CHAPTER THIRTEEN - Revenue and Inventories

Revenue is

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

IFRS 15 includes

• revenue (sales, turnover)

• interest

• dividends

• royalties

Steps - Recognition of Revenues

1. Identify the contract with the customer

2. Identify the performance obligations in the contract

3. Determine the transaction price

4. Allocate the transaction price to the performance obligations

5. Recognise revenue when performance obligation is satisfied

Revenue Step 1 - Identify the Contract with the Customer

• written, verbal or implied and approved by all parries

• clearly identifies each party’s rights and payment terms

• contract has commercial substance

• probable that the entity will collect the consideration

Revenue Step 2 - Identify the Performance Obligations in the Contract

Either:

• a distinct good or service

• a bundle of goods and services

• a series of distinct goods or services

Revenue - Step 3 Determine the Transaction Price

• The total amount of consideration receivable

• May include fixed and variable elements

Revenue - Step 4 Allocate Transaction Price to Performance Obligations

The overall transaction price that is allocated to each distinct performance obligation based on their individual selling prices

• Total Contract = £10, 000

Revenue - Step 5 Recognise Revenue when a performance obligation satisfied

a performance obligation is satisfied when control of the goods or services has transferred to the customer:

• at a point in time

• over a period of time

Goods and Services in One Contract

If an entity sells goods and serviced together as a package, the total transaction price will need to be unbundled and allocated to the separate performance obligations

• e.g. a buying a phone that has a contract attached - separate physical phone, texts and calls

Goods and Services in One Contract - Fair Value of the Service is

cost of the service + reasonable profit

Deferred Consideration

If an entity offers a period of “interest free” credit, the revenue receivable has two elements that need to be recognised separately:

• FV of the goods/services on date of sale

• Financing Income

Deferred Consideration - Fair Value of Goods/Services is

Future receipts discounted back to Present Value

Deposits/Advanced Sales

• any consideration received before the performance obligations have been satisfied will be create a deferred income liability.

Advance Sales - Journal Entry

Dr Cash

Cr Deferred Income

Performance Obligations satisfied over time will meet one of the following :

• customer receives and consumes the benefits and the performance obligation occurs

  • e.g. cleaning

• entity’s performance creates/enhances an asset as the asset is created/enhanced

  • e.g. construction contract

• entity creates an asset with no alternative use, and entity has an enforceable right to payment for the performance

  • e.g. development of a website

Recognising Revenue at Stages of Completion

Revenue can be recognised by:

• Output Methods - Sales Value

• Input Methods - Costs Incurred

If Revenue cannot be estimated reliably,

only recognise revenue to the extent of the costs recognised that are expected to be recoverable

Contract Asset/Liability

a contract where performance obligations are recognised over time can give rise to a contractual asset/liability in the statement of financial position

Consignment Sales

• a sale/return arrangement

• original seller only recognised the sale when the buyer sells goods onto a third party

Bill and Hold Arrangements

• goods delivered once a final instalment is received

• risks and rewards are transferred to the buyer

• revenue recognise when deposit is received and is ready for delivery

Repurchase Agreement

• where seller agrees to repurchase the goods at a later date

• control never transfers to the buyer

Subscriptions to Publications

• should be recognised on a straight line basis, from when the publications are dispatched

• when the values are varied, revenue should be recognised in relation to estimated sales values of what has been dispatched

Servicing Fees

• when sales price includes ‘free servicing’, revenue should be deferred and recognised over a period

Agent v Principal

A principal has:

• responsibility for providing goods or services to the customer

• bears inventory and customer credit risks

• establish prices charged to the customer

• should record revenue as gross

Modern Business Models

• substance over form = more important in IFRS 15

• new business models may present new challenges

Contract Asset - Substance over Form

• only recognise revenue when the risks and rewards are transferred over to the buyer

Disclosure

• revenue recognised from contracts must be disclosed separately

• any impairment losses from contracts must be disclosed separately

• opening and closing balances of receivables/contract assets/liabilities with customers

• revenue recognised in the reporting period

Inventories should be measured at:

the lower of cost and net realisable value

Inventories - Cost

costs of purchase, conversation and other directly attributable costs to bring the inventories to the present location and condition

• includes fixed and variable overheads

• allocation on normal capacity

• other costs = non-production costs

• excludes abnormal costs = selling costs, admin overheads

Inventories - Determining Cost

• standard cost on normal activity levels

• retail method

Inventories - Estimating Cost

• FIFO

• Weighted Average Cost

• LIFO = not permitted

Inventories - Net Realisable Value

Estimated Selling Price - (estimated cost to completion + sale costs)

Inventories - Net Realisable Value is based on:

• contracted price if the inventory is held to meet a firm contract

• selling price in a specific market where the inventory is intended to be sold

Inventories - Net Realisable Value may fall below cost because of:

• increase in costs or fall in selling price

• physical deterioration in condition

• obsolescence of products

• strategic decision to sell at a loss

• errors in production or purchasing

Where NRV falls below cost,

inventory is written down to its recoverable amount and the fall in value is charged to P/L

Where NRV falls below cost,

the write down will be disclosed separately

Inventory Disposal

• Once sold, inventory is no longer an asset and has become a sale

• Expense will be recognised in COS sold.

Disclosure

• accounting policies adopted in measuring inventories

• total CA of inventories and that they are classified appropriately

• CA = FV - cost to sell

• inventories recognised as an expense

• write downs of inventory recognised as an expense

• any reversals of write downs

• circumstances that lead to a reversal

• CA of inventories pledged as securities for liabilities

Financial Statements must disclose, either:

• Cost of inventories recognised as an expense during the period

• Operating costs, applicable to revenues, recognised as an expense

Assurance Risks

• revenue over statement - recognising too early

• judgemental issues - unbundling services

• existence of inventories

• state of completion judgements WIP

• estimation of NRV

• valuation of receivables

• risk of understating payables

Revenue Procedures

• discuss with management the reason for the increase/decrease in revenue

• obtain a breakdown of revenue and trace a sample to signed GDN dated pre-year end to ensure occurrence

Revenue Procedures - Inspection

• inspect and compare revenue data for CY against PY

• inspect and compare budgets to ensure that movements correspond with management explanations and are reasonable

• inspect a sample of pre year end GDN and ensure the corresponding sales invoices has been included in revenue to ensure completeness

• inspect a sample of sales invoices and ensure they have been recognised in revenue correctly to ensure accuracy

• inspect a sample of sales invoices and ensure they have been recognised in revenue to ensure accuracy

• inspect a sample of sales in foreign currencies, agree the transaction rate used to ensure accuracy

• review post year-end credit notes for evidence

Trade Receivables Procedures

• Obtain direct confirmation of a sample of trade receivables at the year end to confirm existence and right to receive cash.

• Inspect cash received after the year end (per bank statements and ledger) which relate to year end trade receivables to confirm valuation.

• Inspect aged receivables analysis to identify overdue balances and discuss with management (enquire) the basis of any allowance against the receivables to ensure reasonable.

• Inspect post year end credit notes to identify if they relate to current year invoices to ensure whether original sales appear genuine (valuation and rights).

• Inspect GDNs and invoices, comparing the dates on GDN to the dates on sales invoices to ensure the sales invoice is in the correct period (i.e. rights).

• Obtain written representation regarding the allowance against receivables to confirm completeness and reasonableness.

Trade Payables Procedures

• Inspect a sample of supplier statements based on supplier significance and reconcile back to supplier ledger to confirm completeness.

• Inspect GRNs and purchase invoices, comparing the dates on GRN to the dates on the purchase invoices to ensure the purchase invoice is in the correct period (obligation).

• Inspect a sample of overseas purchase invoices and ensure they have been translated at an appropriate exchange rate to ensure valuation.

Inventory Procedures

• Attend the inventory count and observe the approach, the count instructions being followed, how movements are being dealt with, how slow-moving lines are being identified, whether counting in pairs…. These are tests of controls which contribute to ensuring existence and cut-off.

• Inspect a sample of physical inventory and compare to the number counted on the stock sheets to confirm completeness.

• Inspect a sample of items counted on the stock sheets to the physical inventory to ensure existence.

• Inspect post year-end sales invoices for a sample of inventory to ensure recognised at lower of cost vs NRV therefore correctly valued.

• Enquire with management the basis of any items reduced to NRV and consider whether the basis is reasonable (valuation).

• Obtain written representation regarding the inventory reduced to NRV to confirm completeness and reasonableness.