Financial Accounting 2

ACC203 Financial Accounting 2

Workshop 7 Revenue

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Material adapted from Financial reporting in Australia / Janice Loftus, Ken Leo, Sorin Daniliuc, Noel Boys, Belinda Luke, Hong Ang, Karyn Byrnes. Second edition.

John Wiley & Sons Australia, Ltd

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Learning objectives

1. Describe the scope of AASB 15/IFRS 15 2. Explain the definition of ‘income’ under the conceptual

framework and distinguish it from the definition of ‘revenue’

3. Explain and apply the five steps in recognising revenue 4. Explain and apply the recognition criteria for revenue,

distinguishing between the sale of goods and the rendering of services.

5. Interpret and analyse the revenue recognition issues and disclosures arising in specific industries in practice

Class Discussion

• What are the key distinctions between ‘income’ and ‘revenue’? Why do you think the AASB/IASB made these distinctions?

• What is a multiple-element transaction? Give two examples.

Learning objectives

1. Describe the scope of AASB 15/IFRS 15 2. Explain the definition of ‘income’ under the conceptual

framework and distinguish it from the definition of ‘revenue’

3. Explain and apply the five steps in recognising revenue

4. Explain and apply the recognition criteria for revenue, distinguishing between the sale of goods and the rendering of services

5. Interpret and analyse the revenue recognition issues and disclosures arising in specific industries in practice

AASB 15/IFRS 15 Revenue

Principles Cashflow from contract

Timing

Uncertainty of revenue

Nature

Date Released

• Released in 2014 • Became effective on or after 1 January

2018 • Replaces AASB 118/ IAS 18 and AASB

111/ IAS 11 Construction Contracts and the related interpretations on revenue recognition.

AASB 15/IFRS 15 is applied to all contracts except for: 1. Lease agreements 2. Construction contracts 3. Financial instruments and other contractual rights or obligations 4. Non‐monetary exchanges between entities in the same line of business to

facilitate sales to customers or potential customers.

Class Activity

• What is the ‘asset/liability’ model for the definition and recognition of income under the conceptual framework?

• Does it give a different outcome from other models permitted under AASB 15/IFRS 15?

Learning objectives

1. Describe the scope of AASB 15/IFRS 15 2. Explain the definition of ‘income’ under the conceptual

framework and distinguish it from the definition of ‘revenue’

3. Explain and apply the five steps in recognising revenue

4. Explain and apply the recognition criteria for revenue, distinguishing between the sale of goods and the rendering of services

5. Interpret and analyse the revenue recognition issues and disclosures arising in specific industries in practice

Definition of income

• An increase in an asset or a decrease in a liability will result in income

• Defined in Appendix A of AASB 15/IFRS 15 and paragraph 70(a) of the conceptual framework

Exception: If the increase or decrease arises from equity contribution, then this item cannot be classified as income.

Components of income

What is ordinary activities?

• The term ‘ordinary activities’ is not defined in the conceptual framework or in AASB 15/IFRS 15.

• Common practice however is to interpret ordinary activities as those relating to the core business operations of an entity.

Difference between revenues and gains

• Ordinary activities and gross inflows: – Revenue is a gross concept, whereas gains tend to

be net. – Once an item is classified as revenue, the question of

gross or net can still arise. • Addressed in paragraph B35 of AASB 15/IFRS 15.

Class Activity

• State which of the following meets the definition of ‘revenue’ under AASB 15/IFRS 15 for Toys2U Ltd, a retailer of toys. Give reasons for your answer.

1. Sales tax collected on behalf of the taxing authority 2. Gain on the sale of an investment property 3. Amounts receivable from customers who have

purchased toys 4. Gain on the sale of equity securities held as

investments 5. Revaluation increase on the revaluation of operating

properties under AASB 116/IAS 16

Learning objectives

1. Describe the scope of AASB 15/IFRS 15 2. Explain the definition of ‘income’ under the conceptual

framework and distinguish it from the definition of ‘revenue’

3. Explain and apply the five steps in recognising revenue

4. Explain and apply the recognition criteria for revenue, distinguishing between the sale of goods and the rendering of services

5. Interpret and analyse the revenue recognition issues and disclosures arising in specific industries in practice

The steps in recognising revenue

• AASB 15/IFRS 15 identifies five steps in recognising revenue: – Identify the contract or contracts with the customer. – Identify the performance obligations in the contract. – Determine the transaction price. – Allocate the transaction price to the performance

obligation. – Recognise revenue when (or as) the entity satisfies a

performance obligation.

Step 1: identify the contract or contracts with the customer.

Appendix A of AASB 15/IFRS 15 defines a contract as:

– An agreement between two or more parties that creates enforceable rights and obligations.

What is a contract?

A contract does not exist if each party to the contract has the unilateral enforceable right to terminate a wholly unperformed contract without compensating the other party.

Step 2: identify the performance obligations in the contract.

• When the entity enters into a contract with a customer it should identify the performance obligations.

A promise to the customer to transfer either:

1. a distinct good or service (or distinct bundle of goods or services); or

2. a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

What are performance obligations?

• To classify as a distinct good or service, two criteria have to be met:

1. The customer should benefit from the good or service on its own or alongside other readily available resources.

2. The entity’s promise to transfer the good or service to the customer is separately identifiable in the contract.

Step 2: identify the performance obligations in the contract.

What is a distinct good or service?

In other words, the good or service is required to be unique. If the good or service is not unique, they should be combined together with other goods or services until entity identifies a bundle which becomes unique

Source: Para. 27, IFRS 15

Step 3: determine the transaction price.

The amount of consideration to which the 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. GST].

What is a transaction price?

Source: Appendix A, IFRS 15

Must take into account: variable consideration; deferred consideration and exchanges or swaps.

Step 4: allocate the transaction price to the performance obligation.

• When multiple performance obligations are identified in a contract with a customer, the entity must allocate the transaction price to each performance obligation.

• This is necessary because the revenue might be recognised at different times for the various performance obligations.

Multiple performance obligations

Performance obligation in a contract

The transaction price to be allocated to the performance obligations in the contract is the relative stand‐alone selling prices.

What is a stand alone selling price? A stand alone selling price the price at which an entity would sell a promised good or service separately to a customer.

Source: Para. 74, IFRS 15

Step 4: allocate the transaction price to the performance obligation

Methods for estimating stand-alone prices can include: – adjusted market assessment approach – expected cost plus a margin approach.

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

• Revenue is recognised when control passes to the customer.

The ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.

What does control mean?

Source: Para. 33, IFRS 15

Alternatively, control over the asset (the goods or services provided to the customer) may transfer to the customer over time

Class Activity

State whether each of the following is true or false.

1. Revenue is measured at the fair value of the consideration given by the seller.

2. Revenue is measured at the transaction price that is allocated to that performance obligation.

3. If payment for the goods or services is deferred, the fair value of the consideration will be less than the nominal amount of the cash receivable.

4. A swap or exchange for goods or services of a similar nature and value generates revenue.

5. Collectability of amounts due from customers is a measurement issue, not a recognition issue.

Learning objectives

1. Describe the scope of AASB 15/IFRS 15 2. Explain the definition of ‘income’ under the conceptual

framework and distinguish it from the definition of ‘revenue’

3. Explain and apply the five steps in recognising revenue

4. Explain and apply the recognition criteria for revenue, distinguishing between the sale of goods and the rendering of services

5. Interpret and analyse the revenue recognition issues and disclosures arising in specific industries in practice

The recognition criteria An item that meets the definition of an element should be recognised if: • it is probable that any future economic benefit

associated with the item will flow to or from the entity; and

• the item has a cost or value that can be measured with reliability.

Recognition of income in the income statement occurs simultaneously with the recognition of increases in assets or decreases in liabilities.

Source: Paras. 83-92, Conceptual Framework

Recognition criteria to consider when classifying an element of revenue

Recognition criteria in the income statement

Revenue recognition criteria (Sale of goods)

Revenue recognition in relation to contracts with customers requires an entity to satisfy performance obligations and transfer control of the asset to the customer.

An entity shall recognise not only the revenue for the transferred products in the amount of consideration to which the entity expects to be entitled but also a refund liability and an asset for its rights to recover products from customers on settling the refund liability.

Contracts

Contracts with customers’ right to return and receive refunds

Note that delivery services cannot be recognised in revenue

Source: Paras. 110-128, IFRS/AASB 15

The recognition criteria (Rendering Services)

– The revenue recognition criteria for the rendering of services shall be determined by reference to the performance obligations satisfied over time if the criteria stated in paragraph 35 of AASB 15/IFRS 15 are met.

– An entity shall consider the effects of contractual restrictions and practical limitations in assessing whether an asset has an alternative use to an entity.

Class Activity

• Compare and contrast the revenue recognition criteria for the sale of goods with those for the rendering of services.

Class Activity

Compare and contrast the revenue recognition criteria for the sale of goods with those for the rendering of services.

Class Activity

Exercise 15.5: Measurement – dates for recognition

Soda Ltd sells plastic bottles. Wholesale customers that purchase more than 10 000 bottles per month are entitled to a discount of 6% on their purchases. On 1 March 2019, Customer P ordered 10 crates of bottles from Soda Ltd. Each crate contains 2000 bottles. The normal selling price per crate is $400. Soda Ltd delivered the 10 crates on 15 March 2019. Customer P paid for the goods on 15 April 2019. The end of Soda Ltd’s reporting period is 30 June.

Required Prepare the journal entries to record this transaction by Soda Ltd for the year ended 30 June 2019.

Class Activity

Exercise 15.6: Revenue recognition – sale of goods

In each of the following situations, state at which date, if any, revenue will be recognised.

1. A contract for the sale of goods is entered into on 1 May 2019. The goods are delivered on 15 May 2019. The buyer pays for the goods on 30 May 2019. The contract contains a clause that entitles the buyer to rescind the purchase at any time. This is in addition to normal warranty conditions.

Class Activity

2. A contract for the sale of goods is entered into on 1 May 2019. The goods are delivered on 15 May 2019. The buyer pays for the goods on 30 May 2019. The contract contains a clause that entitles the buyer to return the goods up until 30 June 2019 if the goods do not perform according to their specification.

Class Activity

3. A contract for the sale of goods is entered into on 1 May 2019. The goods are delivered on 15 May 2019. The contract contains a clause that states that the buyer shall pay only for those goods that it sells to a third party for the period ended 31 August 2019. Any goods not sold to a third party by that date will be returned to the seller.

4. Retail goods are sold with normal provisions allowing the customer to return the goods if the goods do not perform satisfactorily. The goods are invoiced on 1 May 2019 and the customer pays cash for them on that date.

Class Activity

Arizona Ltd sells goods to Barbados Ltd. The agreement between the two parties states that Barbados Ltd pays for the goods in advance of delivery which will occur in 12 months’ time. The control of the goods pass to Barbados Ltd at the date of delivery. Barbados Ltd pays $40 000 to Arizona Ltd on 1 July 2019. Arizona Ltd delivers the goods to Barbados Ltd on 1 July 2020.

Required Advise Arizona Ltd on how to appropriately recognise the revenue from this transaction.

Learning objectives

1. Describe the scope of AASB 15/IFRS 15 2. Explain the definition of ‘income’ under the conceptual

framework and distinguish it from the definition of ‘revenue’

3. Explain and apply the five steps in recognising revenue

4. Explain and apply the recognition criteria for revenue, distinguishing between the sale of goods and the rendering of services

5. Interpret and analyse the revenue recognition issues and disclosures arising in specific industries in practice

Revenue recognition issues in various industries and practices

• The principal/agent distinction: – AASB 15/IFRS 15 includes revenue recognition with

regards to transactions involving the principal–agent relationship.

– The key distinction is whether the principal or agent is exposed to the transfer of assets associated with the sale of goods or the rendering of services.

Revenue recognition issues in various industries and practices

• Indicators of whether an entity is acting as an agent or principal in a transaction:

Revenue recognition issues in various industries and practices

• Telecommunications: • Numerous revenue recognition issues arise in the

telecommunications industry, including: – multiple-element arrangements – upfront connection fees – sale of handsets via distributors – fees from third-party content providers.

Revenue recognition issues in various industries and practices

• Retail: • The 2016 annual report of Woolworths Limited serves as

a summary of revenue recognition in the retail industry.

Revenue recognition issues in various industries and practices

• Airline: • Some airlines previously accounted for their frequent

flyer programs by: – providing for the incremental cost of flying the

passenger when the award credits are redeemed – rather than by allocating the consideration between

the components. – Overall, means that the airlines recognised all the

revenue at the time of the sales transaction and at the same time provided for the expected incremental cost.

Class Activity

• Discuss how an entity would determine whether it acts as an agent or principal in sales transactions. In your answer, discuss the distinguishing features between an agency versus principal relationship and the consequences for revenue recognition.

References

Loftus, J. , Ken, L., Sorin D., Boys N., Luke B., Hong A. and Byrnes K., (2018) Financial Reporting, 2nd edn. Australia: John Wiley, pp.604-635

Australian Accounting Standard Board (2018) , AASB 15 Revenue from contracts with customers. [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB15_12- 14_FP_COMPdec16_01-18.pdf (Accessed 2 October 2019)

International Financial Reporting Standard Foundation(2013) , IFRS 15 Revenue from contracts with customers. [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB15_12- 14_COMPsep18_01-19.pdf(Accessed 2 October 2019)

End of the Workshop