When to Recognize Revenue ?

“Revenue is recognized when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably” (IAS 18 Revenue).

Revenue can take various forms, such as sales of goods, provision of services, royalty fees, franchise fees, management fees, dividends, interest, subscriptions, and so on.

The principle issue in the recognition of revenue is its timing – at what point is it probable that future economic benefit will flow to the entity and can the benefit be measured reliably.

Some of the recent highly publicized financial scandals that caused turmoil in the financial world globally were allegedly the result of financial manipulations resulting from recognizing revenue based on inappropriate accounting policies. Such financial shenanigans resulting from the use of aggressive revenue recognition policies have drawn the attention of the accounting world to the importance of accounting for revenue.

It is absolutely critical that the point of recognition of revenue is properly determined. For instance, in case of sale of goods, is revenue to be recognized on receipt of the customer order, on completion of production, on the date of shipment, or on delivery of goods to the customer ? The decision as to when and how revenue should be recognized has a significant impact on the determination of “net income” for the year (i.e., the “bottom line”), and thus it is a very critical element in the entire process of the preparation of the financial statements.

Revenue from the sale of goods should be recognized when all of the following criteria are satisfied :

(a) the significant risks and rewards of ownership of the goods have been transferred to the buyer

(b) the seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold

(c) the amount of the revenue can be reliably measured

(d) it is probable that economic benefits associated with the transaction will flow to the seller

(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.

The transfer of “significant” risks and rewards is essential. For example, if goods are sold but the receivable will be collected only if the buyer is able to sell, then “significant” risks of ownership are retained by the original seller and no sale is recognized.

The point of time at which significant risks and rewards of ownership transfer to the buyer requires careful consideration involving examining the circumstances surrounding the transaction. Generally, the transfer of significant risks and rewards of ownership takes place when title passes to the buyer or the buyer received possession of the goods. However, in some circumstances, the transfer of risks and rewards of ownership does not coincide with transfer of legal title or the passing of possession, as when a building that is still under construction is sold.

Revenue from the rendering of services can be recognized by reference to stage of completion if the final outcome can be reliably estimated. This would be the case if :

(a) the amount of revenue can be measured reliably

(b) it is probable that economic benefits associated with the transaction will flow to the seller

(c) the stage of completion can be measured reliably

(d) the cost incurred and the cost to complete can be measured reliably.

Revenue arising from the use by others of an entity’s asset that yield interest, dividends, or royalties are recognized in this way :

(a) Interest is recognized using the “effective interest method”

(b) Royalties are recognized on an accrual basis in accordance with the royalty agreement

(c) Dividends are recognized when the shareholder has a right to receive payment.

Source of this article : IFRS Practical Implementation Guide and Workbook (Second Edition) - Abbas Ali Mirza, Magnus Orrell and Graham J. Holt

For further reference, read also a related article from CFO.com regarding on Revenue Recognition in here >>

IASB Publishes IFRS for Small and Medium-sized Entities

On Thursday, 9 July 2009, IASB has published the IFRS for SMEs. Following is the Press Release which was posted from the IASB website :

The International Accounting Standards Board (IASB) issued today an International Financial Reporting Standard (IFRS) designed for use by small and medium-sized entities (SMEs), which are estimated to represent more than 95 per cent of all companies*. The standard is a result of a five-year development process with extensive consultation of SMEs worldwide.

The IFRS for SMEs is a self-contained standard of about 230 pages tailored for the needs and capabilities of smaller businesses. Many of the principles in full IFRSs for recognising and measuring assets, liabilities, income and expenses have been simplified, topics not relevant to SMEs have been omitted, and the number of required disclosures has been significantly reduced. To further reduce the reporting burden for SMEs revisions to the IFRS will be limited to once every three years.

Benefits

The IFRS for SMEs responds to strong international demand from both developed and emerging economies for a rigorous and common set of accounting standards for smaller and medium-sized businesses that is much simpler than full IFRSs. In particular, the IFRS for SMEs will:

(a) provide improved comparability for users of accounts

(b) enhance the overall confidence in the accounts of SMEs, and

(c) reduce the significant costs involved of maintaining standards on a national basis.

The IFRS for SMEs will also provide a platform for growing businesses that are preparing to enter public capital markets, where application of full IFRSs is required.

The IFRS for SMEs is separate from full IFRSs and is therefore available for any jurisdiction to adopt whether or not it has adopted the full IFRSs. It is also for each jurisdiction to determine which entities should use the standard. It is effective immediately on issue.

Rigorous development

In developing the IFRS for SMEs the IASB consulted extensively worldwide. A 40-member Working Group of SME experts advised the IASB on the structure and content of the IFRS at various stages in its development. The exposure draft of the IFRS, published in 2007, was translated into five languages to assist SMEs in responding to the proposals. More than 50 round-table meetings and seminars were held to receive direct feedback, and the draft IFRS was field-tested by over 100 small companies in 20 countries. As a result, further simplifications have been achieved in the final document.

Paul Pacter, Director of Standards for SMEs for the IASB, has agreed to lead a group to support international adoption of the standard. Further details of this group will be announced shortly.

Global education initiative

To support the implementation of the IFRS for SMEs the IASC Foundation is developing comprehensive training material. The Foundation is also working with international development agencies to provide instructors for regional workshops to ‘train the trainers’ in the use of the training material, particularly within developing and emerging economies. The training material will be published in a number of languages. The English language material will be downloadable free of charge from the IASB’s website in late 2009.

The complete IFRS for SMEs (together with the basis for conclusions, illustrative financial statements, and a presentation and disclosure checklist) can be downloaded free of charge from http://go.iasb.org/IFRSforSMEs from today.

Introducing the IFRS for SMEs, Sir David Tweedie, IASB Chairman, said:

The publication of IFRS for SMEs is a major breakthrough for companies throughout the world. For the first time, SMEs will have a common high quality and internationally respected set of accounting requirements. We believe the benefits will be felt in both developed and emerging economies.
I thank Paul Pacter for his tireless efforts in leading the project, as well as the hundreds of people and SMEs worldwide who have assisted in the development of the IFRS.

Commenting on the announcement, Paul Pacter, Director of Standards for SMEs, said:

The IFRS for SMEs will provide businesses with a passport to raise capital on a national or an international basis.

Journal of Accountancy on July 9, 2009 has commented the release of this IFRS for SMEs standard through its article titled “New Option for Private Companies in Streamlined IFRS.”

U.S. private companies have a new choice for accounting and financial reporting—a slimmed-down version of IFRS tailored more to their needs. IFRS for SMEs (small- and medium-size entities) is a simplification of full IFRS. The International Accounting Standards Board (IASB), which released the standard Thursday after five years of work on the project, defines SMEs as businesses that publish general-purpose financial statements for external users and do not have public accountability. Many U.S. private companies would fit that definition.

Read further in here >>. And another related article from CFO.com in here >>

Fair Value at Initial Recognition (ED Fair Value Measurement)

Paragraph 34 – 37 of  Exposure Draft (ED) Fair Value Measurement (ED/2009/5) regulates the Fair Value at Initial Recognition of asset or liability.

When an asset is acquired or a liability is assumed in an exchange transaction for that asset or liability, the transaction price is the price paid to acquire the asset or received to assume the liability (often referred to as an entry price). In contrast, the fair value of the asset or liability represents the price that would be received to sell the asset or paid to transfer the liability (an exit price). Entities do not necessarily sell assets at the prices paid to acquire them. Similarly, entities do not necessarily transfer liabilities at the prices received to assume them. In some cases, eg. in a business combination, there is not a transaction price for each individual asset or liability. Likewise, sometimes there is not an exchange transaction for the asset or liability, eg when biological assets regenerate (Par. 34).

Although conceptually entry prices and exit prices are different, in many cases an entry price of an asset or liability will equal the exit price (eg. when on the transaction date the transaction to buy an asset would take place in the market in which the asset would be sold). In such cases, the fair value of an asset or liability at initial recognition equals the entry (transaction) price (Par. 35).

Par. 36 states that in determining whether fair value at initial recognition equals the transaction price, an entity shall consider factors specific to the transaction and the asset or liability. For example, the transaction price is the best evidence of the fair value of an asset or liability at initial recognition unless :

(a)  the transaction is between related parties.

(b)  the transaction takes place under duress or the seller is forced to accept the price in the transaction. For example, that might be the case if the seller is experiencing financial difficulty.

(c)  the unit of account represented by the transaction price is different from the unit of account for the asset or liability measured at fair value. For example, that might be the case if the asset or liability measured at fair value is only one of the elements in the transaction, the transaction includes unstated rights and privileges that are separately measured or the transaction price includes transaction costs.

(d)  the market in which the transaction takes place is different from the market in which the entity would sell the asset or transfer the liability, ie. the most advantageous market. For example, those markets might be different if the entity is a securities dealer that transacts in different markets with retail customers (retail market) and with other securities dealers (inter-dealer market).

If an IFRS requires or permits an entity to measure an asset or liability initially at fair value and the transaction price differs from fair value, the entity recognises the resulting gain or loss in profit or loss unless the IFRS requires otherwise (Par. 37).