Revenue from the sale of goods should be recognized if all of the five conditions mentioned below are met.
(1) The reporting entity has transferred significant risks and rewards of ownership of the goods to the buyer;
(2) The entity does not retain either continuing managerial involvement (akin to that usually associated with ownership) or effective control over the goods sold;
(3) The quantum of revenue to be recognized can be measured reliably;
(4) The probability that economic benefits related to the transaction will flow to the entity exists; and
(5) The costs incurred or to be incurred in respect of the transaction can be measured reliably.
The determination of the point in time when a reporting entity is considered to have transferred the significant risks and rewards of ownership in goods to the buyer is critical to the recognition of revenue from the sale of goods.
If upon examination of the circumstances of the transfer of risks and rewards of ownership by the entity it is determined that the entity could still be considered as having retained significant risks and rewards of ownership, the transaction could not be regarded as a sale.
Some examples of situations illustrated by the standard in which an entity may be considered to have retained significant risks and reward of ownership, and thus revenue is not recognized, are set out below.
(1) A contract for the sale of an oil refinery stipulates that installation of the refinery is an integral and a significant part of the contract. Therefore, until the refinery is completely installed by the reporting entity that sold it, the sale would not be regarded as complete.
(2) Goods are sold on approval, whereby the buyer has negotiated a limited right of return. Since there is a possibility that the buyer may return the goods, revenue is not recognized until the shipment has been formally accepted by the buyer, or the goods have been delivered as per the terms of the contract, and the time stipulated in the contract for rejection has expired.
(3) In the case of “layaway sales,” under terms of which the goods are delivered only when the buyer makes the final payment in a series of installments, revenue is not recognized until the last and final payment is received by the entity. However, based upon experience, if it can reasonably be presumed that most such sales are consummated, revenue may be recognized when a significant deposit in received from the buyer and goods are on hand, identified and ready for delivery to the buyer.
If the reporting entity retains only an insignificant risk of ownership, the transaction is considered a sale and revenue is recognized.
Another important condition for recognition of revenue from the sale of goods is the existence of the probability that the economic benefits will flow to the entity. For example, for several years an entity has been exporting goods to a foreign country. In the current year, due to sudden restrictions by the foreign government on remittances of currency outside the country, collections from these sales were not made by the entity. As long as it is uncertain if these restrictions will be removed, revenue should not be recognized from these exports, since it may not be probable that economic benefits in the form of collections will flow to the entity. Once the restrictions are withdrawn and uncertainty is removed, revenue may be recognized.
Yet, another important condition for recognition of revenue from the sale of goods relates to the reliability of measuring costs associated with the sale of goods. Thus, if expenses such as those relating to warranties or other post-shipment costs cannot be measured reliably, then revenue from the sale of such goods should also not he recognized. This rule is based on the principle of matching of revenues and expenses.
(Sources : Wiley IFRS 2008 : Interpretation and Application of International Financial Reporting Standards - Barry J. Epstein, Eva K. Jermakowicz)
