Topic 10: Revenue Recognition Financial Accounting BFA201 Readings and references • Deegan Chapter 15 • AASB Framework • AASB 118 Revenue • AASB 111 Construction Contracts • AASB 101 Presentation of Financial Statements 2 Learning Objectives • Define and apply the concepts of income, revenue and gains • Apply the requirements of AASB 118 for the recognition and measurement of revenue • Able to explain the issues associated with recognising revenues for long-term construction projects 3 New Requirements • There is a joint project being conducted by IASB and FASB in the development of a new accounting standard to address revenue derived from contracts with customers • This new standard will replace two of the current AASBs that are the topic of today’s session: AASB 118 Revenue and AASB 111 Construction Contracts. • An exposure draft was released in 2011 for this converged standard. • Subsequent comments and deliberations of the IASB and FASB have occurred. • It was determined at the February 2013 IASB meeting that a final standard would be prepared and this would be applicable for reporting periods beginning on or after 1 January 2017 4 New Requirements • The reason for the development of the new converged standard was that it was argued that the recognition of revenue for some transactions as required under AASB 118 and AASB 111 were inconsistent with the definition and recognition criteria for revenue in the IASB conceptual framework. • Recognition criteria in these current standards use a recognition criteria dependent upon whether the transaction transferred the ‘risks and rewards’ of ownership of assets rather than ‘control’ of assets as required by the framework • Adopting this view, the proposed new standard embraces the view that revenue recognition should be a direct function of whether goods and services have been transferred to the control of the customer. • We will be discussing the current AASB 118 and AASB 111 in this lecture, but will try to anticipate the potential changes that 5 will come about because of the new converged standard. AASB Framework: Income Definition of Income and Revenue • Income and expenses are not defined by AASB 101 and therefore we must look to the AASB Framework • Income is defined under the AASB Framework (para 70) as: • • Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases in liabilities that result in an increase in equity, other than those relating to contributions from equity participants The AASB Framework (para 74) reinforces the point that income is divided into ‘revenues’ and ‘gains’ Definition of income and revenue Income Revenues Ordinary activities (par 74) Sales, fees, rent, interest, div. royalties Gains Other income – eg.Sell NCA; revaluations; (par 75-76); displayed separately; often net of related expenses 8 Definition of Income and Revenue • Revenues (para. 74 of the AASB Framework) • • revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names (including sales, feeds, interest, dividends, royalties and rent) Gains (paras 74 and 75 of AASB Framework) • Other items that meet the definition of income and may or may not arise in the course of the ordinary activities of an entity. Gains represent increases in economic benefits and as such are not different in nature from revenue. Definition of Income and Revenue Revenues and gains (par. 75, AASB Framework): • Gains include those arising on the disposal of non- current assets. • The definition of income also includes unrealised gains, for example those arising on the revaluation of marketable securities and those resulting from increases in the carrying amount of long-term assets. • When gains are recognised in the income statement, they are usually displayed separately because knowledge of them is useful in making economic decisions. • Gains are often reported net of related expenses. Definition of Income and Revenue • Generally speaking, revenues relate to the ordinary incomegenerating activities of an entity, e.g. sales or rental receipts • Gains relate to ‘other income’—not necessarily part of the ordinary activities of an entity • When gains are recognised in the income statement, they are usually displayed separately because knowledge of them is useful in making economic decisions. Gains are often reported net of related expenses. • Differentiation based on some degree of professional judgment • What is an ‘ordinary’ activity for one business may not be ‘ordinary’ for another—so the benefits might be deemed ‘revenue’ in one entity and a ‘gain’ in another Recognition of Income • AASB Framework (para 83) provides that an element of a financial statement should be recognised if: • • • The item has a cost or value that can be measured reliably; and It is probable that any future economic benefit associated with the item will flow to or from the entity. Para 92 also indicates that income is recognised in the income statement (statement of comprehensive income) when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. AASB 118 Revenue Definition of Revenue Scope of AASB 118 ‘Revenue’ is fairly restricted—applied to accounting for revenue arising from transactions and events relating to (par. 1): a) the sale of goods b) the rendering of services c) the use by others of entity assets yielding interest, royalties and dividends Note that the AASB Framework provides a general definition – you should note the difference. Measurement of Revenue Where revenue has been recognised, AASB 118 requires that the revenue be measured at the fair value of the consideration or contributions received or receivable (par. 9) – If cash is not to be received for some period of time the future amount to be received would need to be discounted to its present value and the present value recognised as revenue (refer to AASB 118, par. 11) – If cash is received for goods and services provided the revenue recorded is equal to the cash received 15 Measurement of Revenue • Measured at fair value of consideration (see definition of fair value at para 7) taking into account any trade or volume discounts • Usually the consideration is in the form of cash or cash equivalents. • Where the inflow of cash or cash equivalents is deferred it will be necessary to discount the deferred amount to the present value (see para 11) • Where goods are exchanged or swapped: – Similar in nature, then there is not a transaction that generates revenue; – Dissimilar in nature, there is a transaction and the revenue is measured at the fair value of the goods or services received. Recognition of Revenue • The AASB Framework provides that revenue is recognised when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably. • However, AASB 118 takes these general criteria and adds two or three more for each of the types of transactions (sale of goods; services; and interest, royalties and dividends). Recognition criteria: sale of goods para. 14 . PLUS 3 extra Common 2 Probable FEBs Revenue measured reliably Transferred risks & rewards Control / mgement Costs measured reliably 18 Recognition of Revenue Revenue from the sale of goods is to be recognised when all of the following conditions have been satisfied (paras 16 and 17): • • • • • the entity has transferred to the buyer the significant risks and rewards of ownership of the goods the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods the amount of revenue can be measured reliably it is probable that the economic benefits associated with the transaction will flow to the entity the costs incurred or to be incurred in respect of the transaction can be measured reliably Recognition of Revenue • The Appendix to AASB 118 also gives guidance in relation to the recognition of different types of revenues. For example: • • • • • • • For example, the Appendix looks at sales of goods subject to conditions. For example: • • • • • Goods sold subject to conditions; Lay-by sales Orders when partial payment received in advance Subscriptions to publications Instalment sales Real estate sales. Returns Sale and leaseback Call and put options Customer loyalty programs And provides guidance for recognition Returns • Company sells its product with right for customer to return the product • Revenue from the sales transaction may be recognised at time of sale if the company is reasonably assured to be entitled to the revenue (calculated by prior experience) – a refund liability and an asset relating to right to recover the product will be recognised 21 Example - Returns • Company sells 500 products for $100 each, expects to have 1% returned. • Return policy is 30 days for full refund. • Cost of each product is $70. • Prepare journal entries for the above. 22 Solution Cash at bank 50,000 Revenue 49,500 Refund liability Cost of good sold Right to recover Inventory 500 34,650 350 35,000 23 Solution When customer returns goods: Refund liability 500 Cash at bank Inventory Right to recover 500 500 500 24 Customer Loyalty Programmes • Loyalty award credits: sales transaction results in sale and also future redemption of free or discounted goods or services Dr Revenue Cr Deferred revenue Recognition of awarding of award points Dr Deferred revenue Cr Revenue Recognition of redemption of award points 25 Recognition Criteria: rendering of services para. 20 26 Recognition Criteria: Services • Where the revenues arise from providing services, there are additional recognition requirements (para. 20): • AASB 118 requires the use of the percentage of completion method for revenue arising from the provision of services. • When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognised by reference to the stage of completion of the transaction at the end of the reporting period. • However, note the common criteria: revenue can be measured reliably AND Probably economic benefits associated with the transaction will flow to the entity • Construction contracts are a good illustration of these recognition criteria being applied. Recognition Criteria: interest, royalties, dividends para. 29 and 30 28 Unearned revenue – liability! Allen Ltd rents a building to Moore Ltd for $12,000 payable twelve months in advance on 1 June 2012. 1 June 2012 Cash at bank 12,000 Rent received in advance 30 June 2012 Rent received in advance Rent income 12,000 1,000 1,000 29 AASB 111 Construction Contracts Construction Contracts 31 Accounting issues • Contracts span several reporting periods • What’s the value of a partly completed job? • When do you recognise revenues & expenses? AASB111 requires: • Percentage-of-completion method 32 Accounting for construction contracts (AASB 111) • Accounting issues result from some construction projects taking a number of financial periods to complete – Should revenue be recognised progressively throughout the contract? – If so, how would the amount of revenue be determined? • Deferral of revenue recognition until completion of project would result in greater volatility of reported revenues and of related profits or losses Accounting for construction contracts – AASB 111 Definition • Construction contract defined (AASB 111, par. 3): – 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 of their ultimate purpose or use Construction Contract - Definition • A contract relating to the construction of an item or a combination of items and including: – contract to design, build, construct or produce – contract relating to the supervision and coordination of construction activity – contracts for architectural, engineering and other services relating to construction activity (AASB 111 para 4) Accounting for construction contracts – Definition Accounting requirements • Individual construction contracts must be accounted for separately and the requirements of the standard must be applied separately to each contract Accounting for construction contracts – Recognition and Measurement Accounting requirements • AASB 111 requires (if certain criteria are satisfied) that contractors use the percentage-of-completion method to account for construction contracts • Profit on construction contract is recognised in proportion to the work performed in each reporting period in which construction occurs Accounting for construction contracts – Recognition and Measurement • Percentage-of-completion method should be used provided that certain conditions are met that enable the outcome of the contract to be reliably estimated AASB 111 (par. 22): • When the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract are to be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date Accounting for construction contracts – Types Types of construction contracts • Fixed-price contracts • Cost-plus contracts • Type of contract determines the conditions that must be satisfied to use the percentage-of-completion method • AASB 111 paragraph 3 has definitions Accounting for construction contracts – Fixed price Conditions of use of percentage-of-completion method (AASB 111, par. 23): • With fixed-price contract: – total contract revenue can be measured reliably; – it is probable that economic benefits arising from the contract will flow to the contractor; – both the contract costs to complete the contract and stage of contract completion as at reporting date can be measured reliably; and – the contract costs attributable to the contract can be clearly identified and measured reliably so that actual costs can be compared with prior estimates. 40 Accounting for construction contracts – Cost-Plus Conditions of use of percentage-of-completion method (AASB 111, par. 24): • With cost-plus contract: – it is probable that the economic benefits arising from the contract will flow to the contractor; and – the contract costs attributable to the contract, whether or not specifically reimbursable can be clearly identified and measured reliably 41 Accounting for construction contracts – Recognition and Measurement If conditions are not satisfied: • no profit is to be brought to account until they are satisfied • at the extreme, no profit to be recognised until project completion Note: When outcome of construction contract cannot be estimated reliably (AASB 111, par. 32): (a) revenue is to be recognised only to the extent of contract costs incurred that it is probable will be recoverable; and (b)contract costs are to be recognised as an expense in the period in which they are incurred Accounting for construction contracts Measurement Measuring progress towards completion • Percentage of completion can be measured in a number of ways (per AASB 111, par. 30): – The entity uses the method that measures reliably the work performed. Depending on the nature of the contract, the methods may include: (a) in the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs; (b) surveys of work performed; or (c) completion of physical proportion of the contract work. • Progress payments and advances received from customers often do not reflect the work performed Accounting for construction contracts Measurement Measuring progress towards completion Cost basis: • The percentage of completion is measured by comparing costs incurred to date with the most recent estimate of the total costs to complete the contract • Only those contract costs that reflect the work performed are included in costs incurred to date. Examples of contract costs excluded are: – contract costs that relate to future activity on the contract, such as costs of materials delivered or set aside but as yet not installed, used or applied – payments made to subcontractors in advance of work performed 44 Accounting for construction contracts Types of costs incurred by contractors (a) Costs related directly to a specific contract, e.g. direct materials, direct labour, depreciation of equipment, costs of moving plant and equipment, expected warranty costs, costs of design and technical assistance directly related to contract, costs of securing contract, costs of hiring plant and equipment (b) Costs that are attributable to contract activity in general and capable of being allocated on a reasonable basis to specific contracts, e.g. tender preparation, insurance, design and technical assistance Accounting for construction contracts Types of costs incurred by contractors (continued) (c) Costs that relate to the activities of the reporting entity generally or that relate to contract activity generally and are not normally related to specific contracts, e.g. general administration and selling costs, finance costs and research and development costs not directly related to contract Note: • Costs (a) and (b) are normally included in accumulated contract costs • Costs (c) are usually excluded from accumulated contract costs because they do not relate to reaching the present stage of completion of a specific contract Measuring progress COST method - proportion of costs incurred for work performed to date % Complete = Costs incurred to date Most recent estimate of total costs Current period revenue = Estimated TOTAL revenue X % complete LESS revenue previously recognised 47 Accounting for construction contracts Measurement Journal entries for construction contract accounting • To record costs of construction: Dr Construction in process Cr Materials, cash, payables, etc. • To record billings to customers: Dr Accounts receivable Cr Billings on construction in process Accounting for Construction Contracts Measurement Journal entries for construction contract accounting • To record collections of billings: Dr Cash Cr Accounts receivable • To record contract revenue and contract expenses: Dr Construction in process Dr Construction expenses (costs incurred) Cr Revenue from long-term contracts Accounting for construction contracts Measurement Journal entries for construction contract accounting To record final approval of contract: Dr Billings on construction in process Cr Construction in process Construction contracts summary 2. Bill customers Dr Accounts receivable Cr Billings on contracts in progress 1. Record costs to date Dr Construction in progress Cr Cash / Accounts payable 3. Record cash received Dr Cash Cr Accounts receivable 4. Record profit based on % completed Dr Construction in progress (year’s profit) Dr Construction expenses (costs) Cr Revenue – long term construction Prepare 1. 2. 3. 4. 5. 5. On completion: Dr Billings on C.I.P Cr Construction in progress schedule of costs for each year – calculating… Costs incurred for year AND total accumulated costs to date Total estimated costs to complete contract Percentage complete (total costs to date ÷ total est. costs) Estimated total gross profit/loss (total contract price – total est. costs) Gross profit recognised for the year (est. total profit x % complete) [recognise LOSS immediately] 51 Accounting for construction contracts Measurement Application of percentage-of-completion method to account for construction contracts – Lecture Example 2.1 Part A (a) and (b) – Lecture Example 2.1 Part A (c) – outcome cannot be reliably measured Lecture Case Study XYZ signs a contract on 30 June 2006, agreeing to build a bridge for ABC at a contract price of $40million. XYZ estimates that construction costs will be as follows: Year ending Cost 30 June 2007 30 June 2008 30 June 2009 $10m $16m $ 6m $32m Payments on each 30 June $ 8m $ 20m $ 12m $ 40m The contract is completed as expected on 30 June 2009. Assume that actual costs & cash collections occurred. a. Calculate yearly income b. Provide journal entries assuming these CAN be reliably estimated c. Provide journal entries for each year assuming stage & outcome cannot be reliably measured. 53 Solution – Case Study (a) 2007 40,000,000 2008 40,000,000 2009 40,000,000 10,000,000 22,000,000 32,000,000 8,000,000 31.25% 26,000,000 6,000,000 32,000,000 8,000,000 81.25% 32,000,000 8,000,000 31.25% 2,500,000 20X8 Less profit already recognised Profit recognised in year 8,000,000 81.25% 6,500,000 2,500,000 4,000,000 20X9 Less profit already recognised Profit recognised in year 8,000,000 1.00 8,000,000 6,500,000 1,500,000 Contract Price Less Estimated cost Costs to date Estimated costs to complete Estimated total cost Estimated total gross profit/loss Percent complete Gross Profit recognised in: 20X7 32,000,000 8,000,000 100.00% 54 Solution – Case Study (b) cont. 2007 Dr Cr 10.0 10.0 I Construction in progress (A) Cash, accounts payable etc To record costs incurred ii Accounts receivable Billings on contracts in progress (-A) To record billings to customers 8.0 Cash Accounts receivable To record cash collections 8.0 iii iv v Construction in progress (A) Construction expenses (E) Revenue from long term contracts (R ) To record periodic income recognised Billings on contracts in progress (-A) Construction in progress (A) To record final approval and acceptance 2008 Dr Cr 16.0 16.0 2009 Dr Cr 6.0 6.0 20.0 12.0 8.0 20.0 20.0 8.0 2.5 10.0 12.0 20.0 4.0 16.0 12.5 12.0 12.0 1.5 6.0 20.0 7.5 40.0 40.0 55 Solution – Case Study (c) cont. Stage of contract completion cannot be reliably determined 2007 Dr Cr iv Construction in progress (A) Construction expenses (E) Revenue from long term contracts (R ) To record periodic income recognised 10.0 2008 Dr Cr 8.0 6.0 16.0 10.0 2009 Dr Cr 16.0 14.0 56 Lecture Case Study – further Assume the same facts as in the previous question, except that XYZ now estimates at the beginning of the 2008 financial year that construction costs will be as follows: Year ending 30 June 2007 30 June 2008 30 June 2009 Cost $10m $21m $15m $46m Required: • Provide journal entries for each year assuming that the percentage-of-completion method is used. 57 Solution – Case Study further PART A (a) 2007 40,000,000 2008 40,000,000 2009 40,000,000 10,000,000 22,000,000 32,000,000 8,000,000 31.25% 31,000,000 15,000,000 46,000,000 -6,000,000 67.39% 46,000,000 8,000,000 31.25% 2,500,000 20X8 Less profit already recognised Profit recognised in year -6,000,000 67.39% -6,000,000 2,500,000 -8,500,000 20X9 Less loss already recognised* Profit recognised in year -6,000,000 1.00 -6,000,000 -6,000,000 0 Contract Price Less Estimated cost Costs to date Estimated costs to complete Estimated total cost Estimated total gross profit/loss Percent complete Gross Profit recognised in: 20X7 *2500000 + (8500000) 46,000,000 -6,000,000 100.00% S Assuming stage of completion cannot be reliably determined Accounting for construction contracts – Definition of Loss Accounting for long-term contract losses When current estimates of total contract costs and revenues for any contract indicate that a loss is probable: – Provision should be made for any foreseeable loss on the contract regardless of the amount of work already performed – Loss is to be brought to account as soon as it is foreseeable Accounting for construction contracts – Recognition of Expected Loss Accounting for long-term contract losses (cont.) AASB 111 (par. 36): When it is probable that total contract costs will exceed total contract revenue, the expected loss shall be recognised as an expense immediately. This is irrespective of whether work has commenced, the stage of completion, contract costs or revenue from other contracts. Accounting for construction costs – Recognition of Loss AASB 111 (par. 37): Expected loss (excess of total contract costs over total contract revenue) arising from a construction contract is recognised as an expense irrespective of: – whether work has commenced on the project – the stage of completion of the activity; or – the difference between total contract costs and total contract revenue expected to arise from other construction contracts Lecture Example 2.1 Part B Accounting for construction contracts Disclosure Disclosure requirements • AASB 111 requires that the balance sheet or accompanying notes: – disclose the gross amount of work in progress (or contract costs incurred) – the related aggregate billings deducted from the work in progress Accounting for construction contracts - Disclosure Disclosure requirements (cont.) • Work in progress will include the profit recognised throughout the contract • If progress billings exceed the gross amount of construction work in progress, the net amount should be shown as a liability or otherwise disclosed as an asset • Disclosure requirements are outlined in AASB 111 (pars 39– 42) • Appendix to AASB 111 provides an example of a disclosure that might appear in an entity’s financial report To do before next lecture Chapter readings for this week’s topic Independent study tasks – individually attempt this topic’s independent study tasks and check your answers Tutorial - Prepare answers in you log book and attend to check your work and understanding (ask questions during class) Topic consolidation - Attend a PASS session; re-read or further reading; Ask questions on MyLO discussion boards and/or in study groups; If stuck, bring your workings/notes to staff consultation. Pre-read next week’s chapter(s) Ensure you have completed your essay assignment and lodged it on time. Next Week – Statement of Comprehensive Income and Changes in Equity Copyright notice © Copyright University of Tasmania, School of Accounting & Corporate Governance All rights reserved. Commonwealth of Australia Copyright Regulations 1969 - WARNING This material has been reproduced and communicated to you by or on behalf of the University of Tasmania pursuant to Part VB of the Copyright Act 1968 (the Act). The material in this communication may be subject to copyright under the Act. Any further reproduction or communication of this material by you may be the subject of copyright protection under the Act. Do not remove this notice. 66
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