REVENUE

RECOGNITION
ACT4102 FINANCIAL ACCOUNTING AND REPORTING 5
OUTLINE

Why need new

The new standard –
revenue recognition
MFRS 15
standard?

Adoption methods The 5-steps model

MFRS 15
O MFRS 15 Revenue
From Contract With
Customers
O Effective 1 Jan 2018
 The industries most impacted by IFRS 15 are
likely to be telecom, software development,
real estate and other industries with long-
term contracts. This includes an industry
where bundled contracts of ‘product +
service’ are quite common.
 Address the weakness in the previous revenue recognition issues. Due
to the complexity of some transactions, many believe the revenue
recognition process is increasingly complex to manage, more prone to
error, and more material to financial statements compared to any other
area of financial reporting
 Reduce manipulation/earnings management by companies when
recognizing revenue
 Provides a more robust framework for addressing revenue issues.

WHY NEED NEW REVENUE

RECOGNITION STANDARD?
 WHY NEED NEW REVENUE
RECOGNITION STANDARD? –
CONT’D
 Improves comparability of revenue recognition practices across entities,
industries, jurisdictions and capital market.
 Provides more useful information to users to financial statements
through improved disclosure requirements
 Simplifies the preparation of financial statements by reducing the
number of requirements to which an organization must refer.
ADOPTION METHODS

FULL • All periods, all contracts

RETROSPECTIVE • Disclosure of the reason for the change and
APPROACH the method of applying the change

• Only the current period, any contracts

MODIFIED existing as of the effective date
RETROSPECTIVE • Requires two sets of accounting records in
APPROACH
year of adoption
The guidance applies to most contracts
with customers with only a few
exceptions. It does not apply to other
transactions or activities.

A customer is “a
party that has
contracted with an
entity to obtain goods or
services that are an
output of the entity’s
ordinary activities.”
In order to determine revenue, the entity applies five steps:
1. IDENTIFY THE CONTRACT WITH CUSTOMERS.

 A contract is an agreement that creates

enforceable rights or obligations and
1. has commercial substance,
2. has been approved and both parties are
committed to performing their obligations,
3. the company can identify each party’s rights
regarding the goods or services to be
transferred, and
4. the payment terms.
 A performance obligation is a promise in
a contract to provide a product or service
to a customer. THE 5-STEP
A performance obligation exists if the customer
MODEL
can benefit from the good or service on its own 2. IDENTIFY
or together with other readily available
resources.
THE
SEPARATE
A contract may be comprised of multiple
PERFORMA
performance obligations. NCE
The accounting for multiple performance
OBLIGATIO
obligations is based on evaluation of NS IN THE
whether the product or service is distinct CONTRACT.
within the contract.

If each of the goods or services is distinct, but

is interdependent and interrelated, these
goods and services are combined and
reported as one performance obligation.
 DETERMINATION OF SEPARATE
PERFORMANCE OBLIGATIONS
EXAMPLE 1

An entity licenses customer relationship management software to

a customer. In addition, the entity promises to provide consulting
services to significantly customize the software to the customer’s
information technology environment for total consideration of
$600,000.
 Are the software and consulting services one
performance obligation or two?
Determination of separate performance obligations
Example 1 solution

► The entity is providing a significant service of integrating the

goods and services (the license and the consulting services)
into the combined item for which the customer has
contracted.
► The software is significantly customized by the entity in
accordance with the specifications negotiated with the
customer.
► Thus, the goods and services are not distinct as the criterion
that the customer can benefit from the customer management
software on a stand-alone basis has not been met.
► Therefore, the entity would account for the license and
consulting services together as one performance obligation.
3. DETERMINE THE TRANSACTION PRICE.

 The transaction price is the amount of consideration that a company

expects to receive from a customer in exchange for transferring goods
and services.
 In determining the transaction price, companies must consider the
following factors: (a) variable consideration, (b) time value of money,
(c) noncash consideration, (d) consideration paid to a customer, and (e)
upfront fee payments.
(a) Variable Consideration
EXAMPLE 2
Catherine’s Costumes sells 1,000 Halloween
costumes to a wholesaler for total consideration of
$20 per costume. The contract provides the
customer with the right to return all unsold
costumes after Halloween. What is the estimated
Due to its extensive experience in this industry, transaction price for the
Catherine’s Costumes can reliably provide the contract?
following range of probability of returns based on
this sales volume.

Costumes returned Probability

50 40%
75 45%
100 15%
 (a) Variable consideration
Example 2 Solution
► Expected value method: the estimated contract price is
measured using the sum of the probability-weighted amounts
in the range of possible consideration amounts. Therefore, the
calculation is as follows:
Estimated contract price = (950 x 40% x $20) + (925 x 45% x $20) +
(900 x 15% x $20)
= $7,600 + $8,325 + $2,700
= $18,625

► Most likely amount method: based on the highest probability

of 45% for 75 costumes being returned, this would be
considered the most likely amount. Therefore, Catherine’s
Costumes will calculate using 925 costumes multiplied by $20
per costume for a total estimated contract price of $18,500.
(b) Time Value of Money Consideration
► If the time between (1) when the entity provides the goods or
services and (2) the customer makes the payment for these
goods or services is more than one year, the entity may need to
adjust the amount of the consideration to reflect the time value
of money.

Example 3
Madison Wholesalers enters into a contract with a
customer to sell a product for $200,000. The product will
be delivered in two years, but the customer pays for it
today. Typical credit rates in the industry are 5% annually.

What are the journal entries that Madison Wholesalers will

record over the two-year period?
 (b) The time value of money
Example 3 solution
What are the journal entries that Madison Wholesalers will
record over the two-year period?
► At the date that Madison Wholesalers receives the cash, it records:
Dr. Cash $200,000
Cr. Deferred revenue $200,000
► During the two-year period, Madison Wholesalers will recognize interest
expense of $20,500 (200,000 x (1.052-1)).
Dr. Interest expense $20,500
Cr. Deferred revenue $20,500
► When the product is transferred in two years, Madison Wholesalers will
recognize revenue based on the balance of the deferred revenue account.
Dr. Deferred revenue $220,500
Cr. Revenue $220,500
4. ALLOCATE THE TRANSACTION PRICE TO SEPARATE
PERFORMANCE OBLIGATIONS.

 If there is more than one performance obligation, allocate the

transaction price based on relative fair values.
 The best measure of fair value is what the good or service could be sold
for on a standalone basis (standalone selling price).
ALLOCATION OF THE TRANSACTION
PRICE
EXAMPLE 4
LEDD Company enters into a contract with a customer to sell
three products for a total transaction price of $50,000. Each
product is appropriately classified as a separate performance
obligation. LEDD Company typically sells these three
products on a standalone basis for the following prices:

Product Standalone selling price

A $10,000
B 22,000
C 20,000
Total $52,000

► How should LEDD Company allocate the transaction

price to the three products?
 Allocation of the transaction price
Example 4 solution

LEDD Company should allocate the $50,000 transaction price

based on the products’ relative, standalone selling prices as
follows:

Standalone Allocated transaction

Product selling price Percentage price
A $10,000 19.2% $ 9,600
B 22,000 42.3% 21,150
C 20,000 38.5% 19,250
Total $52,000 100.0% $50,000
 5. RECOGNIZE REVENUE WHEN EACH PERFORMANCE
OBLIGATION IS SATISFIED

 A company satisfies its performance obligation when the customer

obtains control of the good or service.
 Companies satisfy performance obligations either at a point in
time or over a period of time.
(a) Recognized Revenue At A Point In
Time
If satisfied at a point in time, then revenue is recognized
when control is transferred. Some indications of
transfer of control are as follows:
 The seller has a present right to payment.
 The customer has a legal title to the asset.
 The seller has transferred physical possession of the
asset to the customer.
 The customer has significant risks and rewards of
ownership of the asset.
 The customer has accepted the asset.
(a) RECOGNITION AT A POINT IN TIME
EXAMPLE 5

Kentucky Associates enters into a contract to sell a product to a

customer. The product is shipped free on board shipping point.
Should Kentucky Associates recognize revenue when the product is
shipped or received by their customer?

Solutions:
Kentucky Associates can recognize revenue when the product is
shipped because the customer obtains control of the product when it
is shipped. Although the customer doesn’t have physical possession
of the product when it is shipped, it has legal title and the risks and
rewards of ownership.
CRITERION EXAMPLE

The customer simultaneously

receives and consumes the benefits
Routine or recurring
services (b)Recognize
provided by the entity’s
performance as the entity
performs.
e.g. cleaning services
d revenue
over time
The entity’s performance creates Building an asset on a
or enhances an asset (for example, customer’s site
work in progress) that the customer Performance obligation
controls as the asset is created or
is satisfied over time if
enhanced.
one of the criteria is
met out of three:

The entity’s performance does not Building a specialised

create an asset with an alternative asset that only the
use to the entity (e.g. selling it to a customer can use or
different customer) and the entity building an asset to a
has an enforceable right to customer’s
payment for performance specifications
completed to date
(b)Recognized revenue over time
An entity applies either output method or input method of measuring progress
towards complete satisfaction of the obligation. The objective is to depict the
transfer of control of the goods or services to the customer.

Method Description Examples

Output Based on direct measurements of the  Surveys of
value to the customer of goods or performance to date
services transferred to date, relative to
 Appraisals of results
the remaining goods or services achieved
promised under the contract
 Milestones reached
 Time elapsed

Input Based on an entity’s efforts or inputs  Resources consumed

towards satisfying a performance  Costs incurred
obligation, relative to the total
expected inputs into the satisfaction of  Time elapsed
that performance obligation  Labour hours
  expended
 Machine hours used
(b) Recognition Over A Period Of Time
Example 6

The PJG Company has extensive experience in the road construction

business. PJG has an excellent track record in estimating costs of projects
and is a very efficient construction company.
PJG has entered into a two-year contract to build a 25-mile toll road for $50
million. The toll road is adjacent to an old gravel road. The toll road operator
plans on opening the toll road in five-mile sections as the paving is
completed.
PJG estimates this project will require $30 million of road construction
material and 400,000 construction hours at an average cost of $25 per
hour. At the end of year one, 10 miles of toll road have been turned over
and are in use by the toll road operator. Some work has also been done on
the next section of the road. Road material costs of $15 million and
200,000 construction hours have been incurred.
What revenue should PJG record for this performance obligation at
the end of year one using the input method? The output method?
(b) Recognition Over A Period Of Time
Example 6 Solution

 Input method:

Revenue using the input method should be based on the seller’s

efforts to satisfy its performance obligation. PJG has incurred 50% of
the road material costs ($15 million/$30 million) and 50% of the
construction hours (200,000 hours/400,000 hours). Therefore, $25
million should be recognized as revenue at the end of year one,
calculated as 50% of the $50 million.
 Output method:

Revenue using the output method should be based on the value of

the goods transferred to the customer. PJG has completed 10 miles
of road and turned them over to the toll road operator. The remaining
15 miles are not currently available to the toll road operator.
Therefore, $20 million should be recognized as revenue at the end of
year one, calculated as 40% (10 miles/25 miles) of the $50 million.
 Contract Costs

(a) Incremental (b) Costs to fulfil a

costs of obtaining contract
a contract • If not within the
• Recognized as scope of another
an asset if the standard (MFRS
entity expects to 102, 116 or 138),
recover them then it is
If not incremental, recognized as an
then expensed. asset.
• Two types of contract
costs, usually
capitalized (if certain
criteria are met).
• Any capitalized
contract costs are
amortized.

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 Other Revenue Issues

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 Other Revenue Issues (cont.)

FINANCIAL ACCOUNTING AND REPORTING 3 All Rights Reserved

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 Other Revenue Issues (cont.)

FINANCIAL ACCOUNTING AND REPORTING 3 All Rights Reserved

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 Other Revenue Issues (cont.)

FINANCIAL ACCOUNTING AND REPORTING 3 All Rights Reserved

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 Other Revenue Issues (cont.)

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 Disclosure Requirement

 An entity should disclose qualitative and

quantitative information about all of the
following:
– Its contracts with customers,
– The significant judgements, and changes in the
judgements, made in applying the guidance to
those contracts, and
– Any assets recognized from the costs to obtain or
fulfil a contract with a customer.

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 Source:

 E&Y Academic Resource Centre

 Kieso, Weygandt & Warfiedl,
Intermediate Accounting
 Routledge, Karim & Kim (2016). The
FASB's and IASB's New Revenue
Recognition Standard: What Will Be the
Effects on Earnings Quality, Deferred
Taxes, Management Compensation, and
on Industry-Specific Reporting?
 KPMG IFRS 15 Handbook
 https://sobelcollc.com
 Financial accounting and reporting 3 (text
book)