Professional Documents
Culture Documents
OBJECTIVES
Recognition of revenue in the statement of profit and loss account arising in the ordinary course of business i.e. from
A.
B. C.
The Sale of Goods The Rendering of Services ; and The use by Others of enterprise resources yielding interest, royalties and dividends.
APPLICABILITY
1.
Revenue arising from Construction Contracts. 2. Revenue arising from Hire Purchase or Lease Agreements. 3. Revenue arising from Government Grants or Other Similar subsidies. 4. Revenue of Insurance Companies arising from insurance business.
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DEFINITIONS
1)
REVENUE Revenue is the gross inflow of cash, receivables or other consideration arising in the course of ordinary activities of an enterprise from the sale of goods, from the rendering of services and from the use by others of enterprise resources yielding interest, royalty and dividend. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivable or other consideration.
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DEFINITIONS
2)
COMPLETED SERVICE CONTRACT Completed Service Contract method is a method of accounting which recognises revenue in the statement of profit and loss only when the rendering of services under a contract is completed or substantially completed.
3)
PROPORTIONATE COMPLETION METHOD Proportionate completion method is a method of accounting which recognises revenue in the statement of profit and loss proportionately with the degree of completion of services under a contract.
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A. SALE OF GOODS
The seller has transferred the property in the goods to the buyer for a consideration. The transfer of property in goods in most cases results in or coincides with the transfer of significant risk and reward of ownership to the buyer. There may be the case where transfer of property in goods does not coincide, the transfer of significant risk and rewards of ownership. The time for recognising the revenue in both the point no. 2 and 3 above, is only when the risks and reward of ownership is transferred to the buyer.
Sales against advance payment received. When full or partial payment is received for the goods not presently held in stock i.e. stock is still to be manufactured or is to be received directly by the customer from a third party. Revenue from such sales should not be recognised until goods are manufactured, identified and ready for delivery to the buyer by the third party.
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Delivery delayed at buyers request but buyer accepts title/billing. The seller should recognise the revenue even if goods are not dispatched provided the goods are ready, buyer takes title and accepts billing and the seller holds the goods in his premises on behalf of buyer i.e. revenue is recognised when risk and reward of ownership are transferred.
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Barter transactions As per IAS 18 Revenue When goods or services are exchanged or swapped for goods or services which are of a similar nature and value, the exchange is not recorded as transaction which generates revenue but when goods are sold or services are rendered in exchange for dissimilar goods or services, the exchange is regarded as transaction which generates revenue and the revenue is measured at the fair value of goods or services received, adjusted by the amount of any cash or cash equivalent transferred. When the fair
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Fair Value = Rs. 500,000 i.e. Rs. 5,000 per day x 1000 free days) Also the corresponding consultation cost Rs. 50 lakhs shall be accounted by the hotel.
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Approval Revenue should not be recognised until the goods have been formally approved and accepted by the buyer or the buyer has done the act adopting the transactions or the time period for rejection has elapsed or where no such time is fixed, a reasonable time has elapsed. Guaranteed Sales i.e. delivery is made giving the buyer unlimited right of return. Recognition of revenue in this case depends on the substance of transactions/agreement. E.g. in case of retail sales offering a guarantee of Money back if not completely satisfied, it may be appropriate to recognise the sale but suitable provision for returns based on the past experience is made.
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c)
e)
Consignment Sales Revenue is not recognised until the goods are sold to the third party. Cash on delivery sales Revenue should not be recognised until cash is received by the seller or his agent from buyer. Sale by installment payment Delivery of goods on final payment Revenue from such sales should not be recognised until goods are delivered. However, when experience indicates that most such sales have been consummated, revenue may be recognised when a significant deposit is received.
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5.
Installment Sales When the consideration is receivable in installments, revenue attributable to the sales price exclusive of interest should be recognised at the date of sale. The interest element should be recognised as revenue, proportionately to the unpaid balance due to the seller. Sale/Repurchase Agreement When seller concurrently agrees to repurchase the same goods at a later date. - For such transactions that are in substance a financing agreement, the resulting cash inflow is not revenue as defined and should not be recognized as revenue. The same treatment would apply when the seller has a call option to repurchase or
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7.
Sales to intermediate parties Revenue from such sales can generally be recognised if significant risks of ownership have passed. However, in some situation the buyer may in substance be an agent and in such cases the sale should be treated as consignment sales. Subscription for publication Revenue received or billed should be deferred and recognised either on a straight line basis over time or, where items delivered vary in value from period to period, revenue should be based on sales value of the the items delivered in relation to the total sales value of all items covered by the subscription.
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9.
Sale of immovable property Case : A company entered into a sale deed of its immovable property before the end of the year, though the deed was registered with the registrar only subsequent to the balance sheet date because of approval from Housing Urban Development Authority (HUDA) was not yet received. Can sale and gain be recognised at the balance sheet date?
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Revenue recognition for export sales on CIF basis. Case : Export made on CIF basis were dispatched on 28th
and 29th March, as evidenced by the Bill of Lading/Air way bill issued on these dates. Accordingly, sales were recognized for the year ended 31 March. The auditors did not agree with the contention of the company and commented that the sales and profit were overstated to the extent of above transaction. Their opinion was based on the following logic ; "Under a CIF contract, the property passes to the buyer as the shipping documents (if they are considered to be documents of the title to the goods according to the section 2(14) of the Sales of Goods Act) are handed over to them. In the above case
documents were handed over to the bankers for collection after March 31.
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Fact : A company expects 2% sales return on an average in the month following the sales. Though the company is not legally obliged to accept the goods back (since they were accepted by the customer after proper inspection), it does so to maintain good business relations. At the year end how should the company account for the anticipated 2% sales return in respect of its last month sales? Response : AS 9 contains the following provision : Paragraph 9.3 - "When the uncertainty relating to collectability arises subsequent to the time of sales or rendering of the service, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded".
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Trade Discount and Volume Rebate given Trade discounts and volume rebates received are not encompassed within the definition of revenue, since they represent a reduction of cost. Trade discounts and volume rebates given should be deducted in determining revenue. Fact : T Ltd. Purchased the goods on credit for Rs. 5 Crores for export from ABC Ltd. Upon the export order being cancelled, T Ltd. Decided to sell the same in the domestic market at a discounted price. Accordingly, ABC Ltd was requested to offer a price discount of 25%. ABC Ltd. wants to adjust the sales figure to the extent of discount requested by T Ltd.
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B. RENDERING OF SERVICES
Revenue from the rendering of services can be recognised based on the following two methods :
1.
Proportionate Completion Method Performance consist of execution of more than one act. Revenue is recognised based on the performance of each act. The amount of revenue to be recognised is determined based on contract value, associated cost, number of acts or other suitable basis.
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B. RENDERING OF SERVICES
2.
Completed Service Contract Method Performance consist of execution of single act. Alternatively, services are performed in more than a single act and the services yet to be performed are so significant in relation to the transaction taken as a whole that a performance can not be deemed to have been completed until execution of those acts. Hence, the revenue is recognised when sole or final act takes place and service becomes chargeable.
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Freight and Handling Income Fact : The company is engaged in the business of handling and transportation of containerised cargo. Freight and Handling income/expenses are accounted for at the time of booking of containers. Ground rent and wharfrage are accounted for at the time of release of containers on completed service contract method. Claims and penalties are accounted at the time of settlement. Whether the accounting treatment is correct?
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Installation Fees In cases where installation fees are other than incidental to the sale of a product, they should be recognized as revenue only when the equipment is installed and accepted by the customers.
3.
Freight on incomplete Voyage Some shipping companies recognise freight income only when the voyage is complete. Other companies recognise freight on pro-rata basis for voyages in progress at the balance sheet date. The practice in India is mixed . In any case, whichever method is followed, cost should be matched to the revenue recognised. Thus, if on incomplete voyage, revenue is not recognised, cost on such voyage should be carried forward as WIP. If on the other hand revenue is recognised on pro-rata, the corresponding pro-rata cost should also be recognised in the profit and loss account.
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Internet Service Internet service providers provide internet access to customers at a given price for a specified number of hours to be used within a specified period. Most internet service providers recognize revenue based on the usage by the customers. At the end of the specified period, the remaining unutilized hours, if any are recognized as revenue. Revenue from banner advertisement and sponsorship contracts hosted on the website of the service provider is recognized ratably over the period in which the advertisement are displayed. Revenue from electronic commerce transactions are recognized when the transaction is complete.
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Revenue should be recognized when the service is completed. For advertising agencies, media commissions will normally be recognized when the related advertisement or commercial appears before the public and the necessary intimation is received by the agency, as opposed to production commission, which will be recognized when the project is completed. Insurance agency commissions should be recognized on the effective commencement or renewal dates of the related policies.
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Financial Service commission A financial service may be rendered as a single act or may be provided over a period of time. Similarly, charges for such services may be made as a single amount or in stages over the period of the service or the life of the transaction to which it relates. Such charges may be settled in full when made or added to a loan or other account and settled in stages. The recognition of such revenue should therefore have regard to: (a) Whether the service has been provided once and for all or is on a continuous basis. (b) the incidence of the costs relating to the service;
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binding obligation has been entered into. Commitment, facility or loan management fees which relate to continuing obligations or services should normally be recognized over the life of the loan or facility having regard to the amount of the obligation outstanding, the nature of the services provided and the timing of the costs relating thereto.
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Front end fees/ Processing fees Front end fees or processing fees are received under various situations, for example, a housing finance company receives it on sanction of the loan or a lessor receives lease management fees on a grant of lease, etc. Theoretically, there are essentially, three ways in which such income can be recognized. (a) Recognize the entire fees upfront i.e. on sanction of the loan or lease contract. (b) Recognize the fees equally over the period of the loan or lease agreement.
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Admission fees Revenue from artistic performances, banquets and other special events should be recognized when the event takes place. When a subscription to a number of events is sold, the fee should be allocated to each event on a systematic and rational basis.
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Franchisee fees of Training Institute Fact : A well known computer training institute appointed some franchisee to conduct training. The institute earns franchisee fees in exchange of its brand and technical assistance. The franchisee fees is payable in lumpsum or in installments and is nonrefundable. The institute wants to recognize the franchisee fees in the profit and loss account upfront, is that acceptable? Response : The franchisee fees are in the nature of royalty in exchange of a right to use an asset (brand) over a defined period of time and therefore revenue on franchisee fees should be recognised on a time proportion basis over the period of agreement unless
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Training Fees and Registration Fees received in Advance Training fees should be recognized on accrual basis proportionately over the period of instructions.
Fact : A company grants license for certain number of years to the franchisee for using the companys brand name and full assistance of technical know-how in the field of providing education and training in IT and to use intellectual property for which the company takes registration fees. How are the registration fees accounted for? Response : The registration fees should be recognized on a time proportion basis over the period of agreement.
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Income from consultancy fees As 7 would apply to revenue Recognition from consultancy fees received only for design engineering and project management directly related to construction of an asset whereas, revenue from consultancy fees received for design engineering and project management not directly related to construction of an asset would be recognized as per AS 9. recognition of revenue from design engineering on turnkey projects directly related to construction of an asset on a predetermined fixed percentage basis would be appropriate provided it represents the stage of the completion achieved on the relevant project at the end of each year. The stage of completion on the contract should be determined by considering all relevant factors as stated in AS 7 and no special weightage should be given to a single factor.
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B. REVENUE FROM USE BY OTHERS OF ENTERPRISE RESOURCES YIELDING INTEREST, DIVIDEND AND ROYALTY
1.
2.
INTEREST Charges for the use of Cash resources or amounts due to the enterprise. Recognized on accrual basis based on the outstanding amount and rate applicable. (Para 8.2) ROYALTY Charges for the use of such assets as know-how, patents, trade marks and copy rights. Recognized based on the relevant agreement or unless having regard to the substance of the transactions, it is more appropriate to recognize revenue on some other systematic basis. (Para 8.3)
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B. REVENUE FROM USE BY OTHERS OF ENTERPRISE RESOURCES YIELDING INTEREST, DIVIDEND AND ROYALTY
3.
DIVIDEND Rewards from the holding of investment in shares. Recognized in the profit and loss account only on the right to receive payment is established. (Para 8.4) INTEREST, ROYALTY AND DIVIDEND FROM FOREIGN COUNTRIES (PARA 8.5) If the above income is earned from foreign countries and requires exchange permission and uncertainty in remittance is anticipated, revenue recognition may need to be postponed.
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4.
Interest on Overdue Debtors Fact : The invoice, if not paid within the stipulated period, attracts interest at a rate of 1% above the rate of bank borrowings. An analysis of the debtors recently revealed that the interest accrued and accounted in earlier years had very poor rate of acceptance and recovery. In many cases the amounts of interest had been protested and in some cases contested and sought to be adjusted after necessary rectification in the original invoices for low-grade supplies. There is also an apprehension about recovery of the face value of mounting invoice on which interest is provided on accrual basis. Under these circumstances, how should such interest be recognized?
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Dividend Income The right to receive dividend should be construed as right to receive dividend by the balance sheet date. Therefore, if dividend has been declared after the balance sheet date of a company holding such investment, dividend will be recorded as income for the year in which such dividend is declared, since the right to receive dividend did not exist as on balance sheet date. Fact : Your client that has calendar year end is a shareholder of AbyBaby Ltd. In March 2004, your client is in the process of finalizing year ended 31 December 2003 accounts. AbyBaby had their AGM in January 2004 in which it declared dividend and Rs. 5 million was received by your client in February 2004. Your client has recognized the dividend in the December 2003 accounts. As auditors are you in agreement?
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Effects on Revenue
Uncertainties
on
Revenue is measurable and ultimate collection is reasonable. At the time of raising of any claim like escalation of price, export incentive, the ability to assess the ultimate collection with reasonable certainty is lacking, the recognition of revenue is postponed to the extent of uncertainty is involved. If the uncertainty regarding the collectability of revenue arises after the sales or rendering of services, separate provision of the same is made in the books instead of adjusting the amount against the original revenue recorded.
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Effects on Revenue
Uncertainties
on
The essential criteria for recognition of revenue in all the three cases given above i.e. Sales of goods, rendering of services or use by others of enterprise resources is the amount of consideration receivable should be determinable. If such consideration is not determinable, the revenue should be postponed. When recognition of revenue is postponed due to the effect of uncertainties, it is considered as revenue of the period in which it is properly recognized.
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Main Principles
Revenue form the Sales or service transactions should be recognized only when the requirement of Para 11 and 12 are satisfied provided the expected ultimate collection is reasonable. The amount of revenue should be disclosed on the face of Profit and loss in the following manner.
XX XX XX
The amount of excise duty to be deducted from Turnover is total excise duty for the year except the excise duty related to the difference between the closing stock and opening stock as the same needs to be shown separately in the statement of profit and loss with explanatory note in notes to accounts to explain the nature of the two amounts of excise duty.
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What is performance?
1.
In case of sales of Goods In case of transactions for sales of goods, the following two conditions should be satisfied to recognize the revenue. The seller of the goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership ; and No significant uncertainty exists regarding the amount of consideration that will be derived from the sale of the goods.
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What is performance?
2.
3.
In case of rendering of service In a transaction involving the rendering of services, performance should be measured either under the completed service contract method or under the proportionate completion method, whichever relates the revenue to the work accomplished. Such performance should be regarded as being achieved when no significant uncertainty exists regarding the amount of the consideration that will be derived from rendering the service. In case of use by others of enterprise resources Revenue should be recognized only when no significant uncertainty as to measurability or collectability exists.
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What is performance?
Interest : On a time proportion basis taking into account the amount outstanding and the rate applicable. Royalties : On an accrual basis in accordance with the terms of the relevant agreement. Dividend : When the owner's right to receive payment is established.
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Disclosure
In addition to the disclosure requirement of Accounting standard 1 on "Disclosure of Accounting Policies", an enterprise should also disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties.
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Definition Under IGAAP revenue is defined as Revenue is the gross inflow of cash, receivables or other consideration arising in the course of ordinary activities of an enterprise from the sale of goods, from the rendering of services and from the use by others of enterprise resources yielding interest, royalty and dividend. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivable or other consideration.
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Measurement Under IGAAP, the revenue is recognised at nominal amount i.e. cash and cash equivalent received or receivable. Under IFRS, the revenue is measured at fair value of consideration received or receivable in case where the inflow of such consideration is deferred.
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4.
Exchange Transactions In case of IFRS, the exchange transactions is recorded in the books in case of dissimilar exchange of goods or services whereas under IGAAP there is no such specific guidance available. Multiple-element arrangements No detailed guidance for such contracts are available both under IFRS as well as IGAAP but under IFRS, the recognition criteria are usually applied to the separately identifiable components of a transaction in order to reflect the substance of the transactions. However, the recognition criteria are applied to two or more transactions together when they are linked in such a way that the whole commercial effect can not be understood without reference to the series of transactions as a whole and under IGAAP, company is applying the same principle.
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