MAICSA STUDY MANUAL

Chapter 10 REVENUE

15.1 This standard deals with the recognition of revenue arising in the course of the ordinary
activities of the enterprise from: -
a. The sale of goods
b. The rendering of services, and
c. The use by others of enterprise assets yielding interest, royalties and dividends.

15.2 WHAT IS REVENUE

 Revenue can be simply regarded as the cash you receive when you sell something – an
exchange transaction. For example, an exchange of an item of inventory for cash, the
accounting entries would be to derecognised the inventory and recognised the asset of cash or
trade receivable.

 The Framework defines INCOME as increases in economic benefits during the accounting
period in the form of inflows or enhancements of assets or decreases in liabilities that results
in the increase in equity, other than those relating to the contributions from equity
participants. It further states that income encompasses both revenues and gains.

 FRS 118 defines REVENUE is the GROSS INFLOW of economic benefits during the period
arising in the COURSE OF THE ORDINARY ACTIVITIES of an enterprise when those
inflows result in INCREASES IN EQUITY, other than increases relating to the contributions
from equity participants.
Example 1

The following transactions occur in an accounting period for entity A

 1 million RM1 shares are issued at a premium on nominal value of RM2

 property is sold for RM3 million
 Entity A deals in the retail of Grammies and makes sales of RM300,000, 60% of which are
on credit.
Identify the revenue for entity A in accordance with FRS 118.

 FAIR VALUE is the amount for which an asset could be exchanged or liability settled,
between knowledgeable, willing parties in an arm's length transaction.

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
PROBABLE is defined as more likely than not to occur and a probability of greater than 50
percent would be regarded as more likely than not to occur.
[NUMBERING: TO USE 15 ONLY. PLS RENUMBER WHOLE WKSHEET]

16 MEASUREMENT & RECOGNITION OF REVENUE

 Revenue recognition is mainly concerned with the point in time when income is recognised, i.e.
the timing of the recording of revenue, in the income statement of an enterprise.
There are two traditional principles involved in recognised the revenue.

 Accruals principle – Revenue is earned when the goods have been provided or when the
services have been rendered.

 Realisation principle – Revenue is earned when cash has been received or when the
likelihood of a cash receipt is a probable expectation.

 The amount of revenue arising on a transaction is Measured at the Fair Values of the
consideration received or receivable that is usually determined by agreement between the
enterprise and the buyer of the asset (net of any trade discount and volume rebates).

 It excludes amounts collected on behalf of third parties such as sales taxes, goods and services or
value added tax.

 In an agency relationship, the revenue is the amount of commission and not the gross inflow of
cash received or receivable or other consideration.

Example 2
An entity receives RM500 for the sale of an item of inventory. This amount subjects to a sales tax
of 25% on cost which is payable to the tax authorities. The entity also sells another item of
inventory on behalf of the principal for which it only retains a 20% commission charge on the
selling price.

Identify the revenue to the entity in accordance with FRS 118.

 However, when the inflow of cash or cash equivalents is DEFERRED, the fair value of the
consideration may be less than the amount of cash received or receivable. Thus, in an interest free
credit to the buyer, the fair value of the consideration is determined by DISCOUNTING all future
receipts using an imputed rate of interest. The difference between the fair value and the nominal
amount of the consideration is recognised as interest revenue.

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Example 3
Cost of an item is RM120,000 and was disposed of for RM280,000. The sale proceed was to be
received in 3 years' time. Discount rate is 8%.

 When goods or services are exchanged or swapped (barter trade) for goods or services that are
SIMILAR in nature and value, (for example commodities like oil or milk where suppliers
exchange in various locations to fulfil demand on a timely basis in a particular location) the
exchange is NOT regarded as a transaction which generates revenue. This is because it involves
giving up one class of inventory and receiving another class of inventory, both of which are for
the purpose of the same trade.
Example 4
A transferred trading inventory to B (cost price of RM400,000) at invoiced value of RM500,000.
In return, B transferred trading inventory at a cost of RM450,000, invoiced value RM550,000 to
A.

A also paid RM50,000 to B as full settlement.

Determine the accounting entries of the above transactions.

 When goods are sold or services are rendered in exchange for DISSIMILAR goods or services, the
exchange is regarded as a transaction that generates revenue. The revenue is measured at the fair
value of the goods or services received, adjusted by the amount of any cash or cash equivalents
transferred.
Example 5
Same as example 4 above but B pays for the inventory by transferring a machine with a fair value
of RM500,000 to A.

17 IDENTIFICATION OF THE TRANSACTION

 As revenue is considered as arising from an exchange transaction which gives rise to gross
inflows from ordinary activities, it follows that the exchange transaction can be viewed as a
contract between a seller and a buyer that will give rise to an increase in equity.

 The recognition criteria should be applied separately to IDENTIFIABLE components in order

to reflect the SUBSTANCE of the transaction. In other words, the standard requires that
conditions have to be met before revenue can be recognised. FRS 118 identifies that revenue
arises from three types of transaction and event:

A) SALE OF GOODS

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 The standard provides that revenue from the sale of goods should be recognised when
ALL the following conditions have been satisfied: -
 The seller has transferred to the buyer the significant risks and rewards of ownership
of the goods,
 The seller retains neither continuing managerial involvement to the degree usually
associated with ownership nor effective control over the goods sold,
 The amount of revenue can be measured reliably,
 It is probable that the economic benefits associated with the transaction will flow to
the enterprise, and
 The costs incurred or to be incurred in respect of the transaction can be measured
reliably.
 The key point to recognise revenue from the sale of goods is that the seller has transferred
to the buyer significant risk and rewards of ownership. If the seller retains significant
risks of ownership, the transaction is not a sale and revenue is not recognised. If the
seller retains only an insignificant risk of ownership, the transaction is a sale and revenue
is recognised.
The following situations in which the seller may retain the significant risks and rewards
of ownership are: -

i. When the seller retains an obligation for unsatisfactorily performance not covered by
normal warranty provisions;
ii. When the receipt of the revenue is contingent on the derivation of revenue by the
buyer from its sale of the goods;
iii. When the goods subject to installation are shipped and the installation is a significant
part of the contract which has not yet been completed by the enterprise;
iv. When the buyer has the right to rescind the purchase for a reason specified in the
sales contract and the enterprise is uncertain about the probability of return.
 When uncertainty arises about the collectability of an amount already included in
revenue, the uncollectable amount in doubt is recognised as an expense, for example
doubtful debts.

Example 6
An entity transfers assets to a customer as follows:

 4,000 bottles of wine in exchange for RM4,000 cash with the option for the customer is
allowed to return as many of the bottles, unopened, within 7 days and claim a refund of
the cash paid for each.
 400 of glasses in exchange for RM100 cash where the customer is required to [?] all
glasses within 7 days or pay the full price for them.
Identify in each case whether a sale has occurred and therefore revenue should be
recognised.

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Examples of situations where the seller transfers the significant risks and rewards of ownership are: -

 ‘Bill and hold’ sales, i.e. delivery are delayed at buyer’s request but buyer takes title and accepts
billing.

Revenue is recognised when the buyer takes title, provided: -

 It is probable that delivery will be made;

 The item is on hand, identified and ready for delivery to the buyer at the time the sales is
recognised.
 The buyer specifically acknowledges the deferred delivery instruction; and
 The usual payment terms apply
Revenue is not recognised when there is simply an intention to acquire or manufacture the
goods in time for delivery.

 Sales on approval

Revenue should not be recognised until the buyer has formally accepted the shipment or the
time period for rejection has lapsed.

 Guaranteed sales i.e. shipment is made giving the buyer an unlimited right of return.

Recognition of revenue in such circumstances will depend on the substance of the agreement.

In the case of normal retail sales (e.g. chain store offering ‘money back if not completely
satisfied’) it may be appropriate to recognise the sale but to make a suitable provision for
returns based on previous experience. In other case, the substance of the agreement may
amount to a sale on consignment, in which case it should be treated as indicated below.

 Consignment sales i.e. a shipment is made whereby the recipient undertakes to sell the goods
on behalf of the shipper.

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Revenue should not be recognised until the goods are sold to a third party.

 Instalment sales

When the consideration is receivable in instalments, revenue attributable to the sales price
exclusive of interest should be recognised at the date of sale. The interest element should be
recognised as revenue, proportionately to the unpaid balance due to the seller. If collection is
not reasonably assured, revenue should be recognised when cash instalments are received.

RENDERING OF SERVICES
 When the outcome of a transaction involving the rendering of services that can be estimated
reliably, revenue associated with the transaction should be recognised by reference to the
stage of completion (also known as the percentage completion method) of the transaction at
the statement of financial position date.
 The outcome of a transaction can be estimated reliably when all the following conditions are
satisfied: -
 The amount of revenue can be measured reliably;
 It is probable that the economic benefits associated with the transaction will flow to the
enterprise;
 The stage of completion of the transaction at the statement of financial position date can be
measure reliably;
 The costs incurred for the transaction and the costs to complete the transaction can be
measured reliability.

 Revenue from service transactions is usually recognised as the service is performed and when
no significant uncertainty exists regarding.
(i) The consideration that will be derived from rendering the service, and
(ii) The associated costs incurred or to be incurred in rendering the service.

 The Percentage Of Completion Method is appropriate where performance consists of the

execution of more than one act. Under this method revenue is recognised proportionately in
each accounting period on the basis of:
(i) Surveys of the work performed;
(ii) Services performed to date as a percentage of total services to be performed; or
(iii) The proportion that costs incurred to date bear to the estimated total costs of the
transaction.

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 When services are provided by an indeterminate number of acts over a specific period of
time, revenue is recognised on a straight-line basis over the specific periods unless there is
evidence that some other methods better represent the pattern of performance.

 Progress payments and advances received from customers often do not reflect the services
performed.

 When the outcome of the transaction involving the rendering of services cannot be estimated
reliable, revenue should be recognised only to the extent of the expenses recognised that are
recoverable.

Example 7

Delta has a contract with Zippo to provide daily security services for a period of three years. The
contract involves a payment by Zippo of RM100,000 per annum and commences at Delta’s
opening statement of financial position.
Determine how the revenue should be recognised.

Example 8

A recruitment agency has contract with Omega to seek and appoint a new chief executive. The
contract is for a period of 18 months. On the appointment of the CE the agency will receive a
payment of RM30,000.

Determine when should the revenue be recognised.

Examples of the recognition of revenue from services rendered:

 Installation fees

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In cases where installation fees are other than incidental to the sale of a product, they should be
recognised as revenue only when the equipment is installed and accepted by the customer.

 Admission fees

Revenue from artistic performances, banquets and other special events should be recognised
when the event takes place. When a subscription to a number of events is sold" the fee should be
allocated to each event on a systematic and rational basis.

 Tuition fees
Revenue should be recognised over the period of instruction.

 Franchise fees

Generally, franchise fees may cover the supply of any combination of initial and subsequent
services, equipment and other supplies, know-how etc. Frequently, the determination of such
matters, and the allocation of the franchise fee thereto, are difficult and require considerable
judgement. As a general guidance, however, the following methods of fee recognition may be
appropriate: -

 The portion of the initial franchise fee that relates to tangible assets (if any) should be
recognised when the items are delivered
 The portion that applies to future services (if any) should be deferred and recognised as
revenue when the services are rendered
 If continuing fees receivable under the agreement are inadequate to cover the cost and a
reasonable profit level for the continuing services, recognition of some or the entire initial
franchise fee should be delayed.

Example 9

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XYZ enters into a franchise agreement with ABC for the use and market its patented branded
products. The arrangement requires an initial payment of RM16 million to cover the initial
supply of equipment plus technical support and services for the next 5 years.

The cost of technical support and services is estimated to be RM1 million per annum and it is
considered that a 60 % mark-up is considered a reasonable profit for the services.

Determine how the RM16 million franchise fee should be recognised as revenue in the books
of XYZ.

 Initiation entrance and membership fees.

Revenue recognition from those sources will depend on the nature of the services being provided.

If the fee permits only membership, and all other services or products are paid for separately, or if
there is a separate annual subscription, the fee should be recognised when received. If the fee
entitles the member to services or publications to be provided during the year, it should be
recognised on a systematic and rational basis having regard to the timing and nature of all
services provided.

INTEREST, ROYALTIES AND DIVIDENDS

 Revenue arising from the use by others enterprise assets yielding interest royalties and
dividends should be recognised on the bases set out below when: -
 It is probable that the economic benefits associated with the transaction will flow to the
enterprise; and
 The amount of revenue can be measured reliable.

 Revenue should be recognised in the following bases: -

 Interest should be recognised on a time proportion basis that takes into account the
effective yield on the asset;

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Example 10
AB invested RM2 million at simple interest rate of 6% p.a. in a bank on 1 April 20x5.
What is the interest revenue for the year ended 31 December 20x5 assuming there is no
significant uncertainty on realisation of the revenue?

 Royalties should be recognised on an accrual basis in accordance with the substance of

the relevant agreement;
Example 11
A royalty agreement states that the owner of a mining company should be paid RM8 for
every ton of minerals extracted. During the year ended 31 December 20x6, a total of
5,000 tonnes of minerals have been extracted and only $30,000 has been paid.

What is the amount of royalty revenue to be recognised?

 Dividends should be recognised when the shareholder's right to receive payments is

established i.e. when the shareholders’ name appears in the register of members at the
date when the register is closed for the purpose of determining shareholders entitlement
to the dividends.

5) DISCLOSURE

 An enterprise should disclose: -

 The accounting policies adopted for the recognition of revenue including the methods
adopted to determine the stage of completion of transactions involving the rendering of
services;
 The amount of each significant category of revenue recognised during the period
including revenue arising from: -
 The sale of goods;
 The rendering of services;
 Interest;
 Royalties; and
 Dividends.
 The amount of revenue arising from exchanges of goods or services included in each
significant category of revenue. For example,

 Licence fees and royalties

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Fees and royalties paid for the use of an enterprise's assets (such as trademarks, patents,
software, music copyright, record masters and motion picture films) are normally recognised
in accordance with the substance of the agreement. As a practical matter, this may be on a
straight-line basis over the life of the agreement, for example, when a licensee has the right
to use certain technology for a specified period of time.

Question 2

The timing of revenue (income) recognition has long been an area of debate and inconsistency in
accounting. Industry practice in relation to revenue recognition varies widely; the following are
examples of different points the operating cycle of businesses that revenue and profit can be
recognized:

- on the acquisition of goods;

- during the manufacture or production of goods;

- on delivery/acceptance of goods;

- when certain conditions have been satisfied after the goods have been delivered;

- receipt of payment for credit sales;

- on the expiry of a guarantee or warranty.

In the past the ‘critical event’ approach has been used to determine the timing of revenue
recognition. The International Accounting Standards Committee (IASC) in its ‘Framework for the
Preparation and Presentation of Financial Statements (Framework) has defined the ’elements’ of
financial statements, and it uses these to determine when a gain or loss occurs.

Required:
 Explain what is meant by the critical event in relation to revenue recognition and discuss the
criteria used in the Framework for determining when a gain or loss arises. (5 marks)

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 For each of the stages of the operating cycle identified above, explain why it may be an
appropriate point to recognize revenue and, where possible, give a practical example of an
industry where it occurs. (12 marks)

 Jenson has entered into the following transactions/agreements in the year to 31 March 2000:
(i) Goods, which had cost of RM20,000, were sold to Wholesaler for RM35,000 on 1 June 1999.
Jenson has an option to repurchase the goods from Wholesaler at any time within the next
two years. The repurchase price will be RM35,000 plus interest charged at 12% per annum
from the date of sale to the date of repurchase. It is expected that Jenson will repurchase the
goods.
(ii) Jenson owns the rights to a fast food franchise. On 1 April 1999 it sold the right to open a new
outlet to Mr. Cody. The franchise is for five years. Jenson received an initial fee of RM50,000
for the first year and will receive RM5,000 per annum thereafter. Jenson has continuing
service obligations on its franchise for advertising and product development that amount to
approximately RM8,000 per annum per franchised outlet. A reasonable profit margin on the
provision of the continuing services is deemed to be 20% of revenue received.
(iii) On 1 September 1999 Jenson received total subscriptions in advance of RM240,000. The
subscriptions are for 24 monthly publications of a magazine produced by Jenson. At the year-
end Jenson had produced and despatched six of the 24 publications. The total cost of
producing the magazine is estimated at RM192,000 with each publication costing a broadly
similar amount.

Required:

Describe how Jenson should treat each of the above examples in its financial statements in the year to
31 March 2000. (8 marks)

Question 3

Identify for the following transaction if and when the risks and rewards associated with the
transaction have been passed between the parties concerned.

1) A publisher sells books to a retailer on sale or return. If the books are not sold the retailer returns

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them to the publisher for a refund. It is impossible to estimate reliably how many books will
remain unsold.
2) A retailer offers a 12-month guarantee on all its products whereby a customer can the return the
products for whatever reasons and have a full refund. In the normal course of business it has been
found that 1% per annum of its products are subject to such refunds.
3) A software house develops a customized finance system for a customer. Title to the software
passes to the customer on a given date but included in the agreement is a three-month warranty
period beyond this date to cover the need for amendments or debugging of the system. It is
impossible to estimate the potential for these costs.
4) A piece of machinery is sold by Alpha Enterprise to Beta for RM100,000. In addition Beta is
required to pay RM75,000 to Alpha for the installation of the machinery. The machine is
inoperable without the installation.
5) Alpha sells another machine to Gamma but under an agreement that allows Gamma to return the
machine if a contract Gamma is seeking, and for which it needs the machine, is not won. No
information is available on the likelihood of Gamma’s winning the contract.

Question 4

Identify when the revenue, if indeed there is such, in the following transactions should be
recognised.

a) An entity sells a product plus a servicing agreement for three years for RM30,000. The product
without the service could be sold at fair value of RM18,000.
b) Commitment fees received by an entity to originate or purchase a loan.
c) Advertising media commissions carried out for a client where inflows will be received when the
advert is exposed in the media.
d) Tuition fees paid to Citypro.

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