Chapter 5

Revenue (Text Book Pages 279-309)

IFRS 15 & five-step framework
Recognize revenue at single point in time

Dr. Nafis Rahman

Intermediate Accounting 1

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 Framework of IFRS 15
Core principle of IFRS 15
Seller recognizes revenue as the promises to the customer are satisfied in an
amount that reflects the expected consideration that the seller is entitled to.

Performance
obligations
satisfied at a point
in time

Performance Performance
Contract Customer obtains obligations
obligations control of asset satisfied over time
REMEMBER: Revenue is earned only when the seller delivers the goods or
services to the customers. The timing of revenue DOES NOT depend on the
timing of the payment received from customer. 5-2
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 Framework of IFRS 15
Control of assets
Control is the ability to decide on the use of an asset so as to obtain
substantially the remaining benefits from that asset, in its present form
and condition.

In simple words, if you have control over an asset, you can:

1. enjoy the benefits of the assets
2. prevent others from using the asset
3. decide to modify/alter/ dispose the asset
4. direct the use of the asset to another person of your choice

The point when control is transferred to a customer signifies the timing of

revenue recognition.

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 Framework of IFRS 15
Distinct Goods and Services

A contract includes promises made by the seller to the customer to deliver

distinct goods or services. Two conditions must exist for a good or
service to be distinct.

The good or service The promises to

must be able to deliver distinct goods
provide benefits on its
own or with resources and or service must be
specifically spelt out in
readily available to the the contract
customer

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 Framework of IFRS 15
At the point of exchange between seller and customer, seller
recognizes the increase in:

Contract asset Cash Accounts

receivable

A contract asset is the right to Accounts receivable is the right of

consideration (i.e. cash) that is the seller to receive payment
conditional on factors other than from a customer and is
the passage of time. conditional on time.

The seller has to perform Accounts Receivable is a

additional tasks to make it usable financial asset that can be turned
to the customers. Only then s/he into cash without additional effort
becomes eligible for payment

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 Framework of IFRS 15
Contract Asset vs Contract Liability
Suppose: a seller has a contract to bake a super fancy wedding cake

It takes 3 days to prepare the cake.

This batter is a contract asset.

Cannot just deliver
the batter. Need to
deliver the cake to
get paid.

In cases where seller

receives payment in
advance of fulfilment of a Contract liability
promise to a customer, a
contract liability is created. 5-6
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 5-Step Framework of IFRS 15
Step 1: Identify contract with a customer

A contract is an agreement that creates legally enforceable rights

and obligations. Under IFRS 15, we recognize revenue
associated with contracts that are legally enforceable.

Written/oral

Implied

Contract Implicit

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 5-Step Framework of IFRS 15
Step 2: Identify the Performance Obligation(s)
Performance obligations are promises to transfer goods and services to the
buyer. If performance obligations are distinct, they are accounted for separately.
~~~In our wedding cake example, the entire cake is the performance obligation.
You cannot sell the cream, decoration, and the base separately.

1. Prepayments: Not a separate performance obligation

2. Right of return: Not a separate performance obligation
3. Quality assurance warranties: Not a separate performance
obligation
4. Extended warranties: Is a separate performance obligation
because they represent additional services that could be sold
separately.
5. Option for additional goods and services: Is a separately
performance obligation if it confers a material right to the buyer

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 5-Step Framework of IFRS 15
Step 3: Determine the Transaction Price

The transaction price is the amount the seller expects to be entitled to

receive from the buyer in exchange for providing goods and services.

Transaction price may comprise of the following:

Variable Noncash consideration is Consideration payable to a

consideration is when a customer makes customer is when a
estimated as either payment by transferring company pays cash or gives
the probability- noncash items such as equity a voucher to a customer that
weighted amount or shares. Noncash can be used to offset future
the most likely consideration is to be payments
amount. measured at fair value

When time value of money is significant, a sales transaction is viewed as including two parts:
a delivery component (for goods or services) and a financing component (either interest paid to
the buyer in the case of a prepayment or to the seller in the case of a receivable).

If delivery and payment happen close to each other (if the gap between the two 5-9
dates is less than 1 year), then we can just ignore time value of money 5-9
 5-Step Framework of IFRS 15
Step 3: Determine the Transaction Price (accounting for variable
consideration)
TrueTech enters into a contract with ProSport Gaming to add ProSport’s online
games to the Tri-Net network. ProSport will pay TrueTech an up front $300,000
fixed fee for six months of featured access, as well as a $200,000 bonus if Tri-
Net users access ProSport products for at least 15,000 hours during the six-
month period. TrueTech estimates a 75 percent chance that it will achieve the
usage target and earn the $200,000 bonus.
Probability-Weighted Amount
Possible Amounts Probabilities Expected Amounts

$500,000 x 75% = $375,000

$300,000 x 25% = $75,000
Expected contract price at inception $450,000

Let’s write journal entries for this transaction: 5-10

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 5-Step Framework of IFRS 15
Step 3: Determine the Transaction Price (accounting for variable
consideration)
Most Likely Amount
The most likely amount of bonus is $200,000

so a transaction price based on the most likely amount would be

$300,000 + 200,000 = $500,000

Let’s write journal entries for this transaction:

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 5-Step Framework of IFRS 15
Step 3: Determine the Transaction Price (accounting for non-
cash consideration)
On March 5, 2022, TrueTech enters into a contract with Virtual-Gym to deliver
1,000 online exercise modules to Virtual-Gym on December 5, 2022. In return,
Virtual-Gym pays cash of $10,000 and transfers specialized software to
TrueTech to develop the online modules. TrueTech has control of the software
after delivery.
Fair value of the software is reliably estimable (straightforward method)
Fair value of noncash consideration. The fair value of the software is $30,000.

Journal Entry (Mar 5, 2022) Debit Credit

Cash 10,000
Intangible assets 30,000
Contract liability 40,000

Journal Entry (Dec 5, 2022) Debit Credit

Contract liability 40,000 5-12
Revenue 40,000 5-12
 5-Step Framework of IFRS 15
Fair value of the software is not reliably estimable, use the stand-alone prices of
the goods
Stand-alone prices of the goods. The stand-alone price of 1,000 online
modules is $45,000. Since cash consideration is $10,000, the remaining
consideration of $35,000 is attributed to the software which the Virtual-Gym
has transferred to TrueTech as noncash payment.

Journal Entry (Mar 5, 2022) Debit Credit

Cash 10,000
Intangible assets 35,000
Contract liability 45,000

Journal Entry (Dec 5, 2022) Debit Credit

Contract liability 45,000
Revenue 45,000

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 5-Step Framework of IFRS 15
Step 3: Determine the Transaction Price (accounting for
consideration payable to a customer)
Let’s say that you received a voucher of $50 to offset against the next purchase of $500.
The retailer records the following transactions upon sales of goods:

Journal Entry Debit Credit

Cash 450
Revenue 450

Suppose the retailer instead promises to give you a voucher of $50 if you post an
advertisement for the retailer on your social media app. You bought goods of $500.

Journal Entry (on posting of ad) Debit Credit

Marketing expenses 50
Cash 50
Journal Entry (on sale of goods) Debit Credit
Cash 500
Revenue 500
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 5-Step Framework of IFRS 15
Step 3: Determine the Transaction Price (accounting for the time
value of money)
On January 1, 2023, TrueTech enters into a contract with GameStop Stores to
deliver four Tri-Box modules that have a fair value of $1,000.

Receivable Case:

TrueTech delivers the modules on January 1, 2023, and GameStop agrees to

pay TrueTech $1,103 on December 31, 2024. TrueTech delivers the modules
significantly in advance of payment, such that TrueTech is viewed as loaning
money to GameStop and TrueTech earns interest revenue.
2 years gap between the payment and delivery. 5-15
The financial year-end for both companies is December 31. The time value of
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 5-Step Framework of IFRS 15
Step 3: Determine the Transaction Price (accounting for the time-value
of money). What if Payment was made 2 years AFTER the delivery?
Receivable (Delivery on Jan 1 2023. Payment on December 31 2014)

Journal Entry (Delivery occurs) Debit Credit

Accounts receivable 1,000
Revenue 1,000

Journal Entry (Year 1 interest expense) Debit Credit

Accounts receivable 50
Interest revenue ($1,000 x 5%) 50

Journal Entry (payment occurs) Debit Credit

Cash 1,103
Interest revenue ($1,050 x 5%) 53
Accounts receivable 1,050
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 5-Step Framework of IFRS 15
Step 3: Determine the Transaction Price (accounting for the time
value of money)
On January 1, 2023, TrueTech enters into a contract with GameStop Stores to
deliver four Tri-Box modules that have a fair value of $1,000.

Prepayment Case:
GameStop pays TrueTech $907 on January 1, 2023, and TrueTech agrees to
deliver the modules on December 31, 2024. GameStop pays significantly in
advance of delivery, such that TrueTech is viewed as borrowing money from
GameStop and TrueTech incurs interest expense.

The financial year-end for both companies is December 31. The time value of
money in both cases is 5 percent.

2 years gap between the payment and delivery. 5-17

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 5-Step Framework of IFRS 15
Step 3: Determine the Transaction Price (accounting for the time-value of
money). What if delivery made 2 years after payment?
Prepayment (payment on Jan 1 2023. Delivery on Dec 31 2024)

Journal Entry (Upon prepayment) Debit Credit

Cash $1,000 x 0.90703 (PV) = 907 907
Contract liability/ Deferred Revenue 907

Journal Entry (Year 1 interest expense) Debit Credit

Interest expense ($907 x 5%) 45
Contract liability/ Deferred Revenue 45

Journal Entry (Delivery occurs) Debit Credit

Interest expense ($962 x 5%) 48
Contract liability / Deferred Revenue 952
Revenue 1,000
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 5-Step Framework of IFRS 15
Step 4: Allocate the Transaction Price to the Performance
Obligations
The transaction price is allocated to separate performance obligations in
proportion to their relative stand-alone selling prices. When stand-alone
selling prices are uncertain, a seller might estimate stand-alone selling
prices using the residual method.

Approaches to estimate stand-alone selling prices

Adjusted market
assessment approach: The
seller considers what it could
sell the product or services
for in the market in which it
normally conducts its
business. The seller may
perhaps refer to prices
charged by competitors.
Expected cost Residual approach: The seller
plus margin estimates an unknown (or highly
approach: The uncertain) stand-alone selling
seller estimates its price by subtracting the sum of
costs of satisfying a the known or estimated stand-
performance alone selling prices of other
obligation and then goods or services in the contract
adds an appropriate from the total transaction price of
profit margin the contract

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 5-Step Framework of IFRS 15
Step 4: Allocate the Transaction Price to the Performance
Obligations (Using the Residual Technique)
The Tri-Box System has a wholesale price of $270, which includes the physical Tri-Box
console as well as a one-year subscription to the Tri-Net of Internet-based games and
other applications.

CompStores orders 1,000 Tri-Boxes at the normal wholesale price of $270.

Scenario 1: Adjusted Market Assessment Approach:

Suppose the stand alone market price for one-year subscription to the Tri-Net is $50.
TrueTech does not sell a Tri-Box module without the initial one-year Tri-Net
subscription, but estimates that it would charge $250 per unit if it chose to do so.

Scenario 2: Residual Approach:

TrueTech does not sell a Tri-Box module without the initial one-year Tri-Net
subscription, but estimates that it would charge $250 per unit if it chose to do so.

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 5-Step Framework of IFRS 15
Step 4: Allocate the Transaction Price to the Performance
Obligations (Using the Adjusted Market Assessment Approach)
Value of the subscriptions
Stand alone fair value of Tri-box = 250
Stand alone fair value of 1-year subscription = 50 .
Total Price of items if purchased separately = $300
We sell the combined product for $270. We make proportional allocations:
For the $270 combined product,
Tri-box module contributes: $270*(250/300) = $225
The one-year subscription contributes: $270 *(50/300) = $45

Journal Entry (on the date of delivery) Debit Credit

Accounts receivable 270,000
Revenue [$270,000 x (250/300)] 225,000
Contract liability [$270,000 x (50/300)] 45,000

TrueTech would convert the contract liability or unearned revenue

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to revenue over the one-year term of the Tri-Net subscription.
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 5-Step Framework of IFRS 15
Step 4: Allocate the Transaction Price to the Performance
Obligations (Using the Residual Approach)
Value of the subscriptions
Total price of Tri-Box with Tri-Net subscription $270,000
Estimated price of Tri-Box sold without subscription $250,000
Estimated price of Tri-Net subscription $20,000

Journal Entry on the date of delivery Debit Credit

Accounts receivable 270,000
Revenue ($270,000 x 250/270) 250,000
Contract liability ($270,000 x 20/270) 20,000

TrueTech would convert the contract liability or unearned revenue

to revenue over the one-year term of the Tri-Net subscription.
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 5-Step Framework of IFRS 15
Step 5: Recognize revenue when (or as) each performance
obligation is satisfied
Seller recognizes revenue allocated to each performance obligation when it
satisfies the performance obligation

Recognizing Revenue at a single Recognizing Revenue over a period

point in time of time

In our fancy wedding cake example, the entire cake is the performance obligation.
It is delivered at a point in time (on the wedding date).
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 Recognizing Revenue at a
Single Point in Time
The performance obligation is satisfied when control of the goods or
services is transferred from the seller to the customer

IFRS 15 provides five indicators (non-exhaustive) to decide

whether control has been transferred
The customer is more likely to control a good or service if the customer has :

An obligation to Legal title to Accepted the

pay the seller the asset asset

Physical Assumed the risks

possession of the and rewards of
asset ownership

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 Recognizing Revenue at a
Single Point in Time
When more than one company is involved in providing goods and
services to a customer, we need to determine whether the company is
acting as a principal or as an agent.

IFRS 15 provides the following “clues” to determine if a party is a principal or

agent

1. The principal is the party who is primarily responsible for fulfilling the
contractual promises to the customer.
2. The principal, and not he agent, bears inventory risks before transfer takes
place and after returns (if any) are made.
3. The principal has the right to set prices for the goods and services.
4. The agent’s consideration is in the form of a commission.
5. The agent is not exposed to credit risk from accounts receivable.
When you buy a videogame box from Alibaba for $300, most likely Alibaba is
the agent. Alibaba’s revenue is not $300. Alibaba’ revenue is a small
percentage of that $300 (commission). 5-25
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 Recognizing Revenue at a
Single Point in Time
Sometimes a company arranges for another company to sell its product
under consignment. In these arrangements, the consignor physically
transfers the goods to the other company (the consignee), but the
consignor retains legal title.

IFRS 15 states that indicators of a consignment arrangement include, but are

not limited to the following:

1. Product is under the control of the consignor until a specific event occurs.
2. The consignor is able to require the return of the product or the transfer to
another dealer.
3. The consignee does not have an unconditional obligation to pay for the
product.

Generally, university bookstore will only buy textbooks on consignment. If

the students do not buy them, the bookstore will return the unsold books to
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the publisher.
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 Recognizing Revenue at a
Single Point in Time
In a franchise arrangement, a franchisor grants to the franchisee the
right to sell the franchisor’s products and use its name. In franchise
arrangements, the fees to be paid by the franchisee to the franchisor
usually comprise (1) an initial franchise fee and (2) continuing
franchise fees.
If the initial fee is collectible in installment over an extended period of time. It is
necessary to consider (1) the uncertainty of cash collection and (2) the time
value of money

Continuing franchise fees is recognized by the franchisor as revenue over time

in the periods the services are performed by the franchisor.

When you buy a sandwich from the Subway store at HKU (near HSBC), you
are buying from a franchisee. The franchisee paid an initial fee to the
original Subway company to use their name. Each year they also pay a
continuing franchise fees for support and training from the main company.
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 Recognizing Revenue at a
Single Point in Time
Customers sometimes pay a licensing fee to use a company’s
intellectual property (“IP”). We have to first identify whether the license
is distinct from other goods or services
If license is not distinct from other goods and services than it is not a separate
performance obligation.
If licenses are distinct from other goods and services, then we have to consider if
performance obligation is satisfied over time or at a point in time.

1. Right of use licenses has significant standalone functionality. The benefit the
customer receives from the license isn’t affected by seller’s ongoing activity.
2. Right of access licenses requires ongoing activities by the seller. The seller might
make changes to the IP over the course of the license or could perform marketing or
other activities that affect the value of the license to the customer.

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 Recognizing Revenue at a
Single Point in Time
SingaTunes carries a playlist of popular Cantopop songs. Customers buy a 3-
year membership fee for $1. Each member pays $2 for every song
downloaded and may keep the song forever. A member can also pay $10 per
year for unlimited streaming of ‘live’ songs.

Revenue Recognition:
Non-refundable 3-year membership fee: When SingaTune receives $1 from a customer,
the company cannot recognize revenue immediately. The company has to provide
services (access to its playlist) to the customer for next 3 years. The company recognizes
$0.33 every year of membership fee revenue for the next 3 years.

Download fee: The download fee is a right-of-use license. Once the customer downloads
the song, the customer has full control over that downloaded song for personal
consumption. The company recognizes the $2 revenue the moment the customer
downloads the song.

Streaming fee: The $10 annual fee for unlimited streaming is a right-of-access license. The
license is dependent on the on-going activities of Singa-Tunes to upload new popular
songs and maintain its playlist. The performance obligation is satisfied over time. The
company only recognizes the $10 revenue after 1 year. 5-29
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 Recognizing Revenue at a
Single Point in Time
A bill-and-hold arrangement exists when a customer is billed for the
goods but takes physical possession only at a later date.
In addition to the overriding question relating to control, sellers need to ask
some tough questions required by IFRS 15 to justify recognizing revenue:

1. Was there a genuine reason for the bill-and-hold arrangement?

Fundamentally, was it the customer who initiated this arrangement?
2. Can the product be identified separately as belonging to the customer?
3. Is the product ready to be delivered to the customer?
4. Does the customer have the ability to use the product or to direct it to
another customer? (correct your textbook..page 308).

If the answer to any of the question is negative, control has

not been transferred and revenue should not be recognized

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 Recognizing Revenue at a
Single Point in Time
In a sale and repurchase agreement, control is not transferred to the
customer.

IFRS 15 requires us to analyze the real nature of the transaction as follows:

DO NOT recognize revenue for a sale and repurchase agreement.

1. If the discounted value of the repurchase price is higher than the sale price,
the arrangement is a financing arrangement, with the difference between the
two prices being a financing cost.

2. If the discounted value of the repurchase price is lower than the sale price,
the arrangement is a leasing arrangement, with the difference between the
two prices being the lease rental for the item.
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 Recognizing Revenue at a
Single Point in Time
Boomerang made a sale to Catcher Co. for $3000 on Dec 15 2020,
with an agreement to buy back the sold item for $3200 in January 15
2021. Notice how Boomerang is effectively taking a loan from Catcher
company, and paying it high interest rate ($200 for just 30 days).
Let’s ignore the time-value-of-money in this exercise, since the gap between the sale
date and repurchase date is only 1 month.

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