CHAPTER 38

REVENUE FROM CONTRACTS WITH

CUSTOMERS
PFRS 15

BELTRAN, JONATHAN
TIZON, MARIMEL
CORPUZ, YVONNE STEPHANIE
 1. Define revenue and income.

Revenue is money brought into a company by its business activities. 

◦ the total amount of income generated by the sale of goods or services related to the company's primary
operations. 
◦ known as the top line because it appears first on a company's income statement. 
◦ is also known as sales on the income statement.
◦ The revenue number is the income a company generates before any expenses are taken out. Therefore, when a company
has "top-line growth," the company is experiencing an increase in gross sales or revenue.

Income or Net income is a company's total earnings or profit. When investors and analysts speak of a company's income,
they're actually referring to net income or the profit for the company. 
◦ Net income is calculated by taking revenues and subtracting the costs of doing business, such as depreciation, interest,
taxes, and other expenses. The bottom line, or net income, describes how efficient a company is with its spending and
managing its operating costs.
◦  is an important measure of the profitability of a company.
◦ net income is the bottom line or the "bottom" figure on a company's income statement.
2. What is a core principle of revenue recognition?

“ an entity should recognize revenue to depict the transfer of goods or services to customers in an
amount that reflects the consideration to which the entity expects to be entitled in exchange for
those goods or services.”

This principle ensures that companies in compliance with GAAP recognize their revenue when
the service or product is delivered to the customer — not when the cash is received.
 3. What is the five-step model in recognizing
revenue?

Step 1 – Identify the Contract.

In previous standards this was pretty straight forward. With ASU 606, one of the biggest changes is the requirement to
combine multiple contracts into one for the purpose of financial reporting. This is required if the contracts have the same
commercial objective, are interdependent, or share a single performance obligation.
Step 2 – Identify Performance Obligations.
Once all contracts have been identified, and if necessary, combined, we are now required to identify each distinct or
“bundled” performance obligations within each contract. These performance obligations will now be our benchmarks for
when and how we recognize revenue.
Step 3 – Determine the Transaction Price.
Gone are the days when the stated price of the contract is the determining factor for actual value of the contract. Instead,
we must now determine the transaction price of the contract by estimating the consideration we expect to be entitled to
upon completion of the contract.
Step 4 – Allocate the Transaction Price.
this will be the one that most people get hung up on. There are three methods available for use when allocating the transaction price among
it’s performance obligations. These methods are the adjusted market approach, the expected cost plus margin approach, and the residual
approach. Each method requires an in depth discussion to truly understand proper application, but for brevities sake, identification of these
methods will have to do.

 Adjusted market assessment approach involves the entity evaluating the market in which it sells goods or services, and estimating
the price that a customer in that market would be willing to pay for those goods or services. This might also include referring to prices
from the entity’s competitors for similar goods or services, and adjusting those prices as necessary to reflect the entity’s costs and
margins.

 Using the Expected cost plus margin approach, the entity estimates the costs of satisfying the performance obligation, and then adds
an appropriate margin.

 Residual approach The residual approach involves the entity:

• Estimating the stand-alone selling price by reference to the total transaction price, and then deducting
• The sum of the observable stand-alone selling prices of other goods or services promised in the contract.

Step 5 – Recognize Revenue.

It is finally time to recognize revenue! Revenue is recognized as performance obligations are satisfied. The key point to
remember about this step is that revenue should be recognized either over time, or at a point in time, and that these two
approaches are mutually exclusive from each other.
4. Define a Contract.

a binding agreement between two or more persons or parties especially : one legally enforceable. If
ever try to breaks the contract, might be sued.
a business arrangement

a written or spoken agreement, especially one concerning employment, sales, or tenancy, that is
intended to be enforceable by law.
The promise may be to do something or to refrain from doing something. The making of a contract
requires the mutual assent of two or more persons, one of them ordinarily making an offer and
another accepting. If one of the parties fails to keep the promise, the other is entitled to legal redress.
 5. What are the criteria for recognizing a contract
with a customer?

a. All parties have approved the agreement – Contracts may be written, oral or implied depending on entity’s normal business
practices. Contract enforceability is a matter of law, an entity should consider the legal jurisdiction in which it operates as the rules
for contract enforceability.

b. All parties are committed to fulfilling their obligations – If each party has the unilateral right to terminate a wholly unperformed
obligation, then the standards states that no contract exists. This criterion addresses termination clauses.

c. Each party’s rights are identifiable – A prerequisite for recognizing the contract and the rights and obligations within it is that the
agreement must clearly indicate the goods and/or services to be provided. Through identifying the transfer of control, this helps to
recognize the revenue.

d. The contract has commercial substance – In order to be recognized as a contract, it is important that it causes a change in risk to
the customer, timing of delivery of the goods and services as also the amount of cash that flows to an entity. The contract must not
entertain any social contract.

e. Collectability is probable – The new standard requires vendor to evaluate a customer’s credit risk at the inception of the
contract. Revenue recognition only takes place when payment is likely to be received.
 6. Define a performance obligation.

Performance Obligation
A performance obligation is a promise to deliver a good or service in a contract with customer. A promise constitutes a performance
obligation if the promised good or service is distinct. A promised good or service is distinct if it meets both of the following criteria:

a. The customer can benefit from the good or service.

b. The entity's promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.

Distinct good or service

1. Sale of finished goods produced by a manufacturer

2. Sale of merchandise inventory by a retailer

3. Constructing, manufacturing or developing asset on behalf of customer, as in long-term construction contract

4. Granting license or franchise

5. Performing a contractually agreed-upon task for a customer, as in bookkeeping service or payroll processing service
 7. Define a transaction price.

Transaction Price

The transaction price is the amount of consideration in a contract to which an entity expects to be entitled in exchange for
transferring good or service to a customer.

The transaction price is adjusted for discount, rebate, price concession, return, performance bonus, penalty and other similar
item.

In determining the transaction price, consideration must be given to past business practice and published policy.

Factors that may affect the transaction price are:

a. Variable consideration

b. Time value of money

c. Noncash consideration

d. Consideration payable to a customer

 8. Explain the allocation of the transaction price to
multiple performance obligation.

Allocation of the transaction price

The transaction price is allocated to each performance obligation on the basis of relative stand-alone selling price of each good
or service.

Stand-alone selling price is the price that the entity would sell a promised good or service separately to a customer.

Determining stand-alone selling price

The best evidence of the stand-alone selling price is an observable price of a good or service when sold on a stand-alone basis
or when sold separately.

If the stand-alone selling price is not directly observable, the entity must estimate such price by using the following methods:

a. Adjusted market assessment approach

b. Expected cost plus margin approach

c. Residual approach
 9. When is revenue recognized?

Recognition of revenue

As entity shall recognize revenue when or as it satisfies a performance obligation by transferring control of a
good or service to a customer.

Simply stated, revenue should be recognized when an entity transfers control of the good or service to a
customer.

The amount of revenue is the amount allocated to the performance obligation.

Control of an asset refers to the ability to direct the use of the asset and obtain substantially all of the benefits
from the asset.

Revenue can be recognized either at point in time or over time.

 10. Explain the revenue recognition at a point in
time or over time.

Revenue recognition at a point in time.

The following factors would indicate revenue recognition at a point in time:

a. The entity has the right to receive payment for the asset and for which the customer is obliged to pay.

b. The customer has legal title to the asset.

c. The entity has transferred physical possession of the asset to the customer.

d. The customer has the significant risks and rewards of ownership of the asset.

e. The customer has accepted the asset.

 10. Explain the revenue recognition at a point in
time or over time.

Revenue recognition over time

Revenue is recognized over time when any of the following is satisfied:

a. The customer simultaneously receives and consumes the benefits provided by the entity's performance as the
entity performs. For example, routine or recurring payroll processing services.

b. The entity's performance creates or enhances an asset that the customer controls as the asset is created or
enhanced. For example, constructing an asset on a customer site.

c. The entity's performance does not create an asset with an alternative use to the entity and the entity has an
enforceable right to receive payment for performance completed to date.

For example, constructing a specialized asset that only the customer can use or constructing an asset in accordance
with customer order.
 11. Explain the recognition of a sale with a right of
return.

PFRS 15, paragraph B21, provides that an entity shall recognize the following with respect to a sale
with a right of return:

a. Revenue equal to the total sale price less the sale price of the expected return.

b. Refund liability equal to the sale price of the expected return.

c. A recover asset and the corresponding reduction of cost of goods sold equal to the cost of the
expected return.
 12. Define Consignment.

Consignment is a method of marketing goods in which the entity called the consignor transfers physical possession
of certain goods to a dealer or distributor called the consignee that sells the goods on behalf of the consignor.

The consignor shall not recognize revenue upon delivery of the goods to the consignee until the goods are sold by
the consignee.

The reason is that the product is controlled by the consignor and the consignee does not have an unconditional
obligation to pay for the product.
When consigned goods are sold by the consignee, a report called account sales is given to the consignor together
with a cash remittance for the amount of sales minus commission and other expenses chargeable against the
consignor.
13. Define bill and hold arrangement.

Bill and hold arrangement is a contract under which an entity bills a customer for a product but the
entity retains possession of the product.
For example, a customer may request an entity to enter into such contract because of lack of space for
the product or because of delays in the customer’s production schedule.

Depending on the terms of contract, revenue shall be recognized when the customer obtains control or
takes title of the product even though the product remains in an entity’s physical possession.
 14. What are the criteria for the recognition of
revenue in a bill and hold arrangement?

All of the following criteria must be met for the recognition of revenue in a bill and hold arrangement:

a. The customer has requested for the arrangement.

b. The product must be identified separately as belonging to the customer.

c. The product must be ready for physical transfer to the customer anytime.

d. The entity cannot have the ability to use the product or to direct it to another customer.
15. Explain a customer loyalty program.

Many entities use a customer loyalty program to build brand loyalty, retain their valuable customers
and of course, increase sales volume.

The customer loyalty program is generally designed to reward customers for past purchases and to
provide them with incentives to make further purchases.
Customers may be required to accumulate a specified minimum number of award credits or
“points” before they can be redeemed.
PROBLEMS
Problem 38-1 (AICPA Adapted)
Fenn Company had sales of P 5,000,000 during December. Experience had shown that merchandise equaling
7% of sales will be returned within 30 days and an additional 3% will be returned within 90 days.
Returned merchandise is readily resalable. In addition, merchandise equaling 15% of sales will be exchanged
for merchandise of equal or greater value.

What amount should be reported for net sales in the income statement for the month of December?

a. 4,500,000

b. 4,250,000

c. 3,900,000

d. 3,750,000
Problem 38-1 (Solution)
Fenn Company Reported Net Sales in the income statement for the month of December.

Sales ₱ 5,000,000

Less: Sales Returns- within 30 days( 5,000,000x7%) ₱ 350,000

Sales Returns- within 90 days( 5,000,000x3%) 150,000 ( 500,000)

Net Sales ₱ 4,500,000

Problem 38-3 (IFRS)
On July 1, 2020, Love Company, a manufacturer Of office furniture, supplied goods to Kaye Company for P
1,200,000 on condition that this amount is paid in full on July 1, 2021.
Kaye Company had earlier rejected an alternative offer from Love Company whereby it could have bought
the same goods by paying cash of P 1,080,000 on July 1, 2020.

1. What amount should be recognized as sales revenue on July 1, 2020?

a. 1,080,000

b. 1,200,000

c. 1,140,000

d. 1,000,000
 Problem 38-3 (IFRS)
2.What amount should reported as interest income for 2020?

a. 120,000

b. 100,000

c. 60,000
d. 0

Solution:

Sales ₱ 1,200,000

Less: COGS 1,080,000

Interest Income ₱ 120,000