Session 6

IAS 18 Revenue

FOCUS
This session covers the following content from the ACCA Study Guide.

B. Accounting for Transactions in Financial Statements

10. Revenue
a) Apply the principle of substance over form to the recognition of revenue.

Session 6 Guidance
Learn the definition of fair value according to IFRS 13 Fair Value Measurement (s.1.2).
Read through the examples, taken from the standard itself, to understand the application of the
concept of substance over form (s.5)

(continued on next page)

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VISUAL OVERVIEW
Objective: To describe the principles of revenue recognition.

REVENUE
Scope
Measurement of Revenue
Revenue Recognition
Disclosure

SALE OF GOODS RENDERING OF INTEREST, ROYALTIES

SERVICES AND DIVIDENDS
Revenue Recognition
Revenue Recognition Revenue Recognition
Risks and Rewards
Stage of Completion Recognition Bases
Cost Recognition
Reliable Estimate of
Outcome

SUBSTANCE OVER FORM

Conceptual Framework
Sale of Goods
Rendering of Services
Licence Fees and Royalties

Session 6 Guidance
Learn, for example, the need to separate a service element from a sale of goods contract, where
relevant (s.5.3.2).
Understand how this session links to the substance over form issue covered in Session 3.

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Session 6 IAS 18 Revenue F7 Financial Reporting

1 Revenue

1.1 Scope
The main issue in accounting for revenue is identifying when
revenue should be recognised.
The period of recognition can sometimes be difficult to identify
as can whether revenue should be recognised at all; substance
over form needs to be considered when deciding if revenue
should be recognised or not.
IAS 18 Revenue identifies the three sources from which
revenue arises:

Revenue

SALE OF GOODS RENDERING OF USE OF ENTITY ASSETS

SERVICES YIELDING INTEREST,
Including goods
Typically involves
ROYALTIES AND DIVIDENDS
produced or purchased
for resale. performance of a Interestcharges for use of
Examples: contractually agreed task cash or amounts due.
merchandise over an agreed period Royaltiescharges for use of
purchased by a retailer of time. long-term assets.
land and property held Dividendsdistributions
for resale. of profits to owners.

Revenuethe gross inflow of economic benefits during the period

arising in the course of ordinary activities of an entity when those
inflows result in increases in equity, other than increases relating to
contributions from equity participants.*

*Only income receivable by an entity on its own account is included

in revenue. The collection of taxes on behalf of the government is
not revenue. Where an entity acts as an agent, revenue recognised
is the commission receivable.

*This definition of
fair value which is
Fair valuethe price which would be received to sell an asset or now used is defined
paid to transfer a liability in an orderly transaction between market in IFRS 13 Fair Value
participants at the measurement date.* Measurement.

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F7 Financial Reporting Session 6 IAS 18 Revenue

1.2 Measurement of Revenue

This takes into account trade discounts and volume rebates
allowed.
Where payment is made outside of normal credit terms then Revenue is
the cash flows should be discounted to present value in order measured at fair
to arrive at a fair value for the transaction. In accounting value of the
consideration received
there is no such thing as interest-free credit.
or receivable.

Illustration 1 Interest-Free Credit

On 1 January 2014, SFD sold furniture for $4,000 with three years'
interest-free credit. SFD's cost of capital is 8%.

Revenue recognised in 2014 will be $3,175 ($4,000 1/(1.08)3).

Also, SFD will recognise interest income of $254 ($3,175 8%).
In 2015, interest income will be $274 ((3,175 + 254) 8%).
And in 2016, the remaining interest income of $297 will be
recognised.
This means that the full $4,000 will be recognised as revenue over
the three years.

Exhibit 1 DETERMINING AND

APPLYING FAIR VALUE
The following extract is taken from the notes to the financial statements of Vodafone
Group plc's Annual Report 2013.

Revenue recognition
Arrangements with multiple deliverables
In revenue arrangements including more than one deliverable, the deliverables
are assigned to one or more separate units of accounting and the arrangement
consideration is allocated to each unit of accounting based on its relative fair value.
Determining the fair value of each deliverable can require complex estimates due
to the nature of the goods and services provided. The Group generally determines
the fair value of individual elements based on prices at which the deliverable is
regularly sold on a standalone basis after considering volume discounts where
appropriate.

1.3 Revenue Recognition

According to the Framework, income is recognised (in profit or
loss) when there is a probable increase in a future economic
benefit which can be measured reliably.*

*Note that under the Framework's definition of "income" there is no

distinction between revenue and gains which arise in the ordinary
course of activities. However, such gains (which are often reported
net of related expenses) are usually disclosed separately because the
information is useful for decision-making purposes.

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Session 6 IAS 18 Revenue F7 Financial Reporting

The recognition criteria in IAS 18:

are usually applied separately to each transaction;
but may be applied to separately identifiable components in
a transaction; or
to two or more linked transactions.

1.4 Disclosure
Accounting policies adopted for revenue recognition.
Amount of each significant category of revenue recognised
during the period.

2 Sale of Goods

2.1 Revenue Recognition Criteria

Neither continuing managerial involvement nor effective
control over the goods sold is retained.
The amount of revenue can be measured reliably. Significant risks and
rewards of ownership
It is probable that economic benefits associated with the are transferred to the
transaction will flow to the entity. buyer.
Costs (to be) incurred in respect of the transaction can be
measured reliably.

2.2 Risks and Rewards

The passing of risks and rewards is crucial to revenue
recognition.
If legal title passes but risk and rewards are retained, there is
no sale to be recognised. For example:
where the entity retains obligation for unsatisfactory
performance not covered by normal warranty provisions; or
where the receipt of revenue is contingent on the buyer
selling the goods; or
goods are to be installed and the installation is a significant
part of the contract and remains uncompleted; or
the buyer has the right to rescind and the seller is uncertain
about the outcome.
If legal title does not pass but the risks and rewards do, then
the transaction is recognised as a sale.

2.3 Cost Recognition

Usually revenue and expenses are to be recognised
simultaneously.
Expenses normally can be measured reliably when other
conditions for revenue recognition have been satisfied.
Revenue cannot be measured when the related expenses
cannot be measured reliably. In such cases, any consideration
is recognised as a liability, not as revenue.

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F7 Financial Reporting Session 6 IAS 18 Revenue

3 Rendering of Services

3.1 Revenue Recognition Criteria

Revenue is recognised by reference to the "stage of completion" of

the transaction at the end of the reporting period (but only if the
outcome can be estimated reliably). This "percentage completion
method" is also applied in IAS 11 Construction Contracts.

3.2 Stage of Completion

Methods to determine the stage of completion include:
surveys of work completed (or "work certified");
services performed as a percentage of total services;* and *The percentage
completion method
proportion of costs to date to total estimated costs. provides useful
information on service
3.3 Reliable Estimate of Outcome activity in the period.

3.3.1 Conditions
A reliable estimate is subject to all the following conditions
being satisfied:
the amount of revenue can be measured reliably;
it is probable that the economic benefits associated with the
transaction will flow to the entity;
the stage of completion of the transaction can be measured
reliably; and
costs to complete can be measured reliably.

3.3.2 Factors to Be Considered

The ability to make a reliable estimate of an outcome depends
on:
Agreement with the customer about:
enforceable rights of each party;
consideration to be exchanged; and
manner and the terms of settlement.
The existence of an effective internal financial reporting and
budgeting system.
If an outcome cannot be measured reliably, revenue is
recognised only to the extent that expenses recognised are
recoverable.

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Session 6 IAS 18 Revenue F7 Financial Reporting

Illustration 2 Sale of Goods

with Service Component
ABC sells a computer to a customer, on the first day of the period, for $20,000.
Included in the sales contract is a servicing element for three years from the
date of sale. ABC estimates that the cost of service will be $1,500 per year
and expects to make a profit of 25% on the servicing work.

$1,500/0.75 = $2,000 per year. Therefore, for two years, $4,000 will be
excluded from revenue and presented as deferred income in the statement of
financial position (ignoring the time value of money).
Revenue of $16,000 will be recognised in the period of the sale: $14,000 for
the sale of goods and $2,000 for the first year's servicing contract.

4 Interest, Royalties and Dividends

4.1 Revenue Recognition Criteria

It is probable that economic benefits will flow to the entity.
The amount of the revenue can be measured reliably.

4.2 Recognition Bases

Interestusing the effective interest rate method (see Session
20 Financial Instruments).
Royaltiesan accrual basis in accordance with the substance
of the agreement.
Dividendswhen the shareholder's right to receive payment is
established.

5 Substance Over Form

5.1 Conceptual Framework

The Conceptual Framework defines the elements of financial
statements as assets, liabilities, equity, income and expenses
(see Session 2)
The substance and economic reality of a transaction, and
not merely its legal form, is an important consideration in
assessing whether an item meets a definition of an element.
An appendix to IAS 18 discusses the factors that might
influence the recognition of revenue for different types of
transactions.*

5.2 Sale of Goods Examples generally

assume that amounts
5.2.1 Bill and Hold Sales of revenue and costs
can be measured
Delivery is delayed at the buyer's request, but the buyer takes reliably and that
title and accepts billing. economic benefits are
Revenue is recognised when title passes to the buyer because probable.
in substance there has been a sale but, at the buyer's request,
goods are still physically held by the seller.
Revenue is not recognised when there is simply an intention
to acquire or manufacture the goods in time for delivery.

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F7 Financial Reporting Session 6 IAS 18 Revenue

5.2.2 Goods Shipped Subject to Conditions

Installation and Inspection
Revenue is normally recognised when the buyer accepts
delivery, and installation and/or inspection are complete (i.e.
there is no difference between substance and form).
If installation is a significant activity that is necessary to the
buyer being able to use the goods the seller should delay
revenue recognition until installation has been completed.
If, however, the activity is simple or routine (e.g. unpacking)
the seller will recognise revenue on acceptance of the
delivery.

5.2.3 Consignment Sales*

As the buyer is an agent for the seller revenue is not
recognised by the seller until the goods have been sold
onwards by the agent. *Under consignment
sales contracts, the
The seller does not pass on to the agent the risks and rewards
buyer undertakes
of ownership so in substance a sale has not occured. The to sell the goods on
goods may be held by the agent but he cannot use or dispose behalf of the seller.
of them as he likes.

5.2.4 Sale and Repurchase Agreements

As previously explained (see Session 3) the substance of a
contract for a sale of goods with a repurchase clause is that of
a financing contract. Therefore:
revenue from the legal sale must not be recognised;
the "seller" must recognise the liability to repay the "sale
proceeds" (i.e. loan) received;
over the life of the contract the "seller" will accrue interest
expense (charged to profit or loss).

5.3 Rendering of Services

The substance of most service-based contracts tends to be
consistent with their legal form. The main accounting issue is
when revenue should be recognised (rather than whether revenue
should be recognised).

5.3.1 Installation Fees

Recognise as revenue by reference to the stage of completion IAS 11 Construction
of the installation (similar to accounting for construction Contracts is detailed in
Session 8
contracts), unless they are incidental to the sale of a product
(in which case they are recognised when the goods are sold).

5.3.2 Servicing Fees Included in the Price of the Product

The cost of servicing needs to be separated from the physical
cost of the goods. In substance there are two contracts:
one for the sale of goods; and
another for the servicing/maintenance of the goods sold.
Revenue for the service element is recognised over the period
during which the service is performed.
The amount to be deferred is enough to cover the expected
costs of the services under the agreement, plus a reasonable
profit on those services.

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Session 6 IAS 18 Revenue F7 Financial Reporting

5.3.3 Franchise Fees

Franchise fees are recognised as revenue on a basis that reflects
the substance of the franchise agreement.
Franchise fees may cover:
Supplies of equipment and other tangible assets
The amount, based on the fair value of the assets sold, is
recognised as revenue when the items are delivered or title
passes.
Supplies of initial and subsequent services
The initial fee is recognised as the initial service is
completed.
Fees for the provision of continuing services are recognised
as revenue as the services are rendered.
Sufficient fee must be deferred to cover the costs of
continuing services and to provide a reasonable profit on
those services.*
Continuing franchise fees
*This means that
Recognise as revenue as the services are provided or the some of the fee for
rights used. the initial service
may need to be
5.4 License Fees and Royalties deferred to satisfy this
requirement.
Fees and royalties received are normally recognised in
accordance with the substance of the agreement.
Such fees may be received for the use of an entity's assets.
Examples:
Trademarks
Patents
Software
IAS 18 Revenue
Music copyright
considers when
Motion picture films. revenue should be
As a practical matter, this may be on a straight-line basis over recognised in respect
the life of the agreement (e.g. when a licensee has the right to of the sale of goods,
use certain technology for a specified period of time). giving of services and
interest, royalties
If receipt of a licence fee or royalty is contingent on the and dividends. It
occurrence of a future event, revenue is recognised only when could be the subject
it is probable that the fee or royalty will be received (normally of a question which
when the event has occurred). asks for explanation
and application of its
requirements.

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 Session 6

Summary
Revenue is the gross inflow of economic benefits arising from ordinary operating activities.
Revenue is measured at the fair value of consideration received or receivable.
Discounting is appropriate where the fair value of future consideration is less than the
nominal value.
Recognition means incorporating an item in income when it meets the "probability" and
"reasonable measurability" criteria.
Revenue is recognised according to the substance of a transaction.
Revenue from the sale of goods is recognised when all of the specified criteria are
met. As well as the Framework criteria, these include transfer of risks and rewards and
effective control.
The usual point of revenue recognition is on sale/delivery of goods.
For services rendered, the stage of completion must be measurable.
Revenue is recognised at the earliest point from which profits arising from the transaction
are recognised.

Session 6 Quiz
Estimated time: 15 minutes

1. Define "fair value". (1.1)

2. Explain how revenue is measured. (1.2)

3. State the FIVE criteria which must be satisfied before the sale of goods is recognised. (2)

4. Describe the methods which can be used to estimate the stage of completion for a service
contract. (3)

5. Give the recognition bases for interest, royalties and dividends. (4)

6. State THREE examples of transactions which illustrate the concept of substance over
form. (5)

Study Question Bank

Estimated time: 70 minutes

Priority Estimated Time Completed

MCQs - Session 6 20 minutes
Q16 Jenson 50 minutes

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