CAEA1214 Lecture 1 Revenue Semester 2 2015 2016

8/18/2019 CAEA1214 Lecture 1 Revenue Semester 2 2015 2016

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CAEA1214: FINANCIAL

ACCOUNTING AND REPORTING II

REVENUE


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Outline

• Measurement issue

• Recognition issue

• Sale of goods

• Rendering of services

References:

• S Chapter 5; S & S Chapter 7 & 8

• MFRS118 & MFRS101

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S Chap. 5;

S & S Chap. 7 & 8; MFRS118 & MFRS101


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Learning Objectives

After this lecture, students are able to understand the

requirements of MFRS118, specifically:

• What is revenue?

• Issues relating to revenue:

1. When to recognize revenue.

2. How to measure revenue.

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Why revenue is important?

• To determine the amount of income earned by an

entity in a particular accounting period.

• Income = Revenue + Gain – (Expenses + Losses)

• Income is defined in the Framework for the

Preparation and Presentation of Financial

Statements as increases in economic benefits

during the accounting period in the form of inflows

or enhancements of assets or decreases ofliabilities that result in increases in equity, other

than those relating to contributions from equity

participants.

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What is Revenue?

Revenue is income that arises in the course of ordinary

activities of an entity and is referred to by a variety of

different names including sales, fees, interest, dividends

and royalties.

MFRS118, P7:

Revenue is the gross inflow of economic benefits

during the period arising in the course of the ordinaryactivities of an enterprise when those inflows result in

increases in equity, other than increases relating to

contributions from equity participation.

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What is Revenue?

•Increases in equity can be in the form of:

inflows or enhancements of assets, or

decreases of liabilities

•Ordinary activities including sale of goods (sales

revenues), provision of services (fees), uses of

funds/other resources (interest; dividends; royalties).

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What is Revenue?

• Some inflows of economic benefits do not result in

the increases in equity for the company – some eg.

(P8): amounts collected on behalf of third parties such as

sales taxes, goods and services taxes and value

added taxes, or

amounts collected on behalf of the principal in anagency relationship; revenue for an agent is the

amount of commission earned from a particular

service provided to the principal.

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Conceptual Framework

ASSETS

LIABILITIES

EQUITY

Assets - Liabilities = Equity or net assets

RetainedEarnings

Share capital

+

Contributions

by owners

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Conceptual Framework

Framework

REVENUE EXPENSES

INCOME

Revenue - expenses = operating income

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•Assets•Liabilities

•Equity

•Investments by owners

•Distributions to owners•Income

•Revenue

•Expenses

•Gains•Losses

Balance sheet

Income Statement

Statement ofmovement in equity

How do you distinguish the followings:

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When to recognize revenue?

• The primary issue in accounting for revenue is

determining when to recognize revenue, i.e. the

timing.

• Revenue is recognized when it is probable that

future economic benefits will flow to the entity

and these benefits can be measured reliably.

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Revenue arises from MFRS118, P1:

Sale of goods – P3 Rendering of

services – P4

Use of entity’s

assets: interest,

royalties &

dividends – P5

Goods

produced

by entity

Goods purchased

for resale

Land & other property

held for resale

Performance of a

contractually agreed task

e.g. Construction contracts – MFRS111

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Use of Resources – P5

(a) Interest — charges for the use of cash or cashequivalents or amounts due to the entity;

(b) Royalties — charges for the use of long-term

assets of the entity, for example, patents,

trademarks, copyrights and computer software; and(c) Dividends — distributions of profits to holders of

equity investments in proportion to their holdings

of a particular class of capital.

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Revenue is the first item that appears in the incomestatement – MFRS101, P82 (see also the example given

in P102).

It represents the gross inflow of cash, receivables or otherconsiderations arising in the ordinary activities of an

enterprise.

What is meant by “ordinary activities”?? Ordinary activities are any activities which are

undertaken by the company as part of the main operations

of the company.

Presentation of Revenue

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How is revenue measured?MFRS118, P9 - 10:

Revenue should be measured at the fair value of the

consideration received or receivable minus any tradediscounts or rebates allowed.

What is fair value??

Fair value is the amount for which an asset could beexchanged, or a liability settled, between knowledgeable,

willing parties in an arm’s length transaction – P7.

Measurement of Revenue

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Measurement of revenue is usually straight forward.

However, in the following circumstances, substance

over form considerations are applied:

• Barter trade or exchange transaction – P12

• In substance financing arrangements – P11

• Combination of sale and services example,

franchising arrangements


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Barter trade: if transactions consists of exchanges of

non-cash assets – need to differentiate as either similar or

dissimilar assets. Only recognize as revenue in the case of

dissimilar assets;How to determine the amount of revenue?

Measured at the fair value of the goods or services

received, adjusted by the amount of any cash or cash

equivalents transferred or the fair value of the goods or

services given up, adjusted by the amount of any cash or

cash equivalents transferred.



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Important point to note:

Revenue can only be recognized if it has been

earned or realized, not a mere transfer of assets.


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Example 1

On 2nd February 2016 Awan Bhd transferred trading

merchandize to Emas Bhd with a cost of RM1,000,000 for

an invoice amount of RM1,020,000. In return Awan Bhd

received from Emas Bhd trading merchandize at a cost ofRM1,010,000 and can be sold at a retail price of about

RM1,030,000. Apart from the exchange of merchandize,

Awan Bhd. paid cash of RM100,000 to Emas Bhd.

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Example 1

Question: Can the transaction be recognized as revenue

by Awan Bhd?

The transaction should be treated as a mere transfer ofmerchandize and not as a realized sale transaction.

Why?

Because it involves a swap of inventories in variouslocations to fulfill demand on a timely basis in a particular

location, both of which are for the purpose of Awan’s

trading operations – P12.

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Example 1: Solution

In the book of Awan Bhd.Journal entries:

RM’000 RM’000

Dr. Inventories account 1,010(for the good received from Emas Bhd)

Cr. Inventories (old) account 1,000(for the good transferred to Emas Bhd)

Cr. Cash account 100

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Example 2

Refer to example 1, assume that the transaction

represents a sale of goods to Emas Bhd. Emas Bhd pays

for the goods by transferring a machine to Awan Bhd.

The fair value of the machine is RM 1,010,000.

Question: How should this transaction be recognized byAwan Bhd?

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Example 2: Solution

In this case, this is an exchange of dissimilar assets &

therefore, Awan Bhd should recognize the transaction as

a sales revenue. The amount of revenue should be

measured at RM 1,010,000, which is the fair value of the

machine received – P12.

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Example 2: Solution

In the book of Awan Bhd.Journal entries:

RM’000 RM’000 Dr. Machinery account (under PPE) 1,010

Cr. Sales revenue 1,010

Dr. Cost of goods sold 1,000Cr. Inventories account 1,000

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What do you do when you cannot measure reliably the

fair value of the non-cash asset received?

• Measure by reference to the fair value of goodssold/services provided, or

• Use selling prices for goods and services

Example 2: Solution

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Example 3

Awan Bhd sold goods to Emas Bhd with a cost ofRM1,020,000 for an invoice amount of RM1,060,000.

In payment for the goods received, Emas Bhd

transferred non-cash asset to Awan Bhd worth about the

invoice amount, the fair value of which cannot bedetermined reliably. The normal selling price of Awan’s

goods is 50% markup on cost.

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Question: How will Awan Bhd measure this revenue?

Example 3

Amount of sales should be based on the normal selling

price less trade discounts given.So based on the normal selling price, amount of revenue

would have been RM1,080,000 (i.e. 150% x

RM1,020,000).

The difference between this amount and the actual invoicevalue should be deemed as trade discounts allowed to the

buyer.

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In the book of Aman Bhd.

Journal Entries:

RM’000 RM’000

Dr. Sundry assets 160Cr. Sales revenue 160

Dr. Cost of good sold 120

Cr. Inventories account 120

Example 3

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In Substance Financing – P11

How??

For example, a company gives credit under hire purchaseor installment plan, hence, necessary to split up the total

consideration receivable into:

• Revenue from sale of goods; and

• Interest revenue for the financing provided.

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1. Value of revenue from the sale of goods may be measured

by discounting all future receipts using an implicit rate ofinterest in the arrangement; or

2. The equivalent cash sale price is used if it is clearly more

evident.

• The imputed rate of interest is the more clearlydeterminable of either:

• (a) the prevailing rate for a similar instrument of an issuer

with a similar credit rating; or• (b) a rate of interest that discounts the nominal amount of

the instrument to the current cash sales price of the

goods or services.

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•This revenue should be recognized based on the

normal requirement for sale of goods.

•The interest revenue is measured as the difference

between the total consideration receivable and the fairvalue of the sales revenue; the interest revenue should

be spread over the financing period.

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Example 4

Baba Bhd sold a machine with a cost of RM1,000,000to Nyonya Bhd on 12 February 2016. The terms of the

sale include a five annual installments of RM300,000

each payable at the end of each year. The cash selling

price of the machine is RM1,020,000.

Question: How will you record the revenue in the

accounts of Baba Bhd ?

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Example 4: Solution

The total consideration receivable is RM1500,000 (i.e.RM 300,000 x 5 years). The cash selling price of the

machine is RM1,020,000 and may be used to measure the

revenue from the sale of goods.

Therefore, the difference of RM480,000 should be treated

as interest revenue and be recognized over the five years

period using an appropriate basis such as sum of digitmethod or straight line method.

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In the book of Bayu BhdJournal Entries:

RM’000 RM’000

Dr. Debtor’s account 1,500

Cr. Sales revenue 1,020Cr. Deferred interest revenue 480

Dr. COGS 1,000

Cr. Machinery Inventories account 1,000

Example 4: Solution

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At the end of each year, over the five years period, an

appropriate amount is recognized as interest revenue as

follows:

Example 4: Solution

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The total interest revenue is allocated over a 5 year period based on sum of digits method.

Sum of digits = 1+2+3+4+5= 15

allocation of interest: SOD SL

2014 5/15 x 480,000 = 160,000 96,0002015 4/15 x 480,000 = 128,000 96,000

2016 3/15 x 480,000 = 96,000 96,000

2017 2/15 x 480,000 = 64,000 96,000

2018 1/15 x 480,000 = 32,000 96,000480,000 480,000

Example 4: Solution

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Journal Entries:

RM’000 RM’000

2016 Sum of digits Straight line

Dr. Cash 300 300

Cr. Debtor account 300 300

Dr. Deferred revenue 160 96

Cr. Interest revenue 160 96

Example 4: Solution

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Combination of sales of goods and

rendering of services – P13

For example:

• Sales of computer software plus free after sale services

and technical support;

• Franchise arrangements which cover initial supply of

equipment and continuing services;

• Sale of goods which provide after sale services for

specified periods.

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bi i f l f d d


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Then, you have to split the transactions into two:

• Sale of goods

•

Services to be rendered.

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Combination of sales of goods and

rendering of services – P13


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Example 5

Mapple Bhd entered into a franchise arrangement with

BBM Bhd for the latter to use and market its patented

computer software, Doors.

The arrangement calls for payment of RM100 million upfront to cover initial supply of software and technical

support and services because Doors is unique to BBM

Bhd itself and there is no market equivalent service price

of this nature.

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However, the estimated cost to provide the technical

support and services, based on the company similar

franchise arrangements in the past, is about RM20 million

and it is considered that a 50% mark-up on cost is areasonable profit for services.

Example 5

Question: How would you record the franchise revenue?

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Example 5: Solution

The fair value of the service revenue should be measuredfirst.

In this case, it can be measured with reference to the given

cost plus a reasonable profit:

RM20 million x 150% = RM30 million.

This service revenue of RM30 million may be recognized

progressively over the five years period by reference to

the stage of completion of the services provided. The

difference of RM70 million represents revenue from the

sales of the software.

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The measurement issue also affects the timing of revenuerecognition.

How?

Revenue must be reliably measured before it can berecognized.

When there are uncertainties relating to the measurability of

the amount of revenue arising from a transaction, revenuerecognition should be postponed until the uncertainties are

resolved.


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Recognition of Revenue

Sale of Goods – P14:

Provided that the amount is measurable and it is not

unreasonable to expect ultimate collection, then revenue

is recognized when following conditions are satisfied:

• The enterprise has transferred to the buyer the

significant risks and rewards of ownership of the

goods, see also P15.• All significant acts have been completed see also P16 .

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• The enterprise retains no continuing managerialinvolvement in or effective control of the goods

transferred to a degree usually associated with ownership,

see also P17; and


• No significant uncertainty exists regarding:• consideration• costs

• Returns, see also P17, 18 and 19.

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Service Revenue:

Essential feature: Performance – P20

• Revenue is recognized as the service is performed(stage of completion method) provided that no

uncertainty exists regarding:1. Consideration

2. Costs3. Stage of completion.


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• The stage of completion/percentage of completionmethod – revenue is recognized in the accounting

periods in which the services are rendered.

• The recognition of revenue on this basis provides

useful information on the extent of service activityand performance during a period.


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The stage of completion may be determined by a variety

of methods include:(a) surveys of work performed;

(b) services performed to date as a percentage of total

services to be performed; or

(c) the proportion that costs incurred to date bear to the

estimated total costs of the transaction. Only costs

that reflect services performed to date are included in

costs incurred to date. Only costs that reflect services performed or to be performed are included in the

estimated total costs of the transaction.


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Interest revenue:

Interest should be recognized on a time proportion basis

taking into account the principal outstanding and therate applicable – MFRS118, P30 (a).

However,


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For Financial institutions in Malaysia, the recognition ofinterest revenue on loans & advances must also be inaccordance with BNM guidelines (BNM/GP3 and GP8)relating to suspension of interest on non-performing

loans.Covered under specialized accounting course


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Example 6

May Bank Berhad grants a loan of RM1 million on 1

April 2015 at an interest rate of 12 % per annum to a

client.

Question: What is the amount of interest to be recognizedas revenue by May Bank for year ended 31 December

2015?

May Bank Berhad should recognize an interestincome of RM90,000 ( i.e. RM 1,000,000 x 9/12 x

12%)

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Royalties:

Royalties should be recognized on an accrual

basis in accordance with the term of the relevant

agreement – MFRS118, P30(b).


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Example 7

Kuari Bhd owns a granite quarry. Bitumen Bhdoperates the quarry. The royalty agreement between

Kuari Bhd and Bitumen Bhd stipulates that Kuari

Bhd should be paid RM100 for every square meterof granite extracted by Bitumen Bhd.

Question: When will Kuari Bhd recognize theroyalty revenue?

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As and when Bitumen Bhd extracts the granite,

usually there will be some form of statement

which Bitumen Bhd should submit to Kuari Bhd

and Kuari Bhd will recognize accordingly as the

statement been received.

Example 7

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Dividend revenue:

Dividends should be recognized when the

shareholder’s right to receive payment is

established – MFRS118, P30 (c).


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Example 8

Angkasa Bhd is an investment company. It hasinvestments in shares of listed companies on

Bursa Malaysia. Its year end is 30 June. It had the

following shares:Counter No of Shares Dividend/ Date

Share Declared

A 100,000 0.02 31.03.15

B 200,000 0.05 30.04.15C 300,000 0.10 30.09.15

D 100,000 0.10 01.01.16

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Question: What is the dividend revenue recognizedfor the year ended 30 June 2016?

Example 8

Counter No of Shares Dividend/ Date

Share DeclaredA 100,000 0.02 31.03.15

B 200,000 0.05 30.04.15

C 300,000 0.10 30.09.15

D 100,000 0.10 01.01.16

Financial year end: 01/07/15 - 30/06/16

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Dividend revenue recognized for the year ended 30 June

2016:

C shares (300,000 x 0.10) = RM 30,000

D shares (100,000 x 0.10) = RM 10,000Gross dividends RM 40,000

Example 8

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MFRS118 id i t f


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MFRS118 provides circumstances of

uncertainties relating to the measurement

of revenue:

Consideration

Costs

Returns

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Guide to test for revenue


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Is ultimate collection reasonably

expected?

Yes

NoDeferrecognition

Is consideration reasonably

determinable?

Yes

No

Defer

recognition


recognition…

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Are costs (including warranties) to be

incurred reasonably determinable?

Are returns significant and

unpredictable?

Yes

Defer

recognition

Defer

recognition

No

Recognize revenue

Yes

No

Yes


recognition…

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Disclosure Requirements

P35:

• Accounting policies adopted, 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

recognized;

• The amount of revenue arising from exchange of goods

or services;

• Any contingent liabilities or assets (P36).

Documents

CAEA1214 Lecture 1 Revenue Semester 2 2015 2016