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19 Example: applying the IFRS five-step model

19 Example: applying the IFRS five-step model

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(ii)



Identify the separate performance obligations in the contract. If a promised good or service is

not distinct, it can be combined with others.



(iii)



Determine the transaction price. This is the amount to which the entity expects to be 'entitled'.

For variable consideration, the probability – weighted expected amount is used. The effect of any

credit losses shown as a separate line item (just below revenue).



(iv)



Allocate the transaction price to the separate performance obligations in the contract. For

multiple deliverables, the transaction price is allocated to each separate performance obligation in

proportion to the stand-alone selling price at contract inception of each performance obligation.



(v)



Recognise revenue when (or as) the entity satisfies a performance obligation, that is when the

entity transfers a promised good or service to a customer. The good or service is only considered

as transferred when the customer obtains control of it.



Application of the five-step process to TeleSouth

(i)



Identify the contract with a customer. This is clear. TeleSouth has a twelve-month contract with

Angelo.



(ii)



Identify the separate performance obligations in the contract. In this case there are two distinct

performance obligations:

(1)

(2)



The obligation to deliver a handset

The obligation to provide network services for twelve months



(The obligation to deliver a handset would not be a distinct performance obligation if the handset

could not be sold separately, but it is in this case because the handsets are sold separately.)

(iii)



Determine the transaction price. This is straightforward: it is $2,400, that is 12 months × the

monthly fee of $200.



(iv)



Allocate the transaction price to the separate performance obligations in the contract. The

transaction price is allocated to each separate performance obligation in proportion to the standalone selling price at contract inception of each performance obligation, that is the stand-alone

price of the handset ($500 and the stand-alone price of the network services ($175 × 12 =

$2,100.00):

Performance obligation

Handset

Network services

Total



(v)



Stand-alone

selling price

$

500.00

2,100.00

2,600.00



% of total

19.2%

80.8%

100%



Revenue (=relative selling

price = $2,400 × %)

$

460.80

1,939.20

2,400.00



Recognise revenue when (or as) the entity satisfies a performance obligation, that is when the

entity transfers a promised good or service to a customer. This applies to each of the performance

obligations:

(1)



When TeleSouth gives a handset to Angelo, it needs to recognize the revenue of $460.80.



(2)



When TeleSouth provides network services to Angelo, it needs to recognize the total

revenue of $1,939.20. It’s practical to do it once per month as the billing happens.



Journal entries

On 1 January 20X4

The entries in the books of TeleSouth will be:

DEBIT

CREDIT



Receivable (unbilled revenue )

Revenue



Being recognition of revenue from the sale of the handset



28



1: Financial reporting framework  Part A Regulatory and ethical framework



$460.80

$460.80



On 31 January 20X4

The monthly payment from Angelo is split between amounts owing for network services and amounts

owing for the handset.

DEBIT

CREDIT

CREDIT



Receivable (Angelo)

$200

Revenue (1,939.20/12)

Receivable (unbilled revenue )(460.80/12)



$161.60

$38.40



Being recognition of revenue from monthly provision of network services and ‘repayment’ of handset



4.20 Presentation

Contracts with customers will be presented in an entity’s statement of financial position as a contract

liability, a contract asset or a receivable, depending on the relationship between the entity’s performance

and the customer’s payment.

A contract liability is recognised and presented in the statement of financial position where a customer

has paid an amount of consideration prior to the entity performing by transferring control of the related

good or service to the customer.

When the entity has performed but the customer has not yet paid the related consideration, this will give

rise to either a contract asset or a receivable. A contract asset is recognised when the entity’s right to

consideration is conditional on something other than the passage of time, for instance future performance.

A receivable is recognised when the entity’s right to consideration is unconditional except for the passage

of time.

In practice, this aligns with the previous IAS 11 treatment. Where revenue has been invoiced a receivable

is recognised. Where revenue has been earned but not invoiced, it is recognised as a contract asset.



4.21 Disclosure

The following amounts should be disclosed unless they have been presented separately in the financial

statements in accordance with other standards:

(a)



Revenue recognised from contracts with customers, disclosed separately from other sources of

revenue.



(b)



Any impairment losses recognised (in accordance with IFRS 9) on any receivables or contract

assets arising from an entity’s contracts with customers, disclosed separately from other

impairment losses.



(c)



The opening and closing balances of receivables, contract assets and contract liabilities from

contracts with customers.



(d)



Revenue recognised in the reporting period that was included in the contract liability balance at the

beginning of the period; and



(e)



Revenue recognised in the reporting period from performance obligations satisfied in previous

periods (such as changes in transaction price).



Other information that should be provided;

(a)



An explanation of significant changes in the contract asset and liability balances during the

reporting period



(b)



Information regarding the entity’s performance obligations, including when they are typically

satisfied (upon delivery, upon shipment, as services are rendered etc.), significant payment terms

(such as when payment is typically due) and details of any agency transactions, obligations for

returns or refunds and warranties granted.



(c)



The aggregate amount of the transaction price allocated to the performance obligations that are not

fully satisfied at the end of the reporting period and an explanation of when the entity expects to

recognise these amounts as revenue.



Part A Regulatory and ethical framework  1: Financial reporting framework



29



(d)



Judgements, and changes in judgements, made in applying the standard that significantly affect the

determination of the amount and timing of revenue from contracts with customers.



(e)



Assets recognised from the costs to obtain or fulfil a contract with a customer. This would include

pre-contract costs and set-up costs. The method of amortisation should also be disclosed.



4.22 Contracts where performance obligations are satisfied over time

These contracts are generally construction contracts, and it is possible that you will see this term used as

the old standard, IFRS 11 used it.

A company is building a large tower block that will house offices, under a contract with an investment

company. It will take three years to build the block and over that time it will obviously have to pay for

building materials, wages of workers on the building, architects' fees and so on. It will receive periodic

payments from the investment company at various predetermined stages of the construction. How does it

decide, in each of the three years, what to include as income and expenditure for the contract in profit or

loss?



Example: contract where performance obligations are satisfied over

time

Suppose that a contract is started on 1 January 20X5, with an estimated completion date of 31 December

20X6. The final contract price is $1,500,000. In the first year, to 31 December 20X5:

(a)

(b)

(c)

(d)



Costs incurred amounted to $600,000.

Half the work on the contract was completed.

Certificates of work completed have been issued, to the value of $750,000.

It is estimated with reasonable certainty that further costs to completion in 20X6 will be $600,000.



What is the contract profit in 20X5, and what entries would be made for the contract at 31 December

20X5?



Solution

This is a contract in which the performance obligation is satisfied over time. The entity is carrying out the

work for the benefit of the customer rather than creating an asset for its own use and it has an enforceable

right to payment for work completed to date. We can see this from the fact that certificates of work

completed have been issued.

IFRS 15 states that the amount of payment that the entity is entitled to corresponds to the amount of

performance completed to date, which approximates to the costs incurred in satisfying the performance

obligation plus a reasonable profit margin.

In this case the contract is certified as 50% complete. At 31 December 20X5 the entity will recognise

revenue of $750,000 and cost of sales of $600,000, leaving profit of $150,000. The contract asset will be

the costs to date plus the profit - $750,000. We are not told that any of this amount has yet been invoiced,

so no amount is deducted for receivables.



Summary of accounting treatment

Statement of profit or loss

(a)



30



Revenue and costs

(i)



Sales revenue and associated costs should be recorded in profit or loss as the contract

activity progresses.



(ii)



Include an appropriate proportion of total contract value as sales revenue in profit or loss.



1: Financial reporting framework  Part A Regulatory and ethical framework



(b)



(iii)



The costs incurred in completing that amount of the performance obligation are matched

with this sales revenue, resulting in the reporting of results which can be attributed to the

proportion of work completed.



(iv)



Sales revenue is the value of work carried out to date.



Profit recognised in the contract

(i)



It must reflect the proportion of work carried out.



(ii)



It should take into account any known inequalities in profitability in the various stages of a

contract.



Statement of financial position

(a)



Contract asset (presented separately under current assets)

Costs to date

Plus recognised profits

Less any recognised losses

Less receivables (amounts invoiced)

Contract asset (amount due from the customer)



(b)

(c)



Receivables

Unpaid invoices



$

X

(X)

X

(X)

X

(X)

X

X



Contract liability. Where (a) gives a net amount due to the customer this amount should be included

as a contract liability, presented separately under current liabilities.



Example

P Co has the following construction contract (performance obligations satisfied over time) in progress:

$m

750

225

340

290



Total contract price

Costs incurred to date

Estimated costs to completion

Progress payments invoiced and received



Now we will calculate the amounts to be recognised for the contract in the statement of profit or loss and

statement of financial position assuming the amount of performance obligation satisfied is calculated

using the proportion of costs incurred method.

1



Estimated profit

$m

750

(225)

(340)

185



Total contract price

Less costs incurred to date

Less estimated costs to completion

Estimated profit

2



Percentage complete

Costs to date / total estimated costs: 225 / (225 + 340) = 40%



Part A Regulatory and ethical framework  1: Financial reporting framework



31



3



Statement of profit or loss

Revenue (40% x $750)

Cost of sales (40% x (225 + 340))

Profit (40% x 185)



4



$m

300

(226)

74



Statement of financial position

Costs incurred to date

Recognised profits

Less receivable

Contract asset



$m

225

74

(290)

9



How would we account for this if it was a loss-making contract? We will reduce P Co’s contract price to

$550m.

1



Estimated loss

Total contract price

Less costs incurred to date

Less estimated costs to completion

Estimated loss



2



$m

550

(225)

(340)

(15)



Percentage complete

Costs to date / total estimated costs: 225 / (225 + 340) = 40%



3



Statement of profit or loss

Revenue (40% x $550)

Cost of sales (balancing figure)

Loss



4



$m

220

(235)

(15)



Statement of financial position

Costs incurred to date

Recognised loss

Less receivable

Contract liability



$m

225

(15)

(290)

(80)



4.23 Likely impact on companies

Revenue is generally an entity‘s most important financial performance indicator, and one extensively

scrutinised by analysts and investors. IFRS 15 is likely to impact on the timing, measurement,

recognition and disclosure of revenue. These impacts will require adjustments in policies, procedures,

internal controls and systems.



4.23.1 Timing of revenue

By far the most significant change in IFRS 15 is to the pattern of revenue reporting. Even if the total

revenue reported does not change, the timing will change in many cases.

The example of TeleSouth, our fictitious company in Section 4.19 above, illustrates this point. Under IAS

18 Revenue, the old standard, TeleSouth would not recognise any revenue from the sale of handset, on

the grounds that TeleSouth has given it to Angelo free. TeleSouth would view the free handset as a cost of

acquiring a new customer, and the cost would be recognised in profit or loss immediately.



32



1: Financial reporting framework  Part A Regulatory and ethical framework



Revenue from the provision of network services would be recognised on a monthly basis as follows:

DEBIT

CREDIT



Receivable/Cash

Revenue



$200

$200



TeleSouth’s year-end is 31 July 20X4, which means that the contract falls into more than one accounting

period. The impact of changing from IAS 18 to IFRS 15 for TeleSouth, for the year ended 31 July 20X4 is

as follows:

Performance obligation

Handset

Network services: (200 × 6)/ (161.60 × 6)

Total



Under IAS 18

$

00.00

1,200.00

1,200.00



Under IFRS 15

$

460.80

969.60

1,430.40



The variation in timing has tax implications, and if the tax rate changes, may have an overall effect on

profit.



4.23.2 Use of judgement

The standard will require entities to use more judgement and make more estimates than under IAS 18,

which, as seen from the example above, is simpler, although less realistic.



4.23.3 Retrospective application

IFRS 15 must be applied retrospectively, that is as if it has always been in place. Companies will therefore

need to re-perform any calculations performed under IAS 18 and adjust opening balances. This will be

labour intensive for companies with a lot of long-term contracts, particularly in the construction industry.



4.23.4 Practical implications

As the firm EY pointed out in an October 2014 briefing paper, it is not only accounting that is affected. EY

stated that IFRS 15 will require changes to a large number of business functions, including:

(a)

(b)

(c)

(d)

(e)

(f)

(g)

(h)

(i)

(j)



Project management

Tax planning

Business operations

Training and communication

Business operations

Management information

Investor relations

Legal issues

Human resources

IT systems



4.24 Topical example



Case Study

In September 2014, supermarket giant, Tesco made headline news amid claims that it had overstated its

first-half profits by some £250m. At the time of writing a full investigation has yet to take place, but it is

possible that the issue of incorrect timing of revenue recognition could definitely have played a part. IAS

18’s vagueness and inconsistency will not have helped in this respect, and has allowed scope for

aggressive earnings management, although this has not yet been demonstrated in the case of Tesco. In

particular, the timing of revenue has been a cause for criticism because of the lack of clear and

comprehensive guidance.



Part A Regulatory and ethical framework  1: Financial reporting framework



33



On the website Wiley Global Insight, Steve Colling wrote:

It appears that Tesco may have accelerated the recognition of revenue relating to suppliers’ rebates

(hence recognising revenue too early) and at the same time delayed the recognition of costs. The

result of this accounting treatment is that accounting profits are brought into the first half of the

year, with costs pushed into the second half of the year so that the profits look disproportionately

healthy in the first-half of the year.

[…]

Whether this new standard [IFRS 15] will lessen the potential for companies to adopt aggressive

earnings management in their revenue recognition policies remains to be seen. The steps in IFRS

15 do offer more clarity than IAS 18.



4.25 Recommended articles

Two Student Accountant articles, Revenue Revisited Parts 1 and 2, should be read, as they may give an

indication of the examining team’s focus. The first of the articles goes into detail on the five-step process

for revenue recognition. The second explores the issues surrounding the definition and nature of a

contract according to IFRS 15 in greater depth, as well as the scope of the standard and its interaction

with other standards. Key points to take away from the second article are the five criteria that must be met

before an entity can apply the revenue recognition model to a contract and these have been derived from

previous revenue recognition and other standards:



Criterion 1



The parties should have approved the contract and are committed to perform their

respective obligations.



Criterion 2



It is essential that each party's rights can be identified regarding the goods or

services to be transferred.



Criterion 3



It is essential that the payment terms can be identified regarding the goods or

services to be transferred.



Criterion 4



The contract must have commercial substance before revenue can be recognised



Criterion 5



It should be probable that the entity will collect the consideration due under the

contract.



Links are as follows.

Part 1: http://www.accaglobal.com/an/en/student/exam-support-resources/professional-exams-studyresources/p2/technical-articles/revenue-revisited1.html

Part 2: http://www.accaglobal.com/uk/en/student/exam-support-resources/professional-exams-studyresources/p2/technical-articles/revenue-revisited2.html



4.26 Question practice

Exam focus

point



34



A key member of the examining team recently emphasised that revenue recognition is an important topic,

so have a go at the questions below.



1: Financial reporting framework  Part A Regulatory and ethical framework



Question



Recognition



Discuss under what circumstances, if any, revenue might be recognised at the following stages of a sale.

(a)

(b)

(c)

(d)

(e)

(f)



Goods are acquired by the business which it confidently expects to resell very quickly.

A customer places a firm order for goods.

Goods are delivered to the customer.

The customer is invoiced for goods.

The customer pays for the goods.

The customer's cheque in payment for the goods has been cleared by the bank.



Answer

(a)



A sale must never be recognised before the goods have even been ordered by a customer. There is

no certainty about the value of the sale, nor when it will take place, even if it is virtually certain that

goods will be sold.



(b)



A sale must never be recognised when the customer places an order. No performance obligation

has been satisfied at that point. Even though the order will be for a specific quantity of goods at a

specific price, control over the goods has not yet been transferred to the customer. The customer

may cancel the order, the supplier might be unable to deliver the goods as ordered or it may be

decided that the customer is not a good credit risk.



(c)



A sale will be recognised when delivery of the goods is made only when:

(i)

(ii)



The sale is for cash, and so the cash is received at the same time; or

The sale is on credit and the customer accepts delivery (eg by signing a delivery note).



(d)



The critical event for a credit sale is usually the despatch of an invoice to the customer. At that

point the performance obligation has been satisfied. There is then a legally enforceable debt,

payable on specified terms, for a completed sale transaction.



(e)



The critical event for a cash sale is when delivery takes place and when cash is received; both take

place at the same time.

It would be too cautious or 'prudent' to await cash payment for a credit sale transaction before

recognising the sale, unless the customer is a high credit risk and there is a serious doubt about

his ability or intention to pay.



(f)



It would again be over-cautious to wait for clearance of the customer's cheques before recognising

sales revenue. Such a precaution would only be justified in cases where there is a very high risk of

the bank refusing to honour the cheque.



Question



Revenue recognition



Caravans Deluxe is a retailer of caravans, dormer vans and mobile homes, with a year end of 30 June

20X8. It is having trouble selling one model – the $30,000 Mini-Lux, and so is offering incentives for

customers who buy this model before 31 May 20X7:

(a)



Customers buying this model before 31 May 20X7 will receive a period of interest free credit,

provided they pay a non-refundable deposit of $3,000, an instalment of $15,000 on 1 August 20X7

and the balance of $12,000 on 1 August 20X9.



(b)



A three-year service plan, normally worth $1,500, is included free in the price of the caravan.



On 1 May 20X7, a customer agrees to buy a Mini-Lux caravan, paying the deposit of $3,000. Delivery is

arranged for 1 August 20X7.



Part A Regulatory and ethical framework  1: Financial reporting framework



35



As the sale has now been made, the director of Caravans Deluxe wishes to recognise the full sale price of

the caravan, $30,000, in the accounts for the year ended 30 June 20X7.

Required

Advise the director of the correct accounting treatment for this transaction. Assume a 10% discount rate.

Show the journal entries for this treatment.



Answer

The director wishes to recognise the sale as early as possible. However, following IFRS 15Revenue from

contracts with customers, he cannot recognise revenue from this sale because control of the caravan has

not been transferred, so the performance obligation has not been satisfied. This happens on the date of

delivery, which is 1 August 20X7. Accordingly, no revenue can be recognised in the current period.

The receipt of cash in the form of the $3,000 deposit must be recognised. However, while the deposit is

termed 'non-refundable', it does create an obligation to complete the contract. The other side of the entry

is therefore to deferred income in the statement of financial position.

The journal entries would be as follows:

DEBIT

CREDIT



Cash

Liability (deferred income)



$3,000

$3,000



Being deposit received in advance of the sale being recognised.

On 1 August 20X7, when the sale is recognised, this deferred income account will be cleared. In addition:

The revenue from the sale of the caravan will be recognised. Of this, $12,000 is receivable in two years'

time, which, with a 10% discount rate, is: $12,000/ 1.12 = $9,917. $15,000 is receivable on 1 August 20X7.

The service plan is not really 'free' – nothing is. It is merely a deduction from the cost of the caravan. The

service plan must be recognised separately at its stand-alone selling price of $1,500. It is deferred income

and will be recognised over the three year period as the performance obligation of providing a service plan

is satisfied.

The sales revenue recognised in respect of the caravan will be a balancing figure.

The journal entries are as follows:

DEBIT



Deferred income



DEBIT

DEBIT



Cash (1st instalment)

Receivable (balance discounted)



CREDIT



Deferred income (service

plan monies received in

advance)



CREDIT



Revenue (balancing figure)



$3,000

$15,000

$9,917

$1,500



$26,417



BPP Note. This question is rather fiddly, so do not worry too much if you didn't get all of it right. Read

through our solution carefully, going back to first principles where required.



5 Professional skills: guidance from the ACCA

FAST FORWARD



Marks are awarded for professional skills.

Ethics and professionalism are a key part of your ACCA qualification. Accordingly, the ACCA has stated

that marks for professional skills will be awarded at the Professional Level. The examiner has provided

specific guidance for P2 Corporate Reporting.



36



1: Financial reporting framework  Part A Regulatory and ethical framework



5.1 Professional Skills – Basis of the award of marks

Marks will be awarded for professional skills in this paper. These skills encompass the creation, analysis,

evaluation and synthesis of information, problem solving, decision making and communication skills.

More specifically they will be awarded for:

(a)



Developing information and ideas and forming an opinion.



(b)



Developing an understanding of the implications for the entity of the information including the

entity's operating environment.



(c)



Analysing information and ideas by identifying:

The purpose of the analysis

The limitations of given information

Bias and underlying assumptions and their impact

Problems of liability and inconsistency



(d)



Identifying the purpose of a computation and whether it meets its purpose.



(e)



Analysing information, drawing conclusions and considering implications, and any further action

required.



(f)



Identifying appropriate action in response to the information/analysis including advice or

amendments to the data.



(g)



Considering, discussing and combining ideas and information from diverse sources to arrive at a

solution or a broader understanding of the issues.



(h)



Analysing the information in the context of the views and reactions of the stakeholders.



(i)



Identifying solutions to problems or ranking potential solutions, or ways to manage the problem, or

recommending a course of action.



(j)



Exercising good judgement and an ethical approach to providing advice in line with:

Relevant standards

Stakeholders' interests

The stated objectives



(k)



Communicating effectively and efficiently in producing required documents including:

The intended purpose of the document

Its intended users and their needs

The appropriate type of document

Logical and appropriate structure/format

Nature of background information and technical language

Detail required

Clear, concise and precise presentation



There will be four marks awarded in each paper for the above professional skills. The marks will be

awarded in Questions 2, 3 and 4, but not in Question 1. Not all skills will be required in each paper.



Part A Regulatory and ethical framework  1: Financial reporting framework



37



Chapter Roundup





Corporate governance has been important in recent years and in the current syllabus it is important in the

context of ethical behaviour.







The 1989 Framework for the Preparation of Financial Statements was replaced in 2010 by the Conceptual

Framework for Financial Reporting. This is the result of a joint project with the FASB. In 2015 an ED was

issued with proposals for a revised Conceptual Framework.







Revenue recognition is straightforward in most business transactions, but some situations are more

complicated.







IFRS 15 Revenue from contracts with customers is concerned with the recognition of revenues arising

from fairly common transactions.









The sale of goods

The rendering of services

The use by others of entity assets yielding interest, royalties and dividends







Generally revenue is recognised when the entity has transferred promised goods or services to the

customer. The standard sets out five steps for the recognition process.







Marks are awarded for professional skills.



Quick Quiz



38



1



What is corporate governance?



2



Why is a conceptual framework necessary?



3



What are the disadvantages of a conceptual framework?



4



What are the seven sections of the IASB's Framework?



5



Which concept will be reintroduced in the Conceptual Framework under the proposals in the May 2015

Exposure Draft?



6



Revenue is generally recognised; under IFRS 15, as earned at the …………. …………. ………….

(fill in the blanks).



7



How is revenue measured?



8



How should revenue be recognised when the transaction involves the rendering of services?



1: Financial reporting framework  Part A Regulatory and ethical framework



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