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Section 23 – Revenue.
23.1.1 Exclusions from Section 23.
23.2.1 Extract from FRS 102-Section 23.3-23.4.
23.2.2.1 Revenue – definition and basic requirements.
23.2.2.1.1 Definition of revenue.
23.2.2.1.2 Recognition criteria.
23.2.2.1.2.1 Definition of probable.
23.2.2.1.2.2 Reliable measurement
23.2.2.1.2.3 Sales incentives/rebates/settlement
23.2.2.1.3 Principal versus agent
23.2.2.1.3.1 Definition of an agent
23.2.2.1.3.2 Definition of a person acting as principal
23.2.2.1.3.3 Indication that a party is acting as principal
23.3.1 Extract from FRS 102- Section 23.5.
23.4 Exchanges of goods or services.
23.4.1 Extract from FRS 102 – Section 23.6-23.7.
23.5 Identification of the revenue transaction.
23.5.1 Extract from FRS 102 – Section 23.8-23.9.
23.5.2.2 Assessing whether separable identifiable components exist
23.5.2.2.1 Methods of allocating total consideration between components.
23.5.2.2.1.1 The relative fair value basis.
23.5.2.2.1.2 Cost plus a reasonable margin method.
23.5.2.3 Customer loyalty awards.
23.5.2.3.1 Issues to consider when determining the fair value of an award.
23.6.1 Extract from FRS 102 – Sections 23.10-23.13.
23.6.2.2 Revenue recognition criteria.
23.6.2.1.1 Example of risk and rewards of ownership transferring.
23.6.2.2.2 Assessing whether ongoing managerial involvement exists.
23.6.2.3 Right of return in exchange for cash/vouchers.
23.6.2.7 Sale of extended guarantee.
23.6.2.9 Recognition where risk and rewards of ownership based on shipment terms.
23.6.2.10 Sale of goods with retention of title clause.
23.6.2.11 Bill and hold sales.
23.6.2.12 Goods shipped subject to conditions.
23.6.2.14 Payments in advance.
23.6.2.15 Sale and repurchase agreements.
23.6.2.16 Sales to intermediate parties, such as distributors, dealers or others for Resale.
23.6.2.17 Subscriptions to publications and similar items.
23.6.2.18 Instalment sales, under which the consideration is receivable in instalments.
23.7 Agreements for the construction of real estate.
23.7.1 Extract from FRS 102 – Section 23A.14-23A.15.
23.8.1 Extract from FRS 102 – Sections 23.14-23.16, 23.21, 23.23-23.24.
23.8.2.1 Service recognition criteria.
23.8.2.1.1 Costs that relate to future activity.
23.8.2.1.2 Reliable measurements not probable.
23.8.2.1.3 Collectability no longer profitable.
23.8.2.1.4 Changes in estimates in revenues.
23.8.2.2 Intermediate number of acts over specified period.
23.8.2.3 Service with a significant act
23.8.2.4 Stage of completion method – 3 methods.
23.8.2.4.1 Proportion of costs method.
23.8.2.5 Other specific examples as extracted from the Appendix to Section 23 of FRS 102.
23.8.2.5.2 Servicing fees included in the price of the product
23.8.2.5.3 Advertising commissions.
23.8.2.5.4 Insurance agency commissions.
23.8.2.5.5 Financial services fees.
23.8.2.5.8 Initiation, entrance and membership fees.
23.8.2.5.9.1 Franchise fees: Supplies of equipment and other tangible assets.
23.8.2.5.9.2 Franchise fees: Supplies of initial and subsequent services.
23.8.2.5.9.3 Franchise fees: Continuing franchise fees.
23.8.2.5.9.4 Franchise fees: Agency transactions.
23.8.2.5.10 Fees from the development of customised software.
23.9.1 Extract from FRS 102 – Sections 23.17-23.27.
23.9.2.1 Definition of construction contract and its importance.
23.9.2.1.1 Requirements of length of a construction contract
23.9.2.2 Combination and segmentation of contracts.
23.9.2.3 Recognition of Contract revenue and contract costs.
23.9.2.4.1 Changes in fair value – reasons.
23.9.2.4.2 Penalties and variations – recognition and impact
23.9.2.4.3 Incentive payments.
23.9.2.5.1 Directly related contract costs.
23.9.2.5.2 Incidental income from directly related costs.
23.9.2.5.3 Costs directly attributable to the contract in general – overhead costs.
23.9.2.5.3.1 Costs excluded from directly attributable overhead costs.
23.9.2.5.4 Directly attributable costs to be excluded (specific costs)
23.9.2.6 Percentage of completion.
23.9.2.6.1 Methods to determine the percentage of completion.
23.9.2.6.1.1 Preparation of costs incurred over total expected costs.
23.9.2.6.1.2 Surveys of work performed.
23.9.2.6.1.3 Completion of physical preparation of contract work.
23.9.2.6.2 Assessment of which method to use.
23.9.2.7 Reliable measurement – stage of completion cost to complete.
23.9.2.8 Loss expected on contract
23.10.1 Extract from FRS102 – Section 23.29(a)
23.11.1 Extract from FRS102 – Section 23.29(b)
23.11.2.2 Assignment of rights.
23.11.2.3 Licence fee or royalty contingent on future events.
23.11.2.4 Points to consider when deciding recognition initially or over a period of time.
23.12.1 Extract from FRS102 – Section 23.29(c)
23.13.1 Extract from FRS102 – Section 23.30.
23.13.2.1 Accounting policies.
23.13.2.1.2 Acconting policy for insuracne broker
23.13.2.1.4 Accountig policy note where turnover is derived from investments.
23.13.2.1.5 Accounting policy for a software company.
23.13.2.1.6 Extract from accounting policy showing royalty income.
23.13.2.1.8 Contracting work – accounting policy.
23.13.2.2 Note to the financial statements.
23.13.2.2.1 Turnover and segmental analysis.
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23.6 Sale of goods
23.6.1 Extract from FRS 102 – Sections 23.10-23.13
23.10 An entity shall recognise revenue from the sale of goods when all the following conditions are satisfied:
(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
(c) the amount of revenue can be measured reliably;
(d) it is probable that the economic benefits associated with the transaction will flow to the entity; and
(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.
23.11 The assessment of when an entity has transferred the significant risks and rewards of ownership to the buyer requires an examination of the circumstances of the transaction. In most cases, the transfer of the risks and rewards of ownership coincides with the transfer of the legal title or the passing of possession to the buyer. This is the case for most retail sales. In other cases, the transfer of risks and rewards of ownership occurs at a time different from the transfer of legal title or the passing of possession.
23.12 An entity does not recognise revenue if it retains significant risks and rewards of ownership. Examples of situations in which the entity may retain the significant risks and rewards of ownership are:
(a) when the entity retains an obligation for unsatisfactory performance not covered by normal warranties;
(b) when the receipt of the revenue from a particular sale is contingent on the buyer selling the goods;
(c) when the goods are shipped subject to installation and the installation is a significant part of the contract that has not yet been completed; and
(d) when the buyer has the right to rescind the purchase for a reason specified in the sales contract, or at the buyer’s sole discretion without any reason, and the entity is uncertain about the probability of return.
23.13 If an entity retains only an insignificant risk of ownership, the transaction is a sale and the entity recognises the revenue. For example, a seller recognises revenue when it retains the legal title to the goods solely to protect the collectability of the amount due. Similarly an entity recognises revenue when it offers a refund if the customer finds the goods faulty or is not satisfied for other reasons, and the entity can estimate the returns reliably. In such cases, the entity recognises a provision for returns in accordance with Section 21 Provisions and Contingencies.
23.6.2 OmniPro comment
23.6.2.1 Overview
Section 23.10 to 23.11 of FRS 102 above details the specific requirement for when a sale should be recognised. See 23.6.2.2 for further details.
23.6.2.2 Revenue recognition criteria
The criteria for revenue recognition for the sale of goods as detailed in section 23.10 of FRS 102 are:
(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods (see 23.6.2.2.1);
(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold (see 23.6.2.2.2);
(c) the amount of revenue can be measured reliably (see 23.2.2.1.2.2);
(d) it is probable that the economic benefits associated with the transaction will flow to the entity (see 23.2.2.1.2.1); and
(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.
Probability has been discussed at 23.2.2.1.2.1.
23.6.2.2.1 Example of risk and rewards of ownership transferring
One of the key features for recognition is that the risks and rewards of ownership must have transferred before revenue is recognised. Examples of where risk and rewards of ownership may not have transferred and the entity does not retain either continuing managerial involvement or effective control over the goods as given in Section 23.12 of FRS 102 are:
(a) when the entity retains an obligation for unsatisfactory performance not covered by normal warranties;
(b) when the receipt of the revenue from a particular sale is contingent on the buyer selling the goods;
(c) when the goods are shipped subject to installation and the installation is a significant part of the contract that has not yet been completed; and
(d) when the buyer has the right to rescind the purchase for a reason specified in the sales contract, or at the buyer’s sole discretion without any reason, and the entity is uncertain about the probability of return.
See further discussions with regard to risk and rewards of ownership and shipping terms at 23.6.2.9.
23.6.2.2.2 Assessing whether ongoing managerial involvement exists.
In relation to the ongoing managerial involvement as stated in Section 23.10(b) of FRS 102 some indicators of this would be:
- Seller guarantees the return of the buyer’s investment, or a return on that investment, for a significant period
- Seller can control future onward sale price
- Seller has control over the re-sale of the goods
- The terms of the agreement mean that it is likely the purchase will return the goods to the seller
- The seller is responsible for the management of the goods after sale.
23.6.2.3 Right of return in exchange for cash/vouchers
Where an entity sells goods and allows customer to bring them back within a certain time of purchase for cash or vouchers as long as they are not damaged etc. then a certain level of revenue should be deferred/provision made for such returns. Where an entity has past experience about the level of returns this should be incorporated, if not the full amount should be deferred.
This is stated in section 23.13 of FRS 102.
Example 13: Right of return in exchange for cash/vouchers
A clothes retailer selling goods and provides the customer a right to return the goods within 20 days. Based on past experience 5% of customers return the goods in return for cash or vouchers. The margin on the sale is generally 20%. The total sales for the month were CU10,000.
At month end the Company should defer 5% of the sales revenue for the estimated returns and increase inventory/other assets by 5% of the cost. The journals to be posted would be:
| CU | CU | |
| Dr Revenue
(CU10,000*5%) |
500 | |
| Cr Deferred Income | 500 |
Being journal to defer the risk of returns
| CU | CU | |
| Dr Inventory/Other Asset (assuming the stock can be sold for more than its cost) | 400 | |
| Cr Cost of Sales
(CU10,000*80%=CU8,000 being the cost * 5%) |
400 |
The provision and asset is released as the clothes are returned or when the time period for the return lapses. The journal required on physical return is:
| CU | CU | |
| Dr Deferred Income (or revenue where provision is utilised in full) | XX | |
| Cr Bank (or deferred revenue where voucher issued) | XX |
23.6.2.4 Retention of title
Section 23.13 of FRS 102 makes it clear where an insignificant risk of ownership is retained this does not prevent revenue from being recognised. Therefore, where the seller holds as reservation of title until the goods are paid for, this would be considered to be insignificant and therefore the revenue should be recognised in full as substantially all of the risks and rewards are transferred assuming the remaining recognition criteria in section 23.10 of FRS 102 has been met.
23.6.2.5 Discount coupon
Where a coupon has been distributed the entity does not recognise a liability for the coupon issued. Instead the coupon is debited against revenue when it is redeemed.
Example 14: Discount coupons
Company A issued coupons in a local supermarket providing a discount of 10% on redemption.
In this case no provision is made at the time of issue as it is merely a cost of promoting the stores.
Example 15: Discount coupons – buy one get one free
Company A issued coupons in a local supermarket which allowed a customer to get a free raincoat when a pair of wellingtons is purchased.
In this case no provision is required on issuance unless they are onerous contracts. However, when the coupon is redeemed, the costs relating to the coupons (i.e. the discounts) are charged to cost of sales. This is a cost of sale and not a marketing cost. The revenue recognised is the price paid by the customer and the cost of sales is the costs of both products.
23.6.2.6 Gift vouchers
Example 16: Gift vouchers
Company A issues gift vouchers during the month for CU10,000.
The sale of the gift vouchers should be included within deferred revenue and revenue should not be recognised until the shorter of when:
- The vouchers are redeemed
- Vouchers pass the sell by date
- Where there is a long history that allows the Company to determine when it becomes remote that a voucher will be redeemed with the estimate adjusted based on changes in redemption patterns.
The journal required to account for the voucher is:
| CU | CU | |
| Dr Bank | XXX | |
| Cr Deferred Revenue/Voucher Liability | XXX |
23.6.2.7 Sale of extended guarantee
Example 17: Sale of extended guarantee
Company A sells a sofa with a standard guarantee of 6 months but provides an option to the customer to purchase an extended guarantee of one year.
In this instance recognition of the revenue for the purchase of the extended option only begins at the end of the normal 6 month period and from that date is released over the one year period of the extended warranty.
Note the normal guarantee provision is posted as a cost into cost of sales.
23.6.2.8 Interest free credit
Example 18: Interest free credit
Company A sells goods interest free to customers for 6 months. Company A enters into an arrangement with a finance company whereby the finance company pays Company A the invoice price less finance charges.
The net sales amount after deduction of the finance charges should be recognised in revenue.
23.6.2.9 Recognition where risk and rewards of ownership based on shipment terms
The timing of when the risk and rewards of ownership transfer differs depending on the terms of delivery. There are a number of shipping terms which have different meanings.
Where shipping terms are free on board (FOB), this would mean that the risk and rewards of ownership should transfer when the goods are loaded onto the ship at the sellors port. At that point the purchaser is required to insure and transport the products to the final destination and will incur loss if they are damaged on route. Revenue can be recognised in this instance once proof has been obtained that the goods are on the ship. This would be similar for the sipping term ‘carriage, insurance and freight’ (CIF).
However where the shipping terms and contract state that goods do not pass until it reaches the port of destination, then revenue cannot be recognised until that time. Obviously in all these cases the other requirements in Section 23.10 of FRS 102 should be complied with.
23.6.2.10 Sale of goods with retention of title clause
Section 23.10 of FRS 102 does not require title to have transferred instead it requires the risks and rewards of ownership to have transferred. Therefore where all the conditions have been met a sale can be recognised where a retention of title clause exists. The reservation of title is merely held as a fall back in the event of non-payment. This is stated in section 23.13 of FRS 102.
23.6.2.11 Bill and hold sales
See extract from the appendix to Section 23 FRS 102 below which details the revenue recognition requirements for bill and hold arrangements. A bill and hold merit arrangement is an arrangement where delivery is delayed at the buyer’s request, but the buyer takes title and accepts billing.
‘Bill and hold’ sales
The seller recognises revenue when the buyer takes title, provided:
(a) it is probable that delivery will be made;
(b) the item is on hand, identified and ready for delivery to the buyer at the time the sale is recognised;
(c) the buyer specifically acknowledges the deferred delivery instructions; and
(d) the usual payment terms apply.
Revenue is not recognised when there is simply an intention to acquire or manufacture the goods in time for delivery (Section 23A.3 of FRS 102).
23.6.2.12 Goods shipped subject to conditions
See extract from the appendix to Section 23 FRS 102 below which details the revenue recognition requirements for goods shipped subject to conditions. It is not always apparent when the installation is simple and therefore when revenue should be recognised. If it is difficult to ascertain or where installation is integral to the item, then revenue cannot be recognised until the installation is complete unless the fair value of the installation element can be determined. Where fair value of the separate element can be determined and it is a key part to show the product is functional then no revenue can be recognised for any goods delivered.
(a) Goods shipped subject to conditions: installation and inspection
The seller normally recognises revenue when the buyer accepts delivery, and installation and inspection are complete. However, revenue is recognised immediately upon the buyer’s acceptance of delivery when:
(b) the installation process is simple, for example the installation of a factory-tested television receiver that requires only unpacking and connection of power and antennae; or
(c) the inspection is performed only for the purposes of final determination of contract prices, for example, shipments of iron ore, sugar or soya beans (Section 23A.4).
(d) Goods shipped subject to conditions: on approval when the buyer has negotiated a limited right of return
If there is uncertainty about the possibility of return, the seller recognises revenue when the shipment has been formally accepted by the buyer or the goods have been delivered and the time period for rejection has elapsed (Section 23A.5).
(e) Goods shipped subject to conditions: consignment sales under which the recipient (buyer) undertakes to sell the goods on behalf of the shipper (seller)
The shipper recognises revenue when the goods are sold by the recipient to a third party (Section 23A.6 of FRS 102).
(f) Goods shipped subject to conditions: cash on delivery sales
The seller recognises revenue when delivery is made and cash is received by the seller or its agent (Section 23A.7 of FRS 102).
23.6.2.13 Lawaway sales
For layaway sales under which the goods are delivered only when the buyer makes the final payment in a series of instalments, the seller recognises revenue from such sales when the goods are delivered. However, when experience indicates that most such sales are consummated, revenue may be recognised when a significant deposit is received, provided the goods are on hand, identified and ready for delivery to the buyer (Section 23A.8 of FRS 102).
23.6.2.14 Payments in advance
For orders when payment (or partial payment) is received in advance of delivery for goods not currently held in inventory, for example, the goods are still to be manufactured or will be delivered direct to the buyer from a third party, the seller recognises revenue when the goods are delivered to the buyer (Section 23A.9).
23.6.2.15 Sale and repurchase agreements
For a sale and repurchase agreement on an asset other than a financial asset, the seller must analyse the terms of the agreement to ascertain whether, in substance, the risks and rewards of ownership have been transferred to the buyer. If they have been transferred, the seller recognises revenue. When the seller has retained the risks and rewards of ownership, even though legal title has been transferred, the transaction is a financing arrangement and does not give rise to revenue. For a sale and repurchase agreement on a financial asset, the derecognition provisions of Section 11 apply (Section 23A.10 of FRS 102). Examples of a sale and repurchase agreement in relation to a lease is given in Section 20-Leases at 20.12.3.2.
23.6.2.16 Sales to intermediate parties, such as distributors, dealers or others for Resale
The seller generally recognises revenue from such sales when the risks and rewards of ownership have been transferred. However, when the buyer is acting, in substance, as an agent, the sale is treated as a consignment sale (Section 23A.11 of FRS 102).
23.6.2.17 Subscriptions to publications and similar items
When the items involved are of similar value in each time period, the seller recognises revenue on a straight-line basis over the period in which the items are dispatched. When the items vary in value from period to period, the seller recognises revenue on the basis of the sales value of the item dispatched in relation to the total estimated sales value of all items covered by the subscription (Section 23A.12 od FRS 102).
23.6.2.18 Instalment sales, under which the consideration is receivable in instalments
The seller recognises revenue attributable to the sales price, exclusive of interest, at the date of sale. The sale price is the present value of the consideration, determined by discounting the instalments receivable at the imputed rate of interest. The seller recognises the interest element as revenue using the effective interest method (Section 23A.13 of FRS 102).
The inputted interest rate is either the difference between the price charged and the normal cash price or the rate that would be charged on borrowings to the customer a bank/third party.
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Examples
Example 1: Probable or possible criteria on sale.
Example 2: Sales incentives/rebates.
Example 6: Deferred payment example.
Example 7: Deferred payment example.
Example 8: Identifying separable components and allocating relative fair value.
Example 9: Identifying separable components and allocating relative fair value – goods.
Example 10: Relative fair value results in a loss.
Example 11: Cost plus a reasonable margin.
Example 12: Customer loyalty awards
Example 13: Right of return in exchange for cash/vouchers.
Example 15: Discount coupons – buy one get one free.
Example 17: Sale of extended guarantee.
Example 18: Interest free credit
Example 19: Construction real estate – buyer has the right to specify structural design.
Example 20: Construction real estate – buyer has no right to specify structural design.
Example 20A: Reliable measurement
Example 20B: Reliable measurement
Example 21: Stage of completion – detailed in the contract
Example 22: Stage of completion.
Example 23: Proportion of costs method.
Example 24: Insurance agency commissions.
Example 25: – Proportion of cost basis.
Example 26: Inability to reliably measure the contract
Example 28: Application of change in estimate.
Example 29 – Extract from the Accounting policy notes.
Example 32: Extract from notes to the financial statements for revenue derived by brokers.
Example 33: Extract from notes to the financial statements for construction contracts
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