Revenue Recognition Under IFRS Primarily IAS 18 & IAS 11
Recognition – what does it mean? • Recognition is the process of incorporating in the balance sheet or income statement an item that meets the definition of an element and satisfies the criteria for recognition. • It involves the depiction of the item in words and by a monetary amount and the inclusion of that amount in the balance sheet or income statement totals. • Disclosure in the notes is no substitute for recognition! Very similar to language in FASB’s conceptual framework
IAS 18 General Rules (apply to all types of revenue) • Revenue shall be recognized when: • it is probable that the economic benefits associated with the transaction will flow to the entity; and • the amount of the revenue can be measured reliably. • Specific guidance for • Sale of goods • Provision of services • Revenues arising from use of entity assets by others
IAS 18 Revenue from sale of goods • Revenue from the sale of goods shall be recognized when all the following conditions have been satisfied: • Risks and rewards of ownership transferred to buyer; • Seller has no continuing managerial involvement with or effective control over the goods sold; • The amount of revenue can be measured reliably; • it is probable that the economic benefits will be received by seller • The costs incurred or to be incurred can be measured reliably.
Significant risks of ownership include • Seller has an obligation for unsatisfactory performance not covered by normal warranty provisions; • When the receipt of the revenue from a particular sale is contingent on re-sale of goods by the buyer; • When the goods are shipped subject to installation and it is a significant part of the contract; and • When the buyer has the right to rescind the purchase for a reason specified in the sales contract and the seller is uncertain about the probability of return.
IAS 18 Rendering of services • When the outcome of related to the rendering of services can be estimated reliably, revenue is recognized according to the stage of completion. • The outcome of a transaction can be estimated reliably when all the following conditions are satisfied: • the amount of revenue can be measured reliably; • it is probable that the economic benefits will be received by service provider; • The stage of completion can be measured reliably; and • The costs incurred or to be incurred can be measured reliably.
Service Contracts (IAS 18) • Must use percentage of completion • Exception: no estimate of completion is feasible • Use “zero profit method” • This method puts just enough revenue on the income statement to cover the costs incurred. • The result is basically same as completed contract (no profit is reported) but would change to percentage of completion at a later point in time when estimates become possible
Stage of completion • Depending on the nature of the transaction, the 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. Only costs that reflect services performed or to be performed are included in the estimated total costs of the transaction. • Progress payments and advances received from customers often do not reflect the services performed.
Services vs. Construction • The stage of completion method is also used for long-term construction contracts under IAS 11 • The rules are slightly different and it might not be clear, in some cases, whether one is providing construction services or a product (completed building, highway, etc.) • The problem is discussed in IFRIC Interpretation 15 • It looks as though we’ll have some of the same issues to deal with under the new PROPOSED revenue recognition critiera which is based on recognizing revenue when performance obligations have been satisfied (more later)
When estimates of stage of completion cannot be estimated reliably • Revenue shall be recognized only to the extent of the expenses recognized that are recoverable. • In other words: revenues are recognized EQUAL to the recoverable costs • This may result in “zero profit” or a loss if not all costs are recoverable
IAS 18 Interest, royalties and dividends • Revenues arising from the use by others of entity assets yielding interest, royalties and dividends: • Interest shall be recognized using the effective interest method • Royalties shall be recognized on an accrual basis in accordance with the substance of the relevant agreement; and • Dividends shall be recognized when the shareholder’s right to receive payment is established.
Costs concurrent with sales • If revenue can be recognized in accordance with guidance, then book simultaneously: • Bad debt expense (estimated) • Warranties and other costs to be incurred after the shipment of the goods
IAS37: Onerous contracts – a unavoidable loss will be incurred • The unavoidable costs under a contract is the LOWER OF: • The cost of fulfilling it • Any compensation or penalties arising from failure to fulfill it • This amount is measured and recognized as a “provision” (liability) • This would seem to be equivalent to the US GAAP practice of recognizing 100% of projected loss on a long-term construction contract
Exchanges of goods & services • Like-kind exchanges • Do not generate revenue • Swaps of dissimilar goods or services • Revenue is measured at the fair value of the goods or services received less any cash transferred • If the fair value of what is received cannot be measured reliability, use fair value of what is given up
IAS 11 • This is the only IASB revenue recognition guidance that is specific to an “industry” • A construction contractis 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 their ultimate purpose or use. • Two types: • Fixed price contract • Cost plus contract
Contract revenue under IFRS • Contract revenue shall comprise: • the initial amount of revenue agreed in the contract; and • variations in contract work, claims and incentive payments • (i) to the extent that it is probable that they will result in revenue; and • (ii) they are capable of being reliably measured.
Construction costs • Contract costs shall comprise: • costs that relate directly to the specific contract; • costs that are attributable to contract activity in general and can be allocated to the contract; and • such other costs as are specifically chargeable to the customer under the terms of the contract.
Recognition of contract revenue and expenses • When the outcome can be estimated reliably: • Use the stage of completion method • When the outcome cannot be estimated reliably: • Use the zero-profit method • Switch to stage of completion method when estimates become sufficiently reliable • In either case, an expected loss on the construction contract shall be recognized as an expense immediately – same as US GAAP
Zero Profit Method • When the outcome cannot be estimated reliably: • revenue shall be recognized only to the extent of contract costs incurred that it is probable will be recoverable; and • contract costs shall be recognized as an expense in the period in which they are incurred. • In other words, there will be no profit because revenues are booked to exactly offset the costs
Balance sheet presentation • Some “strange” terminology but basically identical to the US GAAP presentation: • If CIP > PB “the gross amount due from customers for contract work” is reported as an asset • If PB > CIP“the gross amount due to customers for contract work” is reported as a liability • The “gross” terminology seems misleading since the IAS 11 specifically says it is the cost plus profit less losses and progress billings • In other words, the computation same under IASB and FASB but it has a different title
Construction accounting terminology IFRS US GAAP • Current asset: “Gross amount due from customers for contract work” • Current liability: “Gross amount due to customers for contract work” • Current asset: “Costs of uncompleted contracts in excess of related billings” • Current liability: “Billings of uncompleted contracts in excess of related costs”
Real Estate Transactions • Accounted for under either IAS 11 or IAS 18 depending on which one best fits the situation as discussed in • IFRIC Interpretation 15Agreements for the Construction of Real Estate
What’s Next? Joint Project of FASB & IASB on Revenue Recognition Exposure Draftcomments due Oct. 22, 1010