FAR - Chapter 6 - Revenue and Inventories

What is the IFRS 15 definition of revenue?

‘income arising in the course of an entity’s ordinary activities’.

What does “ordinary activities” mean?

normal trading or operating activities

What are the 3 things revenue results from?

1. the sale of goods

2. the rendering of services

3. the receipt of royalties.

What is the core principle of IFRS 15? (when an entity should recognise revenue)

an entity shall recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services

What are the 5 steps of revenue recognition?

1. Identify the contract

2. Identify the separate performance obligations

3. Determine the transaction price

4. Allocate the transaction price to the performance obligations

5. Recognise revenue as or when a performance obligation is satisfied

What is a contract? (in terms of revenue recognition)

An agreement between 2 or more parties that creates enforceable rights and obligations

What are performance obligations?

Promises to transfer distinct goods or services to a customer

What is the transaction price?

The amount to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer

What 4 criteria must an entity meet before they can account for revenue?

1. the parties have approved the contract and each party’s rights can be identified

2. payment terms can be identified

3. the contract has commercial substance (it represents a genuine sale)

4. it is probable that the selling entity will receive consideration.

What does IFRS 15 say about distinct performance obligations within a contract?

They must be identified

When is an entity the principal?

An entity is the principal if it controls the good or service before it is transferred to the buyer.

When they’re providing the good or service itself.

(Think principal as the first person or the boss)

When is an entity the agent?

arranging for the goods and services to be provided by another party

What is the agent allowed to recognise as revenue?

Commission only

What does the treatment of warranties depend on?

whether an extra service is received by the customer, or whether the warranty simply provides an assurance that the item will work as intended.

What should a warranty providing an extra service be treated as?

As a separate performance obligation, according to IFRS 15

*a warranty that would normally be purchased separately (e.g. the purchase of an extended warranty), always falls under IFRS 15.

What should a warranty that only provides assurance that the item will work as intended be recognised as?

A provision under IAS 37

What 3 things should be considered about transaction price?

1. Variable consideration

2. Financing

3. Non-cash consideration

What are 8 examples of variable consideration?

1. Discounts

2. Incentives

3. Rebates

4. Credits

5. Refunds

6. Price concessions

7. Performance bonuses

8. Penalties

What must an entity do if a contract includes variable consideration?

the entity must estimate the amount it expects to receive

Under what conditions will the estimate of variable consideration be included in the transaction price?

if it is highly probable that a significant reversal in the amount of revenue recognised will not occur when the uncertainty is resolved.

What shall an entity adjust when determining the transaction price?

‘In determining the transaction price, an entity shall adjust the promised amount of consideration for the effects of the time value of money - IFRS 15

When may a significant financing component exist?

‘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 agreed to by the parties to the contract

When doesn’t an entity need to adjust the promised amount of consideration of a significant financing component if the entity expects?

An entity need not adjust the promised amount of consideration for the effects of a significant financing component if the entity expects, at contract inception, that the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less

What are non-cash considerations measured at?

Any non-cash consideration (e.g. other 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/services should be used.

What should the total transaction price be allocated to?

The total transaction price should be allocated to each performance obligation in proportion to standalone selling prices.

What must you do if the selling price isn’t directly observable?

it must be estimated.

What are the 2 general rules on bundled sales?

1. Any discount should be generally allocated across each component in the transaction

2. Discount should only be allocated to a specific component of transaction if component is regularly sold separately at a discount

When is revenue recognised?

when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer.

When must an entity determine whether it satisfies the performance obligation over time or at a point in time?

At the contract inception

i) If the performance obligation is satisfied over time, then the revenue must be recognised over time, otherwise,

ii) the revenue is recognised at a point in time, which is when control of the asset transfers to the customer

What are the 3 criteria that which if one is satisfied then an entity has satisfied a performance obligation?

1. the customer simultaneously receives and consumes the benefits from the entity’s performance

2. the entity is creating or enhancing an asset controlled by the customer - e.g. building a football stadium for a customer

3. the entity cannot use the asset ‘for an alternative use’ and the entity can demand payment for its performance to date. - e.g. building company constructing an asset for a customer

What happens to the revenue recognised if the outcome of the contract cannot be reliably determined?

the revenue recognised is restricted to the costs incurred that are recoverable from the customer.

What is the output method?

We base the completion on the value of work completed as a proportion of total contract price

What is the input method?

Revenue recognised based on costs incurred as a proportion of total expected cost

When is a performance obligation normally satisfied in a point in time?

When the customer obtains control of the promised asset.

When does an entity control an asset?

if it can direct its use and obtain its remaining benefits.

What are 5 indicators that control has passed to the customer?

1. the customer has physical possession of the asset

2. the customer has accepted the asset

3. the customer has the significant risks and rewards of ownership

4. the customer has legal title

5. the seller has a right to payment.

What are consignment sales?

Where the buyer of the goods undertakes to sell them on behalf of the original seller.

The original seller only recognises the sale when the buyer sells them on to a third party

What are bill and hold arrangements?

An entity bills a customer but delivery is delayed with agreement of the customer.

The entity must determine whether control has been transferred to the customer

What are sales with a right of return (refunds)?

Recognise revenue for the goods transferred and a liability for refunds

What are the 2 different ways that a warranty is recognised?

If the warranty has been separately purchased by the customer, or provides a service, it should be recognised as a separate performance obligation under IFRS 15.

Otherwise, the warranty is accounted as a provision under IAS 37 Provisions, Contingent Liabilities and Contingent Assets

What are platform business models?

Platform business models which connect buyers with sellers such as Uber, eBay, Airbnb and Etsy.

What are subscription economy models?

Subscription economy models where customers pay a monthly fee for services instead of buying a product outright, such as Netflix, Amazon Prime, Spotify, Office 365

What are on-demand services?

On-demand services where businesses send independent contractors to provide services like food delivery or handyman tasks immediately, such as Uber Eats, Deliveroo, TaskRabbi

What is the main disclosure requirement of IFRS 15 Revenue from Contracts with Customers?

revenue from contracts with customers is disclosed separately from other sources of revenue

What 3 types of inventory are there?

1. Raw materials

2. Works in progress

3. Finished goods

What are raw materials?

Components and consumables (such as oil) used in the production process

Materials or supplies used to produce a good or provide a service

What is work in progress?

Partly finished goods

What are finished goods?

Completed items manufactured by the business or goods purchased for resale

What are inventories valued at the lower of?

Cost and NRV (net realisable value)

What is the cost of inventory?

The cost of bringing items of inventory to their current location and condition

Cost = cost of purchase + conversion costs

What is the cost of purchase?

Purchase price plus directly attributable costs such as import duties, delivery costs.

What are conversion costs?

Costs directly related to producing inventory units e.g. labour, materials

How do you allocate overheads that are incurred in converting materials into finished goods?

i) Variable production overheads (e.g. electricity) - Allocated based on actual units of production

ii) Fixed production overheads (e.g. factory rent) - Allocated based on budgeted normal levels of production

What is the actual unit cost method & when is it used?

This is the actual cost of purchasing identifiable units of inventory.

Only used when items of inventory are individually distinguishable and of high value

What is the FIFO method & when is it used?

For costing purposes, the first items of inventory received are the first ones sold.

When a sale is made, the cost of sales is the cost of the oldest goods purchased.

What is the AVCO method & when is it used?

The cost of an item of inventory is calculated by taking the average of all inventory held.

Appropriate where the inventory physically mixes e.g. bulk liquids

What is NRV?

Net realisable value (NRV) is actual or estimated selling price LESS all future costs to complete the sale (including all costs to be incurred in marketing, selling and distribution

What are the 5 main disclosure requirements of IAS2 Inventories?

1. accounting policy adopted, including the cost formula used

2. total carrying amount, classified appropriately

3. amount of inventories carried at NRV

4. amount of inventories recognised as an expense during the period

5. details of any circumstances that have led to the write-down of inventories to their NRV