Financial Accounting 3 Topic 1 Revenue 1420 (5)

1 Educating Professionals Creating and Applying Knowledge Engaging our Communities

Financial Accounting 3

Unless otherwise stated all slides were prepared by John Medlin2

AssessmentAssignment 10%Essay 25%Exam 65%

Must achieve at least 50% in the final exam to pass the course

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Prepared for UniSA 2014 Prepared for UniSA 2014

2PrerequisitesMust pass FA2 to do FA3, cannot do them at the same time.Students who have failed FA 2 will be unenrolled after enrolment add deadline. By then, the chance to enrol in a different course will be gone.Students sitting deferred or supplementary exams may maintain their enrolment. Fail grades as a result of the deferred or supplementary exams will also result in them being unenrolled.

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Success Rates 80% of first timers pass the course 60% of repeat students passLets see if we can get this higher!!!If you re-run a race you need to work harder and smarterIf work, personal issues,illness etc. affect your study then withdraw

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Gym UniSAPaying University fees is like paying for Gym membershipYour lecturers & tutors are like personal trainers at the GymThey provide guidance and encouragement but you have to do all the work

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If the personal trainer does all the exercise

While you just play with your mobile phone

The trainer gets fit while you remain

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3Education is not a spectator sport: it is a transforming encounter. It demands active engagement; not passive submission; personal participation, not listless attendance.

(Rhodes, 2001, 65 cited in Gump, 2005).http://w3.unisa.edu.au/counsellingservices/balance/workload.asp

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CARTOON

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What do you expect?What do you expect to achieve by doing FA3?

What have you heard about the course?

Aspire to be great accountant, not an average one!!!

http://www.charteredaccountants.com.au/Students/Working-as-a-Chartered-Accountant

http://www.cpaaustralia.com.au/

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Financial Accounting 3

Topic 1: Revenue

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You have probably bought something in the last week or two.

So how does the company account for your purchase?

It is income but is it revenue or a gain?AASB118 / IAS18

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5Objectives1. Explain the nature of income, revenue and

other gains2. Apply recognition criteria as they apply to

revenue3. Account for revenues arising from various

types of transactions or other events in accordance with AASB118 / IAS18: Revenue

4. Apply the requirements of AASB111 / IAS 115. Apply the requirements for disclosure of

revenue in accordance with AASB118 / IAS 18

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ReadingChapter 15, Revenue recognition

Deegan (2012) Australian Financial Accounting, 7thedition

Available on course learnonline site under eReadingslink within Course EssentialsAASB118 / IAS18: Revenue

AASB111 / IAS11: Construction Contracts

Framework

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Real Company example of Revenue

What determines whether Income is recorded

here?or here?

20Y2 20Y1

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Revenues

Gains

20Y2 20Y1

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6Definition of Income, Revenue & GainsIncome defined (par. 70 of the AASB Framework) as

Income is divided into revenues and gains

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CARTOON

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Definition of Revenue & GainsRevenues generally relate to the ordinary income-generating activities of an entity

Gains relate to other incomenot necessarily part of the ordinary activities of an entity

Differentiation between revenue and gains in Framework para 74 & 75

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Definition of Revenue & GainsScope of AASB 118 / IAS18 Revenue is fairly restrictedapplies to accounting for revenue arising from transactions and events relating to (par. 1)

a) the sale of goodsb) the rendering of servicesc) the use by others of entity assets

yielding interest, royalties and dividendsRecognition criteria provided for each of the above categories of revenue, e.g. sale of goods (par. 14)

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7Definition of Revenue & GainsRevenue is measured at the fair value of the consideration or contributions received or receivable (par. 9)

if cash is received if cash is not to be received for some period

of time (refer to AASB 118 / IAS18, par. 11)

What if consideration is not cash?

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Income & revenue recognition current practice

AASB 118 / IAS18 (Illustrative Examples) provide guidance in relation to the recognition of different types of revenues.

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1Revenue?Revenue

Gain

Sale of non-current assetSale of inventoryProvision of serviceRevaluation of assetsGoods & Services TaxDividends

Revaluation of fin. Instru.

InterestRoyalties

Rent

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Accounting for sales with associated conditionsTransactions involving the sale of assets with conditions attached should be reviewed to assess whether

control of the future economic benefits has passed from the seller to the purchaser; and

it is probable that the inflow of economic benefits to the seller has occurred

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1Accounting for sales with associated conditions revenue recognition when right of return exists

Alternative treatments available when the seller is exposed to continued risks of ownership through return of the product

not record sale until all return privileges have expired

record sale but reduce sales by an estimate of future returns

record sale and account for returns as they occur

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Sale not recorded untilUnlikely land will be

returned

Accounting for sales with associated conditions sale and leaseback

ownership transferred to purchaser/lessor, but vendor/lessee normally retains controlfinancing arrangementleased property used as collateral for a loanTransaction does not constitute a sale and does not give rise to revenue

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Interest & dividends interest revenueInterest revenue recognised over timePrepayment of interest not regarded as revenue to lenderInterest revenue might be implicit in the terms of a transaction

for example, where goods are sold on extended credit, vendor is effectively financing the purchaser

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2Interest & dividends dividend revenueDividend revenue recorded once it is considered probable that inflow of future economic benefits has occurred and when these benefits can be measured reliably

in most cases this will be at the time the board of directors or other governing body proposed the dividend

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Dividends recognised once right to payment

established

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Usually once dividend declared

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House Proud Pty Ltd is operating a promotion selling furniture under the following conditions: Initial deposit of 20% of purchase price. Immediate delivery of furniture. Interest rate of 12.5%pa charged on the outstanding balance. Repayment of the balance (including the interest) over 24 equal monthly installments. House Proud retains legal title to the furniture until the final monthly payment has been made.House Proud would recognise revenue as follows:a)Recognise interest as it is received (monthly) and recognise the revenue on the sale of the goods upfront. b)Recognise the whole amount of revenue upfront c)Recognise interest as it is received (monthly) and recognise the revenue on the sale of the goods once the final payment has been received.d)Recognise all revenue as it is received

a) Recognise interest as it is received (monthly) and recognise the revenue on the sale of the goods upfront.

b) Recognise the whole amount of revenue upfront c) Recognise interest as it is received (monthly) and

recognise the revenue on the sale of the goods once the final payment has been received.

d) Recognise all revenue as it is received 36


3Unearned RevenueRecorded when payment is received in advance

The receipts have not been earnedConsidered to be liabilities

Refer to Worked Example 15.3 on page 534Revenue received in advance

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Educating Professionals Creating and Applying Knowledge Engaging our Communities

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Accounting for construction contractsAccounting issues result from some construction projects taking a number of financial periods to complete

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4 Deferral of revenue recognition until completion of project would result in greater volatility of reported revenues and of related profits or losses

Currently, governed by AASB 111 / IAS11 Construction Contracts

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AASB 111 / IAS11 requires use the percentage-of-completion method to account for construction contracts

Profit on construction contract is recognised in proportion to the work performed in each reporting period in which construction occurs

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Construction costs plus gross profit earned to date accumulated in (debited to) an inventoryaccount (Construction in progress)

Progress billings are credited to the Construction in progress account.

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Percentage of completion method

Reliable measurement

Real Company Example

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5Percentage of completion method

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Percentage-of-completion method should be used provided that certain conditions are met that enable the outcome of the contract to be reliably estimated

Revenue and expenses are recognised by reference to the stage of completion of the contract activity at the reporting date

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If conditions are not satisfied- no profit is to be brought to account until they are satisfied- at the extreme, no profit to be recognised until project completionNote When outcome of construction contract

cannot be estimated reliably (AASB 111 / IAS11, par. 32)(a) revenue is to be recognised only to the extent of

contract costs incurred that it is probable will be recoverable; and

(b) contract costs are to be recognised as an expense in the period in which they are incurred

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6Measuring progress towards completionPercentage of completion can be measured in a number of ways

may include(a) the proportion that contract costs incurred

for work performed to date bear to the estimated total contract costs;

(b) surveys of work performed; or(c) completion of physical proportion of the

contract work.

Progress payments and advances received from customers often do not reflect the work performed

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Measuring progress towards completionCost basis

Costs incurred to the end of the current periodMost recent estimate of total costs

Current period revenue or gross profit= estimated total revenue or gross profit

multiplied by percentage complete less total revenue or gross profit already recognised

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Disclosure requirementsAASB 111 / IAS11 requires that the balance sheet or accompanying notesdisclose the gross amount of work in progress (or contract costs incurred) the related aggregate billings deducted from the work in progress

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Application of percentage-of-completion method to account for construction contracts

Refer to Worked Example 15.4 on pp. 539Percentage-of-completion method


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Illustration accounting for construction contractBig Builder signed a contract on January 1, 20Y1, agreeing to build a warehouse for Storage Solutions at a contract price of $20,000,000. Big Builder estimated that construction costs would be as follows

20Y1 $5,000,00020Y2 $8,000,00020Y3 $3,000,000

$16,000,000

The contract provided that Storage Solutions would make payments on December 31 of each year as follows

20Y1 $ 4,000,00020Y2 $10,000,00020Y3 $ 6,000,000

$20,000,000The contract was completed and accepted on December 31, 20Y3. Assume that actual costs and cash collections coincided with expectations.


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Illustration accounting for a construction contract Income recognised each year

20Y1 20Y2 20Y3Contract price $20 000 000 $20 000 000 $ 20 000 000Less estimated cost:

Costs to date 5 000 000 13 000 000 16 000 000Estimated costs to complete 11 000 000 3 000 000 ___________

Estimated total cost 16 000 000 16 000 000 16 000 000

Estimated total gross profit/(loss) $ 4 000 000 $ 4 000 000 $ 4 000 000Per cent complete 31.25% 81.25% 100%

Gross profit: $4m * 31.25% = $1 250 000$4m * 81.25% - $1.25m = $2 000 000$4m * 100% - $1.25m - $2m = $750 000


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(b) Journal Entries P.O.C. Method20Y1 20Y2 20Y3

(i) To record costs incurredDr Construction in progress

(contract asset) 5 8 3Cr Cash, a/c pay., depn etc 5 8 3

(ii) To record billings to customersDr Accounts receivable 4 10 6

Cr Construction in progress(contract asset) 4 10 6


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(iii) To record cash collections 20Y1 20Y2 20Y3Dr Cash 4 10 6Cr Accounts receivable 4 10 6

(iv) To record periodic income recognisedDr Construction in progress

(contract asset) 1.25 2 0.75Dr Construction expenses(Statement of comp. income) 5 8 3Cr Revenue from LT Contract(Statement of comp. income) 6.25 10 3.75


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Long term contracts

20Y2 20Y1

Refer to Worked Example 15.5 on pp. 541Construction contract where outcome cannot be reliably estimated

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Accounting for long-term contract lossesWhen current estimates indicate that a loss is probable

provision should be made for any foreseeable loss on the contractloss is to be brought to account as soon as it is foreseeable

AASB 111 / IAS11 (par. 36)

Refer to Worked Example 15.6 on page 542Percentage of completion with recognition of a loss

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Expected Loss on Contract


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The future Comprehensive reform IFRS 15 Revenue from Contracts with Customers .Joint release with the US Financial Accounting Standards Board, which has issued a corresponding Accounting Standards Update of the same name. IFRS 15 represents 12 years of work 1500 comment letters as the project has progressed. Significant enhancements to the quality and consistency of how revenue is reported. (ICAA ANT March 2014)IFRS 15 from 1 January 2017, early adoption is permitted.

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The main objectives of the new standard are to:

single revenue recognition model based on the transfer of goods and services.

remove inconsistencies and weaknesses in existing revenue recognition standards

simplify the preparation of financial statements enhance disclosures about revenue, providing guidance

for transactions that were not previously addressed comprehensively (for example, service revenue and contract modifications) and improving guidance for multiple-element arrangements. (ICAA ANT March 2014)


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Financial Accounting 3 Topic 1 Revenue 1420 (5)