IAS 18 Revenue Recognition Scope General principles Timing of recognition Multiple element arrangements Links to other standards 1

Revenue – definition (IAS 18.7)

• Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an enterprise when those inflows result in increases in equity, other than increases relating to contributions from equity participants. • Revenue is referred to by a variety of different names including sales, fees, interest, dividends and royalties 2

IAS 18 – Scope (IAS 18.1 – 6)


Sale of goods


Rendering of services Use by others of an entity’s assets, yielding
interest, royalties and dividends X Lease income (IAS 17) X Dividends from associates accounted using equity method (IAS 28) X Insurance contracts (IFRS 4) X Changes in fair value/disposal of financial instruments (IAS 39) X Changes in value of other assets (including agricultural and biological assets – IAS 41) 3

General Principles - Recognition

Goods (IAS 18.14) • Transfer of risks & rewards • Management involvement • Substance of the transaction

Recognise revenue when: 1. Measure reliably 2. Flow of economic benefits probable 3. Costs measured reliably

Services (IAS 18.20-28) • Performance of obligations • Use percentage of completion method (IAS 18.21) (see IAS 11 construction contracts for percentage of completion methodology)

Others (IAS 18.30) Interest – time apportion Royalties – accruals basis Dividends – when right to receive established

• If a specific act is much more significant than others, postpone revenue recognition until executed (IAS 18.25) 4

Multiple-element transactions Matching revenue and costs – IAS 18.13 vs 18.19 • The aim of IAS 18 is to recognise revenue when, and to the extent that, goods have been delivered to a customer or services have been performed • Apply recognition criteria to: – separately identifiable components of a single transaction – two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole (IAS 18.13) – see also IAS 11.7-10 for guidance on segmenting or combining contracts

• Revenue and expenses that relate to the same transaction are recognised simultaneously; matching of revenues and expenses (IAS 18.19) 5

Multiple-element transactions (continued)

BUT – IAS 18 not explicit on when components are separately identifiable or not – IFRIC suggests that IAS 18.19 applies only if the entity has to incur further costs directly related to items already delivered, e.g. to install goods or meet warranty claims (see IFRIC 13 Customer Loyalty Programmes) – otherwise IAS 18.13 applies

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Multiple-element transactions Example

• In accordance with local consumer legislation, a manufacturer, entity M, gives warranties at the time of sale to purchasers of its product. Under the terms of the sale contract the manufacturer undertakes to make good, by repair or replacement, manufacturing defects that become apparent within one year from the date of sale. The goods cannot be sold without this standard warranty. • Customers can, at the same time as purchasing the product, purchase an optional extended warranty from the manufacturer to cover defects arising in the two years after the basic warranty period – effectively providing a 3-year warranty period from the date of sale. • The extended warranty can only be purchased at the time of the initial sale, it cannot be purchased separately at a later date. How should entity M recognise revenue from the warranties? 7

Multiple-element transactions Example solution • The sale can be analysed into three components – product supply – standard 1-year warranty service – extended warranty service • The product and the standard 1-year warranty are not capable of being sold separately and so they are combined for the purpose of revenue recognition – IAS 18.19 applies: – entity M recognises revenue based on the fair value of the product and standard warranty, making provision for the estimated costs of providing the standard warranty service • Although M only sells the extended warranty together with the product sale, the customer can take the product without the extended warranty so the components have stand-alone value – IAS 18.13 applies: – entity M defers recognition of the revenue for the extended warranty, recognising it over the 2-year period during which this warranty service is provided 8

IFRIC 13 Customer Loyalty Programmes

• Effective for annual periods beginning on or after 1 July 2008 • Scope – loyalty award credits issued as part of a sales transaction that customers can redeem in future for free/discounted goods and services • Apply IAS 18.13 to allocate FV to award credits as separate component of revenue (IFRIC 13.5) • If the unavoidable costs of meeting the obligations to supply the awards are expected to exceed the consideration received and receivable for them, recognise a liability for onerous contracts in accordance with IAS 37 (IFRIC 13.9) 9

IFRIC 13 Customer Loyalty Programmes

• If the entity supplies the awards itself, recognise revenue when: – award credits are redeemed and – the entity fulfils its obligations to supply awards (IFRIC 13.7) • The amount of revenue recognised shall be based on the number of award credits that have been redeemed in exchange for awards, relative to the total number expected to be redeemed (IFRIC 13.7) 10

Customer Loyalty Programmes Example - Awards supplied by the entity

• Retailer grants programme members loyalty points when they spend a specified amount in store • Programme members can redeem the points for further goods • Points do not expire • In 20X8, retailer grants 10,000 points • Management expects 8,000 of these points to be redeemed • Management estimates the fair value of each loyalty point to be one currency unit (CU1) • Retailer initially defers revenue of CU10,000 11

Customer Loyalty Programmes Example - Awards supplied by the entity (cont)

• At end of 20X8, – 4,000 points have been redeemed in exchange for goods, ie half of expected redemptions • Retailer recognised revenue of CU5,000 – (4,000 points / 8,000*) x CU10,000 • *number of points expected to be redeemed

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Customer Loyalty Programmes Example - Awards supplied by the entity (cont)

• At end of 20X9, another 4,100 points are redeemed, so total points redeemed is now 8,100 – management revises its expectations. It now expects 9,000 points to be redeemed altogether • cumulative revenue recognised is CU9,000 – (8,100 points / 9,000 points) × CU10,000 • Retailer recognised revenue of CU5,000 in the 20X8, so it recognises CU4,000 in 20X9 13

Customer Loyalty Programmes Example - Awards supplied by the entity (cont)

• At end of 20Y0, another 900 points are redeemed, so total points redeemed is now 9,000 – management still expects 9,000 points to be redeemed altogether • cumulative revenue recognised is CU10,000 – (9,000 points / 9,000 points) × CU10,000 • Retailer recognised revenue of CU5,000 in 20X9 and CU4,000 in 20X8, so it recognises CU1,000 in 20Y0 14

Recognition of revenue when a 3rd Party supplies the awards (IFRIC 13.8) • If a third party supplies the awards, assess whether consideration allocated to the award credits is collected as the principal or as an agent • (a) If collecting the consideration on behalf of the third party: – (i) measure its revenue as the net amount retained on its own account; and – (ii) recognise this net amount as revenue when the third party becomes obliged to supply the awards and entitled to receive consideration for doing so – If the customer can choose to claim awards from either the entity or a third party, recognition may occur only when the customer chooses to claim awards from the third party • (b) If the entity is collecting the consideration on its own account, it shall measure its revenue as the gross consideration allocated to the award credits and recognise the revenue when it fulfils its obligations in respect of the awards 15

Revenue - Measurement

Fair value of consideration received or receivable (IAS 18.9)

If consideration is receivable in the future, use present value and recognise interest income as discount unwinds (IAS 18.11)

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Exchange of goods/services (IAS 18.12) (see also SIC 31 Revenue – Barter transactions involving advertising services)

• Goods or services exchanged or swapped for goods or services of a similar nature and value is not a revenuegenerating transaction – eg when suppliers of commodities like oil exchange or swap inventories in various locations to fulfil demand on a timely basis in a particular location

• Goods or services exchanged or swapped for goods or services of a dissimilar nature and value is a revenuegenerating transaction – revenue is measured fair value of the goods or services received, adjusted by the amount of any cash or cash equivalents transferred – if fair value of the goods or services received cannot be measured reliably, fair value of the goods or services given up is used instead 17

Revenue Barter Transactions Involving Advertising Services - SIC 31

• Seller that provides advertising services in the course of its ordinary activities recognises revenue from a barter transaction involving advertising when (SIC 31.3) – the services exchanged are dissimilar (IAS 18.12) – the amount of revenue can be measured reliably (IAS 18.20(a)) Issue: • under what circumstances can a seller reliably measure revenue at the fair value of advertising services received or provided in a barter transaction. 18

Revenue Barter Transactions Involving Advertising Services - SIC 31 • Revenue cannot be measured reliably at FV of advertising services received • Seller can reliably measure revenue at FV of advertising services provided only by reference to non-barter transactions that: – (a) involve advertising similar to the advertising in the barter transaction; – (b) occur frequently; – (c) represent a predominant number of transactions and amount when compared to all transactions to provide advertising that is similar to the advertising in the barter transaction; – (d) involve cash and/or another form of consideration (eg marketable securities, non-monetary assets, and other services) that has a reliably measurable fair value; and – (e) do not involve the same counterparty as in the barter transaction. 19

Disclosures IAS 18.35

1. Accounting policies adopted including methods to determine stage of completion of services 2. Amount of each significant category of revenue recognised during the period including revenue arising from goods, services, interest, royalties and dividends 3. Amount of revenue arising from exchanges of goods and services included in each significant category of revenue 20

Agreements for the Construction of Real Estate (IFRIC 15) - Issue

• Many contracts for the construction of real estate involve the construction of an asset to meet customer specifications • Diversity has developed in practice as to the treatment of 'off-plan' sales, ie sales of real estate units before construction is completed • Issue: – Under which standard should such pre-completion contracts be accounted for (IAS 11 or 18)? – Which method of revenue recognition should be applied? 21

IAS 11 or IAS 18?

• IAS 11 should be applied in accounting for construction contracts in the financial statements of contractors – A construction contract is a contract specifically negotiated for the construction of an asset or a combination of assets (IFRIC 15.11 and IAS 11.3) – such negotiation requires the buyer to be able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether it exercises that ability or not) •

Some contracts for the rendering of services are directly related to construction contracts. – revenue arising from these contracts is not dealt with in IAS 18 but is dealt with in accordance with the requirements for construction contracts as specified in IAS 11.5a (IFRIC 15.11 and IAS 18.4) 22

IAS 11 or IAS 18? (continued)

• An agreement for the construction of real estate in which – construction could take place independently of the agreement – buyers have only limited ability to influence the design of the real estate, eg to select a design from a range of options specified by the entity, or to specify only minor variations to the basic design • is an agreement for the sale of goods within the scope of IAS 18 (IFRIC 15.12)

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Accounting for revenue from the construction of real estate • construction contract – apply IAS 11 percentage of completion method • agreement for the rendering of services (generally where the entity is not required to acquire and supply construction materials: IFRIC 15.15) – apply recognition criteria in IAS 18.20, which also applies the percentage of completion method described in IAS 11 (IAS 18.21) • agreement for the sale of goods (generally where the entity is required to supply both services and construction materials: IFRIC 15.16) – apply recognition criteria in IAS 18.14: • if criteria are met continuously as construction progresses, use percentage of completion method • if entity transfers control and significant risks/rewards at a single point in time (eg at completion or on delivery), recognise revenue when all criteria of IAS 18.14 are met 24

Accounting for revenue from the construction of real estate Example • Entity D is developing 40 residential units on an owned plot of land • During construction, D enters into sale agreements with buyers of individual units: – buyer has right to acquire specified unit when ready for occupation – buyer pays deposit, refundable only if D fails to deliver the completed unit - balance of payment due in two further instalments • one on completion of main structural elements • the remainder on contractual completion of the unit – buyers cannot alter the main structural elements of the design but can select fixtures and fittings design specifications from a range of offerings – if buyer fails to make specified payments, entity D retains the right to complete the unit and find an alternative buyer 25

Accounting for revenue from the construction of real estate Example solution • Agreement is not a construction contract • Agreement is a forward contract that gives the buyer – an asset in the form of a right to acquire, use and sell the completed real estate at a later date and – an obligation to pay the purchase price in accordance with its terms. • Entity D retains control and the significant risks and rewards of ownership of the work in progress in its current state until the completed real estate is transferred • Therefore, revenue should be recognised only when all the criteria in IAS 18.14 are met - at contractual completion 26

Accounting for revenue from the construction of real estate Example 2 • Assume same facts as previous example except: – In the jurisdiction, the law requires the entity to transfer immediately to the buyer ownership of the real estate in its current state of completion and that any additional construction becomes the property of the buyer as construction progresses. – The sale agreement confirms that if the agreement is terminated before construction is complete, the buyer retains the work in progress and entity D has the right to be paid for the work performed – The contract can be terminated by the buyer subject to an agreed notice period and payment of a termination penalty

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Accounting for revenue from the construction of real estate Example 2 solution • Agreement is not a construction contract • Agreement is an agreement for the sale of goods. • Entity D applies judgement to decide if the terms of the contract transfers control along with ownership of the work in progress in its current state • If so, this may indicate that the criteria in IAS 18.14 are met continuously as construction progresses and revenue is recognised using the percentage of completion method 28

Service Concession Arrangements IFRIC 12 – scope (IFRIC 12.4-9) Service concessions in which • a public sector body (the grantor) engages a private entity (the operator) to provide services to the public; and • those services involve the use of infrastructure by the operator (public to private service concessions) Operator only Applies where: • grantor regulates services provided, who provided to and pricing arrangements • grantor controls any significant residual interest in the infrastructure at end of arrangement • infrastructure was either constructed or acquired by operator or provided by grantor for the purpose of the concession Contracts within IFRIC 12 are excluded from IFRIC 4 scope 29

IFRIC Developments – IFRIC 12 Service Concessions (continued) Issues addressed • rights over infrastructure - do not recognise as property, plant and equipment of the operator (IFRIC 12.11) • recognition and measurement of arrangement consideration – account for revenue and costs in accordance with IAS 11 and IAS 18 (IFRIC 12.12-14) • construction or upgrade services provided – record a financial asset or an intangible asset depending on the character of the receivable (IFRIC 12.15-19) – –

financial asset if unconditional right to receive cash intangible asset if receives a right (licence) to charge users 30

IFRIC Developments – IFRIC 12 Service Concessions (continued) Other issues addressed • •

•

•

other services provided during the term of the arrangement – apply IAS 18 (IFRIC 12.20) contractual obligations to maintain or restore infrastructure recognised and measured in accordance with IAS 37 (FRIC 12.21) borrowing costs incurred in the construction phase – book as an expense unless there is a contractual right to receive an intangible asset (IFRIC 12.22) subsequent accounting for the financial or intangible asset that the arrangement gives rise to – apply IAS 32/39 & IFRS 7 or IAS 38 as appropriate (IFRIC 12.23-26) 31

Service Concession Arrangements Example • Grantor and operator enter 10-year agreement with following terms and expected costs – construct toll road within 2 years (1-2): CU500 pa – maintain and operate road for next 8 years (3-10): CU10 pa – resurface road at end of year 8: CU100

• The operator will receive the tolls from road users: estimated at CU200 pa • Grantor guarantees operator a minimum of CU700 plus interest of 6.18% • Operator pays interest on borrowings at 6.7% • Operator usually earns cost plus 5% on construction activities • Assume all cash flows are due and occur at the end of each year 32

Service Concession Arrangements Example solution

• Operator determines revenue to be recognised on construction activities – recovered partly by the minimum guarantee (a financial asset receivable of CU722) and partly from the toll receipts (the licence to collect these is an intangible asset with cost CU361) • Income of CU1,083 recognised for the two years of construction activity (under IAS 11) at fair value of: – cost plus 5% – interest income on the outstanding balance of the guaranteed minimum income – recovery of capitalised borrowing costs on proportion of construction costs funded by borrowings, ie not covered by guaranteed minimum receivable 33

Service Concession Arrangements Example solution (cont)

• Toll receipts of CU200 pa are allocated to: – recovery of the financial asset (plus interest income) CU117 and – income statement revenue from the intangible asset CU83

• The intangible asset is amortised over the 8-year operating period – CU 45 for each of years 3-10 • The provision for the expected cost of CU100 for resurfacing at end of year 8 is gradually built up as the road is used between years 3 – 8, together with the unwinding of the discount 34

Questions

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