Revenue Recognition & Ethics

• Session will cover revenue recognition and ethical issues

Revenue Recognition

• Recording a transaction involves accruals accounting, where revenue is recognized in advance of cash receipt

• Transactions need recognition when they occur

• Revenue includes income derived from an entity's ordinary activities like sales, services, interest, royalties, and dividends

• Normal trading or operating activities are ordinary ones

• The core principle of IFRS 15 requires revenue recognition that depicts promised goods or services to customers

• Transfer of goods and services is evidenced by the transfer of their control

A Five-Step Process

• Step 1: Identify the contract with a customer
• Step 2: Identify the separate performance obligations
• Step 3: Determine the transaction price
• Step 4: Allocate the transaction price to the performance obligations
• Step 5: Recognize revenue as, or when, a performance obligation is satisfied

Step 1: Identify the Contract with the Customer

• Contracts may be written, verbal, or implied.
• In IFRS 15, a contract signifies an agreement between two parties establishing rights and obligations
• Revenue from a contract is recorded when the parties have approved the contract
• Revenue from contracts can be accounted for if each party's rights and payment terms are identifiable
• Revenue from contracts includes any commercial substance and a probable selling entity

Step 2: Identify the Performance Obligations

• IFRS 15 mandates the identification of distinct performance obligations within a contract

• Performance obligations are promises to transfer goods or services to a customer

• Transferring distinct goods or services to a customer means the goods and services can be sold separately and have a distinct function

• Examples of transferring distinct goods or services include sale or resale of goods or services, acting as an agent to transfer goods or services, granting licenses, and granting options to purchase goods or services.

• If another party is involved, determine if the entity is the principal or agent

• A principal provides the good or service, while an agent arranges for another party to do so

• An entity becomes the principal if it controls goods/services before transfer to the buyer

Warranties

• Treatment of warranties depends on whether an extra service is received or whether the manufacturer warranty is for assurance the item will work as intended
• Warranties providing an extra service fall under IFRS 15 and are treated as a separate performance obligation
• Warranties offering assurance that the item will work as intended are recognized as a provision under IAS 37

Step 3: Determine the Transaction Price

• The transaction price is the consideration an entity expects in exchange for transferring goods or services

• Considerations:

  • Variable consideration
  • Financing
  • Non-cash

Variable Consideration

• Promised consideration may include a variable amount if the contract contains discounts, rebates, bonuses, and/or penalties
• An entity must estimate the amount it expects to receive
• The estimate is included in the transaction price if it is highly probable there will not be a significant revenue reversal when the uncertainty is resolved

Financing

• In determining the transaction price, an entity should adjust the promised amount of consideration for the effects of the time value of money
• A significant financing component may exist regardless of whether the promise of financing is explicitly stated in the contract or implied by the payment terms

Non-cash Consideration

• Any non-cash consideration (assets, products, or shares) is measured at fair value at the date of transfer
• If fair value cannot be determined, the stand-alone selling price of the goods or services should be used

Step 4: Allocate the Transaction Price

• The total transaction price is allocated to performance obligations based on standalone selling prices
• If a standalone selling price is not directly observable, then it must be estimated

Step 5: Recognize Revenue

• Recognize revenue when (or as) a performance obligation is satisfied.
• A performance obligation can be satisfied at a point in time or over time
• Judgment is used to determine whether it is okay to recognize revenue over time or at a point in time

Satisfied at a Point in Time

• This happens when the control transfers to the buyer
• Transfer of control is indicated when the customer has physical possession, has accepted, and has the significant risks and rewards of ownership, legal title; and the seller has a right to payment.

Satisfied Over Time

• IFRS 15 says that an entity only satisfies a performance obligation over time if one of the following criteria is met:
  • The customer simultaneously receives and consumes the benefits from the entity's performance
  • The entity is creating or enhancing an asset controlled by the customer
  • The entity cannot use the asset for an alternative use, and it can demand payment for its performance to date
• When the contract cannot be reliably determined, the revenue recognized is restricted to recoverable costs from the customer

Explore revenue recognition principles, including accruals accounting and IFRS 15. Understand the five-step process for recognizing revenue, starting with identifying the contract with the customer. Also includes ethical considerations.