4.2_revenue_(insights_into_ifrs)

4.2 Revenue (Conceptual Framework, IAS 11, IAS 18, IFRIC 13, IFRIC 15, IFRIC 18, SIC-27, SIC-31) OVERVIEW OF CURRENTLY EFFECTIVE REQUIREMENTS CURRENTLY EFFECTIVE REQUIREMENTS This publication reflects IFRSs in issue at 1 August 2011. The requirements related to this topic are derived mainly from IAS 18 Revenue, IAS 11 Construction Contracts, IFRIC 13 Customer Loyalty Programmes, IFRIC 15 Agreements for the Construction of Real Estate and IFRIC 18 Transfers of Assets from Customers. FORTHCOMING REQUIREMENTS AND FUTURE DEVELOPMENTS When a currently effective requirement will be changed by a new requirement that is issued but is not yet effective, it is marked with a # as a forthcoming requirement and the impact of the change is explained in the accompanying boxed text. The forthcoming requirements related to this topic are derived from IFRS 13 Fair Value Measurement, which is effective for annual periods beginning on or after 1 January 2013. A brief outline of the impacts on this topic is given in 4.2.20.80 and 380.60. The currently effective or forthcoming requirements may be subject to future developments and a brief outline of the relevant project, which may affect several aspects of revenue recognition, is given in 4.2.730. 4.2.10 SCOPE AND DEFINITION 4.2.10.10 IFRSs contain general principles for revenue recognition that apply to all entities, with additional guidance in respect of certain types of transactions, e.g. IFRIC 13 in respect of customer loyalty programmes. While IFRIC 12 (see 5.12) and IFRIC 15 include revenue recognition guidance that is specific to an industry, in general IFRSs contain limited industry-specific guidance on revenue recognition. For example, there is no specific guidance for the recognition of revenue and costs by entities in the software industry. 4.2.10.20 The appendix to IAS 18 contains examples illustrating how to apply the general guidance in the standard to specific types of transactions. The appendix accompanies, but is not part of, the standard. 4.2.10.30 The definition of revenue is similar to the Conceptual Framework for Financial Reporting (the Conceptual Framework) definition of income (see 1.2.30). Revenue is income that arises in the course of the ordinary activities of the entity, e.g. the sale of inventory. Other income (i.e. income that does not arise in the course of the ordinary activities of the entity) is not revenue but is a gain, and falls outside the scope of IAS 18 (see 3.2.440.30). [IAS 1.34, 18.7] 4.2.10.40 Generally the sale of an item of property, plant and equipment by an entity results in the recognition of a gain or loss. However, if on a routine basis an entity rents out property, plant and equipment and then sells it, then the proceeds from such sale are recognised as revenue (see 3.2.440.37). [IAS 16.68A] 4.2.10.50 In our view, the general revenue recognition criteria (e.g. evaluating the extent to which risks and rewards are transferred) are considered to determine the timing of recognition of any gain or loss. 4.2.10.60 Contributions by shareholders in their capacity as shareholders do not generate revenue or income. For example, in our view the forgiveness of a loan granted by a shareholder generally should not be treated as income, but rather as a capital contribution, unless the shareholder was not acting in the capacity of a shareholder (see 7.3.370). A similar assessment may need to be carried out for loans forgiven by fellow subsidiaries, as the waiver might have been instigated by the common parent. 4.2.20 MEASUREMENT # 4.2.20.10 Revenue is measured at the fair value of the consideration received, taking into account any trade discounts and volume rebates. The amount of revenue recognised is discounted to the present value of consideration due if payment extends beyond normal credit terms. [IAS 18.9-11] 4.2.20.20 In our view, when payment for goods sold or services provided is deferred beyond normal credit terms, and the entity does not charge a market interest rate, the arrangement effectively constitutes a financing arrangement and interest should be imputed if the impact is material. In these cases the amount of revenue recognised on the goods sold or services provided will be less than the amount that ultimately will be received. [IAS 18.11, 39.38, AG35, AG53] 4.2.20.30 When a current cash price is available, the imputed rate of interest is the rate that exactly discounts the amount to be received in the future to the current cash sales price. In practice the price for normal credit terms often is treated as the cash price equivalent. [IAS 39.AG64] 4.2.20.40 When a current cash sales price is not available, the imputed rate of interest is a market rate for a similar instrument, giving consideration to the counterparty's credit risk. For example, Company M sells a car to Company B for 1,100 and payment is due in 12 months. M will not charge B any interest. Current market interest rates for a similar level of risk are 10 percent. The fair value of the consideration, and therefore the revenue recognised on the sale of the car, is 1,000, calculated as the present value of the future payment of 1,100. The difference of 100 should be recognised as interest income over the period of financing, using the effective interest method (see 7.6.280). Because M will receive the revenue only in a year, which is outside normal credit terms, the revenue recognised for the sale transaction is less than the amount that will be received. 4.2.20.50 The length of normal credit terms will depend on the industry and the economic environment. 4.2.20.60 In contrast, when payment is received in advance of the related goods being sold or the services rendered, in our view generally revenue should not be adjusted for the time value of money. One of the reasons for this approach is that the entity already has received the consideration due, so there are no future cash flows. 4.2.20.70 Revenue is recognised by an entity when goods or services are rendered in exchange for dissimilar goods and services. Revenue is measured at the fair value of the goods or services received, adjusted by the amount of any cash or cash equivalents received or paid. If the fair value of goods or services received cannot be measured reliably, then revenue is measured at the fair value of goods or services given up, adjusted by the amount of any cash or cash equivalents received or paid. When goods and services are exchanged for goods or services that are similar in nature and value, the exchange is considered to lack commercial substance and is not treated as a transaction that generates revenue. See 5.7 for further guidance on non-monetary transactions. [IAS 18.12] FORTHCOMING REQUIREMENTS 4.2.20.80 IFRS 13 replaces most of the fair value measurement guidance contained in individual IFRSs with a single definition of fair value, provides fair value application guidance and establishes a comprehensive disclosure framework for fair value measurements. See 1.2.57 for further details. 4.2.30 LINKED TRANSACTIONS 4.2.30.10 In general, this section refers to revenue recognition in the context of a single transaction. However, in some cases two or more transactions may be linked so that the individual transactions have no commercial effect on their own. In these cases the combined effect of all such transactions together is analysed as one arrangement. 4.2.30.20 In the context of revenue recognition, the following could indicate that transactions might be linked. 4.2.30.30 For example, Company D sells a subsidiary to Company E. The purchase and sale agreement includes a manufacture and supply agreement. According to the manufacture and supply agreement, D agrees to supply specific products to E. The selling price of the products covers all of D's manufacturing costs (direct and indirect), transportation costs, duties and other taxes, and insurance costs, but includes no profit margin to D. The manufacturing and supply agreement commences on completion of the purchase and sale agreement and ends five years later. Other relevant facts include the following. 4.2.30.40 The agreement includes two transactions: (1) the disposal of a subsidiary; and (2) a manufacture and supply agreement of goods. In our view, the transactions are linked and should be analysed together as one arrangement, which contains separately identifiable components. Therefore, a portion of the proceeds on the sale of the subsidiary should be deferred and recognised as the goods are delivered. Any subsequent changes in the estimate of goods to be delivered are changes in estimates and should be accounted for as such (see 2.8.60). 4.2.40 OVERALL APPROACH 4.2.40.10 Revenue may be generated by: 4.2.40.20 In order to recognise revenue, the entity (seller) should have supplied the goods, or performed the services, as agreed. The required actions may be specified in a formal contract such as a purchase order or service agreement. However, revenue recognition does not require written or formal evidence of an arrangement; for example, revenue may be recognised even if a formal purchase order is not prepared. Furthermore, the form and contents of the contract may not correspond with performance and revenue recognition. [IAS 18.14, 20] 4.2.40.30 The general steps involved in the recognition of revenue are illustrated in the diagram below; the detailed revenue recognition criteria are discussed in the sections that follow. While the diagram assumes that the contract has a number of components, in many cases the contract will have only a single component; in that case the entity will go straight to Step 3: recognise revenue (see 4.2.70). 4.2.50 Step 1: Identify components 4.2.50.10 The first step in recognising revenue is to determine whether a single arrangement comprises separately identifiable components. However, when revenue recognition for the components occurs at the same time and the components belong to the same category of revenue for disclosure purposes, generally there is no need to identify the separate components of the transaction because doing so has no impact on the timing or disclosure of revenue recognition. [IAS 18.13, 35(b)] 4.2.50.20 This process also involves identifying the relevant standards and/or interpretations that apply. In some cases the components of a revenue-generating transaction will fall under a single standard, e.g. a sale and subsequent servicing under IAS 18; in other cases they will relate to more than one standard, e.g. construction and subsequent servicing under IAS 11 and IAS 18, respectively. The scope of the respective standards is discussed throughout this section. 4.2.50.30 In an arrangement that comprises more than one activity, it may be appropriate to identify the separable components within the contract and allocate revenue to each separately identified component (see 4.2.60). If no separable components are identified, then it may not be appropriate to recognise any revenue until completion (or acceptance) of the final deliverables if the transaction is accounted for under IAS 18. 4.2.50.40 The identification of components within a single arrangement is consistent with the general principles in IAS 18, i.e. the requirement that it may be necessary to apply the revenue recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. [IAS 18.13] 4.2.50.50 This general principle is expressed explicitly in a number of recent interpretations: 4.2.50.60 IAS 18 does not provide detailed guidance on how separate components within a contract or agreement should be identified. However, in our view an entity should consider the requirements of IAS 11 in respect of combining and segmenting construction contracts (see 4.2.240), and the following test contained in IFRIC 18, by analogy to other types of contracts: 4.2.50.61 IFRIC 18 does not define, nor does it provide guidance about application of the term 'stand-alone value'. One view is that a delivered element has stand-alone value if a vendor sells the item on a stand-alone basis or the customer could resell it. Another view is that an item has stand-alone value if the customer derives value from that item that is not dependent on receiving other deliverables under the same arrangement. 4.2.50.62 In our view, both of these interpretations of stand-alone value are acceptable. We believe that an entity should choose an accounting policy, to be applied consistently, in determining the definition of stand-alone value. Regardless, of the policy applied, the determination of whether a component within an arrangement has stand-alone value to the customer depends on facts and circumstances and requires judgement. 4.2.50.70 In some cases a contract may identify separate components, but it may be appropriate to account for them as a single transaction. For example, supply or service transactions may involve charging a non-refundable initial fee with subsequent periodic payments for future products or services. The initial fees may, in substance, be wholly or partly an advance payment for future products or services, or the ongoing rights or services being provided which are essential to the customers receiving the expected benefit of the upfront payment. In these cases the upfront fee and the continuing performance obligation related to the services to be provided should be assessed as an integrated package. In our view, in these circumstances upfront fees, even if non-refundable, are earned as the services are performed over the term of the arrangement or the expected period of performance and generally should be deferred and recognised systematically over the periods that the fees are earned. Determining when to recognise initial fees as revenue depends on facts and circumstances and requires judgement (see 4.2.320). 4.2.50.80 The terms, conditions, and amounts of these upfront fees typically are negotiated in conjunction with the pricing of all elements of the arrangement, and the customer would ascribe a significantly lower, and perhaps no, value to elements apparently associated with the upfront fee in the absence of the entity's performance of other contract elements. 4.2.50.90 For example, Biotechnology Company U agrees to provide research and development services to a customer for a specified period of time. The customer needs to use certain technology owned by U. The technology is not sold or licensed separately without the related research and development activities. Under the terms of the arrangement, the customer is required to pay a non-refundable 'technology access' fee in addition to periodic payments for research and development activities over the term of the contract. 4.2.50.100 We believe that the activity completed by U (i.e. providing a license to access the technology to the customer) is not a significant revenue-earning event and has no stand-alone value to the customer. The customer is purchasing the ongoing rights, products, or services being provided through U's continuing involvement and the revenue earning process is completed by performing under the terms of the arrangement, not simply by originating a revenue-generating arrangement. This is supported by the fact that U does not sell the initial rights, products or services separately, i.e. without the company's continuing involvement. The upfront fee should be recognised systematically over the period that the research services are provided since that is the period over which the fees are earned. 4.2.50.110 See also 4.2.200 and 4.2.320 for further examples. 4.2.60 Step 2: Allocate consideration 4.2.60.10 When a contract or agreement includes more than one component, the second step in recognising revenue is to allocate the overall consideration to the different components. However, to the extent that revenue recognition for components occurs at the same time and the components belong to the same category of revenue for disclosure purposes, generally no allocation of revenue is necessary because those components are accounted for collectively. 4.2.60.20 IAS 18 largely is silent on the allocation of revenue to components. However, there is specific allocation guidance included in recent interpretations such as IFRIC 13 in respect of customer loyalty programmes, and IFRIC 15 in respect of real estate sales. Under these interpretations, revenue could be allocated to components using either of the following methods: 4.2.60.30 Using relative fair values, the total consideration is allocated to the different components based on the ratio of the fair values of the components relative to each other. For example, assume a transaction comprises two components, X and Y. If the fair value of component X is 100 and of component Y is 50, then two thirds of the total consideration would be allocated to component X. If the total consideration is 120, then revenue of 80 would be allocated to component X and 40 to Y. [IFRIC 13.5-7, AG3, 15.8] 4.2.60.40 Using the residual method, the undelivered components are measured at fair value, and the remainder of the consideration is allocated to the delivered component. For example, assume a transaction consists of two components, X and Y; at the reporting date only component X has been delivered. If the fair value of component Y is 90 and the total consideration is 120, then revenue of 30 would be allocated to component X and 90 to Y. 4.2.60.50 [Not used] 4.2.60.60 In our view, the reverse residual method, in which the delivered components are measured at fair value, and the remainder of the consideration is allocated to the undelivered component(s), is not an appropriate basis for allocating revenue. Application of the reverse residual method may result in excessive revenue being allocated to the delivered components of a transaction. 4.2.60.70 In our view, if a single contract comprises one or more components within the scope of IAS 18 and one or more components within the scope of IAS 11, then the allocation of revenue, based on the methodologies described in 4.2.60.20, to the various components might result in different profit margins on different components of a single contract. To the extent that components of a single contract fall within the scope of IAS 11, that standard includes specific guidance on the extent to which further separation of the construction component of the contract is required (see 4.2.240). [IFRIC 12.BC31, 15.BC13] 4.2.60.80 In some cases the allocation of revenue to the different components of an arrangement might result in revenue being recognised even though the related consideration will not be paid by the customer until future services are performed by the entity (seller). For example, Company L sells equipment and installation services in a bundled arrangement for 950. The fair value of the installation services is 100 based on the price charged by other vendors. L also sells the equipment without installation services for 900. The payment terms are 650 payable on delivery of the equipment, and the remaining 300 once installation is complete. Applying the relative fair value method (see 4.2.60.20), revenue would be allocated as follows: 4.2.60.90 Under this approach, L would generally recognise 855 as revenue when the equipment is delivered, as long as the other criteria in IAS 18 for the sale of goods are met (see 4.2.70 and 100). [IAS 18.14(d)] 4.2.60.100 When applying either the relative fair value method or the residual method, IAS 18 refers to estimating the value of a component of revenue based on the expected cost of delivery plus a reasonable margin (cost-plus-margin method). In our view, the cost-plus-margin method generally should be applied only when it is difficult to