Revenue Recognition

Front 1

What is income?

Back 1

According to the conceptual framework, income is the increase in assets or decrease in liabilities resulting in an increase in equity, other than those relating to contributions from holders of equity claims.

Front 2

What is revenue?

Back 2

According to the conceptual framework, revenue is a subset of income. It is income which arises in the course of ordinary business activities and includes sales, fees, royalties, rent, interest and dividends. It excludes gains.

Front 3

Why is revenue so important to companies?

Back 3

1) it a key figure in financial statements

2) top line figure in SOCI

3) measure performance (unicorn)

4) impacts share price

5) used to calculate figures and ratios e.g GPM

6) U.S. studies show that over half of all financial statements related to fraud cases are related to the misstatement of revenue

7) directly related to profits

Front 4

What is aggressive earnings management?

Back 4

Refers to the use of accounting policies and stretching judgments of what is acceptable to present information in a more favourable light.

Front 5

What incentives are there to understate/overstate revenue?

Back 5

1) adverse market reactions to share price when results fail to meet market expectations

2) directors’ & managers’ income directly related to results

3) importance of meeting targets to ensure the protect of jobs of directors, management and other employees.

4) the desire to understate profits to reduce taxation liabilities

5) legal and regulatory requirements to meet specific financial thresholds

- e.g. mergers revenue exceed requirements, they will be looked into therefore company will understate profits to avoid investigation

6) the need to ensure compliance with loan covenants and pacify bankers

Front 6

Why was a new standard needed?

Back 6

Under IAS 18, there was limited guidance on how to account for the increasingly complex transactions that companies entered in to ie. multi-element arrangements whereby one or more good service was being delivered under the same arrangement.

- people turned to US GAAP for guidance on how to account for these but US GAAP has industry-specific rules with more than 200 pronouncements which lead to transactions of a similar economic nature being accounted for differently.

- this reduced the usefulness of financial informations for users.

Front 7

Why was a new standard needed? part 2

Back 7

1) removes inconsistencies and weaknesses in existing requirements with improved comparability

2) provides more useful information with improved disclosure requirements

3) provides a more robust framework to address revenue issues

4) simplifies the preparation of financial statements by reducing the no. of requirements with one revenue framework

Front 8

What is the five step approach to revenue recognition?

Back 8

1) identify contract with customer

2) identify performance obligations in the contract

3) determine transaction price

4) allocate transaction price to the performance obligation in the contract

5) recognise revenue when or as the entity satisfies a performance obligation

Front 9

Which industries will have their income accelerated under IFRS 15?

Back 9

Purchasing a 24 month contract at £40/month. Receive a phone with the calls+texts+data package.

1) contract has been identified

2) performance obligations: a)phone & b)package

3) total transaction price: £40 x 24months = £960

4) Under IAS18, £40 was recognised every month. IFRS15: find MV of phone: £600 so £300 for package. £360/24months= £15/month

5) recognise £600 now and then £15 every month

REVENUE IS ACCELERATED

Front 10

Which industries will have their income deferred under IFRS 15?

Back 10

Purchasing a software with SAGE with 2 years support for £600 (one-time fee)

1) contract has been identified

2) performance obligation: a)software b)software support

3) transaction price £600

4) software is £500 support is £50 a year (£100/2years)

5) Under IAS18, £600 would've been recognised straight away

Under IFRS15, recognise £500 now and £50 at the end of each year

REVENUE IS DEFERRED

Front 11

What will be some of the practical issues to companies transferring from IAS 18 to IFRS 15?

Back 11

1) more disclosure requirements

2) more judgements

3) IT processes

4) Internal controls

5) contracts

Front 12

Issues continued...

Back 12

1) Bundling: makes it increasingly difficult to follow through these steps e.g. phone & contract - determining MV price can be an issue as now you are accounting for various products

2) Performance Obligations: if price is not accurately determined, it will not be able to correctly be allocated with the performance obligations

Front 13

Revenue Recognition Difficulties Examples

Back 13

1) Tesco clubcard points: receive clubcard points & able to use points to receive discount on future transactions. Do you recognise points when they are given to customers or when they are used?

2) Returns: recognise return of product when it is returned or when it is purchased?

3) Supplier rebates: given to retailers - if they sell a certain level of products and are based on estimates (TESCO)

Front 14

Explain the Tesco Scandal

Back 14

Tesco recognised revenue due from suppliers but because they did not reach their sales targets, revenue was over-estimated and not due therefore they over-recognised revenue by more than £250m. Tesco accelerated recognition of revenue related to supplier rebates. As a result, 3 directors were charged with fraudulent offences and sacked. This also resulted in a loss of £2bn on the value of shares.

Front 15

Explain the Enron Scandal

Back 15

Enron inflate their revenue by recording them at whole sale prices rather than just at service fee levels. For example, when acting as a middleman for the seller and buyer of a contract, they would record gross revenue in the contract rather than the commission or fees for the delivery of the contract.

Between 1996 and 2000, Enron's revenue increased from $13.3bn to $100.8bn - 750% increase or 66% increase each year.

Front 16

IFRS 15 - Revenue from contracts with customers

Back 16

1) IFRS 15 now covers all contracts (short-term & long-term goods and services which IAS18 did not do.

2) FULLY CONVERGED STANDARD now provides more guidance in timing and measurement of revenue

3) addresses the increasing complexity of income