FAR Revenue Recognition
How to value a company without earning or positive operating cash flows?
Revenue growth as a potential indicator of future performance and profitability
What is revenue and how does it relate to “income”?
income is an increase in economic benefits in the form of inflows of assets or decreases of liabilities that result in increases in equity
Income may arise from two different sources:
1. Revenues
2. Gains
Characteristics of revenues (2):
1. Economic benefits arising in the course of the ordinary activities of an enterprise
2. High probability of recurrence
Characteristics of gains (3):
1. May or may not arise during ordinary activities of an entity
2. Typically either incidental activities
3. Low probability of recurrence
What is IFRS 15?
Revenue Recognition Framework (revenue from contracts with customer)
IFRS 15 applies to annual reporting period as of ... replacing ...
January 1, 2018 & IAS 11 / IAS 18
IFRS 15: three main points
1. Distinction between performance obligations satisfied over time and performance obligations satisfied at a point in the future
2. Focus on transfer of control instead of risk and rewards
3. Substantially more guidance on the application for complex transactions
Scope of IFRS 15: All contract with customers to provide good or services are included, expect for (4) ...
1. Lease contracts
2. Insurance contracts
3. Financial instruments and other contractual rights or obligations
4. Non-monetary exchanges
IFRS 15: The 5-step Revenue Recognition Framework
1. Identification of a contract
2. Identification of performance obligations
3. Determination of transaction price
4. Allocation of transaction price to performance obligations
5. Revenue recognition when satisfying performance obligations
Step 1: Definition of a contract (5)
1.1 The contract has been approved by the parties to the contract
1.2 Each party’s rights can be identified
1.3 The payment terms can be identified
1.4 The contract has commercial substance
1.5 It is probable that the consideration will be collected
A contract does not exist when
1. the contract is not pending (‘wholly unperformed’) anymore
2. revenue can not be recognized
Revenue cannot be recognized until a contract exists
Continuous assessment
If the requirements of IFRS 15.9 are not fulfilled at any point in time, the entity can only recognize consideration received as revenue when ...
such amounts are non-refundable
If the requirements of IFRS 15.9 are not fulfilled at any point in time, the entity can only recognize consideration received as revenue when such amounts are non-refundable and either of the following events has occurred (2)
1. the entity has completed performing all of its obligations under the contract and has received all, or substantially all, of the consideration promised by the customer; OR
2. the contract has been terminated
If an entity enters into multiple contracts with the same customer at, or near, the same time, it has to combine these individual contracts to a combined contract, if (3)
1. the contracts are a package with the intent of meeting a singular business purpose, or
2. price in one contract is impacted by the price or performance of the other contract, or
3. some of the goods or services promised in the individual contracts form a single performance obligation
If the contract modifications are approved by both parties, then (2) ...
1. the scope needs to be increased
2. the price needs te increased
Step 2: (Identification of) a Separate Performance Obligations ...
is a distinct good or service
A separate performance obligation needs two requirements ...
2.1 The goods or services are capable of being disctinct, AND
2.2 The goods or services are distinct when considered in the context of the entire contract
Right of return is never a ...
seperate performance obligation
A customer option is considered a material right, if:
1. The customer would not receive the option to acquire additional goods or services without entering into that contract, AND
2. The price for the additional goods or services does not refelct the stand alone selling price
Principal vs. Agent: When a third party is involved in providing goods or services to a customer, the vendor is required to determine whether the nature of its promise is a performance obligation to (2) ...
1. Provide the specified goods or services itself (principal), or
2. Arrange for a third to provide those goods or services
Gross revenue recognition definition: ...
Entity controls goods or services before the trasnfer to the customer, so entitiy acts as principal
Net revenue recognition definition: ...
Entity arranges for the provision of goods or services by another party, entity acts as an agent
Revenue Recognition – Step 3
Determination of the Transaction Price
The transaction price reflects the amount of
3.1 variable consideration (f.e. discount, refunds)
3.2 significant financing components
3.3 non-cash consideration
3.4 consideration payable to customer
Variable consideration consist of two calculations:
3.1.1 Most likely outcome (recommended in scenarios with only two possible outcomes)
3.1.2 Expected value (recommended in scenarios of multiple contracts with similar characteristics and a large number of possible outcomes)
Constraint on estimation of variable consideration:
Estimated variable consideration shall be included in the transaction price only to the extent that it is highly probably that a significant revenue reversal will not occur
Constraining estimates of variable consideration
1. Estimates introduce a degree of uncertainty into the amount of revenue
2. Purpose of a constraint: avoid overly optimistic estimates being included in the calculation
3. Judgement and consideration of all facts required to assess whether a constraint is necessary
Contract with a significant financing component (3) ...
3.2.1 Adjustment for the time value of money if there is significant benefit from financing
3.2.2 Special cases for which the adjustment is not necessary
3.2.3 No adjustment if financing period is < 1 year
3.2.2. Special cases for which the adjustment of a contract with a significant financing component is not necessary (3) ...
1. Advanced payment
2. Substantial amount of consideration is variable
3. Difference between promised consideration and cash selling price arises for other reasons other than the provision of finance
3.3 Non-cash consideration
1. Measurement at fair value
2. If fair value estimate is not available, measured by reference to stand alone selling price
4. Allocation of transaction price to performance obligations (3)
4.1 General rule: allocation to performance obligations by reference to their stand alone selling prices
4.2 The stand alone selling price is the observable price (at which an entity would sell a promosid good or service separately to a customer)
4.3 Estimation neccessary if a stand alone selling price is not directly observable
Estimation necessary if a stand alone selling price is not directly observable (3) ...
4.3.1 Adjusted market assessment approach (estimate the price that a customer in that market would be willing to pay)
4.3.2 Expected cost plus a margin approach
4.3.3 Residual approach (estimate the stand alone selling price by reference to the total transaction price less the sym of the observable stand alone selling prices
Residual approach - conditions according to IFRS (2) ...
1. The entitiy sells the same good or services to different customers for a broad range of amounts, OR
2. The entity has not yet established a price for that good or service and the good or service has not previously been sold on a stand alone basis
Definition of a discount
Generally allocated proportianately to all performance obligatoins in the contract
Only if all of the following criteria are met, discount is allocated a specific performance obligation
1. Each distinct goods or service is regularly sold on a stand alone basis
2. A bundle of some of those distincit goods or services is regularly sold at a discount
3. This discount is substantially the same as the discount in the contract
Step 5 of revenue recognition:
Revenue recognition when satisfying performance obligation
Transfer of control over time (3)
1. Customer receives benefits as the entity performs
2. Entity creates an asset that the customer already controls during performance (f.e. a building)
3. Asset does not have alternative use to the entity and eforceable right to receive payment already exists (f.e. audit report)
Two methods of recognising revenue on arrangements for the transfer of goods over time:
1. Output method (measure the value of goods transferred relative to those undelivered)
2. Input method (measurement based on the entity's efforts or inputs relative to the total expected inputs)
Adjustment to measrue progress may be required if (2):
1. cost incurred does not contribute OR 2. is not proportionate to the entity's progress in satisfying the performance obligation
Three essential characteristics of an asset
1. The resource must contain future economic benefits
2. The entity must have control over the economic benefits
3. There must have been an past event
Three essential characteristics of a liability
1. A present obligation exists
2. Must result in giving up resources
3. must have resulted from a past transaction
Measurement is the process of
determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the financial statements
There are a number of different measurement bases (4)
1. Historical costs
2. Current costs
3. Realisable value
4. Present value
Financial capital is measured in terms of (2)
1. actual amount of currency
2. purchasing power
Physical capital is measured in terms of ...
operating capability
The IFRS standard was developed developed that would (4)
1. Remove inconsistencies
2. Provide a more robus framework
3. Provide a singel reference point
4. Provide more usefull information
Difference between IFRS 15 and IAS 11 / 18
1. Focus on transfer of control instead of risk and rewards
2. More guidance vs limited guidance
Good and services are capable of being distinct if ...
the customer can benefit from it
Goods and services are distinct in the context of the contract when ...
they are separable from other promises