Slide 1

Revenue Recognition

Slide 2

Revenue recognition landscape

Construction contracts

Multiple elements

1

2

34

5

6

IAS 18

IAS 11

IAS 18, 28, 39

IAS 18,39

IAS 18

IAS 18SIC 31

Revenue Recognition

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Slide 3

Definition and scope exclusion

Definition:

• Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants.

• Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

Revenue Recognition

Scope exclusion:Does not apply to:• Lease agreements;• Dividends from investments accounted for

under the equity method (IAS 28 Investments in Associates);

• Insurance contracts within the scope of IFRS 4: Insurance Contracts;

• Changes in the fair value of financial assets and financial liabilities or their disposal (IAS 39 Financial Instruments: Recognition and Measurement);

• Changes in the value of other current assets;• Initial recognition and from changes in the fair

value of biological assets related to agricultural activity (IAS 41: Agriculture);

• The extraction of mineral ores

Slide 4

Timing of Recognition Sale of goods

SALE OF GOODS:

Revenue recognition criteria common under IFRS and Indian GAAP

1. Risks/rewards transfer

2. Probable inflow of benefits

3. Revenue measurable reliably

Additional revenue recognition criteria under IFRS

4. Costs measurable reliably

5. No continuing managerial involvement

Construction contracts

Probable benefits inflow

Measurable costs incurredMeasurable coststo complete

Multiple elements

1

2

34

5

6

Revenue Recognition

Slide 5

Timing of Recognition

No Continuing Managerial involvementIndicators of continuing managerial involvement or retention of effective control might include:

• Control over future price of the item.

• Responsible for the management of the goods subsequent to the sale.

• Transaction allows the buyer to compel the seller, or give an option to the seller, to repurchase the item.

• Guarantees the return of the buyer’s investment or a return on that investment for a limited or extended period.

Continuing Managerial

Involvement Exists!

No Sale!

No Revenue!

Revenue Recognition

Slide 6Slide 6

Handout 1

Continuing Managerial involvement

Continuing Managerial involvement

Revenue Recognition

Slide 7

Revenue recognition – Quick quiz

Revenue Recognition

Scenarios Revenue Recognition

1 Entity which does not retains an obligation for unsatisfactory performance not covered by normal warranty provisions can recognise the revenue immediately

2 When the receipt of the revenue from a particular sale is contingent on the derivation of revenue by the buyer from its sale of the goods, the seller can not recognised the revenue immediately.

3 Revenue can not be recognised when, the goods are shipped subject to installation and the installation is a significant part of the contract which has not yet been completed by the entity.

4 Revenue should not be recognised when the buyer has right to rescind the purchase for a reason specified in the sales contract and the entity is uncertain about the probability of return.

5 If an entity retains only an insignificant risk of ownership, the transaction is a sale and revenue is recognised.

6 Seller can recognise the revenue where transaction allows the buyer to compel the seller, or give an option to the seller, to repurchase the item.

7 If seller guarantees the return of the buyer’s investment or a return on that investment for a limited or extended period, revenue can not be recognised immediately.

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P

P

POP

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Slide 8

Timing of Recognition – Sales on FOB/CIF terms

Revenue Recognition

Sold on FOB basis

No further performance obligations

Recognition on dispatch

is likely to be acceptable

Sold on CIF basis

Evaluate the exact terms

of arrangement

Recognise when risk of

loss is transferred

to buyer

Slide 9

Gross v/s Net reporting – Certain Items

Revenue Recognition

Particulars Reporting

Sales taxes Net off Sales

Excise Duty Gross / Net allowed (policy choice)

Rebates Reduced from Sales

Cash discounts Net

Product return Reduced from sales

Warranties Expensed off separately

Shipping and handling charges– Reimbursement– Otherwise

NetGross

Slide 10

Measurement of revenue

* The discount rate is the more clearly determinable of the following:• the prevailing rate for a similar instrument of an issuer with a similar credit rating; or

• a rate of interest that discounts the nominal amount of the instrument to the current cash sales price of the goods or services.

The difference between the fair value and the nominal amount of the consideration is recognised as interest revenue (as per IAS 39)

Revenue Recognition

Consideration is deferred

Revenue = Both a sale and financing transaction.

Discounted fair value of consideration*

Slide 11

Agency Arrangements

Revenue Recognition

Principal or Agent ?• expectation by the customer that the entity is acting as

the primary obligor in the arrangement.

• freedom to set the selling price with the customer.

• assumes inventory risk

• performs part of the services provided or modifies the goods supplied.

• assumes the credit risk

• discretion in selecting suppliers

Principal!

Gross Reporting!

If these conditions not satisfied – NET REPORTING !

Slide 12

Warranties Initial warranty

• Recognise the full consideration if warranty– not a separate element and – represents an insignificant part of the

transaction, the seller has completed substantially all the required performance

• Expected future cost relating to the warranty – not a reduction of revenue– but a cost of sale,

• Costs of warranties determined at the time of the sale - make a provision for warranty costs

• Costs cannot be measured reliably -recognise revenue when the warranty period expires; or cost can be measured reliably

Revenue Recognition

Extended warranty• The revenue from the sale of the extended

warranty should be deferred and recognised over the period covered by the warranty,

• No costs should be accrued at the inception of the extended warranty agreement

Rendering of services

Slide 14

Timing of recognition Services

Sale of goods

Probable benefits inflow

Measurable costs incurredMeasurable coststo complete

Interest

2

3

45

6

1

Revenue Recognition

Slide 15

Rendering of services – Revenue recognition

Revenue Recognition

Outcome cannot be estimated reliably

revenue recognised = recoverable expensesDuring the early stages of a transaction, it is often

the case that the outcome of the transaction cannot be estimated reliably.

Is it probable that the entity will recover the transaction costs incurred?

• Revenue is recognised only to the extent of costs incurred that are expected to be recoverable.

• No profit is recognised.

• Revenue is not recognised

• The costs incurred are recognised as an expense.

When the uncertainties that prevented reliable estimation no longer exist, revenue is recognised

YES NO

Outcome of a transaction estimated reliably

Stage of completion method

Outcome be estimated reliably if:

• Revenue measured reliably;• Probable that economic benefits

flow to the entity;• The stage of completion measured

reliably; and• The costs incurred for the

transaction and the costs to complete the transaction can be measured reliably

Slide 16

Rendering of services - Measurement

Revenue Recognition

Measurement of Revenue

by “Percentage of Completion method” depending on nature of transaction methods may include

• surveys of work performed;

• services performed to date as a percentage of total services to be performed; or

• the proportion that costs incurred to date bear to the estimated total costs of the transaction. Only costs that reflect services performed to date are included in costs incurred to date.

Progress payments and advances received from customers often do not reflect the services performed.

Slide 17

Rendering of services

Revenue Recognition

Treatment of certain specific services Revenue Recognition

1 Performance over Time• services are performed by an

indeterminate number of acts • over a specified period of time

Revenue is recognised on a straight-line basis unless a better method represents the stage of completion

2 Recognition of contracts containing significant acts

When significant act is executed (e.g. Loan origination fees for arranging loan)

3 Contracts with milestone payments -(payment of cash upon the achievement of certain ‘milestones’ identified in the contract

Revenue recognition will vary depending on the substance of the arrangements

4 Subscriptions Recognised on a straight-line basis over the period when the items are dispatched

5 Admission fees Admission fees for special events are recognised when the event takes place

6 Tuition fees Recognised as revenue over the period of instruction.

Slide 18

Sale of Software

Following points have to be considered• Physical delivery of the software - less indicative of when a sale should be recognised • Recognition delayed till acceptance by buyer• Depends on type of software

Revenue Recognition

Standard off the shelf

Customised software

Recognise revenue on delivery

Percentage of completion method

• Subject to installation

Process is substantial, Risk of non-acceptance

Installation process is simple upon the buyer's acceptance of delivery

recognition after >installation >Inspection >customer acceptance

Multiple Element Arrangement

Slide 20

Timing of recognition Multiple Elements

Multiple Elements

IAS 18 para 13:

In certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction to reflect substance.

• Identifying components of a transaction to reflect substance

• Combining if commercial effect cannot otherwise be understood

• linked transactions

Rendering of services

Dividends, royalties

3

4

56

1

2

Revenue Recognition

Slide 21

Multiple Element transactions

1. Separation of Elements

• A transaction may contain separately identifiable components that should be accounted for separately.

• Apply the revenue recognition criteria to each separately identifiable component of a single transaction to reflect the transaction's substance.

Customer’s Perspective

To assess the transaction's substance, view from

customers’ perspective

customer views the purchase as one

product

customer perceives there to be a

number of elements to the transaction,.

Apply recognition criteria to transaction as

whole

Apply recognition criteria to each element

separately.

Revenue Recognition

Slide 22

Multiple Element transactions

2. Allocation of Consideration

• Revenue in respect of each separable component of a transaction = its fair value.

• Fair value = price that is regularly charged for an item when sold separately

Total revenue > the sum of the fair value of the separable elements

additional revenue attributable to the activity of managing the two elements of

the contract

additional revenue recognised when full contract substantially complete

Total revenue < the sum of the fair value of the separable elements

Difference = discount

discount allocated between the separable components using:1. relative fair values 2. cost plus a reasonable margin

If overall loss on contract recognise immediately

Revenue Recognition

Slide 23Slide 23

Handout 3

Multiple Element Transactions

Multiple Element Transactions

Revenue Recognition

Slide 24

Measurement of revenue- Barter transactions

Revenue Recognition

Goods or services are exchanged or swapped for goods or services which are of a similar nature and value?

YES NO

NOT a transaction which generates revenue.

a transaction which generates revenue.

Can fair value of goods and services received be measured reliably?

YES NO

revenue is measured at the fair value of the goods or services received, adjusted by the amount of any cash or cash equivalents transferred.

the revenue is measured at the fair value of the goods or services given up, adjusted by the amount of any cash or cash equivalents transferred.

Slide 25

Interests, royalties and dividends

Revenue Recognition

Revenue arising form use by others of entity’s asset yielding interests royalties and dividends shall be recognised

when

on the following basis:

it is probable that the economic benefits associated with the transaction will flow to the entity.

the amount of the revenue can be measured reliably.

AND

Interests

Royalties

Dividends

using the effective interest method as set out in IAS 39.

on an accrual basis in accordance with the substance of the relevant agreement.

when the shareholder's right to receive payment is established

Slide 26

Thank You