04 Revenue - s18 - Final - Gripping Gaap Graded Questions PDF

Preview

Summary

Solution 4.Part A – Definitions and overview of the processa) Revenue is defined as: income arising in the course of an entity's ordinary activities. IFRS 15 App A Revenue thus differs from income in that it is simply a type of income – one that arises from ordinary activities. Thus, income can aris...

Description

Solutions to GAAP: Graded Questions

Revenue from contracts with customers

Solution 4.1 Part A – Definitions and overview of the process a) Revenue is defined as: • • •

income arising in the course of an entity's ordinary activities. IFRS 15 App A

Revenue thus differs from income in that it is simply a type of income – one that arises from ordinary activities. Thus, income can arise from a variety of other sources, including an entity's activities that are not considered to be 'ordinary'. Thus, income from an entity’s activities that are not considered to be ‘ordinary’ would not meet the definition of revenue. b) False. IFRS 15 does not apply to all contracts. It is only applicable if the contract: • • • •

meets the definition of a contract and involves a customer/s that meet the definition of a customer; and is not covered by another accounting standard (IFRS) (e.g. lease contracts & insurance contracts); and does not involve:   

the exchange of non-monetary items between entities in the same line of business to facilitate sales to customers or potential customers. See IFRS 15.5-6

c) Revenue recognition and measurement involves a 5-step process. These 5 steps are as follows: Step 1: Identify whether we have a contract with a customer. Step 2: Identify the performance obligations contained in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the identified performance obligations. Step 5: Recognise revenue when the performance obligations are satisfied. d) Revenue is recognised when the performance obligations inherent in the contract have been satisfied, allowing the entity to be entitled to that revenue. See IFRS15.9 e) A contract asset is an entity’s right to consideration in exchange for goods or services that the entity has transferred to a customer when that right is conditioned on something other than the passage of time. A receivable is the right to receive payment per IFRS 9, where that right in the context of IFRS 15 arises out of the satisfaction of a performance obligation. Part B continues on the next page

© Service & Kolitz, 2018

Chapter 4: Page 1

Solutions to GAAP: Graded Questions

Revenue from contracts with customers

Solution 4.1 continued… Part B – Identifying the contract f) A customer is defined as: • • • •

a party that has contracted with an entity to obtain goods or services that are an output of the entity's ordinary activities in exchange for consideration. IFRS 15 App A

g) A contract is defined as: • •

an agreement between two or more parties that creates enforceable rights and obligations. IFRS 15 App A

h) If the contract does not meet the definition of a contract as provided in IFRS 15:

i)

•

we would not be able to recognise receipts from the customer as revenue and would thus have to recognise these as a refund liability instead; and

•

we would have to continually reassess whether the criteria necessary to meet the contract definition have subsequently been met, in which case the refund liability would then be reversed and recognised as revenue.

In order to conclude that we have a contract that would fall within the scope of IFRS 15, there are 5 criteria that must be met: • • • • •

It must be approved by all parties who are also committed to fulfilling their obligations. Each party’s rights to the goods and/or services must be identifiable. The payment terms must be identifiable. The contract must have commercial substance. It must be probable that the entity will collect the consideration to which it expects to be entitled. See IFRS 15.9

Part C – The transaction price j)

The transaction price is defined as: • • • •

The amount of consideration To which an entity expects to be entitled In exchange for transferring goods or services to a customer Excluding amounts collected on behalf of third parties. See IFRS 15 App A

k) The transaction price is C120 000, irrespective of how much is considered to be probable of being recovered. Collectability of the consideration is not considered when measuring the transaction price. Collectability is only considered when determining whether a valid contract existed (see the fifth criteria listed in the solution to part (i) above). •

If the consideration to which the entity expects to be entitled is considered to be probable of being collected, we would have a contract, the transaction price of which would be C120 000.

•

If the consideration to which the entity expects to be entitled is not considered to be probable of being collected, we would not have a contract and thus IFRS 15 would not apply.

© Service & Kolitz, 2018

Chapter 4: Page 2

Solutions to GAAP: Graded Questions

Revenue from contracts with customers

Solution 4.1 continued… Part C continued … l)

Constraining estimates is a process that is applied when determining the amount of variable consideration to be included in the transaction price. Constraining estimates simply means limiting the amount of variable consideration to be included in the transaction price: The amount that we include in the transaction price is limited in a way that ensures that it is 'highly probable that a significant reversal' of revenue will not be required when the uncertainty around this consideration is eventually resolved. See IFRS 15.56

m) The variable consideration to be included in the transaction price is calculated as follows: Step 1: Estimate the amount of variable consideration, using either the ‘most likely amount’ or an ‘expected value’; and then Step 2: Limit this estimate to an amount that is ‘highly likely of not resulting in a significant reversal of revenue in the future’. n) A contract is said to contain an element of financing (i.e. a ‘financing component’) if the following dates differ: • •

the date of transfer of goods or services, and the date of settlement agreed to in the contract (explicitly or implicitly).

See IFRS 15.60

This financing component could provide the benefit to either the customer or the entity. o) The existence of a financing component in the contract may or may not affect the calculation of the transaction price: •

If the period between these dates is equal to or less than a year, the effect of financing may be ignored (the practical expedient).

•

If the period between these dates is greater than a year, but the effect of the financing is considered to be insignificant, then the effect of financing may be ignored.

•

If the period between these dates is greater than a year but the effect of the financing is considered to be significant, then the contract is said to contain a significant financing component. In this case, the transaction price must be adjusted to exclude the effects of the financing.

p) The effect of financing (if it is considered to be significant) is calculated by: •

First measuring the transaction price at the cash price: The cash price is calculated at the present value of the expected consideration to which the entity expects to be entitled.

•

Then, calculate the effect of financing: The effect of financing is the difference between this cash price and the expected consideration.

The interest (expense or income) is then recognised over the period of the financing using the effective interest method described in IFRS 9 Financial instruments.

© Service & Kolitz, 2018

Chapter 4: Page 3

Solutions to GAAP: Graded Questions

Revenue from contracts with customers

Solution 4.1 continued… Part C continued … q) When calculating the present value of consideration to which the entity expects to be entitled, we must use an appropriate discount rate. A discount rate is appropriate if it: •

is determined at contract inception, and

•

is the rate: -

that the entity and the customer would have agreed upon had they entered into a separate financing contract, and

-

takes into account the specific circumstances at contract inception regarding: o

the credit risk of the borrower and

o

any security that the borrower may have offered. See IFRS 15.64

Part D – Allocating the transaction price r) The allocation of a transaction price means apportioning the transaction price to each of the performance obligations contained in the contract. s) The allocation of a transaction price to the various performance obligations is normally done based on their relative stand-alone selling prices. If there is only one performance obligation, the entire transaction price is allocated to that one performance obligation. See IFRS 15.74

t)

If an item is sold as part of a bundle but this item has never been sold on an individual basis before, the transaction price allocated to this item is allocated on a ‘residual basis’. This means that the transaction price for the entire bundle is first allocated to each of the items in the bundle which have been sold before (and for which we can estimate a standalone selling price). Once this has been completed, the remaining amount (i.e. the residual amount) is allocated to the item which has not been sold on its own before.

u) For an item that has been sold on an individual basis before and is now sold as part of a bundle, the transaction price is allocated on a ‘proportionate basis’. This means that if there are two items in a bundle costing C120 000, and product A was previously sold for C70 000 and product B was sold for C100 000 on a standalone basis, then the C120 000 is allocated to each product proportionately. Thus, C49 412 will be allocated to product A and C70 588 to product B. Part E – Satisfying the performance obligations v) A performance obligation is defined as: •

A promise contained in a contract

•

To transfer to a customer either: 

A distinct good or service or bundle of goods or services; or



A series of distinct goods or services that are: 

substantially the same; and



have the same pattern of transfer to the customer. See IFRS 15.22 (reworded)

© Service & Kolitz, 2018

Chapter 4: Page 4

Solutions to GAAP: Graded Questions

Revenue from contracts with customers

Solution 4.1 continued… Part D continued … w) Performance obligations are classified as either: • •

satisfied over time or satisfied at a point in time.

x) We must measure an entity’s ‘ progress towards complete satisfaction of a performance obligation’ when this performance obligation is classified as ‘satisfied over time’. y) Progress may be measured using either: •

an input method (e.g. costs incurred to date as a percentage of total costs expected to be incurred); or

•

an output method (e.g. work certified to date as a percentage of total work to be certified).

z) The essential difference between the input method and output method of measuring progress towards complete satisfaction of the performance obligation is that: •

The input method is a measure of the entity’s efforts to date towards completion of the performance obligation.

•

The output method is a measure of the value that the customer has received to date.

© Service & Kolitz, 2018

Chapter 4: Page 5

Solutions to GAAP: Graded Questions

Revenue from contracts with customers

Solution 4.2 ADAPTATION: It may be of interest to you to extend the ‘required’ by including a further part (part D), showing the effects of a financing component: Part D: An entity signs a contract with Mr Lime for an amount of C100 000 on 1 January 20X1. The terms of the contract require that the goods be transferred to the customer immediately but that the customer pay the entity on 31 December 20X2. The appropriate discount rate, determined at contract inception, is 10%. Required: a)

Calculate the transaction price assuming that the effect of the financing is considered to be insignificant and show the journal entries for the year-ended 30 June 20X1 assuming that the goods were transferred to the customer on 1 January 20X1.

b) Calculate the transaction price assuming that the effect of the financing is considered to be significant and show the journal entries for the year-ended 30 June 20X1 assuming that the goods were transferred to the customer on 1 January 20X1. c)

Briefly explain your answer to part (a) and part (b) above.

Part A Discounts a) Transaction price = Contract price: C100 000 – Expected early settlement discount: C10 000 = C90 000 b) The transaction price is the amount of consideration to which the entity expects to be entitled. Thus, if the entity expects that the customer will qualify for the discount, the entity expects to be entitled to C90 000 (C100 000 – C10 000). Part B Rebates a) Transaction price = Contract price: C100 000 – Expected rebate: C40 000 = C60 000 b) The transaction price is the amount of consideration to which the entity expects to be entitled. Thus, if the entity expects that the customer will qualify for the rebate, the entity expects to be entitled to C60 000 (C100 000 – C40 000). Part C Financing (less than a year of financing – always ignored) a) Transaction price = Contract price: C100 000 b) Transaction price = Contract price: C100 000 c) The transaction price was not adjusted for the financing component in either part (a) or part (b),. This is because, whether or not the effects of the financing are considered to be significant, the period between the date of transfer of the goods or services and the date of settlement is only 6 months: the effects of financing are only accounted for if the period is greater than a year. Part D continues on the next page…

© Service & Kolitz, 2018

Chapter 4: Page 6

Solutions to GAAP: Graded Questions

Revenue from contracts with customers

Solution 4.2 continued… Part D Financing (more than a year of financing) a)

Transaction price = Contract price: C100 000 Debit 1 January 20X1 Receivable (A) Revenue from customer contract Revenue from customer contract satisfied at a point in time

Credit

100 000 100 000

No further journals would be required. b) Transaction price = Present value of the contract price: C82 645 Debit 1 January 20X1 Cash price: PV of Receivable (A) consideration (see calc below) Revenue from customer contract Revenue from customer contract satisfied at a point in time 30 June 20X1 Receivable (A) 82 645 x 10% x 6/12 Interest income (I) Interest income recognised on the significant financing component using the effective interest method

Credit

82 645 82 645

4 132 4 132

PV can be calculated using a financial calculator or using a basic calculator as follows: C100 000 ÷ 1.1 ÷ 1.1 = 82 645 c)

The transaction price is only adjusted for the financing component if the period between transfer of the goods or services and the date of settlement is greater than a year and the effects of the financing are considered to be significant. -

Part (a): although the period of financing was greater than a year, the effects of the financing were considered to be insignificant and thus the transaction price was not adjusted.

-

Part (b): the period of financing was greater than a year and the effects of financing were considered to be significant, and thus the transaction price needed to be adjusted.

© Service & Kolitz, 2018

Chapter 4: Page 7

Solutions to GAAP: Graded Questions

Revenue from contracts with customers

Solution 4.3 a) Journals during the year ended 30 June 20X1: Debit 28 February 20X1 Contract price Receivable (A) Receivable: settlement discount allowance (-A) Given Transaction price Revenue from customer contract Revenue from customer contract satisfied at a point in time 1 April 20X1 Given Receivable: settlement discount allowance (-A) Revenue from customer contract Settlement discount forfeited by the customer is reversed and recognised as revenue (the TP has increased since the entity now expects to be entitled to a higher amount) 5 April 20X1 Contract price Bank (A) Receivable (A) Receipt from customer is recorded

Credit

100 000 10 000 90 000

10 000 10 000

100 000 100 000

Transaction price at contract inception: (Contract price: 100 000 – Expected discount: 10 000) b) Discussion: The transaction price is the amount of consideration to which the entity expects to be entitled. Thus, if the entity expects that the customer will qualify for the discount, the entity expects to be entitled to C90 000 (C100 000 – C10 000) and thus this amount is said to be its transaction price. The contract involves a single performance obligation and thus the entire transaction price of C90 000 (C100 000 – C10 000) is allocated to the single performance obligation. Journal on 28 February 20X1: Revenue is recognised as and when the performance obligations are satisfied. Since there is a single performance obligation that is satisfied at a point in time, we recognise the full revenue when this performance obligation is satisfied. The performance obligation is satisfied when the customer obtains control over the goods or services. In this case, the customer obtains control over the goods (glasses) on 28 February 20X1. The receivable account is debited with the full price of C100 000 (this receivable asset records how much the customer has agreed to pay) and the expected settlement discount of C10 000 is credited to an allowance account (a measurement account that effectively reduces the carrying amount of the receivable asset). The related revenue is thus recognised (credited) at the transaction price of C90 000, being the amount to which the entity expects to be entitled. Journal on 1 April 20X1 (or close of business on 31 March 20X1): The customer had not yet paid as at 31 March 20X1 and thus the customer forfeits the settlement discount that had been offered to him. The settlement discount allowance must thus be reversed (thus we debit this account). Since the discount has been forfeited, it means that the amount to which the entity expects to be entitled is now C100 000 (i.e. the transaction price is now C100 000 – it is no longer C90 000). Thus, the total revenue to be recognised from this performance obligation, once completed, is C100 000 (not C90 000). Since the performance obligation had already been satisfied by the time the discount was forfeited, the revenue from this performance obligation had already been recognised. Thus, the adjustment to the transaction price is recognised as an immediate adjustment to revenue (credit revenue). Journal on 5 April 20X1: The customer settles his account (debit the bank account) and thus the receivable account is reversed (credit the receivable account).

© Service & Kolitz, 2018

Chapter 4: Page 8

Solutions to GAAP: Graded Questions

Revenue from contracts with customers

Solution 4.4 a) Definitions A contract asset is defined as: • an entity’s right to consideration • in exchange for goods or services that the entity has transferred to a customer • when that right is conditioned on something other than the passage of time (e.g. the entity’s future performance). IFRS 15 App A A re...