Revenue Recognition

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Revenue & Recognition

Ridhollah Muhammad A.Monica Putri S.RenySuwondoYudi Dwiprasanto

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• revenue reflects the firm's past operations and is used to predict future performance

• different business modelsdifferent measurement

• revenue recognition as an area where improved guidance is needed



Nature of revenue



Definition of Revenue

• associates with factors that create revenue• the gross increase in the value of assets and

capital• created predominantly by the production and

sale of the output of the entity (main operations of the business)



the physical and the monetary flows

the physical flow :

entails the event of producing and selling

the output

Object: the output or product

the monetary flow :

involves the event of increasing

the value of the firm (due to production or sales to customers of

the firm's output)

the dollar amount of the asset produced or sold

which of the four constitutes the

essence of revenue?



• Based on the implications of the ideal case, revenue must be directly related to the monetary event (an increase or flow), not an object , of value increasing in the firm, which arises out of production or sale of output

• the Paton and Littleton:

revenue is :the `product of the enterprise’ => the physical flowrepresented by the flow of funds from the

customers



Definition of Revenue

• IAS 18/AASB 118 Revenue, paragraph 7:“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. “

• In the AASB Framework, paragraph 74:“The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent”

paragraph 77:Assets received or enhanced by income may include cash, receivables and goods and services received in exchange for goods and services supplied

• In the United States, the FASB defines revenues:

“Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations.”



elements of income

Revenue

Realised Gains

Unrealised gains

ongoing major or central

operations (FASB)

peripheral or incidental

transactions‘ (FASB)

IASB: no different in nature so they are not considered a separate element in the Framework

Martin: no reason that revenues and gains should not follow the same rules for their recognition and measurement. Fundamentally, be represent increases in net assets and they should therefore be treated identically



Behavioural View of Revenue

• Revenue generally comes about because the entity does something to make it happen or undertakes certain activities

• Revenue is not simply a sum of money



Behavioural View (cont..)

Paton and Littleton• revenue indicates the

`accomplishment' of the firm, measure of ‘gross performance’

• When expenses are seen as representing the `effort' of the firm, then the matching of revenues and expenses results in profit: the `net accomplishment' of the firm

Bedford• stresses an operational view

of revenue and profit• Profit arises only from those

activities that are designated business operations

• The general business operations specified by Bedford are:• acquisition of money

resources• acquisition of services• use of services• recombination of acquired

services• disposition of services• distribution of money

resources

Myers• Related to certain critical

events and decisions made by the managers of the firm

• profit is earned at the moment of making the most critical decision or of performing the most difficult task in the cycle of a complete transaction

• the critical event will be at a different point depending on the nature of the business

•that revenue and profit accrue throughout the earning process

•there is a continual change in value of the total assets and capital as the firm undertakes the activities specified in the process

•This definition conforms with the theoretical view already mentioned

Contrast to

The FASB's definition of revenue:`the inflows or other enhancements of assets of an entity or settlements of its liabilities' due to `delivering or producing goods, rendering services'



Recognition of Revenue(Historical Perspective)

• 19th century, Income (profit)increase in net worth

• May stated:“… realisation postulate was not accepted prior to the First world War. In 1913, leading authorities in all these fields in England and America seemed to agree on the ‘increase in net worth’ concept of income”

o Increase in net worth income had to be realised because the use of specialised non-current assets



• In Australia, Jordan CJ said:“The word ‘income’ is not a term of art, and what forms of receipt…, and what principles..to ascertain how much of those receipts…as income, must be determined in accordance with the ordinary concepts and usages of mankind,…”

o Ryan, the ‘ordinary concepts of mankind’ :1. Remuneration for personal services

2. Income from property

3. Income from carrying on business

o ‘Exclude receipt which were of a capital nature’



• Hughes declared:“It is of the essence of income that it should be realised…. Income necessarily implies separation and realisation. The increase of the forests is not income until it is cut. The increase in the value of lands due to the growth and prosperity of the community is not income until it is realised. Where investments are concerned, there is no income until there has been a separate, realised gain”

o Two cases in Australia (foreign exchange gain):1. The company borrowed funds in the US as an injection of capital.

On repayment, the gaincapital

2. Payments for goods delivered in the previous year. The gainprofit

o IAS, the most exchange rate gains on a long term debt (or receivables) be recognised in profit or loss of the period in which they arise



• In the US, appraisal valuations in the 1920s contributed in part to the Great Depression of the 1930s

• Accountants adopted a conservative attitude and the recognition or realisation principle was an outcome of this defensive posture

• ‘Realisation’ occurred in 1932, special committee supported the realisation criterion and rejected the asset appraisal



Criteria for Revenue Recognition

• ‘At what point during the earning process can revenue be recorded as earned because there is sufficient evidence?’

• Revenue recognition may take places at a number of stages in a firm’s operating



1. Devising an idea 2. Making

purchases

3. Receipt of orders before commercing production

4. Commercing production

5. Progressively

throughout production

6. Completion

of production

7. Receipt of orders after completing production

8. Delivery of goods to customers

9. Receipt of cash



Based on the need for objective evidence, there are three criteria:

1. Measurability of Asset Value

2. Existence of a transaction

3. Substantial Completion of The Earning Process



Measurability of Asset Value

• Revenue is mainly an inflow that increases the value of the total assets

• Fair value measurement also focuses on the enhancement of assets,without any actual or physical inflow of assets (Holding the Assets)

• Fair valueconsistent with the accrual accounting approach, but inconsistent with historical cost conservatism and the realisation concept.



Measurability of Asset Value

• Recognition of changes in asset values is less of an issue where there are ready markets for asset, ex. Shares

• It becomes problematic where market value are not readily available, or the asset in use is greater than its carrying value



Analysis of Criteria for Revenue Recognition

Measurability of asset value

Existance of a transaction

Substantial completion

CriteriaCriteria




• Revenue >> increase value of total asset, increase in equity >> Reasonable• No inflow >> objectively? >> IAS 39, 40, 41 >>

conservatism• Fair value accounting consistent with accrual, but

inconsistent with conservatism




Must asset be liquid?• FASB >> Revenue is recognized when realised or realizable• must be liquid? YES• why?• Recognition vs Realisation

Collectability• Resolving uncertainty assosiated with realisation• Based on experience• The longer collectibility period, the more uncertain



EXISTANCE OF A TRANSACTION

– nn



EXISTANCE OF A TRANSACTION

• Presently, except in spesified cases, the firms must be direct participated in the transaction >> historical cost is the most feasible.

• Critics from CCA and EPA, the firm doesn’t need to be a party, but the market transaction is sufficient >> gain is recorded before the sale

• E.g. wheat and barley• Why is it allowed? Sufficient objective evidence • In some cases it is not reliable, but we cann’t demand that

in all cases the firm must be a direct participant.



SUBSTANSIAL COMPLETION

• Not explicitly stated in framework

• Revenue is not generated (earned) until the firm has

performed most of the activities for which the firms earns

revenue

• Signing contract?

• A number of activities?



Guidance From Standard Setters

Recognition:

a) it is probable that any future economic benefit associated with the item will flow to or from the entity; and

b) the item has a cost or value that can be measured with reliability.

IASB Framework



Measurement:Revenue shall be measured at the fair value of the consideration received or receivable

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.

IAS 18



Transactions create Revenues:

a) the sale of goods;b) the rendering of services; andc) the use by others of entity

assets yielding interest, royalties and dividends.



The Sale of Goods

Revenue Shall be recognized when:a) Transferred significant risks and

rewards of ownershipb) retains neither continuing

managerial involvement nor effective control

c) can be measured reliablyd) Probable economic benefitse) the costs incurred or to be incurred

can be measured reliably



WHAT IS SALE?

“The verifiable evidence of revenue often consists of an external sales transaction, so that revenue cannot usually be recognised before the point of sale”

Martin



Exceptions to sales basis

1. During production Percentage of Completion Method

2. End of production3. Cash received after sale instalment

method & cost recovery method



Percentage of Completion Method

“.. Is appropriate only when reasonably reliable estimates can be made..”

Three ways to determine it:1. Proportion of cost incurred to

estimated total cost2. Surveys of work performed3. Completion of a physical proportion of

the contract work



Rendering of services

When the outcome can be estimated realibly, revenue shall be recognised by reference to the stage of completion of the transaction



outcome can be estimated realibly, when:

a) revenue can be measured reliablyb) Probable economic benefitsc) the stage of completion of the

transaction can be measured realiblyd) the costs incurred or to be incurred

can be measured reliably



Multiple acts and time of services

• if there is a significant act, Recognition should not occur until this act has been performed

• Where services consist of an indeterminate number of acts, revenue should be recognised on a straight line basis



Revenue from the use by others of entity assets, recognised on the bases:

a) Interest effective interest methodb) Royalties accrual basis accordance

to the agreementc) Dividends the shareholder’s right

to receive payment is established.



STANDARD SETTER’S CURRENT ACTIVITIES

• IASB/FASB joint project• Revenue transactions are not well served

by existing guidance literature• Revenue transactions have become more

complex




• 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




• 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




• 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



REPORTING FINANCIALPERFORMANCE

• 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)


Revenue Recognition

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