OVERVIEW
Objective
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To describe the principles of revenue recognition.SPECIFIC EXAMPLES INTRODUCTION
INTEREST, ROYALTIES AND
DIVIDENDS SALE OF GOODS
¾ Scope
¾ Definitions
¾ Measurement of revenue
¾ Disclosure
RENDERING OF SERVICES
¾ Sale of Goods
¾ Rendering of Services
1
INTRODUCTION
1.1
Scope
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Revenue arising fromSale of
goods Rendering of services Use of entity assets yielding interest, royalties and
dividends
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Including goods produced/purchased for resale e.g.−
merchandise purchased by a retailer−
land andproperty held for resale.
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Typically involves performance of a contractually agreed task over an agreed period of time.¾
Interest – charges for use of cash/cash equivalents or amounts due¾
Royalties – charges for use of long-term assets e.g. patents, trademarks, copyrights and computer software¾
Dividends – distributions of profits to owners.1.2
Definitions
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Revenue is the gross inflow of economic benefits during the period arising in the course of ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants.¾
Fair value is the amount for which an asset could be exchanged, or aliability settled, between knowledgeable, willing parties in an arm’s length transaction.
1.3
Measurement of revenue
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At fair value of the consideration received or receivable.Illustration 1
Accounting policies (extract) Valuation methods and definitions Sales to customers
Sales to customers represent the sales of products and services rendered to third parties, net of general price reductions and sales taxes. Sales are recognised in the income statement at the moment when the significant risks and rewards of ownership of the goods have been transferred to the buyer, which is mainly upon shipment.
Nestlé
Consolidated accounts 2006Illustration 2
Revenue recognition and presentation
Revenues from mobile telecommunications comprises amounts charged to customers in respect of monthly access charges, airtime charges, messaging, the provision of other mobile telecommunications services, including data services and information provision, fees for connecting users of other fixed line and mobile networks to the Group’s network, revenue from the sale of equipment, including handsets, and revenue arising from the Group’s Partner Network agreements.
Vodafone Annual Report 2006
1.4
Disclosure
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Accounting policies adopted for revenue recognition¾
Amount of each significant category of revenue recognised during the period.2
SALE OF GOODS
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Revenue recognition criteria Significant risks and rewards of ownership are transferred to the buyer
Neither continuing managerial involvement nor effective control over goods sold are retained
The amount of revenue can be measured reliably
Costs (to be) incurred in respect of the transaction can be measured reliably.
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The passing of risks and rewards is critical to revenue recognition. If legal title passes but risk and rewards are retained, no sale shall be recognised. For example:
−
where the entity retains obligation for unsatisfactory performance not covered by normal warranty provisions, or−
where the receipt of revenue is contingent on the buyer selling the goods on, or−
goods are to be installed and the installation is a significant part of the contractand remains uncompleted, or
−
the buyer has the right to rescind and the seller is uncertain about the outcome. If legal title does not pass but the risks and rewards do then the transaction shall be recognised as a sale.
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Cost recognition Usually revenue and expenses are to be recognised simultaneously.
Expenses can normally be measured reliably when other conditions for revenue recognition have been satisfied.
Revenue cannot be measured when the related expenses cannot be measured reliably. In such cases proceeds shall be recognised as a liability not a sale.
3
RENDERING OF SERVICES
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Revenue recognition criteria Recognise revenue by reference to the stage of completion of the transaction at the end of the reporting period (but only if the outcome can be estimated reliably).
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this is known as the percentage completion method−
it is applied in IAS 11 Construction contracts−
it provides useful information on service activity in the period.¾
Stage of completion shall be estimated using the method that measures reliably the services performed. May include: surveys of work completed (known as work certified). services performed as a percentage of total services. proportion of costs to date to total estimated costs.
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Reliable estimate of outcome is subject to the following conditions (all must be satisfied). It is probable that the economic benefits associated with the transaction will flow to the entity,
The stage of completion of the transaction can be measured reliably, Costs to complete can be measured reliably.
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Ability to make reliable estimate depends on Agreement with the customer about
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enforceable rights of each party−
consideration to be exchanged−
manner and the terms of settlement Existence of an effective internal financial reporting and budgeting system.
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If outcome cannot be measured reliably recognise the revenue only to the extent of the expenses recognised that are recoverable.4
INTEREST, ROYALTIES AND DIVIDENDS
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Revenue recognition criteria It is probable that economic benefits will flow to the entity and The amount of the revenue can be measured reliably.
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Recognition bases Interest – a time proportion basis
Royalties – an accrual basis in accordance with the substance of the agreement Dividends – when the shareholder’s right to receive payment is established.
5
SPECIFIC EXAMPLES
5.1
Sale of Goods
5.1.1
Bill and hold sales
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Delivery is delayed at the buyer’s request but the buyer takes title and accepts billing¾
Revenue is recognised when the buyer takes title, provided: it is probable that delivery will be made;
the item is on hand, identified and ready for delivery to the buyer at the time the sale is recognised;
the buyer specifically acknowledges the deferred delivery instructions; and the usual payment terms apply.
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Revenue is not recognised when there is simply an intention to acquire or manufacture the goods in time for delivery.5.1.2
Goods shipped subject to conditions
5.1.2.1 Condition — installation and inspection
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Revenue is normally recognised when the buyer accepts delivery, and installation and inspection are complete. However, revenue is recognised immediately upon the buyer’s acceptance of delivery when: The installation process is simple in nature, (e.g. the installation of a piece of equipment which only requires unpacking and connection of power) or
The inspection is performed only for purposes of final determination of contract prices, (e.g. shipments of commodities e.g. iron ore).
5.1.2.2 Condition — on approval when the buyer has negotiated a limited right of return
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If there is uncertainty about the possibility of return, revenue is recognised when the shipment has been formally accepted by the buyer or the goods have been delivered and the time period for rejection has elapsed.5.1.2.3 Consignment sales — Under these contracts the buyer undertakes to sell the goods
on behalf of the seller
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Revenue is recognised by the shipper when the goods are sold by the recipient to a third party.5.1.2.4 Cash on delivery sales
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Revenue is recognised when delivery is made and cash is received by the seller or its agent.5.1.3
Lay away sales
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Revenue from such sales is recognised when the goods are delivered.¾
However, revenue may be recognised earlier, i.e. when a significant deposit is received, provided the goods are on hand, identified and ready for delivery to the buyer, when experience indicates that most such sales will actually proceed to completion.5.1.4
Orders when payment (or partial payment) is received in advance of delivery for
goods not presently held in inventory
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Revenue is recognised when the goods are delivered to the buyer.5.1.5
Sale and repurchase agreements
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Under these agreements the two parties enter into an agreement where the seller may repurchase the goods at some later date. For example: As the result of an explicit agreement; The seller has a call option to repurchase;
The buyer has a put option to require the repurchase, by the seller, of the goods.
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Revenue is recognised according to the substance of the transaction. If the substance of the arrangement is that the seller has transferred the risks and rewards of ownership to the buyer revenue shall be recognised.
If the substance of the arrangement is that the seller retains the risks and rewards of ownership (even if legal title is transferred) the transaction is a financing
arrangement and does not give rise to revenue.
5.1.6
Sales to intermediate parties, such as distributors, dealers or others for resale
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Revenue from such sales is generally recognised when the risks and rewards of ownership have passed.¾
However, when the buyer is acting, in substance, as an agent, the sale is treated as a consignment sale.5.1.7
Subscriptions to publications and similar items
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When the items involved are of similar value in each time period, revenue is recognised on a straight-line basis over the period in which the items are despatched.¾
When the items vary in value from period to period, revenue is recognised on the basis of the sales value of the item despatched in relation to the total estimated sales value of all items covered by the subscription.5.1.8
Instalment sales
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Revenue attributable to the sales price, exclusive of interest, is recognised at the date of sale.¾
Note that the sale price is the present value of the consideration, determined by discounting the instalments receivable at the imputed rate of interest.¾
The excess of cash receipts over the initial sale price recognised is interest and shall be recognised as revenue as it is earned, on a time proportion basis that takes into account the imputed rate of interest.5.1.9
Real estate sales
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Revenue is normally recognised when legal title passes to the buyer.¾
However the basic transaction might be subject to complication e.g. In some jurisdictions the equitable interest in a property may pass at a date which is different to that at which legal title passes
Real estate may be sold with a degree of continuing involvement by the seller such that the risks and rewards of ownership have not been transferred.
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In such cases revenue shall be recognised to reflect the substance of the transaction.5.2
SPECIFIC EXAMPLES — Rendering of Services
5.2.1
Installation fees
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Recognise as revenue by reference to the stage of completion of the installation, unless they are incidental to the sale of a product in which case they are recognised when the goods are sold.5.2.2
Servicing fees included in the price of the product
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Recognised as revenue over the period during which the service is performed.¾
The amount to be deferred is enough to cover the expected costs of the services under the agreement, plus a reasonable profit on those services.5.2.3
Advertising commissions
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Media commissions – recognise when the related advertisement or commercial appears before the public.¾
Production commissions – recognise by reference to the stage of completion of the project.5.2.4
Admission fees
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Recognise when the event takes place.5.2.5
Tuition fees
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Revenue is recognised over the period of instruction.5.2.6
Initiation, entrance and membership fees
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Recognise as revenue when no significant uncertainty as to its collectability exists as long as it is a membership fee only and any other service is paid for separately.¾
If the fee entitles the member to other benefits it is recognised on a basis that reflects the timing, nature and value of the benefits provided.5.2.7
Franchise fees
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Franchise fees may cover the supply of initial and subsequent services, equipment and other tangible assets, and know-how.¾
Franchise fees are recognised as revenue on a basis that reflects the purpose for which the fees were charged.5.2.7.1 Supplies of equipment and other tangible assets
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The amount, based on the fair value of the assets sold, is recognised as revenue when the items are delivered or title passes.5.2.7.2 Supplies of initial and subsequent services
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The initial fee is recognised as the initial service is completed¾
Fees for the provision of continuing services are recognised as revenue as the services are rendered.¾
Sufficient fee must be deferred to cover the costs of continuing services and to provide a reasonable profit on those services. (This means that some of the fee for the initial service may need to be deferred to satisfy this requirement).5.2.7.3 Continuing franchise fees
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Recognise as revenue as the services are provided or the rights used.5.3
SPECIFIC EXAMPLES — Interest, Royalties and Dividends
5.3.1
License fees and royalties
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Fees and royalties received are normally recognised in accordance with the substance of the agreement.¾
Such fees may be received for the use of an entity’s assets e.g. Trademarks Patents Software
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As a practical matter, this may be on a straight-line basis over the life of the agreement, for example, when a licensee has the right to use certain technology for a specified period of time.¾
If receipt of a licence fee or royalty is contingent on the occurrence of a future event revenue is recognised only when it is probable that the fee or royalty will be received, (which is normally when the event has occurred).FOCUS
You should now be able to:
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outline the principles of the timing of revenue recognition;¾
discuss and give examples of the various points in the production and sales cycle where it may, depending on circumstances, be appropriate to recognise gains and losses;