Chapter 2 IAS 18 Revenue

Definition Definition Revenue: The gross inflow of economic benefits (cash, receivables, other assets) arising from the ordinary operating activities of an enterprise (such as sales of goods, sales of services, interest, royalties, and dividends).

Measurement fair value of the consideration received / receivable net of trade discounts, allowances and volume rebates If the inflow of cash or cash equivalents is deferred, discounting is appropriate

Sale of goods the seller has transferred significant risks and rewards of ownership; the seller retains neither continuing managerial involvement nor effective control over the goods sold;

Sale of goods the amount of revenue and costs can be measured reliably; it is probable that the economic benefits will flow to the seller;

Rendering of services Same as sale of goods the stage of completion at the balance sheet date can be measured reliably

Interest, Royalties, and Dividends interest: on a time proportion basis royalties: on an accruals basis in accordance with the substance of the relevant agreement; and dividends: when the shareholder's right to receive payment is established.

Exam question — Barking As a result of the acquisition the company will change the way in which it recognises sales of residential properties. It used to treat such properties as sold when the building work substantially complete,

Exam question — Barking defined as being when the roof and internal walls had been completed. The new policy will be to recognise a sale when a refundable deposit for the sale of the property has received and the building work is physically complete.

Exam question — Barking Legal costs incurred on the sale of the property are currently capitalised and show as current assets until the sale of the property has occurred.

Exam question — Barking Solution: IAS 18 requirements (see above) More prudent than old policy but still recognise revenue before a legal contract

Exam question — Barking Refundable deposit and physically complete don ’ t mean a legal contract signed Most companies within the industry will follow IAS18, so new policy makes comparison more difficult Deposit — deferred income Legal cost--expensed

Exam question — Tyre Tyre, a public limited company, operates in the vehicle retailing sector. The company is currently preparing its financial statements for the year ended 31 May 2006 and has asked for advice on how to deal with the following items:

Exam question — Tyre Tyre requires customers to pay a deposit of 20% of the purchase price when placing an order for a vehicle. If the customer cancels the order, the deposit is not refundable and Tyre retains it.

Exam question — Tyre If the order cannot be fulfilled by Tyre, the company repays the full amount of the deposit to the customer. The balance of the purchase price becomes payable on the delivery of the vehicle when the title to the goods passes.

Exam question — Tyre Tyre proposes to recognise the revenue from the deposits immediately and the balance of the purchase price when the goods are delivered to the customer.

Exam question — Tyre The cost of sales for the vehicle is recognise when the balance of the purchase price is paid. Additionally, Tyre had sold a fleet of cars to Hub and gave Hub a discount of 30% of the retail price on the transaction.

Exam question — Tyre The discount given is normal for this type of transaction. Tyre has given Hub a buyback option which entitles Hub to require Tyre to repurchase the vehicles after three years for 40% of the purchase price.

Exam question — Tyre The normal economic life of the vehicle is five years and the buyback option is expected to be exercised. Solution: Revenue recognition IAS 18 requirements (see above)

Exam question — Tyre Deposit recognition — as a deferred income except: --when goods are delivered and accepted, or --when cancellation of the contract by the customer Recognition of revenue and related cost should be under same way

Exam question — Tyre Sale of a fleet of cars Buyback option is expected to be exercised, so risks and rewards are not transferred. No sale arises

Exam question — Tyre Operating lease --30% discount is normal(not normal in fact for selling cars) --only 40% of purchase price to buy back --lease term / UEL = 3/5 = 60% (75%) --PVMLP/FV = (100x70%- 70x40%)/100=42% (90%)

Exam question — Tyre The assets will be still recognised as NCA and depreciated under IAS 16 The buyback option — IAS 39 financial liability

Exam question — Tyre Dr Cash 70 Cr Buyback option 28 (40%) Cr deferred income 42

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