Week 2 - Revenue & How Useful is Corporate Reporting? Flashcards
IFRS 15 Revenue: 5 Recognition steps
COPAR
Identify CONTRACTS w customer
Identify the OBLIGATIONS
Determine PRICE
ALLOCATE the price to the performance obligation (only relevant if multiple performance obligations
RECOGNISE revenue when the entity satisfies a performance obligation
Allocating Transaction Prices:
How to do the working
Obligation | Price per obligation (total cost) | Allocate to transaction price (pro rate it to transaction price) | Revenue
TOTAL row at the bottom: Price per obligation total should be higher than the transaction price, then the Revenue columns TOTAL should = transactio price, as they should all have been prorated
e.g. Transaction price is £50,000
Machine & installation obligation price is £51k, and the service checks (£600) AND technical Support (£4k) comes to a total price per obligation of £55,600
So in Allocate to transaction price column, for the machine & installation we would do (51,000/55,600) x 50,000
Then (600/55,600) x 50,000 = 540
(4,000/55,600) x 50,000 = 3,597
45,863+540+3,597 = 50,000 (transaction price)
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Recognising Revenue Example
Machine sold for £100,000, £20k deposit refundable if machine not delivered. Yet to be deliverd. How to recognise the revenue?
Machine sold fo £100,000, £20k deposit refundable if machine not delivered. How to recognise the revenue?
Debit cash £20k, Credit Contract Liability £20k (NO REVENUE AS ITEM NOT DELIVERED TO CUSTOMER YET, even though deposit is non-refundable)
Once machine’s delivered:
Debit cash £80,000
Debit Contract Liability £20,000
Credit Revnue £100,000
Recognising Revenue: Warranty Example
Firm sells printers for £5k, but offers 12 month warranty.
Total yearly cost of repairs & replacements onw arranty is £50k
Dr Cash: £5k
Cr Revenue: £5k
Set up a provision:
Dr Expenses: £50k
Cr Provision: £50k
Recognising revenue, Example:
On 1 January 2023, Bristol Road Bikes Ltd sell and deliver a moped bike to a customer. The list price of the moped is £8,500 but the customer paid £3,000 on delivery of the moped followed by 3 payments of £2,000.
Each payment of £2,000 is made on 1 January of the next 3 years starting on 1 January 2024.
The customer is free to use the moped as they see fit from 1 January 2023 and from that point becomes responsible for insuring the moped against any damage/theft. The effective rate of interest is 4.5%.
If we were asked to recognise using the 5 steps, the transaction price (STEP 3) would be as follows:
List price = £8,500 but customer pays £9,000. We need to split into revenue & interest.
23 3,000 1.045^-1 3,000
24 2,000 1.045^-2 1,914
25 2,000 1.045^-3 1,831
26 2,000 1.045^-4 1,753
Transaction Price 8,498
,’, Interest income = 502 (9,000 - 8,498)
Recognising revenue, Example:
On 1 January 2023, Bristol Road Bikes Ltd sell and deliver a moped bike to a customer. The list price of the moped is £8,500 but the customer paid £3,000 on delivery of the moped followed by 3 payments of £2,000.
Each payment of £2,000 is made on 1 January of the next 3 years starting on 1 January 2024.
The customer is free to use the moped as they see fit from 1 January 2023 and from that point becomes responsible for insuring the moped against any damage/theft. The effective rate of interest is 4.5%.
If we were asked to recognise using the 5 steps and do the double entries, the Recognising Revenue (STEP 5) would be as follows:
On delivery 1/1/23:
Dr Cash 3,000
Dr Receivables 5,498 (becasue revenue of 8,498 - deposit of 3,000)
Cr Revenue 8,498
At 31/12/23:
Unwind discount on receivable: 5,498 x 4.5% = 247
Dr Receivables 247
Cr Interest Income 247
,’, at 31/12/23 we have a receivable of £5,745 (4,498 + 247), interest income of £27 & revenue of £8,498
Recognising rev for multiple obligations
statements for year ended 30 June 20X2
Supply machine, installed 1 October 20X. Also agreed to provide a maintenance service for a 48-month period. Paid deposit of £60,000 when signing the contract, the remaining balance of £800,000 was paid on the day of delivery.
Usual price is £700k for the machine & £5,400 per month for maintenance
1) contract? yes
2) Obligations: Supply and install the machine, 48 months maintenance
3) Price: FV = £860k
4) Allocating price to obligations:
Standalone price| Allocation| Revenue
Supply & install| 700k| (700/959.2) x 860| 627,606
Maintenance| (5400x48)= 259,200| (259.2/959.2) x 860| 232,394
860,000
5) Recognise revenue as the performance obligations are fulfilled
Supply and install machine = on delivery date 1 October 20X1= £627,606
Maintenance service = starts Oct X1 to year end June X2 = 9 months so 9/48 x 232,394 =£43,574
Total rev. recognised for year to June 20X2 = £671,180
Dr Cash 860,000
Cr Revenue 671,180
Cr Contract Liability (39/48 x 232,394) £188,820
Benefits of the IASB Conceptual Framework
2
Ensures consistent accounting practices for comparability (one of the objectives of reporting)
Avoids the disadvantages of rules-based accounting, such as reporters providing info favourably rather than reality
Criticisms of the framework
3 (4,2,1)
Inconsistencies with IFRS standards:
- Deferred tax liabilities (IAS 12) not meeting framework definition of a liability.
- Some assets must be measured at historic cost (inventory IAS2), , but biological asset inventories must be measured at fair value
(Agriculture IAS 40). Barker & Teixeira (2018)
- Some standards require discounting to be used for the measurement of non current liabilities (e.g. Provisions IAS37, Financial Instruments IFRS9) whereas some standards prohibit this (IAS 12 deferred tax)
- Prudence should be neutral, neither understatement nor over. However ‘asymmetric prudence’ common in IFRS standards e.g. IAS 37 Provisions: Uncertain liabilities reocgnised when “probable” but unceratin assets recognised when “virtually certain”. Argument is it reduces “natural bias towards optimism” (IASB, 2018)
Principles its based on are flawed:
- uses balance sheet approach which Barker & Penman (2019) argue marginalises importance of income statement
- Focuses on financial principles and not non-financial concepts such as sustainability
Too little attention on stewardship:
- One reason users need reporting is to assess the stewardship of management. Pelger (2020) critices lack of consideration for this. The info for investors to buy/sell/hold may not be the same as for stewardship decisions. so contradictory.
Criticisms of corporate reporting
6
- Focus on short-term financial performance rather thanlong-term prospects
- Are too historic and are released too late andinfrequently for decision making needs
- Are too long, contain unnecessary information and areprepared to comply with laws and standards rather than to inform stakeholders
- Are susceptible to manipulation e.g. use of ‘earnings management’ practices
- Do not recognise ‘value creation intangible assets’ which drive company value and future prospects (Lev & Gu 2016)
- Tend to show insufficient consideration of climaterelated risk (see next chapter) with a mismatch between sustainability reports and financial
- Boilerplate, refer to FRC findings and reports on this
Materiality in reporting & FRC
FRC’s 2024 thematic review:
“materiality is a practical tool that companies can use to focus reporting on what matters”
“better reporting does not equate to more disclosures”
Assurance vs Service warranty & recognising in statements
assurance warranty comes with the good as standard ,’, not seperate obligation
Service type warranty is seperate obligation
Need to recognise a warranty liability in statements for both, derecognise when costs incurred
Explain the criteria for the satisfaction of performance obligations over time or at a point in time
Performance obligations are settled over time if:
* Customer receives and consumes benefits
* Entity performance creates or enhances an asset the customer controls
* Entity’s performance does create an asset with an alternative use to the entity and entity has enforeable right to payment
