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Introduction
Learning objective
Define revenue
Understand how to measure revenue
Understand when to recognize
revenue
Understand the disclosure
requirements for revenue
Definition of Revenue
Introduction
Accrual accounting is based
on matching of costs with
revenue .It is important to
establish a point at which
revenue
and cost are is
recognized
IAS 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 Revenue
Measurement of Revenue
Revenue applies to the following
Measurement refers to the amount
of revenue to be recognized or
recorded in the financial records
1. Supply of goods on cash or credit
2. Provision of service on cash or credit
3. Rent received or receivable from
equipment or property hire
4. Interest or dividends receive or
receivable on trade investment
Revenue is measured as the Fair
Value of the consideration received
or receivable less trade discounts
and Volume rebates
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Revenue recognition
Revenue recognition
Recognition refers to the
time when transaction are
recorded in the financial
statements
To be recognized revenue must be;
1. Earned - activities undertaken to
create
the revenue
must be
substantially complete
2. Realized - an event has occurred
which significantly increase the
likelihood of conversion into cash .
Mostly it the date of sale
Critical event in revenue
recognition
Critical event in revenue
recognition
The 'critical event' is the point in the
earnings process or operating cycle at
which the transaction is deemed to
have been sufficiently completed to
allow the profit arising from the
transaction, or a distinct component
part of it, to be recognised as income
in a particular period.
Revenue recognition at the
point of sale and delivery
This is the general rule as to
when revenue recognized
At this stage revenue is earned
and realized
The following will be considered
1. Revenue recognition at the time of
sale and delivery
2. Revenue recognition before delivery
3. Revenue recognition after delivery
4. Other Revenue recognition
situations
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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Recognition of revenue: sale of
goods
Solution
IAS 18 requires the following condition be
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 of
financial position
9/12 X 1,728,000=K1,296,000
Dr revenue K1,296,000
Cr deferred income 1,296,000
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 reliably
4. Probable that economic benefit will flow to
seller
5. Costs incurred or to be incurred can be
measured reliably
Point 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 ,the
amount for service is deferred and recognized
as revenue over the period during which the
service is performed .
The amount deferred must cover the cost of
service with the reasonable profit on those
services
The same rule applies to service ,interest
,royalties and dividend revenue
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
Question 2
A
computerized
accountancy
package is sold with one year's after
sales support. The cost of providing
support to one customer for one
year is calculated to be K100, 000.
The company has a mark-up on cost
of 15%. The product is sold for K700,
000. How should this sale be
accounted for?
Recognition of revenue from
service
According to stage of completion at reporting date.
All the following conditions should be met
1. The amount of revenue can be measured reliably
2. It is probable that the economic benefits associated
with the transaction will flow to the entity
The stage of completion of the transaction at the
reporting date can be measured reliably
4. The costs incurred for the transaction and the costs
to complete the transaction can be measured
reliably
If the above are not met recognize revenue to the
extent of expenses recognized that are recoverable
3.
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Question 3
Solution
On 1 July 20X3, Company A signs a contract with
customer under which Company A delivers an offthe-shelf IT system on that date and then
provides support services for the next three years.
The contract price is K3,700,000.The cost of the
support services is estimated at K300, 000 pa and
Company A normally makes a profit margin of
25% on such work. Company A makes up financial
statements to 31 December each year.
Required
What revenue should be recognized in the
financial statements for the year ended 31
December 2003?
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 return
Question 4
Revenue must only be
recognized once the return
period has elapsed
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
TITAs 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?.
Solution
From the total sales value only
K400,000 should be recorded in
revenue for the year to 31 December.
The remaining K400,000 is for
goods that are still being held under
a sale or return agreement and
therefore cannot be recognized in
the financial statements.
Solution
Adjustment needed
1.
Remove revenue under return agreement
Dr. Revenue
400,000
Cr. Receivables (SFP)
400,000
2.
Bring the goods back into inventory
Dr. Closing inventory(SFP)
Cr Cost of sales
320,000
320,000
(400,000/125 x 100)
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Agency sales
Question 4b
When acting as an agent only the
commission earned can be recorded as
revenue by the agent.
The principal is responsible for
recording the actual sales revenue in its
own financial statements.
GBMs 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 GBMs income
statement ?
Solution
Recognition of revenue from
Interest ,Royalties and Dividends
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 Dividends
The following bases are used to recognize
revenue for interest ,royalties and dividend
1. 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
Recognize revenue when:
1. It is probable that the
economic benefits associated
with the transaction will flow
to the entity; and
2. The amount of the revenue can
be measured reliably
Disclosure
The 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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Disclosure
2. 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 a
valid promise of payment ,
Condition exist that contractually
guarantee subsequent sale.
Accounting for this is discussed
under IAS 11 construction contracts
Revenue recognition after
delivery
Revenue recognition after
delivery
Applies if the collection of sales
is not reasonably assured and
revenue recognition is deferred.
2 methods are used to deferrer
revenue .
The installment method were
revenue is recognized when the
cash installment is received.
Cost recovery method revenue only
recognized when cash payments
exceeds the cost of sales
Expense recognition
Expense recognition
An expense is decreases in economic
benefits during the accounting period
in the form of outflows or depletions of
assets or incurrence of liabilities
Can be divided in to 3 categories
1. Direct matching
2. Systematic and rational
allocation
3. Immediate recognition
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Direct matching
Systematic and rational
allocation
This is where expenses are related
to specific revenues.
This involves assets that benefit more
Expenses include those related to
revenue although not incurred.
Recognition is done immediately
when related revenue is recognized
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
than one accounting period .
The cost of Non current assets are spread
Immediate recognition
Immediate recognition
Applies to expenses that are not
related to specific revenue but are
incurred to obtain goods and
services that indirectly help to
generate revenue.eg utilities
Since these are used immediately
they are recognized in the period of
acquisition
It is also applicable when future
benefits are highly uncertain e.g.
research and development
Most
loses
are
recognized
immediately e.g. loss from natural
disaster ,loss from disposal of
assets
