HAC311 TUTORIAL SOLUTIONS

CHAPTER 4: ACCOUNTING FOR REVENUE

Discussion Questions
1.What are the key distinctions between income and revenue? Why do you think the IASB made these
distinctions?
Income consists of revenue and gains, where revenue arises in the course of the ordinary activities of the
business while gains represent other items that meet the definition of income and may or may not arise in
the course of the ordinary activities of an entity. Hence, revenue is a subset of income to distinguish
between ordinary activities and other activities.
The IASB made the distinctions to differentiate income from ordinary activities from income from other
activities as each has a different effect on the entitys reported performance and each affects the decision
making of users differently. For example, gains from non-ordinary activities may be excluded from the
calculation of earnings-per-share (EPS) because they are non-frequent, thus investors may make their
decision to invest in a company based on profit from ordinary activities rather than profit after the inclusion
of gains from non-ordinary activities.

4. What are the recognition criteria for income under the Conceptual Framework? How do these differ from
the key stated purpose of IAS 18?
Under the Conceptual Framework, income is recognised when it is probable that the income has been
earned and that an inflow of economic benefits relating to an increase in an asset or a decrease in liability
can be measured reliably. Hence, the recognition of income occurs simultaneously with the recognition of
increases in assets and decreases in liabilities.
The key stated purpose of IAS 18 is to identify when revenue should be recognised, and revenue is recognised
when it is probable that future economic benefits will flow to the entity and these benefits can be measured
reliably. IAS 18 then specifies the circumstances in which these criteria will be met. In that sense, IAS 18
imposes additional revenue recognition criteria beyond those in the CF for recognition of income and the
recognition criteria are specified for sales of goods, rendering of services and interest, royalties and
dividends. For example, in the sale of goods, there is an additional criterion for recognition not in the CF
which is that the costs incurred or to be incurred in respect of the transaction can be measured reliably.
Hence, the IAS 18 does not strictly follow the recognition criteria set out in the CF.

5. What is a multiple-element transaction? Give two examples of these and discuss how IAS 18 applies to
such transactions.
Multiple-element transactions are those which provide bundled arrangements to customers. For example, a
telephone company may provide a telephone handset free of charge to a customer who subscribes for a
service contract with the company. Another example is when a television station company such as Sky
television provides a headset free of charge to customers who subscribe to their station.

Exercises:
4.1 State which transaction meets the definition of revenue under IAS 18 for Company Z, a retailer of toys.
Give reasons for your answer:
Definition of revenue under IAS 18, par. 7: the gross inflow of economic benefits during the period arising in
the course of the ordinary activities of an entity when those inflows result in increases in equity, other than
increases relating to contributions from equity participants.

1. Sales tax collected on behalf of the taxing authority

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Fails the definition of a revenue as there is no inflow of economic benefits as the GST is collected on behalf of
the government and is then payable to the government, hence there is no increase in equity.

2. Gain on the sale of an investment property

Fails the definition of a revenue as the sale of investment property is not an ordinary activity of Company Z
which is a toy retailer.

3. Amounts receivable from customers who have purchased toys

Meets the definition of revenue as the increase in asset (i.e. accounts receivable) is related to the sale of toys
which is the ordinary activity of Company Z. Such activities will result in the increase of equity.

4. Gain on the sale of equity securities held as investments

Fails the definition of a revenue as the sale of equity securities held for investment is not an ordinary activity
of Company Z, a toy retailer.

5. Revaluation increase on the revaluation of operating properties under IAS 16

Fails to meet the definition of a revenue as revaluation increase is not an ordinary activity of Company Z.

4.5 Company R sells plastic bottles. Wholesale customers that purchase more than 10,000 bottles per
month are entitled to a discount of 6% on their purchases. On 1 March, 2013, Customer P ordered 10 crates
of bottles from Company R. Each crate contains 2,000 bottles. The normal selling price per crate is $400.
Company R delivered the 10 crates on 15 March 2013. Customer P paid for the goods on 15 April 2013. The
end of Company Rs reporting period is 30 June.
Prepare the journal entries to record this transaction by Company R for the year ended 30 June 2013.

Solution:
Total revenue without discount = 10 crates x $400 = $4,000
Sales discount = $4,000 x 6% = $240
Revenue after sales discount = $4,000 - $240 = $3,760

Journal entry as per IAS 18 which requires revenues to be recognised net of trade discounts or volume
rebates:
Dr: Cash 3,760
Cr: Revenue 3,760

Note that this is the journal entry when payment is received on 15 April 2013. However, IAS 18 requires
revenue to be recognised once the goods have been delivered to the customer, which in this case is on 15
March 2013. Hence, to following journal entries record the revenue when it is recognised, and then
consideration when it is received.

Journal entry on 15 March 2013 when the bottles are delivered (and payment not yet received):
Dr: Accounts Receivable 3,760
Cr: Revenue 3,760

So when payment is received on 15 April 2013, the journal entry is:

Dr: Cash 3,760
Cr: Accounts Receivable 3,760

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If IAS 18 did not require trade discount to be deducted, the following journal entries would be recorded:
Dr: Accounts receivable 3,760
Dr: Discount allowed expense 240
Cr: Revenue 4,000

Dr: Cash 3,760

Cr: Accounts receivable 3,760

4.6 State at which date, if any, revenue will be recognised in each of the following situations:
IAS 18, par. 14 revenue from the sale of goods shall be recognised when all of the following conditions
have been satisfied:
(a) the entity has transferred to the buyer the risks and rewards of ownership of the goods;
(b) the entity retains neither continuing managerial involvement to the degree usually associated with
ownership nor effective control over the goods sold:
(c) the amount of revenue can be measured reliably;
(d) it is probable that the economic benefits associated with the transaction will flow to the entity; and
(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.

1. A contract for the sale of goods is entered into on 1 May 2013. The goods are delivered on 15 May 2013.
The buyer pays for the goods on 30 May 2013. The contract contains a clause that entitles the buyer to
rescind the purchase at any time. This is in addition to the normal warranty conditions.
The date of revenue recognition depends on whether the customers right to rescind the purchase is limited
or unlimited. If it is a limited right which expires after the payment of the goods by customer on 30 may
2013, then the significant risks and rewards of ownership have been transferred to the customer. When the
buyer pays for the goods, there is inflow of economic benefit. In this case, the revenue can be recognised on
30 May 2013 when the buyer pays for the goods.
If however, the customers right to rescind the purchase is unlimited, which is any time in the future even
after paying for the purchase, then the entity is obliged to take the goods back at any time and provide a
refund to the customer. In that sense, the entity has not transferred the significant risks and rewards of
ownership to the customer. Therefore, no revenue is recognised and this transaction is accounted for as a
financing transaction.
In practice, the revenue would most likely be recognised on the day the payment is received if the buyer is
given the right to rescind the purchase at any time in the future. If the buyer then decides to rescind the
purchase, then this would be recognised as sales returns.

2. A contract for the sale of goods is entered into on 1 May 2013. The goods are delivered on 15 May, 2013.
The buyer pays for the goods on 30 May 2013. The contract contains a clause that entitles the buyer to
return the goods up until 30 June 2013 if the goods do not perform according to their specification.
The revenue is recognised on 30 June 2013 when the clause that entitles the buyer to return the goods
expires. At this date, the entity has no more obligation to the customer and the significant risks and rewards
of ownership have been transferred to the buyer. Also, the economic benefits have been received when the
consideration was received.

3. A contract for the sale of goods is entered into on 1 May 2013. The goods are delivered on 15 May 2013.
The contract contains a clause that states that the buyer shall only pay for those goods that it sells to a third

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party for the period ended 31 August 2013. Any goods not sold to a third party by that date will be returned
to the seller.
In this case, the receipt of revenue by the entity is contingent on the buyer on-selling the goods. Unless the
buyer has sold the goods to a third party, the entity retains significant risks of ownership as the goods will be
returned if they are not sold by the 31 August 2013. Only the sale of goods that have been sold by the buyer
to a third party by the 31 August can be recognised as revenue, and these can be recognised on the date the
buyer on-sells the goods to the third party. Unsold goods that are returned to the entity by the buyer will not
be recorded as revenue.

4. Retail goods are sold with normal provisions allowing the customer to return the goods if the goods do
not perform satisfactorily. The goods are invoiced on 1 May 2013 and the customer pays cash for them on
that date.
Revenue in this case can be recognised on the 1 May 2013, the time the sale is made, so long as the entity
can reliably estimate future returns and recognise a liability for goods returned. When the goods are sold,
the risks of ownership have been transferred to the owner and the economic benefits have been received
when the cash payment was received from the customer.
In this case, the entity will recognise sales returns when the goods are returned by the customer.

4.7 Agreement between Company Z and Customer S states that the total consideration to be paid for the
system will be $860,000. Company Z expects its total costs for developing the system to be $670,000. At the
end of its reporting period, 30 June 2014, Company Z had incurred labour costs of $130,000 and materials
costs of $360,000. Of the material costs, $60,000 is in respect of materials that have not yet been used on
the system. Of the labour costs, $25,000 is an advance payment to a subcontractor who had not performed
his work on the project as at 30 June 2014. As at 30 June 2014, Customer S had made progress payments to
Company Z of $500,000.
Company Z has determined that IAS 11 does not apply to this transaction and calculates the percentage of
completion using paragraph 24(c) of IAS 18.
Calculate the revenue to be recognised by Company Z for the year ended 30 June 2014 and prepare the
journal entries to record the transactions described. Assume all of Company Zs costs are paid for in cash.
Solution:
In this case, the percentage of completion method is applied. The percentage of completion is calculated as
follows:
Costs incurred to date:
Labour costs 130,000
Materials 360,000
Total Costs to date 490,000
Less: costs for services not yet performed
Unperformed labour 25,000
Unused materials 60,000
Total 85,000
Total Actual Costs for the period 405,000 (490,000 85,000) (a)
Total Estimated Costs 670,000 (b)
Percentage complete 60% (rounded off) (a)/(b)
Total estimated revenue under the agreement 860,000 (c)
Revenue to be recognised as at 30 June 2014 519,850 60% x (c)

Journal entries:

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Dr: Labour Costs (expense) (130,000 25,000) 105,000
Dr: Material Costs (expense) (360,000 60,000) 300,000
Dr: Prepayments (490,000 105,000 300,000) 85,000
Cr: Cash 490,000
(To record costs incurred and payment for those costs)

Dr: Cash 500,000

Dr: Accounts receivable 19,850
Cr: Revenue 519,850
(To recognise revenue earned for the period using percentage completion method)

4.10 In each of the following situations, state at which date(s), if any, revenue will be recognised:
IAS 18, par. 20: When the outcome of a transaction involving the rendering of services can be estimated
reliably, revenue associated with the transaction shall be recognised by reference to the stage of completion
of the transaction at the end of the reporting period. The outcome of a transaction can be estimated reliably
when all the following conditions are satisfied:
(a) the amount of revenue can be measured reliably;
(b) it is probable that the economic benefits associated with the transaction will flow to the entity;
(c) the stage of completion of the transaction at the end of the reporting period can be measured
reliably; and
(d) the costs incurred for the transaction and the costs to complete the transaction can be measured
reliably.

1. A contract for the rendering of services is entered into on 1 May 2014. The services are delivered on 15
May 2014. The buyer pays for the services on 30 May 2014.
Revenue is recognised on the day the transaction is completed (stage of completion of transaction), which in
this case the date the service is delivered and is assumed to have been completed, the 14th May 2014. On this
day, it is probable that the economic benefits will flow into the entity when the customer has the obligation
to pay for the service performed, and the amount of revenue can be measured reliably.

2. A contract for the rendering of services is entered into on 1 May 2014. The services are delivered
continuously over a 1-year period commencing on 15 May 2014. The buyer pays for all the services on 30
May 2014.
The IAS states that the revenue from rendering of services is recognised by reference to the stage of
completion of the transaction at the end of the reporting period. IAS 18, par. 25 however, states that
revenue for services performed by an indeterminate number of acts over a specified period of time is
recognised on a straight-line basis over the specified period. It is not clear from this case whether the
percentage of completion method can be used for recognition, therefore, the proviso under par. 25 can be
used, in which the revenue is recognised on a straight-line basis over the period of service.
Hence, if the financial year end is 30 June, then the revenue for the period 15 May 2014 30 June 2014 will
be recognised on 30 June 2014 using a straight-line method. The revenue relating to the period 1 July 2014
14 May 2015 will be recognised on 30 June 2015, the end of the financial period, based on the straight-line
method. The payment received from the buyer on 30 May 2014 would be recorded as deferred revenue, a
liability, until the revenue is recognised. Thus, the journal entries would be as follows:
30 May 2014
Dr: Cash xxx
Cr: Deferred revenue xxx

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To record payment received in advance from customer

30 June
Dr: Deferred revenue xx
Cr: Revenue xx
To record revenue as services are provided to customer

3. A contract for the rendering of services is entered into on 1 May 2014. The services are delivered
continuously over a 1-year period commencing on 15 May 2014. The buyer pays for the services on a
monthly basis, commencing on 15 May 2014.
The IAS states that the revenue from rendering of services is recognised by reference to the stage of
completion of the transaction at the end of the reporting period. IAS 18, par. 25 however, states that
revenue for services performed by an indeterminate number of acts over a specified period of time is
recognised on a straight-line basis over the specified period. In this case, if the monthly payments are made
in relation to the completion of monthly service, then the revenue can be recognised at the completion of
performing the service at the end of each month. Thus, at the end of each month, the following journal entry
would be made:
Dr: Accounts receivable xx
Cr: Revenue xx
To record revenue for service performed during the month

When payment is received from the customer:

Dr: Cash xx
Cr: Accounts receivable xx
To record payment received for services performed.

4. Company A is an insurance agent and provides insurance advisory services to Customer B. Company A
receives a commission from Insurance Company I when Company A places Customer Bs insurance policy
with Insurance Company I, on 1 April 2014. Company A has no further obligation to provide services to
Customer B.
The commission revenue is recognised on 1 April 2014 when Company A places Customer Bs insurance
policy with Insurance Company I. The service has been provided by Company A with the completion of a
significant act (in accordance with par. 25 of IAS 18 the placement of the insurance policy).

5. Company A is an insurance agent and provides insurance advisory services to Customer B. Company A
receives a commission from Insurance Company I when Company A places Customer Bs insurance policy
with Insurance Company I, on 1 April 2014. Company A is required to provide ongoing services to Customer
B until 1 April 2015. Additional amounts are charged for these services. All amounts are at market rates.
The commission revenue is recognised on 1 April 2014 when Company A places Customer Bs insurance
policy with Insurance Company I. The service has been provided by Company A with the completion of a
significant act (in accordance with par. 25 of IAS 18 the placement of the insurance policy). The revenue for
the ongoing services will be recognised when those services have been performed as those services are
charged for separately from the advisory service relating to the placement of Customer Bs insurance policy.

6. Company A receives a non-refundable upfront fee from Customer B for investment advice, on 1 March
2014. Under the agreement with Customer B, Company A must provide ongoing management services until

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1 March 2015. An additional amount is charged for these services. The upfront fee is higher than the market
rate for equivalent initial investment advice services.
Although the upfront fee received by Company A from Customer B is non-refundable, the upfront fee is
higher than the market rate. According to IFRIC, if the fee is in substance related to ongoing services until 1
March 2015, then the revenue from the upfront fee should be deferred. Thus, no revenue is recognised until
the ongoing service period has expired, on 1 March 2015. On this date, the upfront fee can be recognised as
revenue, and the additional amounts charged can be recognised when the advisory service has been
performed.