. ‘N CHAPTER 7 Vv Ae eine ™ Income: Revenue Recognition and Measurement Learning Outcomes WW A Atthe end of this chapter, you should be able to: > explain the income element > undstand the framework to recognize revenue (revenue model) > recognize and measure revenue using the 5 (five) steps approach (revenue mode) > manage revenue recognition issues << Scanned with CamScanner219 Chapter 7 Income: Revenue Recognition and Measurement Income includes reventi and gains wh ofabusiness and includes sates, fees i are derived from activities that anes, In this chapter, we will 1 here revenue is derived from the ordinary or normal acti terest and dividends. Gains fulfil the definition of income but ae Not part of the ordinary activities of a business. tint 00k at underst lit e me element which is reported in the aoe of profit or loss and other cient 4 — bere sussing the aiterent types s ie oe a ‘roduce and explain the new framework to recognize revenue (see Figure by relecing a pice aes the recognition and measurement of different types of revenue polar ~ Revenue from Contract with Customers (effective for annual periods ordinate he tet 1 January, 2018). few fundamental elements on income are highlighted according to the Conceptual Framework for Financial Reporting. STEP Sta steps sTePs eee corns Aca the Recognize Pee. occu \ tansacion revenue oo ceria price tothe wien (rs) Geter performance" theentity | oblgationsin ——_satisiesa the contact performance abigation, Figure 7.1 Flowchart showing fram ae Source: IFRS 15 wchart showing framework to recognize revenue 7.1 Income Income is defined in the Revised Conceptual Framework for Financial Reporting (2018) as increases in economic benefits during the accounting period in the form of inflow or enhancement of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. Revenue is income that results from the ordinary or normal activities of an entity, Ordinary or normal activities refer to the main business activities of an entity. For example, the ordinary activities of a car manufacturer is _ assembling cars and then selling the cars, However, if a ear manufacturer _ sells off its old furniture (disposal of a non-current asset), this activity is not one of its ordinary business activities and thus will be recorded as other income. There are different types of income (revenne) which include sales, fees, interest, dividends and royalties. An entity shall recognize revenue to repi xls or services to customer t sent the transfer of promised [ones madeup ot an amount that reflects the consideration both revenue and gain. which the entity is expected to be entitled in exchange for those goods and ices. For example, the amount of revenue recognized reflects any trade ts and volume rebates the entity allows (para 34, MERS 101 2019), Scanned with CamScanner280 Financia Accounting ond Reporting 1 In genera, the thre different main categories ofincome are: (a) The sale of goods: (b) The rendering of services: and (6) The use of an entity's assets by of dividends). ‘The sale of goods includes goods produced by eo ps Leta of sale as ina manufacturing business. At the sam “ purchased for resale, such as merchandise purchased by a retailer oF lang andotherproperty elder rete ally aged tsk ofa ‘The rendering of services invol . ‘over an agreed period of time. The services aye ecore within a period or over more than one period. Some contracts for’ lering of Services are directly related to construction contracts. for example those op the services of project managers and architects. , "The use of an entity's asets by others ves ise to revenue inthe form of Charges for the use of cash or cash equivalents, or hers (interest. royalties ang (a) Interest amounts due to the entity: Fee (b) Royalties—Charges for the use of long-term assets of the entity, such as patents, trademarks, copyrights and computer software, and . (c) Dividends—Distributions of profits to holders of equity investments in proportion to their holdings of a particular class of capital, ‘Therefore, he next section shall cover the accounting for these different categories of income. 7.2 Principles of Accounting for Revenue ‘The MFRS 15 - Revenue from Contracts with Customers has been developed andissued tohavea common model of accounting treatment for revenue. It sets up the principles for reporting useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity's contract with their customers. This, standard is in effect on | January, 2018 (MASB, 2019), and it supersedes the following MFRSs (or IFRSs/1ASs/IERICs/SICs"): (a) MERS 111 (IAS 11) - Construction Contracts; (b) MERS 118 (IAS 18) - Revenue; (c) IFRIC 13 - Customer Loyalty Programmes; 1 IAS and SICare the Standards and Interpretations created by the predecessors ofthe TASB and the IFRS Interpretations Committee. These had been adopted by the IASB and the IFRS Interpretations Council when they took overin 2001, and therefore fer part ofthe body of IFRS requirements* * (Source: cht: /wwesfr.org/IFRSS/Pages/IFRS aspx> accessed 12 May. 2015) Scanned with CamScanner281 Chapter 7 Income: Revenue Recognition and Measurement (a) IFRIC 15 - Agreements for the Construction of Real Estate: () IFRIC 18 - Transfers of Assets from Customers; (9 SIC31 ~Revenue: ew Services. : and farter Transactions Involving Advertising In MFRS 15, one ofthe core principles in revenue recognition isto show the transfer of promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled to in exchange for those goods or services. Moreover, an entity must consider the terms of the contract, and all relevant facts and citcumstances, and apply the standard consistently to contracts with si similar circumstances. ‘The recognition ofincome occursat the same ti amet sual framework, para 5.4, 2018): 1e time as (MASB Conceptual ilar characteristics and in (i) the initial recognition of an asset, or an inerease in the carrying amount of an asset; or Gi) the derecognition of a liability, ora decrease in the carryingamount ofa liability. ‘The primary issue in accounting for revenue is determining when to recognize revenue. Revenue is recognized when it is probable that fature economic benefits will flow to an entity, and these benefits can be measured reliably, It is important to highlight that the accrual basis and realization concept of accounting are the two main accounting concepts and assumptions to be complied with in recording revenue. Revenue includes only the gross inflow of economic benefits received by business or an entity on its own account. Therefore, the amount collected ‘on behalf of third parties such as sales taxes, goods and services taxes, and value added taxes are not economic benefits which flow to the entity, and these items do not result in increases in equity. Thus, they are excluded from revenue. Like any recognition of the other elements (ie, assets, liabilities and owner's equity) of financial statements, revenue recognition is the process of incorporating in the statement of profit or loss and comprehensive income an item that meets the definition of income, and satisfies the criteria for recognition. Items that satisfy the revenue recognition criteria should be recognized in the statement of profit or loss and comprehensive income, In general, a revenue item that meets the definition of an income element must be recognized ift (a) It is probable that any future economic benefit associated with the revenue item will low to the entity; and (b) The revenue item has a value that can be measured reliably. This is due to the fact that the financial information presented must be both relevant and faithfully represented. In addition, materiality of the said revenue item must be taken into account. However, an item that possesses the important characteristics of an income clement, but does not meet the criteria for revenue recognition, Scanned with CamScannera Financial Accourtng and Reporting 1 may alternatively be disclosed in the notes, explanatory material, or jy supplementary schedules. : Let us now look at the main criteria to recognize revenue under thy revenue model. 7.3 Main Criteria for Revenue | Recognition 4 Revenue is recognized or recorded tocustomers in an amount that an’ those goods or services. Therefore, to show the transfer of goods or services entity expects to receive in exchange for the revenue is recognized or recorded if the entity has earned the revenue, irrespective of whether cash is already received or not. Accrual basis of accounting and realization concept are the two main accounting concepts and assumptions to be complied with in recording revenue. How does an entity recognize revenue? ‘An entity recognizes revenue by applying the following five steps (MERS 15, 2018) in the revenue model: ‘Step 1: Identify the contract(s) with a customer A contract is an agreement between two ot more parties that creates enforceable rights and obligations. Step 2: Identify the performance obligations in the contract A contract includes promises to transfer goods or services to a customer, If those goods or services are distinct, the promises are performance obligations and are accounted for separately. A good or service is distinct if'the customer can benefit from the good or service on its own or together with other resources that are readily available to the customer and the entity's promise to transfer the good or service tothe customer is separately identifiable from other promises in the contract. 1 aca iia Step 3: Determine the transaction price 4 The transaction price is the amount of consideration in a contract to which ‘an entity expects to be entitled in exchange for transferring promised goods or services toa customer. 4 Step 4: Allocate the transaction price to the performance obligations in the ‘contract ‘An entity typically allocates the transaction price to each performance obligation on the basis of the relative stand-alone selling prices of each distinct good or service promised in the contract. Sometimes, the transaction price includes a discount or variable amount of consideration that relates entirely toa part ofthe contract. Step & Recognize revenue when (or as) the entity satisfies a performance obligation. 4 Scanned with CamScannerChapter 7 Income: Revenue Recognition and Measurement 283 ‘An entity recognizes revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer (which is when the customer obtains control of that good or service). The amount ofrevenue recognized is the amount allocated to the satisfied performance obligation. A performance obligation may be satisfied at a point in time (typically for promises to transfer goods to a customer) or over time (typically for promises to transfer services to a customer). The following section will discuss and illustrate the 5 (five) steps involved in revenue recognition and measurement. process. 7.4 Revenue Recognition and Measurement Consistent with its definition, income is recognized in the statement of profit or loss and other comprehensive income, Revenue is recognized only when it is probable that the economic benefits associated with the transaction will low to the entity. However, when an uncertainty arises about the collectability of an amount already included in revenue, the uncollectible amount, or the amount in respect of which recovery has stopped to be probable, is recognized as an expense rather than as an adjustment of the amount of revenue originally recognized. ‘The amount of revenue to be recognized, or recorded, is measured at the fair value of the consideration received or receivable (cash to be collected or received in the future). In normal circumstances, the amount of revenue is agreed by both parties (the entity, and the buyer or user of the asset) taking into account the entity's trade discounts and volume rebates, ifany. A seller recognizes revenue only when it is probable that the economic benefits associated with the transaction will flow to his business. However, in a few cases, this may not be probable until the consideration is received, or until an uncertainty is removed. ‘The following subsections are the discussion and illustration on the five steps to be followed under the revenue model in the process to recognize and measure revenue for all entities. 74.1 — Identify Contract with Customer Al contracts (defined as an agreement between two or more parties that ‘reates enforceable rights and obligations) with customers are included in this chapter discussion except the following (as mentioned earlier in Section 7:3): (a) lease contracts within the scope of MFRS 16 Leases; Scanned with CamScanneron 284° Financial Acrin and Reporig 1 (b) insurancecontracts within the scope of MFRS4 Insurance Contrgey, (©) financial instruments and other contractual rights oF obi within the scope of MFRS 9 Financial Instruments, MERS jy Consolidated Financial Statements, MFRS 11 Joint Arrange, [MERS 127 Separate Financial Statements and MERS 128 Investmeny, in Associates and Joint Ventures, and (4) non-monetary exchanges between entities in the same tine of business to facilitate sales to customers or potential customers. Fog | example, this Standard would not apply to a contract between tg cil companies that agree to an exchange of oil to fulfil demand from their customers in different specified locations on a timely basis, How do we know whether dealings with customers meet the definition of a contract? There are & (five) criteria to be met to be considered as g Tevente contract as follows: (i) The contract is approved by all parties (ii) The entity can identify the rights of each party. ‘The entity can identify the payment terms for goods or services to be transferred. (iv) The contract has commercial substance. (¥) The collectability of the amount of consideration is probable, Mlustration 1 ‘business consultancy service signs a24-month agreement with acustomer seeking their expertise for the purpose of marketing a robotic product. The customer pays RM2,000 per month, The agreement does not include any provisions for automaticextensions. The agreement expired on30 June2019, ‘The two parties signed a new agreement on 30 September 2019 that requires the customer to pay RM2,200 per month in fees, retroactive to 1 July 2019, ‘The customer continued to pay RM2,000 per month for July, August and September 2019 and the business consultant continued to provide services during that period. In addition, there were no disputes about performance between the parties for the period. Negotiation of rates was carried out under the new contract, Does a contract exist for the period from July to September 2019 (before the contract was renewed)? Criteria (i) is met in which the contract is approved by all parties. The business consultant provided services and the customer continued to pay M2000 per month according to the previous contract (even though the initial contract had already expired). Criteria (i) and (ii) are also met. The entity can identify the rights of each party, negotiation of rates was carried out and there were no disputes on performance during that period. Criteria iv) and(v)are metin that the services ofthe business consultant has commercial substance forthe customer and the collectability of revenue by the business consultant is highly probable (more likely to happen than not) since the customer continued to make payments even after the expiry of the initial contract. i a | | Scanned with CamScannerry Copter 7 Income: Revenue Reeoption ard Measure! 785 refore, a conti i a tract appears to exist for the period July to September m eden eeu doa meet thefivecriteriatobea revenue SP cabeaicadlba Y Bas received consideration, the consideration can when the am etl : ‘efundable and one of the following events freee raat (i) Allperformance obligations have been completed and the entity has received all or a substantial amou bythe customer. int ofthe consideration promised (ji) Thecontract has been terminated. In addition, all consideration received must be recognized as liabilities until one of the events above has occurred or until the contract meets the criteria of the revenue model, Furthermore, in some instances, entities have to combine individual ‘contracts (only for contracts entered into at or near the same time) of the same customers if these contracts meet with at least one of the following teria: {i) The contracts are negotiated as a package. {ii) The amount of consideration to be paid by the customer in one contract affects the price or performance of the other contract. (ii) Some or all of the goods or services promised in the individual contracts form a single performance obligation. 742 — Identify Performance Obligations ina Contract After an entity has identified a contract with a customer, it has to identify thepromised goods and servicesin the contract. Atthis stage, itis important forthe entity to identify which promised goods or services are to be treated ‘as separate performance obligations. Promised goods or services are accounted for as separate performance, cbligations ony if they are distinet or are part of a serie of distinct goods or services. In order to know whether the promised goods or services are distinct, the entity has to consider the following 2 (two) criteria: (i) The goods and services are capable of being distinct, ‘meaning that’ customers can benefit from some services or goods on their own or in combination with readily available resources. (i) The goods and services ae distinct when considered inthe context ofthe entire contract: Mlustration 2 Smart Solution Bhd is a business that of to customers from various industries. sells computer and accounting software, an ‘accounting workshops conducted at its cus ffers professional accounting services In addition, Smart Solution Bhd also \dofferstraining services through tomers’ premises, Scanned with CamScanner286 Financial Accounting and Reporting 1 Situation A-. and services are sold separately Smart Soliton nd detifes that all individual goods and services in jg business contracts are capable of being distinct because — Solutions Bhd regularly sells each element in the contracts separat Ir Customers can purchase goods (accounting software) or accounting ete a without significantly affecting the other goods or services purchased Customers can also sign up for the accounting workshop without having to purchase accounting services or software. Therefore, the accounting software, professional accounting services and accounting workshops are each accounted for as separate performance obligations. Situation B- Accounting software not sold separately e Smart Solution Bhd identifies that its accounting services are distinct because the services can be purchased on a stand-alone basis. Furthermore, the accounting workshop is also distinct because it can be offered to customers on a stand-alone basis. However, the accounting software is always sold as a package with the accounting workshop. Therefore, Smart Solution Bhd determines that the accounting software is not distinct and concludes that the accounting software is an integral part of the accounting workshop. Therefore, the accounting workshop and accounting software should be accounted for as one performance obligation. On the other hand, the accounting services which are distinct would be a separate performance obligation. 4 If a good or service is identified to be distinct but is part of a series of goods and services that are substantially the same and have the same pattern of transfer, that series of goods and services must be treated asa j 4 single performance obligation when these 2 (two) criteria are met: a 3 (i) Each distinct good or service in the series is a performance | obligation to be satisfied over time. 4 (ii) The measure used to assess the progress of performance obligation 4 is the same for each distinct good or service. Customer options for additional goods or services: . Customer options come in different forms (eg. goods or services priced at discount, sales incentives, customer award credits), This customer option, ‘material right (customer would not receive the option without entering into. thecontract). 74.3 Determine the Transaction Price The revenue model requires an entity to determine the transaction Transaction price is the amount of consideration an entity expects exchange for transferring promised goods or services to a customer. The Scanned with CamScannersurement 287) Chapter 7 Income: Revenue Recognition and Mes tractual terms and customary practice of the business have to-be considered in determining the transaction price, ‘This step is important use the amount of transaction price determined is allocated to the identified performance obligation in the next step in the revenue model. Transaction price is easy to determine when the entity receives fixed wayment (e.g. the sale of goods, {na sundry shop). However, the transaction price can be challenging to determine under other situations such as when; (i) the transaction price is variable (variable consideration) (ii) acustomer pays for the goods or services before or after the entity's performance (significant financing component) (ii) acustomer paysin theform other than cash (non-cash consideration) (iv) an entity pays consideration to the customer (consideration payable tocustomer) Variable consideration If consideration promised in a contract includes a variable amount {performance bonuses, penalties, discounts, rebates, price concessions. Incentives, and the customer rights to return product), an entity must estimate the amount of consideration entitled and include that amount in the transaction price, subject to a constraint. If the entity's entitlement toa consideration subject to the occurrence or non-occurrence of a future event, the transaction price is considered to be variable. ‘Variable consideration can be estimated using either (i) expected value | approach, or (ii) most likely amount approach depending on which method better predicts the amount of consideration, Expected value approach is based on probability weighting the possible outcomes of a contract. If we are using the most likely approach, an entity will select the amount that is most likely to be received considering the range of possible amounts. |All information, historical, current or forecast events that is reasonably available to the entity must be considered when applying either ofthese two approaches, In addition, after estimating the amount of variable consideration, ‘constraint’ must be applied to the estimated amount. The constraint is intended to prevent revenue from being overstated. Illustration 2 provides an example of estimating variable consideration using expected value approach and most likely amount approach. | | | | Mlustration 3 Situation A (Volume discount) On I January, 2020, Bersih Bhd (fiscal year ends every 31st December) enters into a contract with a customer, Cahaya Sdn Bhd, for the sale of a product (laundry detergent) for a total consideration of RM1O per bottle, The contract is for a one-year period. If Cahaya Sdn Bhd purchases more than 125 bottles of the laundry detergent, the total consideration will be RM8 per bottle retrospectively applied (i.e. all purchases will be RMS per bottle). ‘At first, Bersih Bhd does not believe Cahaya Sdn Bhd will purchase more than 125 bottles. However, on 25 June, 2020, Bersih Bhd analyses Cahaya Sdn Scanned with CamScanner788 Faria ccoming and eprig Bha's purchasing pattern and believes that Cahaya Sdn Bhd will n fact mooy this target. Assume that the purchase pattern is as follows: January 10 February 10 March 10 April 4 May 4 q June Therefore, since the total contract consideration of RM10/bottie includes a fixed component (ie. RM8/bottle) and a variable component (1, RM2/bottle), the variable component must be assessed to determine the estimated value and whether this amount should be constrained, Consider the following: At contract establishment Based on past history (that has predictive value) with this iaundry detergent product and Cahaya Sdn Bhd, the customer, Bersih Bhd does not believe Cahaya Sdn Bhd will meet the target required for the consideration to drop to RM8/bottle. Bersih Bhd believes instead there is a high probability 4 significant revenue reversal will not occur because the target expected purchases will not exceed 100 bottles and therefore Bersih Bhd expects to be entitled to a consideration of RMI0/unit rather than RM8/unit. Bersih, Bhd records the total consideration amount of RM10/bottle. 31 March, 2020 If the conclusion arrived at contract establishment remains suitable, revenue for the period ending 31 March, 2020 will be recognized using the RM10/bottle price. 25May, 2020 Bersih Bhd now estimates that due to increased purchases, Cahaya Sdn Bhd will likely exceed the targeted 125 units. It is now highly probable significant revenue reversal will occur. Thus, revenue will have to be adjusted retrospectively to RM8/bottle. This adjustment will be made in the current period, i.e, June, 2020. Time Period Amount of Revenue to be Recognized January-May M580 =(10+10+10+14+14 bottles) x RM10 per bottle June 25 RMA = (10+10+10+14+14 bottles) x (RM8/bottle - RMIO/ bottle) + (15 bottles) x RMB/bottle Situation B (Performance bonus) 3 Suci Bhd offers shuttle bus services to Smart College students to and from their accommodations in Serdang under a one-year contract. Suci Bhd is required to provide a one-year scheduled bus services for a fixed fee — of RM500.000 annually. In addition, Suci Bhd is eligible to performance bonuses for on-time performance. Its performance may earn a bonus from Scanned with CamScannerfou stated amounts; RMO, RM200, its history with Smart Colloge 000, KM500,000 and RIM800,000. Based eatiroates the probal Bonus amount an at) Probability of outcome (96) 200,000 * 500,000 | “ 5 Consider the following: xpected value approach Unde approach, Variable consideration is estimated at RM275,000 ave 00 ba ys (Ruts,000 x 359%) + (RM800,000 x 5%)), Then, Suci Bhd has to consider the effect of the constraint on the amount of variable consideration included in the transaction price. However, there are only four potential outcomes under the contract. Thus, the constraint limits the amount of revenue Suci Bhd can recognize to one of the mentioned bonus amounts. In Situation B, Suci Bhd can only include or limited to RM200,000 in the estimated transaction price until itis highly probable that the next Jevel ofbonus (i.e. RM500,000) is achieved. ‘Most likely amount approach ‘There is a limited number of outcomes for the amount of potential bonus tobe received. Suci Bhd is worried if probability weighted estimate is used (expected value approach), then, it may result in an amount that is not & potential outcome, Thus,Suci Bhd determines thatidentifyingthemostlikely ‘outcome approach can be the best predictor in estimating the transaction price. Based on the listed probabilities, it is only 40% (i.e. 35% + 5%) likely to receive a bonus of at least RMS500,000 and 70% (ie. 30% + 35% + 5%) likely to receive a bonus of at least RM200,000. Therefore, Suci Bhd would include only RM200,000 in its estimate of the transaction price. Significant financing component Inmany business transactions, when a customer pays before (or after) the goods or services are provided, actually the entity is receiving financing from {or giving financing to) customer. The revenue model requires an entity to assess whether the arrangement containsa significant financing component. Inthis assessment, the following two factors must be considered: (a) thedifference,ifany, between theamountof promised consideration and the cash selling price of the promised goods or services [MFRS 15};and (b) the combined effect of both of the following [MFRS 15]; (j) the expected length of time between when an entity transfers the promised goods or services to a customer and when the customer pays for those goods or services: and (ii) the prevailing interest rates in the relevant market. Scanned with CamScanner290 Fart Aconig at eporing The interest income or Interest expense resulting fom ® senicgy financing component should be presented separately from revenue fro, contracts with customers. However, an entity might present interest income as revenue in circumstances in which interest income represents income from the entity's ordinary activi Illustration 4 Advance payment and assessment of discount rate Source (Illustrative Example 29, IFRS 15 Revenue from Contracts witp Customers) : san ‘An entity enters into a contract with a customer an asset, Control of the asset will transfer to the customer in two years time (ie. the performance obligation will be satisfied at a point in time). The contract includes two alternative payment options: payment of CUS,000 in two years’ time when the customer obtains control ofthe asset or payment of CUi4,099 when the contract is signed. ae ‘The customer elects to pay CU4,000 when the contract is signed, The entity concludes that the contract contains a significant financing component because of the length of time between when the customer ‘Pays for the asset and when the entity transfers the asset to ‘the customer, as well as the prevailing interest rates in the market. ‘The interest rate implicit in the transaction is 11.8 per cent, which is the interest rate necessary to make the two alternative payment options economically equivalent. However, the entity determines that. in accordance with paragraph 64 of IFRS 15, the rate that should be used in adjusting the promised consideration is six per cent, which is the entity's incremental borrowing rate, The following journal entries illustrate how the entity would account for the significant financing component: lity for the CU4000 payment received at 1. Recognize a contract lis contract inception: Dr Cash cu4,000 Cr Contract liability cu4,000 2° During the two years from contract inception until the transfer of the asset, the entity adjusts the promised amount of consideration and ‘accumulate the contract liability by recognizing the interest on CU4,000 at six per cent for two years: Dr Interest expense CUS94 Cr Contract liability cuss4 3 Recognize revenue for the transfer of the asset: Dr Contract liability CU4,494 Cr Revenue cu4a94 *CU494 = CU4,000 contract liability x (6% interest per year for two years). Scanned with CamScanner)) Chapter 7 Income: Revenue cognition and Measurement Lalit ee Still encounter a situation in which both the above factors exist, but nevertheless, may conclude that a significant financing component docs not exist. In order for thi Boro lling fecors must be pe eo Be set least () the customer paid for the goods or services in advance and Gi) the timing of the transfer of those goods or services is at the discretion ofthe customer (for example, in the telecommunications industry, when a customer purchases a prepaid phone card). Non-cash consideration Furthermore, the revenue model requires that non-cash consideration received be measured at the fair value of the consideration received. If fair value cannot be reasonably estimated, the consideration will be measured byreference to the stand-alone selling price ofthe good or service promised in the contract. The fair value of non-cash consideration may vary. Consideration paid or payable to the customer This consideration payable is treated as a reduction of the transaction price (revenue), unless it is related to a distinct good or service received from the customer. If it is related to a distinet goods or service from the customer, there is no reduction of the transaction price and the transaction would be treated as a regular purchase similar to any other external third- party purchase. Consideration payable (include coupons, vouchers, signing bonuses, slotting and listing fees) to a customer may constitute a payment for distinct goods or services, or payment of a discount or refund. If this amount is variable when determining the transaction price, the variable consideration constraint must be assessed. 7.44 Allocate Transaction Price to the Performance Obligation How is the transaction price allocated to the performance obligations in a contract? ‘The transaction price (at inception) should be allocated to all the performance obligations in a contract in proportion to the stand-alone selling prices of each performance obligation. This is to make sure the ‘amount allocated to each performance obligation represents the amount of consideration to which an entity expects to be entitled in the exchange. ‘Thus, itis crucial todetermine the stand-alone selling prices of the goods or services underlying the performance obligations. However, the stand- alone selling price which is not directly observable should be estimated by ‘considering all information (market conditions, specific factors, class of ‘eustomers) reasonably available. Furthermore, appropriate methods for estimating the stand-alone selling Price include the adjusted market assessment approach, the expected cost- plus-a-snargin approach and. in limited circumstances, theresidual approach, Scanned with CamScanner2 Fraret ea vrtig and Regering 1 ad used, it should be applied consistently yy, Irrespective of the meth ' selling price of goods or Services with gin,” estimating the stand-alone characteristics, An entity should allocate promised goods or services ina contract, discount or variable consideration y gy Mlustration 5 Allocating the transaction price : Luhur Sd Bhd sels to John a bedroom set (a king size bed and a three-jgg, wardrobe) for RM5,000, Luluur Sdn Bhd has determined that these are ty, separate performance obligations and regularly sells the bed for Rata s5q and the three-door wardrobe for RM3.500. ; In this case, the entity will allocate the RM4,000 total transaction price follow 12,083 = M5,000 x (RM2,500 / (1RM2,500 + RM3,500)) RM2,917 = RM5,000 x (RM3,500 / (RM2,500 + RM3.500)) In this transaction, there isan inherent discount of RM1,000 which does not relate to a specifi performance obligation and is therefore allocated to All performance obligations on a relative stand-alone selling price basis, 7.4.5 — Recognize Revenue when (or as) an Entity Satisfies a Performance Obligation ‘The revenue model fs based on transfer of control and not based on the transfer of risks and reward. An assessment based on the transfer of control ‘was more appropriate due toa number of reasons. sly, an assessment based on the transfer of control would result in more consistent decisions about when goods or services are transferred. On the other hand, itis difficult o assess whether a suitable level of the risks and rewards of ownership has been transferred to the customer, especially in cases when the selling entity retains some of the risks and rewards (eg. risks retained during transport under a Free-on-Board (FOB) shipping point arrangement). Additionally, control is the ability to direct the use of, and obtain substantially all of, the remaining benefits associated with the asset. However, control can also be an ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset. Control transfers over time if one of the criteria noted in the decision tree below is met. none of these criteria is met, then the transfer of couteul ‘occurs at a point in time but further analysis is required to determine the point in time the transfer occurs and revenue can be recognized. {n ondet to determine the point in time at which control transfers (Le. the point at which revenue recognition will occur), entities shall consider the translet of the significant risks and rewards of ownership us one of the indicators this assessment. Scanned with CamScannerChapter 7 Income: Fevenue Recognition and Measurement 293. 7.5 — Issues in Revenue Recognition 75.1 Accounting for Multiple Elements Arrangement Revenue is crucial and is most often a measure of an entity’s achievement. Different and inconsistent revenue recognition practices are increasing due to the fact that the previous standard (MFRS 118) on accounting for revenue has limited guidelines on many important areas. MFRS 15 which comes up with a new revenue model is taking into account one main area of revenue which is the accounting for arrangements with multiple elements. Examples would be the arrangements that have variable considerations (as discussed in Section 7.4). For instance, agreements for the construction of real estates and the transfer of control are not definite. This situation creates different views. Limited guidance on emerging transactions, like licensing arrangements and warranties included in the service component, are also issues in revenue recognition. 752 MFRS 15— Revenue from Contracts with Customers ‘The MERS 15 ~ Revenue from Contracts with Customers has been developed and issued to have a common model of accounting treatment for revenue. It Scanned with CamScannereee 294 Francia counting and Reporting 1 {ul information to users of financiay i for reporting use! sep the pips fa eer a yo een amount, statements about the nature, amour nto ain cash ows arising from an entity’ contract with their customers, The objective of MENS 15 is to improve the financial reporting of revenue, This new revenue model is expected to: offer a clearer guidance for revenue recognition, especially areas wherein the previous requirements Iinintentionally ereate differences in practice, or for transactions that were shensively. not previously addressed comprehens : Itis anticipated that in| effect, MFRS 15, would: encies and weaknesses in prior revenue recognition > Eliminate incon arrangements; > Provide a more forceful an > Improve revenue recognition Pi jurisdictions and capital markets: > Present more useful information to better requirements on disclosure: > simplify the preparation of financial statements: and > Manage emerging complex revenue transactions. 1d sound framework on revenue issues; ractices across entities, industries, users of financial statements through 7.6 Conclusion Income increases in economic benefits during the accounting period in the form of inflows of assets, or decreases of liabilities, that cause increases in equity (excluding contributions from equity participants). Income consists of revenue and gain, Revenues basically recognized when it is probable that future economic benefits will flow to an entity and these benefits can be measured reliably. There are a few pressing issues in accounting for revenue such as ‘multiple elements arrangement, and agreement for constructions of real estates, and licensing arrangement and warranties that include a service component. Thus, MFRS 15 - Accounting for Contract Revenue with. Customers is introduced to be a common revenue model for accounting is, applied, hopefully, to overcome most of the revenue recognition issues in accounting, ems that satisfy the main revenue recognition criteria, under the MFRS 15 revenue model, should be recognized in the statement of profit or loss and other comprehensive income. The accrual basis and realization concept of accounting are the two main accounting concepts and assumptions to be complied with in recording revenue. Therefore, revenue is recognized if the entity has earned the revenue irrespective of whether cash is already collected or not, Revenue and expenses that relate to, rare associated with the same transactions are to be recognized or recorded simultancously. Revenues an important benchmark or measure for an entity’s performance of achievement. Nevertheless, as new types of transactions arise, new revenue recognition issues also arise, Scanned with CamScannerIncome increases in econ ve docreases of Habili 1omic benefits during the accounting period in the form of inflow of assets. ilities that result in increases in equity. Income is made up of both revenue and gain, > Revenue is in : }come that results from the normal activities ofa business or an entity. » There are three diffe : aad the wal gees ‘malin categories of income which are sale of goods. rendering of services y others of an entity's assets (interest, royalties and dividends). > Revenue is re i: - pore ear ‘when itis probable that future economic benefits are expected to flow into an se future economic benefits can be measured reliably. > Asound accounting treatment fo isi Ir Te i eel eepamesiae einem important, in order to have both relevant and faithfully > Materiality ofthe recognized revenue item must be taken into account. > An entity must recognize revenue by applying the 5 steps in the revenue model under MFRS 15 effective from 1 January, 2018 in Malaysia. > The five steps to be followed closely are: (i) identify the contract(s) with a customer, (ii) determine the performance obligation, (iii) identify the transaction price, (iv) allocate the transaction price, and eventually, (v) recognize the revenue when an entity satisfies the performance obligation > The five criteria must be met to be considered as contract revenue te, depending on the business activities such as during production Jetion method), on completion of production, when cash is received after cash has been > Other points may be appropt (using the percentage of comp! {it there is serious doubt as tothe collectabiity of eas, and at some point received. > Theamount ofrevenue tobe recognized orrecordedis measured thefairvalueofthe consideration reveived or receivable (cash to be collected or received in the future) evenue is agreed by both parties (an entity or business > In normal circumstances, the amount of r to account an entity's or business's trade discounts and and the buyer or user ofthe asset) taking int volume rebates, ifany. > Aseller recognized revenue only when itis probable that thee transaction will flow to the business. However, in a few cases, Consideration i received or until an uncertainty isremoved, recognizedorrecortedis measured at the air value oftheconsideration fo be collected or received in the future) ,conomic benefits associated with the this may not be probable until the > Theamount ofrevenuetobe received or receivable (cash t Scanned with CamScanner296 Financial Accounting ad Reporting + siness's ievemnent. > Revenue’ racial and most af the time isa measure fora business's ahi ae ing due to the fact that > Different and inconsistent revenue recognition practices are ines io toa os previous standard (MERS 118) on accounting for revenue has limite’ gs : areas such as the accountng for arrangements with multiple element with Customers has itis highly anticipates ie : been developed to have g > MERS 15 ~ Accounting for Revenue from Contracts od thatit would overcome common mode! of accounting treatment for revenue. ‘most, if not all the accounting issues arising from revenue recognit jon treatment. Concepts for Review, > Income > Reverine cotter > Gain > Revenue recognition criteria & > Contracts > Transaction price > Performance obligation > Variable considerations « References IFRS 15 (2015), Revere from Contracts with Customers. Lazar, and Huang, CC. (2012), Malaysian Financial Reporting Standards, Revised 3rd edn. McGraw Hill Education, Malaysia: Kuala Lumpur. ‘MASB (2018), MFRS Framework: The Conceptual Framework for Financial Reporting, April 2018 accessed 1 December, 2018. MASB (2014), MFRS 101 ~ Presentation of Financial Statements, 31 July 2012 accessed 1 March, 2014, ‘MASB (2014), MERS 118 ~ Accounting for Revenue, 19 November 2011, accessed 1 March, 2014. ‘MASB (2018), MFRS 15 ~ Revenue from Contracts with Customers, 1 January 2018, accessed 1 December, 2018. Picker, R, Clark, K, Dunn, J. Kolitz, D, Livne, G, Loftus, J. and van der Tas, L. (2016), Applying JERS. ‘Standards, Ath edn., United Kingdom: John Wiley & Sons, Z ‘Tan, LT. (2014), Financial Accounting and Reporting in Malaysia, Vol. 1, Sth edn., Malaysia: CCH Asia. Scanned with CamScannerrement 297. [ Chapter 7 Income, Revenue Recognition and Meas stions Review Questions What is income? Briefly Coin evenue and gain and is there any distinction between revenue and income? g Whatis(are) . ie Core principle(s) of having MFRS 15 - Revenue from Contracts with Customers? What is considered as contract revenue? 4 What are te five criteria to be met to be considered as contract revenwe? What are the main accounting issues i it id bow meee ime wn of revenue and how MERS 15 address those issues? mena Discuss the steps involved in recognizing revenue under MFRS 15, revenue model. What is a transaction price? ; Explain common forms of variable ‘consideration. Application Exercises _ or 1 Anautomobile dealership, Kereta Hebat Bhd has different models of cars available tobe used by its customers for test drives. The cars used for test drives are used for more than six months and then they will be sold as used cars. Kereta Hebat Bhd sells both new and used cars. Required Isthe sale of a car used for test drives accounted for as revenue or as a gain? 2. Excellent Vehicle Sdn Bhd, a motor vehicle service provider has a 24-month agreement to provide ‘Amir, its customer, with car services for which Amir pays RM300 per month. The agreement does not include any provisions for automatic extensions, and it expires on 31 December, 2018. Excellent Vehicle and Amir sign a new agreement on 1 February, 2019 that requires the customer topay RM350 per month in fees, retroactive to 1 January, 2019, ‘The customer continued to pay RM300 per month during January 2019 and the service provider continued to provide services during that period. There are no performance issues being disputed between the parties in the expired period, only negotiation of rates under the new contract. Required Does a contract exist in January 2019 (prior to the new agreement being signed)? 3 Beg Bhd, a ladies’ handbag manufacturer enters into an arrangement with Ladies Sdn Bhd to sell 100 items of goods (ladies’ handbags) for RM20,000 (RM200 per handbag). The goods are distinct and are transferred to Ladies Sdn Bhd over a three-month period. The parties modify the contract inthe second month to sell an additional 20 handbags for RM170 each. The price of the additional handbags represents the stand-alone selling price on the modification date. Required Should Beg Bhel, the manufacturer, accounts forthe modification as a separate contract? Briefly discuss, Scanned with CamScannerSAS Stud 298 Fnancat Accounting and Reporting 1 ‘4+ Harta Bhd, a property developer, enters intoa contract with Jaya Sdn Bhd forthe sale ofa building for RMS million, Jaya Sdn Bhd plans to have its electrical appliance business centre in the 4 ‘The building is located in an area where new electrical appliance businesses face stiff competition, 4 Jaya Sdn Bhd has little experience in the electrical appliance market. Jaya Sdn Bhd pays a non, a refundable deposit of RM250,000 at the inception of the contract, and enters into a long-term financing agreement with Harta Bhd for the remaining 95 per cent of the promised consideration, ‘The financing arrangement is provided on a non-recourse basis, which means that ifJaya Sdn Bhg defaults, Harta Bhd can repossess the building, but cannot seek further compensation from Jay, ‘Sdn Bhd even ifthe collateral does not cover the full value ofthe amount owed. Harta Bhd's cost fo the building is RM3 million, Jaya Sdn Bhd obtains control of the building at contract inception, Required: Does the contract meet the criteria stated in MFRS 152 Discuss your views. Multiple Elements Arrangements N-ROC is a manufacturer and seller of wall-mounted ai conditioning units. The purchase price of the air-conditioning unit includes installation of the air-conditioning unit, two years’ warranty, and annual service for three’ ‘years from the date of purchase. The warranty covers repairs and breakdowns, Whereas the service is for preventative maintenance. The air-conditioning unit cannot be purchased ‘outright on its own. History indicates that one repair will be required to be performed on each unit sold over the two- year warranty period. NOC provides maintenance services to customers with NROC air-conditioning that do not take this option upfront, or whose units are more than three years old It does not install non-N.ROC air- conditioning units. NROC can determine the cost of providing each service offered in its sales package. There are no refunds on the air-condit installation. NROC's competitors sell air-conditioners without any installation, service or extended warranties attached to the product. The standard warranty period for the sale of all such air-conditioning units is one year. units unless they are faulty within three months of Required: ‘Should this arrangement be accounted for under MFRS 15? Explain your answer. Scanned with CamScanner