Case Study – Session 1

Revenue recognition, Functional currency and Financial instruments

Revenue recognition
Case Study 1 An entity sells goods on extended credit. The goods are sold for C1,200, on 1
January 20X1, receivable on 1 January 20X3. The customer can borrow at 4.5% a
year.

Question: At what amount should the revenue be recognised? Please pass

accounting entries for all the dates (on January 1, 20X1, December 31, 20X1,
December 31, 20X2 and January 1, 20X3).
Case study 2 A retailer is offering a special 'buy one get one half price' deal whereby customers
who purchase one box of chocolates are then entitled to purchase another box at
the same time and obtain the second box for half the price. How should the retailer
record the transaction?

Question: Will the discount given on the second box be accounted as a cost of sale
or a marketing expense?
Case study 3 Entity B (incorporated in Singapore) which is a subsidiary of Entity A (incorporated in
India) enter into a tripartite contract with Entity C (incorporated in India). As per the
contract, Entity B will supply raw material X, important for the operation of Entity C,
to Indian ports as agreed in the agreement. Entity A shall be responsible for transfer
of the entire raw material consignment from the port to the factory of Entity C.
Entity C shall pay Entity B the cost of goods and Entity A the handling charges based
on the quantity of raw material X reaching their factory.

Question:
- When can Entity B recognise revenue in its standalone books?
- When can Entity A recognise revenue in its standalone books?
- For the consolidated accounts of Entity A and Entity B will there be a change
in the accounting from the standalone?
Case study 4 Micrium, a computer chip manufacturing company, sells its products to its
Multiple distributors for onward sales to the ultimate customers. Due to frequent
choice fluctuations in the market prices for these goods, Micrium has a “price protection”
questions clause in the distributor agreement that entitles it to raise additional billings in case
of upward price movement. Another clause in the distributor’s agreement is that
Micrium can at any time reduce its inventory by buying back goods at the cost at
which it sold the goods to the distributor. Distributors pay for the goods within 60
days from the sale of goods to them. When should Micrium recognize revenue on
sale of goods to the distributors?
(a) When the goods are sold to the distributors.
(b) When the distributors pay to Micrium the cost of the goods (i.e., after 60 days of
the sale of goods to the distributors).
(c) When goods are sold to the distributor provided estimated additional revenue is
also booked under the “protection clause” based on past experience.
(d) When the distributor sells goods to the ultimate customers and there is no
uncertainty with respect to the “price protection” clause or the buyback of goods.

2. ABC Inc. is a large manufacturer of machines. XYZ Ltd., a major customer of ABC
Inc., has placed an order for a special machine for which it has given a deposit of
112,500 to ABC Inc. The parties have agreed on a price for the machine of 150,000.
As per the terms of the sales agreement, it is an FOB (free on board) contract and
the title passes to the buyer when goods are loaded onto the ship at the port. When
should the revenue be recognized by ABC Inc.?

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Revenue recognition, Functional currency and Financial instruments

(a) When the customer orders the machine.

(b) When the deposit is received.
(c) When the machine is loaded on the port.
(d) When the machine has been received by the customer.

3. Revenue from an artistic performance is recognized once

(a) The audience register for the event online.
(b) The tickets for the concert are sold.
(c) Cash has been received from the ticket sales.
(d) The event takes place.

4. X Ltd., a large manufacturer of cosmetics, sells merchandise to Y Ltd., a retailer,

which in turn sells the goods to the public at large through its chain of retail outlets.
Y Ltd. purchases merchandise from X Ltd. under a consignment contract. When
should revenue from the sale of merchandise to Y Ltd. be recognized by X Ltd.?
(a) When goods are delivered to Y Ltd.
(b) When goods are sold by Y Ltd.
(c) It will depend on the terms of delivery of the merchandise by X Ltd. to Y Ltd. (i.e.,
CIF [cost, insurance, and freight] or FOB).
(d) It will depend on the terms of payment between Y Ltd. and X Ltd. (i.e., cash or
credit).

5. Company XYZ Inc. manufacturers and sells standard machinery. One of the
conditions in the sale contract is that installation of machinery will be undertaken
by XYZ Inc. During December 2005, XYZ received a special onetime contract from
ABC Ltd. to manufacture, install, and maintain customized machinery. It is the first
time XYZ Inc. will be producing this kind of machinery, and it is expecting numerous
changes that would need to be made to the machine after the installation is
completed, which one period is described in the contract of sale as the
“maintenance period.” The total cost of making the changes during the maintenance
period cannot be reasonably estimated at the time of the installation. When should
the revenue from sale of this special machine be recognized?
(a) When the machinery is produced.
(b) When the machinery is produced and delivered.
(c) When the installation is complete.
(d) When the maintenance period as per the contract of sale expires.

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Case Study – Session 1
Revenue recognition, Functional currency and Financial instruments

Functional currency
Case study 1 A real estate entity operates in Russia. It owns several office buildings in Moscow
and St. Petersburg that are rented to Russian and foreign entities. All lease contracts
are denominated in US dollars, but payments can be made in either US dollars or in
Russian roubles. However, almost all of the lease payments are settled in roubles.
This has also been the historical pattern of payment.

Question: What is the functional currency of the real estate entity?

Case study 2 Entity A operates an oil refinery in Saudi Arabia. All of the entity's income is
denominated and settled in US dollars. The oil price is subject to the worldwide
supply and demand, and crude oil is routinely traded in US dollars around the world.
Around 45% of entity A's cash costs are imports or expatriate salaries denominated
in US dollars. The remaining 55% of cash expenses are incurred in Saudi Arabia and
denominated and settled in riyal. The non-cash costs (depreciation) are US dollar
denominated, as the initial investment was in US dollars.

Question: What is the functional currency of Entity A?

Case study 3 Entity A is a US bank with a US dollar functional currency. Entity A establishes a
Special Purpose Entity “SPE” in a European country in order to invest in a European
bond portfolio. Entity A has funded the SPE with equity and inter-company debt
denominated in euros.

The SPE uses the financing to purchase a portfolio of euro government bonds. There
is no intention for the SPE to perform any activities other than holding the bond
portfolio. The directors are all employees of the US parent, and the SPE has no
active management of its own.

Question: What is the functional currency of the SPE?

Case study 4 1. Which of these considerations would not be relevant in determining the entity’s
Multiple functional currency?
choice (a) The currency that influences the costs of the entity.
questions (b) The currency in which finance is generated.
(c) The currency in which receipts from operating activities are retained.
(d) The currency that is the most internationally acceptable for trading.

2. Foreign operations that are an integral part of the operations of the entity would
have the same functional currency as the entity. Where a foreign operation
functions independently from the parent, the functional currency will be
(a) That of the parent.
(b) Determined using the guidance for determining an entity’s functional currency.
(c) That of the country of incorporation.
(d) The same as the presentation currency.

3. An entity started trading in country A, whose currency was the dollar. After
several years the entity expanded and exported its product to country B,
whose currency was the euro. The functional currency of the entity was deemed to
be the dollar but by the end of 20X7, 80% of the business was conducted in country
B using the euro. At the end of 20X6, 30% of the business was conducted in the
euro. The functional currency should
(a) Remain the dollar.
(b) Change to the euro at the beginning of 20X7.

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Revenue recognition, Functional currency and Financial instruments

(c) Change to the euro at the end of 20X7.

(d) Change to the euro at the end of 20X7 if it is considered that the underlying
transactions, events, and conditions of business have changed.

4. An entity started trading in country A, whose currency was the dollar. After
several years the entity expanded and exported its product to country B, whose
currency was the euro. The business was conducted through a subsidiary in country
B. The subsidiary is essentially an extension of the entity’s own business, and the
directors of the two entities are common. The functional currency of the subsidiary
is
(a) The dollar.
(b) The euro.
(c) The dollar or the euro.
(d) Difficult to determine.

5. An entity acquired all the share capital of a foreign entity at a consideration of €9

million on June 30, 20X6. The fair value of the net assets of the foreign entity at that
date was €6 million. The functional currency of the entity is the dollar. The financial
year-end of the entity is December 31, 20X6. The exchange rates at June 30, 20X6,
and December 31, 20X6, were €1.5 = $1 and €2 = $1 respectively.
What figure for goodwill should be included in the financial statements for the year
ended December 31, 20X6?
(a) $2 million.
(b) €3 million.
(c) $1.5 million.
(d) $3 million.

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Revenue recognition, Functional currency and Financial instruments

Financial instruments
Case study 1 An entity purchased quoted equity shares from the market with the intention of
profiting from short-term price fluctuations. The entity held the shares for three
years due to a large unexpected downturn in the stock market after which it sold
the shares in a more buoyant market.

Question: What will be the classification on initial recognition? Will the classification
change subsequently?
Case study 2 Company A is evaluating whether each of these items is a financial instrument and
whether it should be accounted for under IAS 32:
(a) Cash deposited in banks
(b) Gold bullion deposited in banks
(c) Trade accounts receivable
(d) Investments in debt instruments
(e) Investments in equity instruments, where Company A does not have significant
influence over the investee
(f) Investments in equity instruments, where Company A has significant influence
over the investee
(g) Prepaid expenses
(h) Finance lease receivables or payables
(i) Deferred revenue
(j) Statutory tax liabilities
(k) Provision for estimated litigation losses
(l) An electricity purchase contract that can be net settled in cash
(m) Issued debt instruments
(n) Issued equity instruments

Question: Help Company A to determine (1) which of the above items meet the
definition of a financial instrument and (2) which of the above items fall within the
scope of IAS 32.
Case study 3 1. Are there any circumstances when a contract that is not a financial instrument
Multiple would be accounted for as a financial instrument under IAS 32 and IAS 39?
choice (a) No. Only financial instruments are accounted for as financial instruments.
questions (b) Yes. Gold, silver, and other precious metals that are readily convertible to cash
are accounted for as financial instruments.
(c) Yes. A contract for the future purchase or delivery of a commodity or other
nonfinancial item (e.g., gold, electricity, or gas) generally is accounted for as a
financial instrument if the contract can be settled net.
(d) Yes. An entity may designate any nonfinancial asset that can be readily
convertible to cash as a financial instrument.

2. Which of the following assets is not a financial asset?

(a) Cash.
(b) An equity instrument of another entity.
(c) A contract that may or will be settled in the entity’s own equity instrument and is
not classified as an equity instrument of the entity.
(d) Prepaid expenses.

3. Which of the following liabilities is a financial liability?

(a) Deferred revenue.
(b) A warranty obligation.

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Revenue recognition, Functional currency and Financial instruments

(c) A constructive obligation.

(d) An obligation to deliver own shares worth a fixed amount of cash.

4. Which of the following is not a category of financial assets defined in IAS 39?
(a) Financial assets at fair value through profit or loss.
(b) Available-for-sale financial assets.
(c) Held-for-sale investments.
(d) Loans and receivables.

5. Which of the following transfers of financial assets qualifies for derecognition?

(a) A sale of a financial asset where the entity retains an option to buy the asset
back at its current fair value on the repurchase date.
(b) A sale of a financial asset where the entity agrees to repurchase the asset in one
year for a fixed price plus interest.
(c) A sale of a portfolio of short-term accounts receivables where the entity
guarantees to compensate the buyer for any losses in the portfolio.
(d) A loan of a security to another entity (i.e., a securities lending transaction).

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