Session outline Session outline: Introduction Objective Scope 6 Construction contracts IAS 11 1 Identification of transactions Timing of recognition Measurement of Revenue Sale of goods Rendering of services Interests, royalties and dividends Disclosures IAS 18, 5 28, 39 IAS 18 IAS 18, 39 4 IAS 18 Multiple elements IAS 18 SIC 31 3 2 Slide 3
What is revenue? 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. Slide 4
Exceptions Does NOT apply to leases agreements ; dividends from investments accounted for under the equity method ( IAS 28 Investments in Associates); insurance contracts within the scope of IFRS 4 Insurance Contracts; changes in the fair value of financial assets and financial liabilities or their disposal (IAS 39 Financial Instruments: Recognition and Measurement); changes in the value of other current assets; initial recognition and from changes in the fair value of biological assets related to agricultural activity ( IAS 41 Agriculture); initial recognition of agricultural produce ( IAS 41); and the extraction of mineral ores construction contracts (IAS 11) Slide 5
Key issues in Revenue Recogniton Identification of the Transaction Timing of Recognition Measurement of Revenue Other issues-gross vs Net Slide 6
Key issues in Revenue Recogniton Identification of the Transaction Timing of Recognition Measurement of Revenue Other issues-gross vs Net Slide 7
Identification of the transaction The recognition criteria are usually applied separately to each transaction however in certain circumstances it is necessary to Apply the recognition criteria to the separately identifiable components of a single transaction to reflect the substance of the transaction. Apply the recognition criteria to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole. Slide 8
Key issues in Revenue Recogniton Identification of the Transaction Timing of Recognition Measurement of Revenue Other issues-gross vs Net Slide 9
Timing of Recognition Sale of goods SALE OF GOODS: Risks/rewards transfer No continuing managerial involvement 6 Construction contracts 1 Probable inflow of benefits Revenue measurable reliably Costs measurable reliably 5 Probable benefits inflow Measurable costs incurred Measurable costs to complete 2 4 Multiple elements 3 Slide 10
Timing of recognition Services SERVICES: Percentage of completion Probable inflow of benefits 1 Sale of goods 2 The following is measurable reliably: Stage of completion Revenue 6 Probable benefits inflow Measurable costs incurred Costs incurred Costs to complete Measurable costs to complete 3 5 Interest 4 Slide 11
Timing of recognition Multiple elements Multiple elements IAS 18 para 13: In certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction to reflect substance. Identifying components of a transaction to reflect substance 1 2 Rendering of services 3 4 Combining if commercial effect cannot otherwise be understood linked transactions) 6 Dividends, royalties 5 Slide 12
Multiple Elements transactions 1. Separation of Elements A transaction may contain separately identifiable components that should be accounted for separately. Apply the revenue recognition criteria to each separately identifiable component of a single transaction to reflect the transaction's substance. To assess the transaction's substance, view from customers perspective customer views the purchase as one product Customer s Perspective customer perceives there to be a number of elements to the transaction,. Apply recognition criteria to transaction as whole Apply recognition criteria to each element separately. Slide 13
Multiple Elements transactions 2. Allocation of Consideration Revenue in respect of each separable component of a transaction = its fair value. Fair value = price that is regularly charged for an item when sold separately Total revenue > the sum of the fair value of the separable elements Total revenue < the sum of the fair value of the separable elements additional revenue attributable to the activity of managing the two elements of the contract additional revenue recognised when full contract substantially complete Difference = discount discount allocated between the separable components using: 1. relative fair values 2. cost plus a reasonable margin If overall loss on contract recognise immediately Slide 14
Timing of recognition Multiple elements The company sells computers. Fair values of components are: CPU 700 2 Rendering of services 3 Monitor 300 Keyboard 100 1,100 The price of PC as a whole 1,000 1 4 The company sold the whole PC but delivered only the CPU by year-end. 6 Dividends, royalties 5 Slide 15
Multiple elements Analysis: The company s receivable (total price) 1,000 If monitor and keyboard remains undelivered, the customer does not have to pay 300 + 100 = ( 400) Amount receivable for the delivered CPU: 600 Portion of the total price of the PC normally allocable to the CPU is 1,000 x 700 / 1,100 = 636 Recognise revenue of 600 on delivery of the CPU* (It depends). Slide 16
Multiple elements Classification in the P&L Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities. Multiple element transactions: Free gifts, marketing costs etc. Dr: Cash 100 Cr: Revenue 95 Cr: Liabilities 5 Dr: Cash 100 Cr: Revenue 100 Dr: Cost of sales 5 Cr: Liabilities 5 Slide 17
Exercise Multiple elements Practical examples: ABC TVs sale of big screen TVs and subsequent installation Southern telecom free DVD player Slide 18
Timing of recognition Interests INTEREST: Effective interest method Origination fees 3 Multiple elements 4 Commitment fees IAS 39 effective interest method 2 Right to payment established 5 1 6 Construction contracts Slide 19
Timing of recognition Royalties ROYALTIES: On accruals basis based on substance of the agreement Licencing upfront or defer? 4 Interest 5 Contingencies DIVIDENDS: When the right to receive payment is established 3 Right to payment established 6 Revenue or adjust the cost of the investment 2 Sale of goods 1 Slide 20
Timing of Recognition 2. No Continuing Managerial involvement Indicators of continuing managerial involvement or retention of effective control might include: Control over future price of the item. Responsible for the management of the goods subsequent to the sale. Transaction allows the buyer to compel the seller, or give an option to the seller, to repurchase the item. Guarantees the return of the buyer s investment or a return on that investment for a limited or extended period. Continuing Managerial Involvement Exists! No Sale! No Revenue! Slide 22
Timing of Recognition 2. No Continuing Managerial involvement Example: Entity A sells a racehorse to entity B. As part of the arrangement entity A continues to house and train the horse, determine which races the horse will enter and set stud fees for the horse. Should entity A recognise revenue on the sale of the horse to entity B? Ans: If a proper training agreement is in place that provides a market fee for the services that entity A provides and any winnings or fees achieved by the horse going to the buyer, it may be appropriate to recognise revenue on the sale. However, it would also be necessary to consider whether entity A had given any guarantees or incurred other obligations that may indicate it had not disposed of the significant risks and rewards of ownership of the horse Slide 23
Timing of Recognition Other issues 3.Revenue measurable reliably An entity can make reliable estimates after it has agreed with the other parties to the transaction on the following: each party's enforceable rights regarding the service to be provided and received by the parties; the consideration to be exchanged; and the manner and terms of settlement. The entity reviews and, when necessary, revises the estimates of revenue as the service is performed. The need for such revisions does not necessarily indicate that the outcome of the transaction cannot be estimated reliably Slide 24
Timing of Recognition Other issues 4. Costs measurable reliably Goods manufactured for sale All manufacturing costs IAS 2 Inventories Goods purchased for resale All purchase costs New entity/ product Pre-production cost segregated from manufacturing cost Contracts for services IAS 11 Construction Contracts Price paid or production cost Slide 25
Timing of Recognition Other issues 5. Probable inflow of benefits Revenue recognised only when it is probable that the economic benefits associated with the transaction will flow to the entity. This may not be probable until the consideration is received or an uncertainty is removed. For e.g. it may be uncertain that a foreign governmental authority will grant permission to remit the consideration from a sale in a foreign country. When the permission is granted, the uncertainty is removed and revenue is recognised. When an uncertainty arises -the uncollectible amount included in revenue recognised as an expense, not an adjustment of revenue already recognised. Slide 26
Key issues in Revenue Recogniton Identification of the Transaction Timing of Recognition Measurement of Revenue Other issues-gross vs Net Slide 27
Measurement of revenue Revenue shall be measured at the fair value* of the consideration received or receivable. determined by agreement between the entity and the buyer or user of the asset; after any trade discounts and volume rebates; *Fair Value is defined as the amount for which an assets could be exchanged or a liability settled between knowledgeable willing parties, in an arm s length transaction. Slide 28
Measurement of revenue-i Consideration in the form of cash or cash equivalents Revenue = amount of cash or cash equivalents received or receivable. Other issues: Whether a principal/agency relationship exists. If an entity is acting as an agent in a relationship, revenue should only be recognised to the extent that it represents payment for acting as an agent The existence of trade discounts, volume rebates and other incentives,which should be taken into account in measuring the fair value of the consideration received. Whether the transaction forms part of a multiple element transaction. Where this is the case, the total consideration should be allocated to each element of the transaction Slide 29
Measurement of revenue-ii Consideration is deferred Both a sale and financing transaction. Revenue = Discounted fair value of consideration* * The discount rate is the more clearly determinable of the following: the prevailing rate for a similar instrument of an issuer with a similar credit rating; or a rate of interest that discounts the nominal amount of the instrument to the current cash sales price of the goods or services. The difference between the fair value and the nominal amount of the consideration is recognised as interest revenue (as per IAS 39) Slide 30
Key issues in Revenue Recogniton Identification of the Transaction Timing of Recognition Measurement of Revenue Other issues-gross vs Net Slide 31
Agency Arrangements Principal or Agent? expectation by the customer that the entity is acting as the primary obligor in the arrangement. freedom to set the selling price with the customer. assumes inventory risk performs part of the services provided or modifies the goods supplied. assumes the credit risk discretion in selecting suppliers Principal! Gross Reporting! (illustrative) If these conditions not satisfied NET REPORTING! Refer other PPT Slide 32
Other issues Matching Concept Revenue and expenses that relate to the same transaction or other event are recognised simultaneously; this process is commonly referred to as the matching of revenues and expenses. E,.g Expenses, including warranties and other costs to be incurred after the sale can normally be measured reliably when the other conditions for the recognition of revenue have been satisfied. Hence cost should be provided for at the time the sale is recognised If expense not measurable reliably - revenue not recognised any consideration already received - recognised as a liability. Slide 33
Rendering of services Outcome of a transaction estimated reliably Stage of completion method Outcome be estimated reliably if: revenue measured reliably; probable that economic benefits flow to the entity; the stage of completion measured reliably; and the costs incurred for the transaction and the costs to complete the transaction can be measured reliably Slide 34
Rendering of services Outcome cannot be estimated reliably revenue recognised = recoverable expenses. During the early stages of a transaction, it is often the case that the outcome of the transaction cannot be estimated reliably. Is it probable that the entity will recover the transaction costs incurred? YES Revenue is recognised only to the extent of costs incurred that are expected to be recoverable. No profit is recognised. NO Revenue is not recognised The costs incurred are recognised as an expense. When the uncertainties that prevented reliable estimation no longer exist, revenue is recognised Slide 35
Rendering of services Measurement of Revenue - by Percentage of Completion method depending on nature of transaction,methods may include surveys of work performed; services performed to date as a percentage of total services to be performed; or the proportion that costs incurred to date bear to the estimated total costs of the transaction. Only costs that reflect services performed to date are included in costs incurred to date. Progress payments and advances received from customers often do not reflect the services performed. Slide 36
Rendering of services Treatment of certain specific services Performance over Time services are performed by an indeterminate number of acts over a specified period of time, Revenue is recognised on a straight-line basis unless a better method represents the stage of completion. Contracts containing significant acts recognised when significant act is executed. Slide 37
Rendering of services Contracts with milestone payments- payment of cash upon the achievement of certain milestones identified in the contract. Accounting is generally very complex. Following points need to be considered The reasonableness of the payments compared to the effort, time and cost to achieve the milestones. The nature of royalty or licence agreements relating to the product being developed. The existence of any cancellation clauses. The risks associated with achievement of milestones. Any obligations that must be completed to receive payment under the contract or the existence of penalties for failure to deliver. Slide 38
Measurement of revenue- Barter transactions Goods or services are exchanged or swapped for goods or services which are of a similar nature and value? YES NOT a transaction which generates revenue. NO a transaction which generates revenue. Can fair value of goods and services received be measured reliably? YES revenue is measured at the fair value of the goods or services received, adjusted by the amount of any cash or cash equivalents transferred. NO the revenue is measured at the fair value of the goods or services given up, adjusted by the amount of any cash or cash equivalents transferred. Slide 39
Barter transaction for advertising SIC 31 SIC 31 then states that the seller can only reliably measure the fair value of advertising services it provides in the exchange by reference to non-barter transactions. For such evidence to be sufficient for reliable measurement the nonbarter transactions must: Involve advertising similar to the advertising in the barter transaction. Occur frequently. Represent a predominant number of transactions and amount when compared to all transactions to provide advertising that is similar to the advertising in the barter transaction. Involve cash and/or another form of consideration (for example, marketable securities, non-monetary assets and other services) that has a fair value that is reliably measurable. Not involve the same third party as in the barter transaction. Slide 40
Customer Loyalty Programmes- IFRIC 13 Customer loyalty programmes, which, deals with point schemes or award credits'. Such as points earned through the purchase of goods or services can only be redeemed for goods and services provided by the issuing entity. points earned through the purchase of goods or services cannot be redeemed for goods or services sold by the issuing entity. points earned through the purchase of goods or services can be redeemed either at the issuing entity or at other entities that participate in the loyalty programme. Examples are airlines that offer 'free' air miles and supermarkets that offer loyalty cards that accumulate points that can then be used to reduce the cost of future purchases or may sometimes be redeemable for cash Slide 41
IFRIC 15 Agreements for the Construction of Real Estate Construction contract or sale of goods? CONSTRUCTION OF AN ASSET IFRIC 15 SPECIFICALLY NEGOTIATED a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or ultimate purpose or use. Slide 42
Construction contract or sale of goods? Specify major structural elements (before/during construction) Limited ability to influence design IAS 11 IAS 18 IFRIC 15 whether analogy shall be applied Slide 43
Disclosures Slide 44
Disclosures An entity shall disclose: the accounting policies adopted for recognition of revenue. methods adopted to determine the stage of completion of transactions in rendering of services. the amount of revenue arising from exchange of goods or services in each significant category. Slide 45
Disclosures the amount of each significant category of revenue recognised during the period, including revenue arising from: sale of goods rendering of services interests dividends royalties Slide 46
Revenue Recognition Overview in Select Industries 1. Telecom 2. Banking & Leasing 3. Investment Banking 4. Automobile 5. FMCG/Pharma/Retail 6. Contract Manufacturing 7. Biological asset 8. Airline 9. Real Estate 10.Software Slide 47
Key Differences Between Indian GAAP and IFRS 1. Additional conditions Cost measurable reliably 2. Additional conditions - Significant managerial involvement 3. Bill and hold transactions 4. Real estate sales 5. Financial income 6. Service Concession agreement Covered separately 7. Agriculture Covered separately 8. Barter Transactions; advertising & non-advertising 9. Receiving shares for services rendered. 10. Gross Consideration v/s Fair Value of Consideration 11. Multiple Deliverables Slide 48
Revenue recognition Quick quiz Scenarios 1 Entity which does not retains an obligation for unsatisfactory performance not covered by normal warranty provisions can recognise the revenue immediately 2 When the receipt of the revenue from a particular sale is contingent on the derivation of revenue by the buyer from its sale of the goods, the seller can not recognised the revenue immediately. 3 Revenue can not be recognised when, the goods are shipped subject to installation and the installation is a significant part of the contract which has not yet been completed by the entity. 4 Revenue should not be recognised when the buyer has right to rescind the purchase for a reason specified in the sales contract and the entity is uncertain about the probability of return. 5 If an entity retains only an insignificant risk of ownership, the transaction is a sale and revenue is recognised. 6 Seller can recognise the revenue where transaction allows the buyer to compel the seller, or give an option to the seller, to repurchase the item. 7 If seller guarantees the return of the buyer s investment or a return on that investment for a limited or extended period, revenue can not be recognised immediately. Revenue Recognition Slide 49
Any Questions? Slide 50
Let s Recap
Thank You. CA Arpit Mundra + 91 98 33 881398 arpit.mundra@rediffmail.com This presentation has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this presentation without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this presentation, and, to the extent permitted by law, Arpit Mundra or the entity for which he works, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this presentation or for any decision based on it. Without prior written permission of Arpit Mundra, the contents of this presentation may not be quoted in whole or in part or otherwise referred to in any documents. Moreover, the presentation has to be considered along-with the session given by Arpit Mundra and not on as it is, standalone or any other basis.