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Revenue & Recognition

Ridhollah Muhammad A. Monica Putri S. Reny Suwondo Yudi Dwiprasanto

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revenue reflects the firm's past operations and is used to predict future performance different business modelsdifferent measurement revenue recognition as an area where improved guidance is needed

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Nature of revenue
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Definition of Revenue
associates with factors that create revenue the gross increase in the value of assets and capital created predominantly by the production and sale of the output of the entity (main operations of the business)

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the physical and the monetary flows

the physical flow :
entails the event of producing and selling the output

the monetary flow :

involves the event of increasing the value of the firm (due to production or sales to customers of the firm's output)

Object: the output or product

the dollar amount of the asset produced or sold


which of the four constitutes the essence of Templates revenue?

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Based on the implications of the ideal case, revenue must be directly related to the monetary event (an increase or flow), not an object , of value increasing in the firm, which arises out of production or sale of output the Paton and Littleton: revenue is : the `product of the enterprise => the physical flow represented by the flow of funds from the customers

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Definition of Revenue
IAS 18/AASB 118 Revenue, paragraph 7:
Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants.

In the AASB Framework, paragraph 74:

The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent

paragraph 77:
Assets received or enhanced by income may include cash, receivables and goods and services received in exchange for goods and services supplied

In the United States, the FASB defines revenues:

Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations.

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elements of income

eason that revenues and gains ollow the same rules for their and measurement. ally, be creases in net assets and they fore be treated identically

IASB: no different in nature so they are n considered a separate element in the Framework

Unrealised gains

ongoing major or central operations (FASB)

Realised Gains
peripheral or incidental transactions (FASB) Powerpoint Templates

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Behavioural View of Revenue

Revenue generally comes about because the entity does something to make it happen or undertakes certain activities Revenue is not simply a sum of money

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Behavioural View (cont..)

Paton and Littleton
revenue indicates the that revenue and `accomplishment' of the firm, measure of gross profit accrue performance throughout When expenses are seen as representing the process `effort' of the the earning firm, then the matching of there is a continual revenues and expenses results in profit: the `net change in value of accomplishment' of the firm

stresses an operational view of revenue and profit Profit arises only from those activities that are designated business operations The general business operations specified by Bedford are: Contrast to acquisition of money resources acquisition of services use of services recombination of acquired services disposition of services distribution of money resources

Related to certain critical events and decisions made by the managers of the firm profit is earned at the moment of making the most critical decision or of performing the most difficult task in the cycle of a complete transaction the critical event will be at a different point depending on the nature of the business

the total assets and capital as the firm undertakes the activities specified in the process This definition conforms with the theoretical view The FASB's definition of revenue: already mentioned `the inflows or other enhancements of assets of an entity or settlements of its Powerpoint Templates Page 10 liabilities' due to `delivering or producing goods, rendering services'

Recognition of Revenue (Historical Perspective)

19th century, Income (profit)increase in net worth May stated:
realisation postulate was not accepted prior to the First world War. In 1913, leading authorities in all these fields in England and America seemed to agree on the increase in net worth concept of income

o Increase in net worth income had to be realised because the use of specialised non-current assets
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In Australia, Jordan CJ said:

The word income is not a term of art, and what forms of receipt, and what ascertain how much of those receiptsas income, must be determined in accordance with the ordinary concepts and usages of mankind,

o Ryan, the ordinary concepts of mankind :

1. 2. 3. Remuneration for personal services Income from property Income from carrying on business

o Exclude receipt which were of a capital nature

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Hughes declared:
It is of the essence of income that it should be realised. Income necessarily implies separation and realisation. The increase of the forests is not income until it is cut. The increase in the value of lands due to the growth and prosperity of the community is not income until it is realised. Where investments are concerned, there is no income until there has been a separate, realised gain

o Two cases in Australia (foreign exchange gain):

1. 2. The company borrowed funds in the US as an injection of capital. On repayment, the gaincapital Payments for goods delivered in the previous year. The gainprofit

o IAS, the most exchange rate gains on a long term debt (or receivables) be recognised in profit or loss of the period in which they arise
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In the US, appraisal valuations in the 1920s contributed in part to the Great Depression of the 1930s
Accountants adopted a conservative attitude and the recognition or realisation principle was an outcome of this defensive posture Realisation occurred in 1932, special committee supported the realisation criterion and rejected the asset appraisal
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Criteria for Revenue Recognition

At what point during the earning process can revenue be recorded as earned because there is sufficient evidence? Revenue recognition may take places at a number of stages in a firms operating

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1. Devising an idea

9. Receipt of cash

2. Making purchases

8. Delivery of goods to customers

3. Receipt of orders before commercing production

7. Receipt of orders after completing production

4. Commercing production

6. Completion of production

5. Progressively throughout production

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Based on the need for objective evidence, there are three criteria:

1. Measurability of Asset Value 2. Existence of a transaction 3. Substantial Completion of The Earning Process
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Measurability of Asset Value

Revenue is mainly an inflow that increases the value of the total assets Fair value measurement also focuses on the enhancement of assets,without any actual or physical inflow of assets (Holding the Assets) Fair valueconsistent with the accrual accounting approach, but inconsistent with historical cost conservatism and the realisation concept.
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Measurability of Asset Value

Recognition of changes in asset values is less of an issue where there are ready markets for asset, ex. Shares It becomes problematic where market value are not readily available, or the asset in use is greater than its carrying value
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Analysis of Criteria for Revenue Recognition

Measurability of asset value


Existance of a transaction Substantial completion

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Measurability of asset value

Revenue >> increase value of total asset, increase in equity >> Reasonable No inflow >> objectively? >> IAS 39, 40, 41 >> conservatism Fair value accounting consistent with accrual, but inconsistent with conservatism

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Measurability of asset value

Must asset be liquid? FASB >> Revenue is recognized when realised or realizable must be liquid? YES why? Recognition vs Realisation Collectability Resolving uncertainty assosiated with realisation Based on experience The longer collectibility period, the more uncertain
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Presently, except in spesified cases, the firms must be direct participated in the transaction >> historical cost is the most feasible. Critics from CCA and EPA, the firm doesnt need to be a party, but the market transaction is sufficient >> gain is recorded before the sale E.g. wheat and barley Why is it allowed? Sufficient objective evidence In some cases it is not reliable, but we cannt demand that in all cases the firm must be a direct participant.

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Not explicitly stated in framework Revenue is not generated (earned) until the firm has performed most of the activities for which the firms earns

Signing contract? A number of activities?

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Guidance From Standard Setters

a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and b) the item has a cost or value that can be measured with reliability. IASB Framework

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Revenue shall be measured at the fair value of the consideration received or receivable

Fair Value:

is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction.

IAS 18
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Transactions create Revenues:

a) the sale of goods; b) the rendering of services; and c) the use by others of entity assets yielding interest, royalties and dividends.

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The Sale of Goods

Revenue Shall be recognized when: a) Transferred significant risks and rewards of ownership b) retains neither continuing managerial involvement nor effective control c) can be measured reliably d) Probable economic benefits e) the costs incurred or to be incurred can be measured reliably

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The verifiable evidence of revenue often consists of an external sales transaction, so that revenue cannot usually be recognised before the point of sale Martin

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Exceptions to sales basis

1. During production Percentage of Completion Method 2. End of production 3. Cash received after sale instalment method & cost recovery method

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Percentage of Completion Method

.. Is appropriate only when reasonably reliable estimates can be made.. Three ways to determine it: 1. Proportion of cost incurred to estimated total cost 2. Surveys of work performed 3. Completion of a physical proportion of the contract work

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Rendering of services
When the outcome can be estimated realibly, revenue shall be recognised by reference to the stage of completion of the transaction

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outcome can be estimated realibly, when:

a) revenue can be measured reliably b) Probable economic benefits c) the stage of completion of the transaction can be measured realibly d) the costs incurred or to be incurred can be measured reliably

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Multiple acts and time of services

if there is a significant act, Recognition should not occur until this act has been performed
Where services consist of an indeterminate number of acts, revenue should be recognised on a straight line basis

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Revenue from the use by others of entity assets, recognised on the bases: a) Interest effective interest method b) Royalties accrual basis accordance to the agreement c) Dividends the shareholders right to receive payment is established.

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IASB/FASB joint project Revenue transactions are not well served by existing guidance literature Revenue transactions have become more complex

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They propose
recognising revenues when they arise measuring them at fair value at that point measuring them when they arise from an increase in assets or a decrease in liabilities, at the fair value of that change

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Resulting changes in emphasis
revenue is recognised when it arises
changes emphasis from realisation to timeliness

revenue can result from the changes in asset and liability values and from holding assets
that is, from remeasurements

revenue recognition and measurement reflect fair value measurement should be reliable
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Tentative agreement that two criteria must be met to recognise revenue
a change in assets or liabilities must have occurred
the elements criterion

the change in assets or liabilities can be appropriately (reliably) measured

the measurement criterion

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Tentative conclusions are
an all-inclusive, single income statement where all changes to assets and liabilities will be disclosed realisation is not the basis for inclusion of items separate disclosure of performance (income flows) and remeasurement (valuation adjustments)

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