How Revenue Is Treated in Accordance with IAS 18 - Assignment Example

PART A. Introduction This assignment will explore revenue as set out in IAS 18. The discussion will explore how revenue is treated in accordance with IAS 18. The discussion will also outline the IAS 18 principles underpinning for the recognition criteria for Revenue. Specifically, the discussion will identify each part and explore the recognition criteria applied. The discussion will also identify the principles underpinning the measurement of Revenue. Last but not least, the paper will outline some of the difficulties and solutions in implementing IAS 18 Revenue. These principles will be applied to a case in real life practice to test their applicability. Question one: Define Revenue according to IAS 18. According to IAS 18, revenue is simply the gross inflow of financial benefits (receivables, cash, and other assets) emanating from the normal operating activities of a business (like sales of services, sales of goods, royalties, dividends and interest) (Elliott & Elliott 2013 ). Accordingly, an exchange for services or goods of a comparable value and nature is not considered as a transaction that yields revenue. Though, exchanges for dissimilar goods and services are considered as revenue generation. Question Two IAS 18 outlines the underpinning principles for the recognition criteria for Revenue in three different parts. Identify each of the three parts and discuss the recognition criteria for each part. The three principles are sale of goods, provision of services and finally Interest, royalties and dividend (Connolly 2013). 1.  Sale of goods: According to IAS 18, revenue is recognized only when all the following circumstances have been fully satisfied: (a) When the significant amount of risks and rewards have been transferred by the seller to the buyer in the form of ownership (Kirk 2005). (b) When the seller loses the control of ownership or control over goods and services that have been transferred to the buyer. (c) It is possible to measure the amount of generated revenue with ease (d) When there is guarantee that the seller will ultimately benefit from the transaction between him and the buyer. (e) When the expenses that have been incurred by the seller, from the dealings with the customer, can be reliably measured. Basing on the above conditions, it is notable that: Some of the conditions particularly (a) and (b) are subject to some level of interpretation ( Picker & Loftus 2013). 2. Provision of services: Basing on the above statement, there is a dissimilar approach taken to the realization or recognition of revenue particularly from the services that have been provided ( Holt, Tweedie, & Richard 2013). In short, instead of realizing the revenue at one point such as the sale of goods, it should be realized gradually. According to IAS 18, in order to estimate the outcome of a transaction reliably the following conditions are met: (a) The revenue generated can be reliably measured. (b) When there is a likelihood that the seller will benefit from the transaction economically. (c) At the end of the transaction, it is easier to measure the completion stage (Holt, Tweedie, & Richard 2013). (d) The costs of the transaction both to date and completion stage can be measured reliably. IAS 18 indicates that though it does not provide for methods of measuring the transaction at completion stage, the following methods are suitable: (a) Surveys of work performed. (b) Services performed calculated as the percentage of total services to be carried out. (c) The percentage that expenses incurred bear to the transaction costs. 3. Interest, dividends and royalties According to IAS 18, businesses should recognize or realize revenue from the usage of their assets to yield royalties, dividends and interest particularly when: (a) there is a likelihood that the benefits accruing from the transaction will significantly benefit the business (b) the revenue generated out of the transaction can be measured without difficulty The exact procedure for the realization of income from the use particularly by others of the assets of the seller depends on the transaction type: (a) it is on the effective interest basis that interest revenue should be realized. (b) Royalties should be realized on the basis of accruals in line with amounts receivable from the use of assets (Greuning 2001). (c) Dividend revenue, on the other hand, should be realized when the right particularly to receive payment is set. Question three: Briefly identify and discuss the principles underpinning the measurement of Revenue IAS 18 indicates the need to measure revenue at the fair value of the consideration received (Greuning 2001). However, in the case where the consideration or payment is deferred, the arrangement will constitute the substance of the transaction and a financing transaction. In such situations, the amount receivable is classified into: (a) The receivable amount for the supply of services and goods (Zülch 2011). (b) An amount receivable for the supply of finance to the buyer. Question four: Outline some of the difficulties in implementing IAS 18 Revenue and briefly discuss current efforts by the professional standard setters to decrease the difficulties The key challenges associated with the implementing of IAS 18 Revenue is that its principles for revenue recognition are quite broad. In addition, under IAS 18, there is clarity on how to recognize revenue. Professional bodies have introduced the principle of IFRS 15 ( Bragg 2011). With this principle, a business recognizes revenue to show the transfer of services or goods to clients. In addition, it reflects the payment to which the business expects for having offered goods and services. Part B Introduction In accordance with IAS 18, “Revenue shall be measured at the fair value of the consideration received or receivable” (12) (Deloitte, 2014). Some of the aspects that are taken into account when determining the fair value includes volume rebates or trade discounts granted by the seller. Ordinarily, ‘fair value’ corresponds to the cash or cash equivalents received. Nevertheless, in the event that the consideration takes place in the future (deferred), IAS 18 requires that such an arrangement should be taken as a financing transaction while the provision of finance and supply of goods and services is the substance of the transaction. This report is an analysis of 3 different scenarios, which represent different treatments of revenue recognition, in accordance with AIA 18 provisions. Scenario 1 On 1 January 2014, the fund that the seller would receive is divided into: i. The sales amounting to €10,000 (w1), which is recognised straight away by debiting receivables and crediting revenue. ii. Interest revenue amounts to €3,310 (w2), which is recognised over the three years, including 2014, 2015, and 2016, as shown below: Year ended 31st December Opening receivable (€) Finance income (10%) (€) 2014 10,000 1,000 11,000 2015 11,000 1,100 12,100 2016 12,100 1,210 13,310 Consequently, the cash receivable is recognised on 1 January 2017, when it is received. The double entry would be done as follows: Receivable (Dr) €10,000 Revenue (Cr) €10,000 When interest is received (2014)..... Cash (Cr) €11,000 Revenues (Cr) €11,000 Scenario 2 Apparently, the above case shows that two or more essential conditions for the recognition of revenue following sale of goods have been violated, including: i. Whiskey Distillers (WD) retains rewards and risks of ownership even though legal ownership has been transferred to the buyer. ii. Whiskey Distillers (WD) retains managerial responsibilities to the extent of ownership. As such, it is not correct for Whiskey Distillers to recognise revenue when goods are sold to the buyer for €450,000, on 1 January 2014. Instead, the sales revenue ought to have been recognized as a loan, attracting 8.5% annual finance cost. Therefore, the loan should be distributed for the subsequent 5 years, as follows. Year ended 31 December Opening borrowing € Finance cost (8.5%) € 2014 450,000 38,250 488,250 2015 488,250 41,501.25 529,751.25 2016 529,751.25 45,028.86 574,780.11 2017 574,780.11 48,856.31 623636.42 2018 623636.42 53,009.10 676,645.52 The purchase on 1 January 2014, which is near re-purchase, will remove the loan. Double entry... Finance cost (Dr) 38,250 Loan (Dr) 450,000 Revenue (Dr) 488,250 Scenario 3 The excepted cost of providing free services, is €5,000 (2*€2,500). This amounts to €6250 (€ 5,000*100/80), based on the normal service work margin. For that reason, Whirlwash Plc would recognise €33,750 (€40,000-€6250) as the revenue from the proceeds, at the supply date. On the other hand, service revenue would amount to €6250, for the subsequent two years, following the supply. Nevertheless, the current scenario is complicated since, although the fair value is known, the products are supplied at a special price. Conclusion This report shows different scenarios that relates to revenue recognition. The approach is guided by the provisions of IAS 18, which states that “Revenue shall be measured at the fair value of the consideration received or receivable” (12) (Deloitte, 2014). This is a very significant role of the accountants, after all revenue is a critical aspect of financial statements, which aids in assessment of an entity’s position and financial performance. Apparently, both revenue recognitions in the Financial Reporting Standards (IFRSs) and in US generally accepted accounting principles (GAAP) are very useful, but they both need some improvements in their grey areas. References Bragg, S., 2011, IFRS made easy. Hoboken, N.J: John Wiley & Sons. Deloitte, 2014. IAS 18 – Revenue (online) Available from < http://www.iasplus.com/en/standards/ias/ias18> (accessed 1 November 2014). Holt, G., Tweedie, D., & Richard, P., 2013, International financial reporting standards (ifrs) workbook and guide : practical insights, case studies, multiple-choice questions, illustrations. Hoboken, N.J: Wiley. Picker, R., & Loftus, J., 2013, Applying International Financial Reporting Standards. Milton, Qld: Wiley. Connolly, C., 2013, International Financial Accounting and Reporting. Dublin: Chartered Accountants Ireland. Elliott, B., & Elliott, J., 2013, Financial Accounting and Reporting with MyAccountingLab Access Card. Harlow : Pearson Education, Limited. Greuning, H., 2001, International accounting standards : a practical guide. Washington, DC: World Bank. Kirk, R., 2005, International Financial Reporting Standards in Depth. Amsterdam ; Boston: Elsevier/ Butterworth Heinemann/CIMA Pub. Zülch, H., 2011, International Financial Reporting Standards (IFRS) 2011. Weinheim: Wiley-VCH. Appendix W 1: €13,310/1.103 = 10,000 W2: 13,310 – 10,000 = 3,310 Read More