Welcome to

C101 AUT19 Financial

Accounting
• Tutorial 2 - Revenue Recognition
• Tutor:
• Matthew Grosse
• mgrosse@london.edu
Help?!?!?!
 To Succeed in C101
 Lectures
 After Class – Self-study questions and solutions on Canvas
 Quiz – Problem Set
 Tutorials – questions before, during, or after class
 Consultation – Eli has consultation hours – see canvas
 Consultation – Email me to arrange to meet before or after class if you need
further help
The plan for today
 Revision from last week
 Revenue Recognition
 Summary of key points
 Problem Set Questions

 Other requests?
Topic 1 - Revision
 What are the 4 Financial statements companies must prepare?
 What information is presented on each of those statements?

 Today:
 Where is Revenue?
 Why is it important?
 What makes it difficult to record accurately?
Topic 1 – Revision
 Income Statement
 Revenues – Expenses = Net Profit
 Statement of Changes in Equity
 Changes in Retained Earnings
 Changes in Contributed Capital
 Balance Sheet
 Assets = Liabilities + Owners Equity
 Cash Flow Statement
 Operating + Investing + Financing = Net Cash Flows
 Starting Cash + Net Cash Flows = Ending Cash
Topic 1 - Revision
 Transactions are accounted for using double entry accounting (minimum
of 2 accounts are affected)

 Record the following transactions:

 Matt’s Accounting Services provides a customer with 10 hours of
accounting help and sends the customer an invoice totalling £500.

 Matt’s Bike Store purchased 100 e-bikes for £75,000. Matt sells the
100 e-bikes for £125,000 in total to customers. He received £90,000 in
Cash, and is still owed the rest.
Topic 1 - Revision
 Matt’s Accounting Services provides a customer with 10 hours of accounting
help and sends the customer an invoice totalling £500.
 Service Revenue increases by 500 (P&L goes up)
 Accounts Receivable increases by 500 (Assets go up)
 Matt’s Bike Store purchased 100 e-bikes for £75,000. Matt sells the 100 e-
bikes for £125,000 in total to customers. He received £90,000 in Cash, and is
still owed the rest.
 Sales Revenue increases by 125,000 (P&L goes up)
 Cash increases by 90,000 (Assets go up)
 Accounts Receivable increases by 35,000 (Assets go up)
 Inventory decreases by 75,000 (Assets go down)
 Cost of Goods Sold Expense increases by 75,000 (P&L goes down)
Revision Questions – Adjusting Entries
 Think of a simple business example where an adjusting entry is
necessary. List the accounts and directions they would move for both
the original transaction entry and the adjusting entry for the following
four cases.
 Deferred Revenue – Cash first – revenue later
 Accrued Revenue – Revenue first – cash later
 Deferred Expenses – Cash first – expense later
 Accrued Expenses – Expense first – cash later
Deferred Revenue – Cash first – revenue later
• Gym membership - Gym receives $500 for a 12 month membership
• 1/Jan/2019
• Cash (A) increases 500
• Unearned Revenue (L) increase 500

• 30/June/2019
• Unearned Revenue (L) decrease $250
• Sales Revenue (Rev) increase $250 (P&L increase)
Accrued Revenue – Revenue first – cash later
• Electricity provider – provides electricity to LBS valued at £1,000 for the month of Feb. They send the invoice on 15th
March. LBS pays the bill on 30th March
• Provide the transactions:
• 28 Feb
• Accrued Revenue 1,000
• Sales revenue 1,000

• 15th March
• Accounts Receivable (A) increases 1,000
• Accrued Revenue (A) decreases 1,000

• 30th March
• Cash (A) increases 1,000
• Accounts Receivable decreases 1,000
Topic 2 – Revenue Recognition
 The Income Statement starts by listing Revenue

 What is Revenue?

 If Dell computing sell a PC, is it part of their revenue?

 If London Business School sell a PC, is it part of their revenue?
Revenue
 IAS 18
 Revenue is the gross inflow of economic benefits during the period arising
from 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.
Revenue vs Cash Flows
 Are revenues different from cash inflows from a sale?
 When is a cash inflow recognised?
 When is a revenue recognised?
Revenue Recognition
 Revenue must be recognised when the company has earned
the revenue, and the amount is realisable.
 Revenue is earned when the control of the goods or services
passes to the customer
 Point of Sale
 Subscription Method
 Multiple deliverables?
 Percentage of completion
 Amount
 Grossed up amount or Net amount
Revenue Recognition
 The choice of accounting policy alters the TIMING and AMOUNT of
revenue/income recognition.
 There is NO ONE RIGHT policy. The right policy is context-specific and depends on
the substance of the contracts between buyer and seller.
 IFRS 15
 Identify the contract with a customer
 Identify all the individual performance obligations within the contract
 Determine the transaction price
 Allocate the price to the performance obligations
 Recognize revenue as the performance obligations are fulfilled
Timing - Deferred Revenue
 Deferred Revenue
 Receive cash first. Earn / recognise the revenue at a later date.

 Recording Deferred Revenue transactions

 Problem Set Q1 – Q3 – Deferred Revenue recording transactions
 Problem Set Q4- Q7 – Deferred Revenue understanding the financial
statements
Timing - Multi year contracts
 When should you use?
 Completed contract
 Percentage of completion
 Valid promise of payment – guarantee of sale.
 Reliable estimate of total contract revenue
 Reliable estimate of total cost to complete
 Reliable estimate of stage of completion.

 Problem Set Q8 – Q9.

Amount – Gross or Net Revenue
 Recognise Gross Revenue if
 The seller is a principal
 Seller bears transaction risk (owning inventory)
 Seller involvement in the transaction (e.g., establishing price, changing
product, etc.)
 Recognise Net Revenue if
 The seller is an agent
 Receives a commission from the sale
 Doesn’t take inventory risk

 MercadoLibre lecture example

Practice Question 1. Gross vs Net
• Tim’s Tours & Tickets (TTT) sells tickets to major sporting events. TTT
negotiates to buy 1,000 tickets to Wimbledon. TTT paid $120,000 to
purchase the tickets. He plans on selling the tickets for $300 each to
his customers. TTT had to pay $5,000 to operate a website to on-sell
the tickets. Wimbledon proved to be a very popular tournament, and
TTT sold all 1,000 tickets.
• Prepare the Income Statement for TTT.
Practice Question 1. Gross vs Net
• TTT should use the Gross Method. They are taking all the risk of inventory,
they are in charge of setting the prices and delivering the inventory. They
are not receiving a commission.

• TTT Income Statement

• Revenue = 1,000 * $300 = 300,000
• Cost of Goods Sold = 120,000
• Gross Profit = 180,000
• Operating costs = $5,000
• Net Profit = $175,000
Practice Question 2. Gross vs Net
• Sam’s Sporting Safari (SSS) sells tickets to major sporting events. SSS have
an arrangement with Manchester United to sell tickets to their matches to
overseas Manchester United supporter’s club members at a special price.
Manchester United allows SSS to sell up to 1,000 of their match day tickets
at a 15% price discount to the recommended retail price of $120. SSS do
not purchase the tickets themselves, they receive the tickets only after
requested and paid for by their customers. SSS receive a 10% commission
based on the ticket price. All 1,000 available tickets were sold. SSS printed a
special overseas supporter club member ticket at the cost of $2 per ticket
and shipped it to the customers.
•
• Prepare the Income Statement for SSS
Practice Question 2. Gross vs Net
• SSS should use the Net Method. They are NOT taking the risk of the
inventory. They never own the tickets. They do not get to set the
price. They are simply acting as a sales agent on behalf of Manchester
United.
• SSS Income Statement
• Revenue = 1,000 * 85% * $120 * 10% = $10,200
• Cost of Goods Sold = $2 * 1,000 = $2,000
• Gross Profit = 10,200 – 2,000 = $8,200
Multiple Deliverables
 If a product or service has multiple deliverables when you recognise
revenue may be problematic.
 I.e. the iPhone example
 Others?

 Identify if the products/service price can be separated. If not, spread

revenue over the whole period of the product/service delivery.
Other issues
 Non GAAP reporting
 What is it?
 Why do companies do it?
Non-GAAP earnings
• https://www.ft.com/content/32cd0750-4f38-11e8-a7a9-37318e776bab
• Financial analysts and writers started raising concerns about corporate earnings reports well before any
elected official used the phrase “fake news”. It was late 2015 when researchers at Audit Analytics found that
88 per cent of companies reported non-GAAP metrics in their financial reports. And of the companies that
reported a non-GAAP measure of income, 82 per cent had higher income than would have been reported
otherwise, the study found

• https://www.ft.com/content/94e0f54e-d3c1-11e6-9341-7393bb2e1b51
• Problems arise when companies go off-piste, using metrics that bear no relation to GAAP. The SEC sees
nothing wrong with a measure such as Ebitda, for example, which takes a GAAP number — net income —
and adds back interest, tax, depreciation and amortisation. It’s long been used as a decent guide to
operating income.
But when a company starts talking about bookings and backlogs, referring to orders that are expected to be
converted into revenues over the next 12 months — then that’s a different matter.

• https://www.ft.com/content/2a54da40-1771-11e6-9d98-00386a18e39d
Conclusion
 When to record revenue, and how much revenue is recorded is context specific.
 Follow IFRS 15
 Cash flows and revenues will be different