AFM391 Lecture Notes - Lecture 8: Income Statement

Concept/objective

realized or realizable and earned.

According to paragraph 83 of the IASB's Framework for the Preparation and Presentation of Financial Statements, revenue is recognized when (1) "it is probable that any future economic benefit" will flow to the entity and (2) such a benefit can be measured reliably. Further, paragraph 93 of the IASB Framework indicates that revenue normally must be earned before it can be recognized.

Definition of revenue

Paragraph 78 of FASB Concepts Statement No. 6, Elements of Financial Statements, defines revenue as "inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations."

Paragraph 74 of the IASB Framework states, "The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent."

Paragraph 7 of IAS 18 defines revenue as "the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants."

Sale of goods or products

There is persuasive evidence of an arrangement.

Delivery has occurred (e.g., an exchange has taken place).

The sales price is fixed or determinable.

Collectibility is reasonably assured.

In addition, ASC 605-15 provides guidance on product transactions that include a right of return. Further, various industry- and transaction-specific guidance is provided in other U.S. GAAP.

The "entity has transferred to the buyer the significant risks and rewards of ownership of the goods."

The "entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold."

The "amount of revenue can be measured reliably."

"[I]t is probable that the economic benefits associated with the transaction will flow to the entity."

The "costs incurred or to be incurred in respect of the transaction can be measured reliably."

Rendering services

There is persuasive evidence of an arrangement.

Service has been rendered.

The sales price is fixed or determinable.

Collectibility is reasonably assured.

Other than the limited guidance in >ASC 605-20, no specific guidance on the rendering of services exists under U.S. GAAP. The appropriate method for recognizing revenue in such transactions depends on the individual transaction but is usually based on the proportional performance as of the balance sheet date.

Paragraph 20 of IAS 18 states, "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 [i.e., percentage] of completion of the transaction at the balance sheet date." Paragraph 20 goes on to list specific conditions for determining whether an outcome of a transaction can be estimated reliably. And subsequent paragraphs provide guidance on determining the stage of completion.

Paragraph 26 of IAS 18 states, "When the outcome of the transaction involving the rendering of services cannot be estimated reliably, revenue shall be recognised only to the extent of the expenses recognised that are recoverable."

Software arrangements

ASC 985-605 provides guidance on recognizing revenue in a software arrangement.

There is no specific guidance on software revenue recognition in IFRSs. An entity should apply the provisions of IAS 18 as appropriate.

Construction-type contracts

ASC 605-35 provides guidance on construction-type contracts.

ASC 605-35-25-90 indicates that when the percentage-of-completion method is deemed inappropriate (e.g., when dependable estimates cause the outcome to be doubtful), the completed-contract method is preferable.

ASC 605-35-25-25 through 25-27, the customer must approve the scope and price of change orders before the related revenue can be recognized.

IAS 11, Construction Contracts, provides guidance on construction-type contracts.

Paragraph 32 of IAS 11 indicates that when the percentage-of-completion method is deemed inappropriate (e.g., when the outcome of the contract cannot be estimated reliably), revenue is recognized to the extent that costs have been incurred, provided that the costs are recoverable. Use of the completed-contract method is prohibited under IFRSs.

Paragraph 13 of IAS 11 specifies that when it is probable that the customer will approve the scope and price of a change order, the related revenue can be recognized.

Milestone method

ASC 605-28 provides guidance on the application of the milestone method for recognizing revenue in research or development arrangements.

There is no specific guidance in IFRSs on the application of the milestone method for recognizing revenue in research or development arrangements.

Multiple-element arrangements

ASC 605-25 provides guidance on multiple-element revenue arrangements and establishes detailed criteria for determining whether each element may be separately considered for recognition. This guidance does not apply to arrangements or deliverables that are within the scope of other authoritative literature (e.g., ASC 985-605).

"[I]t is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction."

Two or more transactions "are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole."

Bill-and-hold arrangements

The SEC staff lists specific criteria that must be met for revenue to be recognized in bill-and-hold arrangements before delivery of the product. (Non-SEC entities also use these revenue recognition criteria because no other authoritative guidance in U.S. GAAP addresses the accounting for these transactions.) The criteria restrict revenue recognition to limited circumstances.

Illustrative Examples to IAS 18 list criteria for recognizing revenue under bill-and-hold arrangements before delivery of the product. While the objective for recognizing revenue in bill-and-hold arrangements may be similar to that in U.S. GAAP, the criteria are not the same.

Gross versus net

ASC 605-45 provides guidance on whether to report revenue on the basis of the gross amount billed to the customer (as a principal) or the net amount retained by the company (as an agent).

Paragraph 8 of IAS 18 requires that revenue be reported on a net basis in agency relationships but does not provide specific guidance to consider.

Improvements to IFRSs issued in April 2009) provides examples that indicate whether an entity is acting as a principal or as an agent.

Customer loyalty programs

Revenue recognition for customer loyalty programs is not specifically addressed in U.S. GAAP. (The EITF attempted to address this issue but did not reach a consensus.) Although entities account for customer loyalty programs in different ways, such programs are typically accounted for under ASC 605-25 as multiple-element arrangements or under an incremental-cost model.

IFRIC 13 indicates that customer loyalty programs are deemed multiple-element revenue transactions and that the fair value of the consideration received should be allocated between the components of the arrangement.

Rebates, discounts, incentives, and other consideration

ASC 605-50 indicates that consideration given by an entity to its customers is presumed to be a reduction of revenue unless an identifiable benefit whose fair value can be reasonably estimated is received.

Paragraph 10 of IAS 18 states that revenue "is measured at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed by the entity." There is no specific guidance on other types of consideration given by an entity to its customers.

Specific industry and other guidance

Certain standards in U.S. GAAP provide specialized guidance on revenue recognition, including guidance that applies to specific industries and transactions.

IFRSs provide no (or limited) revenue recognition guidance that applies to specific industries or transactions.