(Intermediate Accounting 3)

LECTURE AID

2020

ZEUS VERNON B. MILLAN

Chapter 3 Revenue from Contracts
with Customers
Related standard: PFRS 15 Revenue from Contracts
with Customers
Learning Objectives
• State the five steps in the recognition of revenue.
• Describe how performance obligations are identified
in a contract.
• Describe how the transaction price is determined and
how it is allocated to the performance obligations.
• State the timing of revenue recognition and its
measurement.
• State the presentation of contracts with customers in
the statement of financial position.
INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)
 Income vs. Revenue

The Conceptual Framework provides the following definitions:

• Income – increases in economic benefits during the
accounting period in the form of inflows or enhancements of
assets or decreases of liabilities that result in increases in
equity, other than those relating to contributions from equity
participants. Income encompasses both revenue and gains.
• Revenue – income arising in the course of an entity’s
ordinary activities.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 PFRS 15 supersedes the following standards:
• PAS 18 Revenue;
• PAS 11 Construction Contracts;
• IFRIC 13 Customer Loyalty Programmes;
• IFRIC 15 Agreements for the Construction of Real
Estate;
• IFRIC 18 Transfers of Assets from Customers; and
• SIC-31 Revenue - Barter Transactions Involving
Advertising Services.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Applicability of PFRS 15

PFRS 15 shall be applied to contracts wherein the counterparty

is a customer.
• Contract – An agreement between two or more parties that
creates enforceable rights and obligations. A contract can be
written, oral, or implied by an entity’s customary business
practice.
• Customer – A party that has contracted with an entity to
obtain goods or services that are an output of the entity’s
ordinary activities in exchange for consideration.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Applicability of PFRS 15 (continuation)
PFRS 15 shall not be applied to the following:
• Lease contracts (PAS 17 Leases);
• Insurance contracts (PFRS 4 Insurance Contracts);
• Financial instruments; and
• Non-monetary exchanges between entities in the same line of
business to facilitate sales to customers. For example, PFRS 15
is not applicable to a contract between two oil companies that
agree to exchange oil to fulfil customer demands in different
locations on a timely basis.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Core principle

• An entity recognizes revenue to depict the

transfer of promised 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.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Steps in the recognition of revenue

PFRS 15 requires the following steps in recognizing revenue:

• Step 1: Identify the contract with the customer
• Step 2: Identify the performance obligations in the contract
• Step 3: Determine the transaction price
• Step 4: Allocate the transaction price to the performance
obligations in the contract
• Step 5: Recognize revenue when (or as) the entity satisfies a
performance obligation
 

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Step 1: Identify the contract with the customer

Requirements before a contract with a customer is accounted for under

PFRS 15:
a. The contract must be approved and the contracting parties are
committed to it;
b. rights and payment terms are identifiable;
c. The contract has commercial substance; and
d. The consideration is probable of collection.

No revenue is recognized if the contract does not meet the criteria

above. Any consideration received is recognized as liability.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Step 2: Identify the performance obligations in the contract

Each promise in a contract to transfer a distinct

good or service is treated as a separate
performance obligation.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Identifying distinct goods or services
A good or service is distinct if:
(a) the customer can benefit from it, either on its own or together
with other resources that are readily available to the customer
(e.g., the good or service is regularly sold separately); and
(b) the good or service is separately identifiable (i.e., not an input
to a combined output, does not significantly modify the other
promises, or not highly interrelated with the other promises).

A good or service that is not distinct shall be combined with the other
promises in the contract. Combined promises are treated as a single
performance obligation.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Step 3: Determine the transaction price

• The entity shall determine the transaction price because this is

the amount at which revenue will be measured.

• Transaction price is “the amount of consideration to which an

entity expects to be entitled in exchange for transferring promised
goods or services to a customer, excluding amounts collected on
behalf of third parties (e.g., some sales taxes).” The consideration
may include fixed amounts, variable amounts, or both.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Step 4: Allocate the transaction price to the performance obligations

• The transaction price shall be allocated to each performance

obligation identified in a contract based on the relative stand-
alone prices of the distinct goods or services promised to be
transferred.
 
• The stand-alone selling price is the price at which a promised good
or service can be sold separately to a customer.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Estimating the stand-alone selling price
If the stand-alone selling price is not directly observable, the entity shall
estimate it using one or a combination of the following methods:
 

• Adjusted market assessment approach – the entity evaluates the

market in which it sells goods or services and estimates the price that a
customer in that market would be willing to pay for those goods or services.
• Expected cost plus a margin approach – the entity forecasts its
expected costs of satisfying a performance obligation and then add an
appropriate margin for that good or service.
• Residual approach – the entity estimates the stand-alone selling price as
the total transaction price less the sum of the observable stand-alone
selling prices of other goods or services promised in the contract.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Step 5: Recognize revenue when (or as) the entity satisfies a
performance obligation

• A performance obligation is satisfied when the control over

a promised good or service is transferred to the customer.
• Revenue is measured at the amount of the transaction
price allocated to the satisfied performance obligation.

• Performance obligations are classified into the following:

1. Performance obligation that is satisfied over time
2. Performance obligation that is satisfied at a point in time

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Performance obligations satisfied over time
For a performance obligation that is satisfied over time, revenue is recognized
over time AS the entity progresses towards the complete satisfaction of the
obligation .

A performance obligation is satisfied over time if one of the following criteria is

met:
a.The customer simultaneously receives and consumes the benefits provided by
the entity’s performance as the entity performs.
b.The entity’s performance creates or enhances an asset that the customer
controls as the asset is created or enhanced.
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 payment for performance
completed to date.
INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)
 Measuring progress towards complete satisfaction of a performance
obligation

• For each performance obligation satisfied over time, an entity shall

recognize revenue over time by measuring the progress towards
complete satisfaction of that performance obligation.
• Examples of acceptable measurement methods:
1. Output methods (e.g., surveys of work performed)
2. Input methods (e.g., relationship between costs incurred to date
and total expected costs)

If efforts or inputs are expended evenly throughout the performance

period, revenue may be recognized on a straight-line basis.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Cost-recovery Approach

• If the outcome of a performance obligation cannot be reasonably

measured, revenue shall be recognized only to the extent of
costs incurred that are expected to be recovered.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Performance obligations satisfied at a point
in time
• A performance obligation that is not satisfied over time is
presumed to be satisfied at a point in time.
• For a performance obligation that is satisfied at a point
in time, revenue is recognized WHEN the performance
obligation is satisfied.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Contract costs

Contract costs include the following:

(a) Incremental costs of obtaining a contract – recognized as asset if
they are recoverable and avoidable. As a practical expedient, the
costs are recognized as expense if their expected amortization
period is 1 year or less.
(b) Costs to fulfill a contract –if within the scope of PFRS 15, they are
recognized as asset if they are: (a) directly related to a contract, (b)
generate or enhance resources, and (c) recoverable.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 Presentation
A contract where either party has performed is presented in the statement
of financial position as a contract liability, contract asset or receivable.
• Contract liability – is an entity’s obligation to transfer goods or
services to a customer for which the entity has received consideration (or
the amount is due) from the customer.
• Contract asset – is an entity’s right to consideration in exchange for
goods or services that the entity has transferred to a customer when that
right is conditioned on something other than the passage of time.
• Receivable – is an entity’s right to consideration that is unconditional.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 ADDITIONAL CONCEPTS
Concepts related to Step 2 (Identifying the performance obligations)
• A warranty that provides the customer service in addition to assurance that the
product complies with agreed-upon specifications is a performance obligation. A
warranty required by law is not a performance obligation.

• An option granted to a customer to acquire additional goods or services is a

performance obligation if it gives the customer a material right.

• Non-refundable upfront fee is a performance obligation only if it relates to the

transfer of goods or services. It is not a performance obligation if it relates to
administrative tasks to set up a contract. In the latter case, the non-refundable upfront
fee is treated as a prepayment and recognized as revenue only when the related goods
or services are transferred to the customer.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 ADDITIONAL CONCEPTS
Concepts related to Step 3 (Determining the transaction
price)
• Discounts are allocated to all of the performance obligations,
unless it is clear that the discount relates only to some, but not all, of
those obligations.
• In a sale with right of return, the entity does not recognize
revenue from goods that are expected to be returned. An asset (and
corresponding adjustment to cost of sales) is recognized for the
entity’s right to recover products from the customer on settling the
refund liability.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

ADDITIONAL CONCEPTS
Concepts related to Step 3 (Determining the transaction
price) - continuation
• If the timing of agreed payments provides the customer or the entity
with a significant benefit of financing, the revenue recognized
shall reflect the cash selling price of the goods or services. As a
practical expedient, the effect of time value of money may be
disregarded if the consideration is expected to be collected within 1
year from the date of transfer of the goods or services.

INTERMEDIATE ACCTG 3 (by: Zeus

Vernon B. Millan)
 ADDITIONAL CONCEPTS
Concepts related to Step 3 (Determining the transaction
price) - continuation

• A non-cash consideration is measured at:

a. fair value; or
b. if fair value is not available, at the selling price of
the good or service promised to be transferred to the
customer.

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 APPLICATION OF CONCEPTS
 

PROBLEM 2: FOR CLASSROOM DISCUSSION

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 OPEN FORUM
QUESTIONS????
REACTIONS!!!!!

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)

 END

INTERMEDIATE ACCTG 3 (by: Zeus Vernon B. Millan)