Revenue Recognition Principles

MODULE 1:
PROBLEMS WITH
REVENUE RECOGNITION
Dr Jacek Welc:
jacek.welc@ue.wroc.pl
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Selected Practical Issues in the Field of Financial Accounting and Auditing: Problems with Revenue Recognition
PART 1:
REVENUE RECOGNITION
PRINCIPLES UNDER IFRS
1
ACCOUNTING STANDARDS RELATING TO REVENUE
RECOGNITION
In May 2014 the IASB (International Accounting Standards Board) published a new,
comprehensive standard: IFRS 15 – Revenue from Contracts with Customers.
There were two basic reasons for issuing this new standard:
to more precisely regulate the issues relating to timing of revenue recognition and
measuring revenues (which so far were regulated by several standards, with limited
guidance on some relevant and problematic issues),
to converge revenue recognition principles under IFRS to those under US GAAP (US
Generally Accepted Accounting Principles, which are effective in the USA).
IFRS 15 is effective for annual periods beginning on or after 1 January 2017, although earlier
application is permitted. IFRS 15 supersedes the following standards:
IAS 18 – Revenue,
IAS 11 – Construction Contracts.
2
FUNDAMENTAL REVENUE RECOGNITION PRINCIPLES UNDER
CURRENTLY EFFECTIVE STANDARDS (IAS 18 AND IAS 11)
According to IASB:
“Previous revenue recognition requirements in IFRS provided limited guidance and,

consequently, the two main revenue recognition Standards, IAS 18 and IAS 11, could be
difficult to apply to complex transactions. In addition, IAS 18 provided limited guidance on
many important revenue topics such as accounting for multiple-element arrangements.”
Accordingly, the revenue-related standards effective so far (IAS 18 and IAS 11) offered
limited guidance on how and when to measure revenues.
These “old” (although still effective, until 2017) regulations are summarized below.
3
According to IAS 18 - Revenue:
Revenue is measured at the fair value of the consideration received or receivable
(where fair value, according to IFRS 13 – Fair Value Measurement, is the price that
would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date),
If the payment of cash or cash equivalents is deferred, the related revenue should be
measured at the discounted value (with an estimated appropriate discount rate), the
resulting difference between a monetary amount of payment received and its
discounted value (which reflects a time value of money) should be treated as an interest
(financial) income,
The revenue recognition criteria should be applied to the separately identifiable
components of a single transaction (although IAS 18 does not offer any detailed
guidelines on how to “split” a single transaction into its identifiable components).
4
According to IAS 18 - Revenue, revenue from the sale of goods should be recognized if all of the
following five conditions are met:
The reporting entity has transferred significant risks and rewards of ownership of the goods
to the buyer (if not, e.g. if the buyer retains unconditional right to return the goods, the
revenue should be deferred),
The entity does not retain either continuing managerial involvement or effective control
over the goods sold,
The amount of revenue to be recognized can be measured reliably (if not, e.g. when the
volume of product returns is unpredictable, the revenue should be deferred),
The probability that economic benefits related to the transaction will flow to the entity
exists,
The costs incurred or to be incurred in respect of the transaction can be measured reliably (if
not, e.g. when future warranty expenses are unpredictable, the revenue should be deferred).
5
According to IAS 18 - Revenue, when the outcome of the transaction involving the rendering of
services can be estimated reliably, revenue recognition relating to that transaction should refer to
the stage of completion of the underlying service. The outcome may be estimated reliably if all the
following four conditions are met:
The amount of revenue can be measured reliably,
The probability that the economic benefits related to this transaction will flow to the entity
exists,
The stage of completion of the transaction at the end of the reporting period can be
measured reliably,
The costs incurred for the transaction and the costs to complete the transaction can be
measured reliably.
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The stage of completion of a transaction is a proportion of the contract work completed and
may be determined using one of several methods that reliably measures it, including:
Surveys of work performed (e.g. on the ground of complex engineering measurements),
Services performed to date as a percentage of total services to be performed (e.g. when
200 km of the straight road was constructed, out of a 500 km contracted),
The proportion of costs incurred to date to the estimated total costs of the transaction.
When the stage of completion is measured on a cost basis, the following costs should be
omitted when estimating the stage of completion:
Contrast costs that relate to future activity (e.g. ordered but not yet used materials),
Advance payments to subcontractors (before their services are rendered).
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THE NEW STANDARD (IFRS 15)
The core principle of IFRS 15 is that an entity recognizes revenue by applying the
following five steps:
STEP 1: Identify the contract with a customer – a contact is an agreement
between two or more parties that creates enforceable rights and obligations,
STEP 2: Identify the performance obligations in the contract – if the goods or
services promised in the contract are distinct, they should be accounted for
separately:
A good or service is distinct, if the customer can benefit from the good or
service on its own or together with other resources that are readily available
to the customer and the entity’s promise to transfer the good or service to
the customer is separately identifiable from other promises in the contract.
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STEP 3: Determine the transaction price – the transaction price is the amount
of consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer:
The transaction price can be a fixed amount of customer consideration, but it
may sometimes include variable consideration or consideration in a form
other than cash,
The estimated amount of variable consideration should be included in the
transaction price only to the extent that it is highly probable that a
significant reversal in the amount of cumulative revenue recognized will not
occur when the uncertainty associated with the variable consideration is
subsequently resolved,
The transaction price must also be adjusted for the effects of the time value
of money if the contract includes a significant financing component.
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STEP 4: Allocate the transaction price to the performance obligations in the

contract:
An entity should allocate the transaction price to each performance

obligation on the basis of the relative stand-alone selling prices of each
distinct good or service promised in the contract,
If a stand-alone selling price is not observable, an entity estimates it.
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STEP 5: Recognize revenue when (or as) the entity satisfies a performance
obligation:
A performance obligation may be satisfied at a point in time (e.g. for
promises to transfer goods) or over time (e.g. for promises to transfer
services),
For performance obligations satisfied over time, an entity recognizes
revenue over time by selecting an appropriate method for measuring the
entity’s progress towards complete satisfaction of that performance
obligation,
The amount of revenue recognized is the amount allocated to the satisfied
performance obligation.
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STEP 2 – SEPARATION OF DISTINCT PERFORMANCE
OBLIGATIONS
Factors that indicate that en entity’s promise to transfer a good or service to a customer
is separately identifiable include, but are not limited to, the following:
The entity does not provide a significant service of integrating the good or service
with other goods or services promised in the contract into a bundle of goods or
services that represent the combined output for which the customer has
contracted,
The good or service does not significantly modify or customize another good or
service promised in the contract,
The good or service is not highly dependent on, or highly interrelated with, other
goods or services promised in the contract (for example, when customer could
decide to not purchase the good or service without significantly affecting the other
promised goods or services in the contract).
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OBLIGATIONS
EXAMPLE 1: THE GOODS AND SERVICES WHICH ARE DISTINCT
A software company, specialized in an accounting and business software, sold one of its standardized
products to its business client. The total contract price of 1 million EUR (payable within 30 days after signing
the contract) covers a bundle of the following goods and services:
• A license to use a software, valid for ten computers (which is transferred to the customer immediately
after signing a contract),
• The training in using the software for up to ten customer’s employees (which is to be provided within a
timeframe of up to two months after signing a contract),
• The optional software support (up to 100 consulting hours) available to the customer in the course of
the twelve months (following the date of signing the contract),
• The update of the software (to adjust it to the expected change of tax regulations) after twelve months.
All these separable parts should be considered distinct performance obligations, because they may be
provided independently. For example, a customer might purchase a license itself while ordering the software
trainings from another vendor (which is familiarized with that software). Similarly, the software support
could be provided by the customer’s own IT specialists (instead of ordering it from a software vendor).
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OBLIGATIONS
EXAMPLE 2: THE GOODS AND SERVICES WHICH ARE NOT DISTINCT
A software company, specialized in an accounting and business software, entered a contract in which it
designs a customized management software for a business customer. The total contract price of 1 million EUR
covers a bundle of the following goods and services:
• Designing a management software specifically tailored to the unique features of the customer’s
business operations,
• Integration of the created software with the other software used by the customer,
• The 100 hours of the software trainings which are to be provided to the customer’s employees
simultaneously with the integration of the customized software with the customer’s other software.
All these performance obligations should be treated as inter-related (and not distinct), because they may not
be provided independently. For example, a customer may not be able to order an integration of such a
customized software from another IT company, because it would not be familiarized with the non-
standardized software designed by other IT firm specifically for the company. Likewise, the trainings
constitute an integral part of the whole contract, because without them the customer would not be able to
use the software after it is designed and integrated with its other software, and the trainings may be
provided only by the company which is the author of that customized software.
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PROBLEM 1: Variable consideration
calls for estimates, which may be
subjective and difficult to verify
STEP 3 – DETERMINING THE TRANSACTION PRICE

The most significant problem related to the determination of the transaction price
is the treatment of a variable consideration:
An amount of consideration can vary because of discounts, rebates, refunds,
credits, price concessions, incentives, performance bonuses, penalties,
The promised consideration can also vary if an entity’s entitlement to the
consideration is contingent on the occurrence or non-occurrence of a future
event (for example, if either a product was sold with a right of return or a fixed
amount is promised as a performance bonus on achievement of a specified
milestone).
The entity should estimate an amount of variable consideration by using one of the
two methods (the expected value or the most likely amount), depending on which
method the entity expects to better predict the amount of consideration to which it
will be entitled.
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PROBLEM 1 (cont.): Both methods PROBLEM 2: Evaluation of such
require subjective judgments and probability is subjective and difficult
are difficult to verify to verify

Methods of estimating the amount of a variable consideration:
The expected value – the sum of probability-weighted amounts in a range of
possible consideration amounts. It is deemed an appropriate method if an
entity has a large number of contracts with similar characteristics,
The most likely amount – the single most likely amount in a range of possible
consideration amounts (i.e. the single most likely outcome of the contract). It is
deemed an appropriate method if the contract has only two possible outcomes
(for example, an entity either achieves a performance bonus or does not).
However, an entity shall include in the transaction price some or all of an amount
of estimated variable consideration only to the extent that it is highly probable that
a significant reversal in the amount of cumulative revenue recognized will not occur
when the uncertainty associated with the variable consideration is subsequently
resolved.
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PROBLEM 2 (cont.): All such
estimates are heavily subjective and
difficult to verify

Factors that could increase the likelihood or the magnitude of a revenue reversal
include, but are not limited to, any of the following:
The amount of consideration is highly susceptible to factors outside the
entity’s influence (e.g. volatility in a market, the actions of third parties,
weather conditions),
The uncertainty about the amount of consideration is not expected to be
resolved for a long period of time,
The entity’s experience with similar types of contracts is limited, or that
experience has limited predictive value,
The contract has a large number and broad range of possible consideration
amounts.
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PROBLEM 3: Discount rate calls for estimating
the credit riskiness of individual customers
(and appropriate premium for credit risk)

In determining the transaction price, an entity shall adjust the promised amount of
consideration for the effects of the time value of money:
As a practical expedient, an entity need not adjust the promised amount of
consideration for the effects of a significant financing component, if the
expected term of payment is one year or less,
In other cases, an entity shall use the discount rate that would be reflected in a
separate financing transaction between the entity and its customer at contract
inception,
The discount rate applied should reflect the credit characteristics of the party
receiving financing in the contract, as well as any collateral or security provided
by the customer or the entity.
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EXAMPLE 3: ADJUSTING THE TRANSACTION PRICE FOR THE TIME VALUE OF MONEY
On March 31, 2013, the company sold a product for 1 million EUR and granted a customer a 360 days
payment term. Thus, the company expects collecting the resulting receivable until the end of March 2014. In
such case, it may be argued that the total sales price (1 million EUR) consists of two separable elements:
• The price of the underlying product (which was sold),
• The financing component (i.e. the interest rate on a loan granted to the customer).
Although these two elements are separable, they are not directly observable (because they are bundled into
a total price). Thus, they must be estimated. According to the company’s estimates, the customer’s credit
characteristics call for applying a discount rate (DR) of 8% (in annual terms). Under such assumptions the
discounted value of a deferred payment is computed as follows:
૚. ૙૙૙. ૙૙૙ ࡱࢁࡾ
ࡰ࢏࢙ࢉ࢕࢛࢔࢚ࢋࢊ ࢜ࢇ࢒࢛ࢋ = ≈ ૢ૛૞. ૢ૛૟ ࡱࢁࡾ
૚ + ૙, ૙ૡ
Accordingly, out of the total deferred payment of 1 million EUR, 925.926 EUR will be recognized as sales
revenue (and included in an income statement when the product is transferred to the customer), while the
remaining 74.074 EUR will be recognized as a financial income (an included in an income statement ratably
throughout the following twelve months).
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STEP 4 – ALLOCATING THE TRANSACTION PRICE TO DISTINCT
PERFORMANCE OBLIGATIONS
The objective when allocating the transaction price is for an entity to allocate the
transaction price to each performance obligation (or distinct good or service) in an
amount that depicts the amount of consideration to which the entity expects to be
entitled in exchange for transferring the promised goods or services to the
customer.
To allocate the transaction price to each performance obligation on a relative
stand-alone selling price basis, an entity shall determine the stand-alone selling
price at contract inception of the distinct good or service underlying each
performance obligation in the contract and allocate the transaction price in
proportion to those stand-alone selling prices.
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PROBLEM 4: Allocation of transaction
price may require estimating
unobservable stand-alone selling prices

The stand-alone selling price is the price at which an entity would sell a promised
good or service separately to a customer. The best evidence of a stand-alone selling
price is the observable price of a good or service when the entity sells that good or
service separately in similar circumstances and to similar customers.
If a stand-alone selling price is not directly observable, an entity shall estimate the
stand-alone selling price at an amount that would result in the allocation of the
transaction price meeting the allocation objective. When estimating a stand-alone
selling price, an entity shall consider all information (including market conditions,
entity-specific factors and information about the customer) that is reasonably
available to the entity. In doing so, an entity shall maximize the use of observable
inputs and apply estimation methods consistently in similar circumstances.
21
PROBLEM 4 (cont.): All such
estimates are heavily subjective and
difficult to verify

Suitable methods for estimating the stand-alone selling price of a good or service
include, but are not limited to, the following:
Adjusted market assessment approach – an entity could evaluate the market
in which it sells goods or services and estimate the price that a customer in that
market would be willing to pay for those goods or services,
Expected cost plus a margin approach – an entity could forecast its expected
costs of satisfying a performance obligation and then add an appropriate
margin for that good or service,
Residual approach – an entity may estimate the stand-alone selling price by
reference to the total transaction price less the sum of the observable stand-
alone selling prices of other goods or services promised in the contract (this
method may be used in limited circumstances).
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A customer receives a discount for purchasing a bundle of goods or services if the
sum of the stand-alone selling prices of those promised goods or services in the
contract exceeds the promised consideration in a contract.
Except when an entity has observable evidence that the entire discount relates to
only one or more, but not all, performance obligations in a contract, the entity shall
allocate a discount proportionately to all performance obligations in the contract.
The proportionate allocation of the discount in those circumstances is a
consequence of the entity allocating the transaction price to each performance
obligation on the basis of the relative stand-alone selling prices of the underlying
distinct goods or services.
23
Variable consideration that is promised in a contract may be attributable to the
entire contract or to a specific part of the contract. For example:
A bonus may be contingent on an entity transferring a promised good or
service within a specified period of time,
The consideration promised for the second year of a two-year cleaning service
contract will increase on the basis of movements in a specified inflation index.
An entity shall allocate a variable amount (and subsequent changes to that amount)
entirely to a performance obligation or to a distinct good or service that forms part
of a single performance obligation if the terms of a variable payment relate
specifically to the entity’s efforts to satisfy the performance obligation or transfer
the distinct good or service.
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STEP 5 – RECOGNITION OF REVENUE
An entity shall recognize revenue when (or as) the entity satisfies a performance
obligation by transferring a promised good or service (i.e. an asset) to a customer.
An asset is transferred when (or as) the customer obtains control of that asset.
For each performance obligation an entity shall determine at contract inception

whether it satisfies the performance obligation over time or satisfies the
performance obligation at a point in time.
If an entity does not satisfy a performance obligation over time, the performance
obligation is satisfied at a point in time.
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An entity transfers control of a good or service over time and, therefore, satisfies a
performance obligation and recognizes revenue over time, if one of the following
criteria is met:
The customer simultaneously receives and consumes the benefits provided by
the entity’s performance as the entity performs (e.g. security services),
The entity’s performance creates or enhances an asset that the customer
controls as the asset is created or enhanced (e.g. constructing or renovating a
customer’s headquarter building),
The entity’s performance does not create an asset with an alternative use to
the entity and the entity has an enforceable right to payment for performance
completed to date (e.g. designing and implementing a customized software).
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PROBLEM 5: In many business situations
determination of a moment of a transfer
of control may be difficult

If a performance obligation is not satisfied over time, it is satisfied at a point in
time. To determine the point in time at which a customer obtains control of a
promised assets and the entity satisfies a performance obligation, the entity shall
consider requirements for control and indicators of the transfer of control, e.g.:
The entity has a present right to payment for the asset,
The customer has legal title to the asset,
The entity has transferred physical possession of the asset (however, physical
possession may not coincide with control of an asset, e.g. under repurchase
agreements, consignment arrangements or bill-and-hold arrangements),
The customer has the significant risks and rewards of ownership of the asset,
The customer has accepted the asset.
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For each performance obligation satisfied over time, an entity shall recognize revenue
over time by measuring the progress towards complete satisfaction of that performance
obligation.
An entity shall apply a single method of measuring progress for each performance
obligation satisfied over time and the entity shall apply that method consistently to
similar performance obligations and in similar circumstances.
Appropriate methods of measuring progress include output methods and input
methods. In determining the appropriate method for measuring progress, an entity shall
consider the nature of the good or service that the entity promised to transfer to the
customer.
An entity shall recognize revenue for a performance obligation satisfied over time if the
entity can reasonably measure its progress towards complete satisfaction of the
performance obligation.
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PROBLEM 6: If some complex output
methods are applied, the obtained
estimates may be very difficult to verify
Output methods recognize revenue on the basis of direct measurements of the
value to the customer of the goods or services transferred to date relative to the
remaining goods or services promised under the contract.
Output methods includes methods such as:
Surveys of performance completed to date (e.g. length of the highway
constructed),
Appraisals of results achieved (e.g. engineering opinions),
Milestones reached,
Time elapsed (e.g. for security services),
Units produced or units delivered.
The disadvantages of output methods are that the outputs used to measure
progress may not be directly observable.
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PROBLEM 7: If a progress of inputs does not
coincide with a progress of contract completion,
the reported revenues may be seriously distorted

Input methods recognize revenue on the basis of the entity’s efforts or inputs to the
satisfaction of a performance obligation, such as:
Resources consumed,
Labor hours expended,
Costs incurred,
Time elapsed,
Machine hours used.
A shortcoming of input methods is that there may not be a direct relationship
between an entity’s inputs and the transfer of control of goods or services to a
customer (e.g. when a cost incurred does not contribute to an entity’s progress in
satisfying the performance obligation or when a cost incurred is not proportionate
to the entity’s progress in satisfying the performance obligation).
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PART 2:
SELECTED PRACTICAL PROBLEMS
WITH REVENUE RECOGNITION
UNDER IFRS
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PROBLEM 1: ESTIMATING VARIABLE CONSIDERATION
When estimating the amount of a variable consideration the company may use one
of the following methods:
The expected value – the sum of probability-weighted amounts in a range of
possible consideration amounts,
The most likely amount – the single most likely amount in a range of possible
consideration amounts (i.e. the single most likely outcome of the contract).
When the expected value method is applied, the probabilities of individual possible
scenarios must be determined. When the most likely amount method is applied,
the single most probable scenario must be pointed. However, these estimates may
be purely subjective and difficult to verify (because in many situations the objective
and quantifiable tools are not available or practically useful). This is illustrated in
Example 4.
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EXAMPLE 4: ESTIMATING VARIABLE CONSIDERATION
On January 1, 2013, the management consulting company won the contract in which it advises to some big
industrial holding in the M&A (merger & acquisition) process (the industrial holding wants to sell all the shares of
one of its subsidiaries). The final price for those consulting services consists of two elements: fixed fee for
analytical, legal and auditing work (1.000.000 EUR) and a variable (conditional) success-fee, calculated as follows:
• The company will receive 500.000 EUR, if the shares are sold for more than 100 million EUR but less than 150
million EUR,
• The company will receive 800.000 EUR, if the shares are sold for more than 150 million EUR but less than 200
million EUR,
• The company will receive 1.000.000 EUR, if the shares are sold for more than 200 million EUR.
The success-fee is conditional on finalization of transaction (and equals 0 EUR if the transaction is not done in 12
months time or the final price is lower than 100 million EUR). On the ground of the current market conditions, the
company estimated the following probabilities:
• The sale of shares will not be closed within a 12 month timeframe: probability of 10%,
• The sale of shares will be closed at the price below 100 million EUR: probability of 20%,
• The sale of shares will be closed at the price in a range of 100-150 million EUR: probability of 40%,
• The sale of shares will be closed at the price in a range of 150-200 million EUR: probability of 20%,
• The sale of shares will be closed at the price above 200 million EUR: probability of 10%.
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EXAMPLE 4 (cont.): ESTIMATING VARIABLE CONSIDERATION
Under such assumptions, the amount of a variable consideration, according to the expected value method, is
computed as follows:
(0 EUR x 10%) + (0 EUR x 20%) + (500.000 EUR x 40%) + (800.000 EUR x 20%) + (1.000.000 EUR x 10%) =
= 460.000 EUR
If the company still believes that the 100-150 million EUR range is the most probable, but with the probability
of 50%, but closing price below 100 million EUR is less likely (with a probability of 10%), the amount of a
variable consideration would be calculated as follows:
(0 EUR x 10%) + (0 EUR x 10%) + (500.000 EUR x 50%) + (800.000 EUR x 20%) + (1.000.000 EUR x 10%) =
= 512.000 EUR
Thus, as might be seen, the probabilities assigned to various scenarios (which are often estimated
subjectively) may significantly influence the amount of a variable consideration (and revenues recognized).
If the company applies the most likely amount method (which is recommended for circumstances when only
two scenario are considered), then it would pick the most likely scenario as a variable consideration. In this
example it would be 500.000 EUR (i.e. the additional revenue receivable if the shares are sold for more than
100 million EUR but less than 150 million EUR.
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PROBLEM 2: ESTIMATING A PROBABILITY OF REVERSAL OF A
VARIABLE CONSIDERATION RECOGNIZED EARLIER AS REVENUE
An entity shall include in the transaction price some or all of an amount of
estimated variable consideration only to the extent that it is highly probable that a
significant reversal in the amount of cumulative revenue recognized will not occur
when the uncertainty associated with the variable consideration is subsequently
resolved.
Thus, an entity should postpone the recognition of a revenue from a variable
consideration, if any factors significantly boost the risk that the revenue recognized
will have to be reversed in the future.
For example, one of the factors suggested by IFRS 15 is high susceptibility of a
variable consideration to factors outside the entity’s influence (e.g. volatility in the
market). In the Example 5 the company estimated probabilities on the ground of
the current market conditions.
35
PROBLEM 2: ESTIMATING A PROBABILITY OF REVERSAL OF A
VARIABLE CONSIDERATION RECOGNIZED EARLIER AS REVENUE
However, the situation on capital markets (and particularly the stock prices) are to a
large extent unpredictable, even in a relatively short-run, and outside a company’s
control. Thus, the company should consider a deferral of recognition of any variable
consideration until the underlying uncertainty disappears (i.e. until the sale of shares is
finalized or a 12 month time frame elapses).
However, the company may claim that in its computations it accounted for the risk of
the unfavorable market changes by assigning a combined 30% probability to both of the
negative scenarios (i.e. the lack of transaction at all or closing it with a price below 100
million EUR). The problem is that these are just the estimates based on current market
conditions, which may change in the course of the next twelve months (causing the
reversal of the prematurely recognized revenue from a variable consideration).
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PROBLEM 3: ESTIMATING DISCOUNT RATE USED FOR
DISCOUTING REVENUES WITH REMOTE PAYMENT TERMS
The discount rate applied to discounting future payments (from revenues with
extended payment terms) should reflect the credit characteristics of the party
receiving financing in the contract, as well as any collateral or security provided by
the customer or the entity.
This means that the discount rate must be estimated with the following formula:
ࡰࡾ࢏ = ࡾࢌࡾ + ࡾࡼ࢏

where:
ࡰࡾ࢏ – discount rate applied to a particular customer,
ࡾࢌࡾ – risk-free rate (e.g. the interest rate of a Treasury bond),
ࡾࡼ࢏ – risk premium, reflecting the credit characteristics of a particular customer.
37
PROBLEM 3: ESTIMATING DISCOUNT RATE USED FOR
DISCOUTING REVENUES WITH REMOTE PAYMENT TERMS
The last factor in the above formula (i.e. the risk premium) should reflect the individual
credit riskiness of a given customer (and the higher should be, the higher is the general
credit risk of a customer). Thus, if the company grants extended credit terms to various
customers, it should discount the resulting future payments with varying discount rates.
However, the credit risk is a function of many variables, including (among others):
The profitability of a customer – profitable firms are generally less risky than the
unprofitable ones,
The size of a customer – larger firms tend to be less risky than smaller ones,
History of the relationship – entering contracts with new customers is generally
riskier than dealing with older (and better known) clients.
Thus, estimation of discount rates applicable to individual customers is prone to many
assumptions. As a result, it may result in distortions of reported financial revenues (if
the discount rates are miscalculated).
38
PROBLEM 4: ESTIMATING UNOBSERVABLE STAND-ALONE
SELLING PRICES
This is one of the most significant problems in accounting for multiple-arrangement
contracts. These are the contracts, where several distinct products and/or services
are bundled under the single price. In such a case, the entity should allocate the
total contract price into its distinct components, using one of the following
approaches:
Adjusted market assessment approach – this is based on the observable (but
adjusted) market prices for products and services, included in a contract,
Expected cost plus a margin approach – this is based on expected costs and
margins of individual distinct products / services,
Residual approach – the total transaction price less the sum of the estimated
prices of other goods or services in the contract (this method may be used in
limited circumstances).
39
SELLING PRICES
The main problem of the adjusted market assessment approach is that for many
companies the prices for similar products or services, observed in various transactions,
may be highly variable, due to the following factors:
Size of a particular contract – the discounts from “catalogue prices”, offered to
individual customers, may be positively related to the size of the transaction (the
larger the contract, the lower the unit prices),
History of relations with a particular customer – the longer the cooperation with a
customer, the deeper may be the price discount offered,
Prestige of serving a given customer – firms may accept lower prices in contracts
with prestigious customers (to boost their own market reputation),
General difficulty and riskiness of the contract – e.g. the perceived potential after-
sale problems with the customer (e.g. its above-average tendency to complain),
General market conditions – in economic slowdowns companies may accept the
sale prices which they would not even consider during economic booms.
40
SELLING PRICES
The main problem of the expected cost plus a margin approach is that under this
method the company itself predicts the expected future costs, which will have to be
incurred to satisfy the individual performance obligations in a contract. Thus, the
entity may prepare a biased cost estimates for individual performance obligations,
if it intends to artificially over-allocate the contract price to some of its components
and under-allocate it to the other ones (to manage reported revenues).
Furthermore, under this approach the allocation of the contract price is not based
on the expected costs themselves, but on the expected costs plus expected
margins. However, the margins on individual products or services differ and may be
variable (between contracts and in time) due to the same reasons as listed above
(for the adjusted market assessment approach).
41
SELLING PRICES
The problems with the residual approach are the same as with the adjusted market
assessment approach and the expected cost plus a margin approach. This is so
because under the residual approach the prices of the other performance
obligations must be estimated first (under either the adjusted market assessment
approach or the expected cost plus a margin approach) and only then the estimated
price of the remaining performance obligations are computed.
Thus, all three approaches to estimating unobservable stand-alone selling prices are
heavily vulnerable to subjective judgments, and as a result they may result in
distortions of reported financial revenues (if the company deliberately over-
allocates the total contract price to some performance obligations and under-
allocates it to the other ones).
42
PROBLEM 5: DETERMINING A MOMENT OF A TRANSFER OF
CONTROL (WHEN IT IS TRANSFERRED AT A POINT IN TIME)
In majority of cases where the control over the asset is transferred at a point in
time, a determination of that point is quite simple. For example, in a retail or a
wholesale distribution of goods, the control is usually transferred together with the
physical possession of those goods (because also the major related risks are
simultaneously transferred).
However, in more complex transactions (particularly in relation to the specialized
and sophisticated products) the determination of a moment of a transfer of control
may be much more difficult. In such cases, the misplaced determination of a
transfer of control may result in premature revenue recognition (and the following
reversal of the recognized revenues). This is illustrated in Example 5.
43
PROBLEM 5: DETERMINING A MOMENT OF A TRANSFER OF
CONTROL (WHEN IT IS TRANSFERRED AT A POINT IN TIME)
EXAMPLE 5: DETERMINATION OF A MOMENT OF A TRANSFER OF CONTROL
A company located in Central Europe manufactures ceramic tiles furnaces. It received an order from a ceramic
tiles manufacturer located in central USA, to supply two furnaces. Thus, the furnaces must be transported
from Central Europe to the customer’s location (including ground and sea or air transportation) and then
installed in the customer’s manufacturing facilities. Then the customer’s staff must be trained in using the
furnace. The customer’s final acceptance for the furnaces is conditional on the quality of the output
manufactured by these furnaces (the customer requires a share of the first-grade output to be no less than
99%), which is checked in either manufacturer’s or customer’s facilities.
Under such arrangements the following potential points in time, when the control is transferred, may be
considered (depending on the particular circumstances):
• The control is transferred when the furnace is provided to the customer in the manufacturer’s facilities
(applicable when the customer is responsible for the whole transportation of the furnaces purchased),
• The control is transferred when the furnace is provided to the customer in its facilities (applicable when
the seller is responsible for the whole transportation of the furnaces purchased),
• The control is transferred when the furnace is installed in the customer’s facilities (applicable when the
installation is complex and the seller is responsible for it),
• The control is transferred after the furnace is tested by the customer.
44
PROBLEM 6: ESTIMATING PERCENTAGE-OF-COMPLETION WITH
COMPLEX OUTPUT METHODS
As was stated before, the main disadvantage of output-based methods of measuring the
stage-of-completion of a contract is that the outputs used to measure progress may not be
directly observable.
In some (rather rare) circumstances, the output-based measurement may be simple,
relatively objective and verifiable. For example, if a construction company enters a contract
to build a 100 km-long highway on a flat ground (without any tunnels, bridges, junctions,
etc.), the progress may be measured on the basis of the length of the highway completed so
far (e.g. completing the first 20 km entail a 20% stage of completion of the whole contract).
However, in other situations the “visual progress” of the contract may not have any relation
to its technical and financial progress. For example, if a construction company builds a 100
km-long highway passing through the mountains (with tunnels, bridges, evacuation systems),
the physical progress may not be reliably measured (and verified). In such cases, the
application of the output-methods may result in misreported revenues.
45
PROBLEM 7: ESTIMATING PERCENTAGE-OF-COMPLETION WITH
ABUSED INPUT METHODS
In contrast to the output-based approaches, the input-based methods of measuring
stage-of-completion are anchored at observable variables (such as contract costs
incurred so far or labor-hours used). However, they have their own significant
drawbacks. Mainly, there may not be a direct relationship between an entity’s
inputs and the transfer of control of goods or services to a customer.
For example, if a construction company suffers from significant cost overruns (e.g.
because of too optimistic cost predictions at contract inception or because of the
operating inefficiencies), the costs incurred so far may deviate from the actual
progress of the contract (they may even move in opposite directions: the
unplanned activities may at the same time entail extra-costs and slow the contract
progress down). In such cases, the application of the input-based methods may
result in misreported revenues.
46
PART 3:
EXAMPLES OF IMPACT OF ABUSED
REVENUE RECOGNITION
ON RELIABILITY
OF FINANCIAL STATEMENTS
47
MISALLOCATION OF A CONTRACT PRICE TO DISTINCT
As was stated before, the available methods of allocating the total contract price to
the its distinct performance obligations are vulnerable to subjective (and hard to
verify) assumptions. Thus, their application may result in distortions of reported
financial revenues (if the company deliberately over-allocates the total contract
price to some performance obligations and under-allocates it to the other ones).
The following example illustrates the effect of an extreme abuse of the allocation
process, when the total contract price is allocated to only one of the performance
obligations in a contract (the one, which is satisfied first). In this example such
misallocation brakes the “matching principle”, which is one of the fundamental
principles of accounting. The resulting effect is the overstatement of reported
earnings at the beginning of the contract and the following reversal later on.
48
EXAMPLE 6: MISALLOCATION OF A CONTRACT PRICE
On January 1, 2013, a business software company entered a contract in which it sold its
software and related services, for a total price of 1 million EUR. The total price covers a
license for a software as well as a prepayment for 300 hours of optional consulting (IT
support) services, which must be rendered to the customer on demand in the course of
the following 24 months.
The company estimated that 50% of the total price (i.e. 500.000 EUR) should be
allocated to the software license while the remaining 50% should be allocated to the
consulting services.
The hourly cost of the IT consultants’ work is 1.000 EUR. In the first 12 months the
customer ordered 200 hours of consulting services and in the next 12 months the
customer ordered remaining 100 hours of consulting services.
49
Incorrect booking entries result in overstatement
of earnings in 2013 (by 500.000 EUR)

Correct booking entries:
2013 2014 2015
Cash / receivables (BS) 1.000.000 Net sales (IS) 333.333 Net sales (IS) 166.667
Net sales (IS) 500.000 Deferred revenues (BS) -333.333 Deferred revenues (BS) -166.667
Deferred revenues (BS) 500.000 Cost of goods sold (IS) 200.000 Cost of goods sold (IS) 100.000
Profit before taxes (IS) 500.000 Profit before taxes (IS) 133.333 Profit before taxes (IS) 66.667
Incorrect booking entries:
2013 2014 2015
Cash / receivables (BS) 1.000.000 Net sales (IS) 0 Net sales (IS) 0
Net sales (IS) 1.000.000 Cost of goods sold (IS) 200.000 Cost of goods sold (IS) 100.000
Profit before taxes (IS) 1.000.000 Profit before taxes (IS) -200.000 Profit before taxes (IS) -100.000
1) Booking entry for net sales and deferred revenues in 2009: (200 / 300) x 500.000 EUR = 333.333 EUR
2) Booking entry for cost of goods sold in 2009: 200 hrs x 1.000 EUR = 200.000 EUR
3) Booking entry for net sales and deferred revenues in 2010: (100 / 300) x 500.000 EUR = 166.667 EUR The reversal of prior
4) Booking entry for cost of goods sold in 2010: 100 hrs x 1.000 EUR = 100.000 EUR overstatement of earnings
50
NOTE THAT:
the profit before income taxes in 2013 is overstated by 500.000 EUR and the balance-sheet
value of deferred revenues (part of liabilities) at the end of 2013 is understated by the same
500.000 EUR (because net sales recognized in income statement in 2013 include 500.000 EUR
of consulting revenues, which should be deferred),
the resulting overstatement of net sales and pre-tax income in 2013 (by 500.000 EUR) must be
reversed sooner or later (because of mechanics of a „matching principle”),
this reversal occurs in the following two years, when the income is understated as a result of
recognition of consulting expenses without any recognition of consulting revenues (because
those revenues were already prematurely recognized in 2013),
therefore, the total impact of the whole transaction (in three-year period) on profit before
taxes is the same and equals 700.000 EUR.
51
SALES WITH A RIGHT OF RETURN
As was stated before, if the performance obligation is satisfied at point in time, the
revenue should be recognized at a time when control over the asset is transferred to a
customer. Thus, the crucial point here is to determine the point in time, when the
control is transferred. If the transfer of control is stated prematurely, it may result in
distortions of reported financial revenues (and premature revenue recognition).
The following example illustrates the effect of a premature recognition of revenues
from sales with a right of return. In such a case, although a customer may obtain a
general control over the asset, not all of the risks are transferred (e.g. the risk of a
demand or obsolescence). Thus, a seller should estimate the probable volume of returns
(and adjust the revenue recognized accordingly). If a seller is not able to reliably
estimate the volume of returns, it should defer the revenue recognition. The premature
revenue recognition, resulting from a sale with a right of return, brings about the
temporary overstatement of reported earnings (and its reversal later on).
52
EXAMPLE 7: MISRECOGNITION OF REVENUES FROM SALES WITH RIGHT OF RETURN
In period t the company ABC sold to its consignment agent 100.000 units of a product for
a unit price of 2,00 EUR. The agreement between the company and its agent states that
the agent can unconditionally return all the products unsold by the agent in the course
of the following 12 months time. Therefore, the ABC should estimate the probable
volume of product returns. If a reliable estimation of such product returns is not viable,
the company should defer the revenue recognition until:
• either the agent re-sells the products further (e.g. to final customers),
• or the 12 months time, during which the agent can return the products, elapses.
In period t+1 agent sold to its customers half of the products purchased from the ABC
company and returned to the company the remaining half of the unsold products.
The products sold by ABC company to its agent were manufactured by ABC for 1 EUR per
unit.
53
Incorrect booking entries result in overstatement
of earnings in period t and the following reversal
of that overstatement (in period t+1)
Period t Period t+1
Net sales (IS) / 100.000
Net sales (IS) 0
Cash or receivables (BS) (50.000x2)
Costs of goods sold (IS) / 50.000
Costs of goods sold (IS) 0
Inventory (BS) (50.000x1)
Profit before taxes (IS) 0 Profit before taxes (IS) 50.000

Period t Period t+1
Net sales (IS) / 200.000 Net sales (IS) / -100.000
Cash or receivables (BS) (100.000x2) Cash or receivables (BS) (50.000x2)
Costs of goods sold (IS) / 100.000 Costs of goods sold (IS) / -50.000
Inventory (BS) (100.000x1) Inventory (BS) (50.000x1)
Profit before taxes (IS) 100.000 Profit before taxes (IS) -50.000
54
SALES WITH CONTINGENT ELEMENTS
An entity shall recognize revenue related to a variable consideration only to the extent
that it is highly probable that a significant reversal in the amount of cumulative revenue
recognized will not occur when the uncertainty associated with the variable
consideration is subsequently resolved. Thus, an entity should postpone the recognition
of a revenue from a variable consideration, if any factors significantly boost the risk that
the revenue recognized will have to be reversed in the future.
The following example illustrates the effect of a premature recognition of revenues
related to a variable consideration (on the ground of Example 4). In such a case, it may
be argued that the variable consideration is highly susceptible to factor outside the
entity’s influence (i.e. volatility in the capital market, including stock market). If such a
factor exists, an entity should defer the revenue recognition until the underlying
uncertainty is resolved. Such a premature revenue recognition may bring about the
temporary overstatement of reported earnings (and its reversal later on).
55
EXAMPLE 8: MISRECOGNITION OF REVENUES FROM SALES WITH CONTINGENT ELEMENT
This is a continuation of Example 4 (from pages 33-34). The company believes that the
transaction price will fall into 100-150 million EUR range with the probability of 50%.
With such an assumption, the estimated variable consideration equals 512.000 EUR
(according to computations presented on page 34). In such a case the company would
recognize (after rendering its consulting services but before the transaction of a sale of
shares is finalized) the total revenue of 1.512.000 EUR (= 1.000.000 EUR of the fixed fee
for analytical, legal and auditing work + 512.000 EUR of the variable consideration,
estimated as the sum of probability-weighted amounts in a range of possible
consideration amounts).
Let’s consider two scenarios:
1) the transaction does not finalize in 12 month time (so the success-fee is lost forever)
2) the transaction is finalized in the course of the following 12 months and the final value is
180 million EUR (so the final success-fee equals 800.000 EUR and exceeds the amount
originally estimated by the company)
56
SCENARIO 1 – TRANSACTION IS NOT FINALIZED (DATA IN THOUSANDS OF EUR)
2013 2014
Net sales (IS) 1.000 Net sales (IS) 0
Cash / receivables (BS) 1.000 Cash / receivables (BS) 0
Pre-tax earnings (IS) 1.000 Pre-tax earnings (IS) 0

2013 2014
Cash / receivables (BS) 1.000 Cash / receivables (BS) -512
Receivables (BS) 512
Pre-tax earnings (IS) 1.512 Pre-tax earnings (IS) -512
57
SCENARIO 2 – TRANSACTION IS FINALIZED AT A PRICE OF 800 MILLION EUR (DATA IN
THOUSANDS OF EUR)
2013 2014

2013 2014
Receivables (BS) 512
58
AGGRESSIVE USAGE OF PERCENTAGE-OF-COMPLETION
The percentage-of-completion method recognizes revenues and costs in proportion to
and as work is completed (and not when the final sale is made). This method is used for
long-term projects (such as construction, ship-building, airplanes manufacturing) when
there is a contract and reliable estimates of completed production, revenues and costs
are possible.
This main problem with the percentage-of-completion is a limited verifiability of the
estimated progress toward completion (except for rather rare cases when this progress
is easily “visible” even for non-specialist). Usually auditors are not able to verify the
complex engineering estimates (on the basis of which the contract progress is measured
and income recognized), provided by company. Usually auditors are not also able to
verify whether the costs incurred are justified given the physical progress of the
contract (or whether those costs got out of control).
59
When a loss on a contract is expected (e.g. because of incurred costs that were
unplanned in the initial budget, the so-called “cost overruns”) the loss should be
immediately recognized in the period when the amount of the loss can be
estimated. However, it is a company’s knowledge (and not the auditor’s or
investor’s), that the loss can be expected. Therefore, if the company wants to
temporarily boost earnings it will pretend that the progress of costs is consistent
with the budget.
The following example illustrates the effect of an aggressive application of a
percentage-of-completion, when the cost overruns occur. In such a case, the
expected loss should be recognized immediately. If the company, instead of
reporting an expected loss, continues the cost-based recognition of a contract
income, it causes the temporary overstatement of reported earnings (and its
reversal later on).
60
EXAMPLE 9: AGGRESSIVE APPLICATION OF PERCENTAGE-OF-COMPLETION
On January 1, 2010, a construction company started a project of building the power plant. The total
construction time is estimated to be 2,5 years (so it should be completed about mid-2012). The
agreed-upon contract price is 12 million EUR and the total budgeted costs of this project are 10
million EUR (so the budgeted profit is 2 million EUR). The company recognizes profits from this project
on the basis of costs incurred to date. The costs actually incurred are shown below:
Data in thousands of EUR 2010 2011 2012
Costs actually incurred in period: 2.000 7.000 4.000
Costs actually incurred (cumulative) 2.000 9.000 13.000
As can be seen, the total costs of the project amounted to 13 million EUR instead of 10 million EUR
(which resulted in actual project loss of 1 million EUR instead of budgeted 2 million EUR profit). The 3
million EUR cost-overrun resulted from incurring additional unexpected expenses in 2011 (when the
actual costs amounted to 7 million EUR while company budgeted only 4 million of EUR for this year).
If at the end of 2011 the company still expected 4 million EUR of costs to be incurred in 2012, it knew
that the total costs of the project would exceed project revenues and the result will be the loss of 1
million EUR. If this was the case, the company should recognize the full expected loss in the income
statement for 2011.
61
Incorrect income recognition
2010 2011 2012
Estimated 20,0% 90,0% 100,0%
percentage-of-completion (2.000 / 10.000) (9.000 / 10.000) (end of the project)
2.400 10.800 12.000

Revenues recognized (cumulative)
(20% x 12.000) (90% x 12.000) (100% x 12.000)
Revenues recognized in the period 2.400 8.400 1.200
Costs recognized in the period 2.000 7.000 4.000
Profit recognized in the period 400 1.400 -2.800
62
Correct income recognition
2010 2011 2012
Estimated 20,0% 60,0%* 100,0%
percentage-of-completion (2.000 / 10.000) (6.000 / 10.000) (end of the project)
2.400 7.200 12.000
Revenues recognized (cumulative)
(20% x 12.000) (60% x 12.000) (100% x 12.000)
Revenues recognized in the period 2.400 4.800 4.800
Costs recognized in the period 2.000 7.000 4.000
Profit recognized in the period 400 -2.200 800

* includes only costs of the project budgeted for the year (4.000) and excludes the cost-overrun of 3.000 EUR
63
NOTE THAT:
the result of the cost-overrun (by 3 million EUR in 2011) is the significant overstatement of 2011
profits and the reporting of positive profits instead of losses (actually, the higher the cost-overrun,
the higher the profit - this is so because the revenues are in this case linearly linked to actual costs),
the total project result is the same under both scenarios (i.e. the total loss of 1.000 million EUR) so
the overstatement of 2011 earnings entails understatement of 2012 earnings (reversal),
the negative impact on earnings of this aggressive approach to percentage-of-completion in 2011 is
postponed until the final completion of the project (in 2012 in this specific case), that is to the
moment when all the revenues and all the costs related to the project are recognized,
all this means that this mechanism enables boosting t-period earnings (by 3,6 million EUR in this
specific case and not just the 3 million EUR resulting from cost-overrun) at the cost of future
earnings (that are understated by the same 3,6 million EUR, in 2012 in this specific case),
if the company works on many projects and has problems with costs control, the overall credibility
of its financial statements can be totally destroyed,
the more complex and sophisticated are the company’s operations, the more defenceless is the
auditor (and investors).
64
PART 4:
REAL-LIFE EXAMPLES
(BASED ON EXTRACTS FROM
CORPORATE ANNUAL REPORTS)
65
The company admits that most of its software contracts The company recognizes revenue from
are multiple-arrangements, in which a sale of a time-based contracts ratably over time.
software license is bundled with support services It allocates the total contract price with
the residual method
EXTRACTS FROM THE ANNUAL REPORT OF SAP FOR 2013

“We derive our revenue from fees charged to our customers for:
(a) licenses to our on-premise software products,
(b) the use of our hosted cloud subscription software offerings and
(c) support, consulting, development, training, and other services.
The majority of our software arrangements include support services, and many also include
professional services and other elements.
Revenue from multi-year time-based licenses that include support services, whether
separately priced or not, is recognized ratably over the license term […]. The amount
allocated to the delivered software is recognized as software revenue based on the residual
method […].
In general, our software license agreements do not include acceptance-testing provisions. If
an arrangement allows for customer acceptance-testing of the software, we defer revenue
until the earlier of customer acceptance or when the acceptance right lapses.
Under such arrangements the revenue is recognized at point in time. This point, however, is not a point when
the software is provided. Instead, the revenue must be deferred until the customer accepts the product
(because only then the transfer of risks is materialized)
66
Under such arrangements the revenue is recognized at point in time. This point, however, is
not a point when the product is supplied to the reseller. Instead, the revenue is deferred until
the reseller sells the product (because only then the transfer of risks is materialized)

We usually recognize revenue from on-premise software arrangements involving resellers on
evidence of sell-through by the reseller to the end-customer, because the inflow of the
economic benefits associated with the arrangements to us is not probable before sell-
through has occurred.
Sometimes we enter into customer-specific on-premise software development agreements.
We recognize software revenue in connection with these arrangements using the
percentage-of-completion method based on contract costs incurred to date as a percentage
of total estimated contract costs required to complete the development work.
When the company works on the customized software (i.e. software designed specifically for a
given customer), it recognizes the revenue and income from this contract with the use of
percentage-of-completion method. The cumulative costs of the contract constitute the basis
for estimating the stage of its completion.
67
The company admits that under majority of its contracts it is obligated to “stand ready” to
support the customer. Thus, the price of a software license constitutes only a part of the
contract’s total price (and part of the total price is attributable to support services).

Support revenue represents fees earned from providing customers with unspecified future
software updates, upgrades, and enhancements, and technical product support services for
on-premise software products. We recognize support revenue based on our performance
under the support arrangements. Under our major support services our performance
obligation is to stand ready to provide technical product support and to provide unspecified
updates and enhancements on a when-and-if-available basis. For these support services we
recognize revenue ratably over the term of the support arrangement. We do not sell
separately technical product support or unspecified software upgrades, updates, and
enhancements.
Revenue from consulting primarily represents fees earned from providing customers with
consulting services which primarily relate to the installation and configuration of our
software products and cloud offerings. […] the related revenue is recognized as the services
are provided using the percentage-of-completion method of accounting.
The company admits that under majority of its contracts it is obligated to “stand ready” to
support the customer. Thus, the price of a software license constitutes only a part of the
contract’s total price (and part of the total price is attributable to support services).
68
The company must allocate the total contract prices
into their distinct performance obligations

The majority of our arrangements contain multiple elements. We account for software,
support, cloud subscription, consulting and other service deliverables as separate units of
account and allocate revenue based on fair value. Fair value is determined by establishing
either company-specific objective evidence, or an estimated stand-alone selling price.
We generally determine the fair value of each element based on its company-specific
objective evidence of fair value, which is the price charged when that element is sold
separately or, for elements not yet sold separately, the price established by our management
if it is probable that the price will not change before the element is sold separately.
We apply the residual method of revenue recognition when company-specific objective
evidence of fair value or estimated stand-alone selling price exists for all of the undelivered
elements in the arrangement, but does not exist for one or more delivered elements. […]
Under the residual method, revenue is allocated to all undelivered elements in the amount of
their respective fair values and the remaining amount of the arrangement fee is allocated to
the delivered element.
But even though these estimates are based on observable prices charged in
contracts, they may still be prone to subjective judgments (and to
manipulations), if prices differ significantly between various contacts 69
EXTRACTS FROM THE ANNUAL REPORT OF BAYER FOR 2013
The company estimates the volume of product returns
and adjusts the revenue recognized accordingly
Sales are reduced by the amount of the provisions for expected returns of defective goods or
of saleable products that may be returned under contractual arrangements. The net sales are
reduced on the date of sale or on the date when the amount of future returns can be
reasonably estimated. Provisions for product returns in 2013 amounted to 0.3% of total net
sales (2012: 0.3%). If future product returns cannot be reasonably estimated and are
significant to a sales transaction, the revenues and the related cost of sales are deferred until
a reasonable estimate can be made or the right to return the goods has expired.
The company defers revenue recognition

when it is unable to obtain the reliable
estimates of product returns
70
EXTRACTS FROM THE ANNUAL REPORT OF SIEMENS FOR 2013
A construction contract is a contract specifically negotiated for the construction of an asset or
a combination of assets that are closely interrelated or interdependent in terms of their
design, technology and function or their ultimate purpose or use. When the outcome of a
construction contract can be estimated reliably, revenues from construction-type projects are
recognized under the percentage-of-completion method, based on the percentage of costs to
date compared to the total estimated contract costs. An expected loss on the construction
contract is recognized as an expense immediately.
The company admits that it applies a percentage-of-completion method

to some of its contracts. The cumulative costs of the contract constitute
the basis for estimating the stage of its completion.
71
EXTRACTS FROM THE ANNUAL REPORT OF SIEMENS FOR 2013
Sales of goods and services as well as software arrangements sometimes involve the
provision of multiple elements. In these cases, the Company determines whether the contract
or arrangement contains more than one unit of accounting. If certain criteria are met,
foremost if the delivered element(s) has (have) value to the customer on a stand-alone basis,
the arrangement is separated and the appropriate revenue recognition convention is then
applied to each separate unit of accounting. Generally, the total arrangement consideration
is allocated to the separate units of accounting based on their relative fair values. However,
if in rare cases fair value evidence if available for the undelivered but not for one or more of
the delivered elements, the amount allocated to the delivered element(s) equals the total
arrangement consideration less the aggregate fair value of the undelivered element(s)
(residual method).
The company must allocate the total
contract prices into their distinct
performance obligations
72
THANK YOU
FOR YOUR ATTENTION
Dr Jacek Welc:
jacek.welc@ue.wroc.pl
73

Revenue Recognition Principles

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Revenue Recognition Principles

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MODULE 1:

“Previous revenue recognition requirements in IFRS provided limited guidance and,

STEP 4: Allocate the transaction price to the performance obligations in the

An entity should allocate the transaction price to each performance

STEP 3 – DETERMINING THE TRANSACTION PRICE

STEP 3 – DETERMINING THE TRANSACTION PRICE

STEP 3 – DETERMINING THE TRANSACTION PRICE

STEP 3 – DETERMINING THE TRANSACTION PRICE

STEP 4 – ALLOCATING THE TRANSACTION PRICE TO DISTINCT

STEP 4 – ALLOCATING THE TRANSACTION PRICE TO DISTINCT

For each performance obligation an entity shall determine at contract inception

STEP 5 – RECOGNITION OF REVENUE

STEP 5 – RECOGNITION OF REVENUE

ࡰࡾ࢏ = ࡾࢌࡾ + ࡾࡼ࢏

MISALLOCATION OF A CONTRACT PRICE TO DISTINCT

Incorrect booking entries:

Pre-tax earnings (IS) 1.000 Pre-tax earnings (IS) 0

Pre-tax earnings (IS) 1.512 Pre-tax earnings (IS) -512

Pre-tax earnings (IS) 1.000 Pre-tax earnings (IS) 800

Pre-tax earnings (IS) 1.512 Pre-tax earnings (IS) 288

2.400 10.800 12.000

Profit recognized in the period 400 1.400 -2.800

Profit recognized in the period 400 -2.200 800

EXTRACTS FROM THE ANNUAL REPORT OF SAP FOR 2013

EXTRACTS FROM THE ANNUAL REPORT OF SAP FOR 2013

EXTRACTS FROM THE ANNUAL REPORT OF SAP FOR 2013

EXTRACTS FROM THE ANNUAL REPORT OF SAP FOR 2013

The company defers revenue recognition

The company admits that it applies a percentage-of-completion method

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