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Revenue recognition

Dr. Reena Kohli

1
Agenda
Principles of revenue recognition:
Sale of goods, rendering of service and
revenues from other sources,
Revenue recognition in special
circumstances:
Multiple elements sales arrangements
Amount of revenues to be recognized

2
Ind AS-18
Recognition of revenue from:
Sale of goods
Rendering of services
From use by others of the company's
resources

3
Ind AS-18 cont..
Recognition of revenue from:
Sale of goods

4
Ind AS-18
Revenue is recognized in the period
in which the significant risks and
rewards incidental to the ownership
of the goods are passed on to the
buyer that is, when goods are
delivered
Exceptions:
Bill and hold sales

5
Ind AS-18 cont..
Delivery subject to conditions like:
Installation and inspection
Delivery subject to approval
COD
Sales to
agent/distributors/dealers/Consignment
sales

6
Flipkart as an agent
ITEM AMOUNT (RS.)
Selling Price (decided by seller) 1000
100 ( assuming
Commission Fee (varies across sub-categories/verticals)
10% )
Shipping Fee (Local shipping , weight 0-500 grams) 30
Collection Fee ( 2.5 % on the Order item value or Rs
25
20whichever is higher )
Fixed Fee 30
Total Marketplace Fee 185
Service Tax (15% of Marketplace Fee including Swachh
27.75
Bharat & Krishi Kalyan cess)
Total deductions 212.75
Settlement Value (Amount credited to sellers
787.25
account via NEFT)

7
Ind AS-18 cont..
The buyer has full authority to use
the goods/asset as per his/her
discretion

8
Ind AS-18 cont..
The amount of revenue can be
reliably measured, that is,
The seller and buyer have agreed on
the price of the goods or the contract
specifies method of determining
price.

9
Ind AS-18 cont..
It is probable that the economic
benefits will flow to the entity, that
is,
The buyer has either paid the price
or it is certain that he will pay, else
seller will postpone the revenue
recognition until collection becomes
certain

10
Ind AS-18 cont..
Cost incurred or to be incurred can
be measured reliably

11
Ind AS-18 cont..
Recognition of revenue from:
Rendering of services
Short term service contracts versus
long term service contracts

12
Ind AS-18 cont..
Determining the stage of completion:
Surveys of the work performed:
Proportion of services performed to date to total
service to be performed over entire contract (AMC
for 5 years for Rs. 6000 in which 3 services will be
provided every year)
Proportion of cost incurred to date to total cost to
be incurred on rendering all services
Do progress payments or advances
received from customers reflect the
proportion of services performed?
13
Question 5A.4
Page 241

14
Ind AS-18 cont..
Recognition of revenue from:
From use by other of the
company's resources:
Interest revenue
Dividend revenue
Royalty, license fees revenue

15
Interest revenue
Interest may arise on loans or on credit sales
Recognition based on accrual concept that
is, during the time when borrower has used
the money or when the due date for interest
has come
Interest income is to recognized separately
from amount of loan or from amount of sale.
Two cases:
Interest payable at the time of taking loan
(discounted loans), given implicitly
Interest payable on maturity, given explicitly

16
Interest Revenue: Payable on maturity

On January 1, 1991 sold a customer Rs. 1,000


of goods. Company received a promissory
note for Rs. 1,000 plus 8% interest to be
paid in one year (on Jan 1, 1992).
Entry for sale?
Entry for accrual of interest on December
31, 1991 (closing date)?
Entry for receipt of payment of note on
January 1, 1992?

17
Jan 1, 1991:
Notes receivable a/c (debit) 1,000
To sales a/c (Credit) 1,000

Dec 31, 1991:


Interest receivable a/c (debit) 80
To Interest a/c (credit) 80

Jan 1, 1992:
Cash a/c (debit) 1,080
To Interest receivable a/c (credit) 80
To Notes receivable a/c (credit) 1,000

18
Interest on Discounted loan
On September 1, 2006, company loaned Rs.
10,000 to one employee for one year, 9%
discounted (payable on 31st August, 2007).
Company closes its accounts on 31 st December
every year.
Entry on Sep 1:
Loan receivable a/c (dr.) 10,000
To cash a/c (cr.) 9,100
To pre collected interest a/c (cr.) 9,00
Entry on Dec 31:
Pre collected interest (dr.) 3,00
To Interest a/c (cr.) 3,00

19
Entry on Aug 31:

Cash a/c (dr.) 10,000


To loan receivable a/c (cr.) 10,000

Pre-collected Interest a/c 6,00


To Interest a/c 6,00

20
Ind AS-18 cont..
Revenues from dividends should be
recognized when the shareholders
right to receive dividend has been
established
And it is established when BOD
directors propose dividends and the
proposal is approved by shareholders
in the board meeting (AGM).

21
Ind AS-18 cont..
In December one of X Limiteds
subsidiary's board agreed to propose
a dividend related to the profits of
the year 2013 (year ends as of
December 31, 2013), to be voted on
at the AGM in March 31, 2014. Can X
Limited account for this dividend in
its separate financial statements for
the year ending 2013??
22
Ind AS-18 cont..
New Advertising Company has 10,000 equity
shares of Rs. 10 each of Media Enterprises on
which the company receives an annual dividend
of 10 percent. Based on this background, the
accountant of New Advertising recognized Rs
10,000 as dividend income for the year ending
31st March 2005 in its books.
The directors of Media Enterprises proposed a
dividend of 15 percent for the year 2004-05 on
10th April 2005 and it was approved in the AGM
that took place on 15th June 2005.
Comment on whether accountants recognition
of dividend is as per the provisions of Ind AS-18?
23
Ind AS-18 cont..
The right to receive dividend is
established on 15th June 2005
Hence, the right was established in the
financial year 2005-06 and accordingly
the revenue should be recognized for
the year 2005-06
The treatment by New Advertising
Company is not as per Ind AS-18
24
Ind AS-18 cont..
Revenues from royalty income,
license fees, franchise fees is
recognized on
Accrual basis
In accordance with the terms and
conditions of the relevant agreement,
Unless there is some other systematic or
rational basis

25
Contract to use the right for a
specific period of time or a contract
to sell the right forever

26
Ind AS-18 cont..
Y Limited licensed its brand to a perfume
company (Z limited) to sell colognes and
other cosmetic products for a one-off fee
of Rs. 5000
At the time of contract
Further, Y Limited is also entitled to
incremental royalties of 10% of the gross
sales. The contract period is for five
years.
Over a period of 5 years
How should Y limited recognize the
revenue from one time fee and royalties?27
Ind AS-18 cont..
Lakers, Inc. receives $6,000 from a
franchisee for the right to use its
trademark and have access to its
know-how for a period of 5 years.
This know-how includes training
sessions, and some one available to
answer questions. When should the
$6,000 be recognized as revenue?

28
Ind AS-18 cont..
Special cases:
Multiple element sales arrangements

29
Multiple element sales
arrangements/bundled offers
Those sales arrangements where
companies sell one standalone product in
combination with some other product or
service.
For instance, in case of software industry,
companies sell software licenses along
with other add on services viz.
Upgrades on licensed software at cheaper
rates and/or post contract customer
support or other support services.

30
In such cases, revenues of each
element of sale offer is considered
separately as and when customers
avail these services.
Revenue is allocated among all
elements based on their fair market
value.

31
Illustration
Bubbles company (BC) sells and maintains
residential hot tubs. The price to purchase a hot
tub from BC, including maintenance services is
$6500. BC offers year long contract for hot tub
maintenance services to customers who may have
bought their hot tub from another retailer. The
price to be charged from customer for
maintenance service would be $500. The hot tub
purchased without a year long maintenance
services is $6200. How will the revenue be
recognized, if the company sold the hot tub
including maintenance service on 1st March, 2013.
The company follows six month accounting period.

32
How much to recognize
Adjustment for:
Bad debts expense
Sale returns
Warranty cost
Sale discount
Adjustment for bad debts
Two methods:
Direct write off method
Allowance/provision method
Estimate as a uniform percentage of credit
sales
Estimate on the basis of aging schedule
(applying higher percentage of default for
the customers that are long overdue)
Aging schedule example
Status as of Amount Estimated Provision
31st December, outstandi % for
2006 ng uncollectib doubtful
le accounts
Current overdue: 207605 1 2076
< 1 month 26003 1 260
1-2 month 10228 5 511
2-3 month 7685 10 769
3-6 month 3876 20 775
6 months and 6853 40 2741
over
Total 262250 7132
Bad Debt Exercise
Consider the following data for ABC
Limited:
Sales for the year were $2,000 for cash and
$6,000 on credit.
A customer, The XYZ Company went
bankrupt. XYZ company owed ABC Limited
$175.
Besides, ABC Limited creates a provision for
bad debts @ 5% based on past experience.
Entry for revenue?
Entry for bad debts - direct write-off?
Entries for bad debts (allowance method)?
(a) Cash a/c (debit) 2,000
Accounts receivables (debit) 6,000
Sales a/c (credit) 8,000

(b) Bad Debt a/c (debit) 1,75


Accounts receivables (XYZ Company) a/c 1,75

(c) Bad Debt a/c (debit) 291.25


Provision for bad debts (credit) 291.25
[(6000-175)*5%= 291.25]
Impact on profit & loss account

Debit Rs. Credit Rs.

Bad debt 466.25


expense
(291.25 + 175)
Impact on balance sheet

Liabilities and equity Rs. Assets Rs.

Provision for bad debts 291.25 Accounts receivable 6,000 5825


Less: XYZ company
1,75
(specific bad debt )

Provision is a contra-asset account.


Only the amount specifically identified as bad
debt would be deducted from the accounts
receivables account
Allowance method
Adjusting entry:
Bad debt expense a/c (debit)
Provision for bad debts a/c (credit)
When an uncollectible account is
identified (after an provision is made) ,
it is written off as follows:
Provision for bad debts a/c (debit)
Accounts receivable (Rams) a/c (credit)
ABC Limited created provision for bad debts @ 5%
on credit sales (Rs. 6,000)
Subsequently, XYZ company (Rs. 175) was identified
as bad debt.
Provision = 300, Bad debt = 175
Entries will be:
Bad Debt expense a/c (debit) 300
Provision for bad debt (credit) 300
Provision for bad debts (debit) 175
XYZ a/c (credit) 175
Impact on profit & loss account

Debit Rs. Credit Rs.

Bad debt expense 300


Impact on balance sheet

Liabilities and equity Rs. Assets Rs.

Provision for bad debts 125 Accounts receivable 6,000 5825


(300-175) Less: XYZ company 1,75
(specific bad debt )

Only the amount specifically identified as bad


debt would be deducted from the accounts
receivables account
Bad debts recovered cont..
If the company has not maintained any provision and has
followed direct write off method:
Restore the receivable that has already been written off
by reversing the write off entry:
Accounts receivables a/c (debit)
Bad debts a/c (credit)
Show its recovery:
Cash a/c (debit)
Accounts receivables a/c (credit)
Rather than passing above two entries you can pass a single
entry as follows:
Cash a/c (debit)
Bad debt a/c (credit)
Or
Cash a/c (debit)
Bad debt recovered a/c (credit)
Bad debts recovered
If the company has maintained provision:
Restore the receivable and recreate the
provision:
Accounts receivables a/c (debit)
Allowance for bad debts a/c (credit)
Show its recovery:
Cash a/c (debit)
Accounts receivables a/c (credit)
Rather than passing above two entries you can
pass a single entry as follows:
Cash a/c (debit)
Allowance for bad debt a/c (credit)
Sales returns and
allowances
Treatment for sales return and
allowances is analogous to bad debt
Direct write off
Estimate percentage of revenues that
will eventually result in returns or
allowances
Sales returns and
allowances cont..
Adjusting entry at end of
period.
Direct write off
Sales returns expense a/c (debit)
Accounts receivable a/c
(credit)
Estimate method
For creating provision:
Sales returns expense a/c (debit)
Provision for Sales Returns & Allowances
a/c (credit)

When goods are actually returned:


Provision for Sales Returns & Allowances
a/c (debit)
Accounts receivable a/c (credit)
Provision for Returns and Allowances can
be treated as allowance as well as a
liability.
Sales Return Exercise

1. Company sold goods worth Rs. 10,000


2. Goods worth Rs. 80 returned by a
customer.
3. Besides returns in point 2 above, on
average 2% of companys sales are
returned.
4. Pass adjusting entries at end of
period.
First entry (direct write off)
Sales return expense a/c (debit) 80

Accounts Receivable a/c 80


Second entry (making allowance)
Sales return expense a/c (debit) 198.40
Provision for returns and allowance a/c (credit)
198.40
[(10,000-80)*2%= 198.40]
Impact on profit & loss account

Debit Rs. Credit Rs.

Sales return expense 278.40


(198.40 + 80)
Impact on balance sheet

Liabilities and equity Rs. Assets Rs.

Provision for sales 198.40 Accounts receivable 9,920


returns and allowances 10,000
Less: XYZ company 80
(specific return)
Provision for sales returns & allowances
2% on sales Rs. 10,000
Subsequently, customers returned goods
worth Rs. 80
Entries will be:
Sales Return expense a/c (debit) 2,00
Provision for Returns and allowances (credit) 2,00
Provision for Returns and allowances (debit) 80
Accounts receivables a/c (credit) 80
Impact on profit & loss account

Debit Rs. Credit Rs.

Sales return expense 2,00


Impact on balance sheet

Liabilities and equity Rs. Assets Rs.

Provision for Sales 120 Accounts receivable 9,920


Returns and 10,000
allowances Less: sales return 80
(200-80) (specific return)

Only the amount of specific returns would be


deducted from the accounts receivables account
Warranty Costs
Amounts are estimated as a percentage
of sales
The adjustment recorded as expense
while allowance for warranty cost is
credited (liability)
When actually warranty costs are
incurred in future in repairing or
replacing goods, allowance for warranty
account is reduced by same amount
and cash/parts inventory is credited.
Entry for recording warranty expense:
Warranty expense a/c (debit)
Provision for warranties a/c (credit)
Warranty cost actually incurred:
Provision for warranties a/c (debit)
To cash a/c (credit)
To spare parts inventory a/c (credit)
Warranty Expenses Exercise
Company estimate that warranty
expenses will be 4% of our $10,000
of sales. Entry?
Company spent $150 on parts and
$250 on labor for repairs under
warranty. Entry?
Warranty expense a/c (debit) 4,00
Allowance for warranties a/c (credit) 4,00

Allowance for warranties a/c (debit) 4,00


To cash a/c (credit) 2,50
Sales discount
Given to get prompt payments from the
customers and to boost sales
Recorded when actually given to the
customers that is at the time of
receipt of cash and not at the time of
sale
Company sold goods worth $1,000. Sales
terms are 1/10, n/60. Customers paid on
the 5th day. What will be the journal entries?
Sales discounts
For goods sold on credit:
Accounts receivables a/c (debit) 1,000
Sales a/c 1,000
For receipt of cash:
Cash a/c (debit) 9,90
Discount a/c (debit) 10
Accounts receivables a/c (credit)
1,000
Impact on profit & loss

Particulars Rs.

Sales 1,000
COGS (850)
Gross profits 1,50
Discount expense (10)
Other operating expenses (50)

Net profits 90
Sales Discount Exercise
Company sold goods worth $10,000.
Sales terms are 2/10, n/30.
Customers paid us for $8,000 of the
merchandise billed within 10 days.
The remaining $2,000 was paid
within 30 days.
Record entry for sales and cash
collection from accounts receivables
Sale entry:
Accounts receivables a/c (debit) 10,000
To sales a/c (credit) 10,000
Entry for receipt of cash from ARs:
Cash a/c (debit) 7,840
Discount a/c (debit) 1,60
To Accounts receivables a/c 8,000
Cash a/c (debit) 2,000
To Accounts receivables a/c 2,000

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