1 Revenue recognition: a five step process

Step 1: Identify the contract with the customer A contract with a customer will be within the scope of IFRS 15 if all the following conditions are met: [IFRS 15:9] the contract has been approved by the parties to the contract; each party’s rights in relation to the goods or services to be transferred can be identified; the payment terms for the goods or services to be transferred can be identified; the contract has commercial substance; it is probable that the consideration to which the entity is entitled to in exchange for the goods or services will be collected.

Step 2: Identify the performance obligations in the contract At the inception of the contract, the entity should assess the goods or services that have been promised to the customer, and identify as a performance obligation: a good or service (or bundle of goods or services) that is distinct; or a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

Factors for consideration as to whether a promise to transfer the good or service to the customer is separately identifiable include, but are not limited to: the entity does not provide a significant service of integrating the good or service with other goods or services promised in the contract. the good or service does not significantly modify or customize another good or service promised in the contract. the good or service is not highly interrelated with or highly dependent on other goods or services promised in the contract.

Step 3: Determine the transaction price The transaction price is the amount of consideration than 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 (IFRS 15 Appendix A).

When determining the transaction price, an entity shall consider the effects of all of the following : Variable consideration – are there some bonuses or discounts, for example, performance bonus? Constraining estimates in variable consideration – you should include variable consideration (e.g. bonus) in the transaction price only when it’s highly probable that you can keep it (this is a big simplification);

Significant financing component – if your clients will pay you with delay, do the payments reflect the time value of money? (P250 Understanding 1) Non-cash consideration – do you receive some non-cash items from your customer in return for your goods or services? Consideration payable to a customer – do you provide some vouchers or coupons to your customers? And other factors. (P250---251 Illustration)

Step4 : Consideration payable to a customer Where a contract has multiple performance obligations, an entity will allocate the transaction price to the performance obligations in the contract by reference to their relative standalone selling prices. If a standalone selling price is not directly observable, the entity will need to estimate it. A stand-alone selling price is a price at which an entity would sell a promised good or a service separately to the customer (not in the bundle). (P252 Understanding 2)

Step5 : Recognizes revenue A performance obligation is satisfied (and revenue is recognized) when a promised good or service is transferred to a customer. This happens when control is passed. A performance obligation can be satisfied either: Over time – in this case, control is passed to the customer over some period of time (e.g. contract term); or At the point of time – in this case, control is retained by the supplier until it is transferred at some moment.

Satisfying a performance obligation at the point of time Revenue will therefore be recognized when control is passed at a certain point in time. Factors that may indicate the point in time at which control passes include, but are not limited to: the entity has a present right to payment for the asset; the customer has legal title to the asset; the entity has transferred physical possession of the asset; the customer has the significant risks and rewards related to the ownership of the asset; and the customer has accepted the asset.

Substance over form The principle that transactions and other events are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. Common features of transactions whose substance is not readily apparent ( P256 Determining the substance of transaction)

Consignment inventory dealer manufacturer delivery hold sale 1 MAY 20X9

To identify the correct treatment, it is necessary to identify: Who bears the risk of the inventory? Who has the benefits or rewards of the inventory?

Indications of assets status Indications that the inventory is not an asset of the dealer at delivery Indications that the inventory is an asset of the dealer at delivery

Indications that the inventory is not an asset of the dealer at delivery: Manufacturer can require dealer to return transfer inventory without compensation. Penalty paid by the dealer to prevent returns or transfers of inventory at the manufacturer’s request. Dealer has unfettered right to return inventory to the manufacturer without penalty and actually exercises the right in practice.

Manufacture bears obsolescence risk. Manufacturer bears slow movement risk. Inventory transfer price charged by manufacturer is based on manufacture’s list price at date of transfer of legal title.

Indications that the inventory is an asset of the dealer at delivery: Manufacturer cannot require dealer to return or transfer inventory. Financial incentives given to persuade dealer to transfer inventory at manufacturer’s request. Dealer has no right to return inventory or is commercially compelled not to exercise its right of return.

Dealer bears obsolescence risk. Dealer bears slow movement risk. Inventory transfer price charged by manufacturer is based on manufacture’s list price at date of transfer of delivery.

Required accounting The inventory is in substance an asset of the dealer at delivery The inventory should be recognized as such in the dealer’s statement of financial position, together with a corresponding liability to the manufacturer. Any deposit should be deducted from the liability and the excess classified as a trade payable.

The inventory is not in substance an assets of the dealer at delivery The inventory should not be include in the dealer’s statement of financial position until the transfer of risk and rewards has crystallized. Any deposit should be included under other receivables.

Past exam papers： Dec 2006 ANGELINO(b) Angelino has entered into the following transactions during the year ended 30 September 20X6: Required: Describe how the above transactions and events should be treated in the financial statements of Angelino for the year ended 30 September 20X6. Your answer should explain, where relevant, the difference between the legal form of the transactions and their substance.(16marks)

Dec 2006 ANGELINO(b/iii-question) Angelino is a motor car dealers selling vehicles to the public. Most of its new vehicles are supplied on consignment by two manufacturers, Monza and Capri, who trade on different terms. (5marks)

Dec 2006 ANGELINO(b/iii-question) Monza supplies cars on terms that allow Angelino to display the vehicles for a period of three months from the date of delivery or when Angelino sells the cars on to a retail customer if this is less than three months. Within this period Angelino can return the cars to Monza or can be asked by Monza to transfer the cars to anther dealership (both at no cost to Angelion). Angelion pays the manufacturer’s list price at the end of the three month period (or at the date of sale if sooner). In recent years Angelion has returned several cars to Monza that were not selling very well and has also been required to transfer cars to other dealerships at Monza’s request.

Dec 2006 ANGELINO(b/iii-answer) ……..These factors strongly indicate that Monza should include the cars in its statement of financial position as inventory and therefore Angelino will not record a purchase transaction until becomes obliged to pay for the cars (three months after delivery or to until sold to customers if sooner).

Dec 2006 ANGELINO(b/iii-question) Capri’s terms of supply are that Angelino pays 10% of the manufacturer’s price at the date of delivery and 1% of the outstanding balance per month as a display charge. After six months (or sooner if Angelino chooses), Angelino must pay the balance of the purchase price or return the cars to Capri. If the cars are returned to the manufacturer, Angelino has to pay for the transportation costs and forfeits the 10% deposit. Because of this Angelino has only returned vehicles to Capri once in the last three years.(5marks)

Dec 2006 ANGELINO(b/iii-answer) ………These factors strongly indicate that Angelino bears the risks and rewards associated with ownership and should recognize the inventory and the associated liability in its financial statements at the date of delivery.

Repurchase agreements Buyer Seller sale repurchase

To identify the correct treatment, it is necessary to identify whether : right to use asset obligation/likely to repurchase sale price below market price

Indications of assets status Indications of sale of original asset to buyer Indications of secured loan

Indications of sale of original asset to buyer: Sale (repurchase) price equals market value at the date of sale (repurchase). No commitment for seller to repurchase asset. Risk of changes in asset value borne by buyer such that buyer does not receive solely a lender’s return. Seller has no right to determine asset’s development or future sale.

Indications of secured loan Sale price does not equals market value at the date of sale. Commitment for seller to repurchase asset. Risk of changes in asset value borne by seller such that buyer receives solely a lender’s return. Seller retains right to determine asset’s use ,development or sale, or rights to profits there from.

Required accounting As secured loan The seller should continue to recognize the original asset and record the proceeds received from the buyer as a liability. Interest should be accrued.

Bill-and-hold arrangements For this to be recognized within revenue, the customer must have obtained control of the product, despite it physically remaining with the entity. There may be a fee for custodial services, where the entity recognizes a fee for holding the goods on behalf of the customer . This performance obligation would be satisfied over time, so any revenue would be recognized on this basis.

Satisfying a performance obligation over time An entity recognizes revenue over time if one of the following criteria is met: [IFRS 15:35] the customer simultaneously receives and consumes all of the benefits provided by the entity as the entity performs; the entity’s performance creates or enhances an asset that the customer controls as the asset is created; or 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. For each performance obligation satisfied over, an entity shall recognize revenue over time by measuring the progress towards complete satisfaction of that performance obligation.

Appropriate methods of measuring progress include output methods and input methods: Output methods (for example, a service contract in which an entity bills a fixed amount for each hour of service provided), the entity may recognize revenue in the amount to which the entity has a right to invoice. Input methods recognize revenue on the basis of the entity’s efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labour hours expended, costs incurred, time elapsed or machine hours used) relative to the total expected inputs to the satisfaction of that performance obligation.