GODFREY HODGSON HOLMES TARCA CHAPTER 9 REVENUE

Revenue defined Income is 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. AASB Framework

Revenue defined Revenue represents a physical and a monetary flow Revenue is an inflow of economic benefits Revenue forms part of income – which also includes gains – and arises in the course of ordinary activities Examples are sales, fees, interest, dividends, royalties and rents

Behavioural view of revenue Revenues are the result of firm activity Net accomplishment of firm revenue = accomplishment expense = effort matching results in profit = net accomplishment A point of recognition must be determined critical event accrual throughout earnings process

Revenue recognition Historical perspective Profit (and revenue) determined on the basis of the increase in the net worth of the firm Supplanted by the notion that profit and revenue had to be realised Developed into the revenue recognition principle (or realisation principle) A distinction between capital and profit emerged from court rulings

Criteria for revenue recognition At what point during the earning process can revenue be recorded as earned because there is sufficient evidence?

Criteria for revenue recognition

Criteria for revenue recognition Recognition criteria are based on the desire for both relevant and reliable accounting information measurability of asset value existence of a transaction substantial completion of the earning process

Revenue measurement Framework – provides 2 criteria for revenue recognition it is probable that any future economic benefit associated with the item will flow to or from the entity the item has a cost or value that can be measured with reliability Revenue recognition is not straightforward because of the wide range of different business revenue-generating activities and circumstances

Revenue measurement IAS 18/AASB 118 Revenue revenue is to be measured at the fair value of the consideration received or receivable

Sale of goods The sales point is generally the most appropriate point to measure and record revenue as all three criteria are met The sales point is when the product is delivered or the services are rendered, or when title passes to the customer

Exceptions to sales basis Exceptions to using the sale point are revenue recognised during production e.g. construction contracts revenue recognised at the end of production production is the critical event and the sale is assured revenue recognised when cash is received after the sale is made instalment method and the cost recover method

Rendering of services Service revenue is to be recognised by reference to the stage of completion It is recognised in the period in which the service is rendered

Interest, royalties and dividends Can be recognised when received For some items, the passing of time signifies revenue has been earned e.g. interest revenue

Developments in revenue recognition and measurement IASB/FASB joint project Void in revenue recognition and measurement guidance and a lack of a conceptual basis for resolving issues Revenue transactions have become more complex

Developments in revenue recognition and measurement They propose recognising revenues when they arise measuring them at fair value at that point measuring them when they arise from an increase in assets or a decrease in liabilities, at the fair value of that change

Developments in revenue recognition and measurement Resulting changes in emphasis revenue is recognised when it arises changes emphasis from realisation to timeliness revenue can result from the changes in asset and liability values and from holding assets that is, from remeasurements revenue recognition and measurement reflect fair value measurement should be reliable

Developments in revenue recognition and measurement Tentative agreement that two criteria must be met to recognise revenue a change in assets or liabilities must have occurred the elements criterion the change in assets or liabilities can be appropriately (reliably) measured the measurement criterion no probability criterion There is less emphasis on ‘substantial completion of the earnings process’ and on notions of ‘realisation’ and ‘earned’

Fair value measurement Under a mixed measurement attribute model, all items are measured at fair value at acquisition and thereafter are carried at historical cost or written down historical cost although some items are subsequently remeasured to fair value Gains and losses are recognised when they occur even if they are unrealised

Financial statement presentation IASB/FASB joint project Tentative conclusions are an all-inclusive, single income statement where all changes to assets and liabilities will be disclosed realisation is not the basis for inclusion of items separate disclosure of performance (income flows) and remeasurement (valuation adjustments)

Issues for auditors Primary issue is the overstatement of revenues by managers intention is to deceive users bonuses managing earnings over-optimism fraud

Summary Issues relating to the definition, measurement and recognition of revenue Critical recognition points Criteria for revenue recognition Revenue measurement Guidance provided by standard setters Current projects and developments Issues for auditors

Key terms and concepts Revenue Behavioural view of revenue Earning process Criteria for revenue recognition Point of sale Fair value Sales of goods and the rendering of services