Revenue Recognition

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Revenue Recognition

Revenue recognition landscape

6 Construction

contracts

IAS 11 5 IAS 18, 28, 39 IAS 18, 39 IAS 18 4 Multiple elements 3 IAS 18 IAS 18 SIC 31 2

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Revenue Recognition

Definition and scope exclusion

Definition: Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction. Scope exclusion: Does not apply to: Lease agreements; Dividends from investments accounted for under the equity method (IAS 28 Investments in Associates); Insurance contracts within the scope of IFRS 4: Insurance Contracts; Changes in the fair value of financial assets and financial liabilities or their disposal (IAS 39 Financial Instruments: Recognition and Measurement); Changes in the value of other current assets; Initial recognition and from changes in the fair value of biological assets related to agricultural activity (IAS 41: Agriculture); The extraction of mineral ores

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Revenue Recognition

Timing of Recognition Sale of goods

SALE OF GOODS:
Revenue recognition criteria common under IFRS and Indian GAAP 1. Risks/rewards transfer 2. Probable inflow of benefits 3. Revenue measurable reliably Additional revenue recognition criteria under IFRS 4. Costs measurable reliably 5. No continuing managerial involvement

6 Construction contracts

Probable benefits inflow Measurable costs incurred Measurable costs to complete

4 Multiple elements 3

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Revenue Recognition

Timing of Recognition
No Continuing Managerial involvement Indicators of continuing managerial involvement or retention of effective control might include: Control over future price of the item. Responsible for the management of the goods subsequent to the sale. Transaction allows the buyer to compel the seller, or give an option to the seller, to repurchase the item. Guarantees the return of the buyers investment or a return on that investment for a limited or extended period.
Continuing Managerial Involvement Exists! No Sale! No Revenue!

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Revenue Recognition

Continuing Managerial involvement

Handout 1
Continuing Managerial involvement

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Revenue Recognition

Revenue recognition Quick quiz

Scenarios
1 2 Entity which does not retains an obligation for unsatisfactory performance not covered by normal warranty provisions can recognise the revenue immediately When the receipt of the revenue from a particular sale is contingent on the derivation of revenue by the buyer from its sale of the goods, the seller can not recognised the revenue immediately. Revenue can not be recognised when, the goods are shipped subject to installation and the installation is a significant part of the contract which has not yet been completed by the entity. Revenue should not be recognised when the buyer has right to rescind the purchase for a reason specified in the sales contract and the entity is uncertain about the probability of return. If an entity retains only an insignificant risk of ownership, the transaction is a sale and revenue is recognised. Seller can recognise the revenue where transaction allows the buyer to compel the seller, or give an option to the seller, to repurchase the item. If seller guarantees the return of the buyers investment or a return on that investment for a limited or extended period, revenue can not be recognised immediately.

Revenue Recognition

P P P P P O P
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5 6 7

Revenue Recognition

Timing of Recognition Sales on FOB/CIF terms

Sold on FOB basis Sold on CIF basis

No further performance obligations

Evaluate the exact terms of arrangement

Recognition on dispatch is likely to be acceptable

Recognise when risk of loss is transferred to buyer

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Revenue Recognition

Gross v/s Net reporting Certain Items

Particulars Sales taxes Excise Duty Rebates Cash discounts Product return Warranties Shipping and handling charges Reimbursement Otherwise Reporting Net off Sales Gross / Net allowed (policy choice) Reduced from Sales Net Reduced from sales Expensed off separately

Net Gross

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Revenue Recognition

Measurement of revenue
Consideration is deferred

Both a sale and financing transaction.

Revenue =

Discounted fair value of consideration*

* The discount rate is the more clearly determinable of the following:

the prevailing rate for a similar instrument of an issuer with a similar credit rating; or a rate of interest that discounts the nominal amount of the instrument to the current cash sales price of the goods or services.

The difference between the fair value and the nominal amount of the consideration is recognised as interest revenue (as per IAS 39)
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Revenue Recognition

Agency Arrangements
Principal or Agent ?
expectation by the customer that the entity is acting as the primary obligor in the arrangement. freedom to set the selling price with the customer. assumes inventory risk performs part of the services provided or modifies the goods supplied. assumes the credit risk discretion in selecting suppliers

Principal! Gross Reporting!

If these conditions not satisfied NET REPORTING !

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Revenue Recognition

Warranties
Initial warranty Recognise the full consideration if warranty not a separate element and represents an insignificant part of the transaction, the seller has completed substantially all the required performance Expected future cost relating to the warranty not a reduction of revenue but a cost of sale, Costs of warranties determined at the time of the sale - make a provision for warranty costs Costs cannot be measured reliably recognise revenue when the warranty period expires; or cost can be measured reliably
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Extended warranty The revenue from the sale of the extended warranty should be deferred and recognised over the period covered by the warranty, No costs should be accrued at the inception of the extended warranty agreement

Rendering of services

Revenue Recognition

Timing of recognition Services

1 Sale of goods

Probable benefits inflow Measurable costs incurred Measurable costs to complete

5 4 Interest
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Revenue Recognition

Rendering of services Revenue recognition

Outcome of a transaction estimated reliably Stage of completion method Outcome cannot be estimated reliably revenue recognised = recoverable expenses
During the early stages of a transaction, it is often the case that the outcome of the transaction cannot be estimated reliably. Is it probable that the entity will recover the transaction costs incurred? YES
Revenue is recognised only to the extent of costs incurred that are expected to be recoverable. No profit is recognised.

Outcome be estimated reliably if:

Revenue measured reliably; Probable that economic benefits flow to the entity; The stage of completion measured reliably; and The costs incurred for the transaction and the costs to complete the transaction can be measured reliably

NO
Revenue is not recognised The costs incurred are recognised as an expense.

When the uncertainties that prevented reliable estimation no longer exist, revenue is recognised
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Revenue Recognition

Rendering of services - Measurement

Measurement of Revenue by Percentage of Completion method depending on nature of transaction methods may include surveys of work performed; services performed to date as a percentage of total services to be performed; or the proportion that costs incurred to date bear to the estimated total costs of the transaction. Only costs that reflect services performed to date are included in costs incurred to date. Progress payments and advances received from customers often do not reflect the services performed.

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Revenue Recognition

Rendering of services
Treatment of certain specific services 1 Performance over Time services are performed by an indeterminate number of acts over a specified period of time Recognition of contracts containing significant acts Contracts with milestone payments (payment of cash upon the achievement of certain milestones identified in the contract Subscriptions Admission fees Tuition fees Revenue Recognition Revenue is recognised on a straight-line basis unless a better method represents the stage of completion When significant act is executed (e.g. Loan origination fees for arranging loan) Revenue recognition will vary depending on the substance of the arrangements Recognised on a straight-line basis over the period when the items are dispatched Admission fees for special events are recognised when the event takes place Recognised as revenue over the period of instruction.

2 3

4 5 6

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Revenue Recognition

Sale of Software
Following points have to be considered Physical delivery of the software - less indicative of when a sale should be recognised Recognition delayed till acceptance by buyer Depends on type of software Standard off the shelf Recognise revenue on delivery

Customised software

Percentage of completion method

Subject to installation Installation process is simple upon the buyer's acceptance of delivery recognition after >installation >Inspection >customer acceptance
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Process is substantial, Risk of non-acceptance

Multiple Element Arrangement

Revenue Recognition

Timing of recognition Multiple Elements

Multiple Elements IAS 18 para 13: In certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction to reflect substance. Identifying components of a transaction to reflect substance Combining if commercial effect cannot otherwise be understood linked transactions

2 Rendering of services

1 4

6 Dividends, 5 royalties
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Revenue Recognition

Multiple Element transactions

1. Separation of Elements A transaction may contain separately identifiable components that should be accounted for separately. Apply the revenue recognition criteria to each separately identifiable component of a single transaction to reflect the transaction's substance.
To assess the transaction's substance, view from customers perspective customer perceives there to be a number of elements to the transaction,.

customer views the purchase as one product

Customers Perspective

Apply recognition criteria to transaction as whole

Apply recognition criteria to each element separately.

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Revenue Recognition

Multiple Element transactions

2. Allocation of Consideration Revenue in respect of each separable component of a transaction = its fair value. Fair value = price that is regularly charged for an item when sold separately
Total revenue > the sum of the fair value of the separable elements Total revenue < the sum of the fair value of the separable elements

additional revenue attributable to the activity of managing the two elements of the contract

Difference = discount

additional revenue recognised when full contract substantially complete

discount allocated between the separable components using: 1. relative fair values 2. cost plus a reasonable margin

If overall loss on contract recognise immediately

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Revenue Recognition

Multiple Element Transactions

Handout 3
Multiple Element Transactions

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Revenue Recognition

Measurement of revenue- Barter transactions

Goods or services are exchanged or swapped for goods or services which are of a similar nature and value? YES NOT a transaction which generates revenue. NO a transaction which generates revenue.

Can fair value of goods and services received be measured reliably? YES revenue is measured at the fair value of the goods or services received, adjusted by the amount of any cash or cash equivalents transferred. NO the revenue is measured at the fair value of the goods or services given up, adjusted by the amount of any cash or cash equivalents transferred.

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Revenue Recognition

Interests, royalties and dividends

Revenue arising form use by others of entitys asset yielding interests royalties and dividends shall be recognised when
it is probable that the economic benefits associated with the transaction will flow to the entity.

AND

the amount of the revenue can be measured reliably.

on the following basis: Interests

using the effective interest method as set out in IAS 39. on an accrual basis in accordance with the substance of the relevant agreement. when the shareholder's right to receive payment is established
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Royalties

Dividends

Thank You

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