workbook revenue upd-1

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REVENUE(Revision 1)

PREFACE This series of workbooks has been updated by the project team of the EuropeanUnion project Implementation of the Accounting Reform in the RussianFederation.

www.accountingreform.ru
http://www.accountingreform.ru/http://www.accountingreform.ru/


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Revenue

The workbooks cover the concepts of International Financial ReportingStandards (IFRS). They are intended to be practical self-instruction aidsthat practicing accountants can use to upgrade their knowledge, understandingand skills.

Each workbook is designed for a maximum of three hours of study.

Each workbook is a combination of:

Information with examples Self Test Questions Multiple choice and Exercises Answers to Self Test Questions

The members of the project team were contributed byPricewaterhouseCoopers, ACCA, FBK and Agriconsulting.

The Workbook Series consists of a range of titles listed on our website.

The copyright of the material contained in each workbook belongs to theEuropean Union and, according to its policy, may be used free of charge forany non-commercial purpose.

The project team would like to express thanks to those who have contributed

their time and thoughts to the content of the workbooks.

Contact:

e-mail [email protected] www.accountingreform.ru

Tel. + 7 495- 967-6000 Fax. + 7 495- 967-6001

Moscow, Russia, January 2007 (updated)

1. Introduction and Definitions......................................................................................................................................................................3

Aim ...................................................................................................3

Objective ......................................................................................... 3

Definitions ......................................................................................32. Transaction Identification.........................................................................................................................................................................43. Sale of Goods...........................................................................................................................................................................................54. Provision of Services................................................................................................................................................................................65. Interest, Royalties and Dividends.............................................................................................................................................................76. Disclosure.................................................................................................................................................................................................97. Specific Examples..................................................................................................................................................................................10

Sale Of Goods .............................................................................. 10

Provision Of Services ..................................................................13

Interest, Royalties And Dividends ..............................................178. Multiple choice Questions......................................................................................................................................................................189. Exercise Questions................................................................................................................................................................................2010. Solutions...............................................................................................................................................................................................21

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Revenue

Answers to Multiple Choice Questions: ........................ ...... ......21

Answers to Exercise Questions: ................................................21

1. Introduction and DefinitionsAIM

The aim of this workbook is to assist you to understand Revenue accordingto IFRS.

OBJECTIVERevenue is the subject of International Accounting Standard 18.IAS 11, 17, 28, 39 & 41 complement IAS 18..

Revenue is income that is derived from ordinary activities of the firm.Income comprises revenue and gains.

The timing of recognition of revenue is a key issue of the standard.

Revenue is recognised when it is probable that future economic benefits will

flow to the firm, and the benefits can be measured.

DEFINITIONS

RevenueOther than increases from contributions by investors, Revenue is the grossinflow of benefits from ordinary activities, when those inflows result in increasesin equity.

Fair valueFair value is the value for which an asset could be sold, or a liabilityextinguished, between willing, independent traders.

Excluded from revenue are amounts collected on behalf of others, such assales taxes, value added tax and money collected on behalf of a principal, in anagency relationship.

MeasurementRevenue should be measured at the fair value of the consideration received,or receivable. Trade discounts and volume rebates should be subtractedfrom revenue.

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Revenue

Where extended credit is given, either interest-free or at an interest chargebelow market rates, future receipts should be discounted to net presentvalue.The rate at which to discount is the higher of the weighted average cost ofcapital or the marginal borrowing cost of the company, which ever is greater.

In the following examples, I/B refers to Income Statement and Balance

Sheet

.

Example:You exchange corn for two machines. One has a market price of $400. One hasno market price, and you exchange corn worth $375 for this machine. The cornexchanged is in inventory, valued at $500. Your revenue = $775, and you havenew fixed assets worth $775.

I/B DR CR

Asset 1 B 400

Asset 2 B 375

Revenue - Corn Sales I 775

Cost of corn sales I 500

Inventory I 500

Assets exchanged for inventory

Where goods are exchanged, revenue is created. Fair value may bedetermined as the value of the goods given up, adjusted for any cashpayment or receipt, relating to the transaction.

2. Transaction Identification

If a transaction involves a servicing element of the product sold, the revenuerelating to the service is spread over the period of the service.

Example:You sell a car for $5000 and promise to service it twice in 6 months.The value of each service =$300Current revenue = $4400, deferred revenue = $600. The $600 is considereda payment in advance of service, and will be recognised as revenue whenthe services occur, or at the end of the 6-month period.

Combined transactions, such as a sale and repurchase agreement, are dealtwith as one transaction.

Example:Your business is the manufacture and sale of machinery. A machine ininventory has a value of $800 and is sold for $1000, in exchange for apromissory note payable in one year from now. The weighted average cost ofcapital is 5% and the marginal borrowing cost is 7%.

The present value of Revenue=$934 ($1000 x 1/1.07).

Revenue of $934 is recognised at date of sale and the $66 is recognised asincome spread over the life of the promissory note.

I/B DR CR

Promissory notes B 1000

Revenue I 934

Deferred Interest Receivable B 66

This records the sale of the machine

Cost of Sales I 800

Inventory B 800

Cost of machine soldDeferred Interest Receivable B 5.5

Interest Received I 5.5

Monthly transfer - deferred income to revenue,each month for 12 months

Cash B 1000

Promissory notes B 1000

1 year later -Cash received

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3. Sale of Goods

A sale is recognised when all the following conditions have been satisfied:

1. The seller has passed to the buyer the significant risks, and rewardsof ownership of the goods.

2. The seller no longer has effective control over the goods, norcontinuing management involvement normally associated withownership.

3. Revenue can be measured reliably.

4. It is probable that the seller will receive economic benefits from thetransaction.

5. Costs related to the transaction can be reliably measured.

The transfer of legal title normally passes the risks and rewards.Normal credit risk derived from sales is not a reason to defer revenuerecognition.

Retention of significant risks means that the sale will not be recognised. For

example:

1. If the contract allows the goods to be returned and you cannotreasonably estimate the probability of return, the sale cannot berecognised until customer acceptance is clear.

2. If installation has not been completed, when the installation is animportant part of the contract, recognition does not take place untilinstallation is complete.

3. If the sale is contingent on the buyer deriving revenue from resale of thegoods, recognition is deferred.

4. If the seller provides exceptional cover against unsatisfactoryperformance of the goods (more than is covered by normal warrantyprovisions.

Example:In March, you supply 5 cars at 400 each to your agent. The contract is aconsignment contract and the ownership and risk remains yours.In July, the agent sells the cars for 600 each, but you do not receive the moneyuntil August. The agent earns commission at 10% on sales.

Revenue is recognised in July, when the cars are sold by the agent.

I/B DR CRConsignment inventory-agent B 2.000

Inventory B 2.000Initial supply- March

Cost of sales I 2.000

Consignment inventory-agent B 2.000

Accounts receivable B 3.000

Revenue I 3.000

Revenue recognition-July

I/B DR CR

Cost of Sales Commission I 300

Accounts Payable B 300Commission earned in July 10% x 3000

Where foreign exchange control restricts the transfer of the sales proceeds,recognition cannot take place until permission (to transfer funds) is granted.

Once an amount has been recognised in revenue, any risk of non-paymentis treated as a bad, or doubtful debt.

Where warranties are given to the buyer, the cost of these will beimmediately recognised as an expense.If these cannot be measured reliably, the proceeds received should be notbe recognised as revenue but as liability until the warranty position is clear.

Example:

You sell goods valued at $200, on credit to a customer with a good credit record.

Recognise $200 as revenue immediately and an account receivable for $200.

I/B DR CR

Accounts receivable B 200

Revenue I 200Credit sale

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In theory, if you had no experience of judging warranty costs the whole$3.000 would be recognised as a liability until the warranty position is clear.In practice, a manufacturer would estimate the warranty liability andrecognise the sales immediately.

4. Provision of ServicesRevenue from the provision of services should be recognised by referring tothe stage of completion at the balance sheet date.

The stage of completion, the costs to date, and the costs to complete thetransaction should be reliably measurable.

Example:You are constructing a building for a client. Project revenue is $20m.

Costs to date are $6m, and you estimate that additional costs to completion are$10m .

The client has, so far, only approved $4m of the expenditure, as his staff is onholiday for the month.

You believe that the $2m ($6-$4m) will be approved). No payment has beenreceived.

Recognise:$4m as expense (the amount approved)$5m as (accrued) revenue (4/16*$20m).

$2m is left as work in progress. ($6m-$4m=$2m)I/B DR CR

Cost of sales I $4m

Work in progress B $4m

Accounts receivable B $5m

Revenue I $5m

Revenue recognition

Revisions to estimates do not mean that the financial outcome of thetransaction cannot be reliably measured.

Advances and progress payments received from clients may not reflect thestage of completion.

Example: Percentage of Completion -iOn day 1 of a $50 million contract, $5 million is received on account.This should not be fully recognised as revenue until 10% of the work has beensuccessfully completed.

I/B DR CRCash B $5m

Deferred revenue B $5mRecording cash receipt on day 1

Example: Percentage of Completion -ii10% is now completed, costs total $3m

Cost of sales I $3m

Example:You sell $3000 of good that cost $2500s. Experience tells you that warrantycosts will be 2% of revenue.

Recognise the revenue of $3000 immediately and create a warranty provision for$60 ($3000*2%) and recognise the warranty expense immediately in the incomestatement.

I/B DR CR

Cash B 3.000

Revenue I 3.000Sale


Inventory B 2.500

Warranty costs I 60

Warranty provision B 60

Warranty provision

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Deferred revenue B $5m

Revenue I $5m

Revenue recognition when 10% of thework is completed

In the early stages of a transaction, it may be that the profitability cannot be

reliably estimated.

If it is likely that only the costs will be recovered, recognise only enoughrevenue to equal the costs. (accounting for the project as breakeven: noprofit, no loss).

Example: Recovery of costsProject revenue is a total of $100 million. $1 million has been spent at the periodend, and there are problems that indicate that no profit will be made on theproject.

Recognise $1million as accrued revenue and $1million as (actual) expenses.

I/B DR CR


Revenue I $1mRevenue recognition

Cost of sales I $1m


Recognising expenses

If it is not probable that the costs will be recovered, no revenue isrecognised, and all costs are immediately expensed.

Example: Expensing costsProject revenue is a total of $80 million. $5 million has been spent by the periodend, and the client has serious financial problems.

Recognise no accrued revenue, and $5 million as (actual) expenses.

I/B DR CR

Cost of sales I $5mWork in progress B $5m

Recognising expenses

To recapitulate:

The three options in calculating Revenue, depending on the level ofknowledge of the transactions final outcome are:

1. Anticipating a profit: Percentage of completion method.

2. Anticipating Break-Even: Recovery of costs, only.

3. Anticipating a loss: Non-recovery of costs (but full expensing of

costs).

Please also see IAS 11 Construction Contracts workbook.

5. Interest, Royalties and Dividends

Revenue should be recognised as follows:

Interest should be recognised on a time-proportion basis, reflecting theeffective yield of the asset. (The effective yield takes account any fees,discount, or premium, at which the financial instrument was issued.)

Example:You make a loan of $500m at 12% interest for a year. Interest is only paid at theend of the period.

Accrue interest receivable of $5m each month.

I/B DR CR


Interest receivable I $5m

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Revenue

Revenue recognition each month

Example:You make a $20.000 loan at 10% for 2 years. Interest is applied annually and paidat the end of each year. Your administration fee is $400 and paid in advance.

The administration fee is treated as deferred revenue $400 and will be recognisedover the 2 year loan period.Cash inflows from this loan are:Year 0 +400

1 +20002 +2000

Total 4400 or 2200 per year.

So the effective interest rate (produces the same amount of cash flow is 11%.

So 11.00% of 20,000 i.e $2200 will be recognised as income in each year.

Year 1 beginning I/B DR CR

Loan receivable B 20.000

Cash B 20.000Cash B 400Deferred revenue fees B 400Providing loan and receiving fee

Annually I/B DR CR

Accrued Interest receivable B 2000Deferred revenue fees B 200Interest income I 2000Fee income I 200Accruing interest and recognisingfees at the end of year 1

Effective Interest RateBoth the nominal and effective interest rates, by definition, areto yield the same amount of interest.

Nominal rate: Invest $1 at 9.65% compounded quarterly.At the end of one year:

= $1.10

Effective rate therefore is 10%

Effective rate: Invest $1 at i% pa. You receive interest only once!

Therefore: = $1.10

So a nominal rate of 9.35% quarterly has an effective rate of 10%i.e you receive with the same amount of interest.

Royalties should be recognised on an accruals basis, based on the relevantcontract.

Example:You sell the US rights to your book at $1 per book.Payment is to be made every six months in arrears.

In month 1, 400.000 copies are sold in the US.In month 2, 1 million copies are sold.

Accrue royalty income of $400.000 for month 1 and $1million for month 2.

I/B DR CRAccounts receivable B $400.000

Revenue I $400.000Revenue recognition-month 1


Revenue I $1m

Revenue recognition-month 2

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Dividends should be recognised only when the shareholder has a legal rightto receive payment.

Example:You have purchased a preferred share. It will pay 3% dividend each quarter, 4weeks after the board declares the dividend.

Accrue the dividend receivable when the board declares the dividend eachquarter.

If the directors declared their intention to declare a dividend no accrual would bemade as no legal rights arise from an intention.

I/B DR CR

Accounts receivable B $3

Dividend receivable I $3Revenue recognition-following declarationof dividend

If the board does not declare a dividend, none must be accrued for thisshare.

Where unpaid interest, or dividends, had accrued before the acquisition of afinancial instrument, the next receipt of interest, or dividend, will be spiltbetween pre-acquisition and post-acquisition periods. The pre-acquisitionportion is deducted from the cost of the financial instrument. Only the post-acquisition portion is recognised as revenue.

Example:You buy a bond for $105 on April 1. It has a face value of $100. It pays interest of20% every December 31st. The price you paid therefore includes 3 months ofaccrued interest. (The $105 includes $5 accrued interest.)

Even though you have only owned it for 9 months, you will receive the full 20%interest on December 31st.

When you receive the interest, it will be spilt between pre-acquisition ($5) andpost-acquisition periods ($15). The pre-acquisition portion ($5) is deducted fromthe cost of the financial instruments.

I/B DR CR

Investment B 100

Accrued interest on bonds B 5Cash B 105Purchase of bond

Cash B 20

Accrued interest on bonds B 5

Interest received I 15

Receipt of interest

Only the post-acquisition portion is recognised as revenue ($15). Next year,the whole $20 will be recognised as interest received.

6. Disclosure

Disclosure includes

Accounting policies used for revenue recognition, including methods of

determining the stage of completion of transactions for services.

Revenue should be split, to show separately, revenue arising from:

1. Sale of goods.2. Provision of services.3. Interest.4. Royalties.5. Dividends.

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1. Revenue from the exchange of goods, or services, should be identified ineach category.

2. Any contingent liabilities, or assets, such as warranty claims should beidentified in each category.

7. Specific Examples

SALE OF GOODS

1. Bill and Hold

Buyer takes title but delivery is delayed.

The seller recognises Revenue when the buyer takes title, if:1. delivery will be made2. the product is identified and ready for delivery3. delayed delivery is agreed4. usual payment terms apply.

Example:You are about to deliver your monthly consignment of goods, when your clientswarehouse burns down. He asks you to store them, at his risk, until he can findalternative storage.

The title to the good and risk has passed to the customer. Revenue is recognisedimmediately.

I/B DR CR

Inventory B 100Inventory held on behalf of customer I 100

Transfer of ownershiip

I/B DR CR


Revenue I 100Revenue recognition

2.Installation and inspection.

Where the contract specifies delivery, installation and inspection, all must becompleted to recognise revenue.Exceptionally revenue may be recognised on delivery, if installation andinspection are short and straightforward.

Example:You sell domestic refrigerators to a retail chain.They must be inspected prior to acceptance, but the inspector is ill.None have been rejected in the last 2 years.

Revenue can be recognised immediately.

3.On approval, with a limited right of return.

Revenue is recognised upon the buyers acceptance, or the time for rejectionhas passed.

Example:You sell curtains to a retailer.Written notification of rejection must be made within 10 days.

At the end of 10 days, if none have been rejected, revenue can berecognised.

4.Consignment sales and sales using agents.

The agent resells the goods before paying the seller. Revenue is recognisedwhen the goods are resold.

Example:In April, you supply 5 cars to your agent. The contract is a consignment contract.

In July, the agent sells the cars, but you do not receive the money untilSeptember.

I/B DR CRConsignment inventory-agent B 500

Inventory B 500Initial supply- April

Cost of sales I 500

Consignment inventory-agent B 500

Accounts receivable B 1.000

Revenue I 1.000

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Revenue recognition-July

Revenue is recognised in July, when the cars are sold by the agent.5.Cash-on-delivery sales.

Revenue recognition occurs when delivery is complete and cash has beenpaid.

Example:You sell books via the Internet. Clients can pay on receipt of the books.

When your agent has received the cash, having delivered the goods, the revenuecan be recognised.

I/B DR CR

Cost of sales I 500

Inventory B 500Accounts receivable B 1.000

Deferred Income B 1.000Recording delivery of books to client

Cash B 1.000

Accounts receivable I 1.000Deferred Income B 1.000

Revenue B 1.000Revenue recognition on receipt of cash

6. Payment by instalments followed by delivery.

Recognition of revenue is on delivery. If experience shows that most clientspay all of their instalments, revenue recognition may take place when mostof the payments have been made, and the goods are ready for delivery.

Example:You are building a house costing $60,000. You accept deposits and progresspayments, prior to the house being finished. When it is finished, 10% of the totalprice of $100.000 remains unpaid, but you anticipate receipt in the next few days.

If the work is complete, revenue may be recognised.I/B DR CR


Work in progress B 60.000Accounts receivable B 10.000

Client deposits B 90.000

Revenue I 100.000Revenue recognition on buildingcompletion7.Payments in advance of manufacture.

Example:A foreign buyer pays for your goods at the start of each month. They are shippedin the middle of the month, and he accepts delivery at the end of each month.

Recognise revenue when the goods are accepted.I/B DR CR

Cash B 100

Deferred Income - Payments in advance B 100Cash received at start of month

Goods Shipped B 80

Inventory B 80Shipment made- mid monthDeferred Income - Payments in advance B 100Revenue I 100Cost of Sales I 80Goods Shipped B 80Revenue recognition on acceptance ofgoods

8.Sales and repurchases of the same items, which are really financingtransactions.

Treat as a financing transaction, rather than recognise revenue.

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Example:You sell a portfolio of shares in March for $5.000, with a contract to repurchasethem for $5.250 in September (6 months).

This is primarily a finance transaction, and no revenue should be recognised.

Monthly, an interest accrual of 250/6 would be made.I/B DR CR

Cash B 5000

Investment B 5000Cash received, investment sold

Borrowing cost I 250

Investment B 5000

Cash B 5250Investment repurchased

9.Subscriptions to publications.

Recognise revenue on a straight-line basis over time.If the product price varies, use the percentage completion method, by value.

Example:You sell a 3-year subscription to your monthly magazine.

Recognise the revenue by as 1/36 of the revenue when each months magazine isissued.

I/B DR CR

Cash B 36

Deferred revenue B 36Cash received

Deferred revenue B 1

Revenue I 1Revenue recognition on magazine issue

If the price rises each year, then split the subscription to match the differentprice levels of each year.

10. Instalment sales.

Interest portion is recognised as interest earned, using the imputed rate ofinterest. The sale price is the present value of the payments (net of interest).The instalments are discounted by the imputed rate of interest.

Example:You sell a car, costing $8000, for $10.000, payable in instalments over one year.The rate of interest is 10%. Interest is included in the price.

Recognise immediately revenue of $9.091(10000/110%) and interest receivable of$909, matched by an accounts receivable of $10.000.The interest receivable of 909 would be recognised monthly over the year in which

it is received.I/B DR CR


Inventory B 8.000Accounts receivable B 10.000

Interest receivable I 909Revenue I 9.091Recording sale and interest charge11. Real estate sales.

Normally, revenue is recognised when title is transferred.Review the contract, and national law, to see if the seller has furthersubstantial obligations to perform to complete the sale.

Example:You sell a house, but have committed your firm to repair the roof. Your roofer isaway for 2 months.

Defer recognition of the sale until the roof is repaired.I/B DR CR


Inventory B 90.000Cash B 100.000

Sales suspense B 100.000Recording conditional sale of house

Sales suspense B 100.000

Revenue I 100.000Revenue recognition on repair of roof

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PROVISION OF SERVICES

12.Installation fees.

Recognised by the stage of completion.

Example:You are installing a computer network in 5 identical buildings for a client,under a single contract.

Recognise 20% of revenue on completion of installation in each building.

13.Service fees / after sales support included in the price of theproduct.

Recognised over the period of the services / support.

Example:You sell a car for $15.000, including a years warranty.

The fair value of the warranty is $1.200.Under the terms of the warranty the car will be brought to you for quarterlyservicing.

Recognise $13.800 as revenue for the sale immediately, and $300 as servicerevenue when the car has each service.Debit: Cash $15.000.Credit: Revenue $ 13.800, Deferred revenue $1.200

I/B DR CR

Cash B 15.000

Warranty provision B 1.200Revenue I 13.800Initial sale

Warranty provision B 300Revenue I 300

Transfer when each service is provided

14. Advertising commissions.

Recognised when the specific advertisement appears.

Example:In July, as an agent, you book for a client, an advertisement to appear in both theNovember and December issues of a magazine. Your commission is $500.

Recognise $250 each time the advertisement appears.I/B DR CR

Cash (or accounts receivable) B 500


Record of bookingDeferred revenue B 250

Revenue I 250

Transfer each time advertisement appears

15. Insurance agency commissions.

Recognition when received, or receivable. Deferred and recognised over thelife of the policy, if further services are required.

Example:

A client signs two insurance policies, which will give your firm a commission ofpolicy (1) $100 and policy (2) $120.For policy (1) all payments are made immediately and for policy (2) payments willbe made monthly over 1 year.

The payments for policy (2) will be collected at the clients home each month.The commission element of each collection will be $10.Recognise commission of $100 now, and $10 each time payment is collected.

I/B DR CR


Deferred revenue commission B 120Revenue commission I 100Signing of the policy

Deferred revenue B 10Revenue I 10

Cash B 10


Transfer when each payment is collected

16. Financial service fees- Integral part of the effective yield.

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Origination fees relating to initiating a loan, such as credit checking and loandocumentation, should be deferred and recognised as an adjustment to theeffective yield. In each period, they are recognised as fees.Example:You provide a $10000 loan at 10% for 2 years. Interest is paid at the end of eachyear. Your administration fee is $200 and paid in advance.

I/B DR CR

Loan receivable B 10.000Cash B 10.000Cash B 200

Deferred revenue B 200Providing loan and receiving fee

Accrue interest monthly, and recognise the fees monthly ($100 each year).I/B DR CR



Interest receivable I 83Fee income I 8Accruing interest and recognising fees

The effective yield of the loan is 11%.(Interest of $2000+ $200 fees) / $10000 loan = 11% p.a.

Commitment fees are considered to be fees for the ongoing involvement.They should be deferred and recognised as an adjustment to the effectiveyield. Recognition will occur at the expiry of the commitment, if the loan is notdrawn down.

Example:You offer a $10.000 loan facility at 10% for 2 years. Interest is paid at the end ofeach year. Your commitment fee is $360 and paid in advance. The loan is drawndown on the 1st day of year 2.

I/B DR CR

Cash B 360

Deferred revenue B 360Loan receivable B 10.000

Cash B 10.000Receiving fee (day 1) and providing loan(1stday of year 2)Accrue interest monthly in year 2, and recognise $30 each month (fees) inyear 2.

I/B DR CR



Interest receivable I 83Fee income I 30Accruing interest and recognising fees

The effective yield of the loan is 13.6%.(Interest of $1.000+ $360 fees) / $10.000 loan = 13.6%.

If the loan had never been drawn down, recognise the fees at the end of year2.

17. Financial service fees - Fees for servicing a loan.

Fees to be recognised when the services are provided.

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Revenue

Example:You provide a loan for 1 year. You have a service fee of $4.000, payable inadvance. Each quarter, you will audit your clients accounts, and review theresults, to confirm that there has been no breach of the covenant contained in theloan contract.

I/B DR CR

Cash B 4.000Deferred revenue B 4.000Loan receivable B 100.000

Cash B 100.000Accruing interest and recognising fees

Recognise $1.000 of fee income on completion of each review.Deferred revenue B 1.000

Revenue I 1.000

Transfer following each review

18. Financial service fees Fees earned for a specific act.

Examples are commissions on the allotment of shares, placement feesrelating to loans and loan syndication fees.

Revenue is recognised on completion, assuming involvement then ceases. Ifpart of the loan is retained, with a higher effective yield, the additional yield isthe syndication fee, which should be recognised, when the syndication iscompleted.

Example:You organise a syndicated loan for $1.000m. You provide 10% of the funds. Youreceive 6% interest, while the other syndicate members receive only 5%.

I/B DR CRLoan receivable B $100 m

Cash B $100 mProvision of loans

Each year, you record $5 million as interest receivable, and $1 million assyndication fees.Cash B $6 m

Interest receivable I $5 m

Fees-syndication I $1 m

Each receipt of interest & fees

19. Admission fees.

Recognition occurs when the event takes place.

Example:In May, you sell tickets for a concert that will take place in July:

I/B DR CR

Cash B 100


Revenue will be recognised after the concert in July:I/B DR CR

Deferred revenue B 100Revenue I 100

20. Initiation, entrance and membership fees.

Recognition reflects the timing of the services provided.

Example:To become a student member of an accounting body, you have to pay $165registration fee and $180 annual membership.

The $165 can be recognised as the accounting bodys revenue when you areregistered:

I/B DR CR

Cash B 345

Revenue I 165Deferred revenue B 180

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Revenue

The membership fee will be recognised at the rate of $15 per month:I/B DR CR


Revenue I 15

21. Franchise fees Supplies of equipment and other tangible assets.

Recognition occurs when the items are delivered, or title passes.

Example:As part of the contract, your fast-food franchisee must buy cooking equipmentfrom you costing $15.000. Title passes when the equipment has been installed,and has been inspected by the local authorities.

I/B DR CR

Cash B $15.000

Deferred revenue B $15.000Recording the receipt of cash for the cooking equipment.Recognise the sale when the inspection has been satisfactorily completed:

I/B DR CR

Deferred revenue B $15.000

Revenue I $15.000

22. Franchise fees Initial and subsequent services.

Recognition reflects the timing of the services provided.

Where subsequent fees do not cover the cost of ongoing services, part of theinitial fee should be deferred and recognised when subsequent serviceshave been provided.

Example:You run a fast-food franchise business.You charge an annual franchise fee of $20.000, payable at the start of the year.You also charge a monthly fee of $1.500 for which you provide a fixed amount offood with a value of $1.800 each month, including your standard profit margin of$300. Any additional food is charged separately.

Recognise only $16400 ($20000-($300*12)=$16400) as fee income at the start ofthe year. Consider the remainder as a payment in advance of the monthly fee,and therefore recognise $1.800 per month.

I/B DR CR

Cash B $20.000

Revenue I $16.400Deferred revenue B $3.600Recording receipt of the annual franchise fee.

I/B DR CR

Cash B 1.500

Revenue I 1.800

Deferred revenue B 300Accounting monthly for the food

23. Franchise fees Continuing.

Recognition reflects the timing of the services provided, or the passage oftime, depending on the franchisors commitment.

Example:You run a car dealer franchise network.$10.000 of the franchise fee, that you charge your franchisees, is for the trainingof 20 staff of your franchisee:

I/B DR CR

Cash B 10.000

Deferred revenue training B 10.000

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Receipt of Franchise FeeI/B DR CR

Revenue I 500Deferred revenue-training B 500Each time one is trained, credit $500 tofees

24. Franchise fees Agency Transactions.

If the franchisor orders supplies for the franchisee at no profit, no revenue,nor cost, is recognised.

Example:You run a fast-food franchise business.You insist that your franchisees have a health and safety audit each year,organised by you, recharged at cost.

I/B DR CR

Cash B 50Audit costs I 50

Accounts receivable franchisee B 50

Audit costs I 50Show this as a recharge, rather than revenue.

25. Fees from customised software development.

Recognition is based on the percentage completion method.Provision should be made for after-sales service.

Example:You have a contract worth $25000 to produce software.$5000 of this sum is allocated to after-sales support.40% of the development has been completed.

The client has paid $6000 so far, and will pay the remainder on completion.

Recognise 40%($25000-$5000) = $8000 of revenue. The $5000 for after salessupport will be amortised over the period to which it relates.

I/B DR CR

Cash B 6.000

Revenue I 8.000Accounts receivable B 2.000

The payment of $6000 has no impact on the revenue recognised. Suchpayments improve cash flow.

INTEREST, ROYALTIES AND DIVIDENDS

26. Licence fees and royalties.

Recognition is based on the substance of the contract. In general, they willbe spread, on a straight-line basis, over the life of the project.

If rights are sold for an unlimited time, without further service involved, thenthis can be treated as a sale.

Examples:You sell the rights to your drug to the Ukraine for $10 million for 5 years.Recognise $2 million per year.

I/B DR CR

Cash B 10million

Revenue I 2million

Deferred revenue B 8millionReceipt of cash and recognition of therevenue from year 1.

You sell the rights to your drug in the US for $50 million, for an unlimitedamount of time, but subject to your help in successfully obtaining theapproval of the Federal Drug Agency (FDA) for the drug.

Recognise the $50million as a sale only when the drug receives FDAapproval.

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8. Multiple choice Questions

Choose the answer closest to that you believe to be correct.

1. Revenue:

1) Includes gains.

2) Is the gross inflow of economic benefits of the ordinary activities,when those inflows result in increases in equity, other than increasesrelating to contributions from investors.

3) Includes sales taxes and value added tax.

2. Fair Value

1) Is the value for which an asset could be sold, or a liabilityextinguished, between willing, independent traders.

2) Is the value agreed between related parties.3) Is based on historical cost.

3. Trade discounts and volume rebates should:

1) Be ignored.2) Be subtracted from revenue.3) Be shown in the balance sheet under equity.

4. Where interest-free, long-term credit is given,

1) Revenue should not be recognised until cash is received.2) Future receipts should be discounted to net present value.3) A bad debt provision should be created.

5. Where goods are exchanged:

1) No bookkeeping is necessary.2) Cash is never involved.3) Revenue is created.

6. A Transaction involves after sales service:

1) It is no longer regarded as revenue.

2) The revenue relating to the service is spread over the period of theservice.

3) It is always a credit transaction.

7. Combined transactions, such as a sale and repurchase agreement:

1) Are dealt with as one transaction.2) Must be shown separately.3) Are illegal.

8. When is a sale recognised?

1) Whenever the seller decides to recognise it.2) At the end of each accounting period.3) When certain conditions have been satisfied.

9. Normal credit risk derived from sales is:

1) The best reason to defer revenue recognition.2) Not a reason to defer revenue recognition.

3) Detailed in the audit report.

10. Retention of significant risks means that:

1) The sale will not be recognised.2) There is no problem with revenue recognition.3) Insurance is mandatory.

11. If the sale is contingent on the buyer deriving revenue from resaleof the goods:

1) It should never be recognised as a sale.2) It should receive shareholder approval.

3) Recognition is deferred.

12. Where foreign exchange control jeopardises the transfer of thesales proceeds:

1) Recognition cannot take place until permission to transfer funds isgranted.

2) The sale is cancelled.3) A bad debt provision should be created.

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13. Once an amount has been recognised in revenue, any risk of non-payment is treated as:

1) A reduction in revenue2) A bad, or doubtful debt expense.3) A charge to accounts payable.

14. Where warranties are given to the buyer, the cost of these will berecognised:

1) As an expense.2) As a reduction in revenue.3) In the following period.

15. Revenue from the provision of services should be recognised byreferring to the:

1) Original estimates.2) Payments received in advance.3) Stage of completion at the balance sheet date.

16. The stage of completion, the costs to date, and the costs tocomplete the transaction should be:

1) Ignored.2) Listed in the accounts.3) Reliably measurable.

17. Revisions to estimates:

1) Mean that the financial outcome of the transaction cannot be reliablymeasured.

2) Mean that the financial outcome of the transaction can be reliablymeasured.3) Cancel the transaction.

18. Advances and progress payments received from clients:

1) Is proof of the stage of completion.2) May not reflect the stage of completion.3) Should be booked to accounts payable.

19. If the costs will probably be recovered, recognise:

1) All revenue.2) Only that amount of revenue, equal to the costs.3) No revenue.

20. Interest revenue should be recognised on a:

1) Time-proportion basis, reflecting the effective yield of the asset.2) Cash basis.3) Time-proportion basis, reflecting collection periods.

21. Royalties should be recognised on:

1) A cash basis.2) An accruals basis.3) An actual basis.

22. Dividends should be recognised:

1) On a cash basis.2) On an accruals basis.3) When the shareholder has a legal right to receive payment.

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9. Exercise Questions

Decide when, and how much, revenue can be recognised in each of thefollowing situations.Provide debits and credits for your answer, where revenue isrecognized.

1. You are about to deliver your monthly consignment of goods, when yourclients delivery service ceases business. He asks you to store them, at hisrisk, until he can find alternative transport.

2. You sell carpets to a retail chain.They must be inspected prior to acceptance, but the inspector is ill. Nonehave been rejected in the last 3 years.

3. You sell radiators to a wholesaler. Written notification of rejection must bemade within 30 days.

4. In April, you supply 40 computers to your agent. The contract is aconsignment contract. In November, the agent sells the computers, but you

do not receive the money until December.

5. You sell software via the Internet. Clients can pay on receipt of thesoftware.

6. You build warehouses. You accept deposits and progress payments, priorto the warehouse being finished. When it is finished, 2% of the total paymentremains unpaid, but is likely to be paid soon.

7. A buyer pays for your goods on the 5th of each month. They are shippedon the 10th of the month, and he accepts delivery on the 15th of each month.

8. You sell a portfolio of shares in January for $10.000, with a contract torepurchase them for $10.500 in March.

9. You sell a 5-year subscription to your hardware support service, payablein advance.

10. You sell a machine for $100.000, payable in instalments over one year.The rate of interest is 10%. Interest is included in the price.

11. You sell a hotel, but have committed your firm to repair the drains. Yourrepairer is away for 2 months.

12. You are installing a telephone network in 20 identical buildings for aclient, under a single contract.

13. You sell a photocopier for $30.000, including a years warranty. The fairvalue of the warranty is $2.400. The copier will require quarterly services.

14. In July, as an agent, you book a band to appear once in March and oncein May at a dance hall. Your commission is $4.000.

15. A client signs an insurance policy, which will give your firm a commissionof $5.000. Payments will be made monthly over 2 years. The payments willbe collected at the clients home. The commission element of each collectionwill be $100.

16. You provide a $100.000 loan at 12% for 3 years. Interest is paid at theend of each year. Your administration fee is $3.600 and paid in advance.

17. You offer a $100.000 loan facility at 15% for 4 years. Interest is paid atthe end of each year. Your commitment fee is $4.800 and paid in advance.The loan is drawn down on the 1st day of year 3.

18. You provide a loan for 4 years. You have a service fee of $32.000,payable in advance. Each quarter, you will audit your clients accounts, andreview the results, to confirm that there has been no breach of covenant (theloan contract).

19. You organise a syndicated loan for $2.000 million. You provide 5% of thefunds. You receive 8% interest, while the other syndicate members receiveonly 6%.

20. In October, you sell tickets for an exhibition that will take place inDecember.

21. To become a member of a car club, you have to pay $100 registrationfee and $600 annual membership. How does the car club recognise itsrevenue?

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22. As part of the contract, your car service franchisee must buy equipmentfor the service bays from you. Title passes when the equipment has beeninstalled, and has been inspected by the local authorities.

23. You charge an annual franchise fee of $80.000, payable at the start ofthe year. You also charge a monthly fee of $6.000. You provide a fixedamount of supplies with a value of $7.200 each month, including yourstandard profit margin of $1.200. Any additional supplies are charged

separately.

24. $30.000 of your franchise fee is for the training of 60 staff of yourfranchisee.

25. You insist that your franchisees have a financial and operational internalaudit each year, organised by you, recharged at cost.

26. You have a contract worth $50.000 to produce software.$10.000 of this sum is allocated to after-sales support.20% of the development has been completed. The client has paid $18.000so far, and will pay the remainder on completion.

27. You sell the rights to your trademark to the Georgia for$70 million for 10 years.

28. You sell the rights to your drug in the US and Europe for $100 million, foran unlimited amount of time, but subject to your help in successfullyobtaining the approval of the Federal Drug Agency (FDA) for the drug.

10. Solutions

ANSWERSTO MULTIPLE CHOICE QUESTIONS:

1. 2) 10. 1) 19. 2)2. 1) 11. 3) 20. 1)3. 2) 12. 1) 21. 2)4. 2) 13. 2) 22. 3)5. 3) 14. 1)6. 2) 15. 3)7. 1) 16. 3)8. 3) 17. 2)

9. 2) 18. 2)

ANSWERSTO EXERCISE QUESTIONS:

1. Revenue can be recognised immediately.Debit: Account receivable. Credit: Revenue.

2. Revenue can be recognised immediately.

Debit: Account receivable. Credit: Revenue.

3. At the end of 30 days, if none have been rejected, revenue can berecognised.Debit: Account receivable. Credit: Revenue. (after 30 days)

4. Revenue is recognised in November, when the computers are sold by theagent.Debit: Account receivable. Credit: Revenue. (in November).

5. When your agent has received the cash, having delivered the software,the revenue can be recognised.Debit: Cash. Credit: Revenue.

6. If the work is complete, revenue may be recognised.Debit: Account receivable, deferred revenue. Credit: Revenue.

7. Recognise revenue when the goods are accepted.Debit: Deferred revenue. Credit: Revenue.

8. This is primarily a finance transaction, and no revenue should berecognised.

9. Divide the revenue by 60, and recognise 1/60 of the revenue each month.Debit: Cash. Credit: Deferred revenue. (on day 1)

Debit deferred revenue. Credit Revenue. (monthly)

10. Recognise immediately revenue of $90.909 (100.000/110%) and interestreceivable of $9.091, matched by an accounts receivable of $100.000.Debit: Accounts receivable $100.000.Credit: Revenue $90.909, Interest receivable $9.091.

11. Defer recognition of the sale until the drains are repaired.Debit: Cash. Credit: Deferred revenue.

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12. Recognise 5% of revenue on completion of installation in each building.Debit: Account receivable. Credit: Revenue. ( for each installation)

13. Recognise $27.600 as revenue for the sale immediately, and $600 asservice revenue when the photocopier has each service.Debit: Cash $30.000. Credit: Revenue $27.600, Deferred revenue $2.400.

14. Recognise $2.000 each time the band appears.Debit: Account receivable $2.000. Credit: Deferred revenue $2.000 eachtime.

15. Recognise commission of $2.600 now, and $100 each time payment iscollected.Debit: Account receivable $5.000.Credit: Revenue $2.600, Deferred revenue $2.400.

16. Accrue interest monthly, and recognise the fees monthly ($100 eachmonth).Debit: Loan receivable $100.000, Cash $3.600.Credit: Cash $100.000, Deferred revenue $3.600. (on day 1)

Debit: Account receivable $1.000, deferred revenue $100.Credit: Interest receivable $1.000, fee income $100. (monthly).

17. Accrue interest monthly in years 3 and 4, and recognise $200 of feeseach month in years 3 and 4.

Debit Account receivable $4.800 Credit: Deferred revenue $4.800. (on day1)

Debit: Loan receivable $100.000. Credit: Cash $100.000. (on drawdown)

Debit: Account receivable $1.250, deferred revenue $200.

Credit: Interest receivable $1.250, fee income $200. (monthly afterdrawdown)

18. Recognise $2.000 of fee income on completion of each review.

Debit: Cash $32.000. Credit: Deferred revenue $32.000. (on day1)

Debit: Deferred revenue $2.000. Credit: Fee Income $2.000. (after review)

19. Each year, you record $6 million as interest receivable, and $2 million assyndication fees.Debit: Loan receivable $100 million. Credit: Cash $100 million. (on day1)

Debit: Cash $8 million.Credit: Interest receivable $6 million, fees $2 million.(when interest is received)

20. Revenue will be recognised after the exhibition in December.Debit: Cash. Credit: Deferred revenue (in October).

21. The $100 can be recognised as the car clubs revenue when you areregistered. The membership fee will be recognised at the rate of $50 permonth.Debit: Cash $700. Credit: Revenue $100, Deferred revenue $600.

22. Recognise the sale when the inspection has been satisfactorilycompleted.Debit: Account receivable. Credit: Deferred revenue. (on day1)

Debit: Deferred revenue. Credit: Revenue. (after inspection).

23. Recognise only $65.600 ($80.000-($1200*12)=$65.600) as fee income atthe start of the year.Consider the remainder as a payment in advance of the monthly fee, andrecognise it at the rate of $1.200 per month to add to the monthly fee.

Debit: Cash $80.000.Credit: Revenue $65.600, Deferred revenue. $14.400. (on day1)

Debit: Deferred revenue $1.200. Credit: Revenue $1.200. (monthly).

24. Each time one is trained, credit $500 to fees.

Debit: Deferred revenue $500. Credit: Revenue $500.

25. Show this as a recharge, rather than revenue.Debit: Accounts receivable. Credit: Recharges-internal audit fees.

26. Recognise 20%($50.000-$10.000) = $8.000 of revenue.Debit: Cash $18.000.Credit: Revenue $8.000, Deferred revenue. $10.000.

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27. Recognise $7million per year.Debit: Cash $70 million.Credit: Revenue $7 million, Deferred revenue. $63 million. (Year 1)

28. Recognise the $100 million as a sale only when the drug receives FDA

approval.

Debit: Accounts receivable $100 million.

Credit: Deferred revenue. $100 million

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This publication has been produced with the assistance of the European Union.The contents of this publication are the sole responsibility of ZAO

PricewaterhouseCoopers and ACCA, FBK and Agriconsultingand can in noway be taken to reflect the views of the European Union.

workbook revenue upd-1

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