Revenue from Contracts with Customers 161

Illustration 1: Sale with right of return

On January 1, 20x1, ABC Co. sold goods worth ₱100,000 to a customer. The contract provides
the customer the right to return the goods within 30 days after date of purchase. The goods are
delivered at contract inception date. The cost of the goods is ₱60,000, ABC Co. estimates that the
costs of recovering the goods will be immaterial and expects that the returned goods can be
resold at a profit.

Case A: Sale on cash basis

The consideration is variable because of the right of return. Using the expected value method,
ABC Co. estimates that it will be entitled to only 80% of the consideration (i.e., 20% of the
goods sold will be returned). ABC Co. concludes that it is highly probable that a significant
reversal in the cumulative amount of revenue recognized will not occur as the uncertainty is
resolved. Full payment is received when the goods are delivered.

Requirement: Provide the journal entries on contract inception.

Solutions:
Jan. 1, Cash 100,000
20x1 Revenue (₱100,00 x 80%) 80,000
Refund liability (₱100,000 x 20%) 20,000
Jan. 1, Cost of goods sold (₱60,000 x 80%) 48,000
20x1 Asset for right to recover product to be
returned (₱60,000 x 20%) 12,000
Inventory 60,000

Case B: Sale on account

Use all the information above except that the sale is on account. Consideration is due when
control of the goods transfer to the customer.

Requirement: Provide the journal entries on contract inception.

Revenue from Contracts with Customers 161

Solution:
Jan. 1, Accounts receivable 100,000
20x1 Revenue (P100,000 x 80%) 80,000
Refund liability (P100,000 x 20%) 20,000
Jan. 1, Cost of goods sold (₱60,000 x 80%) 48,000
20x1 Asset for right to recover product to be
returned (₱60,000 x 20%) 12,000
Inventory 60,000

Receivable is recognized at ₱100,000 because ABC Co. has an unconditional right to the
full consideration until the goods are actually returned. (PFRS 15 Illustrative Examples: 1E206 and 1E207)

Case C: Sale on cash basis

ABC Co. has no relevant historical evidence of product returns or other available market
evidence. Therefore, ABC Co. cannot conclude that it is highly probable that a significant
reversal in the amount of cumulative revenue recognized will not occur. Full payment is received
when the goods are delivered.

Requirement: Provide the journal entries on contract inception.

Solution:
Jan. 1, Cash 100,000
20x1 Refund liability 100,000
Jan. 1, Asset for right to recover product to be 60,000
20x1 returned
Inventory 60,000

Revenue is recognized after 30 days when the right of return elapses. The entries on Jan.
31, 20x1, when the right of return elapses, are as follows (assume none of the goods were
actually returned):

Jan. 31, Refund liability 100,000

20x1 Revenue 100,000
Revenue from Contracts with Customers 161

Jan. 31, Cost of goods sold 60,000

20x1 Asset for right to recover product
to be returned 60,000

Notice the "matching" of cost of goods sold and revenue.

Illustration 2: Net sales revenue.

ABC Co. sold goods to a customer for ₱10,000. The sales representative was paid a 2%
commission based on the selling price.

Requirement: How much net sales revenue is recognized from the transaction?

Answer: ₱10,000. Unlike for sales discounts and sales returns, sales commissions are recognized
separately (e.g., as commission expense) rather than as deduction from revenue.

Illustration 3: Sale with right to rescind contract

ABC Co. sells goods costing ₱80,000 to a customer for ₱200,000. The customer is given the
right to rescind the purchase for a reason not specified in the contract of sale (duly signed by
both parties). ABC is uncertain about the outcome of the transaction.

Case 1: Wholly unperformed contract

The goods are not yet delivered to the customer and the customer did not yet pay for the
consideration.

Analysis:
There is no accounting treatment because the contract is wholly unperformed (i.e., neither party
performed its respective obligation) and the customer exercising its enforceable right in
terminating the contract is uncertain. Moreover, before a contract is accounted for, both
contracting parties must be committed in performing its respective contractual obligation. The
uncertainty poses a question on the customer's commitment in pursuing the contract.
Revenue from Contracts with Customers 161

Case 2: Partially or wholly performed contract

If either party has performed its respective obligation or if both have performed, the contract
shall be treated as a sale with right of return. However, because of the uncertainty, no revenue
shall be recognized until after the period for which the customer can rescind the contract elapses
or until the likelihood of the customer rescinding the contract becomes remote.

The entries are as follows:

Scenario 1
Goods are delivered but
payment is not yet made.
Asset for rt. to recover
product....................80K
Inventory...........80K
Scenario 2
Payment is made but goods are
not yet delivered.
Cash.....................200K
Refund liability...200K
Scenario 3
Goods are delivered and
payment is made.
Asset for rt. to recover
product.................80K
Inventory.........80K
Cash...................200K
Refund liability..200K

Illustration 3: Sale on approval or Sale on trial

ABC Co. delivers products to a customer for trial or evaluation purposes. The contract does not
require the customer to pay any consideration until it accepts or approves the products. If the
customer does not accept or approve the products, he must return them within 30 days otherwise
the goods will be considered as sold.

Analysis:
The contract is not a sale with right or return but rather a sale on approval. A sale on approval is
conditioned on the buyer's acceptance or approval. Title over the goods transfers to the buyer
only if it approves the products, although it can be implied if the buyer retains the products
beyond a reasonable time.

Accounting:
Only a memo entry is made when the products are delivered to the customer. Therefore, the
products remain in ABC's inventory.
Revenue from Contracts with Customers 161

The sale is recorded (and revenue is recognized) only when the buyer approves the products or
when time period for the return elapses.

Existence of a significant financing component in the contract

When determining the transaction price, the promised consideration shall be adjusted for the
effects of the time value of money if the timing of agreed payments explicitly or implicitly
provides the customer or the entity with a significant benefit of financing the transfer of goods or
services to the customer.
The core principle when adjusting the promised consideration is that the revenue
recognized shall reflect the cash selling price, i.e., the price that the customer would have paid
had he paid for the goods or services outright in cash.
When adjusting the promised consideration, the discount rate used shall be the rate that
would be reflected in a separate transaction between the entity and the customer at contract
Inception. That rate reflects the credit characteristics of the party receiving financing in the
contract, as well as any collateral or security and assets transferred in the contract. The discount
rate may be identified as the rate that discounts the promised consideration to the cash selling
price.
After contract inception, the discount rate shall not be updated for changes in interest
rates or other circumstances.
The difference between the promised consideration and the cash selling price is the
financing component, which is recognized as interest revenue or interest expense, separately
from revenue from contracts with customers. Interest revenue or interest expense is recognized
only to the extent that a contract asset (or receivable) or a contract liability is recognized in
accounting for a contract with a customer.
The customer does not have a significant financing component if:
a. The customer paid in advance and the transfer of the goods or services is at the customer's
discretion.
Revenue from Contracts with Customers 161

b. A substantial amount of the consideration is variable and contingent on the occurrence or

non-occurrence of a future event that is beyond the control of the customer or the entity
c. The difference between the promised consideration and the cash selling price arises from
reasons other than financing

The promised consideration need not be adjusted for the effects of a significant financing
component if the consideration is expected to be collected within 1 year from the date of transfer
of the goods or services.

Illustration 1: Significant financing component

Transaction A:
On December 29, 20x1, ABC sold goods costing ₱200,000 for ₱250,000 to a customer who was
granted a special credit period of 2 years. ABC normally sells the goods for ₱220,000 with a
credit period of one month or with a ₱5,000 discount for cash on delivery (i.e., outright payment
in cash).

Requirement: How much revenue is recognized on contract Inception?

Solutions
Normal selling with credit period of one month 220,000
Discount for cash on delivery (5,000)
Revenue from sale - Cash price equivalent of the goods sold 215,000

Both the selling prices of ₱250,000 and ₱220,000 constitute a financing transaction, i.e.,
they include consideration for the credit period granted. To compute for the cash price
equivalent of the goods sold, which is the fair value of the consideration, ₱5,000 discount given
for outright payment in cash is deducted from the normal selling price of ₱220,000 with credit
period of one month.
Revenue from Contracts with Customers 161

Transaction B:
On December 31, 20x1, ABC sold goods in exchange for a ₱1,000,000, noninterest-bearing note
that matures on December 31, 20x4. The implicit rate of interest in the contract is 12%.

Requirement: How much revenue is recognized on contract inception?

Solution:

Face amount of noninterest-bearing note 1,000,000

Multiply by: PV of ₱1 @12%, n=3 0.71178
Revenue from sale - PV of the note 711,780

The difference between the fair values and the nominal amounts of the considerations
received will be recognized as interest revenue over the credit period computed using the
effective interest method.

Transaction A Transaction B
Nominal amount of consideration 250,000 1,000,000
Fair value of consideration 215,000 711,780
Unearned interest 35,000 288,220

For purposes of subsequent amortization of the unearned interest revenue arising from
Transaction A, the imputed interest rate shall be computed using the "trial and error" method or
other methods. These methods are discussed in detail in Intermediate Accounting Part 1A.

Transaction C:
On December 29, 20x1, ABC sold goods for ₱30,000 to a customer who was granted credit
period of 3 months. The goods were delivered at contract inception. The cash selling price of the
goods is ₱28,000.
Revenue from Contracts with Customers 161

Requirement: How much revenue is recognized on contract inception?

Solution:
₱30,000 - the contract price. As a practical expedient, the promised consideration need not be
adjusted for the effects of a significant financing component if the consideration is expected to be
collected within 1 year from the date of transfer of the goods or services.