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IntroductionLearning objective

Define revenueUnderstand how to measure revenueUnderstand when to recognize

revenueUnderstand the disclosure

requirements for revenue

IntroductionAccrual accounting is basedon matching of costs withrevenue .It is important toestablish a point at whichrevenue and cost are isrecognized

Definition of RevenueIAS 18 define revenue as the gross

inflow of economic benefits during the period arising in the course of ordinary activities of an entity

Definition of RevenueRevenue applies to the following1. Supply of goods on cash or credit2. Provision of service on cash or credit3. Rent received or receivable from

equipment or property hire4. Interest or dividends receive or

receivable on trade investment

Measurement of RevenueMeasurement refers to the amount

of revenue to be recognized orrecorded in the financial recordsRevenue is measured as the Fair

Value of the consideration receivedor receivable less trade discountsand Volume rebates

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Revenue recognitionRecognition refers to the

time when transaction arerecorded in the financialstatements

Revenue recognitionTo be recognized revenue must be;1. Earned - activities undertaken to

create the revenue must besubstantially complete

2. Realized - an event has occurredwhich significantly increase thelikelihood of conversion into cash .Mostly it the date of sale

Critical event in revenue recognition

The 'critical event' is the point in theearnings process or operating cycle atwhich the transaction is deemed tohave been sufficiently completed toallow the profit arising from thetransaction, or a distinct componentpart of it, to be recognised as incomein a particular period.

Critical event in revenue recognition

The following will be considered1. Revenue recognition at the time of

sale and delivery2. Revenue recognition before delivery3. Revenue recognition after delivery4. Other Revenue recognition

situations

Revenue recognition at the point of sale and delivery

This is the general rule as towhen revenue recognizedAt this stage revenue is earned

and realized

Question 1

On 1 September 15 2012 a company received total subscriptions in advance of K1,728,000 for 12 months publications of a magazine. At the year end, the company had produced and dispatched three months of the 12 month publications. The total cost of producing one issue of the magazine is estimated at K120, 000

Required. Using the traditional approach to revenue

recognition, how should the company treat the subscriptions in the accounts for the year ended 31 December 2012?

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Solution Only the revenue for 3 months has been earned 3/12 X

1,728,000=K432,000 9 months revenue is un earned it will be carried as a

liability of deferred income in the statement offinancial position

9/12 X 1,728,000=K1,296,000Dr revenue K1,296,000Cr deferred income 1,296,000

Recognition of revenue: sale of goods

IAS 18 requires the following condition be met

1. Seller has transferred significant risks and rewards of ownership to buyer .

2. Seller does not retain continuing managerial involvement and control over goods sold.

3. Amount of revenue can be measured reliably4. Probable that economic benefit will flow to

seller5. Costs incurred or to be incurred can be

measured reliablyPoint 3 and 5 underscores the matching concept

for revenue to be recognized

Recognition of revenue: sale of goods with after sales serving Where the sale of product includes

identifiable amount of after sales serving ,theamount for service is deferred and recognizedas revenue over the period during which theservice is performed .

The amount deferred must cover the cost ofservice with the reasonable profit on thoseservices

The same rule applies to service ,interest,royalties and dividend revenue

Question 2A computerized accountancy

package is sold with one year's aftersales support. The cost of providingsupport to one customer for oneyear is calculated to be K100, 000.The company has a mark-up on costof 15%. The product is sold for K700,000. How should this sale beaccounted for?

Solution The K700,000 includes after sales service of 1 year

which is not earned The cost is K100,000 + the profit of 15 %

100,000+(100,000 x 15%)=115,000

115,000 is deferred 585,000 is recognized as revenue

Recognition of revenue from service

According to stage of completion at reporting date. All the following conditions should be met1. The amount of revenue can be measured reliably2. It is probable that the economic benefits associated

with the transaction will flow to the entity3. The stage of completion of the transaction at the

reporting date can be measured reliably4. The costs incurred for the transaction and the costs

to complete the transaction can be measuredreliablyIf the above are not met recognize revenue to theextent of expenses recognized that are recoverable

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Question 3On 1 July 20X3, Company A signs a contract with

customer under which Company A delivers an ‘off-the-shelf ’ IT system on that date and thenprovides support services for the next three years.The contract price is K3,700,000.The cost of thesupport services is estimated at K300, 000 pa andCompany A normally makes a profit margin of25% on such work. Company A makes up financialstatements to 31 December each year.RequiredWhat revenue should be recognized in thefinancial statements for the year ended 31December 2003?

Solution Note margin means sales is 100%

Markup means sales is 100%+ profit % Cost of service pa is K300,000. Since A adds margin of 25%,it means cost is 75% 100%--

--X(sales)75%------300,000

Sales x=400,000 service revenue pa Total service is revenue is K1,200,000(400,000x3) only

half(K200,000)isearned from July to December Revenue to be recognize is K2,500,000 for

product(3,700-1200) and 200,000 for service Total of K2,700,000

Sale or returnRevenue must only be

recognized once the returnperiod has elapsed

Question 4 TITA Ltd has included K800, 000 of revenue in its

statement of profit or loss for sales made on a sale or return basis. At 31 December 20X8, customers who had not yet paid for the goods had the right to return K400, 000 of them. TITA applied a mark-up of 25% on all these sales. In the past TITA’s customers have sometimes returned goods under this type of agreement.

Required: How should the sales be recorded in the financial

statement for the year ended 31 December 20X8?.

SolutionFrom the total sales value only

K400,000 should be recorded inrevenue for the year to 31 December.The remaining K400,000 is forgoods that are still being held undera sale or return agreement andtherefore cannot be recognized inthe financial statements.

Solution Adjustment needed 1. Remove revenue under return agreement

Dr. Revenue 400,000Cr. Receivables (SFP) 400,000

2. Bring the goods back into inventoryDr. Closing inventory(SFP) 320,000Cr Cost of sales 320,000

(400,000/125 x 100)

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Agency salesWhen acting as an agent only the

commission earned can be recorded asrevenue by the agent.

The principal is responsible forrecording the actual sales revenue in itsown financial statements.

Question 4bGBM’s revenue includes K4 million for goods it sold acting as an agent for ECZ. GBM earned a commission of 20% on these sales and remitted the difference of K3.2 million (included in cost of sales) to ECZ.

Required:How should the agency sale be treated in GBM’s income

statement ?

Solution GBM should not have included K4 million in its

revenue as it is acting as the agent and not the principal. Only the commission element of K800, 000 (4 million x 20%) can be recorded in revenue. The following adjustment is therefore required

Dr. Revenue K3,200,000

Cr. Cost of sales K3,200,000

Recognition of revenue from Interest ,Royalties and DividendsRecognize revenue when:1. It is probable that the

economic benefits associatedwith the transaction will flowto the entity; and

2. The amount of the revenue canbe measured reliably

Recognition of revenue from Interest ,Royalties and Dividends The following bases are used to recognize

revenue for interest ,royalties and dividend1. Interest -on a time proportion basis that

takes into account the effective yield on the asset

2. Royalties - on an accruals basis in accordance with the substance of the relevant agreement

3. Dividends - when the shareholder's right to receive payment is established

DisclosureThe following items should be

disclosed.1. The accounting policies adopted

for the recognition of revenue, including the methods used to determine the stage of completion of transactions involving the rendering of services

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Disclosure2. The amount of each significant category of

revenue recognized during the period including revenue arising from:(i) The sale of goods(ii) The rendering of services(iii) Interest(iv) Royalties(v) Dividends

3 The amount of revenue arising from exchanges of goods or services included in each significant category of revenue

Revenue recognition before delivery

Applies when a customer provides avalid promise of payment ,Condition exist that contractually

guarantee subsequent sale.Accounting for this is discussed

under IAS 11 construction contracts

Revenue recognition after delivery

Applies if the collection of salesis not reasonably assured andrevenue recognition is deferred.

Revenue recognition after delivery

2 methods are used to deferrerrevenue .The installment method were

revenue is recognized when thecash installment is received.Cost recovery method revenue only

recognized when cash paymentsexceeds the cost of sales

Expense recognitionAn expense is decreases in economic

benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities

Expense recognitionCan be divided in to 3 categories1. Direct matching2. Systematic and rational

allocation3. Immediate recognition

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Direct matchingThis is where expenses are related

to specific revenues.Expenses include those related to

revenue although not incurred.Recognition is done immediately

when related revenue is recognized

Systematic and rational allocation

This involves assets that benefit more than one accounting period .

The cost of Non current assets are spread across the periods of expected benefit in some systematic way.

It is difficult to relate these expenses directly to revenue but are necessary if revenue is to be earned

E.g. Depreciation & amortization

Immediate recognitionApplies to expenses that are not

related to specific revenue but areincurred to obtain goods andservices that indirectly help togenerate revenue.eg utilitiesSince these are used immediately

they are recognized in the period ofacquisition

Immediate recognitionIt is also applicable when future

benefits are highly uncertain e.g.research and developmentMost loses are recognized

immediately e.g. loss from naturaldisaster ,loss from disposal ofassets