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 or service itself – the entity is the principal, or
 arranging for the goods and services to be provided by another
party – the entity is the agent.
An entity is the principal if it controls the good or service before it is transferred to the
buyer.
The agent is entitled to recognise commission only as revenue.

Question 7

Revenue recognition 1.6 Step 3: Determine the transaction price

Answer 7

The transaction price is the consideration that the selling entity will be entitled to
once it has fulfilled the performance obligations in the contract.
There are a number of issues to consider here:

Transaction price:
Variable consideration
Financing
Non-cash consideration

Question 8

Revenue recognition 1.6 Step 3: Determine the transaction price
Variable consideration

Answer 8

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.
This estimate of variable consideration will only be included in the transaction price if
it is highly probable that a significant reversal in the amount of revenue
recognised will not occur when the uncertainty is resolved.
An entity shall estimate an amount of variable consideration by
using either of the following methods, depending on which
method the entity expects to better predict the amount of
consideration to which it will be entitled:

(a) The expected value – the expected value is the sum of
probability-weighted amounts in a range of possible
consideration amounts. An expected value may be an
appropriate estimate of the amount of variable consideration
if an entity has a large number of contracts with similar
characteristics.
(b) The most likely amount – the most likely amount is the single
most likely amount in a range of possible consideration
amounts (i.e. the single most likely outcome of the contract).
The most likely amount may be an appropriate estimate of the
amount of variable consideration if the contract has only two
possible outcomes (for example, an entity either achieves a
performance bonus or does not). (IFRS 15, para 53

Question 9

Revenue recognition 1.6 Step 3: Determine the transaction price
Financing

Answer 9

‘In determining the transaction price, an entity shall adjust the
promised amount of consideration for the effects of the time value
of money.’ (IFRS 15, para 60)
‘An entity need not adjust the promised amount of consideration for the effects
of a significant financing component if the entity expects, at contract inception,
that the period between when the entity transfers a promised good or service
to a customer and when the customer pays for that good or service will be one
year or less.’ (IFRS 15, para 63)

I.e. discount if will recieve money after more than a year

Question 10

Revenue recognition 1.7 Step 4: Allocate the transaction price

Answer 10

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

Transaction price:
Performance obligation 1
Performance obligation 2

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

Question 11

Revenue recognition 1.8 Step 5: Recognise revenue

Answer 11

Revenue is recognised ‘when (or as) the entity* satisfies a
performance obligation by transferring a promised **good or service **
… to a customer*.’ (IFRS 15, para 31)
An entity must determine at contract inception 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.

Performance obligation 1:
Satisfied over time?
Satisfied at a point in time?

Question 12

Revenue recognition 1.8 Step 5: Recognise revenue Satisfied over time

Answer 12

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

1. the customer simultaneously receives and consumes the benefits
   from the entity’s performance
2. the entity is creating or enhancing an asset controlled by the
   customer

The entity cannot use the asset ‘for an alternative use’
The entity can demand payment for its performance to date.
Note: If the outcome of the contract cannot be reliably determined, the revenue recognised is restricted to the costs incurred that are recoverable from the customer.

Question 13

Revenue recognition 1.8 Step 5: Recognise revenue Satisfied at a point in time

Answer 13

If a performance obligation is not satisfied over time, 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. Some indicators that control has passed to the
customer include:
 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 14

Revenue recognition 1.9 Contract costs

Answer 14

Contract costs are recognised as an expense over the period of the contract
consistent with the transfer to the customer of the goods or services i.e. the costs are
recognised in the SPL as the revenue is recognised.

Question 15

Revenue recognition 1.9 Contract costs Costs to obtain a contract

Answer 15

Incremental costs of obtaining a contract, such as tendering costs, should be
allocated to the contract if the entity expected to recover those costs. Otherwise, they
must be expensed immediately.

Costs to obtain a contract that would have been incurred
regardless of whether the contract was obtained shall be
recognised as an expense when incurred, unless those costs are
explicitly chargeable to the customer regardless of whether the
contract is obtained. (IFRS 15, para 93)

Question 16

Revenue recognition 1.9 Contract costs Costs of fulfilling a contract

Answer 16

If the costs incurred in fulfilling a contract with a customer are not
within the scope of another Standard (for example, IAS 2
Inventories, IAS 16 Property, Plant and Equipment or IAS 38
Intangible Assets), an entity shall recognise an asset from the
costs incurred to fulfil a contract only if those costs meet all of the
following criteria:

(a) the costs relate directly to a contract or to an anticipated
contract that the entity can specifically identify (for example,
costs relating to services to be provided under renewal of an
existing contract or costs of designing an asset to be
transferred under a specific contract that has not yet been
approved)

(b) the costs generate or enhance resources of the entity that will
be used in satisfying (or in continuing to satisfy) performance
obligations in the future, and
(c) the costs are expected to be recovered. (IFRS 15, para 95)

Question 17

Revenue recognition 1.10 Practical application: Guidance from IFRS 15 Appx B

Area: Consignment sales

Answer 17

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 B.77)

Question 18

Revenue recognition 1.10 Practical application: Guidance from IFRS 15 Appx B

Area: Bill and hold
arrangements

Answer 18

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 B.79)

Question 19

Revenue recognition 1.10 Practical application: Guidance from IFRS 15 Appx B

Area: Sale with a right of
return (refunds)

Answer 19

1 . Recognise revenue only for the goods transferred that are not
expected to be returned.

2a. Recognise a liability for refunds.

2b. Recognise an asset representing the cost of the goods that
are expected to be recovered on return. (IFRS 15 B.21)

Question 20

Revenue recognition 1.10 Practical application: Guidance from IFRS 15 Appx B

Area: Warranties

Answer 20

If the warranty has been separately purchased by the
customer, or provides a service, it should be recognised as a
separate performance obligation under IFRS 15.

Otherwise, the warranty is accounted for under IAS 37
Provisions, Contingent Liabilities and Contingent Assets
(IFRS 15 B.28 – 30)

Question 21

Revenue recognition 1.11 Customer loyalty programmes

Answer 21

Customer loyalty programmes include those where an entity grants loyalty award
credits to customers who buy other goods or services. This results in the obligation to
provide free or discounted goods or services to customers who redeem these award
credits.
 Some of the proceeds from the initial sale should be allocated to the award
credits as a liability, effectively accounting for the award as a separate
component of the sale transaction.

Question 22

Revenue recognition 1.12 Construction contracts

Answer 22

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 the degree
of completion of the contract. The degree of completion can
be assessed in the following ways:

1 Output method
Work certified/Total contract price × 100%
Work certified represents the sales value of the work completed to date. It may be
certified by the customer, or in more complex projects, by an expert.
If this method is required to be used in the exam, the level of work certified will be
given in the question.

2 Input method
Costs incurred to date/Total expected costs × 100%

Question 23

Revenue recognition 1.13 Disclosure requirements The main disclosure requirement of IFRS 15 Revenue from contracts with customers
is:

Answer 23

Revenue from contracts with customers disclosed separately from other
sources of revenue

Question 24

Audit and assurance implications of
revenue: Audit tests

Audit risks:

Identification of a
contract

Answer 24

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.

Question 25

Audit and assurance implications of
revenue: Audit tests

Audit risks:

Identifying separate
performance
obligations

Answer 25

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.

Question 26

Audit and assurance implications of
revenue: Audit tests

Audit risks:

Incorrect transaction
price

Answer 26

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.

Question 27

Audit and assurance implications of
revenue: Audit tests

Audit risks:

Ensure that the
contract price is
appropriately
allocated to each
performance
obligation

Answer 27

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.

Question 28

Audit and assurance implications of
revenue: Audit tests

Audit risks:

Revenue is
recognised over time
if appropriate, or
otherwise, when
control is transferred

Answer 28

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.

Question 29

Audit and assurance implications of
revenue: Audit tests

Audit risks:

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

Answer 29

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).