RevenueSession 8

Course: F0812 Accounting TheoryYear: February 2011

GODFREYHODGSONHOLMESTARCACHAPTER 9 REVENUE

Revenue defined*Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. AASB Framework

Revenue definedRevenue represents a physical and a monetary flowRevenue is an inflow of economic benefitsRevenue forms part of income which also includes gains and arises in the course of ordinary activitiesExamples are sales, fees, interest, dividends, royalties and rents

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Behavioural view of revenueRevenues are the result of firm activityNet accomplishment of firm revenue = accomplishmentexpense = effortmatching results in profit = net accomplishmentA point of recognition must be determinedcritical event accrual throughout earnings process

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Revenue recognitionHistorical perspectiveProfit (and revenue) determined on the basis of the increase in the net worth of the firmSupplanted by the notion that profit and revenue had to be realisedDeveloped into the revenue recognition principle (or realisation principle)A distinction between capital and profit emerged from court rulings

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Criteria for revenue recognition*At what point during the earning process can revenue be recorded as earned because there is sufficient evidence?

Criteria for revenue recognition*

Criteria for revenue recognitionRecognition criteria are based on the desire for both relevant and reliable accounting informationmeasurability of asset valueexistence of a transactionsubstantial completion of the earning process

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Revenue measurementFramework provides 2 criteria for revenue recognitionit is probable that any future economic benefit associated with the item will flow to or from the entitythe item has a cost or value that can be measured with reliability

Revenue recognition is not straightforward because of the wide range of different business revenue-generating activities and circumstances*

Revenue measurementIAS 18/AASB 118 Revenuerevenue is to be measured at the fair value of the consideration received or receivable

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Sale of goodsThe sales point is generally the most appropriate point to measure and record revenue as all three criteria are metThe sales point is when the product is delivered or the services are rendered, or when title passes to the customer

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Exceptions to sales basisExceptions to using the sale point arerevenue recognised during productione.g. construction contractsrevenue recognised at the end of productionproduction is the critical event and the sale is assuredrevenue recognised when cash is received after the sale is madeinstalment method and the cost recover method*

Rendering of servicesService revenue is to be recognised by reference to the stage of completionIt is recognised in the period in which the service is rendered*

Interest, royalties and dividendsCan be recognised when receivedFor some items, the passing of time signifies revenue has been earnede.g. interest revenue

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Developments in revenue recognition and measurementIASB/FASB joint projectVoid in revenue recognition and measurement guidance and a lack of a conceptual basis for resolving issuesRevenue transactions have become more complex*

Developments in revenue recognition and measurementThey proposerecognising revenues when they arisemeasuring them at fair value at that pointmeasuring them when they arise from an increase in assets or a decrease in liabilities, at the fair value of that change*

Developments in revenue recognition and measurementResulting changes in emphasis revenue is recognised when it arises changes emphasis from realisation to timelinessrevenue can result from the changes in asset and liability values and from holding assets that is, from remeasurementsrevenue recognition and measurement reflect fair valuemeasurement should be reliable*

Developments in revenue recognition and measurementTentative agreement that two criteria must be met to recognise revenuea change in assets or liabilities must have occurredthe elements criterionthe change in assets or liabilities can be appropriately (reliably) measuredthe measurement criterionno probability criterionThere is less emphasis on substantial completion of the earnings process and on notions of realisation and earned*

Fair value measurementUnder a mixed measurement attribute model, all items are measured at fair value at acquisition and thereafter are carried at historical cost or written down historical cost although some items are subsequently remeasured to fair valueGains and losses are recognised when they occur even if they are unrealised*

Financial statement presentationIASB/FASB joint projectTentative conclusions arean all-inclusive, single income statement where all changes to assets and liabilities will be disclosedrealisation is not the basis for inclusion of itemsseparate disclosure of performance (income flows) and remeasurement (valuation adjustments)

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Issues for auditorsPrimary issue is the overstatement of revenues by managersintention is to deceive usersbonuses managing earningsover-optimismfraud

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Summary Issues relating to the definition, measurement and recognition of revenueCritical recognition pointsCriteria for revenue recognition Revenue measurementGuidance provided by standard settersCurrent projects and developmentsIssues for auditors

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Key terms and conceptsRevenueBehavioural view of revenueEarning processCriteria for revenue recognitionPoint of saleFair valueSales of goods and the rendering of services

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