AC3202 Financial Reporting

HKFRS 15 Revenue from

Contracts with Customers
Wiley text: Chapter 18

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 Intended Learning Outcomes

LO1: Understand revenue recognition issues.

LO2: Identify the five steps in the revenue recognition process.
LO3: Identify the contract with customers.
LO4: Identify the separate performance obligations in the contract.
LO5: Determine the transaction price.
LO6: Allocation of transaction price to separate performance
obligations.
LO7: Recognize revenue when the company satisfies its performance
obligation.
LO8: Identify other revenue recognition issues.
LO9: Describe presentation and disclosure regarding revenue.

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 Contents
1. Introduction
2. Definition
3. Scope of HKFRS 15
4. Five-step process for revenue recognition
5. Measurement of revenue
6. Presentation
7. Disclosure
8. Accounting for revenue recognition issues

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1. Introduction

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 1. Introduction

What is income ？
Income is increases in economic benefits during the accounting period in the form
of :
 Inflows or enhancements of assets

(e.g. Dr. Cash Cr. Revenue)

or
 Decreases of liabilities

(e.g. Dr. Unearned Revenue Cr. Revenue)

that result in increases in equity, other than those relating to contributions from
equity participants (i.e., share issuance).

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What is income?

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 1. Introduction

 The primary issue in accounting for revenue is to determine the timing of

revenue recognition.

 Revenue is recognized when it is:

(1) probable that future economic benefits will flow to the entity, and
(2) these benefits can be measured reliably.

 Hong Kong Financial Reporting Standard 15 Revenue from Contracts with

Customers (HKFRS 15) establishes principles for reporting useful information to
users of financial statements about the nature, amount, timing and uncertainty of
revenue and cash flows arising from an entity’s contracts with customers.

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 New Revenue Recognition Standard
(Adopt from Wiley ILLUSTRATION 18-1)

Key Concepts of Revenue Recognition

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2. The Five-Step Process

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 The Five-Step Process

Example 1: Overview of the five-step process

Company B sells 10 baking machines to Mary, a bakery shop owner, on 1

July 2017. The sales price for each machine is $2,000. The contract requires
Company B to deliver baking machines to Mary on 31 July 2017 and Mary has
to settle the payment on the same date.

Required:
Should Company B recognize revenue on this transaction? When and how
much revenue should be recognized?

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 The Five-Step Process

Step 1: Identify the B has signed a contract to deliver baking machines to

contract with Mary.
customers.

Step 2: Identify the

separate performance B has only one performance obligation which is to
obligations in the deliver baking machines to Mary.
contract.

The transaction price is the amount of consideration

Step 3: Determine the that an entity expects to receive from a customer in
transaction exchange for transferring a good or service.
price. The transaction price in this contract is $2,000 x 10 =
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$20,000. LO 2
 The Five-Step Process

Step 4: Allocate the

transaction price to the In this case, B has only one performance obligation – to
separate performance deliver 10 baking machines to Mary. The amount for this
obligations. performance obligation is $20,000.

Step 5: Recognize revenue B should recognize revenue of $20,000 for the sale of baking
machines to Mary when it satisfies its performance obligation,
when each performance
i.e., the delivery of baking machines to Mary.
obligation is satisfied.
When B satisfies its performance obligation by delivering baking
machines to Mary, a change of control from B to Mary occurs.

Mary now controls the assets because it has the ability to direct
the use of and obtain substantially all the remaining benefits from
the baking machines.
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 2.1 Step 1: Identify the contracts

Contracts: An agreement between two or more parties that creates enforceable

rights and obligations.

An entity shall account for a contract with a customer that is within the scope of
this Standard only when all of the following criteria are met:
(a) the parties to the contract have approved the contract (in writing, orally or in
accordance with other customary business practices) and are committed to
perform their respective obligations;

(b) the entity can identify each party’s rights regarding the goods or services to
be transferred;

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 2.1 Step 1: Identify the contracts

An entity shall account for a contract with a customer that is within the scope of
this Standard only when all of the following criteria are met:
(c) the entity can identify the payment terms for the goods or services to be
transferred;

(d) the contract has commercial substance (i.e. the risk, timing or amount of the
entity’s future cash flows is expected to change as a result of the contract); and

(e) it is probable that the entity will collect the consideration to which it will be
entitled in exchange for the goods or services that will be transferred to the
customer.
 E.g., the entity need to consider the customer’s ability and intention to pay
the specified amount of consideration when it is due.

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 2.1.1 Step 1: Identify the contracts
– Identification of the transaction
 If a single transaction has separately identifiable components, revenue
is recognized based on each component to reflect the substance of the
transaction.

Example:
 the selling price of a product includes an identifiable amount for
subsequent servicing
 Recognize revenue for 1/the sale of the product and 2/subsequent service
separately.

 award points/credits in customer loyalty programs considered as

separately identifiable components of sales transaction.

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 2.1.1 Step 1: Identify the contracts
Identification of the transaction

Example 2:
Mary’s bakery shop sells coffee, cake and cookies to
customers. Jack, the customer, ordered a cup of coffee
costing $10 and also purchases one cake at a price of $30.
Mary gives the coffee and cake to Jack and receives $40
from Jack.

Required:
Should Mary recognize this transaction and how much
revenue should be recognized?

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 2.1.1 Step 1: Identify the contracts
Identification of the transaction

Determine a valid contract exists:

a. The parties to the contract have approved the contract and are
committed to perform their respective obligations: Mary gives
coffee and cake to Jack and Jack paid for the service for Mary.

b. Identify the performance obligations: Mary’s performance

obligations are to provide coffee and cake to Jack.

c. Determine the transaction prices related to the sale of coffee

and cake. The total price for this transaction is $40.

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 2.1.1 Step 1: Identify the contracts
Identification of the transaction

 d. Identify the payment terms: Mary has two performance obligations: a

cup of coffee and a cake. Each of these performance obligations is distinct
and not interrelated. $10 is the price for providing coffee, and $30 is the
price for providing cake.
 e. The contract has commercial substance and it is probable that the entity
will collect the consideration to which it will be entitled in exchange for
the goods or services that will be transferred to the customer. In this case,
Jack paid cash to Mary for the purchase of coffee and cake.
  f. Revenue is recognized when the coffer and cake are given to Jack.
Mary should recognize $40 of revenue when Jack receives the coffee and
cake.

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 2.1.3 Step 1: Identify the contracts
Combination of contracts

 An entity shall combine two or more contracts entered into at or near the
same time with the same customer and account for the contracts as a single
contract if one or more of the following criteria are met:
a. the contracts are negotiated as a package with single commercial objective; or

b. the amount of consideration to be paid in one contract depends on the price

or performance of the other contract; or

c. the good or services promised in the contracts are a single performance

obligation in accordance with HKFRS 15.22-30

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 2.1.2 Step 1: Identify the contracts
Contracts Modifications

 An entity shall account for a contract modification as a separate contract

if both of the following conditions are present:

a. The modified contract involves distinct goods or services, and

 i.e.,
company sells them separately and they are not interdependent
with other goods and services / contracts.

b. In the modified contract, the company has the right to receive an

amount of consideration that reflects the standalone selling price of the
promised goods or services (i.e., if the goods/services can be sold
separately and have a standalone price)

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 2.1.4 Step 1: Identify the contracts
Contracts Modifications

 Change in contract terms while it is ongoing.

 Companies determine
► whether the change will result in an entirely new contract
(and performance obligations) or
► whether it is just a modification to the existing contract.

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 Step 1: Identify the contracts
Contracts Modifications

Example 5: (extract from HKFRS 15, example 7 )

An entity enters into a three-year contract to clean a customer’s offices on a weekly basis. The
customer promises to pay $100,000 per year. The stand-alone selling price of the services at
contract inception is $100,000 per year. The entity recognizes revenue of $100,000 per year
during the first two years of providing services.

At the end of the second year, the contract is modified and the fee for the third year is reduced
to $80,000. In addition, the customer agrees to extend the contract for three additional years
for consideration of $200,000 payable in three equal annual instalments of $66,667 at the
beginning of years 4, 5 and 6. The stand-alone selling price of the services at the beginning of
the third year is $80,000 per year.

Required:
How much revenue should be recognized in year 3-6?
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 2.1.4 Step 1: Identify the contracts
Contracts Modifications
Example 5: (extract from HKFRS 15, example 7 )

Transaction price (for a contract with a The amount of consideration to which an

customer) entity expects to be entitled in exchange for
transferring promised goods or services to a
customer, excluding amounts to be
collected on behalf of third parties.

- Yr1-2: $100,000 per year

- Yr3: $80,000
- Yr4-6: $200,000

Stand-alone price (of a good/service) The price at which an entity would sell a
promised good/service separately to a
customer.

- Yr1-2: $100,000 per year

- Yr3-6: $80,000 per year
2.1.4 Step 1: Identify the contracts
Contracts Modifications
 To determine whether the modification results in a separate new contract:

 Modified contract involves distinct goods/service?

 Yes – Each week’s cleaning service is distinct (i.e., one week’s service does not

depend on the service provided in other weeks)

 The amount of consideration specified in modified contract reflects the standalone

selling price of the promised goods/service?
 Yes – There exists a standalone selling price for the weekly cleaning service

($80,000/yr * 4 years = $320,000), and the transaction price ($80,000 + $200,000

= $280,000) reflects this standalone selling price with a discount.

=> The entity will account for the modification as a termination of the original contract
and the creation of a new contract, with total consideration of $280,000 for 4 years.
 2.1.4 Step 1: Identify the contracts
Contracts Modifications

 How much revenue to recognize each year under the new contract:

 The amount of revenue recognized is based on the amount of service provided.

 Each year, the amount of service to be provided is the same (weekly cleaning for
the whole year).
 Thus, the amount of revenue to be recognized each year should be the same,
irrespective of the actual cash payment.
 Each year, the company will recognize $280,000/4 years = $70,000 service
revenue.
 The difference between revenue and actual cash receipt will be recorded as
unearned revenue or accounts receivable.
2.2 Step 2: Identify performance obligations

Performance obligation:
 A promise in a contract with a customer to transfer to
the customer either:
 (a) a good/service (or a bundle of goods/services) that
is distinct; or
 (b) a series of distinct goods/services that are
substantially the same and that have the same pattern
of transfer to the customer (e.g., weekly cleaning
service in Example 5)

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 2.2 Step 2: Identify performance obligations

Performance obligation:
A good or service is distinct if

 The consumption of the goods/services does not depend on other

goods/service to be provided:
 The customer can benefit from the good or service on its own or together
with other resources that are readily available to the customer and
 The provision of the goods/services does not depend on other goods/service to
be provided:
 The entity’s promise to transfer the good or service to the customer is
separately identifiable from other promises in the contract. (HKFRS 15.27)

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 2.2 Step 2: Identify performance obligations
 Whether the product is distinct within the contract.
► If performance obligation is not highly dependent on, or
interrelated with, other promises in the contract, then each
performance obligation should be accounted for separately.

Examples:
► the selling price of a product includes an identifiable
amount for subsequent servicing.
► award points/credits in customer loyalty programs
considered as separately identifiable components of sales
transaction.

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2.2 Step 2: Identify performance obligations

 Whether the product is distinct within the contract.

► If each of these services is interdependent and interrelated, these
services are combined and reported as one performance
obligation.

Example:
► An entity may sell goods, and include a warranty to make good
on any defect in its products for one year (often referred to as an
assurance warranty). The sale of the goods and related assurance
warranty are one performance obligation as they are
interdependent and interrelated with each other.

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 2.2 Step 2: Identify performance obligations

Example 7: Warranties service from sales of products

 
G Ltd. sells product at a price of $200,000, with a one-year warranty guarantee that
the product was free of defects. The cost of the product is 150,000 and the estimated
cost to provide the one-year warranty service is $2,000, based on G Ltd. past practice
on the warranty service. In addition, G Ltd. sold extended warranties related to the
products for 3 years beyond the one-year period for $3,000.
 
Required:
How should the above transactions be recognized?

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 2.2 Step 2: Identify performance obligations

• One-year warranty with the sale of product is an assurance-type warranty. The

sale of product and the assurance warranty are interdependent of and interrelated
with each other. Hence, they should be identified as one performance
obligation.
 
• The extended warranty is one kind of service-type warranty. It represents a
separate service and is an additional performance obligation. The service-type
warranty is sold separately and therefore has a stand-alone price. The objective
of the entity is to sell an additional service to customers. Therefore, G Ltd.
should treat the extended warranty as a separate performance obligation (sale
of service-type warranty).
 2.2 Step 2: Identify performance obligations

On the date of sales the product, the following entries should be recorded:
 
Dr. Cash ($200,000 +$3,000) 203,000
Cr. Sale revenue 200,000
Cr. Unearned warranty revenue 3,000
*Separately account for revenue from different performance obligations.
 
Dr. COGS 150,000
Cr. Inventory
150,000 

c. For the one-year assurance-type warranty, G Ltd. should estimate the amount
and record as warranty liability at the end of reporting period.
Dr. Warranty expense 2,000
Cr. Warranty liability 2,000
 2.3 Step 3: Determine the transaction price

 The 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.

 When determining the transaction price, an entity shall consider the effects of
all of the following:
 Variable consideration

 Constraining estimates of variable consideration

 The existence of a significant financing component in the contract

 Non-cash consideration

 Consideration payable to a customer (HKFRS15-48)

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 2.3.1Determining Transaction Price—Step 3

Variable Consideration
If the consideration promised in the contract includes a variable amount:
 Variable amount: the transaction price depends on some future events,
such as discounts, rebates, refunds, credits, price concessions,
incentives, performance bonuses, royalties, penalties or other similar
items.
Companies estimate the amount of revenue to be recognized using one of the
two following ways.
► Expected value
► Most likely amount

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 2.3.1 Determining Transaction Price ： Step 3

Variable Consideration
Companies estimate amount of revenue to recognize.
► Expected value
► The expected value is the sum of probability-weighted
average amounts in a range of possible consideration
amounts.

► An expected value may be an appropriate estimate of the

amount of variable consideration if the entity has a large
number of contracts with similar characteristics.

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 2.3.1Determining Transaction Price—Step 3

Variable Consideration
Companies estimate amount of revenue to recognize.
► Most likely amount
► The most likely amount is the single most likely amount
in a range of possible consideration amounts (i.e., the
single most likely outcome of the contract).

► The most likely amount may be an appropriate estimate of

the amount of variable consideration if the contract has
only two possible outcomes (e.g., an entity either achieves
a performance bonus or not.)

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 Constraining estimates of variable consideration

 An entity shall include in the transaction price some or all of an amount of

variable consideration estimated only to the extent that the amount of
revenue recognized is unlikely to change when the uncertainty associated
with the variable consideration is subsequently resolved.

 Example: Company A sold a piece of equipment to customer. The list price

of the equipment is $1mil, but the customer can get a discount of 10% if it
can pay the consideration in cash within 2 weeks from sales date.
 Two outcomes: $1mil, or $0.9mil payment from customer.

 The company will recognize $0.9mil as revenue, if it is unlikely that the

customer will NOT be able to pay cash within 2 weeks.
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 Variable Consideration

 Companies only recognize variable consideration as revenue if it is

reasonably assured that it will be entitled to the amount.
 Companies only recognize variable consideration if
1. they have experience with similar contracts and are able to
estimate the cumulative amount of revenue (fixed + variable
consideration), and

2. based on experience, they do not expect a significant reversal of

revenue previously recognized.

If these criteria are not met, revenue recognition is constrained.

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 2.3.1 The existence of a significant financing
component in the contract

 In determining the transaction price, an entity shall adjust the

promised amount of consideration for the effects of the time value of
money if the timing of payments agreed to by the parties to the
contract (either explicitly or implicitly) provides the customer or the
entity with a significant benefit of financing the transfer of goods or
services to the customer.

 As a practical expedient, an entity is not required to reflect the time

value of money to determine the transaction price if the time period
for payment is less than a year.

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 2.3.2 Determining Transaction Price ： Step 3

Time Value of Money

When contract (sales transaction) involves a significant financing
component either explicitly stated in contract or implied by the payment
terms agreed to by the parties to the contract:
► Interest accrued on consideration to be paid over time.
► Fair value determined either by measuring the consideration
received or by discounting the payment using an imputed interest
rate.
► Company reports as interest expense or interest revenue.
► Example: Finance Lease
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 Example 6

 An entity sells a product to a customer for $121 that is payable 24 months after delivery.
The customer obtains control of the product at contract inception. The contract permits
the customer to return the product within 90 days. The product is new and the entity has
no relevant historical evidence of product returns or other available market evidence.

 The cash selling price of the product is $100, which represents the amount that the
customer would pay upon delivery for the same product sold under otherwise identical
terms and conditions as at contract inception. The entity’s cost of the product is $80.

Required:
When should the entity recognize revenue from the sales of product and how much of the
amount from selling of the product should be recognized?

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 Example 6 (adopt from HKFRS 15, example 26)

 The entity does not recognize revenue when control of the product
transfers to the customer at the contract inception date. This is because
the existence of the right of return and the lack of relevant historical
evidence means that the entity cannot conclude that it is highly
probable that a significant reversal in the amount of cumulative
revenue recognized will not occur. Consequently, revenue is
recognized after three months when the right of return lapses.

Dr. Accounts receivable 100

Cr. Sales revenue 100

Dr. Cost of goods sold 80

Cr. Inventory 80
 Example 6 (adopt from HKFRS 15, example 26)

 The contract includes a significant financing component. This is evident from the
difference between the amount of promised consideration of $121 and the cash
selling price of $100 at the date that the goods are transferred to the customer.

 The contract includes an implicit interest rate of 10% (i.e. the interest rate that over
24 months discounts the promised consideration of $121 to the cash selling price of
$100). The entity evaluates the rate and concludes that it is commensurate with the
rate that would be reflected in a separate financing transaction between the entity and
its customer at contract inception.
 Example 6 (adopt from HKFRS 15, example 26)

 Interest revenue will be recognized at each fiscal year-end over the 24

months period.

31/12/y1
Dr. Interest receivable ($100*10%) 10
Cr. Interest revenue 10

31/12/y2
Dr. Cash 121
Cr. Accounts receivable 100
Cr. Interest receivable 10
Cr. Interest revenue (10%*($100+$10)) 11
 Example 6 (adopt from HKFRS 15, example 26)

 Sometimes the seller company will call the payment period (e.g.,
24 months in Example 6) an “interest-free” period.

 E.g., Question 3-Assignment: “Company B sells furniture and

offers an interest-free period of 24 months to certain qualifying
customers.”
 “Interest-free period” does not mean there’s no interest – just a
marketing gimmick.
 2.3.3 Non-cash transactions

 To determine the transaction price for contracts in which a customer promises consideration
in a form other than cash, an entity shall measure the non-cash consideration (or promise of
non-cash consideration) at fair value.

For example: receive shares from customer as part of the consideration from sales of goods or
providing services to customers -> use FV of shares.

 If an entity cannot reasonably estimate the fair value of the non-cash consideration, the entity
shall measure the consideration indirectly by reference to the stand-alone selling price of the
goods or services promised to the customer (or class of customer) in exchange for the
consideration.
Selling price (by company) = Consideration paid (by customer)
= Cash consideration + Non-cash consideration
Non-cash consideration = Selling price – Cash consideration, if any

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Example: PP&E, Non-monetary exchange
2.3.4 Consideration Paid or Payable to Customers

Consideration Paid or Payable to Customers

Includes cash amounts that an entity pays, or expects to pay, to the
customer (or to other parties that purchase the entity’s goods or services
from the customer).
May also include discounts, volume rebates, coupons, free products, or
services.
In general, these elements reduce the consideration received/transaction
price and the revenue to be recognized.

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 2.4 Step 4 - Allocating Transaction Price to
Separate Performance Obligations

 An entity typically allocates the transaction price to each performance

obligation on the basis of the relative stand-alone prices of each
distinct good or service promised in the contract.

 If the stand-alone prices information is not available, entity should use

its best estimate of what the good or service might sell for as a stand-
alone unit.

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 2.4 Step 4 - Allocating Transaction Price to Separate
Performance Obligations

Example 3:

Mary wants to provide incentive to improve the sales of coffee, cookies and cakes.
Mary offers to the customers a $5 discount on purchase of cookie together with
coffee. The sales price for one cookie is $15 and coffee is $10 if purchase alone.

Required:

How much revenue should be allocated to coffee and cookie from the above
transaction?

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2.4 Step 4 - Allocating Transaction Price to
Separate Performance Obligations
Example 3:
The transaction price is $20 for purchase coffee and cookie at the same
time. Mary should allocate the revenue $20 to two performance
obligations, sales of coffee and cookie, based on their relative stand-alone
selling prices.
Product Stand-alone % of Transaction Allocated
sales price allocating price (total) amount
($) sales price ($)
Coffee 10 40% 20 8
Cookie 15 60% 20 12
  25   20 20

Mary should recognize $20 of total revenue from the sale of the coffee ($8)
and cookie ($12).
 Example 4
W Ltd. is an established manufacturer of paper cutting machines. The unit selling price is
quoted inclusive of installation and training. The installation process does not involve changes
to the features of the cutting machine.
 
X Ltd. purchased 4 cutting machines from W Ltd. for a price of $1,000,000 including free
installation and training services. The installation service included in the arrangement is
estimated to have stand-alone selling price of $50,000. W Ltd. estimates the stand-alone
selling price of training sessions is $100,000. Both installation and training can be performed
by other companies.
 
X Ltd. is obligated to pay W Ltd. the $1,000,000 on the delivery and installation of the cutting
machines. W Ltd. delivered the cutting machine on 1 June 2017 and finished the installation
process on 1 July 2017 (transfer of control is complete). Training sessions start when the
installation of the cutting machine is completed and last for one year.
 
Required:
a. Identify the performance obligations in this transaction
b. Allocate the transaction price to various components if there is more than one 51
performance obligation.
Example 4

a. Identify the performance obligations in this transaction

•W Ltd. primary objective is to sell cutting machines. Although the quoted price
of the machine includes installation and training, the customer does not have
to purchase installation and training services from W Ltd.
• Thus, the cutting machine is distinct from installation and training
services.

•The installation and training services can be performed separately from

selling the cutting machines.
• Thus, the installation and training services are two distinct services.

•As a result, the cutting machine, installation service and training sessions are
three separate products or services (each has a stand-alone selling price and
is not interdependent).
Example 4

b. Allocate the transaction price to various components if there is more

than one performance obligation.

Product Stand-alone % of Transaction Allocated

sales price ($) allocating price (total) amount
sales price ($)

Cutting 1,000,000 86% 1,000,000 860,000

Machine
Installation 50,000 4% 1,000,000 40,000
Training 100,000 10% 1,000,000 100,000
  1,150,000     1,000,000
Example 4

W Ltd. makes the following entries to recognize the transaction

from selling cutting machine:
 
On 1 June 2017, delivery of the cutting machine:
 
The entity does not recognize revenue when control of the cutting
machine is not transferred to X Ltd. No entry should be recorded.
 
Example 4

On 1 July 2017, the installation of cutting machine is completed, the control

of cutting machine transfers from W to X. Assuming the cost for cutting
machine is $750,000, the following entries should be provided:
 
Dr. Cash 1,000,000
Cr. Sales revenue – cutting machine
860,000
Cr. Service revenue – installation 40,000
Cr. Unearned service revenue – training 100,000
 
Dr. Cost of goods sold 750,000
Cr. Inventory 750,000
Example 4

On 31 December 2017 (the reporting date):

 
The journal entry to recognize the training revenue for 6 months
in 2017 is as follow:
 
Dr. Unearned service revenue – training 50,000
Cr. Service revenue – training
50,000
2.5 Step 5
Recognize revenue when (or as) the entity satisfies a
performance obligation

 An entity recognizes revenue when (or as) it satisfies a

performance obligation by transferring a promised good or service
to a customer
which is when the customer obtains control of that good or
service.
The amount of revenue recognized is the amount allocated to
the satisfied performance obligation.

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

 Company satisfies its performance obligation when the customer obtains

control of the good or service.
 Indicators of control transfer:
 Company has a right to payment for asset.
 Company has transferred legal title to asset.
 Company has transferred physical possession of asset.
 Customer has significant risks and rewards of ownership.
 Customer has accepted the asset.

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

 A performance obligation may be satisfied at a point in time (typically for

promises to transfer goods to a customer) or over time (typically for
promises to transfer services to a customer).

 For performance obligations satisfied over time, an entity recognizes

revenue over time by selecting an appropriate method for measuring the
entity’s progress towards complete satisfaction of that performance
obligation (e.g., straight-line basis if service provided at a constant rate).

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Best Wishes for you!

Thanks!

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