Deegan5e Sm Ch16

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Chapter 16

Revenue recognition issues

16.1 The AASB Framework does not provide a great deal of guidance in relation to when revenueshould be recognised. The former Australian conceptual framework provided guidance whichis not inconsistent with the contents of the AASB Framework. Specifically paragraph 1!" of SA# $ provided a number of tests which would be useful in determining whether torecognise revenue. These were%

&a' an agreement for the provision of goods and services e(ists between the entity andone or more parties e(ternal to the entity)

&b' cash has been received or the entity has a claim against an e(ternal party or partiesthat%

&i' is for a specified consideration in the form of cash other assets or areduction in a liability of the entity)

&ii' cannot be avoided by the e(ternal party or parties without the incurrence of a penalty set sufficiently large as in normal circumstances to defer avoidance)

&c' all acts of performance necessary to establish a valid claim against the e(ternal partyor parties have been completed) and

&d' it is possible to estimate reliably the collectability of debts or the return of goods sold.

*here the above tests are met revenue would generally be recognised because it will be

probable that an inflow of service potential or future economic benefits have occurred.

*here there is an agreement in place that all production will be ac+uired by a particular consumer and it is probable that the inflow of resources will occur then in principle it would

be appropriate to recognise revenue at the point of production. This would particularly be thecase if there was a legal arrangement in place that all production will be purchased. ,n theabsence of such an arrangement revenue would not typically be recognised until a salestransaction had taken place. -owever we need to consider the re+uirements of AASB 11/0evenue which can act to limit the application of this general principle. 2aragraph 1$ of AASB 11 states%

0evenue from the sale of goods shall be recognised when all the following conditionshave been 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.

,n most cases control will not pass at the completion of production hence AASB 11e(cludes revenue recognition at point of production. AASB 11 however does not apply to

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revenue arising from some sources8such as the initial recognition of revenue fromagricultural produce &AASB 1$1 /Agriculture would apply and allows agricultural produceto be valued at fair value less estimated point9of9sale costs'. -ence for some goods such asagricultural produce it can be possible to recognise revenue in advance of a binding salesagreement and to the e(tent that a fair value can be reliably determined.

16.: ,f there was a constant and repetitive series of transactions then once a point was chosen inthe production4sales cycle the revenue to be recognised each year at that point would bee+uivalent to the revenue recognised at any other point8that is there is a constant flowthough the system.

16.! A bad debt occurs when a specific debtor is deemed unlikely to pay its debts and as a resultthe reporting entity recognises a bad debts expense and also reduces the balance of thedebtors ledger &with a corresponding reduction in the debtors subsidiary ledger'. ,t is also

possible that a debtor that goes /bad was anticipated and that a sufficient amount was previously recognised as a doubtful debts e(pense with a corresponding increase in the provision for doubtful debts. ,f this is the case there would be a debit to the provision for doubtful debts and a credit to accounts receivable &also called debtors'.

A doubtful debt is recognised when it is considered perhaps on the basis of past e(periencethat not all debtors will pay the amounts that are due. ;o specific debtors are identified as

being unlikely to pay. 0ather a general provision is created &a provision for doubtful debts 'which is offset against accounts receivable . That is the provision for doubtful debts is acontra account. *hen a doubtful debts expense is recognised no ad


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16.5 F>B stands for free on board . An item may be sold F>B shipping point or F>B destination .estination or shipping point refer to the point at which title of the goods passes to the

purchaser. ,f the goods are shipped F>B destination title does not pass until the buyer receives the goods at the destination. ,n this case revenue would not typically be recogniseduntil the goods reach their destination.

16.6 A put option gives its holder the right to sell an asset at a specified e(ercise price on or before a specified date. The writer &or seller' of the put option agrees to buy the asset at afuture date for the e(ercise price if the put option holder &buyer' should re+uest it. Theholder of the put option &who may also be in possession of the underlying asset' wouldtypically only e(ercise the option &that is re+uire the other party to buy the underlying asset'if the e(ercise price was above the market price.

*here a transaction involves the use of a financial instrument such as an option it isnecessary to evaluate the conditions attaching to the transaction to establish whether insubstance the transaction is a financing arrangement rather than a sale.

,n considering whether to recognise revenue when there are associated options the probability of the e(ercise of the options must be considered. *here it is probable that the put option will be e(ercised and =ddie is re+uired to repurchase the e+uipment revenuesshould not be recognised by =ddie since the re+uisite degree of certainty that the inflow of economic benefits has occurred will not have been attained. The higher the price recorded onthe put option the greater the probability that 3ass 3arketer will re+uire =ddie to re9ac+uirethe assets. -ence the greater the price recorded on the option &which increases thedifferential between the fair value and the option price at the e(ercise date' the lower the


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support its business &for e(ample it is a registered charity' then the donation might be treatedas revenue. >therwise it might be treated as a gain. As paragraph ?$ of the AASBFramework states%

The definition of income encompasses both revenue and gains. 0evenue arises in

the course of the ordinary activities of an entity and is referred to by a variety of different names including sales fees interest dividends royalties and rent.

2aragraph ?5 of the AASB Framework further provides%

@ains represent other items that meet the definition of income and may or maynot arise in the course of the ordinary activities of an entity. @ains representincreases in economic benefits and as such are no different in nature from revenue.-ence they are not regarded as constituting a separate element in the Framework.

16. 2ursuant to AASB 111 the aggregate billings on a construction contract shall be deductedfrom the asset account construction in progress &or construction in progress might also bereferred to as contract costs incurred'. ,f progress billings e(ceed the gross amount of construction in progress the net amount should be shown as a liability otherwise the netamount is shown as an asset.

16.1" 2aragraph !" of AASB 111 provides guidance in determining the percentage of completion.,t states%

The stage of completion of a contract may be determined in a variety of ways. Theentity uses the method that measures reliably the work performed. epending on thenature of the contract the methods may include%&a' 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 a physical proportion of the contract work.2rogress payments and advances received from customers often do not reflect thework performed.

The former accounting standard in place within Australia had allowed in certaincircumstances the use of the /billings basis for determining percentage of completion8thismethod involves calculating the proportion that progress billings to date bear to the totalestimated billings for the contract. AASB 111 e(cludes the use of the billings basis.

The cost basis is commonly used by reporting entities that are involved in constructioncontracts.

16.11 &a' ,f management was rewarded in terms of accounting profits then it would bereasonable to assume that the management would prefer to have non9volatile profitssuch that they would receive a more uniform series of cash flows. Also it would bereasonable to assume that they would prefer that accounting profits not be deferred tofuture periods given that the present value of the future receipts would be lower thanthose received in earlier years. *ith this in mind management rewarded by profit9

based schemes would probably prefer to adopt the percentage9of9completion method.,n adopting this accounting method they would necessarily need to ensure that there+uirements associated with the percentage of completion as noted in AASB 111&such as the re+uirement that for a fi(ed9price contract the future contract revenue

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can be reliably measured and the contract costs to complete the contract and the stageof completion can be measured reliably' are satisfied.

&b' ,f a firm is sub


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&i' To record costs incurred%r #onstruction in progress :.5 $." 1.5

#r #ash accounts payable accum. deprec. :.5 $." 1.5

&ii' To record billings to customers

r Accounts receivable :." 5." !."#r Billings on contracts in progress :." 5." !."

&iii' To record cash collections%r #ash :." 5." !."

#r Accounts receivable :." 5." !."

&iv' To record periodic income recognised%r #onstruction in progress ".6:5 1." ".!?5r #onstruction e(penses :.5"" $." 1.5""

#r 0evenue from long9term contracts !.1:5 5." 1. ?5

&v' To record final approval and acceptance%r Billings on contracts in progress 8 8 1."

#r #onstruction in progress 8 8 1."

&b' Stage of completion cannot be reliably determined. ,n this case contract costs must be recognised as an e(pense in the financial year in which they are incurred and whereit is probable that the costs will be recovered revenue must be recognised only to thee(tent of costs incurred.

2006 2007 2008

&i' To record costs incurred%r #onstruction in progress :.5 $." 1.5#r #ash accounts payable etc. :.5 $." 1.5

&ii' To record billings to customers%r Accounts receivable :." 5." !."

#r Billings on contracts in progress :." 5." !."



&iv' To record periodic e(penses and revenues%r #onstruction e(penses :.5 $." 1.5

#r 0evenue from long9term contracts :.5 $." 1.5

&v' To record the profit on the pro


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#r #onstruction revenue 8 8 1"."

16.1$ &a' Assuming stage of completion can be reliably determined.

2006 2007 2008#ontract price 1" """ """ 1" """ """ 1" """ """Cess estimated cost%

#osts to date : 5"" """ """ """ 11 """ """=stimated costs to complete 5 5"" """ ! """ """ DDDDDDDDDD =stimated total cost """ """ 11 """ """ 11 """ """

=stimated total gross profit4&loss' : """ """ &1 """ """' &1 """ """'2er cent complete 31.25% 72.73% 100%

@ross profit recognised in%

:""6 : """ """ E !1.:5 6:5 """

:""? e(pected loss &1 """ """'Cess profit already recognised 6:5 """Coss recognised in :""? &1 6:5 """'

:"" e(pected loss &1 """ """'Cess profit &loss' already recognised &1 """ """'2rofit4loss recognised in :"" nil

Gournal entries% 2># method

2006 2007 2008

&i' To record costs incurred%r #onstruction in progress :.5 5.5 !."#r #ash accounts payable etc. :.5 5.5 !."





&iv' To record periodic income recognised%r #onstruction in progress ".6:5 8 8 r #onstruction e(penses :.5 5.5 !."

#r 0evenue from long9term contracts !.1:5 !. ?5 !."#r #onstruction in progress 8 1.6:5 8

&v' To record final approval and acceptance%r Billings on contracts in progress 8 8 1"."

#r #onstruction in progress 8 8 1"."

Following the above


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asset /construction in progress will be valued at 1"m which is its recoverable amount.These numbers are reconciled as follows%

#onstructione(penses

#onstructionrevenues

#onstructionin progress

:""6 :.5 !.1:5 !.1:5

:""? 5.5 !. ?5 !. ?5

:"" !." !." !."

11." 1"." 1"."

&b' Assuming stage of contract completion cannot be reliably determined.

2006 2007 2008&i' To record costs incurred%

r #onstruction in progress :.5 5.5 !."#r #ash accounts payable etc. :.5 5.5 !."





&iv' To recognise revenues and e(penses andforseeable losses%

r #onstruction in e(pense :.5 5.5 !."#r #onstruction revenue :.5 $.5 !."#r #onstruction in progress 8 1." 8

&v' To record final approval and acceptance of contract and income:

r Billings on contracts in progress 8 8 1"."#r #onstruction in progress 8 8 1"."

16.15 &a' 2010 2011 2012#ontract price $" """ """ $" """ """ $" """ """Cess estimated cost%

#osts to date 1" """ """ :6 """ """ !: """ """=stimated costs to complete :: """ """ 6 """ """ DDDDDDDDDD =stimated total cost !: """ """ !: """ """ !: """ """

=stimated total gross profit4&loss' """ """ """ """ """ """2er cent complete 31.25% 81.25% 100%

@ross profit recognised in%:"1" """ """ E !1.:5 : 5"" """



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:"11 """ """ E 1.:5 6 5"" """Cess profit already recognised : 5"" """2rofit recognised in year $ """ """

:"1: """ """ E 1"" """ """Cess profit already recognised 6 5"" """2rofit recognised in year 1 5"" """

&b' *here stage of contract completion cannot be reliably determined.


r #onstruction in progress 1"." 16." 6."#r #ash accounts payable 1"." 16." 6."

&ii' To record billings to customers%

r Accounts receivable ." :"." 1:."#r Billings on contracts in progress ." :"." 1:."

&iii' To record cash collections%r #ash ." :"." 1:."

#r Accounts receivable ." :"." 1:."

&iv' To record periodic income recognised%r #onstruction in progress 8 8 ."r #onstruction e(penses 1"." 16." 6."

#r 0evenue from long9term contracts 1"." 16." 1$."

&v' To record final approval and acceptance%r Billings on contracts in progress 8 8 $"."

#r #onstruction in progress 8 8 $"."

&c' Gournal entries assuming stage of completion can be reliably determined.


r #onstruction in progress 1"." 16." 6."#r #ash accounts payable etc. 1"." 16." 6."

&ii' To record billings to customers%r Accounts receivable ." :"." 1:."

#r Billings on contracts in progress ." :"." 1:."



&iv' To record periodic income recognised%r #onstruction in progress :.5 $." 1.5r #onstruction e(penses 1"." 16." 6."

#r 0evenue from long9term contracts 1:.5 :"." ?.5

&v' To record final approval and acceptance%



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r Billings on contracts in progress 8 8 $"."#r #onstruction in progress 8 8 $"."

16.16 &a' 2010 2011 2012#ontract price $" """ """ $" """ """ $" """ """

Cess estimated cost%#osts to date 1" """ """ !1 """ """ $6 """ """=stimated costs to complete :: """ """ 15 """ """ DDDDDDDDDDD =stimated total cost !: """ """ $6 """ """ $6 """ """

=stimated total gross profit4&loss' """ """ & 6 """ """' & 6 """ """'2er cent complete 31.25% 67.39% 100%

@ross profit recognised in%

:"1" """ """ E !1.:5 : 5"" """

:"11 =(pected loss &6 5"" """'

Cess profit already recognised : 5"" """Coss recognised in year & 5"" """'

:"1: =(pected loss &6 """ """'Cess loss already recognised H: 5"" """ I & 5"" """'J &6 """ """'2rofit recognised in year "

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&b' *here stage of contract completion cannot be reliably determined.


r #onstruction in progress 1"." :1." 15."

#r #ash accounts payable accum. deprec. 1"." :1." 15."&ii' To record billings to customers%

r Accounts receivable ." :"." 1:."#r Billings on contracts in progress ." :"." 1:."



&iv' To record periodic income recognised%

r #onstruction e(penses 1"." :1." 15."#r 0evenue from long9term contracts 1"." 15." 15."#r #onstruction in progress 8 6." 8


#r #onstruction in 2rogress 8 8 $"."

&c' Gournal entries assuming stage of completion can be reliably determined.


r #onstruction in progress 1"." :1." 15."#r #ash accounts payable accum. deprec. 1"." :1." 15."

&ii' To record billings to customers%r Accounts receivable ." :"." 1:."

#r Billings on contracts in progress ." :"." 1:."



&iv' To record periodic income recognised%r #onstruction in progress :.5 8 8 r #onstruction e(penses 1"." :1." 15."

#r 0evenue from long9term contracts 1:.5 1:.5 15."#r #onstruction in progress 8 .5 8


#r #onstruction in progress 8 8 $"."

16.1? &a' To provide the


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To determine the interest rate we can divide the fair value of the asset at the date of sale by the periodic payment.

1 "1 ÷ 6""" K !.16 . 0eviewing our present value tables we find that thise+uates to an interest rate of 1" per cent.

Cash Interest Principal utstan!ing"ate pa#$ent revenue re!uction alance

1 Guly :"" 1 "1!" Gune :"1" 6 """ 1 ": $ " 1$ :1!" Gune :"11 6 """ 1 $ : $ 5" 1" $1!!" Gune :"1: 6 """ 1 "$1 $ 5 5 $5$!" Gune :"1! 6 """ 5$5 5 $55 "

:$ """ $ 1 1 "1

Interest revenue e+uals the outstanding liability at the beginning of the financial period multiplied by the interest rate implicit in the agreement which in this +uestion

is 1" per cent.The reduction in the principal is calculated by subtracting the interest revenue fromthe cash payment.

&b' Gournal entries using the net9interest method%Journal entry to record the initial sale on 1 Guly :""

r ;ote receivable 1 "1#r Sales 1 "1

Gournal entry to record the receipt of 6""" on !" Gune :"1"

r #ash 6 """#r ;ote receivable $ "#r ,nterest revenue 1 ":

Gournal entry to record the receipt of 6""" on !" Gune :"11

r #ash 6 """#r ;ote receivable $ 5"#r ,nterest revenue 1 $ :

Gournal entries using the gross method%

Journal entry to record the initial sale on 1 Guly :""r ;ote receivable :$ """

#r Sales 1 "1#r Lnearned interest $ 1

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Gournal entry to record the receipt of 6""" on !" Gune :"1"

r #ash 6 """#r ;ote receivable 6 """

r Lnearned interest 1 ":

#r ,nterest revenue 1 ":Gournal entry to record the receipt of 6 """ on !" Gune :"11

r #ash 6 """#r ;ote receivable 6 """

r Lnearned interest 1 $ :#r ,nterest revenue 1 $ :

16.1 At issue here is whether the claim against Allgas should be recorded as a receivable and asincome in the accounts of SSB. ,f the claim was agreed to by Allgas or the court rules thatAllgas must pay then there would be an inflow of future economic benefits which did notrelate to a contribution of owners and which increased e+uity during the reporting period8 consistent with the definition of income. -owever at issue is the probability that the inflowof future economic benefits has occurred or whether the inflow can be measured reliably. Asthe court case had not been settled and as there seems no strong evidence that SSB will besuccessful or otherwise the inflow is too uncertain to warrant recognition as income.

;evertheless the notes to the accounts of SSB &and Allgas' should provide a description of the claim and the company s assessment of the probability than an amount will be receivedas well as an estimate of the e(pected receipt.

16.1 Because the painting has been given irrevocably as a gift and not as a loan it becomes anasset of the ;ational @allery of Mictoria. Because there has been an inflow of economic

benefits which is not of the nature of a contribution by an owner the donation is to be treatedas income. ,n determining the amount to be recorded for the asset and therefore for theincome the inflow should be recorded at its fair value. Because it did not go to sale theamount will need to be determined by somebody with e(pertise in valuing such works of art.2erhaps if Sotheby s auction reserves have been reliable estimates of market value in pastauctions then the amount placed on the painting by Sotheby s might be used as the basis of measuring the asset. >therwise a valuation might be obtained from an independent /marketanalyst .

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Deegan5e Sm Ch16

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