ACC208 FRS - Open Book - Lecture notes 1-6 PDF

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Study Unit 1: Further Applications of Revenue-Related Standards Chapter 1: Customer Loyalty Programmes 1.1 FRS 113: Customer Loyalty Programmes With effect from 1 January 2018, FRS 115 supersedes INT FRS 113 1.2 for Customer Options to Acquire Additional Goods or Services under FRS 115 –SU1.1: Custo...

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Study Unit 1: Further Applications of Revenue-Related Standards Chapter 1: Customer Loyalty Programmes 1.1.INT FRS 113: Customer Loyalty Programmes With effect from 1 January 2018, FRS 115 supersedes INT FRS 113 1.2.Accounting for Customer Options to Acquire Additional Goods or Services under FRS 115 –SU1.1.2: Customer Options Para B39: Instead of calling them customer loyalty programme, FRS 115 calls them customer options to acquire additional goods or services for free or at a discount.  i.e. Sales incentives, customer award credits or points, contract renewal options or other discounts on future goods or services. Para B39 to B47: The 5-Step Model – Theory (1) Material Right  Para B40: If an entity grants a customer the option to acquire additional goods or services in a contract, that option gives rise to a performance obligation in the contract only if the option provides a material right to the customer that it would not receive without entering into that contract. - E.g. a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer in that geographical area or market  If the option provides a material right to the customer, the customer in effect pays the entity in advance for future goods or services and the entity recognises revenue when those future goods or services are transferred or when the option expires.  Para B41: If a customer has the option to acquire an additional good or service at a price that would reflect the stand-alone selling price for that good or service, that option does not provide a material right to the customer even if the option can be exercised only by entering into a previous contract (2) Allocation Based on Stand-Alone Selling Price  Para B42: Allocate the transaction price to performance obligations on a relative stand-alone selling price basis. - If the stand-alone selling price for a customer’s option to acquire additional goods or services is not directly observable, an entity shall estimate it. That estimate shall reflect the discount that the customer would obtain when exercising the option, adjusted for both of the following: (a) any discount that the customer could receive without exercising the option; and (b) the likelihood that the option will be exercised.  Para B43: If a customer has a material right to acquire future goods or services and those goods or services are similar to the original goods or services in the contract and are provided in accordance with the terms of the original contract, then an entity may, as a practical alternative to estimating the stand-alone selling price of the option, allocate the transaction price to the optional goods or services by reference to the goods or services expected to be provided and the corresponding expected consideration. - Typically, those types of options are for contract renewals. (3) Revenue Recognition  Para B44: Upon receipt of a prepayment from a customer, the entity shall recognise a contract liability in the amount of the prepayment for its performance obligation to transfer, or to stand ready to transfer, goods or services in the future. - An entity shall derecognise that contract liability (and recognise revenue) when it transfers those goods or services and, therefore, satisfies its performance obligation.  Para B45: A customer’s non-refundable prepayment to an entity gives the customer a right to receive a good or service in the future (and obliges the entity to stand ready to transfer a good or service). However, customers may not exercise all their contractual rights. Those unexercised rights are often referred to as breakage. - Para B46: If an entity expects to be entitled to a breakage amount in a contract liability, the entity shall recognise the expected breakage amount as revenue in proportion to the pattern of rights exercised by the customer. - If an entity does not expect to be entitled to a breakage amount, the entity shall recognise the expected breakage amount as revenue when the likelihood of the customer exercising its remaining rights becomes remote. - To determine whether an entity expects to be entitled to a breakage amount, the entity shall consider the requirements in paragraphs 56–58 on constraining estimates of variable consideration.  Para B47: An entity shall recognise a liability (and not revenue) for any consideration received that is attributable to a customer’s unexercised rights for which the entity is required to remit to another party - E.g. a government entity in accordance with applicable unclaimed property laws.

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Application of the 5-Steps Model ABC Ltd operates a chain of petrol stations. It also provides car wash services at $10 per car wash. To boost its business, the company introduces a new customer loyalty programme effective 1 December 20x1. Under this programme, with the purchase of every dollar of petrol will be awarded one FCW point and 100 FCW points may be redeemed for a free car wash. The redemption expires on 31 March 20x2. During the month of December 20x1, the company’s petrol sales under the new programme amounted to $1,000,000. Account for the customer options for free car washes under FRS 115. As at Expected Redemption Rate Actual Redemption Rate 31 December 20X1 80% 31 January 20X2 80% 400,000 28 February 20X2 75% 200,000 31 March 20X2 100,000 Step 1: Identify the contract with a customer  A contract is an agreement between two or more parties that creates enforceable rights and obligations. - E.g. Promises to transfer goods or services to a customer. - A customer is 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. Step 2: Identify the performance obligations in the contract  Separate performance obligations of goods and services: - Petrol - FCW points Step 3: Determine the transaction price  Amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to the customer - Total petrol sales (before unbundling): $1,000,000 Step 4: Allocate the transaction price to the performance obligations in the contract (at contract inception) (Note para B42)  Determine Stand-Alone Selling Price of Petrol and FCW Points: 1. Stand-Alone Selling Price of Petrol = $1,000,000 2. Stand-Alone Selling Price of FCW Points: - Total number of FCW Points = 1,000,000 FCW Points (1 FCW Points per $1 of petrol sale) - Stand-alone selling price of 1 FCW point = $10/100 points = $0.10 - Stand-alone selling price of 1,000,000 FCW points = $0.10 * 1,000,000 = $100,000 - Stand-alone selling price of 1,000,000 Points and adjusted for the likelihood that the option will be exercised = $100,000 * 80% = $80,000  Allocation of Transaction Price: Stand-Alone Selling Price Relative Price Ratio Transaction Price Allocated Petrol $1,000,000 100/108 * $1,000,000 $926,000 FCW Points $80,000 8/108 * $1,000,000 $74,000 Total $1,080,000 $1,000,000 Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation Cash $1,000,000 31/12/20X Dr 1 Cr Petrol Sales Revenue $926,000 Cr Unearned Car Wash Revenue $74,000 31/1/20X2 Dr Unearned Car Wash Revenue $37,000 Cr Car Wash Revenue $37,000 80% expected to be redeemed in total and 400,000 FCW points redeemed in January, hence, 400,000/800,000 * $74,000 = $37,000 earned to date. Since there was no prior “car wash revenue” recognised, $37,000 earned. 28/2/20X2 Dr Unearned Car Wash Revenue $22,200 Cr Car Wash Revenue $22,200 75% expected to be redeemed in total and 200,000 FCW points redeemed in February, hence, (400,000+200,000)/750,000 * $74,000 = $59,200 earned to date. Since $37,000 has been recognised previously, only recognise the additional $22,200. 31/3/20X2 Dr Unearned Car Wash Revenue $14,800 Cr Car Wash Revenue $14,800 100,000 FCW points redeemed in March, i.e. actual redemption is 70%, hence, (400,000+200,000+100,000)/700,000 * 2|Page

$74,000 = $74,000 earned to date. Since $59,200 has been recognised previously, only recognise the additional $14,800. Chapter 2: Construction Contracts 2.1.FRS 11: Construction Contracts 2.2.FRS 23 Borrowing Costs With effect from 1 January 2018, FRS 11 and INT FRS 115 will be superseded by FRS 115 2.3.Accounting for Construction Contracts under FRS 115 –SU1.2.2a Construction Contracts Concepts 2.3.1. The 5-Steps Model for Construction Contracts: Step 1: Identify the contract with a customer  Unlike FRS 11, FRS 115 does not define a construction contract  Para 17: Contract combination An entity shall combine 2 or more contracts entered at/near the same time with the same customer (or related parties of the customer) and account for the contracts as a single contract if one or more of the following criteria are met: (a) the contracts are negotiated as a package with a single commercial objective; (b) the consideration to be paid in one contract depends on the price or performance of the other contract; or (c) the goods or services promised in the contracts (or some goods or services promised in each of the contracts) are a single performance obligation in accordance with paragraphs 22–30.  Paras 18–21: Contract modification - When there is a change in price; or scope, or both in contract, there is a contract modification - Sometimes it is considered a separate contract, sometimes not. Step 2: Identify the performance obligations in the contract Para 22: Identifying performance obligations  At contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either: (a) a good or service (or a bundle of goods or services) that is distinct; or (b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (see paragraph 23). Paras 26 and 27: Distinct goods or services  Para 26(h): Includes constructing, manufacturing or developing an asset on behalf of a customer  Para 27: A good or service that is promised to a customer is distinct if both of the following criteria are met: (a) the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (i.e. the good or service is capable of being distinct); and (b) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e. the good or service is distinct within the context of the contract). Step 3: Determine the transaction price Para 48: Consider the following to determine the transaction price: (a) Paras 50–55, 59: Variable consideration; - Due to discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties - FRS 115 IE Example 20 Penalty gives rise to variable consideration (b) Paras 56–58: Constraining estimates of variable consideration; - Include in the transaction price some or all of an amount of variable consideration estimated only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved. - FRS 115 IE Example 21 Estimating variable consideration (c) Paras 60–65: Existence of a significant financing component in the contract; (d) Paras 66–69: Non-cash consideration; and (e) Paras 70–72: Consideration payable to a customer; Step 4: Allocate the transaction price to the performance obligations in the contract (at contract inception)  Para 74: Allocate on a relative stand-alone selling price basis  Paras 78 and 79: if not directly observable, estimate

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Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer. An asset is transferred when (or as) the customer obtains control of that asset: 1. Over time (aka “percentage-of-completion” method) 2. At a point in time (aka “completed contract” method) Para 35: Revenue Recognition – Over time Recognise revenue when (or as) the entity satisfies a performance obligation over time, if 1 of these are met: (a) The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs; (b) The entity’s performance creates/enhances an asset that the customer controls as the asset is created/enhanced; (c) The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date Para 39: Measurement of Progress Towards Satisfaction of Performance Obligations – Over time  Paras B14–19: Output or Input Methods - Output methods: e.g. based on units constructed - Input methods: e.g. based on cost incurred on construction  Para 40: Apply a single method for that performance obligation consistently  Para 43: Update the changes to measure of progress as a change in accounting estimate 2.3.2. Construction Contract Terminology 1. Construction-in-progress Para 95: An entity shall recognise an asset from costs incurred to fulfil a contract only if it meets all the following criteria: (a) the costs relate directly to a contract or to an anticipated contract that the entity can specifically identify; (b) the costs generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future; and (c) the costs are expected to be recovered. e.g. Construction-in-progress (“CIP”) – Asset  An account (in statement of financial position) to record - all construction costs incurred on the project, and - progressive gross profit or net loss recognised on the project to-date 2. Progress Billings (“PB”) – Contra-Asset  An account (in statement of financial position) to record the amounts billed to the customers for work performed on a contract if they have been paid by the customers.  Like an invoice billed to customer Para 105: Presentation  When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment.  An entity shall present any unconditional rights to consideration separately as a receivable.

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2.4.Accounting Issues 2.4.1. Under an Overall Profitable Construction Contract –SU1.2.2b: Construction Contracts Application ABC Ltd enters into a contract (Project A) in 20X3 to build an overhead bridge for the government. The project is expected to be completed in 20X4. The contract price is $1,000,000 and the other data pertaining to the project during the construction period are as follows. Account for the construction contract under FRS 115. 20X3 ($’000) 20X4 ($’000) Actual Cost for the Year 600 220 Estimated Costs to Complete 200 Progress Billings for the Year 400 600 Cash Collections for the Year 300 700 Project A: Contract price = $1m; to be completed in 2 years  At end of 20X3 (Repeat JE1-3 for end of 20X4) JE1: Current costs incurred for the year= $600,000 31 Dec 20X3

Dr Construction-in-Progress (“CIP”) Cr Cash/Payables/Acc. Depreciation JE2: Billings for the year = $400,000 31Dec 20X3 Dr Receivables Cr Progress Billings (“PB”) JE3: Collections for the year = $300k 31 Dec 20X3 Dr Cash Cr Receivables Must show 5 steps for JE4: Step 1: Check the overall profitability of the contract: 20X3 ($’000) Contract Price 1,000 Less: Estimated Total Cost 600 + 200 = 800 Cumulative Profit/(Loss) 200 (Profitable) Step 2: Compute the percentage of completion: 20X3 (%) 20X3: 600/800 = 75% 20X4: Step 3: Compute the current construction profit/(loss) for the current period: Cumulative to Date 20X3 ($’000) 20X3: 75% * 200 = 150 20X4: Less: Previously Recognised 0 For Current Period 150 –> (b) Step 4: Compute the construction revenue earned for the current period: Cumulative to Date 20X3 ($’000) 20X3: 75% * 1,000 = 750 20X4: Less: Previously Recognised 0 For Current Period 750 –> (c) Step 5: Compute the construction costs incurred for the current period: Cumulative to Date 20X3 ($’000) 20X3: 75% * (600 + 200) = 600 20X4: Less: Previously Recognised 0 For Current Period 600 –> (a) JE4: (Difference of revenue and expense, i.e. profit, is charged to CIP) 31 Dec 20X3 Dr Construction Costs (a) Dr CIP (b) Cr Construction Revenue 31 Dec 20X4 Dr Construction Costs (a) Dr CIP (b)

$600,000 $600,000 $400,000 $400,000 $300,000 $300,000

20X4 ($’000) 1,000 600 + 220 = 820 180 (Profitable) 20X4 (%) 100% 20X4 ($’000) 100% * 180 = 180 150 30 –> (b) 20X4 ($’000) 100% * 1,000 = 1,000 750 250 –> (c) 20X4 ($’000) 100% * (600 + 220) = 820 600 220 –> (a) $600,000 (P/L) $150,000 (SFP) (c) $750,000 (P/L) $220,000 (P/L) $30,000 (SFP) 5|Page

Cr

Construction Revenue

(c) $250,000 (P/L)

JE5: Upon completion of project  Only done at the end of the contract (i.e. end of 20X4)  Set-off the outstanding balances of CIP and PB accounts in the SFP to 0. 31 Dec 20X4 Dr Progress Billings (PB) $1,000,000 Cr Construction in Progress (CIP) $1,000,000 2.4.2. Under an Onerous Construction Contract –SU1.2.2c FRS 115 Construction Contracts Application 2 If a contract with a customer under FRS 115 becomes onerous, a provision is to be recognised.  Onerous Contract: When the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it  Costs of meeting this contract > Construction revenue: A provision for the future expected losses should be made. ABC Ltd enters into a contract (Project A) in 20X3 to build an overhead bridge for the government. The project is expected to be completed in 20X4. The contract price is $1,000,000 and the other data pertaining to the project during the construction period are as follows. Account for the construction contract under FRS 115. 20X3 ($’000) 20X4 ($’000) Actual Cost for the Year 600 920 Estimated Costs to Complete 900 Progress Billings for the Year 400 600 Cash Collections for the Year 300 700 Project A: Contract price = $1m; to be completed in 2 years  At end of 20X3 (Repeat JE1-3 for end of 20X4) JE1: Current costs incurred for the year= $600,000 31 Dec 20X3

Dr Construction-in-Progress (“CIP”) Cr Cash/Payables/Acc. Depreciation JE2: Billings for the year = $400,000 31Dec 20X3 Dr Receivables Cr Progress Billings (“PB”) JE3: Collections for the year = $300k 31 Dec 20X3 Dr Cash Cr Receivables Must show 5 steps (+ Step 5a) for JE4 (+ JE4a): Step 1: Check the overall profitability of the contract: 20X3 ($’000) Contract Price 1,000 Less: Estimated Total Cost 600 + 900 = 1,500 Cumulative Profit/(Loss) (500) (LOSS) Step 2: Compute the percentage of completion: 20X3 (%) 20X3: 600/1,500 = 40% 20X4: Step 3: Compute the current construction profit/(loss) for the current period: Cumulative to Date 20X3 ($’000) 20X3: 40% * (500) = (200) 20X4: Less: Previously Recognised 0 For Current Period (200) –> (b) Step 4: Compute the construction revenue earned for the current period: Cumulative to Date 20X3 ($’000) 20X3: 40% * 1,000 = 400 20X4: Less: Previously Recognised 0 For Current Period 400 –> (c) Step 5: Compute the construction costs incurred for the current period:

$600,000 $600,000 $400,000 $400,000 $300,000 $300,000

20X4 ($’000) 1,000 600 + 920 = 1,520 (520) (LOSS) 20X4 (%) 100% 20X4 ($’000) 100% * (520) = (520) (200) (320) –> (b) 20X4 ($’000) 100% * 1,000 = 1,000 400 600 –> (c) 6|Page

Cumulative to Date 20X3 ($’000) 20X4 ($’000) 20X3: 40% * (600 + 900) = 600 20X4: 100% * (600 + 920) = 1,520 Less: Previously Recognised 0 600 For Current Period 600 –> (a) 920 –> (a) Step 5a: End of 20X3: Provision for future expected losses = 60% * ($1,000,000 - $1,500,000) - $0 = $300,000 –> (d) JE4: (Difference of revenue and expense, i.e. loss, is charged to CIP) 31 Dec 20X3 Dr Construction Costs (a) $600,000 (P/L) Cr CIP (b) $200,000 (SFP) Cr Construction Revenue (c) $400,000 (P/L) JE4a: Recognition of provision of future expected losses at end of e...