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Initial recognition
The primary issue in accounting for revenue from
the sale of goods is when revenue should be recognised.
Revenue recognition involves consideration of whether
an asset has been sold and should be de-recognised;
and whether the revenue from the sale is collectible
and measurable [IAS18R.14-19].
Revenue should be recognised only when the earning
process is complete.
The earnings process
The earnings process is complete and revenue should
be recognised when all of the following have occurred:
| a) |
the entity (seller)
has transferred significant risks and rewards
of ownership to the buyer [IAS18R.14(a)]; |
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| b) |
the entity has relinquished managerial
involvement and effective control over the
goods [IAS18R.14(b)]; |
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| c) |
the costs incurred
or to be incurred can be measured reliably [IAS18R.14(c)]
; |
|
| d) |
it is probable that
any future economic benefit associated with
the revenue will flow to the entity [IAS18R.14(d)];
and |
|
| e) |
the revenue has a cost or value
that can be measured reliably [IAS18R.14(e)].
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Criteria c) d) and e) are straightforward as to
their meaning. In order to recognise revenue, an
entity must be able to measure it reliably, and
the cost of goods sold must be reliably determinable
before the related revenue can be recognised. An
entity must make adequate provision for collection
risks . Criteria a) and b) are
more difficult than the others to determine and
require more attention by management. Assessing
the transfer of risks and rewards must consider
the seller's continuing participation in the future
benefits of the goods sold.
Application of revenue recognition criteria
The effect of criteria a) and b) on revenue recognition
can be best understood by reference to a number
of common commercial situations that are described
below.
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Seller has transferred
risks & rewards
|
Seller has relinquished
managerial involvement
|
Point at which revenue should
be recognised |
| Title transferred with delivery
of goods in an unconditional sale arrangement |
Y
|
Y
|
On transfer of goods |
| Title transferred with delivery
of goods, in an agency arrangement. |
N
|
N
|
When agent's right to return goods
is relinquished and/or agent has generated third
party revenue
|
| Goods are transferred, but seller
retains title for credit protection purposes |
Y
|
Y
|
On transfer of goods. Credit risk
is not a significant risk of ownership
|
| Goods transferred, sale is unconditional;
however, sale price is not fixed until buyer
takes delivery of goods |
Y
|
Y
|
On transfer of goods |
| Buyer and seller enter in a layaway
sales arrangement. |
N
|
N
|
When buyer takes delivery of goods |
| Buyer and seller enter into a
bill and hold sale arrangement |
Y
|
Y
|
When the buyer takes title provided
the conditions for a bill and hold sale are
met (IAS 18 Appendix A Example 1) |
| Buyer takes delivery of goods,
payment to be made subject to satisfactory installation |
N
|
N
|
When installation and inspection
is complete |
| Buyer takes delivery of goods,
seller guarantees product performance outside
of normal warranty provisions |
Will depend on facts and
circumstances
|
Will depend on facts and
circumstances
|
When seller is no longer exposed
to significant risk and has no further performance
obligation |
| Buyer takes delivery of goods,
seller guarantees product performance within
normal warranty provisions |
Y
|
Y
|
When buyer takes delivery of goods;] |
| Buyer takes delivery of goods,
seller continues to share in certain benefits. |
Will depend on facts and
circumstances
|
Will depend on facts and
circumstances
|
When seller has relinquished right
to significant benefits |
| Seller transfers goods to the
buyer, seller has an obligation to repurchase
goods |
N
|
N
|
No sale is recognised, as substantially
all the risks and rewards are retained |
| Seller transfers goods to the
buyer, seller has an option to repurchase goods
at an amount below their fair value |
N
|
N
|
When seller relinquishes purchase
option |
Reliable measurement and collectability
Revenue is recognised only when it is probable that
it is collectible and measurable [IAS18R.14(c)-(e)]
[IAS18R.18]. Revenue can only be collectible when
there is a binding sales agreement. The need for
the binding agreement to be a written agreement
will depend on local business practices and laws.
Once revenue is recognised, any subsequent uncertainty
about the collectability of the revenue is recognised
as an adjustment to the amount receivable rather
than as an adjustment to revenue [IAS18R.18].
Initial measurement
Revenue should be measured at the fair value of
the consideration received or receivable [IAS18R.9].
A cash sale is recognised at the amount of cash
received.
The fair value of revenue receivable from a credit
sale is the present value of the cash receivable.
The difference between the discounted and undiscounted
revenue is usually not material for a short credit
period and can be ignored. However, present value
of the revenue is recognised if a longer, interest-free
credit period is given. The discount rate used should
be the customer's borrowing rate, not the seller's
borrowing rate. The difference between the fair
value and the nominal amount of the consideration
should be deferred in the balance sheet and recognised
as interest revenue using the effective interest
method
[IAS18R.11, 30] .
Foreign currency sales
Foreign currency sales are recorded at the transaction
rate (the spot exchange rate on the date of the
transaction on initial recognition [IAS21R.21].
Where management enters into a forward currency
contract to hedge the receivable's foreign exchange
risk, the revenue is still recorded at the spot
rate on the date of the transaction. Changes in
the fair value of the receivable and the forward
contract are included in the income statement, and
no adjustment is made to revenue . An average exchange rate may
be used for frequent transactions if they result
in the transactions being recorded at amounts closely
approximating the actual rates [IAS21R.22].
Where a contract for the sale of a non-financial
asset is denominated in a foreign currency that
is not the functional currency of either party to
the contract an embedded derivative may exist that
needs to be separated from the host sales contract,
and accounted for as a derivative (Solution 86.14) (Solution 86.15).
Barter transactions
Goods may be sold under barter type arrangements
whereby the consideration is goods rather than cash.
Revenue should only be recognised if the sale represents
the completion of the earnings process. This is
assumed to be the case where the goods or services
exchanges are dissimilar [IAS18R.12]. The exchange
of inventory in different locations by petrol retailers,
for example, is the exchange of similar goods and
does not represent the completion of the earnings
process, and consequently no revenue is recorded.
Where dissimilar goods are exchanged, revenue is
recognised, provided it can be measured reliably.
The amount of revenue to be recognised is measured
at the fair value of the assets received, adjusted
by the amount of the cash equivalents transferred,
or, if more readily determinable, the fair value
of goods given up [IAS18R.9,12] [SIC31.5-10]. Determining
whether goods or services exchanged are similar
or dissimilar can be difficult, and judgement should
be applied
Different rules apply when fixed assets are disposed
of in barter or part-barter transactions. Consideration
received is the fair value of the assets received
in the exchange. This is measured against the cost
of the assets given and the resulting difference
is recognised as a gain or loss in the income statement.
No gain or loss is recognised in the rare situations
where an exchange lacks commercial substance or
the fair value of neither asset can be reliably
measured [IAS16R.24].
Related parties
The requirement to measure revenue at fair value
applies to non-arm's length transactions, as well
as arm's length transactions. Revenue transactions
with related parties are recorded at the fair value
of the consideration received. This is the agreed
amount of any monetary consideration and the fair
value of any non-monetary assets received [IAS18R.9-10].
Disclosure
An entity should disclose the accounting policies
adopted for revenue recognition [IAS18R.35]. The
nature and extent of the disclosure appropriate
in the circumstances will depend on whether the
policy used is peculiar to the industry in which
the entity operates, or whether the policy or the
method of its application is unusual or significant.
The entity should also disclose, as a separate
category of revenue, revenue arising from the sale
of goods [IAS18R.35(b)(i)].
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