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[/et_pb_text][/et_pb_column][/et_pb_row][/et_pb_section][et_pb_section admin_label=”Section” fullwidth=”off” specialty=”off”][et_pb_row admin_label=”Row”][et_pb_column type=”1_2″][et_pb_text admin_label=”Text” background_layout=”light” text_orientation=”center” text_font_size=”14″ use_border_color=”off” border_color=”#ffffff” border_style=”solid”] [button link=”http://www.frs102.com/members/premium-toolkit/” type=”big” color=”red”] Return to Main Index[/button] [/et_pb_text][/et_pb_column][et_pb_column type=”1_2″][et_pb_text admin_label=”Text” background_layout=”light” text_orientation=”center” text_font_size=”14″ use_border_color=”off” border_color=”#ffffff” border_style=”solid”] [button link=”http://frs102.com/members/premium-toolkit/section-23/” type=”big” color=”red”] Return to Section 23 Home[/button] [/et_pb_text][/et_pb_column][/et_pb_row][/et_pb_section][et_pb_section admin_label=”Section” fullwidth=”off” specialty=”off” transparent_background=”off” allow_player_pause=”off” inner_shadow=”off” parallax=”off” parallax_method=”off” padding_mobile=”off” make_fullwidth=”off” use_custom_width=”off” width_unit=”on” make_equal=”off” use_custom_gutter=”off” gutter_width=”3″][et_pb_row admin_label=”Row”][et_pb_column type=”4_4″][et_pb_text admin_label=”Main Body Text” background_layout=”light” text_orientation=”justified” use_border_color=”off” border_color=”#ffffff” border_style=”solid”]Example 1: Probable or possible criteria on sale
Company A sold goods to customer B regularly on 2 months credit. There was no history of non payment in the past. On 1 February due to financial difficulties customer B contacted Company A and all its creditors to enter into an arrangement to restructure its debts. On 4 February Company A ships a product to Customer B which was ordered in January. For this sale, the revenue should not be recognised until the money is received from Customer B as it is not probable that it will be paid for.
For the balance outstanding on the trade debtors listing in relation to sales made pre 1 February any provision required should be posted as a debit to expenses in the profit and loss account as opposed to a debit to revenue.
Example 2: Sales incentives/rebates
Company A provides to customer’s sales incentives to purchase its goods as follows. Where sales for the year are:
CU0-CU50,000 a sales rebate of 0% is applied
CU50,000-CU75,000 a sales rebate of 2% is applied
>CU75,000 a sales rebate of 5% is applied
The listed sales price for Company A product is CU100 plus VAT of CU23. Company A sells goods to customer B. In the past Customer B has always purchased between CU50,000-CU75,000 from Company A and it is probable a similar level will be purchased from Company A for the coming year. When recognising the sale on delivery to the customer the expected rebate to be issued at the end of the year should be incorporated. The journal to be posted on recognition is:
|
|
CU |
CU |
|
Dr Debtors |
123 |
|
|
Cr Revenue |
|
100 |
|
Cr VAT Liability |
|
23 |
Being journal to recognise the sale
|
|
CU |
CU |
|
Dr Revenue (CU100 * 2% being the most probable rate that will be achieved) |
2 |
|
|
Cr Rebate Accrual |
|
2 |
Being journal to reflect estimated rebate payable to the customer based on current sales
If during the year, it looks like the total sales will exceed CU75,000 then the higher rebate of 5% should be applied so a catch up charge on the rebate should be posted to sales to increase the rebate of 2% previously recognised on sales prior to that date to 5%.
Example 3: Early settlements
Company A sells goods on credit to customers. It gives customers a 5% settlement discount if the invoices are paid within 7 days. From past experience 30% of customers take up this option. If we assume sales for the month were CU100,000 which occur at month end, the total revenue to be recognised should be:
CU100,000 * (30%* 5%) = CU1,500. Hence the journal required is to Cr settlement discount accrual and Dr revenue
Example 4: Principal vs Agent
Company A purchases goods from Company B as part of a distribution agreement. The distribution agreement states that:
- Company A takes the inventory into its warehouse and transports and invoices the goods to the final customer but also packages these
- Where Company A has excess stock it can be returned to Company B without any penalty
- Company A is responsible for insuring the goods while in inventory however obsolete stock can be returned
- Company A has no right in determining the selling price, this is dictated by Company B. The mark up included in the sales price by Company A is dictated by Company B – markup is set at 50% of the sales price.
- In the event of default in payment by the customer after all avenues have been exhausted Company B bears the risk of bad debts
During the month Company A sold CU100,000 of the products. The company purchased CU80,000 in stock from Company B which existed at year end.
Based on the evidence available, Company A is acting as agent as it has no say in determining the selling price, bears no inventory risk nor credit risk. Company A would therefore only recognise the net amount as revenue (i.e. the sales price less the cost of purchase of the goods). Company B is the principal and should not recognise any revenue until the Company A sells the goods on to the final customer, it should continue to carry these in stock as it is akin to a consignment stock agreement.
The journals required in the month for Company A are:
|
|
CU |
CU |
|
Dr Debtors |
33,333 |
|
|
Cr Revenue (CU100,000 being the sales price less CU66,667 being the purchase price as Company A earns a 50% mark-up) |
|
33,333 |
Being journal to recognise the net commission earned on the sale
The journals required in the month for Company B are:
|
|
CU |
CU |
|
Dr Debtors |
100,000 |
|
|
Cr Revenue |
|
100,000 |
Being journal to reflect the amounts owed from Company A. Note the inventory of CU53,333 (CU80,000- mark up of CU26,667) is kept in the books of Company B as this inventory is still under the control of Company B.
If in the above example, Company A held the inventory risk in full or could determine the selling price this would usually indicate that it is acting as principal and Company A would then show inventory on the balance sheet and the gross revenue in the revenue line and the cost of the products in cost of sales.
Example 5: Principal vs agent
Company A is a retailer that deals in cash so there is no credit risk. The company sells the following products:
Classification
Mobile phone e-top up’s which are printed from a machine as required. Agent
Stamps (bought in bulk by the retailer and bears the risk if they are not sold) Principal
National lottery tickets which are printed from a machine as required Agent
Scratch cards (bought in bulk by the retailer and bears the risk if they are not sold) Principal
As can be seen where the retailer sells items which are sold in electronic form the seller is acting as an agent as it bear no risk i.e. it does not need to hold inventory of the items and there is no risk of obsolescence, it bears no credit risk as cash is received when sold. In these instances, the sales commission received should be recognised as turnover.
Where there is a tangible product and where the retailer is required to hold stock and bears the risk of loss if these are damaged or stolen then they are acting as a principal. Therefore the gross sales should be recognised in revenue and the cost of the products shown in cost of sales.
Example 6: Deferred payment example
Company A sold goods worth CU50,000 with unusual credit terms on 01/12/13. The credit provided is for a period of up to 31/12/15. The normal cash price for these goods would be CU35,000. The difference of CU15,000 is determined to be a financing transaction. The effective interest rate is calculated at 18.62% as per below. The effective interest rate is determined so as to write the deemed interest income into the P&L over the life of the transaction. The effective interest rate is determined through trial and error or through the use of excel formula.
Here the journals required on initial recognition of revenue are:
|
|
CU |
CU |
|
Dr Trade Debtors |
35,000 |
|
|
Cr Revenue |
|
35,000 |
Being journal to recognise the sale
At the end of year 1, the following journal would be posted
|
|
CU |
CU |
|
Dr Trade Debtors |
536 |
|
|
Cr Interest Cost |
|
536 |
Being journal to reflect the deemed interest for the year under the effective interest rate method. The same journal would be posted for the other years.
Example 7: Deferred payment example
If we take example 6 and assume a cash price cannot be determined. In this case the rate to use would be the interest rate that would be charged by a bank to that particular customer. If we assume the rate the customer would pay if the CU50,000 was borrowed from a bank with similar security would be 5%. The present value of CU50,000 at a discount rate of 5% is CU45,167 (CU50,000/((1/1.05)^2.0833). 2.0833 represents the length of the credit i.e. 2 years and one month. The journals as per example above will be the same.
Example 8: Identifying separable components and allocating relative fair value
Company A is engaged in the business of both selling software and providing service and support. Company A sells these bundled together or can sell them separately. Company A sold the software and the service and support as a bundled product to a customer for CU20,000. The fair value if the software was sold separately is CU12,000 and the fair value of the servicing and support if sold separately is CU10,000.
As these two types of sales have differing points for recognition of revenue, and given that they are sold independently, means that the sales price of CU20,000 should be allocated between the two components. The price for each component should be determined on a relative fair value basis as follows:
Amount allocated to sale of software =
| CU20,000 * CU12,000 = | CU10,909 |
| (CU10,000+CU12,000) |
Amount allocated to sale of service and support =
| CU20,000 * CU10,000 = | CU9,091 |
| (CU10,000+CU12,000) |
The initial sale would be journaled as follows:
|
|
CU |
CU |
|
Dr Trade Debtors |
20,000 |
|
|
Cr Software Revenue |
|
10,909 |
|
Cr Service and Support Revenue |
|
9,091 |
As the transfer of the software/cd to the customer is when the risks and rewards of ownership pass, the condition for recognition would be met. However as service and support is only recognised over the life of the support contract, the sale should be deferred and released over the life of the support contract assuming work is carried out evenly throughout that period.
Therefore the journal required would be to:
|
|
CU |
CU |
|
Dr Service and Support Revenue |
9,091 |
|
|
Cr Deferred Income |
|
9,091 |
Note if in the example above the fair value of both of the offerings came to exactly CU20,000 then obviously the relative fair value formula would not need to be utilised. In the example above on the recognition of the software element, the cost of sale would be recognised for the software product.
As the cost for the servicing are expensed as incurred it will be met by the release of the deferred income element over the life of the service contract.
Example 9: Identifying separable components and allocating relative fair value – goods
Company A sells franking machines but also provides a service for servicing and maintenance, which can be purchased separately but where a customer purchases these together they get a discount. The cost of purchasing a franking machine on its own is CU2,000 and for purchasing a service and maintenance contract is CU500. Where both are purchased together, the customer is charged CU2,200. Assume a customer has purchased both for CU2,200.
To recognise this sale, the relative fair values will need to be determined.
Amount allocated to sale of franking machine =
| CU2,200 * CU2,000 = | CU1,760 |
| (CU2,000+CU500) |
Amount allocated to sale of servicing & maintenance=
| CU2,200 * CU500 = | CU440 |
| (CU2,000+CU500) |
The initial sale would be journaled as follows:
|
|
CU |
CU |
|
Dr Trade Debtors |
2,200 |
|
|
Cr Goods Revenue |
|
1,760 |
|
Cr Service and Maintenance Revenue |
|
440 |
As the transfer of the machine to the customer is when the risks and rewards of ownership pass, the condition for recognition would be met. However as service and maintenance is only recognised over the life of the contract, the sale should be deferred and released over the life of the support contract assuming work is carried out evenly throughout that period. Therefore the journal required would be to:
|
|
CU |
CU |
|
Dr Service and Maintenance Revenue |
440 |
|
|
Cr Deferred Income |
|
440 |
The cost of sale on the sale of the goods would be recognised at the same time of the recognition of the sale.
Where the method used results in a loss on either one of the separable components, then provision for the loss should be made and where appropriate a cost plus reasonable margin approach should be used.
Example 11: Cost plus a reasonable margin
If the entity felt the loss in example 10 was not economic reality, then they could use another approach such as the cost plus a reasonable margin. Here the company would assess how the profit would be allocated as there is a profit overall on the contract of CU550 (CU2,200-CU1,200-CU450). Based on experience the company believe the profit should be split CU450 to the goods and CU100 to the service contract. In this case the journals would be:
|
|
CU |
CU |
|
Dr Trade Debtor |
2,200 |
|
|
Cr Revenue – Goods (cost of CU1,200 + CU450 profit) |
|
1,650 |
|
Cr Deferred Income – Maintenance (cost of CU450 + CU100 profit) |
|
550 |
Being journal to reflect the sale and deferral of income for the maintenance contract
|
|
CU |
CU |
|
Dr Cost of Sales – Cost of Franking Machine |
1,200 |
|
|
Cr Inventory |
|
1,200 |
Being journal to reflect cost of sale on goods
A linked transaction is where an entity sells raw material parts to a manufacturer who carried out further work on these and where there is an agreement that the same entity will purchase the parts back from the manufacturer at a set price, then no sale should be recognised in the books as this transaction has no substance as the entity still holds the inventory risk and is obliged to buy it back from the manufacturer.
Example 12: Customer loyalty awards (Extracted from FRS 102 – Section 23A.16-23A.17)
An entity sells product A for CU100. Purchasers of product A get an award credit enabling them to buy product B for CU10. The normal selling price of product B is CU18. The entity estimates that 40 per cent of the purchasers of product A will use their award to buy product B at CU10. The normal selling price of product A, after taking into account discounts that are usually offered but that are not available during this promotion, is CU95.
The fair value of the award credit is 40% * [CU18 – CU10] = CU3.20. The entity allocates the total revenue of CU100 between product A and the award credit by reference to their relative fair values of CU95 and CU3.20 respectively. Therefore:
(a) Revenue for product A is CU100 * [CU95 / (CU95 + CU3.20)] = CU96.74
(b) Revenue for product B is CU100 * [CU3.20 / (CU95 + CU3.20)] = CU3.26
Example 13: Right of return in exchange for cash/vouchers
A clothes retailer selling goods and provides the customer a right to return the goods within 20 days. Based on past experience 5% of customers return the goods in return for cash or vouchers. The margin on the sale is generally 20%. The total sales for the month were CU10,000.
At month end the Company should defer 5% of the sales revenue for the estimated returns and increase inventory/other assets by 5% of the cost. The journals to be posted would be:
|
|
CU |
CU |
|
Dr Revenue (CU10,000*5%) |
500 |
|
|
Cr Deferred Income |
|
500 |
Being journal to defer the risk of returns
|
|
CU |
CU |
|
Dr Inventory/Other Asset (assuming the stock can be sold for more than its cost) |
400 |
|
|
Cr Cost of Sales (CU10,000*80%=CU8,000 being the cost * 5%) |
|
400 |
The provision and asset is released as the clothes are returned or when the time period for the return lapses. The journal required on physical return is:
|
|
CU |
CU |
|
Dr Deferred Income (or revenue where provision is utilised in full) |
XX |
|
|
Cr Bank (or deferred revenue where voucher issued) |
|
XX |
Example 14: Discount coupons
Company A issued coupons in a local supermarket providing a discount of 10% on redemption.
In this case no provision is made at the time of issue as it is merely cost of promoting the stores.
Example 15: Discount coupons – buy one get one free
Company A issued coupons in a local supermarket which allowed a customer to get a free raincoat when a pair of wellingtons is purchased.
In this case no provision is required on issuance unless they are onerous contracts. However, when the coupon is redeemed, the costs relating to the coupons (i.e. the discounts) are charged to cost of sales. This is a cost of sale and not a marketing cost. The revenue recognised is the price paid by the customer and the cost of sales is the costs of both products.
Example 16: Gift vouchers
Company A issues gift vouchers during the month for CU10,000.
The sale of the gift vouchers should be included within deferred revenue and revenue should not be recognised until the shorter of when:
- The vouchers are redeemed
- Vouchers pass the sell by date
- Where there is a long history that allows the Company to determine when it becomes remote that a voucher will be redeemed with the estimate adjusted based on changes in redemption patterns.
The journal required to account for the voucher is:
|
|
CU |
CU |
|
Dr Bank |
XXX |
|
|
Cr Deferred Revenue/Voucher Liability |
|
XXX |
Example 17: Sale of extended guarantee
Company A sells a sofa with a standard guarantee of 6 months but provides an option to the customer to purchase an extended guarantee of one year.
In this instance recognition of the revenue for the purchase of the extended option only begins at the end of the normal 6 month period and from that date is released over the one year period of the extended warranty.
Note the normal guarantee provision is posted as a cost into cost of sales.
Example 18: Interest free credit
Company A sells goods interest free to customers for 6 months. Company A enters into an arrangement with a finance company whereby the finance company pays Company A the invoice price less finance charges.
The net sales amount after deduction of the finance charges should be recognised in revenue.
Example 19: Construction real estate – buyer has the right to specify structural design
Company A is engaged in the purchase of land and the development of property. The company purchased the land and have entered into an agreement with a customer whereby the customer would purchase the land from Company A and contract Company A to construct the customers house to that customer’s specific requirements. The customer supplies all the materials. The price for the purchase of the land should be paid on transfer of title.
In this example as the customer is able to specify the type of house that they want built and is also providing the material for Company A, Company A should account for the sale on the construction of the property on a percentage of completion basis. The sale of the land can be recognised when title to the land is transferred to the customer i.e. before the house is built.
Example 20: Construction real estate – buyer has no right to specify structural design
Company A is a construction company and purchased land to construct a number of houses on it. The Company offers customers an opportunity to purchase the house off the plan, and provide the customers with a limited number of choice with regard to the houses being built as planning has already been obtained by Company A. The customer can detail what way they want the interior to be designed i.e. choice of colour, tiling, utencils etc. The price is agreed on signing the contract. The customer must pay a deposit of 10% and the remainder on completion of the property.
In this example as the customer has no ability to negotiate a significant part of the structures of the house (i.e. the structures themselves are pre-determined), they have only acquired a right to acquire the house at the set price from the beginning. Here as Company A retains the majority of risks and rewards of ownership no revenue should be recognised on the construction of the house until the conditions in Section 23.10 are met which is likely to be on completion of the house and the legal transfer of the house to the buyer. Company A has to incur the cost of all material for the house.
Example 20A: Reliable measurement
Company A carries out architectural services. It has entered into a contract to provide services for a fixed price of CU500,000. This contract is the first of its type. At the end of year 1, the firm has incurred CU100,000 in costs. At the year end Company A cannot determine what the future costs are likely to be. As a result the company should recognise revenue of CU100,000 such that no profit or loss is recognised.
Example 20B: Reliable measurement
If we take example 20A and now assume at the end of year 2 the company expects a loss on the project of CU100,000. Company A should recognise a provision for this future loss of CU100,000.
Example 21: Stage of completion – detailed in the contract
Company A is an architectural company that provides services to the client. Before a service is provided Company A requires customers to sign a contract stating that the Company has the right to receive payment for any work performed and will be paid for services rendered at the appropriate rate in the contract, even if the contract is broken. If we assume the fee for preparing a drawing of a house including an initial consultation for a customer is CU1,000.
In this case, Company A can recognise revenue over the period in which Company A works on the drawing and meets with the client (i.e. on the percentage of completion basis). If the customer decides to cancel the contract halfway through, then Company A can still recover CU500 from the customer because per the terms of the contract the customer agreed to pay on this basis.
Example 22: Stage of completion
If we take example 21 and assume that the terms of the contract stated that Company A had no right to receive payment until the drawing was completed, then revenue cannot be recognised until the significant act i.e. the completion of the drawing has been fulfilled.
Example 23: Proportion of costs method
Company A is a solicitors firm. They have entered into a contract with a customer to carry out work on the transfer of a property to a third party. Under the terms of the contract a fee of CU2,000 will be charged. The Company estimate that this will cost the firm CU1,300 at the firms charge out rates. At the end of month the company has incurred CU650 in costs. On this basis 50% (CU1,300 total costs expected less CU650 costs incurred) of revenue can be recognised (i.e. CU1,000).
Example 24:
Company A is an insurance underwriter who also provides claims support to a set amount of insurers. The insurance renewals would usually straddle year end. Commission is earned from the insurance company based on each policy taken out with them which incorporates the fact that the broker deals with any claims. Commission is recognised as the policies are accepted by customers. At the year end Company A will have to assess the volume of policies which straddle the Company’s year end and then assess the costs it incurs in servicing claims and dealing with customers after renewal. Based on this assessment of costs, revenue should be deferred.
Example 25: – Proportion of cost basis
Company A entered into a fixed contract during year 1 to construct a building for CU50,000. The expected cost of construction was CU40,000. At the end of year 1 the financial statements are being prepared. At that point total costs incurred to date was CU20,000. The expected future costs are CU22,000. Included in the CU20,000 cost, is construction materials which will be used on the second floor which has not been started by the year end. The total cost of this material was CU2,000. The Company paid a subcontractor CU1,000 for work to be done in the future. The costs to date also include labour costs incurred during two weeks of strike for CU500. Also included in cost to date is CU200 in relation to a specific part produced specifically for the property to be installed in the future.
The cost which should be included in the calculation as costs incurred to date is:
|
Total Costs Incurred to date as per above |
CU20,000 |
|
Less Materials to be used in the future |
(CU2,000) |
|
Less Payment to Subcontractor in advance |
(CU1,000) |
|
Less Wasted Cost Inefficiencies during strike |
(CU500) |
|
Total Costs to date for calculation |
CU16,500 |
The total expected cost to complete of CU22,000 needs to be increased by the CU3,000 (excluding CU500 for the cost of the strike) taken away above = CU25,000
Therefore total revenue to be recognised =
| CU50,000 * 16,500 = | CU19,880 |
| CU25,000 + CU16,500 |
The journals required assuming all costs to date have been posted to the P&L are:
|
|
CU |
CU |
|
Dr Accrued Income/Gross Amounts Due from Customers for Contract Work* |
19,880 |
|
|
Cr Revenue |
|
19,880 |
Being journal to recognise revenue for the period
*note this would be netted against the amounts due to customers if there was a payment in advance.
|
|
CU |
CU |
|
Dr Inventory |
2,000 |
|
|
Dr Other Debtors |
1,000 |
|
|
Cr Cost of Sales |
|
3,000 |
Being journal to show the future material cost in work in progress and the payment in advance to supplier as a receivable balance.
Note the specific part for future work should be included in the costs incurred to date.
Example 26: Inability to reliably measure the contract
Company A entered into a fixed value contract during year 1 to construct a building for CU50,000. At the end of year 1 the financial statements are being prepared. The cost incurred to date was CU15,000 At this date given the complexities in the contract Company A could not reliably measure the costs to complete. The Company believes that it is probable if not certain that all costs incurred to date will be recovered.
As a result of the inability to measure the costs to complete revenue of CU15,000 should recognised.
Example 27: loss on contract
Company A entered into a fixed value contract during year 1 to construct a building for CU50,000. The initial expected costs were CU40,000. At the end of year 1 the total costs incurred were CU15,000 and the expected costs to complete were CU30,000.
At the end of year 2, the total costs incurred was CU45,000 and the company now believe that the total cost to complete will be CU15,000 thereby resulting in an expected loss on the contract of CU10,000.
The accounting for same would be as follows:
At the end of year 1 the amount to be included in revenue is CU16,667 (CU50,000 * (CU15,000/(45,000)).
At the end of year 2 the Company now have an onerous contract.
The total revenue to be recognised at year end is CU20,883 as per below.
|
|
To date (year 2) |
Prior year (year 1) |
To be recognised in year 2 |
|
Revenue recognised |
37,500* |
16,667 |
20,883 |
|
Costs |
45,000 |
15,000 |
30,000 |
|
(Loss)/Profit |
(7,500) |
1,667 |
(9,117) |
|
Provision for future loss |
(2,500) |
– |
(2,500) |
|
Total |
(10,000) |
1,667 |
(11,617) |
The provision for future loss of CU10,000 has now been recognised in full. There is a loss of 11,617 recognised in year 2 as CU1,667 is reversing the previous profit recognised. For the remainder of the contract if the estimates are correct the revenue will equal the costs.
* (CU50,000 * (CU45,000/(60,000))
The journals required at the end of year 2 are:
|
|
CU |
CU |
|
Dr Accrued Income/Gross Amounts Due from Customers for Contract Work |
20,883 |
|
|
Cr Revenue |
|
20,883 |
Being journal to recognise required revenue
|
|
CU |
CU |
|
Dr Cost of Sales |
CU2,500 |
|
|
Cr Provision |
|
CU2,500 |
Being journal to recognise loss on onerous contract
Example 28: Application of change in estimate
Company A entered into a fixed value contract during year 1 to construct a building for CU50,000. The contract finishes at the end of year 3. The initial expected costs were CU40,000.
At the end of year 1 the total costs incurred were CU15,000 and the expected costs to complete was CU30,000.
At the end of year 2, the total cost incurred was CU30,000 and the cost to complete will be CU11,000.
At the end of year 3, the total cost incurred was CU46,000.
The accounting for same would be as follows:
At the end of year 1 the amount to be included in revenue is CU16,667 (CU50,000 * (CU15,000/(45,000)).
At the end of year 2 the total revenue to be recognised is CU36,585 (CU50,000 * (CU30,000/(41,000)).
|
|
To date (year 2) |
Prior year (year 1) |
To be recognised in year 2 |
|
Revenue Recognised |
36,585* |
16,667 |
19,918 |
|
Costs |
30,000 |
15,000 |
15,000 |
|
Profit |
6,585 |
1,667 |
4,918 |
*(CU50,000 * (CU30,000/(41,000))=CU36,585
At the end of year 2 the total revenue to be recognised is CU19,918.
|
|
To date (year 3) |
Prior year (year 2) |
To be recognized in year 3 |
|
Revenue Recognised |
50,000* |
36,585 |
13,415 |
|
Costs |
46,000 |
30,000 |
16,000 |
|
Profit/(Loss) |
4,000 |
6,585 |
(2,585) |
*actual revenue as contract complete
We can see the overall profit shown in the P&L over the three years is CU4,000
Example 29: Sale with unusual credit terms
Company A sold goods worth CU50,000 with unusual credit terms on 01/12/13 (date of transition is 01/01/14). The credit provided is for a period of up to 31/12/15. The normal cash price for these goods would be CU35,000. Under old GAAP CU50,000 was recognised in 2013 and the carrying amount in debtors at 01/01/14 was CU50,000. The difference of CU15,000 is determined to be a financing transaction. Assume the deferred tax rate is 10% and the transition adjustment will be taxed in future tax computation as the finance income is released. The effective interest rate is calculated at 18.62% as per below. The effective interest rate is determined so as to write the deemed interest into the P&L over the life of the transaction. The effective interest rate is determined through trial and error or through the use of excel.
|
Calculated EIR – 18.62% |
||||
|
Period Ending |
Opening Balance |
Interest for Period @ 18.62% |
Cash flow |
Closing Balance |
|
|
|
|
|
|
|
31/12/2013 |
35,000 |
536 |
– |
35,536 |
|
31/12/2014 |
35,536 |
6,617 |
– |
42,152 |
|
31/12/2015 |
42,152 |
7,848 |
(50,000) |
– |
The transition adjustments required to adjust the opening balance sheet at 01/01/14 are:
|
|
CU |
CU |
|
Dr Profit and Loss Reserves (CU15,000-CU536 which relates to pre-transition) |
14,464 |
|
|
Cr Trade Debtors |
|
14,464 |
|
Dr Deferred Tax on BS (CU14,464*10%) |
1,446 |
|
|
Cr Profit and Loss Reserves for Deferred Tax |
|
1,446 |
Being journal to reflect correct carrying amount of CU35,536 in the opening balance sheet and the effect of deferred tax on this adjustment (deferred tax as this was taxed under old GAAP but it has not hit the profit and loss account under FRS 102 at this time, so the deferred tax will be released as this is released to the profit and loss as this amount will be deducted in the tax computation going forward)
The adjustments required to adjust the comparative year (year ended 31/12/14) assuming the opening transition journals above are carried forward and P&L journals above posted to reserves.
|
|
CU |
CU |
|
Dr Trade Debtors |
6,617 |
|
|
Cr Finance Income in P&L (so that the carrying amount is now CU42,152) |
|
6,617 |
|
Dr Deferred Tax P&L |
661 |
|
|
Cr Deferred Tax on BS (CU6,617*10%) |
|
661 |
Being journal to reflect the deemed interest income in the profit and loss for the year and the related deferred tax effect
The adjustments required to adjust the current year (year ended 31/12/15) assuming the opening transition and 2014 journals above are carried forward to reserves.
|
|
CU |
CU |
|
Dr Trade Debtors |
7,848 |
|
|
Cr Finance Income in P&L (so that the carrying amount is now CU50,000) |
|
7,848 |
|
Dr Deferred Tax P&L |
785 |
|
|
Cr Deferred Tax on BS (CU7,848*10%) |
|
785 |
Being journal to reflect the deemed interest income in the profit and loss for the year and the related deferred tax effect
Example 30: Customer loyalty
Company A is a hairdresser. It operates a customer loyalty scheme where if a customer gets 10 hair cuts, they get the next one free. The entity did not account for the fair value of this scheme under old GAAP. The date of transition is 1 January 2014. At the 1 January the Company estimates the total number of customers who hold a loyalty card is 3,000. 1,500 of these customers have the full 10 haircuts obtained and therefore are entitled to a free hair cut. An average of another 500 customers have the card half way filled and the remaining 1,000 has obtained on average 8 hair cuts. The selling price for each hair cut is CU20. At the 31 December 2014 the company estimates the total number of customers who hold a loyalty card is 2,500. 1,500 of these customers have the full 10 haircuts obtained and therefore are entitled to a free hair cut. An average of another 400 customers have the card half way filled and the remaining 600 have obtained on average 8 hair cuts.
Assume a prior year restatement is not required and the hair cuts must be redeemed within a year and will be redeemed by all customers. Assume the deferred tax rate is 10% and the transition adjustment will be tax deductible in the tax computation over a 5 year period.
The amount of revenue to be deferred so as to reflect the fair value of the loyalty scheme awards which remains outstanding at the 1 January 2014 is calculated as follows:
1 January 2014
The fair value of the loyalty scheme every time a hair cut is obtained = CU20/10 hair cuts = CU2. Therefore the total revenue that should be recognised each time the company cuts a head of hair (assuming the customer has a loyalty card and is likely to redeem it when full) is:
Fee/fair value for one hair cut of CU20 – CU2 allocated to the award scheme = CU18
1,500 customers who have 10 haircuts obtained * CU2 = CU30,000 (1,500*CU2*10)
500 customers who have 5 haircuts obtained * CU2 = CU5,000 (500*5*CU2)
1,000 customers who have 8 haircuts obtained * CU2 = CU16,000 (1,000*8*CU2)
Therefore the total revenue to be deferred is CU51,000 (CU30,000+CU16,000+CU5,000)
31 December 2014
1,500 customers who have 10 haircuts obtained * CU2 = CU30,000 (1,500*CU2*10)
400 customers who have 5 haircuts obtained * CU2 = CU4,000 (400*5*CU2)
600 customers who have 8 haircuts obtained * CU2 = CU9,600 (600*8*CU2)
Therefore the total revenue to be deferred is CU43,600 (CU30,000+CU4,000+CU9,600)
The journals required on transition are:
On 1 January 2014
|
|
CU |
CU |
|
Dr Profit and Loss Reserves Net of Tax (CU51,000-CU5,100) |
45,900 |
|
|
Dr Deferred Tax in Balance Sheet (CU5,100*10%) |
5,100 |
|
|
Cr Provision for Cost of Customer Loyalty Scheme |
|
51,000 |
Being journal to defer the fair value of the loyalty scheme on transition and the related deferred tax for the fact that a tax deduction will be obtained in the future.
Journals required in 31 December 2014 year end assuming the above journals are posted to profit and loss reserves
|
|
CU |
CU |
|
Dr Provision for Cost of Customer Loyalty Scheme (CU51,000-CU43,600) |
7,400 |
|
|
Dr Deferred Tax in P&L (CU7,400*10%) |
740 |
|
|
Cr Deferred Tax in Balance Sheet |
|
740 |
|
Cr Revenue |
|
7,400 |
Being journal to defer the fair value of the loyalty scheme at 31/12/14 and the movement in the related deferred tax. The net deferred tax asset of CU4,360 (CU5,100-CU740) will be recovered over a 5 year period under the tax transition rules as assumed in this example, therefore this will be released over those 5 years.
If we assume there was no movement in the 31 December 2015 year then no journals are required. However where there is movement, the same journal as the 2014 year will need to be posted with the exception of the deferred tax journal on this movement as the movement will be taxed in the 2015 year. The deferred tax journal to derecognise the CU4,360 over 5 years will be required as follows:
|
|
CU |
CU |
|
Dr Deffered Tax in P&L (CU4360/5 years) |
872 |
|
|
Cr Deferred Tax Asset |
|
872 |
Being journal to release 1/5 of the deferred tax asset.
Example 31 – Extract from the Accounting policy notes
1.1 Turnover
Turnover represents net sales to customers and excludes trade discounts and Value Added Tax.
Turnover from the sale of goods is recognised when the significant risks and rewards of ownership of the goods have passed to the buyer, usually on dispatch of the goods. Turnover from the provision of services is recognised in the accounting period in which the services are rendered and the outcome of the contract can be estimated reliably. The company uses the percentage of completion method based on the actual service performed as a percentage of the total services to be provided.
Revenue in relation to maintenance and support is recognised on a straight line basis over the term of the contract with any unearned revenue included in deferred revenue.
ACCOUNTING POLICY FOR AN INSURANCE BROKER
Turnover – commission income
Turnover represents commissions earned in the period together with overrider and profit commissions receivable. Commission income is recognised in the accounting period in which the policy commences. To the extent that future services need to be provided over the life of the policy which straddles an accounting period, revenue is deferred. Commission income in relation to claims handling is recognised in the accounting period in which the claims are settled. Overrider and profit commissions, if any, are recognised in line with the underlying agreements and amounts confirmed by product providers.
ACCOUNTING POLICY FOR A MANUFACTURNG COMPANY THAT PRODUCES, INSTALLS AND ALSO ENGAGES IN LONG TERM CONTRACTS USING THE STAGE OF COMPLETION
Turnover
Turnover, excluding value added tax, represents the income received and receivable from third parties, in the ordinary course of business, for goods and services provided. Any discounts given to customers are deducted from turnover.
Revenue from the sale of products is recognised when the goods are dispatched to the customer. Revenue from the servicing of machines is recognised over the period of the performance of the service. Proceeds received in advance of product dispatch or performance of service are recorded as deferred revenue in the balance sheet.
Revenue from the sale of machines and manufactured steel components is recognised over the period of the design, build and installation contract. Where the outcome of a long-term contract can be estimated reliably, revenue and costs are recognised by reference to the stage of completion of the contract activity at the balance sheet date. This is normally measured by surveys of work performed to date. Variations in contract work are included to the extent that it is probable that they will result in revenue and they are capable of being reliably measured.
When the outcome of a long-term contract cannot be estimated reliably, contract revenue is recognised to the extent of contract costs incurred and that it is probable it will be recoverable. Contract costs are recognised as expenses in the period in which they are incurred. When it is probable that total contract costs will exceed total contract revenue, the expected loss is recognised as an expense immediately.
ACCOUNTING POLICY NOTE WHERE TURNOVER IS DERIVED FROM INVESTMENTS
Turnover
Turnover represents dividends and other income received on investments held, net of irrecoverable withholding taxes. Dividends are recognised in the period to which the dividends relate.
Government grants
Government grants are recognised when it is reasonable to expect that the grants will be received and all related conditions will be met.
Grants that relate to specific capital expenditure are treated as deferred income which is then credited to the profit and loss account over the related asset’s useful life on an accruals basis. Revenue grants are credited to the profit and loss account when receivable so as to match them with the expenditure to which they relate.
Dividends
Dividends from the company’s shares are recognised as income on receipt of the dividend.
ACCOUNTING POLICY FOR A SOFTWARE COMPANY
Turnover
Turnover, which excludes value added tax, represents the invoiced value of goods and services supplied and the value of long term contract work done, as outlined below.
The company usually sells its software as part of an overall solution offered to a customer, in which significant customisation and modification to the company’s software generally is required. As a result, revenue generally is recognised over the course of these long term projects.
Initial license fee for software revenue is recognised as work is performed, under the percentage of completion method of accounting. Subsequent license fee revenue is recognised upon completion of the specified conditions in each contract. Service revenue that involves significant ongoing obligations, including fees for customisation, implementation and modification, is recognised as work is performed, under the percentage of completion method of accounting.
Software revenue that does not require significant customisation and modification, is recognised upon delivery and installation. In managed service contracts, revenue from operation and maintenance of customers’ billing systems is recognised in the period in which the bills are produced. Revenue from ongoing support is recognised as work is performed. Revenue from third–party hardware and software sales is recognised upon delivery and installation, and recorded at gross or net amount according to whether the company acts as a Principal or as an Agent. Maintenance revenue is recognised ratably over the term of the maintenance agreement, which in most cases is one year or less. Losses are recognised on contracts in the period in which the liability is identified.
Extract from accounting policy showing royalty income.
Turnover reflects amounts received or receivable in respect of patent royalties license income.
Example 32: Extract from notes to the financial statements for revenue showing revenue by market and class
Turnover and segmental analysis
Turnover comprises the invoice value of goods and services supplied by the company exclusive of trade discounts and value-added tax derived from the company’s principal activities.
|
Turnover by segment: |
2015 |
2014 |
|
|
CU |
CU |
|
|
|
|
|
Revenue from construction contracts |
XXXX |
XXXX |
|
Rental income |
XXXX |
XXXX |
|
Sale of services |
XXXX |
XXXX |
|
Sale of goods |
XXXX |
XXXX |
|
|
XXXX |
XXXX |
The amount of turnover by destination is as follows:
|
|
2015 |
2014 |
|
|
CU |
CU |
|
|
|
|
|
EU Countries |
XXXX |
XXXX |
|
Russia |
XXXX |
XXXX |
|
Africa |
XXXX |
XXXX |
|
Australia and New Zealand |
XXXX |
XXXX |
|
Asia |
XXXX |
XXXX |
|
|
XXXX |
XXXX |
Example 33: Extract from notes to the financial statements for revenue where exemption claimed due to its inclusion being seriously prejudicial to the entity
Turnover and segmental analysis
The company operates in one principal area of activity, that of providing business support systems and related services to the communications industry. It also operates within three geographical markets: Europe, XXXXXX and the rest of the world.
No detailed business and geographical segment analysis of the company is disclosed as, in the opinion of the directors, any of these disclosures would be seriously prejudicial to the interest of the company.
Example 34: Extract from notes to the financial statements for revenue derived by brokers
|
Commission income |
2015 |
2014 |
|
|
CU |
CU |
|
|
|
|
|
Commission income represents commission earned as follows: |
|
|
|
|
|
|
|
Gross value of contracts and services transacted |
XXXXXX |
XXXXXX |
|
|
|
|
|
Commission income earned |
XXXXX |
XXXXX |
Example 35: Extract from notes to the financial statements for construction contracts
ACCOUNTING POLICY NOTE
Turnover – contracting work
Where the outcome of a construction contract can be estimated reliably, revenue and costs are recognised by reference to the stage of completion of the contract activity at the balance sheet date. This is normally measured by reference to the proportion of costs incurred up to the date of the balance sheet to the estimated total costs. Variations in contract work, claims and incentive payments are included to the extent that it is probable that they will result in revenue and they are capable of being reliably measured.
When the outcome of a construction contract cannot be estimated reliably, contract revenue is recognised to the extent of contract costs incurred and that it is probable it will be recoverable. Contract costs are recognised as expenses in the period in which they are incurred. When it is probable that total contract costs will exceed total contract revenue, the expected loss is recognised as an expense immediately.
Turnover and segmental analysis
Turnover comprises the invoice value of goods and services supplied by the company exclusive of trade discounts and value-added tax derived from the company’s principal activities.
|
Turnover by segment: |
2015 |
2014 |
|
|
CU |
CU |
|
|
|
|
|
Revenue from construction contracts |
XXXX |
XXXX |
|
Sale of goods |
XXXX |
XXXX |
|
|
XXXX |
XXXX |
|
Debtors |
2015 |
2014 |
|
|
CU |
CU |
|
|
|
|
|
Trade debtors |
XXXXX |
XXXXX |
|
Prepayments and other debtors |
XXXXX |
XXXXX |
|
Corporation tax |
– |
– |
|
Value added tax |
– |
– |
|
Amounts due from customers for contract work |
XXXXX |
XXXXX |
|
|
XXXX |
XXXX |
|
Creditors |
2015 |
2014 |
|
|
CU |
CU |
|
|
|
|
|
Trade creditors |
XXXXX |
XXXXX |
|
Corporation tax |
– |
– |
|
Deferred revenue |
– |
– |
|
Amounts due to customers for contract work |
XXXXX |
XXXXX |
|
|
XXXX |
XXXX |
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