CM20 Topic 1 Revenue Recognition 2022 (BB Students)

Master in Management
Advanced International
Financial Reporting (CM20)
Topic 1: Revenue Recognition
Readings
o Students have unlimited access to some online textbooks at http://www.vlebooks.com/

(“sign in” via “Google” with your ESCP info)
o Elliott, B. & Elliott, J. Financial Accounting and Reporting, Pearson Education (19th edition).
Chapter 11.
vle books:
https://www.vlebooks.com/Vleweb/Product/Index/1367849
..also, Madrid Campus:
https://login.revproxy.escpeurope.eu/login?url=https://resolver.vitalsource.com/9781292256047
Department of Financial Reporting & Audit 2

Objectives
By the end of the topic, you should be able to:
o Understand the principles of revenue recognition;
o Account for relevant transactions;
o Explain and understand the impact of revenue recognition and its accounting on the firm’s
financial position and performance;
o Have a awareness of common issues arising in practice.

Content
The topic will cover:
o 1.1: Introduction & relevant standards
o 1.2: When is revenue recognized?
o 1.3: How to measure revenue?
o 1.4: How to measure revenue when a transaction concerns several periods?
o 1.5: Critical issues

Question:
Does Mr Rossi reach his 100 mln sales revenue target?
Company MM - Amount invoiced - 2018 To reach the 100 mln

Revenues (mln Eur) Cumulative Revenues (mln Eur)
sales target, the head
35 120
of the sales dept.
proposes for the
30 100
same price a new
25
80 “formula” contract to
20
60
clients.
15
40 Is the selling price of
10
20
the “formula”
contracts immediate
5
0
Jan-Mar 2018 Apr-Jun 2018 July-Set 2018 Oct-Dec 2018
0
sales revenue?
“Formula”
Only machines Machines + 2 years of
maintenance service

Question:
Does Mr Rossi reach his 100 mln sales revenue target?
Company MM - Amount invoiced - 2018

Revenues (mln Eur) Cumulative Revenues (mln Eur)
35 120
Sales of machines
30 100
25
80
20
60
15
40
10
5 20 Maintenance service
0 0
Jan-Mar 2018 Apr-Jun 2018 July-Set 2018 Oct-Dec 2018
“Formula”
Only machines Machines + 2 years of
maintenance service

What is revenue recognition?
Revenue recognition:
o is about recognizing the benefits flowing to the entity as consideration for goods delivered,
services rendered, having allowed the usage of the entity’s assets by others: timing, amount,
etc.;
o is also about recognizing the related expenses / derecognizing the related inventories;
o results in the profit margin being realized in the income statement;
o concerns the primary cash- and income-generating activities of the entity;
o is thus crucial for the entity’s cash flow and performance.

1.1: Introduction & Relevant Standards
Definition of revenue
…What is revenue?
o IFRS 15 gives no definition of Turnover / Net Sales / Sales Revenue,

but only that of Revenue (from ordinary activities) in general
o Revenue:
“income arising in the course of an entity’s ordinary activities”
o …where Income is defined as “increases in economic benefits during the accounting period
in the form of inflows or enhancements of assets or decreases of liabilities that result in an
increase in equity, other than those relating to contributions from equity participants”
o Risk of fraud, errors and inaccuracies in revenue reporting is significant.

Relevant standards
IFRS 15, Revenue from Contracts with Customers

IFRS 15 specifies when and how an entity will recognise revenue. The standard provides a
single, principles based five-step model to be applied to all contracts with customers.
Except for:
ọ financial instruments: IFRS 9 Financial Instruments
ọ lease contracts: IFRS 16 Leases
ọ insurance contracts: IFRS 4 Insurance Contracts
ọ non-monetary exchanges between entities in the same line of business to facilitate sales
to customers or potential customers (e.g. oil companies exchange oil to satisfy demand
from customers).

IFRS 15
The five steps:
Step 1 Step 2 Step 3 Step 4 Step 5
Identification Identification Determination Allocation of Revenue
of of of the the recognition
the contract separate transaction transaction when
performance price price contractual
obligations obligation is
fulfilled
▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

customer benefits from consideration prices that recognition
contracts good or ▪ Variable would be at point in
service consideration charged for time
▪ Combination the elements
▪ Interest
of contracts ▪ Good or separately
component? ▪ Revenue
services ▪ no „cash
▪ Contract separately ▪ Non-cash recognition
restriction“ over time
modifications identifiable consideration
▪ Consideration
payable to the
customer

IFRS 15
The five steps:
fulfilled

▪ Interest
▪ Consideration
payable to the
customer

IFRS 15
Step 1: Identification of the contract
What is a contract?
Attributes of a contract:
(a) the parties to the contract have approved the contract (in writing, orally or in accordance
with other customary business practices) and are committed to perform their respective
obligations;
(b) the entity can identify each party’s rights regarding the goods or services to be transferred;
(c) the entity can identify the payment terms for the goods or services to be transferred;
(d) the contract has commercial substance (ie the risk, timing or amount of the entity’s future
cash flows is expected to change as a result of the contract); and
(e) it is probable that the entity will collect the consideration.

IFRS 15
Step 1: Identification of the contract
Combination of contracts (“linkage”)
IFRS 15 requires entities to combine contracts entered into at, or near, the same
time with the same customer if they meet one or more of the following criteria:
(a) the contracts are negotiated as a package with a single commercial

objective;
(b) the amount of consideration to be paid in one contract depends on the

price or performance of the other contract; or
(c) the goods or services promised in the contracts (or some goods or services
promised in each of the contracts) are a single performance obligation
Contract Modifications
… A change in the scope or price (or both) of a contract that is approved by the
parties to the contract.
(For example: in some industries, a contract modification may be a change order, a
variation or an amendment).
IFRS 15
The five steps:
fulfilled

▪ Interest
▪ Consideration
payable to the
customer

IFRS 15
The five steps:
fulfilled

▪ Interest
▪ Consideration
payable to the
customer

IFRS 15
Step 2: Identification of performance obligations in the contract
…A performance obligation is either:
(a) a good or service (or a bundle of goods or services) that is distinct;
the customer can benefit either on its own or together with other resources that are readily
available to the customer, AND the entity’s promise to transfer is separately identifiable from other
promises in the contract.
or
(b) a series of distinct goods or services that are substantially the same and that have the
same pattern of transfer to the customer.
Factors that indicate that 2 or more promises to transfer goods or services to a customer are not
separately identifiable include (but are not limited to) the following:
• the entity provides a significant service of integrating the goods or services with other goods or
services promised in the contract into a bundle of goods or services that represent the combined
output for which the customer has contracted;
• 1 or more of the goods or services significantly modifies or customizes 1 or more of the other
goods of services promised in the contract;
• the goods or services are highly interdependent or highly interrelated.

IFRS 15
Step 2: Principal vs agent considerations (1/2)
… When more than one party is involved in providing goods or services to a customer, the
standard requires an entity to determine whether it is a principal or an agent in these
transactions.
An entity is a principal (and, therefore, records revenue on a gross basis) if it controls a

promised good or service before transferring it to the customer. An entity is an agent (and,
therefore, records as revenue the net amount that it retains for its agency services) if its
role is to arrange for another entity to provide the goods or services.

IFRS 15
Step 2: Principal vs agent considerations (2/2)
Principal indicators
IFRS 15 provides three indicators of when an entity controls the specified good or service (and is, therefore,
a principal):
Indicators than an entity controls the specified good or service before it is transferred to the customer
include, but are not limited to, the following:
• the entity is primarily responsible for fulfilling the promise to provide the specified good or
service;
• the entity has inventory risk before the specified good or service has been transferred to a
customer or after transfer of control to the customer (for ex., the customer has the right of return);
• the entity has discretion in establishing the price for the specified good or service.

IFRS 15
The five steps:
fulfilled

▪ Interest
▪ Consideration
payable to the
customer

IFRS 15
The five steps:
fulfilled

▪ Interest
of contracts separately
▪ Good or component? ▪ Revenue
services ▪ no „cash recognition
▪ Contract ▪ Non-cash
separately restriction“ over time
modifications consideration
identifiable ▪ Consideration
payable to the
customer

IFRS 15
Step 3: Determination of the transaction price
Transaction price =
„The amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or
services to a customer, excluding amounts collected on behalf of third parties.“
Variable Financing Component Non-cash consideration Consideration payable to a
Consideration customer
Estimate • Adjust price for significant • at fair value of • reduce transaction price
• Expected Value financing component consideration • if distinct: account for as
• Most likely • “Practical expedient”: no • stand-alone selling price regular way purchase
amount need if ≤ 1y of good/service (if fair
• Discount rate value cannot be
• Classify interest as financial determined)
income

IFRS 15
The five steps:
fulfilled

▪ Interest
▪ Consideration
payable to the
customer

IFRS 15
The five steps:
fulfilled

of contracts ▪ Interest separately
▪ Contract ▪ Non-cash restriction“
modifications separately consideration over time
identifiable
▪ Consideration
payable to the
customer
IFRS 15
Step 4: Allocation of the transaction price to the separate
performance obligations
• relative stand-alone selling price basis
• method 1: observable price of a good or service when the entity sells that good or service
separately in similar circumstances and to similar customers
• method 2: estimate (market conditions, entity-specific factors and information about the
customer or class of customer). Maximize the use of observable inputs and apply estimation
methods consistently in similar circumstances
e.g., adjusted market assessment approach, expected cost plus a margin approach, residual
approach
• allocate a discount proportionately, unless observable evidence that

discount relates to only one or more, but not all, performance obligations

IFRS 15
The five steps:
fulfilled

▪ Interest
▪ Consideration
payable to the
customer

IFRS 15
The five steps:
fulfilled

of contracts ▪ Interest separately
▪ Contract ▪ Non-cash restriction“
modifications separately consideration over time
identifiable
▪ Consideration
payable to the
customer
IFRS 15
Step 5: Point in time or over time?
Evaluating whether control
transfer over time
Does the
Does the entity’s
customer performance
Does the entity’s
simultaneously create an asset
performance
receives and with no Revenue
creates or
consumes the alternative use
enhances an recognition
benefits to the entity
asset (e.g., work at a point in
provided by the and the entity
in progress) that time
entity’s has
the customer no
performance as or or enforceable (the entity
controls as the
the entity right to transfers
asset is created or
performs ? payment for control at a
enhanced?
performance
point in
completed to
date? time)
yes
Revenue recognition over time
(the entity transfers control over time)

IFRS 15
Step 5: Control transferred at a point in time
• An entity must determine, at contract inception, whether it will transfer

control of a promised good or service over time. If an entity does not
satisfy a performance obligation over time, it is satisfied at a point in time.
• In many situations, the determination of when that point in time occurs is relatively
straightforward. However, in other circumstances, this determination is more
complex. To help entities to determine the point in time when a customer obtains
control, the entity is required to consider indicators of transfer of control, which
include, but are not limited to, the following:
(a) the entity has a present right to payment for the asset
(b) the customer has legal title to the asset
(c) the entity has transferred physical possession of the asset
(d) the customer has the significant risks and rewards of ownership of the asset
(e) the customer has accepted the asset.

IFRS 15
Step 5: Measuring progress over time
• When an entity has determined that a performance obligation is satisfied

over time, the standard requires the entity to select a single revenue
recognition method for the performance obligation. The standard
provides 2 methods:
• Output methods: Recognize revenue on the basis of direct measurements of the value to the
customer of the goods or services transferred to date relative to the remaining goods or services
promised under the contract. Output methods include surveys of performance completed to date,
appraisals of results achieved, milestones reached, time elapsed and units produced or units
delivered.
• Input methods: Recognize revenue on the basis of the entity’s efforts or inputs to the satisfaction
of performance obligation (e.g., resources consumed, labor hours, expended, costs incurred, time
elapsed or machine hours used) relative to the total expected inputs to the satisfaction of that
performance obligation.

Exercise 1:
A Telco operator proposes the following contracts to customers:
Sale of a mobile phone for a reduced price of 90€ if the client subscribes to mobile services
over 12 months for 100€ per month. The selling price for a phone alone is 300€, and for the
mobile service alone: 100€/month.

Identification of Identification Determination Allocation of Revenue recognition
the contract of of the the transaction when
separate transaction price contractual
performance price obligation is
obligations fulfilled
There are 2 ▪ Contract 1: ▪ Consideration ▪ Selling price for a ▪ Contract 1:

contracts: Deliver mobile to be received phone alone: 300 Revenue
phone from the recognition when
▪ Selling price for
▪ Contract 1: Sale customer: phone is
mobile service alone:
of a mobile ▪ Contract 2: 90 + 12x100 = delivered: 20% of
1,290 100 per month
phone Provide mobile 1,290=258
services over 12 ▪ Total alone: 1,500
▪ Contract 2:
▪ Contract 2: Sale months ▪ %phone: Revenue
of mobile 300/1,500=20% recognition over
services
▪ %service: 12 months: 80% of
1,200/1,500=80% 1,290=1,032;
86 per month

Exercise 1:
Impact on Balance Sheet and Income Statement (in €):
BALANCE SHEET LIABILITIES INCOME STATEMENT
ASSETS & EQUITY EXPENSES INCOME
Non-current Assets Equity Cost of Revenue (1a) 258
Goods Sold (1b) XX
Liabilities
(2b) YY (2a) 86
Current Assets
Inventories (1b) -xx (3b) ZZ (3a) 86
«Contract (1a) +168

Assets» (2a) -14
(3a) -14
Cash (1a) +90

(2b) -YY (2a) +100
(3b) -ZZ (3a) +100
(1) Accounting for contract 1 when the phone is delivered

(2) Accounting for contract 2 when the mobile services is provided for month 1
(3) Accounting for contract 2 when the mobile services is provided for month 2

Exercise 1:
T-accounts and journal entries (in €):
DR CR
(1a) Cash 90 Revenue 258
Contract Assets 168
(1b) Cost of Goods Sold XX Inventories XX
(2a/3a) Cash 100 Revenue 86

Contract Assets 14
(2b/3b) Cost of Goods Sold YY/ZZ Cash YY/ZZ
Cash Contract Assets Inventories
(1a) 90 (1a) 168 (1b) XX

# ???
(2a/3a) 100 (2b/3b) YY/ZZ (2a/3a) 14
Cost of Goods Sold Revenue
(1b) XX (1a) 258

(2b/3b) YY/ZZ (2a/3a) 86

1.2: When revenue has to be recognized?
What it the performance obligation (step 2)?
When is it fulfilled (step 5)?
Exercise 2:
BMZ is a car manufacturer. BMZ has 3 activities:

It sells manufactured cars to car dealers
It sells manufactured cars to car rental firms
(sale-and-buy-back contracts)
It rents cars to companies through leasing contracts
For each of the following transactions you have to specify (and

explain) if a sale of goods (cars) has to be recognised in the
financial statements of BMZ for the year N1:
In December N1, BMZ sold 3,000 cars to car dealers for a total
amount of 80 m€. The Gross margin is 20% (= cost of goods sold is 64m
€). 50% of this amount was paid immediately and the other 50% will be
paid in January N2.

Exercise 2:
Revenue is recognized...
o ...when (or as) the entity satisfies a performance obligation by transferring a

promised good or service (ie an asset) to a customer. An asset is transferred
Main principle when (or as) the customer obtains control of that asset. (Step 5).
o Control of an asset refers to the ability to direct the use of, and obtain
substantially all of the remaining benefits from, the asset. Control includes
the ability to prevent other entities from directing the use of, and obtaining
the benefits from, an asset. The benefits of an asset are the potential cash
flows (inflows or savings in outflows) that can be obtained directly or indirectly.
Solution: Performance obligation: delivery of cars.

BMZ has to record a (sales) revenue of 80 m€ upon
delivery in December N1. (this is a “classic” case)

Exercise 2:
Impact on Balance Sheet and Income Statement N1 (in m€):

Non-current Assets Equity Cost of
Goods Sold 64 Revenue 80
Liabilities
Current Assets
Inventories XXX- 64
Trade
Receivables + 40
Cash + 40

Exercise 2:
T-accounts and journal entries (in m€):
DR CR
(1) Cash 40 Revenue 80
Trade Receivables 40
(2) Cost of Goods Sold 64 Inventories 64
Cash Trade Receivables Inventories
(1) 40 (1) 40 64 (2)
Cost of Goods Sold Revenue
(2) 64 80 (1)

Exercise 3:
On 2 January N1, BMZ sold 500 cars to a car rental firm under the following
conditions:
Selling price: 10 m€ (cost of goods sold: 6 m€)
BMZ will repurchase the cars on June 30, N2 for 2.8 m€
Useful life of the cars: 6 years
What is the performance obligation?

When should revenue be recognized?
Solution:
Performance obligation: provide the use of cars for 18 months.
BMZ cannot recognize a revenue for the sale of goods (cars) in N1 because its
performance obligation is fulfilled over time. A (rent) revenue (total: 10-
2.8=7.2) is recognized over the 18 month-period.
(Also: application of IFRS 16 Leases, leading to the same outcome)

Exercise 3:
Impact on Balance Sheet and Income Statement N1 (in m€):

Non-current Assets Equity Depreciation Revenue 4.8
Cars +6 expense 2.1 [ (10-2.8)*12/18) ]
Acc.Depreciation -2.1 Liabilities
[ (6-2.8)*12/18) ]
Other current
liabilities + 5.2
Current Assets
Inventories XXX- 6
Jan.2 /N1
Cash + 10 Dec.31 /N1

Exercise 3:
DR CR
(1) Cars (non-current assets) 6 Inventories 6
(2) Cash 10 Revenues 4.8
Other curr. liabilities 5.2
(3) Depreciation expense 2.1 Acc. Depreciation 2.1
Cars (non-curr. assets) Cash Inventories Other curr. liabilities
(1) 6 (2) 10 6 (1) 5.2 (2)

(3) -2.1
Depreciation expense Revenue
(3) 2.1 4.8 (2)

Jan.2 /N1
Dec.31 /N1

1.3: How to measure revenue?
Determination of the transaction price (step 3)
Measurement of revenue:
Determination of the transaction price
What is the amount of revenue to be recognized?
• When a performance obligation is satisfied, an entity shall recognize as revenue the
amount of the transaction price that is allocated to that performance obligation.
• The transaction price is the amount of consideration to which an entity expects to be
entitled in exchange for transferring promised goods or services to a customer, excluding
amounts collected on behalf of third parties (for example, some sales taxes). (Step 3).
• The nature, timing and amount of consideration promised by a customer affect the
estimate of the transaction price.
• Consequences:
− Revenue are recorded after deduction of discounts and rebates (so called variable
considerations)
− Product return rights have to be considered
− if there is a significant financing component, explicit or implicit, it has to be taken into
account.

IFRS 15:
Measurement
Revenue recognition
(... Accounting policies)
Source: Novartis AG annual report 2020, p.F12

Notes to the Novartis Group consolidated financial statements

IFRS 15: Measurement
Explicit Financing Component
Exercise 4: The company A sells finished products for 100 K€ on 2 January N1 (Cost:
60 K€). The customer can pay the latest by 28 February N1. If the
payment is made in cash, the customer can deduct a 2 K€ discount.
What are the accounting impacts for Company A in both cases:
o Case 1: cash payment

o Case 2: payment on 28 February N1.

IFRS 15: Explicit Financing Component
Exercise 4:
Impact on Balance Sheet and Income Statement N1 (in k€):
Case 1: cash payment Case 2: payment on 28 February N1
BALANCE SHEET BALANCE SHEET LIABILITIES
LIABILITIES
ASSETS ASSETS & EQUITY
& EQUITY
Non-current Assets Equity Non-current Assets Equity
Current Assets Liabilities Current Assets Liabilities

Inventories (2) -60 Inventories (2) -60
Cash (1) +98 Account Receivables (1) 98
(3) -98
Cash (3) +100
INCOME STATEMENT INCOME STATEMENT

EXPENSES INCOME EXPENSES INCOME
Revenue (1) 98 Revenue (1) 98
COGS (2) 60 COGS (2) 60
Financial Income (3) 2
(1&2): 1 Jan. N1 (1&2): 1 Jan. N1

(3): 28 Feb. N1
IFRS 15: Explicit Financing Component
Exercise 4:
T-accounts and journal entries (in k€):
Case 1: cash payment Case 2: payment on 28 February N1

DR CR 1 Jan. N1 DR CR 1 Jan. N1
(Case 1) Cash 98 Sales Revenue 98 (Case 2) Receivables 98 Sales Revenue 98
COGS 60 Inventories 60 COGS 60 Inventories 60
Cash 100 Receivables 28 Feb.98
Financial Income N1
Cash 100 Receivables 98
Financial Income 98 100 2
Financial
Cash Income
2 Financial Income 2
2
Financial Income
Cash Inventories Receivables Inventories Cash
98 60 98 60 100
98
Financial Income
COGS Sales Revenue COGS Sales Revenue
60 98 60 98 2

Implicit Financing Component
Exercise 5: The company B sells an equipment for 1,000 on 2 January N1 (cost of

goods sold: 600). The company B has an arrangement with its
customer who will pay two years later on 31 December N2.
The discount rate is 10 %.
Present the accounting impacts on 2 January N1,

31 December N1 and 31 December N2.
Solution:
Sales revenue on 2 January N1:
1,000/(1+10%)2 = 826

IFRS 15: Implicit Financing Component
Exercise 5:
Impact on Balance Sheet and Income Statement (year N1):

Goods sold (1) 600 Revenue (1) 826
Liabilities
[ 10% 826 ]
Current Assets
Inventories (1) - 600
Accounts
Receivable (1) 826 (1) 2 Jan N1
(2) 83 (2) 31 Dec N1

Exercise 5:
Impact on Balance Sheet and Income Statement (year N2):

Non-current Assets Equity
Liabilities [ 10% 909 ]
Current Assets
Accounts # 909
Receivable (3) -909
Cash (3) 1,000 (3) 31 Dec N2

Exercise 5:
T-accounts and journal entries:
DR CR
(1) Accounts Receivable 826 (1) Sales Revenue 826
Year N1 COGS 600 Inventories 600
(2) Accounts Receivable 83 (2) Financial Income 83
Year N2 (3) Cash 1,000 (3) Accounts Receivable 909
(3) Financial Income 91
Year N1 Year N2
Accounts Accounts
Receivable Sales Revenue Cash Receivable
826 (1) 826 (1) 1,000 (3) # 909 909 (3)
83 (2)
Financial Income Financial Income
(1) 2 Jan N1
83 (2) 91 (3) (2) 31 Dec N1
[ 10% 826 ] [ 10% 909 ] (3) 31 Dec N2

Return Rights
Exercise 6: HMVL company sells luxury goods to retailers who have a right of
return which can be exercised up to 3 years after the sale.
The % of products effectively returned within the 3 year period is usually
around 15%. In year N1, the amount of sales realised by HMVL is 10 m€.
The cost of goods sold is 30% of the sales revenue.

IFRS 15: Return Rights
Exercise 6:
Impact on Balance Sheet and Income Statement (in m€):

Goods Sold 2.55 Revenue 8.5
Liabilities
[ 85% 3 ]
Current Liabilities [ or 30% 8.5 ]
Current Assets Refund
Liabilities 1.5
Inventories -3
[ 30% 10 ] [ 15% 10 ]
Right to recover 0.45

[ 15% 3 ]
Cash/Receivables 10

IFRS 15: Return Rights
Exercise 6:
DR CR
(1) Cash/Receivables 10 Sales Revenue 8.5
Refund Liabilities 1.5
(2) COGS 2.55 Inventories 3
Right to recover 0.45
Cash/Receivables Refund Liabilities Sales Revenue

10 (1) 1.5 (1) 8.5 (1)
[ 15% 10 ]
Inventories
3 (2)
Cost of Goods Sold
2.55 (2)
Right to recover [ 85% 3 ]
0.45 (2) [ or 30% 8.5 ]
[ 15% 3 ]
Customer Loyalty Programs
Exercise 7: The new customer loyalty program « Repaid », launched in the beginning of Year N from the
group Roundabout, works as follows: each time a customer spends € 1 in the shop, € 0.02 is
added to her Repaid Account. Once the client has more than € 20 on her account she can get
one product of a Roundabout shop free corresponding to the amount on her Repaid account.
Statistically, based on the data of competitors that have similar loyalty programs, only 80% of
the sales generate loyalty points and only 75% of the loyalty points are used by the customers,
while 25% are added to the Repaid accounts but never reach the critical level of € 20. In
January N, the group Roundabout generated one billion € of cash sales. No one used the
Repaid points yet.
The average gross margin on goods sold by Repaid is 60% (of sales revenue).
Present the accounting impacts in January N
Performance obligation: deliver products « purchased » + deliver products for loyalty

The value allocated to the loyalty program component can be estimated at
12 = 1,000 x 80% x 75% x 0.02.

IFRS 15: Customer Loyalty Programs
Exercise 7:
Total standalone price: 1,000+12=1,012
Allocation of the total consideration of 1,000: 98.8%(=1,000/1,012) related to the sale of products and
1.2%(=12/1,012) related to the loyalty program.

Goods Sold 400 Revenue 988
Liabilities
[ 40% 1,000 ]
Current Liabilities
Current Assets Contract
Liabilities 12
Inventories -400
Cash 1,000

Exercise 7:
DR CR
(1) Cash 1,000 Sales Revenue 988
Contract Liabilities 12
(2) COGS 400 Inventories 400
Cash Contract Liabilities Sales Revenue

1,000 (1) 12 (1) 988 (1)
Inventories Cost of Goods Sold

400 (2)
400 (2)
[ 40% 1,000 ]

Example
Source:
Air France-KLM Universal Registration Document 2020, p. 263.
Accounting policies

Example
Source:
Air France-KLM Universal Registration Document 2020, p. 249.
Sales (2020): 11,088 mill. € (2019: 27,188 mill. €)

1.4: How to measure revenue when a
transaction concerns several periods?
Performance obligation satisfied over time (step 5)
IFRS 15: Performance obligations satisfied over time
Requirements for revenue recognition

An entity transfers control of a good or service over time and, therefore,
satisfies a performance obligation and recognizes revenue over time, if one of
the following criteria is met:
(a)the customer simultaneously receives and consumes the benefits
provided by the entity’s performance as the entity performs (e.g.
security service, delivery of electricity);
(b)the entity’s performance creates or enhances an asset the customer
controls as the asset is created or enhanced
(e.g. construction contract under control of the customer, R&D
where the customer owns the findings);
(c)the entity’s performance does not create an asset with an alternative use
to the entity and the entity has an enforceable right to payment for
performance completed to date
(e.g. consulting contract where the client is obliged to pay the work
completed if he cancels the contract).

How to recognize revenue over time?

For each performance obligation satisfied over time, an entity shall
recognize revenue over time by measuring the progress towards complete
satisfaction of that performance obligation.
Methods for measuring progress include:

o Output methods, that recognize revenue based on direct measurements
of the results achieved and the value transferred to the customer.
o Input methods, that recognize revenue based on the entity’s efforts to
satisfy the performance obligation (e.g. resources consumed, labor hours
expended, costs incurred, time elapsed, or machine hours used).

Exercise 8: The customer simultaneously receives and consumes the

benefits provided by the company.
In July N1, A signed a maintenance contract with its client B: the

contract will start on 1 October N1, it is a one–year contract, and B will
pay on 1 October N1 for the total amount of 12 m€.
What revenue must be recorded by A in N1?
Solution:
Revenue to be recorded in N1:
12 m€ * 3/12 = 3 m€

Exercise 8:

Non-current Assets Equity Revenue 3
Current Assets Liabilities

Cash 12 Other
Curr. Liabilities 12
-3

Exercise 8:
DR CR
(1) Cash 12 Other Current Liabilities 12
(2) Other Current Liabilities 3 Sales Revenue 3
Other Current
Cash Liabilities Sales Revenue
12 (1) 3 (2) 12 (1) 3 (2)

1.5: Revenue recognition
Critical issues for financial analysts
Revenue Recognition
Critical Issues for Financial Analysts (1/3)
o Revenue recognition issues are common in accounting manipulation

cases (61% of the cases in USA between 1998 and 2007) 1
o Aggressive revenue recognition
Why?
To increase sales revenue and net income in order to meet the
objectives publicly announced in terms of operating margin, earnings
per share …
1. BEASLEY M.S., CARCELLO J.V., HERMANSON D.R., NEAL T.L. (2010), Fraudulent Financial Reporting
1998-2007: An Analysis of U.S. Public Companies, Committee of Sponsoring Organization of the
Treadway Commission.

Revenue Recognition
Aggressive revenue recognition
How?
Cut-Off Manipulation:
Advancing Sales: the company delivers more products to its retailers
than can be sold, with return rights that are incorrectly estimated
Performance obligation satisfied over time:
Firms can voluntarily overestimate the progress made towards
satisfaction of the performance obligation

Revenue Recognition
Aggressive revenue recognition:

How to spot it?
Analysing any significant increase in net sales: is it consistent with

the market, the industry peers figures…
Investigating the evolution of accounts receivable:
− Day of Sales Outstanding (DSO) may be higher than is
usually observed for industry peers
− DSO may have increased over the last years
Investigating « Related party » disclosures in the notes: the company
could have overstated its sales revenue by making transactions with
related parties (a related party is for example another company
belonging to the owners of the manipulating company or their family
which is not consolidated).

Quiz (√ or X)
1. The FLY company signed a contract with a client with the following conditions in year N:
The client will rent an aircraft, legally owned by Fly, for 25 years, which is almost the useful life of the aircraft.
FLY has to record a sale of an aircraft in year N, at the fair value of the aircraft.
2. Pablo company started a loyalty program for its clients in January N. At the end of year N, the estimated
amount of discounts to be granted to customers in the loyalty program is 200 K€. A liability of 200 K€ has to
be recorded in Pablo’s financial statements.
3. If a company grants the customers the right to return the products for 2 years. Even though a reliable
estimate of returns is possible, the company has to wait 2 years before recording a sale in its financial
statements.
4. On 30 December N, a pharmaceutical company sold vaccines to a foreign public agency under the
following conditions:
- Amount of the sale: 500 K€
- Payment Term : 18 months
The company has to record a sale of 500 K€ in its financial statements N.
5. If a company overestimates the percentage of completion of its service contracts, it leads to an
overstatement of profit.

Further Readings
Beiersdorf, K., and Schmidt, M. (2014), Umsatzerfassung – Bestimmung von

Auftraggeber (Prinzipal) und Vermittler (Agent), Zeitschrift für Internationale
Rechnungslegung, 2014 (12), 457–460.
Biondi, Y., Glover, J., Jamal, K., Ohlson, J., Penman, S., Bloomfield, R. and
Tsujiyama, E. (2011), Accounting for Revenues: A Framework for Standard
Setting, Accounting Horizons, 25 (3), 577–592.
Lim, Y., Azmi, A., Susela Devi, S. and Mahzan, N. (2017), Implementation
Guidance for Standards and Revenue Trend in Aggressive Reporting, The
International Journal of Accounting, 52 (4), 342–353.
Schmidt, M. (2015), Phasenspezifische Methoden zur Messung des
Leistungsfortschritts bei zeitraumbezogener Erlöserfassung nach IFRS 15?,
Zeitschrift für Internationale Rechnungslegung, 2015 (7/8), 267–269.
Srivastava, A. (2013), Selling-price estimates in revenue recognition and the
usefulness of financial statements, Review of Accounting Studies, 19 (2), 661–697.

Case 1
Case 3
Case 4
Case study: Channel-Stuffing Reinvented:
Earnings Management in the Toshiba‘s
Personal Computer Division.
by Gujarathi and Dugar (2020, Issues in Accounting Education)

CM20 Topic 1 Revenue Recognition 2022 (BB Students)

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Master in Management

o Students have unlimited access to some online textbooks at http://www.vlebooks.com/

Department of Financial Reporting & Audit 2

By the end of the topic, you should be able to:

o Understand the principles of revenue recognition;

o Account for relevant transactions;

o Have a awareness of common issues arising in practice.

Department of Financial Reporting & Audit 3

The topic will cover:

o 1.1: Introduction & relevant standards

o 1.2: When is revenue recognized?

o 1.3: How to measure revenue?

o 1.4: How to measure revenue when a transaction concerns several periods?

o 1.5: Critical issues

Department of Financial Reporting & Audit 4

Company MM - Amount invoiced - 2018 To reach the 100 mln

Department of Financial Reporting & Audit 5

Company MM - Amount invoiced - 2018

Department of Financial Reporting & Audit 6

o results in the profit margin being realized in the income statement;

o concerns the primary cash- and income-generating activities of the entity;

o is thus crucial for the entity’s cash flow and performance.

Department of Financial Reporting & Audit 7

o IFRS 15 gives no definition of Turnover / Net Sales / Sales Revenue,

o Risk of fraud, errors and inaccuracies in revenue reporting is significant.

Department of Financial Reporting & Audit 9

IFRS 15, Revenue from Contracts with Customers

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▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

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▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

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(a) the contracts are negotiated as a package with a single commercial

(b) the amount of consideration to be paid in one contract depends on the

▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

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▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

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An entity is a principal (and, therefore, records revenue on a gross basis) if it controls a

Department of Financial Reporting & Audit 18

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▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

Department of Financial Reporting & Audit 20

▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

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Department of Financial Reporting & Audit 22

▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

Department of Financial Reporting & Audit 23

▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

• allocate a discount proportionately, unless observable evidence that

Department of Financial Reporting & Audit 25

▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

Department of Financial Reporting & Audit 26

▪ Separate ▪ Client ▪ Fixed ▪ Relative ▪ Revenue

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• An entity must determine, at contract inception, whether it will transfer

(b) the customer has legal title to the asset

(c) the entity has transferred physical possession of the asset

(e) the customer has accepted the asset.

Department of Financial Reporting & Audit 29