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Revenue Recognition

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What is revenue?

Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity.

Revenue is measured by the fair value of the consideration received or receivable

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Revenue (IAS 18)

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Revenue – IAS 18IAS 18 revenue defines when revenue from

various sources may be recognized. It deals with revenue arising from three types of transaction or events;

1. Sale of goods2. Rendering of services3. Interest, Royalties and dividends from the

assets of the enterprise.

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History of IAS 18 - Revenue

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History of IAS 18 – Revenue RecognitionApril 1981 Exposure Draft E20 Revenue Recognition

December 1982 IAS 18 Revenue Recognition

1 January 1984 Effective date of IAS 18 (1982)

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History of IAS 18 – Revenue Recognition

May 1992 E41 Revenue Recognition

December 1993 IAS 18 Revenue Recognition (revised as part of the

'Comparability of Financial Statements' project)

1 January 1995 Effective date of IAS 18 (1993) Revenue

Recognition

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History of IAS 18 – Revenue RecognitionDecember 1998 Amended by IAS 39 Financial Instruments:

Recognition and Measurement, effective 1 January 2001

16 April 2009 Appendix to IAS 18 amended for

Annual Improvements to IFRSs 2009. It now provides guidance for determining whether an entity is acting as a principal or as an agent.

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Revenue Recognition

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Objective of IAS 18 – Revenue Recognition

The objective of IAS 18 is to prescribe the accounting treatment for revenue arising from certain types of transactions and events.

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Objective of IAS 18 – Revenue RecognitionThe world today is packed with different

kinds of products, services, transactions and many other activities that people and business do. Logically, it is sometimes very tough issue for accountants to determine WHEN and even WHETHER to recognize revenue in the financial statements.

That’s exactly the main aim of the standard IAS 18—to give guidance on the revenue recognition and help in the application of the revenue recognition criteria.

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Key definition

Revenue: the gross inflow of economic benefits (cash, receivables, other assets) arising from the ordinary operating activities of an entity (such as sales of goods, sales of services, interest, royalties, and dividends).

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Recognition of Revenue

Recognition, as defined in the IASB Framework, means incorporating an item that meets the definition of revenue (above) in the income statement when it meets the following criteria:

it is probable that any future economic benefit associated with the item of revenue will flow to the entity, and

the amount of revenue can be measured with reliability

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Agency relationship = revenue?

Here I would like to stress that the revenue includes only the economic benefits received or receivable on the entity’s own account. However, entities often collect the amounts on behalf of the third parties, such as taxes payable to the state budget—these amounts are NOT revenue and CANNOT be recognized as such.

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Agency relationship = revenue?

Also, agency transactions are very common in today’s business and sometimes it’s not easy to determine the agency relationship. In agency relationship, the agent just collects the amounts on behalf of the principal and thus cannot recognize the revenue.

For example, mobile operators often sell some additional content with their monthly prepaid calling plans, such as music or application. The relationship between 3 parties is illustrated in the following scheme:

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IAS - 18

Measurement of Revenue

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Measurement of Revenue The term revenue could apply in any of the

following situations:

1. The supply of goods on cash or credit sale term

2. The provision of services on cash or credit terms

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Measurement of revenue

3. Rent received or receivable from equipment or property hired out

4. Interest or dividends received or receivable on a trade investment

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Measurement of revenue Revenue should be measured at the fair value

of the consideration received or receivable1. If the sale is a cash sale, then the revenue is the

immediate proceeds of sale. Allowance may be made for expected returns.

2. If the sale is a credit sale, i.e. a sale for a claim to cash, then anticipated cash is revenue.

Allowance for irrecoverable debts and returns are usually computed as a separate exercise and disclosed separately.

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Measurement of revenueIf the inflow of cash or cash equivalents is

deferred, the fair value of the consideration receivable is less than the nominal amount of cash and cash equivalents to be received, and discounting is appropriate.

This would occur, for instance, if the seller is providing interest-free credit to the buyer or is charging a below-market rate of interest. Interest must be imputed based on market rates. [IAS 18.11]

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IAS - 18

Traditional approach to revenue recognition

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Traditional approach to revenue recognitionTraditionally, two conditions must be met

before revenue can be recognized:

1. The revenue must be earned, i.e. the activities undertaken to create the revenue must be substantially completed.

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Traditional approach to revenue recognition2. The revenue must be realized, i.e. an event

has occurred which significantly increases the likelihood of conversion into cash. This also means that the revenue must be capable of being verifiably measured.

In most cases, realization is deemed to occur on the date of sale. Thus, the date of the sale transaction is the moment that the revenue is recognized in the financial statements.