GODFREYHODGSON

HOLMESTARCA

CHAPTER 9 REVENUE

Revenue defined

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Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions

from equity participants. AASB Framework

Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions

from equity participants. AASB Framework

Revenue defined

• Revenue represents a physical and a monetary flow

• Revenue is an inflow of economic benefits• Revenue forms part of income – which also

includes gains – and arises in the course of ordinary activities

• Examples are sales, fees, interest, dividends, royalties and rents

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Behavioural view of revenue

• Revenues are the result of firm activity• Net accomplishment of firm – revenue = accomplishment– expense = effort– matching results in profit = net accomplishment

• A point of recognition must be determined– critical event – accrual throughout earnings process

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Revenue recognition

Historical perspective• Profit (and revenue) determined on the basis

of the increase in the net worth of the firm• Supplanted by the notion that profit and

revenue had to be realised• Developed into the revenue recognition

principle (or realisation principle)• A distinction between capital and profit

emerged from court rulings

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Criteria for revenue recognition

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At what point during the earning process can revenue be recorded as earned because there

is sufficient evidence?

At what point during the earning process can revenue be recorded as earned because there

is sufficient evidence?

Criteria for revenue recognition

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Criteria for revenue recognition

• Recognition criteria are based on the desire for both relevant and reliable accounting information– measurability of asset value– existence of a transaction– substantial completion of the earning process

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Revenue measurement

• Framework – provides 2 criteria for revenue recognition– it is probable that any future economic benefit

associated with the item will flow to or from the entity

– the item has a cost or value that can be measured with reliability

Revenue recognition is not straightforward because of the wide range of different business revenue-generating activities and circumstances

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Revenue measurement

• IAS 18/AASB 118 Revenue– revenue is to be measured at the fair value of the

consideration received or receivable

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Sale of goods

• The sales point is generally the most appropriate point to measure and record revenue as all three criteria are met

• The sales point is when the product is delivered or the services are rendered, or when title passes to the customer

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Exceptions to sales basis

• Exceptions to using the sale point are– revenue recognised during production• e.g. construction contracts

– revenue recognised at the end of production• production is the critical event and the sale is assured

– revenue recognised when cash is received after the sale is made• instalment method and the cost recover method

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Rendering of services

• Service revenue is to be recognised by reference to the stage of completion

• It is recognised in the period in which the service is rendered

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Interest, royalties and dividends

• Can be recognised when received• For some items, the passing of time signifies

revenue has been earned– e.g. interest revenue

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Developments in revenue recognition and measurement• IASB/FASB joint project• Void in revenue recognition and measurement

guidance and a lack of a conceptual basis for resolving issues

• Revenue transactions have become more complex

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Developments in revenue recognition and measurement• They propose– recognising revenues when they arise– measuring them at fair value at that point– measuring them when they arise from an increase

in assets or a decrease in liabilities, at the fair value of that change

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Developments in revenue recognition and measurement• Resulting changes in emphasis – revenue is recognised when it arises • changes emphasis from realisation to timeliness

– revenue can result from the changes in asset and liability values and from holding assets • that is, from remeasurements

– revenue recognition and measurement reflect fair value

– measurement should be reliable

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Developments in revenue recognition and measurement• Tentative agreement that two criteria must be

met to recognise revenue– a change in assets or liabilities must have occurred• the elements criterion

– the change in assets or liabilities can be appropriately (reliably) measured• the measurement criterion

– no probability criterionThere is less emphasis on ‘substantial completion of the earnings process’ and

on notions of ‘realisation’ and ‘earned’

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Fair value measurement

• Under a mixed measurement attribute model, all items are measured at fair value at acquisition and thereafter are carried at historical cost or written down historical cost although some items are subsequently remeasured to fair value

• Gains and losses are recognised when they occur even if they are unrealised

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Financial statement presentation• IASB/FASB joint project• Tentative conclusions are– an all-inclusive, single income statement where all

changes to assets and liabilities will be disclosed– realisation is not the basis for inclusion of items– separate disclosure of performance (income

flows) and remeasurement (valuation adjustments)

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Issues for auditors

• Primary issue is the overstatement of revenues by managers– intention is to deceive users– bonuses – managing earnings– over-optimism– fraud

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Summary

• Issues relating to the definition, measurement and recognition of revenue

• Critical recognition points

• Criteria for revenue recognition

• Revenue measurement

• Guidance provided by standard setters

• Current projects and developments

• Issues for auditors

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Key terms and concepts

• Revenue• Behavioural view of revenue• Earning process• Criteria for revenue recognition• Point of sale• Fair value• Sales of goods and the rendering of services

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