Revenue Recognition

Dr. Monika Dhochak

Income Statement Concepts
▪ Conservatism Concept

▪ Consistency Concept

▪ Periodicity Concept/Accounting Period Concept

▪ Matching Concept

▪ Revenue Recognition Concept

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Matching Concept or Expense recognition principle

Match expenses with revenues in the period

when the company makes efforts that generate
those revenues.

“Let the expenses

follow the revenues.”

How to record revenue?

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Basic Concepts Slide 3-13

Today is
March
On March 19, an item of
inventory costing $1,000 is

19 received.

Matching Concept
Basic Concepts Slide 3-14

Today is
April
On April 16, the vendor is
paid in full.

16
Matching Concept
Basic Concepts Slide 3-15

Today is May
On May 9, the item of
merchandise is sold for
$1,500.

9 When should the

merchandise be an
expense to the firm?

Matching Concept
Basic Concepts Slide 3-16

Today is May
On May 9, the item of
merchandise is sold

9 for $1,500.
In May, when the
merchandise is sold.

Matching Concept
Revenue Recognition/Realization Principle

Recognize revenue in the accounting period in

which the performance obligation is satisfied.

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Revenue Recognition
▪ Revenue recognition criteria
▪ realized or realizable, and
▪ Earned

▪ Realized or realizable means that the seller’s net assets

(assets less liabilities) increase.

▪ Earned means that the seller has performed its duties

under the terms of the sales agreement.

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Revenue
▪ Revenue is the gross inflow of economic benefits during the period
arising in the course of the ordinary activities of an entity:
▪ The sale of goods
▪ Includes goods produced by the entity for the purpose of sale and goods purchased for resale,
such as merchandise purchased by a retailer or land and other property held for resale.

▪ The rendering of services

▪ Involves the performance by the entity of a contractually agreed task over an agreed period of
time. The services may be rendered within a single period or over more than one period.

▪ The use by others of entity assets yielding interest, royalties and dividends.
▪ Interest—charges for the use of cash or cash equivalents or amounts due to the entity;
▪ Royalties—charges for the use of long-term assets of the entity, for example, patents,
trademarks, copyrights and computer software; and
▪ Dividends—distributions of profits to holders of equity investments in proportion to their
holdings of a particular class of capital.
What is not Revenue
▪ Dividends arising from investments in Associates

▪ Changes in the fair value of financial assets and financial liabilities or their
disposal

▪ changes in the value of other current assets

▪ Amounts collected on behalf of third parties such as sales taxes, goods and
services taxes and value added taxes
Pfizer’s Revenue Recognition Policy

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Apple’s Revenue Recognition Policy
Net sales consist primarily of revenue from the sale of hardware, software, digital content and applications,
peripherals, and service and support contracts. The Company recognizes revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable…The
Company records deferred revenue when it receives payments in advance of the delivery of products or the
performance of services…Revenue from AppleCare service and support contracts is deferred and recognized over
the service coverage periods.

Revenue Recognition for Arrangements with Multiple Deliverables

For multi-element arrangements that include hardware products containing software essential to the hardware
product’s functionality, undelivered software elements that relate to the hardware product’s essential software,
and undelivered non-software services, the Company allocates revenue to all deliverables based on their relative
selling prices…The Company has identified up to three deliverables regularly included in arrangements involving
the sale of these devices. The first deliverable is the hardware and software essential to the functionality of the
hardware device delivered at the time of sale. The second deliverable is the embedded right included with the
purchase of iOS devices, Mac and Apple TV to receive on a when-and-if-available basis, future unspecified software
upgrades and features relating to the product’s essential software. The third deliverable is the non-software
services to be provided to qualifying versions of iOS devices and Mac. The Company allocates revenue between
these deliverables using the relative selling price method.

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Revenue – the 5 step approach

Core
1 Identify the contract with the customer
principle
Recognize
revenue to
Identify the performance obligations in
depict the
2 the contract
transfer of
promised goods
or services to Determine the transaction price
customers in an
3
amount that
reflects the
consideration to
which the entity 4 Allocate the transaction price
expects to be
entitled in
exchange for Recognise revenue when (or as) a
those goods or 5 performance obligation is satisfied
services
Methods of Revenue Recognition

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Recognition of Revenues
▪ Sale of Good
▪ The entity has transferred to the buyer the significant risks and rewards of ownership of the goods;

▪ The entity retains neither continuing ownership nor effective control over the goods sold;

▪ The amount of revenue can be measured reliably;

▪ It is probable that the economic benefits associated with the transaction will flow to the entity;

▪ The costs incurred or to be incurred in respect of the transaction can be measured reliably.
Recognition of Revenues
▪ Rendering of Services:
▪ Following ‘Percentage of completion method’ revenue is recognised in the accounting periods in which the
services are rendered.

▪ The amount of revenue can be measured reliably;

▪ It is probable that the economic benefits associated with the transaction will flow to the entity;

▪ 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
Recognition of Revenues
▪ Others:
▪ Interest shall be recognised using the effective interest method as set out in Ind AS 39;

▪ Royalties shall be recognised on an accrual basis in accordance with the substance of the relevant agreement;

▪ Dividends shall be recognised when the shareholder’s right to receive payment is established.
Percentage-of-completion method
Construction Inc. is engaged in constructing a massive bridge in
Wonderland. The contract is worth $200 million and the company is
expected to complete it in 3 years. In Year 1 the company has
incurred an amount of $50 million on the contract and the engineers
estimate that in the next 2 years the company is expected to expend
$110 million more.

Based on the physical progress of the project the engineers also

estimate that 40% of the work has been carried out.

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Popular Methods of Revenue Recognition
▪ Delivery Method
▪ When goods are delivered and services are performed

▪ Production Method:
▪ When goods are Produced (not applicable across)

▪ Collection Method:
▪ When amount collected

▪ Instalment Method:
▪ When instalment received (proportionate COGS charged)
Example
Ram produces 200,000 bushels of wheat in his first year of farming. He
incurred Rs.100,000 on expenses like insurance, tax, and salaries. His
variable cost per bushels for seeds, fertilizers etc. were Rs. 0.750/bushel. He
sells 180000 bushels of wheat @ Rs. 3/ bushel and closing price per bushel
at year end is Rs. 3.5/Bushel. If payment from a customer of 5000 bushels is
yet to be received then compute the revenues and inventory values under
Delivery, Production & Collection method.