IAS 18 – Revenue

5 Recognition of revenue

IAS 18 has prescribed the recognition criteria by dividing the transactions and events into three different categories which are as follows:

1. the sale of goods;
2. the rendering of services; and
3. the use by others of entity assets yielding interest, royalties and dividends.

5.1 Sale of goods

Goods include goods produced by the entity for the purpose of sale and goods purchased for resale, such as merchandise purchased by a retailer or land and other property held for resale.

Criteria

Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied:

1. the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
2. the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
3. the amount of revenue can be measured reliably;
4. it is probable that the economic benefits associated with the transaction will flow to the entity; and
5. the costs incurred or to be incurred in respect of the transaction can be measured reliably.

How to know risks and rewards have been transferred?

It depends on circumstances that need careful examination to assess whether transfer has occurred or not. In some cases transfer takes place with the transfer of the title of ownership or possession to the buyer but in some cases transfer occurs at a different time from the transfer of title or possession.

What if risks and rewards have not been transferred?

If the entity retains significant risks of ownership, the transaction is not a sale and revenue is not recognised. An entity may retain a significant risk of ownership in a number of ways. Examples of situations in which the entity may retain the significant risks and rewards of ownership are:

1. when the entity retains an obligation for unsatisfactory performance not covered by normal warranty provisions;
2. when the receipt of the revenue from a particular sale is contingent on the derivation of revenue by the buyer from its sale of the goods;
3. when the goods are shipped subject to installation and the installation is a significant part of the contract which has not yet been completed by the entity; and
4. when the buyer has the right to rescind the purchase for a reason specified in the sales contract and the entity is uncertain about the probability of return.

However, if an entity retains only an insignificant risk of ownership, the transaction is a sale and revenue is recognised.

What if probability of inflow is weak?

Revenue is recognised only when it is probable that the economic benefits associated with the transaction will flow to the entity. In some cases, this may not be probable until the consideration is received or until an uncertainty is removed. However, when an uncertainty arises about the collectibility of an amount already included in revenue, the uncollectible amount or the amount in respect of which recovery has ceased to be probable is recognised as an expense, rather than as an adjustment of the amount of revenue originally recognised.

What if revenue or costs incurred cannot be measured reliably?

Revenue and expenses that relate to the same transaction or other event are recognised simultaneously; this process is commonly referred to as the matching of revenues and expenses. However, revenue cannot be recognised when the expenses cannot be measured reliably; in such circumstances, any consideration already received for the sale of the goods is recognised as a liability.

5.2 Rendering of services

The rendering of services typically involves the performance by the entity of a contractually agreed task over an agreed period of time. The services may be rendered within a single period or over more than one period. Services related to construction contracts are not dealt in this standard.

Criteria

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:

1. the amount of revenue can be measured reliably;
2. it is probable that the economic benefits associated with the transaction will flow to the entity;
3. the stage of completion of the transaction at the end of the reporting period can be measured reliably; and
4. the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.

What is stage of completion method?

The recognition of revenue by reference to the stage of completion of a transaction is often referred to as the percentage of completion method. Under this method, revenue is recognised 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 activity and performance during a period.

What if probability of inflow is weak?

Revenue is recognised only when it is probable that the economic benefits associated with the transaction will flow to the entity. However, when an uncertainty arises about the collectibility of an amount already included in revenue, the uncollectible amount, or the amount in respect of which recovery has ceased to be probable, is recognised as an expense, rather than as an adjustment of the amount of revenue originally recognised.

How to determine stage of completion?

The stage of completion of a transaction may be determined by a variety of methods. An entity uses the method that measures reliably the services performed. Depending on the nature of the transaction, the methods may include:

1. surveys of work performed;
2. services performed to date as a percentage of total services to be performed; or
3. 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.

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

What if outcome of the transaction cannot be measured reliably?

An entity is generally able to make reliable estimates after it has agreed to the following with the other parties to the transaction:

1. each party’s enforceable rights regarding the service to be provided and received by the parties;
2. the consideration to be exchanged; and
3. the manner and terms of settlement.

However, if there is uncertainty about any of the factor and thus unable to judge the outcome of the transaction then revenue shall be recognised only to the extent of the expenses recognised that are recoverable.

When the outcome of a transaction cannot be estimated reliably and it is not probable that the costs incurred will be recovered, revenue is not recognised and the costs incurred are recognised as an expense.

When the uncertainties that prevented the outcome of the contract being estimated reliably no longer exist, revenue is recognised as normal

5.3 Interest, Royalties and Dividends

The use by others of entity assets gives rise to revenue in the form of:

1. interest—charges for the use of cash or cash equivalents or amounts due to the entity;
2. royalties—charges for the use of long-term assets of the entity, for example, patents, trademarks, copyrights and computer software; and
3. dividends—distributions of profits to holders of equity investments in proportion to their holdings of a particular class of capital.

Criteria

General provisions:

Revenue arising from interest, royalties and dividends shall be recognised when:

1. it is probable that the economic benefits associated with the transaction will flow to the entity; and
2. the amount of the revenue can be measured reliably.

Specific provisions:

1. interest shall be recognised using the effective interest method as set out in IAS 39
2. royalties shall be recognised on an accrual basis in accordance with the substance of the relevant agreement; and
3. dividends shall be recognised when the shareholder’s right to receive payment in respect of dividend is established.

When unpaid interest has accrued before the acquisition of an interest-bearing investment, the subsequent receipt of interest is allocated between pre-acquisition and post-acquisition periods; only the post-acquisition portion is recognised as revenue.

Royalties accrue in accordance with the terms of the relevant agreement and are usually recognised on that basis unless, having regard to the substance of the agreement, it is more appropriate to recognise revenue on some other systematic and rational basis.

Revenue is recognised only when it is probable that the economic benefits associated with the transaction will flow to the entity. However, when an uncertainty arises about the collectibility of an amount already included in revenue, the uncollectible amount, or the amount in respect of which recovery has ceased to be probable, is recognised as an expense, rather than as an adjustment of the amount of revenue originally recognised.

6 Disclosures:

An entity shall disclose:

1. 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;
2. the amount of each significant category of revenue recognised during the period, including revenue arising from:
   1. the sale of goods;
   2. the rendering of services;
   3. interest;
   4. royalties;
   5. dividends; and
   6. the amount of revenue arising from exchanges of goods or services included in each significant category of revenue.

An entity discloses any contingent liabilities and contingent assets. Contingent liabilities and contingent assets may arise from items such as warranty costs, claims, penalties or possible losses.