CH 6

Revenue recognition
1. Understanding the nature of sales transactions from a business perspective

Fundamentals of Understanding Sales Transactions
Selling transactions involve an entity transferring goods or services to its customers.
- The goods or services are often called deliverables.
- It is important to focus on whether goods or services (or both) are being transferred.
Why Does This Matter for Accounting Purposes?

Sales of goods and of services are different.
Goods are tangible assets.
- As a result, there is a definite point in time when control over the goods or the item being
sold passes to the buyer.
Control of an asset means that the entity has access to the benefits provided by the asset where
others do not.
- This normally coincides with the transfer of risks and rewards as indicated
by possession and legal title
Services are not tangible assets and therefore the concepts of possession and legal title are
irrelevant.
- Service contracts may be completed in one period but often span more than one period.
- Therefore, there is the added complexity of how much, if any, revenue is earned in any
given period.
Many contracts involve both goods and services (referred to as multiple
deliverables or bundled sales), and this complicates the accounting when the goods and services
are sold together as a bundle for one price.
- This is because possession and legal title to goods might pass before, after, or during the
time when the services are rendered.
Reciprocal Nature
Next, we need to ask regarding a sales transaction: What is being received?
Most business transactions are reciprocal
- That is, the entity gives something up and receives something in return.
- In addition to assessing what we are giving up, we should determine what we are getting
back.
Consideration is what the entity receives in return for the provision of goods or services.

If we assume that the transactions are at arm's length—that is, they are between unrelated
parties—then we may assume that the value of what is given up usually approximates the value
of what is received in the transaction.
Sales agreements normally specify what is being given up and what is being acquired as follows:
 Acquired: Consideration or rights to the consideration. The amount, nature, and timing
of what the customer agrees to pay are normally agreed upon.
 Given up: Goods/services (now or in the future). Details regarding delivery (quantities,
nature of goods/services, timing, shipping terms) are agreed upon.
Recognizing and focusing on the reciprocal and arm's-length nature of transactions, as well as
the detailed agreement between the customer and vendor, allows us to better capture and
measure the economics of transactions in the financial statements.
Just as obligations to deliver in the future create measurement uncertainty, so do rights to receive
consideration in the future.
- For instance, if the entity sells on credit, there is a risk that the customer will not pay.
(This is known as credit risk.)
Consideration that is nonmonetary (as with barter transactions) presents greater challenges for

accounting purposes.
Barter or nonmonetary transactions are transactions where few or no monetary assets are
received as consideration when goods or services are sold.
- Generally, a barter transaction is seen as a sale if the transaction has commercial
substance (transaction is a bona fide—or legitimate—purchase and sale and that the
entity has entered into the transaction for business purposes, exchanging one type of asset
or service for a different type of asset or service)
- After the transaction, the entity will be in a different position and its future cash flows are
expected to change significantly as a result of the transaction in terms of timing, amount,
and/or riskiness.
- When a reciprocal transaction occurs, the entity's risk profile changes (price risk)
Concessionary Terms
Another question to ask regarding a sales transaction is: Are the terms of sale normal or is this a
special deal?
In some cases, one party is in a better bargaining position than the other.
- This might occur, for instance, where supply exceeds demand. In this case, the buyer in
the transaction may be able to negotiate a better deal than normal because there are many
sellers who want to sell their products but there are few buyers.
Concessionary terms are terms negotiated by a party to the contract that are more favourable
than normal. Examples:
 The selling price is deeply discounted.
 The seller agrees to a more lenient return or payment policy (including paying in
instalments over an extended term or using consignment sales).
 The seller loosens its credit policy.
 The seller transfers legal title but allows the customer to take delivery at a later date
(sometimes called “bill and hold”).
 The goods are shipped subject to customer acceptance conditions. Extended trial
periods are an example.
 The seller agrees to provide ongoing or additional services beyond the main
goods/services agreed to in order to make the sale. This might include, for example,
installation of an asset, ongoing servicing, or continuing fees, such as in a franchise
agreement.
 The seller continues to have some involvement, including a guarantee of resale (or
permission to return) or guarantee of profit.

Care must be taken to identify concessionary (or abnormal) terms in any deal because they may
complicate the accounting. Concessionary terms are terms that are more lenient than usual and
are meant to induce sales.
- Concessionary or abnormal terms may create additional obligations or may reflect the
fact that the risks and rewards or control has not yet passed to the customer. These
situations must be carefully analyzed because they create additional recognition and
measurement uncertainty. They may even indicate that no sale has taken place at all.
Helps differentiate between normal selling terms and abnormal concessionary terms

Examples of Normal Selling Examples of Concessionary Selling Terms
Terms
Selling Selling price reflects a normal Selling price is deeply discounted.
price profit margin for the company for
that product.
Payment Sell for cash or on credit. If credit, Any terms that are more lenient than this;
terms payment is usually expected within for example,
30 to 60 days.  selling on credit where the buyer
does not have to pay for 90 days or
more, or
 instalment sales where these are not
normal industry practice.
Extension Sell to customers that are Sell to customers that are riskier than the
of credit creditworthy. existing customer base.
Shipping Ship when ordered and ready to Ship at a later date; for example, the entity
terms ship. may hold the inventory in its warehouse for
an extended period.
Other Once shipped and legal title Extended right of return/warranty period,
terms passes, no continuing involvement cash flow guarantee on future rental of
except for normal rights of return building sold, profit guarantees on future
and/or standard warranties. resale, or buyback provisions.

Examples of Normal Selling Examples of Concessionary Selling Terms
Terms

- Note that many companies continue to change their product mix and selling terms in an
effort to provide maximum value to customers and shareholders. This is a completely
normal part of evolving the business and dealing with changes that may be happening in
the industry.
For instance, a company that usually sells a product to ensure a certain profit margin may sell the
product at a deep discount in order to achieve market penetration and get customers using the
product.
Contract Law
When an entity sells something, both the entity and the customer enter into a contract.
- A contract with customers is an agreement that creates enforceable obligations and
establishes the terms of the deal.
- The contract may be written or verbal or may be evidenced by, for instance, a cash
register receipt. The important thing is that two parties have promised to exchange assets
and this creates a contract.
- There is a promissor (the seller), a promissee (the customer), and an agreement. Thus, the
act of entering into a sales agreement creates legal rights and obligations.
In addition, the contract establishes the point in time when legal title (entitlement and ownership
under law) passes.
- When the customer takes physical possession of the goods straight away, legal title
would normally pass at this point.
- If the goods are shipped, the point at which legal title passes is often indicated by the
shipping terms as follows:
 f.o.b. shipping point: title passes at the point of shipment.

 f.o.b. destination: title passes when the asset is delivered to the customer.

As noted above, if the entity has promised to provide goods and/or services now or in the future,
the contract binds it and can be enforced.
- It creates contractual rights and obligations that may meet the definition of assets and
liabilities.
- The contract also establishes the substantive terms of the deal, which need to be analyzed
when determining if revenue has been earned (including when legal title has passed).
- If, for instance, the contract stipulates that customers must sign invoices as evidence that
they are satisfied with the goods, it may mean that no revenue may be recognized until
this is done.
Constructive Obligation
Performance obligations may arise even if not stated in a contract.
In many cases, an entity may have an implicit obligation even if it is not explicitly noted in a
selling contract. This is called a constructive obligation.
- A constructive obligation is an obligation that is created through past practice or by
signalling something to potential customers.
- Constructive obligations are often enforceable under common or other law.

Any enforceable promise that results from the sale (whether implicit or explicit) may create a
performance obligation that needs to be recognized in the statement of financial position. This
includes both contractual and other promises.
Information for Decision-Making
Revenue recognition is one of the main areas of misrepresentation in financial statements.
- It is often difficult to spot such misrepresentations, because the note disclosures may be
very general.
- It is therefore important to carefully understand the company's underlying business and
business model and to ensure that changes in the business model are reflected
appropriately in the statements.
- Care should also be taken to ensure that large and unusual transactions are entered into
for bona fide business reasons (for example, to add value for the shareholders) rather than
to make the company's performance look better than it really is.
2. The asset-liability approach to revenue recognition: an overview of the five-step
process
There are two approaches to recognizing revenues:
1) the asset-liability approach (sometimes called the contract-based approach)
The new IFRS standard, IFRS 15 Revenue from Contracts with Customers, adopts an asset-
liability approach as the basis for revenue recognition.
Companies account for revenue based on the asset or liability arising from contracts with
customers.
Contracts indicate the terms of the transaction, provide measurement of the consideration, and
specify the promises that must be met by each party.
2) the earnings approach (ASPE)
The earnings approach recognizes and measures revenue based on whether it has been earned.
- In general, the performance obligation is satisfied when there is a change in control from
the seller to the customer.
3. Identifying the contract with customer – Step 1
A company following IFRS applies the revenue guidance to a contract according to the criteria
summarized:

Apply IFRS 15 to Contract If: Disregard IFRS 15 If:

 The contract has commercial substance.  The contract is wholly
unperformed, and
 The parties to the contract have approved the
contract and are committed to perform their  Each party can unilaterally
respective obligations. terminate the contract without
compensation.
 The company can identify each party's rights

Apply IFRS 15 to Contract If: Disregard IFRS 15 If:
regarding the goods or services to be transferred.

 The company can identify the payment terms for
the goods and services to be transferred.
 It is probable that the company will collect the
consideration to which it will be entitled.

- In some cases, there are multiple contracts related to the transaction, and accounting for
each contract may or may not occur, depending on the circumstances. These situations
often develop when not only is a product provided but some type of service is performed
as well.
- In other cases, a company should combine contracts and account for them as one
contract.
- If a contract does not meet the criteria specified above, revenue is recognized only when
the performance obligation is satisfied and substantially all consideration has been
received.
Basic Accounting
On entering into a contract with a customer, a company obtains rights to receive consideration
from the customer and assumes obligations to transfer goods or services to the customer
(performance obligations).
- The combination of those rights and performance obligations gives rise to a (net) asset or
(net) liability.
- If the measure of the remaining rights exceeds the measure of the remaining performance
obligations, the contract is an asset (a contract asset).
- If the measure of the remaining performance obligations exceeds the measure of the
remaining rights, the contract is a liability (a contract liability) under IFRS.
However, a company does not recognize contract assets or liabilities until one or both
parties to the contract perform (that is, when the customer makes an advance payment or the
company delivers a product or provides a service).
- Therefore, the signing of the contract by the two parties is not recorded until one or both
of the parties perform under the contract.
Contract Modifications
Companies sometimes change the contract terms while the contract is ongoing. This is called
a contract modification.
- When a contract modification occurs, companies determine whether a new contract (and
performance obligations) results or whether it is a modification of the existing contract.
A company accounts for a contract modification as a new contract if both of the following
conditions are satisfied:
1. The promised goods or services are distinct.
2. The price increases by an amount of consideration that reflects the stand-alone selling price of
the promised goods or services (that is, the price for which the entity could sell the goods or
services).
- ASPE has no guidance on contract modifications.
4. Identifying separate performance obligations – Step 2
A performance obligation is a promise in a contract to provide a product or service to a
customer.
- This promise may be explicit, implicit, or possibly based on customary business practice.
- To determine whether a performance obligation exists, (1) the company must assess
whether it provides a distinct product or service.
- A good or service is distinct if the customer can separately benefit from it.
Summarizes some classic situations when revenue is recognized as a result of providing a

distinct product or service, therefore satisfying a performance obligation.
Many revenue arrangements may have more than one performance obligation.
- To determine whether a company has to account for multiple performance obligations, it
evaluates a second condition. That is, (2) it assesses whether the product is distinct
within the contract.
In other words, if the performance obligation is not highly dependent on, or interrelated with,
other promises in the contract, then each performance obligation should be accounted for
separately.
Conversely, if these services are interdependent or interrelated, these services are combined
and reported as one performance obligation.
Material Rights
When a customer purchases goods or services, sometimes, a company will grant the customer an
option to acquire future items (for free or at a discount).
- Examples include loyalty points and coupons.
These rights are treated as separate performance obligations as long as the option gives the
customer what is known as a material right.
- A material right is a right that the customer would not otherwise have been entitled to.
In these cases, the customer is in effect paying in advance for future goods or services and the
transaction price must be allocated between the goods or services currently purchased and the
goods or services to be purchased in the future under the option.
- These are two distinct performance obligations. The revenue relating to the option is
deferred.
For instance, many airline companies offer points to their customers based on the amount paid
and distance travelled on purchased flight tickets. These points transfer to the customer a right to
travel for free or at a discount in future (that is, less than the fair value of the flight). The revenue
would generally be recognized when the future goods or services are transferred to the customer.
Note that where loyalty points or gift certificates are awarded by a company, they are often not
all redeemed or used by the customer. Often only a percentage of the total value will be
redeemed by the customer.
- The unredeemed amount is known as breakage.
Warranties
Companies often provide one of two types of warranties to customers

Warranty Description Accounting Treatment
Type

Assurance Provides assurance that the product meets agreed- Represents a cost of selling the
upon specifications in the contract at the time the product (and a warranty liability).
product is sold.

Service Provides an additional service beyond the assurance- Represents a performance
type warranty. obligation.

An assurance-type warranty is nothing more than a quality guarantee that the good or service
is free from defects at the point of sale.
- These types of obligations should be expensed in the period when the goods are provided
or services performed (in other words, at the point of sale).
- In addition, the company should record a warranty liability.
- The estimated amount of the liability includes all the costs that the company will incur
after sale due to the correction of defects or deficiencies required under the warranty
provisions.
- In addition, companies sometimes provide customers with an option to purchase a
warranty separately.
- In most cases, these extended warranties provide the customer with a service beyond
fixing defects that existed at the time of sale.
For example, when you purchase a TV, you are entitled to the company's warranty. You will also
undoubtedly be offered an extended warranty on the product at an additional cost. These service-
type warranties represent a separate service and are an additional performance obligation.
- As a result, companies should allocate a portion of the transaction price to this
performance obligation. The company recognizes revenue in the period that the service-
type warranty is in effect.
Chen Computer Inc. manufactures and sells computers that include a warranty to make good on
any defect in its computers for 120 days. In addition, Chen sells separately an extended warranty,
which provides protection from defects for three years beyond the 120 days. Are the computer
and warranties distinct within the contract?
- In this case, two performance obligations exist: one related to the sale of the computer
and the assurance warranty, and the other to the extended warranty (service warranty).
The sale of the computer and related assurance warranty are one performance obligation
because they are interdependent and interrelated with each other. However, the
extended warranty is separately sold and is not interdependent.
B. Maverick Company sold 1,000 Rollomatics on December 31, 2020, at a total price of $6
million, with a warranty guarantee that the product was free from any defects. The cost of
Rollomatics sold is $4 million. The term of the assurance warranty is two years, with an
estimated cost of $30,000. In addition, Maverick sold extended warranties on 400 Rollomatics
for three years beyond the two-year period for $12,000. What are the journal entries that
Maverick Company should make in 2020 for the sale and the related warranties?
To record the revenue and liabilities related to the warranties:
Cash ($6,000,000 + $12,000) 6,012,000
Warranty Expense 30,000
Warranty Liability 30,000
Unearned Revenue 12,000
Sales Revenue 6,000,000
To reduce inventory and recognize cost of goods sold:
Cost of Goods 4,000,000
Sold
Inventory 4,000,000
Maverick Company reduces the Warranty Liability account over the first two years as the actual
warranty costs are incurred. The company also recognizes revenue related to the service-type
warranty over the three-year period that extends beyond the assurance warranty period (two
years). In most cases, the unearned warranty revenue is recognized on a straight-line basis. The
costs associated with the service-type warranty are expensed as incurred.
- ASPE does not provide detailed guidance regarding accounting for warranties.
Upfront Fees
Companies sometimes receive payments (upfront fees) from customers before they deliver a
product or perform a service.
- Upfront payments generally relate to the initiation, activation, or set-up of a good or
service to be provided or performed in the future.
- In most cases, these upfront payments are non-refundable.
Examples include fees paid for membership in a health club or buying club, and activation fees
for phone, Internet, or cable.
- Often these contracts are structured such that, once the initiation fee is paid, the customer
has the right of renewal at a lower annual price than would be charged if the initiation
fee had not been paid. The right to renew at a lower price is a material right if the
discount is significant compared with the price charged to customers who have not paid
the initiation fee.
- Normally this would be recognized as a separate performance obligation (similar to the
loyalty points). However, instead of recording the option to renew as a separate
performance obligation, IFRS 15 allows the entity to treat the whole thing as one
performance obligation. This is because it would be difficult to determine a stand-alone
value for renewal options.
- Therefore, as long as similar services are provided in each period, including the
renewal period, and the customer uses the services as provided, then we can treat
this as one performance obligation.
Erica Felise signs a one-year contract with Bigelow Health Club. The terms of the contract are
that Erica is required to pay a non-refundable initiation fee of $200 and an annual membership
fee of $50 per month. Bigelow determines that its customers, on average, renew their annual
membership twice before terminating their membership. What is the amount of revenue Bigelow
Health Club should recognize in the first year?
In this case, the membership fee arrangement may be viewed as a single performance
obligation. (Similar services are provided in all periods and the customers use the services as
they are provided.) Bigelow determines the total transaction price to be $2,000—the upfront fee
of $200 and the three years of monthly fees of $1,800 ($50 × 36)—and allocates it over the three
years. In this case, Bigelow would report revenue of $55.56 ($50 + $200/36) each month for
three years.
Series of Goods and Services That Are Substantially the Same
Some longer-term contracts provide a series of goods or services that are substantially the same
over the life of a contract.
An example is a two-year contract to provide monthly payroll processing services. Is this one
performance obligation or multiple monthly obligations?
Under IFRS, as long as the services are substantially the same, and the customer receives
the benefits each month, this is treated as one performance obligation.
- Even though the monthly services are distinct (in that the customer benefits from them
each month), the monthly services are combined into one larger performance obligation
because they are the same each month.
ASPE has very little guidance in terms of multiple element arrangements
5. Determine the transaction price – Step 3

The transaction price is the amount of consideration that a company expects to receive from a
customer in exchange for transferring goods and services.
- The transaction price in a contract is often easily determined because the customer agrees
to pay a fixed amount of cash to the company over a short period of time.
In other contracts, companies should also consider the following factors:
 Variable consideration
 Time value of money
 Non-cash consideration
 Consideration paid or payable to customers.
Note that the requirements below are largely IFRS requirements. ASPE has very little, if any,
guidance on measurement, leaving the decisions to professional judgement.
Variable Consideration
In some cases, the price of a good or service is dependent on future events.
- These future events might include volume discounts, rebates, credits, returns,
performance bonuses, and price concession. In these cases, the company estimates the
amount of variable consideration it expects to receive from the contract to determine the
amount of revenue to recognize.
- Companies use either the expected value, which is a probability-weighted amount, or
the most likely amount in a range of possible amounts to estimate variable
consideration.
Highlights the issues to be considered in selecting the appropriate method:

Expected value: Probability-weighted Most likely amount: The single most likely amount in a
amount in a range of possible consideration range of possible consideration outcomes.
amounts.
 May be appropriate if a company has
 May be appropriate if the contract has only two
a large number of contracts with possible outcomes. (For instance, a bonus will be
similar characteristics. (See Example paid if the goods are delivered early but it will not
6.13.) be paid if the goods are not delivered early.)
 Can be based on a limited number of
discrete outcomes and probabilities.

Peabody Construction Company enters into a contract with a customer to build a warehouse for
$100,000, with a performance bonus of $50,000 that will be paid based on the timing of
completion. The amount of the performance bonus decreases by 10% per week for every week
beyond the agreed-upon completion date. The contract requirements are similar to contracts that
Peabody has performed previously, and management believes that such experience is predictive
for this contract. Management estimates that there is a 60% probability that the contract will be
completed by the agreed-upon completion date, a 30% probability that it will be completed one
week late, and a 10% probability that it will be completed two weeks late.
a. How should Peabody measure the transaction price?
The transaction price should include management's estimate of the amount of consideration to
which Peabody will be entitled. Management has concluded that the probability-weighted
method is the most predictive approach for estimating the variable consideration in this
situation.
b. What is the transaction price?
60% chance of $150,000 [$100,000 + ($50,000 × 1.0)] = $ 90,000
30% chance of $145,000 [$100,000 + ($50,000 × .90)] = 43,500
10% chance of $140,000 [$100,000 + ($50,000 × .80)] = 14,000
$147,500
Thus, the total transaction price is $147,500, based on the probability-weighted estimate.
- Management should update its estimate at each reporting date.
Using a most likely outcome approach may be more predictive if a performance bonus is binary
(Peabody either will or will not earn the performance bonus), such that Peabody earns either
$50,000 for completion on the agreed-upon date or nothing for completion after the agreed-upon
date.
- In this scenario, if management believes that Peabody will meet the deadline and
estimates the consideration using the most likely outcome, the total transaction price
would be $150,000 (the outcome with 60% probability).
Sales with right of return have long been a challenge in the area of revenue recognition.
- A sales contract that allows customers the right to return goods obligates the seller to
honour that promise and to provide a refund. For example, assume that the company
transfers control of hurricane glass to Henlo Builders. The company grants Henlo
the right of return for the product for various reasons (for example, dissatisfaction with
the product) and the right to receive any combination of the following.
1. A refund.
2. A credit.
3. An alternative product in exchange.
The company should recognize all of the following:
a. Revenue (considering the products expected to be returned).
b. A refund liability.
c. An asset (and corresponding adjustment to cost of sales) for its right to recover glass
from Henlo on settling the refund liability.
Venden Company sells 100 products for $100 each to Amaya Inc. payable in 30 days. Venden
allows Amaya to return any unused product within 60 days and receive a full refund. The cost of
each product is $60. To determine the transaction price, Venden decides that the approach that is
most predictive of the amount of consideration to which it will be entitled is the most likely
amount. Using the most likely amount, Venden estimates that:
1. Three products will be returned.
2. The costs of recovering the products will be immaterial.
3. The returned products are expected to be resold at a profit.
Upon transfer of control of the products, Venden recognizes
a) revenue of $9,700 ($100 × 97 products expected not to be returned)
b) a refund liability for $300 ($100 refund × 3 products expected to be returned)
c) an asset of $180 ($60 × 3 products) for its right to recover products from customers on settling
the refund liability.
Hence, the amount recognized in cost of sales for 97 products is $5,820 ($60 × 97).
Venden records the sale as follows.
IFRS ASPE
Accounts Receivable 10,000 Accounts Receivable 10,000
Sales Revenue 9,700 Sales Revenue 10,000
Refund Liability 300 Sales Returns and Allowances 300
Allowance for Sales
Returns and Allowances 300
Venden also records the related cost of goods sold with the following entry.
IFRS ASPE
Cost of Goods Sold 5,820 Cost of Goods Sold 5,820
Estimated Inventory Returns 180 Estimated Inventory Returns 180
Inventory 6,000 Inventory 6,000
When a return occurs, Venden should reduce the Refund Liability/Allowance and Estimated
Inventory Returns accounts.
In addition, Venden recognizes the returned inventory in a Returned Inventory account as shown
in the following entries for the return of two products (2 × $100). If material, companies record
the returned asset in a separate account from inventory to provide transparency. The carrying
value of the returned asset is subject to impairment testing, separate from the other inventory.
IFRS ASPE
Refund Liability 200 Allowance for Sales Returns
Accounts Payable 200 and Allowances 200
Returned Inventory 120 Accounts Payable 200
Estimated Inventory Returned Inventory 120
Returns 120 Estimated Inventory
Returns 120
Volume discounts are another feature of sales contracts that are considered variable
consideration.
- Generally, if a customer buys a certain amount, they will receive a discount in the price
since they are buying a lot of inventory.
- Often these arrangements span the year. If a customer buys more than a set volume by the
end of the year, then the discounted price is applied to the annual sales.
Sung Inc. offers its customers a 3% volume discount if they purchase at least $2 million of its
products during the calendar year. On March 31, 2020, Sung has made sales of $700,000 to
Arctic Inc. In the previous two years, Sung sold over $3 million to Arctic in the period from
April 1 to December 31
In this case, Sung should reduce its revenue by $21,000 ($700,000 × 3%) because it
is probable that it will provide this rebate. Revenue is therefore $679,000 ($700,000 − $21,000).
To not recognize this volume discount overstates Sung's revenue for the first three months of
2020. In other words, the appropriate revenue is $679,000, not $700,000. As noted earlier, under
ASPE a Sales Returns and Allowances account (contra Sales Revenue account) is generally used.
Given these facts, Sung makes the following entry on March 31, 2020, to recognize revenue. The
second journal entry below may be recorded at the end of the quarter or year so that revenues are
not recorded at greater than the expected amount.
- IFRS would support recording no more than the expected amount as revenues whereas
- ASPE would allow the full revenues to be recognized with a Sales Return and
Allowances Account such that net sales are also recorded at expected value.
Historically, Sales Revenues have been presented on a net basis in the financial statements.
IFRS ASPE
Accounts Receivable 700,000 Accounts Receivable 700,000
Sales Revenue 700,000 Sales Revenue 700,000

Sales Revenue 21,000 Sales Returns and
Contract Liability 21,000 Allowances 21,000
Allowance for Sales
Returns and Allowances 21,000
Assuming that Arctic meets the discount threshold, Sung makes the following entry.
IFRS ASPE
Contract Liability 21,000 Allowance for Sales Returns
Accounts Receivable 21,000 and Allowances 21,000
Accounts Receivable 21,000
In many cases, companies provide cash discounts to customers for timely payment. (This is often
referred to as a prompt settlement discount.)
For example, assume that terms are payment due in 60 days, but if payment is made within five
days, a 2% discount is given (referred to as 2/5, net 60).
- These prompt settlement discounts should reduce revenues, if material.
A word of caution—a company allocates variable consideration only if it is reasonably
assured that it will be entitled to that amount. Companies therefore may recognize variable
consideration only if
1) they have experience with similar contracts and are able to estimate the cumulative amount of
revenue
2) based on experience, it is highly probable that there will not be a significant reversal of
revenue previously recognized.
- If these criteria are not met, revenue recognition is constrained, meaning that the
uncertain amounts are not included as part of the consideration until a later point when
the uncertainty is resolved.
Although ASPE does not explicitly deal with this issue, basic accounting concepts would
preclude companies following ASPE from recognizing revenues where there is significant
uncertainty.
Time Value of Money
The timing of payment to the company sometimes does not match the transfer of the goods or
services to the customer. In most situations, companies receive consideration after the product is
provided or the service performed. In essence, the company provides financing for the customer.
Companies account for the time value of money if the contract involves a significant financing
component. When a sales transaction involves a significant financing component (that is,
interest is accrued on consideration to be paid over time), the amount of revenue is determined
by discounting the payments.
- The discount rate reflects the credit risk associated with the sales contract and the
customer.
For instance, the discount rate would be higher for a customer who has a higher credit risk.
Alternatively, you would calculate the interest rate needed to equate the discounted amount of
payments to the cash consideration that a customer would pay for the item at the time of sale.
- The company will report the effects of the financing as either interest expense or interest
revenue.
- A customer may also pay upfront. In this case, care should be taken to consider whether
there is a significant financing component.
Under ASPE, there is no explicit requirement to account for the time value of money, although it
is implied since receivables must be originally recognized at fair value (which would
presumably reflect the time value of money if significant).
On July 1, 2020, SEK Company sold goods to Grant Company for $900,000 in exchange for a
four-year, zero-interest-bearing note with a face amount of $1,416,163. The goods have an
inventory cost on SEK's books of $590,000 and their fair value is $900,000.
a. SEK should record revenue on July 1, 2020 of $900,000, which is the fair value of the
inventory in this case.
b. SEK is also financing this purchase and records interest income on the note over the four-year
period. Since no other information is available, the interest rate is imputed and is determined to
be 12%. The 12% is the rate that discounts the final payment of $1,416,163 to the fair value of
the goods ($900,000). SEK records interest revenue of $54,000 (12% × ½ × $900,000) at
December 31, 2020.
The entry to record SEK's sale to Grant Company is as follows.
July 1, 2020
July 1, 2020
Notes Receivable 900,000
Cost of Goods 590,000
Sales Revenue
Sold 900,000
Inventory 590,000
SEK makes the following entry to record interest revenue at the end of the year.
December 31, 2020
Notes Receivable 54,000
Interest Income (12% × ½ × 54,000
$900,000)
As a practical expedient, companies are not required to reflect the time value of money to
determine the transaction price if the time period for payment is less than a year
Non-cash Consideration
Companies sometimes receive consideration in the form of goods, services, or other non-cash
consideration.
- When these situations occur, companies generally recognize revenue on the basis of
the fair value of what is received
Customers sometimes contribute goods or services, such as equipment or labour, to help fulfill
the contract. This consideration should be treated as non-cash consideration and included in the
transaction price as long as control of the goods or services passes to the company.
Consideration Paid or Payable to Customers
Companies often make payments to their customers as part of a revenue arrangement.
Consideration paid or payable may include coupons, vouchers, or other items.
- In general, these elements reduce the consideration received and the revenue to be
recognized (or are treated as separate performance obligations) as noted earlier under
steps 2 and 3.
- In certain situations, these amounts may be treated as assets or expenses.
For instance, where the company is reimbursing the customer for shared advertising costs, the
amounts paid would be treated as an expense.
Where gift cards are sold, they may not all be redeemed by the customer (or redeemed for less
than the full value).
Ocean Limited sells a $500 gift card to a customer on January 1, with no expiry date. Based on
past gift card sales, 85% of gift cards are redeemed and 15% are unexercised. Ocean feels that
this information has good predictive value and estimates that 15% of the gift card will remain
unredeemed. On December 31, the customer makes one purchase of $50 using the gift card.
Upon sale of the card, the company records a Contract Liability or Unearned Revenue for $500.
January 1
Cash 500
Contract 500
Liability
The breakage is recognized proportionately as the customer uses the card to purchase goods.
Therefore, when the $50 purchase is made, rather than recognizing $50 of revenue, $59 of
revenue will be recognized to incorporate expected breakage (that is, $50 * (500/425this is 85%
of 500)).
December 31
Contract 59
Liability
Sales Revenue 59 6. Allocating the transaction price to separate performance
obligations – Step 4
Companies often have to allocate the transaction price to more than one performance obligation
in a contract.
- If an allocation is needed, the transaction price allocated to the various performance
obligations is based on their relative values. The best measure of the value is the amount
that the company could sell the good or service for on a stand-alone basis, called
the stand-alone selling price.
- If this information is not available, companies should use their best estimate of what the
good or service might sell for as a stand-alone unit.
Summarizes the approaches that companies may follow (in preferred order of use).

Allocation Approach Implementation
Adjusted market Estimate the price that customers purchasing the goods or services will pay. The
assessment company might also look at competitor prices for similar goods or services.
approach
Expected cost plus a Forecast expected costs and add a reasonable profit margin.
margin
Residual approach Use where the selling price is highly variable or uncertain. Estimate the stand-
alone selling price by starting with the total price for the contract and deducting
the observable selling prices of other items being sold.
Handler Company is an experienced manufacturer of construction equipment. Handler's products
range from small to large pieces of automated equipment, to complex systems containing
numerous components. Unit selling prices range from $600,000 to $4 million and are quoted
inclusive of installation and training. The installation process does not involve changes to the
equipment's features and does not require proprietary information about the equipment in order
for the installed equipment to perform to specifications. Handler has the following arrangement
with Chai Company.
 Chai purchases equipment from Handler for $2 million and chooses Handler to do the
installation. Handler charges $2 million for the equipment whether it does the installation
or not. (Some companies do the installation themselves because they prefer their own
employees to do the work or because of relationships with other customers.) The
installation service if sold separately is estimated to have a fair value of $20,000.
 The fair value of the training sessions is estimated at $50,000. Other companies could
also perform these training services but Chai chooses to use Handler for its training so it
does not have to pay extra to another company.
 Chai is obligated to pay Handler the $2 million upon the delivery and installation of the
equipment.
 Handler delivers the equipment and completes the installation on November 1, 2020. (In
other words, transfer of control is complete.) Training related to the equipment starts
once the installation is completed and lasts for one year.
Instructions
a. What are the performance obligations for purposes of accounting for the sale of the
equipment?
b. If there is more than one performance obligation, how should the payment of $2 million be
allocated to various components? Show journal entries.
Solution
a. The equipment, installation, and training are distinct and not interdependent because
the equipment, installation, and training are three separate products or services. Each of
these items has a stand-alone selling price.
b. The total revenue of $2 million should be allocated to the three components based on
their relative values. In this case, the equipment's stand-alone selling price should be
considered to be $2 million, the installation fee is $20,000, and the training is $50,000.
The total value to consider is $2,070,000 ($2,000,000 + $20,000 + $50,000).
The allocation is as follows.
алокатион
Equipment $1,932,367 [($2,000,000 ÷ $2,070,000) × $2,000,000]
Installation $19,324 [($20,000 ÷ $2,070,000) × $2,000,000]
Training $48,309 [($50,000 ÷ $2,070,000) × $2,000,000]
Handler makes the following entry on November 1, 2020, to record both sales revenue and
service revenue on the installation, as well as the unearned service revenue.
November 1, 2020
Cash 2,000,000
Service Revenue—Installation 19,324
Sales Revenue 1,932,367
Assuming the cost of the equipment is $1.5 million, the entry to record cost of goods sold is as
follows.
November 1, 2020
Cost of Goods 1,500,000
Sold
Inventory 1,500,000
As indicated by these entries, Handler recognizes revenue from the sale of the equipment once
the installation is completed on November 1, 2020. In addition, it recognizes revenue for the
installation fee because these services have been performed.
Handler recognizes the training revenues on a straight-line basis starting on November 1, 2020,
or $4,026 ($48,309 ÷ 12) per month for one year (unless a more appropriate method such as the
percentage-of-completion method is warranted). The journal entry to recognize the training
revenue for two months in 2020 is as follows.
December 31, 2020
2
Service Revenue—Training ($4,026 × 8,052
2)
Therefore, Handler recognizes revenue for the year ended December 31, 2020, in the amount
of $1,959,743 ($1,932,367 + $19,324 + $8,052). Handler makes the following journal entry to
recognize the training revenue in 2021, assuming adjusting entries are made at year end.
December 31, 2021
Service Revenue—Training ($48,309 − 40,257
$8,052)
When a company sells a bundle of goods or services, the selling price of the bundle may be less
than the sum of the individual stand-alone prices and this may be due to a specific service or
product.
- In this case, the company should allocate the discount to the service or product that is
causing the discount and not to the entire bundle.
Manitoba Joe's Golf Shop provides the following information about three items that are often
sold as a package. The company often sells the putter and irons as a separate bundle for $550.
Item Stand-Alone Selling Price Price When Bundled
a. Lessons (per session) $100 (b) + (c) $550
b. Custom irons $525
c. Putter $125
Total $750 (a) + (b) + (c) $650
As indicated, the stand-alone prices for the lesson, custom irons, and putter total $750, but the
bundled price for all three is $650. In this case, the discount applies to the performance
obligations related to providing the custom irons and putter. As a result, Manitoba Joe's allocates
the discount solely to the custom irons and putter, and not to the lessons, as follows.
Allocated Amounts
Lessons $100
Custom irons and putter 550
Total $650
As a final note, ASPE does not provide much guidance on allocating the transaction price
7. Recognizing revenue when (or as) each performance obligation is satisfied – step 5
A company satisfies its performance obligation when the customer obtains control of the good or
service. As indicated earlier, the concept of change in control is the deciding factor in
determining when a performance obligation is satisfied.
- The customer controls the product or service when it has the ability to direct the use of
and obtain substantially all the remaining benefits from the asset or service.
- Control also includes the customer's ability to prevent other companies from directing the
use of, or receiving the benefits from, the asset or service.
Summarizes some indicators that the customer has obtained control.


1. The company has a right to payment for the asset.
 2. The company has transferred legal title to the asset.
 3. The company has transferred physical possession of the asset.
 4. The customer has significant risks and rewards of ownership.
 5. The customer has accepted the asset.

- Companies satisfy performance obligations either at a point in time or over a period of
time.
According to IFRS 15.35, companies recognize revenue over a period of time only if one or
more of the following three criteria are met:
1. The customer receives and consumes the benefits as the seller performs. (An
example of this is a one-year contract to water the plants in an office building bi-weekly.)
2. The customer controls the asset as it is created or enhanced. (For example, a builder
constructs a building on a customer's property.)
3. The company does not have an alternative use for the asset created or enhanced and
the amount is collectible. (For example, an aircraft manufacturer builds specialty jets to a
customer's specifications and the company has an enforceable right to payment.)
A company recognizes revenue from a performance obligation over time by measuring the
progress toward completion
- Companies use various methods to determine the extent of progress toward completion.
The most common are the cost-to-cost and units-of-delivery methods. The objective of
all these methods is to measure the extent of progress in terms of costs, units, or value
added.
- Companies identify the various measures (such as costs incurred, labour hours worked,
tonnes produced, or floors completed) and classify them as input or output measures.
Input measures (such as costs incurred and labour hours worked) are efforts devoted to a
contract.
Output measures (with units of delivery measured as tonnes produced, floors of a building
completed, kilometres of a highway completed, and so on) track results.
- Neither is universally applicable to all long-term projects. Their use requires the exercise
of judgement and careful tailoring to the circumstances.
Dandy Limited provides cleaning services to large corporations. Most contracts are two-year
contracts under which the company cleans the offices on a monthly basis. On January 1, Dandy
signed a two-year contract for $30,000 with $6,000 being paid January 31 and the rest monthly at
$1,000 per month (end of month). Historically, Dandy finds that it spends more time cleaning in
the winter and spring and less time in the summer.
Since the contract involves a series of services that are delivered monthly and are substantially
the same, this is considered as one performance obligation. Even though the company spends
more time cleaning in winter and spring, the cleaning services are essentially the same each
month. By treating it as one performance obligation, the entity does not have to determine a
separate stand-alone price for each month's service (step 4).
The customer receives and benefits from the cleaning services each month, and therefore revenue
is recognized over time. This allows the entity to allocate the total contract amount evenly over
the period of the contract (24 months). At the end of January, Dandy would record the following,
assuming the upfront and first payments have been made:
Cash 7,000
Service Revenue 1,250
($6,000 + $24,000)/24
months
The most popular input measure used to determine the progress toward completion is the cost-to-
cost basis.
- Under this basis, a company measures the percentage of completion by comparing costs
incurred to date with the most recent estimate of the total contract costs.
Many companies enter into licensing type arrangements with customers.
- The arrangements allow the customer to use the company's intellectual property
(franchises, rights to use software, patents, movies, pharmaceuticals, team logos, and
songs).
Should the company recognize revenue upfront or over time?
Under IFRS, if the intellectual property is static (it doesn't change), then revenue may be
recognized at a point in time.
- An example is an agreement that gives the customer a right to reproduce a historical work
of art on T-shirts.
If the intellectual property is constantly changing, then revenue is recognized over time.
- An example of this is a contract that gives the customer the right to use a team logo on
clothing. For instance, if your favourite hockey team all of a sudden advances to the next
round of the playoffs, then the value of the right to use the team logo increases.
Summarizes the five-step revenue recognition process.

Earning Approach to revenue recognition
Under the earnings approach, revenues for sale of goods and related costs are recognized when
all the following conditions are met:
1. The risks and rewards of ownership are transferred to the customer or revenues are
earned.
2. The vendor has no continuing involvement in, nor effective control over, the goods
sold.
3. Costs and revenues can be measured reliably.
4. Collectibility is probable.
If the company cannot measure the transaction, then either there is too much uncertainty
surrounding the transaction (for instance, where there are abnormal concessionary terms), or the
company has not completed all that it has to do to earn the revenues.
The earnings process consists of the actions that a company takes to add value. It is an
important part of the business model because it focuses on operating activities.
Selling Goods
When an entity sells goods, there is often one main act or critical event in the earnings process
that signals substantial completion or performance.
- At this point, although some uncertainty remains, its level is acceptable and revenues can
be recognized under accrual accounting.
In businesses that sell goods, substantial completion normally occurs at the point of delivery.
This is generally when the risks and rewards (benefits) of ownership (including legal title and
possession) pass.
- If the earnings process has a critical event, it is often called a discrete earnings process.
The concept of risks and rewards (benefits) of ownership is a core concept in the earnings
approach to revenue recognition.
- It helps to establish ownership and to indicate when ownership passes from one party to
another.
- As a general rule, the entity that has the risks and rewards treats the goods as an asset.
In determining who has the risks and rewards of ownership and, therefore, whether a sale has
occurred at the point of delivery, it is important to look at who has possession of the goods and
who has legal title.
- The principle is quite general and, therefore, there are a wide range of practical
applications. Different companies interpret these principles in different ways.
What about recognizing income before possession and legal title to goods pass to a customer? Is
there ever a situation whereby revenue might be recognized before this critical event?
- In some cases, revenue may be recognized even before there is a specific customer.
Examples of such situations can be found in the forestry and agricultural industries when
some products have assured prices and ready markets. Revenue is recognized over time
as the assets mature. The critical event is the appreciation in value of the asset.
Selling Services
The focus is different when determining the earnings process for services.
- When services are provided, the focus is on performance of the service.
An example of an earnings process for a service that is a discrete earnings process is a
maintenance inspection on a car. The service is offered on the spot and is completed in a very
short time. The critical event is when the mechanic hands over the inspected car and the bill.
Measurability and Collectibility
ASPE does not provide much guidance on how to measure transactions or how to assess
collectibility at contract inception.
8. Other revenue recognition issues
This section is based on IFRS 15. ASPE has little specific guidance in these areas, but is
otherwise generally consistent with the following material in terms of basic principles.
 Repurchase agreements
 Bill and hold
 Principal-agent relationships
 Consignments
Repurchase Agreements
In some cases, companies enter into repurchase agreements, which allow them to transfer an
asset to a customer but result in an obligation or right to repurchase the asset at a later date.
- In these situations, the question is whether the company sold the asset.
- Generally, companies report these transactions as a financing (borrowing). That is, if the
company has an obligation or right to repurchase the asset for an amount greater than or
equal to its selling price, then the transaction is a financing transaction by the company.
Morgan Inc., an equipment dealer, sells equipment on January 1, 2020, to Lane Company for
$100,000. It agrees to repurchase this equipment from Lane Company on December 31, 2021,
for a price of $121,000. Assume that Morgan continues to have control over the asset during the
period.
For a sale and repurchase agreement, the terms of the agreement need to be analyzed to
determine whether Morgan Inc. has transferred control to the customer, Lane Company. As
indicated earlier, control of an asset refers to the ability to direct the use of and obtain
substantially all the benefits from the asset. Control also includes the ability to prevent other
companies from directing the use of and receiving the benefit from a good or service. Therefore,
this agreement is a financing transaction and not a sale. Thus, the asset is not removed from the
books of Morgan Inc.
Assuming that an interest rate of 10% is imputed from the agreement, Morgan Inc. makes the
following entries to record this agreement.
January 1, 2020
Cash 100,000
Contract Liability 100,000
Morgan Inc. records interest on December 31, 2020, as follows.
December 31, 2020
Interest Expense 10,000
Contract Liability ($100,000 × 10,000
10%)
Morgan Inc. records interest and retirement of its liability to Lane Company as follows.
December 31, 2021
Interest Expense 11,000
Contract Liability ($110,000 × 10%) 11,000
Contract Liability 121,000
Cash ($100,000 + $10,000 + 121,000
$11,000)
Bill-and-Hold Arrangements
A bill-and-hold arrangement is a contract under which an entity bills a customer for a product
but the entity retains physical possession of the product until it is transferred to the customer at a
point in the future.
- Bill-and-hold sales result when the buyer is not yet ready to take delivery but does take
title and accepts billing.
For example, a customer may request that a company enter into such an arrangement because of
(1) lack of available space for the product, (2) delays in its production schedule, or (3) more than
sufficient inventory in its distribution channel.
All of the following criteria should be met (IFRS 15.B81):
a. The reason to hold the inventory must be substantive.
b. The product must be identified separately and belong to company.
c. The product must be ready to ship.
d. Butler cannot use the product nor sell it to another customer.
Principal-Agent Relationships
In a principal-agent relationship, the principal's performance obligation is to provide goods or
perform services for a customer.
- The agent's performance obligation is to arrange for the principal to provide these goods
or services to a customer.
Examples of principal-agent relationships are as follows.
 Preferred Travel Company (agent) facilitates the booking of cruise excursions by finding
customers for Regency Cruise Company (principal).
 Pricey Limited (agent) facilitates the sale of various services such as car rentals at Hero
Limited (principal).
In these types of situations, amounts collected on behalf of the principal are not revenue of the
agent. Instead, revenue for the agent is the amount of the commission it receives (usually a
percentage of the total sale price).
Consignments
A common principal-agent relationship involves consignments.
- In these cases, manufacturers (or wholesalers) deliver goods but retain title to the goods
until they are sold.
- This specialized method of marketing certain types of products makes use of an
agreement known as a consignment. Under this arrangement,
the consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer),
who is to act as an agent for the consignor in selling the merchandise.
- Both consignor and consignee are interested in selling—the consignor to make a profit or
develop a market, the consignee to make a commission on the sale.
The consignee accepts the merchandise and agrees to exercise due diligence in caring for and
selling it. The consignee remits to the consignor cash received from customers, after deducting a
sales commission and any chargeable expenses.
- In consignment sales, the consignor uses a modified version of the point-of-sale basis of
revenue recognition.
- That is, the consignor recognizes revenue only after receiving notification of the sale and
the cash remittance from the consignee.
The consignor carries the merchandise as inventory throughout the consignment, separately
classified as Inventory (consignments).
- The consignee does not record the merchandise as an asset on its books.
- Upon sale of the merchandise, the consignee has a liability for the net amount due to
the consignor.
- The consignor periodically receives from the consignee a report called account sales that
shows the merchandise received, merchandise sold, expenses chargeable to the
consignment, and cash remitted.
- Revenue is then recognized by the consignor.
Nelba Manufacturing Co. ships merchandise costing $36,000 on consignment to Best Value
Stores. Nelba pays $3,750 of freight costs, and Best Value pays $2,250 for local advertising costs
that are reimbursable from Nelba. By the end of the period, Best Value has sold two thirds of the
consigned merchandise for $40,000 cash. Best Value notifies Nelba of the sales, retains a 10%
commission, and remits the cash due to Nelba.
NELBA MFG. CO. BEST VALUE STORES
(Consignor) (Consignee)
Shipment of consigned merchandise
Inventory on Consignment 36,000 No entry (record memo of merchandise received).
Finished Goods Inventory 36,000

Payment of freight costs by consignor
NELBA MFG. CO. BEST VALUE STORES
Inventory on Consignment 3,750 No entry
Cash 3,750
Payment of advertising by consignee

No entry until notified. Accounts Receivable 2,250
Cash 2,250
Sales of consigned merchandise
No entry until notified. Cash 40,000
Accounts Payable 40,000
Notification of sales and expenses and remittance of amount due
Cash 33,750 Accounts Payable 40,000
Advertising Expense 2,250 Accounts Receivable 2,250
Commission Expense 4,000 Revenue from Consignment Sales 4,000
Revenue from Consignment Sales 40,000 Cash 33,750
Adjustment of inventory on consignment for cost of sales

Cost of Goods Sold 26,500 No entry.
Inventory on Consignment 26,500
[2/3 ($36,000 + $3,750) = $26,500]
- Under the consignment arrangement, the consignor accepts the risk that the merchandise
might not sell and relieves the consignee of the need to commit part of its working capital
to inventory.
- Consignors use a variety of systems and account titles to record consignments, but they
all share the common goal of postponing the recognition of revenue until it is known that
a sale to a third party has occurred.

Issue Description Implementation

Repurchase Seller has an obligation or right to Generally, if the company has an obligation to
agreements repurchase the asset at a later date. repurchase the asset for an amount greater than
its selling price, then the transaction is a
financing transaction.

Bill and hold Results when the buyer is not yet ready Revenue is recognized depending on when the
to take delivery but takes title and customer obtains control of that product.

Issue Description Implementation
accepts billing.

Principal-agent Arrangement in which the principal's Amounts collected on behalf of the principal are
performance obligation is to provide not revenue of the agent. Instead, revenue for the
goods or perform services for a agent is the amount of the commission it receives.
customer. The agent's performance The principal recognizes revenue when the goods
obligation is to arrange for the principal or services are sold or provided to a third-party
to provide these goods or services to a customer.
customer.

Consignments A principal-agent relationship in which The consignor recognizes revenue only after
the consignor (manufacturer or receiving notification of the sale and the cash
wholesaler) ships merchandise to the remittance from the consignee. (Consignor
consignee (dealer), who is to act as an carries the merchandise as inventory throughout
agent for the consignor in selling the the consignment.) The consignee records
merchandise. commission revenue (usually some percentage of
the selling price).

9. Presentation and disclosure
Presentation
When General Mills delivers cereal to a Loblaw Companies Limited warehouse (satisfying its
performance obligation), it has a right to consideration from Loblaw and if this is a conditional
right it would record a contract asset.
If, on the other hand, Loblaw performs first, by prepaying for this cereal, General Mills has a
contract liability.
- Companies must present these contract assets and contract liabilities on their balance
sheets.
Contract Assets and Liabilities
Contracts with customers create contractual rights and obligations. Contractual rights are of two
types:
1. unconditional rights to receive consideration; for instance, where the company has
satisfied its performance obligation with a customer or the amounts due to the company
are non-refundable; or
2. conditional rights to receive consideration; for instance, where the company has not
satisfied the performance obligation or has satisfied one performance obligation but must
satisfy another performance obligation in the contract before it is entitled to the
consideration.
Companies should report unconditional rights to receive consideration as a receivable on the
SFP.
Conditional rights on the SFP should be reported separately as contract assets.
On January 1, 2020, Finn Company enters into a contract to transfer Product A and Product B to
Obermine Co. for $100,000. The contract specifies that payment for Product A will not occur
until Product B is also delivered. In other words, payment will not occur until both Product A
and Product B are transferred to Obermine. Finn determines that stand-alone prices are $30,000
for Product A and $70,000 for Product B. Finn delivers Product A to Obermine on February 1,
2020. On March 1, 2020, Finn delivers Product B to Obermine.
No entry is required on January 1, 2020, because neither party has performed on the contract. On
February 1, 2020, Finn records the following entry.
February 1, 2020
Contract Asset 30,000
Sales Revenue 30,000
On February 1, Finn has satisfied its performance obligation and therefore reports revenue of
$30,000.
- However, it does not record an account receivable at this point because it does not have
an unconditional right to receive the $100,000 unless it also transfers Product B to
Obermine.
- In other words, a contract asset occurs generally when a company must satisfy another
performance obligation before it is entitled to bill the customer. When Finn transfers
Product B on March 1, 2020, it makes the following entry.
March 1, 2020
Accounts 100,000
Receivable
Contract Asset 30,000
A contract liability is a company's obligation to transfer goods or services to a customer for

which the company has received (or will receive) consideration from the customer.
On March 1, 2020, Henly Company enters into a contract to transfer a product to Propel Inc. on
July 31, 2020. Propel agrees to pay the full price of $10,000 in advance on April 15, 2020. Henly
delivers the product on July 31, 2020. The cost of the product is $7,500.
No entry is required on March 1, 2020, because neither party has performed on the contract. On
receiving the cash on April 15, 2020, Henly records the following entry.
April 15, 2020
Cash 10,000
Unearned 10,000
Revenue
July 31, 2020

Unearned 10,000
Revenue
In addition, Henly records cost of goods sold as follows.
Cost of Goods 7,500
Sold
Inventory 7,500
- Companies are not required to use the terms “contract assets” and “contract liabilities” on
the Statement of Financial Position.
For example, contract liabilities are performance obligations and therefore more descriptive titles
(as noted earlier)—such as unearned revenue, repurchase liability, and return liability—may be
used where appropriate.
For contract assets, it is important that financial statement users can differentiate between
unconditional and conditional rights through appropriate account presentation.
Costs to Obtain and/or Fulfill a Contract
In the process of obtaining a contract, a company may incur costs such as commissions, legal
fees, and proposal costs.
- These are treated as assets as long as they are incremental (that is, they would not be
incurred unless the contract had been obtained) and recoverable.
In completing the contract, the company also incurs costs known as fulfillment costs.
- These are the costs that the company must incur to fulfill the contract, once obtained.
Examples of these include inventory costs; costs of constructing property, plant, or equipment;
costs chargeable to the customer under the contract; payments to subcontractors; and others.
- If these costs are not covered by another standard (such as inventory costs or costs to
create property, plant, or equipment/intangible assets), they may still be treated as assets
as long as they relate directly to the contract, enhance or create economic
resources that can be used in future, and are recoverable.
Other costs that are expensed as incurred include general and administrative costs (unless
those costs are explicitly chargeable to the customer under the contract) as well as costs
of wasted materials and labour.
Summarizes these types of costs and their treatment.
As a practical expedient, a company recognizes the incremental costs of obtaining a contract as
an expense when incurred if the amortization period of the asset that the company otherwise
would have recognized is one year or less.
Disclosure
The disclosure requirements for revenue recognition are designed to help financial statement
users understand the nature, amount, timing, and uncertainty of revenue and cash flows arising
from contracts with customers. To achieve that objective, companies disclose qualitative and
quantitative information about all of the following:
 Contracts with customers. These disclosures include the disaggregation of revenue,
presentation of opening and closing balances in contract assets and contract liabilities,
and significant information related to their performance obligations.
 Significant judgements. These disclosures include judgements and changes in these
judgements that affect the determination of the transaction price, the allocation of the
transaction price, and the determination of the timing of revenue.
 Assets recognized from costs incurred to fulfill a contract. These disclosures include the
closing balances of assets recognized to obtain or fulfill a contract, the amount of
amortization recognized, and the method used for amortization.
To implement these requirements and meet the disclosure objectives, companies provide a range
of disclosures, as summarized in

Disclosure Type Requirements

Disaggregation of Disclose disaggregated revenue information in categories that depict how the
revenue nature, amount, timing, and uncertainty of revenue and cash flows are affected by
economic factors. Reconcile disaggregated revenue to revenue for reportable
segments.

Reconciliation of Disclose opening and closing balances of contract assets (such as unbilled
contract balances receivables) and liabilities (such as deferred revenue) and provide a qualitative

Disclosure Type Requirements
description of significant changes in these amounts. Disclose the amount of
revenue recognized in the current period relating to performance obligations
satisfied in a prior period (such as from contracts with variable consideration).
Disclose the opening and closing balances of trade receivables if not presented
elsewhere.

Remaining Disclose the amount of the transaction price allocated to performance obligations
performance of any remaining performance obligations not subject to significant revenue
obligations reversal. Provide a narrative discussion of potential additional revenue in
constrained arrangements.

Costs to obtain or Disclose the closing balances of capitalized costs to obtain and fulfill a contract
fulfill contracts and the amount of amortization in the period. Disclose the method used to
determine amortization for each reporting period.

Other qualitative Disclose significant judgements and changes in judgements that affect the amount
disclosures and timing of revenue from contracts with customers. Disclose how management
determines the minimum amount of revenue not subject to the variable
consideration constraint.
For ASPE disclosure requirements include accounting policy and major revenue categories
(only).
APPENDIX
Accounting for long-term contracts poses some challenges, however, because they have some
unique features.
- Not only are they longer term (often spanning several reporting periods) but they often
include unique contract terms, such as granting the ability to send progress billings.
- This right to bill helps the company finance the project.
Examples of long-term contracts are construction-type contracts, development of military and
commercial aircraft, weapons delivery systems, service contracts, and space exploration
hardware.
We view some long-term contracts as a series of distinct performance obligations and
therefore revenue is recognized over time as each performance obligation is satisfied (at various
points in time throughout the life of the contract). For instance, when the project consists of
separable units, such as a group of buildings, the contract may provide for delivery over time as
each unit is complete. Revenue is recognized as each building is completed.
ASPE criteria are more general, requiring that revenue reflect the work accomplished. This is not
necessarily different but could result in differences in accounting in practice.
Some of the different outcomes in accounting for long-term contracts.

Long-Term Contracts Example Accounting When to Recognize Revenue
under IFRS under IFRS 15

Many distinct Three-year contract to Treat as many As each performance obligation
performance obligations build 50 planes performance is completed
within a long-term obligations
contract

One performance Construction of hotel in Treat as one Recognize revenue at the end
obligation within a long- downtown area performance when performance obligation
term contract and IFRS obligation satisfied
15.35 criteria not met

One performance Construction of satellite Treat as one Recognize revenue over time
obligation within a long- where company cannot performance using percentage-of-
term contract and IFRS sell to anyone else and has obligation completion method (or zero-
15.35 criteria met right to payment or profit method)
construction of luxury
cottage on customer-
owned property

Many distinct Two-year contract to Treat as one Recognize revenue over time
performance obligations provide cleaning services performance using percentage-of-
within a long-term on a monthly basis obligation completion method or other
contract but each is method (such as time-based
substantially the same method, which recognizes
and has the same pattern revenue as time passes)
of transfer to the
customer
If one of the criteria is met, and if the company can reasonably estimate its progress
toward satisfaction of the performance obligations, then the company recognizes revenue
over time.
- That is, it recognizes revenues and gross profits each period based upon the progress of
the construction—referred to as the percentage-of-completion method.
- The company accumulates construction costs and progress billings in separate accounts
that represent contractual rights and obligations. If the company deferred recognition of
these items until it completed the entire contract, it would misrepresent the efforts (costs)
and accomplishments (revenues) of the accounting periods during the contract.
The rationale for using percentage-of-completion accounting is that, under most of these
contracts, the buyer and seller have enforceable rights.
- The buyer has the legal right to require specific performance on the contract.
- The seller has the right to require progress payments that provide evidence of the buyer's
ownership interest.
- As a result, a continuous sale occurs as the work progresses. Companies should recognize
revenue according to that progression.
Under IFRS, if one of the IFRS 15.35 criteria is met but an estimate cannot be made,
then the company records recoverable revenues equal to costs until the uncertainty is resolved.
This is known as the zero-profit method.
Under ASPE, the entity would use the completed-contract method in these circumstances and
recognize revenues only at the end of the contract.
In order to apply the percentage-of-completion method, a company must have some basis or
standard for measuring the progress toward completion at particular interim dates.
Measuring the Progress Toward Completion
Companies use various methods to determine the extent of progress toward completion. The
most common are the cost-to-cost and units-of-delivery methods.
Both input and output measures have certain disadvantages.
- The input measure is based on an established relationship between a unit of input and
productivity. If inefficiencies cause the productivity relationship to change, inaccurate
measurements result.
- Another potential problem is front-end loading, in which significant upfront costs result
in higher estimates of completion.
- To avoid this problem, companies should disregard some early-stage construction costs—
for example, costs of uninstalled materials or costs of subcontracts not yet performed—if
they do not relate to contract performance.
- Similarly, output measures can produce inaccurate results if the units used are not
comparable in time, effort, or cost to complete. For example, using floors (storeys)
completed can be deceiving. Completing the first floor of an eight-storey building may
require more than one eighth of the total cost because of the substructure and foundation
construction.
The most popular input measure used to determine the progress toward completion is the cost-to-
cost basis.
- Under this basis, a company like CGI, the Montreal-based information technology
consulting company, could measure the percentage of completion by comparing costs
incurred to date with the most recent estimate of the total costs of the contract.
Costs incurred to date/Most recent estimate of total costs=Percent complete
Once CGI knows the percentage that costs incurred represent of total estimated costs, it would
apply that percentage to the total revenue and the estimated total gross profit on the contract. The
resulting amount is the revenue or the gross profit to be recognized to date.
Percent complete × Estimated total revenue(or gross profit)=Revenue (or gross profit)to be
recognized to date
To find the amounts of revenue and gross profit recognized each period, CGI would subtract
total revenue or gross profit recognized in prior periods.
Revenue (or gross profit)to be recognized to date−Revenue (or gross profit)recognized in
prior periods=Current-period revenue(or gross profit)
Assume that Hardhat Construction Company has a non-cancellable contract to construct a $4.5-
million bridge at an estimated cost of $4 million. The contract is to start in July 2020, and the
bridge is to be completed in October 2022. The following data pertain to the construction period.
(Note that, by the end of 2021, Hardhat has revised the estimated total cost from $4,000,000 to
$4,050,000.) Assume that progress billings are non-refundable. Calculate the percentage
complete блять
2020 2021 2022
Costs to date (12/31) $1,000,000 $2,916,000 $4,050,000
Estimated costs to complete (12/31) 3,000,000 1,134,000 -0-
Progress billings during the year 900,000 2,400,000 1,200,000
Cash collected during the year 750,000 1,750,000 2,000,000
Solution
On the basis of the data above, Hardhat would make the following entries to record (1) the costs
of construction, (2) progress billings, (3) collections, and (4) revenues and costs. These entries
appear as summaries of the many transactions that would be entered individually as they occur
during the year. Note that the amount of billings represents consideration that is unconditional
because the contract is non-cancellable and the billings non-refundable. It is therefore recorded
as Accounts Receivable.
The entries are shown below.
In this example, the costs incurred to date are a measure of the extent of progress toward
completion. To determine this, Hardhat evaluates the costs incurred to date as a proportion of the
estimated total costs to be incurred on the project. The estimated revenues that Hardhat will
recognize for each year are calculated as shown below.
Recall that the Hardhat Construction Company example contained a change in estimated costs:
In the second year, 2021, it increased the estimated total costs from $4,000,000 to $4,050,000.
The change in estimate is accounted for in a cumulative catch-up manner. This is done by first
adjusting the percent completed to the new estimate of total costs. Next, Hardhat deducts the
amount of revenues recognized in prior periods from revenues calculated for progress to date.
That is, it accounts for the change in estimate in the period of change. That way, the statement of
financial position at the end of the period of change and the accounting in subsequent periods are
as they would have been if the revised estimate had been the original estimate.
Financial Statement Presentation—Percentage-of-Completion
During the life of the contract, Hardhat reports the contract asset/liability as current (assuming
the related revenues will be earned in the following year).
- Accounts receivable are reported as current assuming they will be received within the
following year.
- In general, the Contract Asset/Liability position is shown net on the statement of financial
position.
- A debit balance represents the excess of the amounts earned to date minus amounts
billed.
- A credit balance represents the excess of amounts billed over amounts earned.
Assume the information from example. How would Hardhat Construction Company present the
information each year in the financial statements?
Hardhat Construction Company would report the status and results of its long-term construction
activities under the percentage-of-completion method as shown below for 2020, 2021, and 2022.
In 2022, presentation in Hardhat's financial statements affects only the income statement because
the bridge project was completed and settled.
Zero-Profit Method
During the early stages of a contract, a company like Bombardier may not be able to estimate the
outcome of the contract. As long as the company is confident that it will be able to recover costs
incurred from the customer, it may use the zero-profit method.
- This method recognizes revenue equal to costs incurred as long as the costs are
recoverable from the customer.
Assume the information given for Hardhat Construction Company except assume that the
company uses the zero-profit method.
a. How much revenue and expense would Hardhat recognize each year over the life of the
contract?
b. What would the journal entries be?
a. The company would report the following revenues over the life of the contract.
To Date Recognized in Prior Years Recognized in Current Year
2020
Revenues (= costs incurred) $1,000,000 $1,000,000
Costs 1,000,000 1,000,000

Gross profit $ 0 $ 0
2021
Revenues (= costs incurred) $2,916,000 $1,000,000 $1,916,000
Costs 2,916,000 1,000,000 1,916,000

Gross profit $ 0 $ 0 $ 0
2022
Revenues (= costs incurred) $4,500,000 $2,916,000 $1,584,000
Costs 4,050,000 2,916,000 1,134,000

Gross profit $ 450,000 $ 0 $ 450,000
b.
2020 2021 2022
Construction Expense 1,000,000 1,916,00 1,134,000
2020 2021 2022
0
Contract 1,000,000 1,916,000 1,134,000
Asset/Liability
(To record
construction expense)
Contract 1,000,000 1,916,00 1,584,000
Asset/Liability 0
Revenue from 1,000,000 1,916,000 1,584,000
Long-Term Contracts
(To record
revenues)
Completed-Contract Method
Under ASPE and the completed-contract method, companies recognize revenue and gross profit
when the contract is completed.
- Companies accumulate costs of long-term contracts in process, but they make no interim
charges or credits to income statement accounts for revenues, costs, or gross profit.
- The completed-contract method is used where performance consists of a single act or the
company is unable to estimate progress toward completion.
The main advantage of the completed-contract method is that reported revenue reflects final
results rather than estimates of unperformed work.
Its major disadvantage is that it does not reflect current performance when the period of a
contract extends into more than one accounting period. Although operations may be fairly
uniform during the period of the contract, the company will not report revenue until the year of
completion, which distorts earnings.
- Under the completed-contract method, the company would make the same annual
entries to record costs of construction, progress billings, and collections from customers
as those illustrated under the percentage-of-completion method. The significant
difference is that the company would not make entries to recognize revenue and
construction expenses until the final year.
Assume the information given for Hardhat Construction Company except assume that the
company uses the completed-contract method. What would the journal entries be?
Hardhat Construction Company would make the same first three entries in Example 6.A.2 each
year, and the following entry in 2022 to recognize revenue and costs and to close out the
inventory and billing accounts. As noted earlier, sometimes the Construction in Process account
is used instead of Contract Asset/Liability.
Contract Asset/Liability 450,000
Construction Expense 4,050,000
Revenue from Long-Term 4,500,000
Contracts
Compares the amount of gross profit that Hardhat Construction Company would recognize for
the bridge project under the three revenue recognition methods assuming that, under the zero-
profit method, the outcome of the contract is finally determinable at the end of the contract.
- Note that, under the completed-contract and zero-profit methods, even though the profit
recognized is the same, there is a difference in that, under the completed-contract method,
no revenue is recognized at all until the final year, whereas under the zero-profit method,
recoverable revenue equal to costs is recognized each year.
Losses On Long-Term Contracts

Two types of losses can occur under long-term contracts:
1. Loss in current period on a profitable contract: This condition occurs when there is
a significant increase in the estimated total contract costs during construction but the
increase does not eliminate all profit on the contract.
Under the percentage-of-completion method only, the increase in the estimated cost
requires an adjustment in the current period for the excess gross profit that was
recognized on the project in prior periods. This adjustment is recorded as a loss in the
current period because it is a change in accounting estimate. Under the other two
methods, no profit has been recorded yet so there is no adjustment needed.
2. Loss on an unprofitable contract: Cost estimates at the end of the current period may
indicate that a loss will result once the contract is completed. Under the percentage- of-
completion, zero-profit, and completed-contract methods, the entire loss that is expected
on the contract must be recognized in the current period.
Assume the facts given except assume that on December 31, 2021, Hardhat estimates the costs to
complete the bridge contract at $1,468,962 instead of $1,134,000.
a. How much loss would the company recognize in 2021?
b. What would the journal entries be?
Hardhat would calculate the percent complete and recognize the loss as shown below. The
percent complete has dropped from 72% to 66½% due to the increase in estimated future costs to
complete the contract.
Cost to date (12/31/21) $2,916,000

Estimated costs to complete (revised)
1,468,962
Estimated total costs $4,384,962

Percent complete ($2,916,000 ÷ 66½%
$4,384,962)
Revenue recognized in 2021
($4,500,000 × 66½%) − $1,125,000 $1,867,500

Costs incurred in 2021
1,916,000
Loss recognized in 2021 $ (48,500)
The loss of $48,500 in 2021 is a cumulative adjustment of the gross profit that was recognized on
the contract in 2020. Instead of restating the prior period, the new estimation is absorbed entirely
in the current period. In this illustration, the adjustment was large enough to result in recognition
of a loss.
Hardhat would record the loss in 2021 as follows:
Revenue from Long-Term Contracts 1,867,500
The loss of $48,500 will be reported on the 2021 income statement as the difference between the
reported revenues of $1,867,500 and the costs of $1,916,000.
Under the completed-contract and zero-profit methods, no loss is recognized in 2021, because
the contract is still expected to result in a profit that will be recognized in the year of completion.
Loss on an Unprofitable Contract
Where a contract becomes onerous (that is, the total estimated costs associated with the contract
exceed the total revenues), the entity would recognize an overall loss. Any prior profits would be
reversed and additional losses recognized.
Assume the facts given except assume that at December 31, 2021, Hardhat Construction
Company estimates the costs to complete the bridge contract at $1,640,250 instead of
$1,134,000. Revised estimates for the bridge contract are as follows.
2020 Original Estimates 2021 Revised Estimates
Contract price $4,500,000 $4,500,000
Estimated total cost 4,000,000 4,556,250*
Estimated gross profit $ 500,000
Estimated loss $ (56,250)
*$2,916,000 + $1,640,250
Under the percentage-of-completion method, Hardhat recognized $125,000 of gross profit in
2020 (see Example 6.A.2). This amount must be offset in 2021 because it is no longer expected
to be realized. In addition, since losses must be recognized as soon as estimable, the company
must recognize the total estimated loss of $56,250 in 2021. Therefore, Hardhat must recognize a
total loss of $181,250 ($125,000 + $56,250) in 2021.
Revenue recognized in 2021:
Contract price $4,500,000
Percent complete (based on costs to date/total estimated × 64%*
costs)
Revenue recognizable to date 2,880,000
Less: Revenue recognized prior to 2021 1,125,000
Revenue recognized in 2021 $1,755,000
*$2,916,000/$4,556,250 = 64%
To calculate the construction costs to be expensed in 2021, Hardhat adds the total loss to be
recognized in 2021 ($125,000 + $56,250) to the revenue to be recognized in 2021.
Revenue recognized in 2021 $1,755,000
Total loss recognized in 2021:
Reversal of profit from 2020 $125,000
Total estimated loss on contract 56,250 181,250
Construction cost expensed in 2021 $1,936,250
Hardhat Construction would record the long-term contract revenues, expenses, and loss in 2021
as follows.
Revenue from Long-Term 1,755,000
Contracts
At the end of 2021, Contract Asset/Liability has a balance of $2,859,750, as shown below.
Contract Asset/Liability Account
Dr. Cr.
2020 Construction costs 1,000,000 2020 Billings 900,000
2020 Recognized gross 125,000 2021 Billings 2,400,000
profit
2021 Construction costs 1,916,000 2021 Recognized loss 181,250
Account Balance 440,250
Under the zero-profit and completed-contract methods, Hardhat would also recognize the
contract loss of $56,250 through the following entry in 2021 (the year in which the loss first
became evident):
Loss on Long-Term Contract 56,250

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Revenue recognition

1. Understanding the nature of sales transactions from a business perspective

Why Does This Matter for Accounting Purposes?

Why Does This Matter for Accounting Purposes?

Consideration that is nonmonetary (as with barter transactions) presents greater challenges for

Why Does This Matter for Accounting Purposes?

 f.o.b. shipping point: title passes at the point of shipment.

Why Does This Matter for Accounting Purposes?

Why Does This Matter for Accounting Purposes?

regarding the goods or services to be transferred.

Summarizes some classic situations when revenue is recognized as a result of providing a

5. Determine the transaction price – Step 3

Summarizes the five-step revenue recognition process.

Finished Goods Inventory 36,000

Payment of advertising by consignee

Revenue from Consignment Sales 40,000 Cash 33,750

Adjustment of inventory on consignment for cost of sales

A contract liability is a company's obligation to transfer goods or services to a customer for

July 31, 2020

Costs 1,000,000 1,000,000

Costs 2,916,000 1,000,000 1,916,000

Costs 4,050,000 2,916,000 1,134,000

Losses On Long-Term Contracts

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