Financial Accounting 3 Topic 1 Revenue 1420

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Financial Accounting 3
Unless otherwise stated all slides were prepared by John Medlin
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Assessment
Assignment 10%
Essay 25%
Exam 65%
Must achieve at least 50% in the final exam to
pass the course
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Prepared for UniSA 2014

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Prerequisites
Must pass FA2 to do FA3, cannot do them at the same
time.
Students who have failed FA 2 will be unenrolled after
enrolment add deadline. By then, the chance to enrol in
a different course will be gone.
Students sitting deferred or supplementary exams may
maintain their enrolment.
Fail grades as a result of the deferred or supplementary
exams will also result in them being unenrolled.
5
Success Rates
80% of first timers pass the
course
60% of repeat students pass
Lets see if we can get this higher!!!
If you re-run a race you need to
work harder and smarter
If work, personal issues,
illness etc. affect your study then
withdraw
6
Gym UniSA
Paying University fees is like
paying for Gym membership
Your lecturers & tutors are
like personal trainers at the
Gym
They provide guidance and
encouragement but you
have to do all the
work
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If the personal trainer does all
the exercise
While you just play with
your mobile phone
The trainer gets fit
while you remain
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Education is not a spectator sport: it
is a transforming encounter. It
demands active engagement; not
passive submission; personal
participation, not listless attendance.
(Rhodes, 2001, 65 cited in Gump,
2005).
http://w3.unisa.edu.au/counsellingser
vices/balance/workload.asp
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CARTOON
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CARTOON
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What do you expect?
What do you expect to achieve by doing FA3?
What have you heard about the course?
Aspire to be great accountant, not
an average one!!!
http://www.charteredaccountants.com.au/Students
/Working-as-a-Chartered-Accountant
http://www.cpaaustralia.com.au/
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Financial Accounting 3
Topic 1: Revenue
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You have probably bought something in the
last week or two.
So how does the company account for your
purchase?
It is income but is it revenue or a gain?
AASB118 / IAS18
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Objectives
1. Explain the nature of income, revenue and
other gains
2. Apply recognition criteria as they apply to
revenue
3. Account for revenues arising from various
types of transactions or other events in
accordance with AASB118 / IAS18: Revenue
4. Apply the requirements of AASB111 / IAS 11
5. Apply the requirements for disclosure of
revenue in accordance with AASB118 / IAS 18
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Reading
Chapter 15, Revenue recognition
Deegan (2012) Australian Financial Accounting, 7
th
edition
Available on course learnonline site under eReadings
link within Course Essentials
AASB118 / IAS18: Revenue
AASB111 / IAS11: Construction Contracts
Framework
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Real Company example of Revenue
What determines whether
Income is recorded
here?
or here?
20Y2 20Y1
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Revenues
Gains
20Y2 20Y1
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Definition of Income, Revenue &
Gains
Income defined (par. 70 of the AASB Framework) as
Income is divided into revenues and gains
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CARTOON
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Definition of Revenue & Gains
Revenues generally relate to the ordinary
income-generating activities of an entity
Gains relate to other incomenot necessarily
part of the ordinary activities of an entity
Differentiation between revenue and gains in
Framework para 74 & 75
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Scope of AASB 118 / IAS18 Revenue is fairly
restrictedapplies to accounting for revenue
arising from transactions and events relating to
(par. 1)
a) the sale of goods
b) the rendering of services
c) the use by others of entity assets
yielding interest, royalties and dividends
Recognition criteria provided for each of the
above categories of revenue, e.g. sale of goods
(par. 14)
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Revenue is measured at the fair value of the
consideration or contributions received or
receivable (par. 9)
if cash is received
if cash is not to be received for some period
of time
(refer to AASB 118 / IAS18, par. 11)
What if consideration is not cash?
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Income & revenue recognition
current practice
AASB 118 / IAS18 (Illustrative Examples) provide
guidance in relation to the recognition of different
types of revenues.
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Revenue?
Revenue
Gain
Sale of non-current asset
Sale of inventory
Provision of service
Revaluation of assets
Goods & Services Tax
Dividends
Revaluation of fin. Instru.
Interest
Royalties
Rent
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Accounting for sales with
associated conditions
Transactions involving the sale of assets with
conditions attached should be reviewed to assess
whether
control of the future economic benefits has
passed from the seller to the purchaser;
and
it is probable that the inflow of economic
benefits to the seller has occurred
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Accounting for sales with associated
conditions revenue recognition when
right of return exists
Alternative treatments available when the seller
is exposed to continued risks of ownership
through return of the product
not record sale until all return privileges have
expired
record sale but reduce sales by an estimate of
future returns
record sale and account for returns as they
occur
29 30
Sale not recorded until
Unlikely land will be
returned
Accounting for sales with associated
conditions sale and leaseback
ownership transferred to purchaser/lessor, but
vendor/lessee normally retains control
financing arrangementleased property used as
collateral for a loan
Transaction does not constitute a sale and does
not give rise to revenue
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Interest & dividends interest
revenue
Interest revenue recognisedover time
Prepayment of interest not regarded as revenue
to lender
Interest revenue might be implicit in the terms of
a transaction
for example, where goods are sold on
extended credit, vendor is effectively financing
the purchaser
32

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Interest & dividends
dividend revenue
Dividend revenue recorded once it is considered
probable that inflow of future economic benefits
has occurred and when these benefits can be
measured reliably
in most cases this will be at the time the board
of directors or other governing body proposed
the dividend
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Dividends
recognised once
right to payment
established
34
Usually once
dividend
declared
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House Proud Pty Ltd is operating a promotion selling furniture
under the following conditions:
Initial deposit of 20% of purchase price.
Immediate delivery of furniture.
Interest rate of 12.5%pa charged on the outstanding balance.
Repayment of the balance (including the interest) over 24 equal
monthly installments.
House Proud retains legal title to the furniture until the final
monthly payment has been made.
House Proud would recognise revenue as follows:
a)Recognise interest as it is received (monthly) and recognise
the revenue on the sale of the goods upfront.
b)Recognise the whole amount of revenue upfront
c)Recognise interest as it is received (monthly) and recognise
the revenue on the sale of the goods once the final payment has
been received.
d)Recognise all revenue as it is received
a) Recognise interest as it is received (monthly) and
recognise the revenue on the sale of the goods upfront.
b) Recognise the whole amount of revenue upfront
c) Recognise interest as it is received (monthly) and
recognise the revenue on the sale of the goods once the
final payment has been received.
d) Recognise all revenue as it is received
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Unearned Revenue
Recorded when payment is received in advance
The receipts have not been earned
Considered to be liabilities
Refer to Worked Example 15.3 on page 534
Revenue received in advance
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CARTOON
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39
Accounting for construction
contracts
Accounting issues result from some construction
projects taking a number of financial periods to
complete
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Deferral of revenue recognition until
completion of project would result in greater
volatility of reported revenues and of related
profits or losses
Currently, governed by AASB 111 / IAS11
Construction Contracts
41
AASB 111 / IAS11 requires use the percentage-
of-completion method to account for construction
contracts
Profit on construction contract is recognisedin
proportion to the work performed in each
reporting period in which construction occurs
42
Construction costs plus gross profit earned to
date accumulated in (debited to) an inventory
account (Construction in progress)
Progress billings are credited to the Construction
in progress account.
43
Percentage of
completion method
Reliable
measurement
Real Company Example
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Percentage of
completion method
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Percentage-of-completion method should be
used provided that certain conditions are met that
enable the outcome of the contract to be reliably
estimated
Revenue and expenses are recognisedby
reference to the stage of completion of the
contract activity at the reporting date
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CARTOON
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If conditions are not satisfied
- no profit is to be brought to account until they are
satisfied
- at the extreme, no profit to be recognised until project
completion
Note
When outcome of construction contract
cannot be estimated reliably (AASB 111 /
IAS11, par. 32)
(a) revenue is to be recognised only to the extent of
contract costs incurred that it is probable will be
recoverable; and
(b) contract costs are to be recognised as an
expense in the period in which they are incurred
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Measuring progress towards completion
Percentage of completion can be measured
in a number of ways
may include
(a)the proportion that contract costs incurred
for work performed to date bear to the
estimated total contract costs;
(b)surveys of work performed; or
(c) completion of physical proportion of the
contract work.
Progress payments and advances received from customers
often do not reflect the work performed
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Measuring progress towards completion
Cost basis
Costs incurred to the end of the current period
Most recent estimate of total costs
Current period revenue or gross profit
=estimated total revenue or gross profit
multiplied by percentage complete
less total revenue or gross profit already
recognised
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Disclosure requirements
AASB 111 / IAS11 requires that the balance sheet
or accompanying notes
disclose the gross amount of work in progress (or
contract costs incurred)
the related aggregate billings deducted from the
work in progress
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Application of percentage-of-completion method
to account for construction contracts
Refer to Worked Example 15.4 on pp. 539
Percentage-of-completion method

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Illustration accounting for construction contract
Big Builder signed a contract on J anuary 1, 20Y1, agreeing to
build a warehouse for Storage Solutions at a contract price of
$20,000,000. Big Builder estimated that construction costs would
be as follows
20Y1 $5,000,000
20Y2 $8,000,000
20Y3 $3,000,000
$16,000,000
The contract provided that Storage Solutions would make
payments on December 31 of each year as follows
20Y1 $ 4,000,000
20Y2 $10,000,000
20Y3 $ 6,000,000
$20,000,000
The contract was completed and accepted on December 31,
20Y3. Assume that actual costs and cash collections coincided
with expectations.

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Illustration accounting for a construction contract
Income recognised each year
20Y1 20Y2 20Y3
Contract price $20 000 000 $20 000 000 $ 20 000 000
Less estimated cost:
Costs to date 5 000 000 13 000 000 16 000 000
Estimated costs to complete 11 000 000 3 000 000 ___________
Estimated total cost 16 000 000 16 000 000 16 000 000
Estimated total gross profit/(loss) $ 4 000 000 $ 4 000 000 $ 4 000 000
Per cent complete 31.25% 81.25% 100%
Gross profit: $4m * 31.25% = $1 250 000
$4m * 81.25% - $1.25m = $2 000 000
$4m * 100% - $1.25m - $2m = $750 000

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(b) J ournal Entries P.O.C. Method
20Y1 20Y2 20Y3
(i) To record costs incurred
Dr Construction in progress
(contract asset) 5 8 3
Cr Cash, a/c pay., dep
n
etc 5 8 3
(ii) To record billings to customers
Dr Accounts receivable 4 10 6
Cr Construction in progress
(contract asset) 4 10 6

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(iii) To record cash collections 20Y1 20Y2 20Y3
Dr Cash 4 10 6
Cr Accounts receivable 4 10 6
(iv) To record periodic income recognised
Dr Construction in progress
(contract asset) 1.25 2 0.75
Dr Construction expenses
(Statement of comp. income) 5 8 3
Cr Revenue from LT Contract
(Statement of comp. income) 6.25 10 3.75

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Long term
contracts
20Y2 20Y1
Refer to Worked Example 15.5 on pp.
541Construction contract where outcome
cannot be reliably estimated
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Accounting for long-term contract losses
When current estimates indicate that a loss is
probable
provision should be made for any foreseeable
loss on the contract
loss is to be brought to account as soon as it
is foreseeable
AASB 111 / IAS11 (par. 36)
Refer to Worked Example 15.6 on page 542
Percentage of completion with recognition of a
loss
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Expected Loss on
Contract

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The future
Comprehensive reform
IFRS 15 Revenue from Contracts with Customers .
J oint release with the US Financial Accounting Standards
Board, which has issued a corresponding Accounting
Standards Update of the same name.
IFRS 15 represents 12 years of work
1500 comment letters as the project has progressed.
Significant enhancements to the quality and consistency of
how revenue is reported. (ICAA ANT March 2014)
IFRS 15 from1 J anuary 2017, early adoption is permitted.
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The main objectives of the new standard are to:
single revenue recognition model based on the transfer of
goods and services.
remove inconsistencies and weaknesses in existing
revenue recognition standards
simplify the preparation of financial statements
enhance disclosures about revenue, providing guidance
for transactions that were not previously addressed
comprehensively (for example, service revenue and
contract modifications) and improving guidance for
multiple-element arrangements. (ICAA ANT March 2014)


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