Chapter 10

Reporting revenue

Introduction
Learning outcomes
Chapter study guidance

Learning topics
1 Context
2 IFRS 15, Revenue from Contracts with Customers
3 Applications of IFRS 15
4 Audit focus
Summary
Self-test questions
Further question practice
Technical reference
Answers to Interactive questions
Answers to Self-test questions
 Introduction

10

Learning outcomes
• Identify and explain current and emerging issues in corporate reporting
• Explain how different methods of recognising and measuring assets and liabilities can affect
reported financial performance
• Explain and appraise accounting standards that relate to reporting performance: in respect of
financial statements; revenue; operating segments; continuing and discontinued operations; EPS;
interim reporting
• Calculate and disclose, from financial and other qualitative data, the amounts to be included in an
entity’s financial statements according to legal requirements, applicable financial reporting
standards and accounting and reporting policies
• Determine for a particular scenario what comprises sufficient, appropriate audit evidence
• Design and determine audit procedures in a range of circumstances and scenarios, for example
identifying an appropriate mix of tests of controls, analytical procedures and tests of details
• Demonstrate and explain, in the application of audit procedures, how relevant ISAs affect audit
risk and the evaluation of audit evidence
Specific syllabus references for this chapter are: 1(e), 2(a), 2(b), 2(d), 14(c), 14(d), 14(f)
10

Chapter study guidance

Use this schedule and your study timetable to plan the dates on which you will complete your study
of this chapter.

Topic Practical Study approach Exam approach Interactive

significance Questions

1 Context Approach This section deals N/A

Revenue is often the You have met this with background
single largest item topic before, but knowledge only.
in the financial now it is examinable
statements, and has at Level A. Read
in the past been through this
open to introductory section
manipulation. This quickly.
led to the Stop and think
development of a
recent standard Can you think of any
IFRS 15, Revenue recent scandals
from Contracts with involving
Customers. recognition of
revenue?
IFRS 15 recognises
separate
performance
obligations will arise
for distinct goods or
services. This could
result in some
revenue being
attributed to goods
or services that were
previously
considered

520 Corporate Reporting ICAEW 2021

Topic Practical Study approach Exam approach Interactive
significance Questions

incidental to the
contract – for
instance, to mobile
phones that are
provided free of
charge with airtime
contracts and to
some post-delivery
services, such as
maintenance and
installation.

2 IFRS 15, Revenue Approach IFRS 15 is a recent, IQ1—4

from Contracts with Pay particular topical standard, Work through all the
Customers attention to the five- and could be tested examples and
The five-stage stage model for in a number of ways. questions on
model will be used recognising revenue It was examined for applying this model,
in practice for in section 2: the first time in July especially:
recognising revenue 2019, when it
(1) Identify the formed a large part IQ5: Caravan
and is useful for contract(s) with a
exam questions. of the content of This deals with all
customer. Question 3 (audit five stages of IFRS
(2) Identify separate and financial 15.
performance reporting).
obligations. The five-stage
(3) Determine the model will help
transaction price. structure your
answer in an exam,
(4) Allocate
but you will get no
transaction price to
marks for just listing
performance
them without
obligations.
applying them to a
(5) Recognise scenario.
revenue as or when
each performance
obligation is
satisfied.
Stop and think
A performance
obligation can be
satisfied at a point in
time, such as in
retail sales, or over
time, such as a
construction
contract taking
place over weeks,
months or even
years. You will not
have studied
construction
contracts before, so
pay particular
attention to section
2.10.

ICAEW 2021 10: Reporting revenue 521

 Topic Practical Study approach Exam approach Interactive
significance Questions

3 Applications of IFRS Approach Any of these topics Work through all the
15 You will have dealt could come up in an examples and
Section 3 deals with with these topics at exam. Revenue is questions on
specific applications Professional Level, regularly examined applying this model,
of IFRS 15. The most so read through for and could take up especially:
important of these revision and focus most of the IQ6: Sale or return
are sale or return, on doing the question.
This is not as
sale and repurchase interactive straightforward as
and goods and questions. you might think.
services in the same Stop and think
contract.
In a principal/agent
relationship, what is
the agent’s
revenue?

4 Audit focus Approach To avoid repetition IQ11: Construction

This gives auditing Study this section of the five stages, it contracts
guidance relating to carefully and is best to deal with A must-do question
each stage of IFRS attempt the each stage first from on auditing revenue
15 and for specific integrated the FR point of view, from contracts in
transactions. interactive question. then in terms of which performance
auditing. Questions obligations are
Stop and think are very likely to test satisfied over time.
Where performance both.
obligations are
satisfied over time,
how would you
determine whether
contract costs had
been overstated?

Once you have worked through this guidance you are ready to attempt the further question practice
included at the end of this chapter.

522 Corporate Reporting ICAEW 2021

 1 Context
Section overview

• Income, as defined by the IASB’s Conceptual Framework, includes both revenues and gains.
Revenue is income arising in the ordinary course of an entity’s activities and it may be called
different names, such as sales, fees, interest, dividends or royalties.
• IFRS 15, Revenuefrom Contracts with Customers establishes a single comprehensive framework
for accounting for the majority of contracts that result in revenue.
• Revenue recognition is straightforward in most business transactions, but can be complicated in
some situations.

1.1 Accrual accounting

Financial statements are prepared on the underlying assumption of the accrual basis of accounting,
whereby effects of transactions are recognised when they occur and not when the cash associated
with them is received or paid.
But this raises questions about when a transaction ‘occurs’:
• Is it when the buyer takes possession of the goods, in circumstances where the contract for sale
contains clauses that seek to ensure that ownership does not pass to the customer until the seller
has been paid in full?
• Is it when services are provided, in circumstances where the seller undertakes to come back to do
additional work without charge if needed, eg, remedial work carried out by a building contractor?
• When does the profit arise on a contract for the provision of services to a customer over time,
such as under a maintenance contract of two years’ duration? Only at the start, only in the middle,
only at the end, or over the period of two years?
IFRS 15, Revenue from Contracts with Customers was brought in to address this.

Professional skills focus: Assimilating and using information

It is by no means always easy in practice to assimilate information about revenue, as the points above
show. An exam question is likely to contain a detailed scenario with revenue apparently occurring at
different times.

1.2 Significance of revenue

Revenue is often the largest single item in the financial statements. US studies have shown that over
half of all financial statement frauds and requirements for restatements of previously published
financial information involved revenue manipulation.
The most blatant example was the Satyam Computer Services fraud in 2009, in which false invoices
were used to record fictitious revenue amounting to £1.5 billion. Revenue recognition fraud also
featured in the Enron and WorldCom cases.
The directors of Enron inflated the value of ‘agency’ services by reporting the entire value of each of
its trades as revenue, rather than just the agency commission on the sale. Other energy companies
then adopted this ‘model’ in a bid to keep up with Enron’s results.
In the UK, an example showing the weaknesses of IFRS 15’s predecessor IAS 18, Revenue is
supermarket giant, Tesco.

Context example: Tesco

In 2014, supermarket giant Tesco made headline news amid claims that it had overstated its first-half
profits by some £250 million. It is possible that the issue of incorrect timing of revenue recognition

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 could have played a part. IAS 18’s vagueness and inconsistency will not have helped in this respect,
and has allowed scope for aggressive earnings management, although this has not yet been
demonstrated in the case of Tesco. In particular, the timing of revenue has been a cause for criticism
because of the lack of clear and comprehensive guidance.
On the website Wiley Global Insight, Steve Collings wrote:
“It appears that Tesco may have accelerated the recognition of revenue relating to suppliers’ rebates
(hence recognising revenue too early) and at the same time delayed the recognition of costs. The
result of this accounting treatment is that accounting profits are brought into the first half of the year,
with costs pushed into the second half of the year so that the profits look disproportionately healthy
in the first-half of the year.
[…]
Whether this new standard [IFRS 15] will lessen the potential for companies to adopt aggressive
earnings management in their revenue recognition policies remains to be seen. The steps in IFRS 15
do offer more clarity than IAS 18.”
IFRS 15 only came into force in January 2018. However, early adoption was permitted. In a paper
given at the Annual Paris Business Research Conference in July 2016 titled IFRS 15 Early Adoption
and Accounting Quality: The Evidence from Real Estate Companies, Nadia Sbei Trabelsi concluded:
“Results indicate that early adoption of IFRS 15 by REC has a significant positive effect on earnings
and stockholders’ equity for all firms analyzed in the paper. The new standard has a double favorable
effect: revenue could be recognized over time and not at a point of time in almost all contracts with
customers and contract costs are more likely capitalized rather than expensed. The application of
IFRS 15 leads to providing accounting information which is in harmony with qualitative characteristics
of the Conceptual Framework.”

1.2.1 Significance for your exam

IFRS 15 is a recent, topical standard, and could be tested in a number of ways. It was examined for
the first time in July 2019, when it formed a large part of the content of Question 3 (audit and
financial reporting). The question focused mainly on performance obligations satisfied (or not
satisfied) over time, and was set in the context of financial reporting (comment on recognition policy),
risk of misstatement and a potential ethical issue (breach of contract). Reference was also made to
data analytics, which could be a focus of future questions on revenue.

2 IFRS 15, Revenue from Contracts with

Customers
Section overview

• Revenue is income arising in the course of an entity’s ordinary activities.

• Revenue should be recognised to depict the transfer of goods or services to a customer in an
amount that reflects the consideration to which the entity expects to be entitled.
• Generally revenue is recognised when the entity has transferred to the buyer control of the asset.
• IFRS 15 sets out a five-stage process for this.

2.1 Objective and scope

The objective of IFRS 15 is to establish the principles that should be applied to report on the nature,
amount, timing and uncertainty of revenue and cash flows arising from a contract with a customer.
(IFRS 15.1)

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 IFRS 15 applies to all contracts with customers except:
• leases within the scope of IFRS 16, Leases
• insurance contracts within the scope of IFRS 4, Insurance Contracts
• non-monetary exchanges between entities in the same line of business

2.2 Revenue
Income is defined in the IASB’s Conceptual Framework (para. 4.2) as “Increases in assets, or
decreases in liabilities, that result in increases in equity, other than those relating to contributions
from holders of equity claims .” Revenue is simply income arising in the course of an entity’s
ordinary activities (IFRS 15: Appendix A) and it may be called different names such as:
• Sales
• Turnover
• Interest
• Dividends
• Royalties

2.3 Core principle

The core principle of IFRS 15, Revenue from Contracts with Customers is that an entity recognises
revenue to depict the transfer of promised goods or services to customers in an amount that reflects
the consideration to which the entity expects to be entitled in exchange for those goods or services
(IFRS 15. IN7).
The transfer of goods and services is evidenced by the transfer of control.
Revenue is recognised in accordance with this core principle by applying a five-step model.

2.4 Five-step model

IFRS 15 takes a five-step approach to recognising revenue:
Step 1 Identify the contract(s) with a customer.
Step 2 Identify separate performance obligations.
Step 3 Determine the transaction price.
Step 4 Allocate transaction price to performance obligations.
Step 5 Recognise revenue as or when each performance obligation is satisfied.
Revenue is therefore recognised when control over goods or services is transferred to the customer.

Professional skills focus: Structuring problems and solutions

IFRS 15 is a good example of an IFRS structuring a problem. The five-stage process provides the
structure.

2.5 Identify the contract with the customer

The contract can be written, verbal or implied. For instance, in retail sales the contract is implied.
The criteria to be met are as follows:
(a) All parties have approved the contract.
(b) The entity can identify each party’s rights regarding the goods or services to be transferred.
(c) The payment terms can be identified.
(d) The contract has commercial substance.
(e) It is probable that the entity will collect the consideration to which it will be entitled in exchange
for the goods or services.
(IFRS 15.9)

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2.6 Identify the performance obligations in the contract
A performance obligation is a promise to transfer to the customer either:
(a) a distinct good or service (or bundle of goods or services); or
(b) a series of distinct goods or services.
(IFRS 15.22)
A good or service is distinct if it can be sold separately and has a distinct function. If this does not
apply, it will form part of a distinct bundle.
The definition of distinct is therefore key when identifying separate performance obligations. A good
or service (or a bundle of goods or services) is distinct if the customer can benefit from the good or
service on its own or together with other readily available resources and the entity’s promise is
separately identifiable from other promises in the contract).
If goods or services are not distinct, the reporting company must combine them with other promised
goods or services until a bundle of goods or services that is distinct can be identified.

Worked example: Performance obligations (1)

Colossal Construction plc has recently signed a contract to build a warehouse for SupaSave Ltd.
Colossal Construction is responsible for designing the building, preparing the site, purchasing raw
materials, construction, plumbing, wiring and finishing.
Requirement
Identify the performance obligation(s) in the contract.

Solution
In the context of this contract, Colossal Construction is contracted to provide a significant service of
integrating the inputs in order to produce a single output; this being the warehouse. Therefore the
provision of each good or service is not separately identifiable.
The promises are not distinct and therefore there is only a single performance obligation, being the
development of the property.

Worked example: Performance obligations (2)

MetaConnect Software Services plc (MetaConnect) supplies computer aided design packages to
customers. It has recently signed a contract with EverTel Design Ltd to provide a licence to use a
software package, installation service (which does not involve customising the software package) and
technical support for four years. MetaConnect is not the only company that could install the software
and provide technical support.
Requirement
Identify the performance obligation(s) in the contract.

Solution
Each good or service provided (the provision of the licence, the installation service and the technical
support) is capable of being distinct because a customer could gain benefit from each either on its
own or by obtaining the other goods/services from another supplier. The good or service could
therefore benefit the customer either on its own or together with other resources that are readily
available.
In the context of this contract, MetaConnect is not integrating the goods or services, none of the
goods or services modifies another and the goods/services are not highly interrelated. Therefore
each promise is separately identifiable. Therefore the promise to transfer the good or service to the
customer is separately identifiable from other promises in the contract
In conclusion, there are three distinct performance obligations in the contract, being:
(1) Installation of the software
(2) Provision of the licence

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 (3) Provision of technical support

2.7 Determine the transaction price

This is the amount of consideration in a contract to which an entity expects to be entitled for
transferring promised goods or services to a customer (IFRS 15.47).
This may include both fixed and variable elements but not amounts collected on behalf of third
parties. Variable amounts could be discounts, refunds, price concessions, incentives, bonuses or
other items.
Variable consideration is included in the transaction price based on either:
• its expected value (the sum of probability weighted amounts in a range of possible outcomes); or
• the single most likely amount (the single most likely amount in a range of possible consideration
amounts).
The expected value approach is generally appropriate if the vendor has a large number of contracts
with similar characteristics.
The single most likely outcome may be appropriate if a contract has only two possible outcomes (eg,
an entity achieves a performance bonus or does not).
The chosen approach should be that which is expected to provide a better prediction of
consideration.
Variable consideration is included in the transaction price only to the extent that it is highly probable
that a significant amount will not be reversed when the uncertainty associated with the variable
consideration is resolved. When assessing whether it is highly probable that a significant reversal will
occur, an entity should consider both the likelihood and magnitude of the revenue reversal. Factors
that may increase the likelihood or magnitude of reversal include any of the following:
(a) The amount of consideration is very susceptible to factors outside the entity’s influence eg,
weather conditions or market volatility.
(b) The uncertainty about consideration is not expected to be resolved for a long period of time.
(c) The entity’s experience with similar types of contracts is limited or has limited predictive value.
(d) The entity has a practice of offering a wide range of price concessions or changing the payment
terms and conditions of similar contracts in similar circumstances.
(e) The contract has a large number and broad range of possible consideration amounts.

Worked example: Variable consideration

On 1 July 20X8, Danmar Construction plc (Danmar) signs a contract to build an extension to a retail
outlet. The total price agreed is £80 million. The contract terms require completion by 31 March
20X9. The price will decrease by £200,000 for every day after this date that the project remains
incomplete. At the year end of 31 December 20X8, Danmar expects that there is an 80% chance of
the project being completed on time, a 10% chance of it being completed a day late, a 7% chance of
it being completed two days late and a 3% chance of it being completed three days late.
Requirement
What is the transaction price?

Solution
The consideration is variable due to the fact that Danmar will accept an amount that is less than the
price stated in the contract if the project overruns (the price concession).
Here the calculation of transaction price is based on expected values.

£
80% × £80,000,000 64,000,000
10% × £79,800,000 7,980,000
7% × £79,600,000 5,572,000

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 £
3% × £79,400,000 2,382,000
Transaction price 79,934,000

2.8 Allocate the transaction price to the performance obligations in the contract
The transaction price is allocated to each performance obligation on the basis of the stand-alone
selling price of each distinct good or service in the contract. If the good or service does not have a
stand-alone selling price, it will need to be estimated (IFRS 15.IN7).
This applies particularly where a bundle of goods is sold which the entity also supplies unbundled.
An example of this is a mobile phone service contract which includes a free handset. In accordance
with IFRS 15, the entity will have to allocate some of the revenue to the handset, based on its stand-
alone selling price.

Worked example: Allocation of transaction price

The contract between MetaConnect and EverTel Design (see Worked example: Performance
obligations 2) is priced at £6,000. The stand-alone selling prices of each element are as follows:

£
Provision of a licence 5,000
Installation service 1,500
Provision of technical support 3,000
9,500

Requirement
Allocate the transaction price to the performance obligations in the contract.

Solution
Licence provision £5,000/£9,500 × £6,000 = £3,158
Installation service £1,500/£9,500 × £6,000 = £947
Technical support service £3,000/£9,500 × £6,000 = £1,895

Context example: Unbundling

A mobile phone company gives customers a free handset when they sign a two-year contract for
provision of network services. The handset has a stand-alone price of £52 and the contract is for £20
per month.
Under IFRS 15, revenue must be allocated to the handset because delivery of the handset constitutes
a performance obligation. This will be calculated as follows:

£ %
Handset 52 10
Network services 480 90
Total value 532 100

As the transaction price is the total receipts of £480, this is the amount which must be allocated to
the separate performance obligations.

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 Revenue will be recognised as follows:

£
Year 1
Handset (480 × 10%) 48
Contract (480 – 48)/2 216
264
Year 2
Contract as above 216

2.9 Recognise revenue when (or as) a performance obligation is satisfied

A performance obligation is satisfied when control of the good or service specified in the contract is
transferred to the customer (IFRS 15.31).
A performance obligation can be satisfied at a point in time, such as in retail sales, or over time, such
as a construction contract taking place over weeks, months or even years.
Where a performance obligation is satisfied at a point in time, that point will occur when control is
transferred. At that point the customer is able to direct the use of the asset and obtain substantially
all the remaining benefits from it (IFRS 15.33).
The following events can indicate that control has been transferred (IFRS 15.38):
• The entity has a present right to payment for the asset
• The customer has legal title to the asset
• The entity has transferred physical possession of the asset
• The significant risks and rewards of ownership have been transferred to the customer
• The customer has accepted the asset
A performance obligation satisfied over time will meet one of the following criteria:
• The customer simultaneously receives and consumes the benefits as the performance obligation
is satisfied.
• The entity’s performance creates or enhances an asset that the customer controls as the asset is
created or enhanced.
• 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.
(IFRS 15.35)
Where performance obligations are satisfied over time, the entity recognises revenue by measuring
progress towards complete satisfaction of the performance obligation. Progress can be measured
using output methods (measuring the value to the customer of goods or services transferred to date)
or input methods (measuring the cost to the entity of goods or services transferred to date) (IFRS
15.B14).
In the early stages of a contract it may not be possible to reasonably measure the outcome of a
performance obligation, but the entity is entitled to recover costs incurred. In this case, revenue can
be measured to the extent of costs incurred.
A contract where performance obligations are recognised over time may give rise to asset or liability
amounts at the end of the reporting period.
Contracts with customers will be presented in an entity’s statement of financial position as a contract
liability, a contract asset or a receivable, depending on the relationship between the entity’s
performance and the customer’s payment.
(IFRS 15.105)

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A contract liability is recognised and presented in the statement of financial position where a
customer has paid an amount of consideration prior to the entity performing by transferring control
of the related good or service to the customer.
(IFRS 15.106)
When the entity has performed but the customer has not yet paid the related consideration, this will
give rise to either a contract asset or a receivable. A contract asset is recognised when the entity’s
right to consideration is conditional on something other than the passage of time, for instance future
performance. A receivable is recognised when the entity’s right to consideration is unconditional
except for the passage of time.
(IFRS 15.107)
Where revenue has been invoiced a receivable is recognised. Where revenue has been earned but
not invoiced, it is recognised as a contract asset.

Worked example: Performance obligation satisfied over time

Associated Solutions Ltd is building a bespoke software system for an insurance company. The
contract started on 1 January 20X7 with an estimated completion date of 31 December 20X9. The
contract price is £2 million. As at 31 December 20X7:
(1) costs incurred amounted to £800,000;
(2) half the work on the contract was completed;
(3) certificates of work completed have been issued by the insurance company, to the value of £1
million; and
(4) it is estimated with reasonable certainty that further costs to completion will be £800,000.
Requirement
What is the contract profit in 20X7, and what entries would be made for the contract at 31 December
20X7?

Solution
This is a contract in which the performance obligation is satisfied over time. The entity is carrying out
the work for the benefit of the customer rather than creating an asset for its own use and in this case
it has an enforceable right to payment for work completed to date. We can see this from the fact that
certificates of work completed have been issued.
IFRS 15 states that the amount of payment that the entity is entitled to corresponds to the amount of
performance completed to date (ie, goods and/or services transferred).
In this case, the contract is certified as 50% complete, measuring progress under the output method.
At 31 December 20X7, the entity will recognise revenue of £1,000,000 and cost of sales of £800,000,
leaving profit of £200,000. The contract asset will be the costs to date plus the profit – that is
£1,000,000. We are not told that any of this amount has yet been invoiced, so none of this amount is
classified as receivables.

Interactive question 1: Publishing revenue

A magazine publisher launched a new monthly magazine on 1 January 20X7. During January it
received £48,000 in annual subscriptions in advance. It has despatched four issues by the year end
31 March 20X7.
Requirement
What revenue should be recognised for the year ended 31 March 20X7?

See Answer at the end of this chapter.

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 Interactive question 2: Advance sales
A DIY store is about to sell a new type of drill. Customer demand is high and the store has taken
advance orders for the drill. The selling price of the drill will be £50 and so far 200 customers have
paid an initial 10% deposit on the selling price of the drill. No drills are yet held in inventory.
Requirement
What amount should be recognised as revenue?

See Answer at the end of this chapter.

Interactive question 3: Rendering of services

A £210,000 fixed-price contract is entered into for the provision of services. At the end of 20X7, the
first accounting period, the contract is thought to be 33% complete and costs of £45,000 have been
incurred in performing that 33% of the work.
Requirements
Calculate the revenue to be recognised in 20X7 on the alternative assumptions that:
(a) The costs to complete are reliably estimated at £90,000; and
(b) The costs to complete cannot be reliably estimated, and it is thought that £40,000 of the costs
incurred are recoverable from the customer.

See Answer at the end of this chapter.

Interactive question 4: Service contract

An entity entered into a contract for the provision of services over a two year period. The total
contract price was £150,000 and the entity initially expected to earn a profit of £20,000 on the
contract. In the first year, costs of £60,000 were incurred and 50% of the work was completed. The
contract did not progress as expected and management was not sure of the ultimate outcome but
believed that the costs incurred to date would be recovered from the customer.
Requirement
What revenue should be recognised for the first year of the contract?

See Answer at the end of this chapter.

2.10 Performance obligations satisfied over time: ‘construction contracts’

Before IFRS 15 came into force ‘construction contracts’, sometimes called ‘long-term contracts’ had
their own IAS, and you may still come across these terms. However, IFRS 15 does not specifically use
these terms, but refers to them as contracts in which performance obligations are satisfied over time.
Such contracts often include contracts for large construction projects falling into more than one
accounting period. As mentioned in section 2.9 above, the entity recognises revenue by measuring
progress towards complete satisfaction of the performance obligation. Progress can be measured
using output methods (measuring the value to the customer of goods or services transferred to date)
or input methods (measuring the cost to the entity of goods or services transferred to date) (IFRS
15.B14).

Worked example: Contract to construct a conference centre

During the year ended 31 July 20X9, Frizco Construction plc (Frizco) began the construction of a
leisure centre on behalf of a local authority. The agreed contract price was £70 million. However this
will be reduced by £6 million if Frizco completes the centre a month or more behind schedule.
During the year ended 31 July 20X9, costs incurred amounted to £18.6 million, including £1,000,000
material that could not be used in the project as it was of the incorrect grade to meet regulations.

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 The total cost of the project (excluding the £1,000,000 in wasted material) is estimated to be £44
million. Work certified at the year-end was £24.5 million.
The construction is currently progressing in accordance with the agreed schedule.
Requirements
1 What amount of revenue is recognised in profit or loss in the year ended 31 July 20X9 if an
output method is used to assess progress?
2 What amount of revenue is recognised in profit or loss in the year ended 31 July 20X9 if an input
method is used to assess progress?

Solution
The transaction price is £70 million. £64 million is fixed consideration and £6 million is variable
consideration. The transaction price is £70 million as the project is currently expected to be
completed on time and therefore the single most likely outcome is the receipt of £70 million.
1 Output method
Using the output method the project is 35% complete:
Work certified ÷ Transaction price = 24,500 ÷ 70,000 = 35%
Therefore 35% × £70m = £24.5 million is recognised as revenue in the year.
2 Input method
Using the input method the project is 40% complete:
Costs incurred to date ÷ Total expected costs = (18,600 – 1,000) ÷ 44,000 = 40%
Therefore 40% × £70m = £28 million is recognised as revenue in the year.
Note that the £1 million wasted material is not relevant to the assessment of progress, however, it
must be recognised in profit or loss as a wastage expense.
Contract costs are considered in further detail in section 2.12.

2.11 Deferred consideration

In some sectors of the retail industry it is common practice to provide interest-free credit to
customers in order to encourage sales of, for example, furniture and new cars.
IFRS 15 refers to this as a ‘financing component’ in the contract. When the contract contains a
significant financing component, such as a period of interest-free credit exceeding one year, the
amount of consideration should be adjusted for the time value of money (IFRS 15.60, .63).
Where an extended period of credit is offered, the revenue receivable has two separate elements:
• The value of the goods on the date of sale
• Financing income
In order to separate these two elements the future receipts are discounted to present value at an
imputed interest rate, identified as either:
• the prevailing rate for lending to a customer with a credit rating similar to that of the customer; or
• the rate of interest which discounts the receivable back to the current cash selling price.
The effect on the timing of the revenue recognition is that:
• the fair value of the goods is recognised on delivery of the goods
• the finance element is recognised over the period that the financing is provided

Worked example: Deferred consideration 1

A car retailer sells its new cars by requiring a 20% deposit followed by no further payments until the
full balance is due after two years. The price of the cars is calculated using a 10% per annum finance
charge.
On 1 January 20X7 a car was sold to a customer for £20,000.

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 Requirement
How should the revenue be recognised in the year ended 31 December 20X7 and what should the
carrying amount of the customer receivable be on that date?

Solution
Revenue to be recognised

£
Sale of goods (£4,000 + £13,223 (W)) 17,223
Financing income (£13,223 (W) × 10%) 1,322

Carrying amount of receivable (£13,223 (W) × 1.10) 14,545

WORKING
The deposit is £4,000 (£20,000 × 20%), so the amount receivable in two years is £16,000.
This is discounted at 10% for two years to £13,223 (£16,000 × 1/1.102).

Context example: Deferred consideration 2

Comfy Couches Ltd sells an item of furniture to a customer on 1 September 20X7 for £2,500 with a
one-year interest-free credit period. The fair value of the consideration receivable is £2,294. (In other
words, if the company tried to sell this debt, this is the amount it would expect to receive now.)
In this case the transaction would be split into two components:
(a) Interest revenue of £206 (2,500 – 2,294), which would be recognised over the period of credit
(b) Sales revenue of £2,294, which would be recognised on 1 September 20X7

2.12 Contract costs

IFRS 15 deals with the costs of obtaining a contract and the costs of fulfilling a contract.

2.12.1 Costs of obtaining a contract

The incremental costs of obtaining a contract (such as sales commission) are recognised as an asset
if the entity expects to recover those costs.
Costs that would have been incurred regardless of whether the contract was obtained are
recognised as an expense as incurred.
Costs incurred in fulfilling a contract, unless within the scope of another standard, (such as IAS 2,
Inventories, IAS 16, Property, Plant and Equipment or IAS 38, Intangible Assets) are recognised as an
asset if they meet the following criteria (IFRS 15.95):
(a) The costs relate directly to an identifiable contract (costs such as labour, materials, management
costs)
(b) The costs generate or enhance resources of the entity that will be used in satisfying (or
continuing to satisfy) performance obligations in the future
(c) The costs are expected to be recovered
Costs recognised as assets are amortised on a systematic basis consistent with the transfer to the
customer of the goods or services to which the asset relates.

Worked example: Costs of obtaining a contract

Copyquick Ltd enters into contracts for five-year terms to service and repair a customer’s
photocopiers. The contracts may be subsequently renewed on a one-year rolling basis and the

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 average customer term is seven years. Copyquick pays its sales staff a commission of £35,000 when a
new customer signs an initial contract.
On 1 January 20X8, the Copyquick sales staff secured a new customer contract.
Requirement
How is the cost of commission of £35,000 accounted for?

Solution
The £35,000 is an incremental cost of obtaining a new contract, and Copyquick expects to recover
the cost by charging the customer for servicing and repairing their photocopiers.
Copyquick should capitalise the £35,000 and amortise it over a period to reflect the transfer of
services to the customer. Although the original contract is for five years, this is usually extended for a
further two years and so the amortisation period is seven years.
Therefore the annual amortisation charge is £5,000 (£35,000/7 years).

Professional skills focus: Applying judgement

As we have seen, while IFRS 15 provides structure and guidance, it does not remove the need for
judgement. The area of costs is one where judgement must be applied. An example of this is the
question of whether to use an input method or an output method.

2.13 Presentation and disclosure

2.13.1 Presentation
Contracts with customers will be presented in an entity’s statement of financial position as a contract
liability, a contract asset, or a receivable depending on the relationship between the entity’s
performance and the customer’s payment.
A contract liability is recognised and presented in the statement of financial position where a
customer has paid an amount of consideration before the entity has transferred control of the related
good or service to the customer.
When the entity has performed but the customer has not yet paid the related consideration, this will
give rise to either a contract asset or a receivable. A contract asset is recognised when the entity’s
right to consideration is conditional on something other than the passage of time, for instance future
performance. A receivable is recognised when the entity’s right to consideration is unconditional
except for the passage of time.
Where revenue has been invoiced, a receivable is recognised. Where revenue has been earned but
not invoiced, it is recognised as a contract asset.

2.13.2 Disclosure
Disclosure of the following is required:
(a) Revenue from contracts with customers (separately from other sources of revenue) in categories
that depict how the nature, timing, amount and uncertainty of revenue and cash flows are
affected by economic factors (eg, by type of goods or geographical area). Sufficient information
should be disclosed to enable users to understand the relationship between the disclosure of
disaggregated revenue and revenue information that is disclosed for each reportable segment
(where IFRS 8 is applied).
(b) Impairment losses recognised on receivables, or contract assets arising from contracts with
customers (by category, as above).
(c) The opening and closing balances of receivables, contract assets and contract liabilities and
explanation of significant changes in contract assets and liabilities, including both qualitative and
quantitative information.

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(d) Revenue recognised in the reporting period that was included in the contract liability balance at
the start of the period and revenue recognised in the period from performance obligations
satisfied in previous periods (eg, due to changes in transaction price).
(e) A description of performance obligations including the following:
(1) When they are typically satisfied
(2) Significant payment terms
(3) The nature of goods or services that an entity has promised to transfer, highlighting
obligations to arrange for another party to transfer goods or services
(4) Obligations for returns, refunds or similar
(5) Types of warranties and related obligations
(f) The transaction price allocated to performance obligations that are unsatisfied at the end of the
reporting period, and an explanation of when related revenue is expected to be recognised. This
information need not be disclosed if the performance obligation is part of a contract lasting 12
months or less, or the entity recognises revenue from the satisfaction of the performance
obligation in the amount that it has a right to invoice (because the amount directly corresponds
with the value to the customer of the entity’s performance completed to date).

Worked example: Applying the IFRS 15 five-step model

On 1 January 20X4, Peterloo enters into a 12-month ‘pay monthly’ contract for a mobile phone. The
contract is with Westerfield, and terms of the plan are as follows:
• Peterloo receives a free handset on 1 January 20X4.
• Peterloo pays a monthly fee of £200, which includes unlimited free minutes. Peterloo is billed on
the last day of the month.
Customers may purchase the same handset from Westerfield for £500 without the payment plan.
They may also enter into the payment plan without the handset, in which case the plan costs them
£175 per month.
The company’s year-end is 31 July 20X4.
Requirement
Show how Westerfield should recognise revenue from this plan in accordance with IFRS 15, Revenue
from Contracts with Customers. Your answer should give journal entries:
(1) On 1 January 20X4
(2) On 31 January 20X4

Solution
IFRS 15 requires application of its five-step process:
(1) Identify the contract with a customer. A contract can be written, oral or implied by customary
business practices.
(2) Identify the separate performance obligations in the contract. If a promised good or service is
not distinct, it can be combined with others.
(3) Determine the transaction price. This is the amount to which the entity expects to be ‘entitled’.
For variable consideration, the probability-weighted expected amount is used.
(4) Allocate the transaction price to the separate performance obligations in the contract. For
multiple deliverables, the transaction price is allocated to each separate performance obligation
in proportion to the stand-alone selling price at contract inception of each performance
obligation.
(5) Recognise revenue when (or as) the entity satisfies a performance obligation. That is when the
entity transfers a promised good or service to a customer. The good or service is only
considered as transferred when the customer obtains control of it.
Application of the five-step process to Westerfield
(1) Identify the contract with a customer. This is clear. Westerfield has a 12-month contract with
Peterloo.

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(2) Identify the separate performance obligations in the contract. In this case there are two distinct
performance obligations:
(a) The obligation to deliver a handset
(b) The obligation to provide network services for 12 months
(The obligation to deliver a handset would not be a distinct performance obligation if the
handset could not be sold separately, but it is in this case because the handsets are sold
separately.)
(3) Determine the transaction price. This is straightforward: it is £2,400, that is 12 months × the
monthly fee of £200.
(4) Allocate the transaction price to the separate performance obligations in the contract. The
transaction price is allocated to each separate performance obligation in proportion to the
stand-alone selling price at contract inception of each performance obligation, that is the stand-
alone price of the handset (£500) and the stand-alone price of the network services (£175 × 12 =
£2,100):

Stand-alone selling Revenue (= relative selling

Performance obligation price % of total price = £2,400 × %)
£ £
Handset 500.00 19.2 460.80
Network services 2,100.00 80.8 1,939.20
Total 2,600.00 100 2,400.00

(5) Recognise revenue when (or as) the entity satisfies a performance obligation. That is when the
entity transfers a promised good or service to a customer. This applies to each of the performance
obligations:
• When Westerfield gives a handset to Peterloo, it needs to recognise the revenue of £460.80.
• When Westerfield provides network services to Peterloo, it needs to recognise the total revenue
of £1,939.20. It’s practical to do it once per month as the billing happens.
Journal entries
(1) On 1 January 20X4
The entries in the books of Westerfield will be:

DEBIT Receivable (unbilled revenue) £460.80

CREDIT Revenue £460.80

Being recognition of revenue from the sale of the handset

(2) On 31 January 20X4
The monthly payment from Peterloo is split between amounts owing for network services and
amounts owing for the handset:

DEBIT Bank/Receivable (Peterloo) £200

CREDIT Revenue (1,939.20/12) £161.60
CREDIT Receivable (unbilled revenue) (460.80/12) £38.40

Being recognition of revenue from monthly provision of network services and ‘repayment’ of
handset.

Interactive question 5: Caravan

Caravans Deluxe is a retailer of caravans, dormer vans and mobile homes, with a year end of 30 June.
It is having trouble selling one model – the £30,000 Mini-Lux, and so is offering incentives for
customers who buy this model before 31 May 20X7.

536 Corporate Reporting ICAEW 2021

 (1) Customers buying this model before 31 May 20X7 will receive a period of interest free credit,
provided they pay a non-refundable deposit of £3,000, an instalment of £15,000 on 1 August
20X7 and the balance of £12,000 on 1 August 20X9.
(2) Equipment for the caravan, normally worth £1,500, is included free in the price of the caravan.
On 1 May 20X7, a customer agrees to buy a Mini-Lux caravan, paying the deposit of £3,000. Delivery
is arranged for 1 August 20X7.
As the sale has now been made, the sales director of Caravans Deluxe wishes to recognise the full
sale price of the caravan, £30,000, in the accounts for the year ended 30 June 20X7.
Requirement
Show how the IFRS 15 five-step plan is applied to this sale. Assume a 10% discount rate. Show the
journal entries for this treatment.

See Answer at the end of this chapter.

3 Applications of IFRS 15
Section overview

• IFRS 15 includes Application Guidance, which explains how the provisions of the standard should
be applied to a number of situations.
• These include:
– Sales with a right of return
– Extended warranties
– Transactions involving an agent
– Licensing
– Royalties
– Repurchase agreements
– Consignment arrangements
– Bill and hold arrangements
– Non-refundable upfront fees

3.1 Sales with a right of return

Some contracts give the customer the right to return the product and receive a refund, a credit or a
replacement.
The entity should recognise (IFRS 15.B21):
• revenue for the transferred products
• a refund liability
• an asset in respect of products to be returned
The asset is:
• measured at the former carrying amount of the products less any expected decreases in value
and other costs to recover the products;
• presented separately from the refund liability; and
• remeasured to reflect changes in expectations about the products to be returned at each
reporting date.

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 Interactive question 6: Sale or return
Bags Galore Ltd operates a number of high-end handbag outlets. On 28 January 20X9, it sells 50
identical bags to different customers for £850 each. The bags cost £400 each. The customers have 28
days in which they can return purchases in exchange for a full refund and, based on past experience,
Bags Galore Ltd expects a returns level of 6%. Bags Galore Ltd’s ‘Fabulous February’ sale starts on 1
February and the selling price of the bags will be reduced to 50% of the original price from that date.
Requirements
6.1 How should Bags Galore account for the sale of the bags?
6.2 How would the accounting treatment change if the selling price of the bags was to be reduced
to 40% of the original price in the Fabulous February sale?

See Answer at the end of this chapter.

3.2 Warranties
It is necessary to distinguish between warranties which give the customer assurance that the product
complies with agreed upon specifications, and warranties which provide the customer with a distinct
service (such as free repairs over a specified period).
A warranty which the customer purchases separately will always be a service warranty.
A service warranty is accounted for as a separate performance obligation and a portion of the
transaction price is allocated to it.
A warranty which does not promise a service is simply accounted for in accordance with IAS 37,
Provisions, Contingent Liabilities and Contingent Assets (IFRS 15.B28–30).
When considering whether a warranty is standard or extended, IFRS 15 requires that the following
factors are considered:
(a) Whether the provision of the warranty is a legal requirement; this would indicate that it is a
standard warranty
(b) The length of the warranty period – the longer the period, the more likely it is to be an additional
or extended warranty
(c) The nature of the tasks promised within the warranty and whether they relate to providing
assurance that a product will function as intended

3.3 Principal versus agent

IFRS 15 specifically excludes amounts collected on behalf of third parties from the transaction price
attached to a contract (IFRS 15.47).
Individually or in combination, the following criteria indicate that the entity is acting as an agent (IFRS
15.B37):
• Another party has the primary responsibility for providing the goods or services to the customer,
or for fulfilling the order.
• The entity does not have the inventory risk before or after the customer order, during shipping or
on return.
• The entity does not have discretion in establishing prices for the goods or services.
• The entity’s consideration is in the form of commission.
• The entity is not exposed to credit risk on the amount due from the customer.
An entity is a principal if it controls the promised good or service before it is transferred to the
customer. In this case, when the performance obligation is satisfied the entity recognises the
revenue.
An entity is an agent if its performance obligation is to arrange for the provision of goods or services
by another party. When this performance obligation is satisfied, it recognises revenue only for the fee
or commission to which it is entitled (IFRS 15.B36).

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 Worked example: Agent or principal?
An entity runs a website which enables customers to buy goods from a range of suppliers. Prices are
set by suppliers, and payments are processed through the entity’s website. Customers pay in
advance and goods are delivered directly from the supplier to the customer.
The entity receives a commission of 10% of the sales price and has no further obligation to the
customer after arranging for the products to be shipped.
Requirement
Is the entity an agent or the principal?

Solution
The entity is acting as an agent based on the following points:
• Goods travel directly from the supplier to the customer, so the entity never has physical custody
of them and does not bear the associated risk.
• The supplier, not the entity, has the obligation to the customer.
• The entity does not set prices or bear credit risk.
• The payment received by the entity is in the form of commission.
So the entity should only recognise the commission received from suppliers as revenue.

3.4 Goods and services provided in one contract

One marketing approach frequently used is to bundle together both goods and services into one
transaction. For example, a car dealer may sell new cars with one year’s free servicing and insurance.
In such cases:
• the components of the package which could be sold separately should be identified; and
• each should be measured and recognised as if sold separately.
IFRS 15 does not specifically state how each component should be measured but general principles
require that each component should be:
• measured at its fair value; and
• recognised as revenue only when it meets the recognition criteria.
If the total of the fair values exceeds the overall price of the contract, an appropriate approach would
be to apply the same discount percentage to each separate component.

Worked example: Goods and services

A car dealer sells a new car, together with 50 litres of fuel per month for a year and one year’s
servicing, for £27,000. The fair values of these components are: car £28,000, fuel £1,200 and
servicing £800.
Requirement
How should the £27,000 be recognised as revenue?

Solution
The total fair value of the package is £30,000 (28,000 + 1,200 + 800) but is being sold for £27,000, a
discount of £3,000 or 10%.
The discounted fair value of the car should be recognised as revenue upon delivery:
£28,000 × 90% = £25,200
The discounted fair value of the fuel should be recognised as revenue on a straight line basis over
the next 12 months:
£1,200 × 90% = £1,080
The discounted fair value of the servicing should be recognised as revenue at the earlier of when the
servicing is provided and the end of the year:

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 £800 × 90% = £720

Interactive question 7: Goods and services

An entity sells an item of equipment to a customer on 1 January 20X7 for £1.5 million. Due to the
specialised nature of the equipment, the entity has agreed to provide free support services for the
next two years, despite the cost to the entity of that support being estimated at £120,000 in total. The
entity usually earns a gross margin of 20% on such support service contracts.
Requirement
How much revenue should the entity recognise for the year ended 30 April 20X7?

£
Revenue:

See Answer at the end of this chapter.

Interactive question 8: Servicing fees

On the last day of its current accounting period, Computer Ltd completes the handover of a new
system to a client and raises an invoice for £800,000. This price includes after-sales support for the
next two years, which is estimated to cost £35,000 each year. Computer Ltd normally earns a gross
profit margin of 17.5% on such support activity.
Requirement
Calculate the revenue to be included in Computer Ltd’s current year statement of profit or loss in
respect of this sale.

After-sales support

Remainder

Total selling price

So the revenue from the sale in the current year is:

See Answer at the end of this chapter.

3.5 Licences
A licence allows a customer to access intellectual property such as software, patents, trademarks,
franchises, copyrights and media (eg, films).
The grant of a licence may be accompanied by the promise to transfer other goods or services in the
following circumstances:
(a) Where the promise to grant a licence is distinct, it forms a separate performance obligation from
that for goods and services.
(b) Where the promise to grant a licence is a separate performance obligation, revenue is either
recognised at a point in time or over time depending on the nature of the contract.

540 Corporate Reporting ICAEW 2021

 (c) Where the promise to grant a licence is not distinct from the promised goods and services, the
goods, services and licence are combined as one single performance obligation (eg, software
that requires ongoing upgrade services in order to function or a software hosting agreement on
an internet site). This performance obligation may be satisfied at a point in time or over time and
this should be determined in accordance with IFRS guidance (see section 2.9).
(d) Where the licence allows the customer access to the vendor’s intellectual property as it exists at
any given time in the licence period (ie, the vendor continues to support and update the
intellectual property), this is a performance obligation satisfied over time.
(e) Where the licence allows the customer access to the vendor’s intellectual property as it exists at
the date the licence is granted, this is a performance obligation satisfied at a point in time.

Worked example: Licensing

A fast food company ‘PizzaTheAction’ grants a franchise licence to a customer, allowing the customer
to use the PizzaTheAction brand and sell company products for a 10-year period. During the 10-year
period, management at PizzaTheAction will perform customer analysis, continuously improve the
product and advertise the brand, all of which will affect the franchise licence.
Requirement
Explain how the revenue arising from this transaction is recognised.

Solution
PizzaTheAction is providing access to its intellectual property as it exists throughout the licence
period (ie, the customer will benefit from continuous improvements and marketing etc). Therefore
the performance obligation is satisfied over time and PizzaTheAction recognises revenue over the
licence period.

3.6 Royalties
A contract to license intellectual property may require as consideration a royalty that is measured by
reference to sales or usage. In such cases, the seller recognises revenue when the later of the
following events occurs:
• The subsequent sale or usage arises.
• The performance obligation to which some or all of the sales- or usage-based royalty has been
allocated is satisfied (or partially satisfied).

3.7 Repurchase agreements

Under a repurchase agreement an entity sells an asset and has the option to repurchase it. This can
come in one of three forms (IFRS 15.B64):
(a) An obligation to repurchase (a forward contract)
(b) A right to repurchase (a call option)
(c) An obligation to repurchase at the customer’s request (a put option)
Under a forward contract or a call option the customer does not obtain control of the asset because
that control is limited by the repurchase option. The contract is accounted for as a lease if the
repurchase price is below the original selling price, or a financing arrangement if the repurchase
price is equal to or above the original selling price (IFRS 15.B66).
Under a put option, if the customer does not have sufficient economic incentive to exercise the right
to request repurchase, the agreement should be treated as if it were a sale with a right of return. If
the customer does have sufficient economic incentive, for instance if the repurchase price is above
the original selling price and above market value, the contract is treated as a financing arrangement
(IFRS 15.B73).

Worked example: Repurchase agreement

An entity sold an investment property to a financial institution for £4 million when the fair value of the
property was £5 million. Further investigation uncovered an agreement whereby the entity could
repurchase the property after one year for £4.32 million.

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 Requirement
How should this transaction be accounted for?

Solution
The entity has a right to repurchase the property – a call option. The repurchase price is above the
original selling price, so this is, in effect, a financing arrangement.
The sale of the property at 20% below fair value is sufficient to cast doubt on whether a real sale has
been made. Also, the repurchase price is below fair value at the date of sale and represents a return
to the financial institution of 8% ((£4.32m – £4m) as a percentage of £4 million) on the amount paid
out.
The substance of the arrangement appears to be that the financial institution has granted the entity a
one-year loan secured on the property, charging interest at 8%.
The transaction should be accounted for by:
• continuing to recognise the property as an asset;
• crediting the £4 million received to a liability account;
• recognising £0.32 million as a finance cost in profit or loss and crediting it to the liability account;
and
• derecognising the liability when the £4.32 million cash is paid out.

Interactive question 9: Sale and repurchase

Builder Ltd specialises in building high quality executive flats in city centres. On 1 March 20X6 it sells
a plot of building land to Finance plc, an unconnected company, for £1.5 million. Builder Ltd retains
rights of access and supervision over the plot, the right to build on this land until 28 February 20X9
and the right to buy the plot back again on that date for £1.9 million. On 1 March 20X6 the plot is
valued at £2.5 million.
Requirement
Explain how this sale transaction would be dealt with in Builder Ltd’s financial statements for the year
ended 28 February 20X7.

See Answer at the end of this chapter.

3.8 Consignment arrangements

In a consignment arrangement, a dealer does not obtain control of an asset. Such arrangements are
common in the motor industry. Often a car manufacturer will enter into an arrangement with a car
dealer such that the dealer takes and displays vehicles with a view to selling them to a customer. In
such situations, the manufacturer cannot recognise any revenue because the dealer does not obtain
control of the cars at the point of delivery.
The following are indicators that an arrangement is a consignment arrangement:
• The product is controlled by the seller (manufacturer) until a specified event occurs (eg, the
product is sold onwards or a specified period of time expires).
• The seller (manufacturer) can require the return of the product or transfer it to another party.
• The customer (dealer) does not have an unconditional obligation to pay for the product.

3.9 Bill and hold arrangements

Under these arrangements, an entity bills the customer for the product but delivery is delayed with
the agreement of the customer, perhaps because the customer is short of space. In this case, the
entity must determine the point in time at which it has satisfied its performance obligation by
transferring control of the product to the customer. It may be that the customer is still able to exercise
control without having physical possession of the product.
(IFRS 15 .B79)

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 Control may pass at the point of delivery or when the product is shipped or at an earlier date ie, the
customer may obtain control even though the seller has physical possession of the product.
All the following IFRS 15 criteria must have been met in a bill and hold arrangement, in order for
control to be said to have passed:
(a) There must be a substantive reason for the bill and hold must be substantive, for example, the
customer has requested it.
(b) The product must be identified as belonging to the customer.
(c) The product must be ready for physical transfer to the customer.
(d) The seller must not be able to use the product or transfer it to another customer.
If these criteria are met, enabling revenue to be recognised on a bill and hold basis, the seller should
consider whether to allocate a proportion of the transaction price to the provision of a storage
service.

Interactive question 10: Bill and hold

Walbrooke Engineering plc enters into a contract with Southfield Beverages Ltd on 1 January 20X8
for the sale of a bottling machine and spare parts. It takes two years to manufacture these and on 31
December 20X9 the customer pays for both the machine and the spare parts, but only takes physical
possession of the machine. The customer inspects and accepts the spare parts, but requests that
Walbrooke Engineering continues to store them at its warehouse.
Requirement
Explain when Walbrooke Engineering should recognise revenue in respect of this transaction.

See Answer at the end of this chapter.

3.10 Options for additional goods and services

An option in a sales contract may grant the customer the right to acquire additional goods or
services for free or at a discount. In some cases this may take the form of ‘loyalty points’. For example,
airlines often give passengers loyalty points when they buy a flight. When enough loyalty points are
acquired, they can be redeemed for a free flight.
The option to acquire additional goods or services forms a separate performance obligation if the
option can only be obtained by entering into the initial sales contract.
In this case, part of the transaction price is allocated to the option to acquire additional goods or
services, and part is allocated to the goods or services that are the subject of the sales contract.
Revenue is recognised in respect of the option to acquire additional goods or services at the earlier
of:
• the date on which the additional goods or services are provided;
• the date on which the option to acquire the additional goods or services expires.
The allocation of transaction price to the option is based on the stand-alone selling price of the
additional goods or services, taking account of the discount and adjusted for the likelihood that the
option will be exercised.
If the option granted to the customer does not offer a discount, it is treated as a marketing offer and
no contract exists until the customer exercises the option to purchase.

Worked example: Customer loyalty scheme

GymGo Ltd, a ‘pay as you go’ gym operates a customer loyalty scheme whereby if a customer pays
for nine visits and has a loyalty card stamped, the tenth visit is provided free of charge. During 20X7,
customers visit the gym a total of 94,995 times, paying £10 per visit, so earning the right to a
maximum of 10,555 (94,995/9) free visits, each of which has an average stand-alone price of £10. The
gym expects 7,400 of the free visits to be claimed and by 31 December 20X7, 4,350 have been
claimed.

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 Requirement
Explain how revenue is recognised by GymGo Ltd.

Solution
The promise to provide a free tenth visit is a performance obligation, and total revenue of £949,950
(94,995 × £10) is allocated between visits to the gym by customers and the loyalty scheme.
Revenue is allocated to the provision of ‘stamps’ based on the expected take up rate and the stand-
alone selling price basis ie, based on a total stand-alone selling price of £74,000 (7,400 × £10):

£
Gym visits £949,950 × (949,950/(949,950 + 74,000)) 881,298
Loyalty stamps £949,950 × (74,000/(949,950 + 74,000)) 68,652
949,950

At 31 December 20X7, 4,350 of the expected 7,400 free visits have been claimed, therefore of the
£68,652 transaction price allocated to loyalty stamps:
• £40,356 (4,350/7,400 × £68,652) is recognised as revenue; and
• £28,296 is recognised as a contract liability for the unredeemed loyalty stamps.
Therefore total revenue recognised in 20X7 is £921,654 (881,298 + 40,356).

3.11 Non-refundable upfront fees

A non-refundable upfront fee is often charged at the beginning of a contract, such as joining fees in
health club membership contracts.
In many cases upfront fees do not relate to the transfer of any promised good or service, but are
simply advance payments for future goods or services. In this case revenue is recognised when the
future goods or services are provided.
If the fee relates to a good or service the entity should evaluate whether or not it amounts to a
separate performance obligation. This depends on whether it results in the transfer of an asset to the
customer. The fee may relate to costs incurred in setting up a contract, but these setup activities may
not result in the transfer of services to the customer.

4 Audit focus
Section overview

This section looks at audit procedures relevant when considering the appropriateness of the
accounting treatment adopted for construction contracts.

4.1 Audit procedures for testing IFRS 15

Stage of IFRS 15 Suggested audit procedures

Step 1 • Obtain copies of contracts between entities and customers

Identify the • Inspect contracts to confirm they are legally binding and effective for
contract(s) with a the year of audit
customer. • For implied contracts (such as retail contracts) clarify the likely
contractual terms to establish rights and responsibilities in each case

544 Corporate Reporting ICAEW 2021

Stage of IFRS 15 Suggested audit procedures

Step 2 • Confirm the goods or services to be transferred, either individually or as

Identify separate part of a series, by reference to the contracts in place
performance • Confirm whether any of the goods or service are not distinct by
obligations. reference to the contracts in place and if separate bundles

Step 3 • Identify the amount of consideration by reference to the contract

Determine the • Where appropriate, confirm the split between variable and fixed
transaction price. elements and re-calculate any variable amounts by reference to the
contract terms
• Test the hypothesis that variable consideration is highly probable by
reviewing the reasonableness of the underlying assumptions used in the
entity’s calculations

Step 4 • Confirm stand-alone prices to individual elements of the contract as

Allocate transaction performance obligations are settled
price to • In the case of estimated stand-alone prices, test the assumptions
performance underpinning the calculations used by the entity for reasonableness
obligations.

Step 5 • For performance obligations satisfied at a point in time (such as retail

Recognise revenue sales) confirm the occurrence of the event required (such as the sale
as or when each itself) by reference to supporting documentation
performance (For performance obligations satisfied over time refer to section 4.2
obligation is below.)
satisfied.

Other tests • For deferred consideration, confirm the proportion split between the
value of the goods on the date of sale and the financing income by
reference to the contract and testing the reasonableness of the entity’s
calculations for recognising revenue (such as interest rates for estimating
fair value)

Returns • Review contract/terms of sale and confirm that this is allowed

• For a sample of goods inwards, determine whether any relate to returns
and ensure no revenue has been recognised for such goods
• Review returns activities in the next reporting period to ensure revenue
has not been overstated in relation to returns

Warranties • For service warranties, review sales activity to identify evidence of

related performance obligations and identify revenue allocated to such
warranties

Revenue collected • Establish existence of any third parties for whom revenue would be
on behalf of third collected (ideally during the process of understanding the entity at the
parties planning stage)
• For a sample of revenue items, confirm the revenue is not due to be
passed on to any third parties identified

Bundled services, • Clearly complex, these will require a review of contracts/terms of sale to
licences, royalties establish their likelihood and conditions and the audit team briefed to
and repurchase include these in audit tests as appropriate
agreements

Consignment • Consider the existence of any indicators of consignment arrangements,

arrangements such as:
– Confirming who controls the product and what (if any) conditions
need to have occurred for control to be passed on

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 Stage of IFRS 15 Suggested audit procedures

– Clarifying who can require the return of a product or transfer it to a

third party

Bill and hold • Consider the existence of such arrangements and if present, review the
arrangements conditions required by IFRS 15 have been met:
– Confirm that the customer owns the products stored by the seller by
reference to the contract terms, and obtain confirmation from the
customer that they are happy for the seller to hold them
– Inspect the agreement between the seller and customer to confirm
the products can be accessed at any time and not transferred to
another customer

Non-refundable • For a sample of revenues recognised during the reporting period,

upfront fees determine whether any related to upfront fees
• Confirm any upfront fees recognised that relate to performance
obligations have now been satisfied (for example, in a health club, that
services have been provided)

4.2 Audit procedures for contracts in which performance obligations are satisfied over
time (‘construction contracts’)
Remember, under IFRS 15, the entity recognises revenue in such cases by measuring progress
towards complete satisfaction of the performance obligation. Progress can be measured using
output methods (measuring the value to the customer of goods or services transferred to date) or
input methods (measuring the cost to the entity of goods or services transferred to date).
(IFRS 15.B14)
The following audit procedures will be relevant:
• Confirm contract price to contract agreed between client and customer
• Determine any amounts of conditional revenue/costs including the associated conditions
• Confirm the progress to date of the work completed, including any potential delays or problems
• Confirm costs incurred to date (inputs) by reference to management accounts, invoices, budgets
and other relevant documentation
• Identify any expenditure not supporting fulfilment of the contract by inspecting board minutes,
management accounts or other documentation (such as legal correspondence)
• Confirm total costs estimated for contract to ensure no planned overspends have been identified
(again, budgets, board minutes or management accounts can be inspected)
• Confirm the amounts of contract work certified as complete (outputs) at the year end by
reference to relevant documentation (such as surveyors’ reports or client estimates)

Interactive question 11: Construction contracts

Construction Co has entered into a fixed price contract to construct an office block. Construction
commenced on 1 March 20X6 and is expected to take 36 months. You are auditing the financial
statements for the year ended 31 December 20X6.
The contract price is made up as follows:

£’000
Contract price 600
Incentive payment if completed on time 40
640

Total contract costs were originally estimated to be £470,000. At the end of 20X6 this estimate has
increased to £570,000 due to extra costs incurred to rectify a number of construction faults.

546 Corporate Reporting ICAEW 2021

At the end of 20X6 the contract was assessed as being 30% complete. The draft financial statements
show that revenue of £192,000 has been recognised in respect of this contract.
Requirements
For the year ended 31 December 20X6:
(a) Identify the audit issues you would need to consider
(b) List the audit procedures you would perform

See Answer at the end of this chapter.

Context example: Carillion

In July 2017, UK construction firm Carillion collapsed leaving over £1 billion in debts and a number
of unfulfilled contracts, as well as a significant unfunded pension scheme. A UK parliamentary
committee interviewed the company’s directors, internal auditors Deloitte, and external auditors
KPMG and asked why this could not have been foreseen in March 2017, only four months earlier,
when the 2016 financial statements were signed off, despite a number of so-called ‘red flags’ which
had been identified by investors.
These ‘red flags’ included poor corporate governance, uncertainty over complex accounting
practices for goodwill and revenue (including the cash-flows on individual contracts) and inadequate
site visits as part of managing high-profile construction contracts clients.
(Source: Shoaib, A. (26 February 2018) Carillion inquiry: missed red flags, aggressive accounting and
the pension deficit. AccountacyAge. [Online]. Available from:
www.accountancyage.com/2018/02/26/carillion-inquiry-missed-red-lights-aggressive-accounting-
pension-deficit/ [Accessed 1 October 2019])

Professional skills focus: Concluding, recommending and communicating

The worked example above (Carillion) illustrates a situation where the professional skills of
concluding, recommending and communicating were not applied. Red flags over revenue were
identified, but the wrong conclusion drawn.

ICAEW 2021 10: Reporting revenue 547

Summary

548 Corporate Reporting ICAEW 2021

 Further question practice
1 Knowledge diagnostic
Before you move on to question practice, complete the following knowledge diagnostic and check
you are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from the topic indicated.

Confirm your learning

1. Can you list and apply the IFRS 15 five-step model for recognising revenue? (Topic 2)

2. What does ‘distinct’ mean in the context of performance obligations? (Topic 2)

3. Can you deal with performance obligations satisfied over time? (Topic 2)

4. What is the IFRS 15 treatment for sales with a right of return? (Topic 2)

5. How would each of IFRS 15’s five steps be audited? (Topic 5)

2 Question practice
Aim to complete all self-test questions at the end of this chapter. The following self-test questions are
particularly helpful to further topic understanding and guide skills application before you proceed to
the next chapter.

Question Learning benefit from attempting this question

Southwell A sale and repurchase question with a financing element, this is a short
question to get you started.

Taplop A comprehensive question on variable consideration, this is an exam-

standard test of this topic (though not exam-style as it is much shorter).

Clavering Part (a) deals with the issue of whether control has transferred, which it
must in order to satisfy a performance obligation. There is scope for
different interpretations. Part (b) deals with identifying performance
obligations and allocating the transaction price.

Once you have completed these self-test questions, it is beneficial to attempt the following questions
from the Question Bank for this module. These questions have been selected to introduce exam style
scenarios to help you improve knowledge application and professional skills development before
you start the next chapter.

Question Learning benefit from attempting this question

Wayte This requires you to separate out performance obligations to determine

the appropriate timing of revenue recognition.

Solvit This tests the five-step process in detail and also the audit aspects.

Roada A comprehensive, detailed question on IFRS 15, focusing mainly on

performance obligations satisfied over time, but with a number of different
revenue streams.

Refer back to the learning in this chapter for any questions which you did not answer correctly or
where the suggested solution has not provided sufficient explanation to answer all your queries.
Once you have attempted these questions, you can continue your studies by moving onto the next
chapter.

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 Technical reference
1 IFRS 15, Revenue from Contracts with Customers
Revenue is income arising in the course of an entity’s ordinary activities. – IFRS 15 Appendix A
Five-step approach is used: – IFRS 15 (IN7)
• Identifying the contract – IFRS 15 (9)
• Identifying the performance obligations – IFRS 15 (22)
– Satisfaction of performance obligations – IFRS 15 (31)
– Performance obligations satisfied over time – IFRS 15 (35)
– Performance obligations satisfied at a point in time – IFRS 15 (38)
• Determining the transaction price – IFRS 15 (47)
• Allocating the transaction price to the performance obligations – IFRS 15 (73)
• Recognising revenue as/when obligations are satisfied – IFRS 15 (31)
Incremental costs of a contract are recognised. – IFRS 15 (91–94)
Costs incurred to fulfil a contract are recognised as an asset if and only if all of certain criteria are
met: – IFRS 15 (95)
• The costs relate directly to a contract (or a specific anticipated contract);
• The costs generate or enhance resources of the entity that will be used in satisfying performance
obligations in the future; and
• The costs are expected to be recovered.
Costs include direct labour, direct materials, and the allocation of overheads that relate directly to the
contract. – IFRS 15 (97)
The asset recognised in respect of the costs to obtain or fulfil a contract is amortised on a systematic
basis that is consistent with the pattern of transfer of the goods or services to which the asset relates.
– IFRS 15 (99)
IFRS 15 gives further guidance on: – IFRS 15 (App B)
• Performance obligations satisfied over time
• Methods for measuring progress towards complete satisfaction of a performance obligation
• Sale with a right of return
• Warranties
• Principal versus agent considerations
• Customer options for additional goods or services
• Customers’ unexercised rights
• Non-refundable upfront fees
• Licensing
• Repurchase agreements
• Consignment arrangements
• Bill-and-hold arrangements
• Customer acceptance
• Disclosures of disaggregation of revenue

550 Corporate Reporting ICAEW 2021

 Self-test questions

Answer the following questions.

1 Webber
Webber sells two types of product, the Sleigh and the Sled. Webber sells the sleigh as an agent of
Caplin receiving commission of 15% on selling price. Webber sells the sled as principal at a gross
margin of 30%.
The following information relates to the year ended 30 September 20X8.

Sleighs Sleds
£ £
Total sales 200,000 75,000
Gross profit 60,000 22,500

Requirement
According to IFRS 15, Revenue from Contracts with Customers what revenue should Webber
recognise in total for Sleighs and Sleds for the year ended 30 September 20X8?

2 Alexander
On 1 January 20X0, Alexander Ltd supplied goods to David Ltd for an agreed sum of £600,000. This
amount becomes payable on 31 December 20X2. David Ltd could have bought the goods for cash
of £450,000 on 1 January 20X0. The imputed rate of interest to discount the receivable to the cash
sales price is 10%.
Requirement
In accordance with IFRS 15, Revenue from Contracts with Customers what amounts for revenue and
interest income should Alexander Ltd record in profit or loss relating to this transaction for the year
ended 31 December 20X0?

3 Southwell
Southwell Ltd, a manufacturing company, sold a property with a carrying amount of £4.5 million for
£5 million to Financier Ltd on 1 January 20X4. Southwell Ltd retains the right to occupy the property
and has an option to repurchase the property after two years for £6 million. Property prices are
expected to rise and the current market value is £8 million. The annual rate for 20% over two years is
9.5%.
Requirement
In accordance with IFRS, 15 Revenue from Contracts with Customers what should be recognised in
the financial statements relating to this transaction for the year ended 31 December 20X4?

4 White Goods
White Goods Ltd sells an electrical appliance for £2,400 on 1 October 20X7 making a mark up on
cost of 20%. The customer is given a one-year interest-free credit period. White Goods Ltd has a cost
of capital of 9%.
Requirement
In accordance with IFRS 15, Revenue from Contracts with Customers, what amount should the
company recognise as revenue from the sale of the appliance in profit or loss for the year ended 31
December 20X7?

ICAEW 2021 10: Reporting revenue 551

5 Tree
You are the accountant of Tree, a listed limited liability company that prepares consolidated financial
statements. Your Managing Director, who is not an accountant, has recently attended a seminar at
which key financial reporting issues were discussed. She remembers being told the following.
• Financial statements of an entity should reflect the substance of its transactions.
• Revenue from the contracts with customers should only be recognised when certain conditions
have been satisfied. Transfer of legal title to the goods is not necessarily sufficient for an entity to
recognise revenue from their ‘sale’.
The year end of Tree is 31 August. In the year to 31 August 20X1, the company entered into the
following transactions.
Transaction 1
On 1 March 20X1, Tree sold a property to a bank for £5 million. The market value of the property at
the date of the sale was £10 million. Tree continues to occupy the property rent-free. Tree has the
option to buy the property back from the bank at the end of every month from 31 March 20X1 until
28 February 20X6. Tree has not yet exercised this option. The repurchase price will be £5 million plus
£50,000 for every complete month that has elapsed from the date of sale to the date of repurchase.
The bank cannot require Tree to repurchase the property and the facility lapses after 28 February
20X6. The directors of Tree expect property prices to rise at around 5% each year for the foreseeable
future.
Transaction 2
On 1 September 20X0, Tree sold one of its branches to Vehicle for £8 million. The net assets of the
branch in the financial statements of Tree immediately before the sale were £7 million. Vehicle is a
subsidiary of a bank and was specifically incorporated to carry out the purchase – it has no other
business operations. Vehicle received the £8 million to finance this project from its parent in the form
of a loan.
Tree continues to control the operations of the branch and receives an annual operating fee from
Vehicle. The annual fee is the operating profit of the branch for the 12 months to the previous 31
August less the interest payable on the loan taken out by Vehicle for the 12 months to the previous
31 August. If this amount is negative, then Tree must pay the negative amount to Vehicle.
Any payments to or by Tree must be made by 30 September following the end of the relevant
period. In the year to 31 August 20X1, the branch made an operating profit of £2,000,000. Interest
payable by Vehicle on the loan for this period was £800,000.
Requirements
5.1 Explain the conditions that need to be satisfied before revenue can be recognised. You should
support your answer with reference to IFRS 15.
5.2 Explain how the transactions described above will be dealt with in the consolidated financial
statements (statement of financial position and statement of profit or loss and other
comprehensive income) of Tree for the year ended 31 August 20X1 in accordance with IFRS
15.

6 Taplop
Taplop supplies laptop computers to large businesses. On 1 July 20X5, Taplop entered into a
contract with TrillCo, under which TrillCo was to purchase laptops at £500 per unit. The contract
states that if TrillCo purchases more than 500 laptops in a year, the price per unit is reduced
retrospectively to £450 per unit. Taplop’s year end is 30 June.
• As at 30 September 20X5, TrillCo had bought 70 laptops from Taplop. Taplop therefore estimated
that TrillCo’s purchases would not exceed 500 in the year to 30 June 20X6, and would therefore
not be entitled to the volume discount.
• During the quarter ended 31 December 20X5, TrillCo expanded rapidly as a result of a substantial
acquisition, and purchased an additional 250 laptops from Taplop. Taplop then estimated that
TrillCo’s purchases would exceed the threshold for the volume discount in the year to 30 June
20X6.

552 Corporate Reporting ICAEW 2021

 Requirements
Calculate the revenue Taplop would recognise in:
(a) The quarter ended 30 September 20X5
(b) The quarter ended 31 December 20X5
Your answer should apply the principles of IFRS 15, Revenue from Contracts with Customers.

7 Clavering
Clavering Leisure Co owns and operates a number of hotels. The company is preparing its financial
statements for the year ended 31 May 20X3, and has come across the following issues.
(1) One of the hotels owned by Clavering Leisure is a complex which includes a theme park and a
casino as well as a hotel. The theme park, casino and hotel were sold in the year ended 31 May
20X3 to Manningtree Co, a public limited company, for £200 million but the sale agreement
stated that Clavering Leisure would continue to operate and manage the three businesses for
their remaining useful life of 15 years. The residual interest in the business reverts back to
Clavering Leisure after the 15-year period. Clavering Leisure would receive 75% of the net profit
of the businesses as operator fees, and Manningtree would receive the remaining 25%.
Clavering Leisure has guaranteed to Manningtree that the net minimum profit paid to
Manningtree would not be less than £15 million per year.
(2) Clavering Leisure has recently started issuing vouchers to customers when they stay in its hotels.
The vouchers entitle the customers to a £30 discount on a subsequent room booking within
three months of their stay. Historical experience has shown that only one in five vouchers are
redeemed by the customer. At the company’s year end of 31 May 20X3, it is estimated that there
are vouchers worth £20 million which are eligible for discount. The income from room sales for
the year is £300 million and Clavering Leisure is unsure how to report the income from room
sales in the financial statements.
Requirement
Advise Clavering Leisure on how the above accounting issues should be dealt with in its financial
statements in accordance with IFRS 15, Revenue from Contracts with Customers.

8 Rockwye
Rockwye is a manufacturer of luxury watches which it sells to customers via a number of independent
retailers. Rockwye recognises revenue and derecognises inventory when it supplies each retailer with
deliveries of watches for display. Watches are then displayed by retailers at a price set by the
manufacturer – once a watch is sold to a customer, the retailer passes the revenue back to Rockwye.
Any unsold watches are returned to Rockwye after a period of 11 months.
Requirement
Comment on the accounting treatment in operation at Rockwye and recommend suitable audit
procedures that you should undertake.

9 Eco-Ergonom
Eco-Ergonom plc is an AIM quoted company which manufactures ergonomic equipment and
furniture, and environmentally friendly household products. You are the Financial Controller, and the
accounting year end is 31 December 20X7.
It is now 15 March 20X8, and the company’s auditors are currently engaged in their work. Deborah
Carroll, the Finance Director, is shortly to go into a meeting with the Audit Engagement Partner, Brian
Nicholls, to discuss some unresolved issues relating to company assets. To save her time, she wants
you to prepare a memorandum detailing the correct accounting treatment.

ICAEW 2021 10: Reporting revenue 553

She has sent you the following email, in which she explains the issues:

To: Financial Controller

From: Deborah Carroll
Date: 15 March 20X8
Subject: Assets
As a matter of urgency, I need you to prepare a memorandum on the correct accounting
treatment of the items below, so that I can discuss this with the auditors.
Stolen lorries
As you know, we acquired a wholly owned subsidiary, a small road-haulage company, on 1
January 20X7 to handle major deliveries once we start producing larger items. So far, it has
proved more profitable to hire out its services to other companies, so the company is a cash-
generating unit.
We paid £460,000 for the business, and the values of the assets, based on fair value less costs to
sell, at the date of acquisition were as follows:

£’000
Vehicles (lorries) 240
Intangible assets (licences) 60
Trade receivables 20
Cash 100
Trade payables (40)
380

Unfortunately, three of the lorries were stolen on 1 February 20X7. The lorries were not insured,
because the road haulage company manager had failed to complete the paperwork in time. The
lorries had a net book value of £60,000, and we estimate that £60,000 was also their fair value less
costs to sell.
I believe that, as a result of the theft of the uninsured lorries, the value in use of the cash-
generating unit has fallen. We should recognise an impairment loss of £90,000, inclusive of the
loss of the stolen lorries.
We have another problem with this business. A competitor has come into operation, covering
similar routes and customers. Our revenue will be reduced by one-quarter, which will in turn
reduce the fair value less costs to sell and the value in use of our haulage business to £310,000
and £300,000 respectively. Part of this decline is attributable to the competitor’s actions causing
the net selling value of the licences to fall to £50,000. There has been no change in the fair value
less costs to sell of the other assets, which is the same as on the date of acquisition.
The company will continue to rent out the lorries for the foreseeable future.
How should we show this impairment in the financial statements?
Fall in value of machines
The goods produced by some of our machines have been sold below their cost. This has affected
the value of the machines in question, which has suffered an impairment. The carrying amount of
the machines at depreciated historical cost is £580,000 and their fair value less costs to sell is
estimated to be £240,000. We anticipate that cash inflows from the machines will be £200,000 per
annum for the next three years. The annual market discount rate, as you know, is 10%.
How should we determine the impairment in value of the machines in the financial statements and
how should this be recognised?
Own brand
This year, Eco-Ergonom has been developing a new product, Envirotop. Envirotop is a new range
of environmentally friendly kitchen products and an ergonomic kitchen design service.

554 Corporate Reporting ICAEW 2021

 The expenditure in the year to 31 December 20X7 was as follows:

Period from Expenditure type £m

1 Jan 20X7 – 31 March 20X7 Research on size of potential market 6
Prototype kitchen equipment and
1 April 20X7 – 30 June 20X7 product design 8
1 July 20X7 – 31 August 20X7 Wage costs in refinement of products 4
Development work undertaken to
1 September 20X7 – 30 November 20X7 finalise design of kitchen equipment 10
Production and launch of equipment
1 December 20X7 – 31 December 20X7 and products 12

40

Currently an intangible asset of £40 million is shown in the financial statements for the year ended
31 December 20X7.
Included in the costs of the production and launch of the products are the cost of upgrading the
existing machinery (£6 million), market research costs (£4 million) and staff training costs (£2
million).
Please explain the correct treatment of all these costs.
Purchase of Homecare
You will also know that, on 1 January 20X7, Eco-Ergonom acquired 100% of Homecare, a private
limited company manufacturing household products. Eco-Ergonom intends to develop its own
brand of environmentally friendly cleaning products. The shareholders of Homecare valued the
company at £25 million based upon profit forecasts which assumed significant growth in the
demand for the ‘Homecare’ brand name. We took a more conservative view of the value of the
company and estimated the fair value to be in the region of £21 million to £23 million, of which £4
million relates to the brand name ‘Homecare’. Eco-Ergonom is only prepared to pay the full
purchase price if profits from the sale of ‘Homecare’ goods reach the forecast levels. The agreed
purchase price was £20 million plus a further payment of £5 million in two years on 31 December
20X8. This further payment will comprise a guaranteed payment of £2 million with no
performance conditions and a further payment of £3 million if the actual profits during this two-
year period from the sale of Homecare goods exceed the forecast profit. The forecast profit on
Homecare goods over the two-year period is £3 million and the actual profits in the year to 31
December 20X7 were £0.8 million. Eco-Ergonom did not feel at any time since acquisition that the
actual profits would meet the forecast profit levels. Assume an annual discount rate of 5.5%.

Requirement
Prepare the memorandum asked for by the Finance Director.

Now go back to the Introduction and ensure that you have achieved the Learning outcomes listed for
this chapter.

ICAEW 2021 10: Reporting revenue 555

Answers to Interactive questions

Answer to Interactive question 1

Magazine revenue: £16,000
Explanation
Revenue for the magazines should be recognised in the periods in which they are despatched,
assuming the items are of similar value in each period. Despatch of the magazine constitutes
satisfaction of the performance obligation. Thus the revenue to be recognised in the year ended 31
March 20X7 is £48,000 × 4/12 = £16,000.

Answer to Interactive question 2

Revenue: £nil
Explanation
Revenue should be recognised when the drills are delivered to the customer. This is the point at
which the performance obligation is satisfied. Until then no revenue should be recognised and the
deposits should be carried forward as deferred income.

Answer to Interactive question 3

(a) Costs to complete are £90,000
This is a contract with performance obligations satisfied over time and 33% of the performance
has been completed to date.
Revenue can be recognised on the output basis by the percentage of completion method, so
33% of £210,000 = £69,300.
Note: The project is profitable overall (total revenue £210,000, total costs £135,000), so no
provision for a contract loss need be made.
(b) Costs to complete cannot be estimated reliably
As the outcome of the overall contract cannot be estimated reliably, revenue is recognised to the
extent of the costs incurred which are recoverable ie, £40,000. The current period therefore
recognises the contract loss to date of £5,000.

Answer to Interactive question 4

Contract revenue: £60,000
Explanation
If the outcome of a services transaction cannot be estimated reliably, revenue should only be
recognised to the extent that expenses incurred are recoverable from the customer.

Answer to Interactive question 5

The Sales Director wishes to recognise the sale as early as possible. However, following IFRS 15,
Revenue from Contracts with Customers, revenue from the sale should only be recognised when the
performance obligations in the contract have been satisfied.
Performance obligations in the contract
The contract contains a promise to deliver the caravan and a promise to deliver additional goods
free of charge. These are distinct promises and therefore the contract contains two performance
obligations.
Transaction price
The transaction price is made up of three elements.
A significant financing component must be considered where consideration is received more than 12
months before or after the date on which revenue is recognised (being the delivery date, 1 August

556 Corporate Reporting ICAEW 2021

20X7). Therefore the payment on 1 August 20X9 must be discounted to present value at 1 August
20X7.

£
Deposit 3,000
Payment on 1.8.X7 (the delivery date) 15,000
Payment on 1.8.X9 (£12,000/1.12) 9,917
27,917

Allocation to performance obligations

The transaction price is allocated based on standalone selling prices:

Caravan 30,000/31,500 × £27,917 = £26,588

Free equipment 1,500/31,500 × £27,917 = £1,329

Recognition of revenue
The two performance obligations are satisfied simultaneously on 1 August 20X7, and therefore all
revenue is recognised on this date.
Journal entries are as follows:
1 May 20X7
The receipt of cash in the form of the £3,000 deposit is recognised on receipt as a contract liability
(deferred income) in the statement of financial position by:

DEBIT Bank £3,000

CREDIT Contract liability (deferred income) £3,000

1 August 20X7
Revenue is recognised together with payment of the first £15,000. The contract liability is transferred
to be revenue:

DEBIT Bank £15,000

DEBIT Contract liability £3,000
DEBIT Receivable £9,917
CREDIT Revenue £27,917

Note: This question is rather fiddly, so do not worry too much if you didn’t get all of it right. Read
through our solution carefully, going back to first principles where required.

Answer to Interactive question 6

6.1 Account for sale
• Bags Galore Ltd expects 3 bags (6% × 50) to be returned.
• Therefore on 28 January 20X9 revenue is recognised in relation to 47 bags, giving a total of
£39,950 (47 × £850).
• A refund liability of £2,550 (3 × £850) is recognised.
• The cost of 47 bags of £18,800 (47 × £400) is transferred to cost of sales. The remaining 3
bags are recognised as an asset (the right to recover the bags) at cost of £1,200 (3 × £400).
The ‘right to recover’ asset is measured at the original cost of the bags that are expected to
be returned because, even in the ‘Fabulous February’ sale, they are capable of being sold for
£425 (50% × £850) ie, more than cost.

ICAEW 2021 10: Reporting revenue 557

 The required accounting entries are:

DEBIT Bank (50 × £850) £42,500

CREDIT Revenue £39,950
CREDIT Refund liability £2,550

To recognise the sale of bags and expectation that 6% will be returned.

DEBIT Asset (right to recover inventory) £1,200

DEBIT Cost of sales (47 × £400) £18,800
CREDIT Asset (inventory) £20,000

To recognise the transfer of items of inventory that are not expected to be returned to become
cost of sales and that are expected to be returned to become assets (the right to recover the 3
bags).
6.2 If the selling price of the bags were reduced to £340 (40% × £850):
• The revenue and refund liability would be recorded as before.
• The retained asset would be measured at £1,020 (3 × £340), so resulting in a write down of
the carrying amount of inventory in profit or loss.

Answer to Interactive question 7

£
Revenue:
Sale of goods (W) 1,350,000
Sale of services (W) 25,000
1,375,000

WORKING

£
After-sale support (120,000/ (100% – 20%)) 150,000
Remainder = sale of goods (bal fig) 1,350,000
Total revenue 1,500,000

Revenue for sale of services recognised in the four months to 30 April 20X7 should be £150,000/2
years × 4/12 = £25,000

Answer to Interactive question 8

£
After-sales support (2 × (35,000/82.5%)) 84,848
Remainder 715,152
Total selling price 800,000
So the revenue from the sale in the current year is: 715,152

558 Corporate Reporting ICAEW 2021

Answer to Interactive question 9
Sale transaction
• As there is an option to repurchase, this is a call option with a repurchase price above the original
selling price, so it is treated as a financing arrangement.
• Through the rights of access and supervision, together with the right to build on the land, Builder
Ltd has retained the risks and rewards of ownership over the building plot, so should continue to
show it as an asset in its statement of financial position.
• The fact that the consideration for the sale on 1 March 20X6 is so far below the valuation is further
evidence that the transaction is in substance a three-year loan, with the £400,000 difference
between the selling and repurchase prices being interest on the loan.
• The right to repurchase in the future for much less than the current valuation (making the exercise
of the repurchase right almost a certainty) is further evidence that this is not a real sale.
• So Builder Ltd will show the building plot in its 28 February 20X7 statement of financial position
as a current asset (as it will be realised in the normal course of its operating cycle) at its original
acquisition cost (not given in the Interactive question).
• In the same statement of financial position it will show the £1.5 million received on 1 March 20X6
as a liability, together with any unpaid part of the £400,000 interest which is attributable to the
first year of the loan.
• The appropriate part of the total interest will be charged to profit or loss for the year ended 28
February 20X7.

Answer to Interactive question 10

The contract contains three performance obligations – transfer of the machine, transfer of the spare
parts and the custodial services. The transaction price is allocated to the three performance
obligations and revenue is recognised when (or as) control passes to the customer.
The machine and the spare parts are both performance obligations satisfied at a point in time, this
being 31 December 20X9. In the case of the spare parts, the customer has paid for them, the
customer has legal title to them and the customer has control of them as they can remove them from
storage at any time.
The custodial services are a performance obligation satisfied over time, so revenue will be
recognised over the period during which the spare parts are stored.

Answer to Interactive question 11

(a) Audit issues
• Whether revenue recognised to date includes a proportion of the incentive payment. This
would only be appropriate if it is probable that this income will be received.
• Total costs to complete have been increased during the year due to rectification costs. There
is a risk that there may be other rectification costs which have yet to be identified.
• Whether the accounting treatment of the revenue recognised is in accordance with IFRS 15.
The current figure of £192,000 appears to be based on 30% of the expected total revenue
(640 × 30%) but it is unclear where this 30% has come from. If revenue is being measured on
costs incurred to date (input basis) the additional £100,000 of contract costs may not be
allowable as part of this calculation. Similarly, if certified as complete (output basis) on a pro-
rated time basis, the contract is only 10 months old – this would give a percentage of 10/36 =
27.8% which could lead to overstated revenue.
(b) Audit procedures
• Agree the contract price and incentive payment to the sales contract.
• Discuss with management the basis on which they have recognised the incentive payment
and review their performance on other similar contracts to determine the likelihood of the
contract being completed on time.
• Establish the basis on which the percentage completion of 30% has been determined. If a
surveyor has been used to make this estimate assess the extent to which this evidence can be
relied on.

ICAEW 2021 10: Reporting revenue 559

 • Discuss with management the nature of the rectification costs and assess the likelihood of
other similar additional costs being incurred. Obtain a schedule of these and agree to
supporting documentation.
• Review management calculations regarding costs to complete and seek corroboration for
any assumptions made.
• Discuss with management the revenue recognition policy adopted. If material to the financial
statements the figures should be revised in accordance with IFRS 15.

560 Corporate Reporting ICAEW 2021

 Answers to Self-test questions

1 Webber
Revenue

£
Revenue recognised as agent (£200,000 × 15%) 30,000
Revenue recognised as principal 75,000
Total revenue 105,000

2 Alexander
At the time of supply, revenue is recognised for the cash sale price of £450,000. Interest will then be
accrued until payment is made. For the year ended 31 December 20X0 the interest charge is
£450,000 × 10% = £45,000.

3 Southwell
As there is an option to repurchase, this is a call option with a repurchase price above the original
selling price, so it is treated as a financing arrangement.

Initial loan: DEBIT Cash £5m

CREDIT Loan £5m
Interest: DEBIT Interest (Profit or loss) (5m × 9.5%) £0.475m
CREDIT Loan £0.475m

Total loan liability is £5.475 million.

4 White Goods
The amount receivable discounted to present value = £2,400 × 1/1.09 = £2,202
This is recognised as income on 1 October 20X7. The difference between this and the sale proceeds
(2,400 – 2,202 = 198) is treated as interest and will be recognised over the 12‑month interest-free
credit period.

5 Tree
5.1 IFRS 15, Revenue from Contracts with Customers states the following (IFRS 15.35):
Revenue is recognised when (or as) a performance obligation is satisfied. The entity satisfies a
performance obligation by transferring control of a promised good or service to the customer.
A performance obligation can be satisfied at a point in time, such as when goods are
delivered to the customer, or over time. An obligation satisfied over time will meet one of the
following criteria:
• The customer simultaneously receives and consumes the benefits as the performance takes
place.
• The entity’s performance creates or enhances an asset that the customer controls as the
asset is created or enhanced.
• 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.

ICAEW 2021 10: Reporting revenue 561

 The amount of revenue recognised is the amount allocated to that performance obligation. An
entity must be able to reasonably measure the outcome of a performance obligation before
the related revenue can be recognised. In some circumstances, such as in the early stages of a
contract, it may not be possible to reasonably measure the outcome of a performance
obligation, but the entity expects to recover the costs incurred. In these circumstances,
revenue is recognised only to the extent of costs incurred.
5.2 Transaction 1
Tree has the option to repurchase the property but cannot be required to do so. This is a call
option in which the repurchase price is equal to or above the original selling price, so it should
be accounted for as a financing arrangement.
Tree has not transferred control of the property to the bank as it still has the right to exercise
this option, so no performance obligation has been satisfied that could justify the recognition
of revenue.
The transaction is essentially a loan secured on the property, rather than an outright sale. The
£50,000 payable for each month that the bank holds the property is interest on the loan.
The property remains in the consolidated statement of financial position at its cost or market
value (depending on the accounting policy adopted by Tree). The loan of £5 million and
accrued interest of £300,000 (6 × 50,000) are reported under non-current liabilities. Interest of
£300,000 is recognised in consolidated profit or loss.
Transaction 2
The key issue is whether Tree has transferred control of the branch.
Tree continues to control the operations of the branch and the amount that it receives from
Vehicle is the operating profit of the branch less the interest payable on the loan. Tree also
suffers the effect of any operating losses made by the branch. Therefore, the position is
essentially the same as before the ‘sale’ and Tree has not satisfied any performance obligation
in return for the consideration of £8 million.
Although Vehicle is not a subsidiary of Tree as defined by IFRS 10, Consolidated Financial
Statements, it is a special purpose entity (quasi-subsidiary). It gives rise to benefits for Tree that
are in substance no different from those that would arise if it were a subsidiary. Its assets,
liabilities, income and expenses must be included in the consolidated financial statements.
The assets and liabilities of Vehicle are included in the consolidated statement of financial
position at £7 million (their original value to the group). The loan of £8 million is recognised as
a non-current liability. The profit on disposal of £1 million and the operating fee of £1,200,000
are cancelled as intra-group transactions. The operating profit of £2 million is included in
consolidated profit or loss, as is the loan interest of £800,000.

6 Taplop
(a) Applying the requirements of IFRS 15 to TrillCo’s purchasing pattern at 30 September 20X5,
Taplop should conclude that it was highly probable that a significant reversal in the cumulative
amount of revenue recognised (£500 per laptop) would not occur when the uncertainty was
resolved, that is when the total amount of purchases was known. Consequently, Taplop should
recognise revenue of 70 × £500 = £35,000 for the first quarter ended 30 September 20X5.
(b) In the quarter ended 31 December 20X5, TrillCo’s purchasing pattern changed such that it
would be legitimate for Taplop to conclude that TrillCo’s purchases would exceed the threshold
for the volume discount in the year to 30 June 20X6, and therefore that it was appropriate to
reduce the price to £450 per laptop. Taplop should therefore recognise revenue of £109,000 for
the quarter ended 31 December 20X5. The amount is calculated as from £112,500 (250 laptops
× £450) less the change in transaction price of £3,500 (70 laptops × £50 price reduction) for the
reduction of the price of the laptops sold in the quarter ended 30 September 20X5.

562 Corporate Reporting ICAEW 2021

7 Clavering
Sale of hotel complex
The issue here is one of revenue recognition, and the accounting treatment is governed by IFRS 15,
Revenue from Contracts with Customers. Step (5) of the standard’s revenue recognition process
requires that revenue is recognised when (or as) a performance obligation is satisfied. The entity
satisfies a performance obligation by transferring control of a promised good or service to the
customer. A performance obligation can be satisfied at a point in time, such as when goods are
delivered to the customer, or over time. In the case of the hotel transfer, the issue is that of a
performance obligation satisfied at a point in time. One of the indicators of control is that significant
risks and rewards of ownership have been transferred to the customer.
It can be argued in some cases where property is sold that the seller, by continuing to be involved,
has not satisfied the performance obligation by transferring control, partly because the seller has
not transferred the risks and rewards of ownership. In such cases, the sale is not genuine, but is often
in substance a financing arrangement. IFRS 15 requires that the substance of a transaction is
determined by looking at the transaction as a whole. If two or more transactions are linked, they
should be treated as one transaction to better reflect the commercial substance.
Clavering Leisure continues to operate and manage the hotel complex, receiving the bulk (75%) of
the profits, and the residual interest reverts back to Clavering Leisure; effectively, Clavering Leisure
retains control by retaining the risks and rewards of ownership. Manningtree does not bear
substantial risk: its minimum annual income is guaranteed at £15 million. The sale should not be
recognised. In substance it is a financing transaction. The proceeds should be treated as a loan, and
the payment of profits as interest.
Discount vouchers
The treatment of the vouchers is governed by IFRS 15, Revenue from Contracts with Customers. The
principles of the standard require the following:
• The voucher should be accounted for as a separate component of the sale.
• The promise to provide the discount is a performance obligation.
• The entity must estimate the stand-alone selling price of the discount voucher in accordance with
paragraph B42 of IFRS 15. That estimate must reflect the discount that the customer would obtain
when exercising the option, adjusted for both of the following:
– Any discount that the customer could receive without exercising the option
– The likelihood that the option will be exercised.
The vouchers are issued as part of the sale of the room and redeemable against future bookings. The
substance of the transaction is that the customer is purchasing both a room and a voucher.
Vouchers worth £20 million are eligible for discount as at 31 May 20X3. However, based on past
experience, it is likely that only one in five vouchers will be redeemed, that is vouchers worth £4
million. Room sales are £300 million, so effectively, the company has made sales worth £(300m +
4m) = £304 million in exchange for £300 million. The stand-alone price would give a total of £300
million for the rooms and £4 million for the vouchers.
To allocate the transaction price, following step (4) of IFRS 15’s five-step process for revenue
recognition, the proceeds need to be split proportionally pro rata the stand-alone prices, that is the
discount of £4 million needs to be allocated between the room sales and the vouchers, as follows:
Room sales: 300/304 × £300m = £296.1m
Vouchers (balance) = £3.9m
The £3.9 million attributable to the vouchers is only recognised when the performance obligations
are fulfilled, that is when the vouchers are redeemed.

8 Rockwye
Matters to consider
The accounting treatment adopted by Rockwye does not appear to comply with IFRS 15 as it
appears to be a consignment arrangement in place with retailers. This means that Rockwye cannot
recognise any revenue or derecognise inventory when the watches are delivered to retailers because

ICAEW 2021 10: Reporting revenue 563

 control has not passed from Rockwye to the retailer due to control being retained (the right to fix the
price and receive the watches back after 11 months).
Revenue should only be recognised when the retailer makes a sale to a customer. This means that
revenue in Rockwye’s financial statements is likely to be overstated. In addition, if watches are
returned unsold, there may also be a risk that inventory is overstated if any of the watches have
suffered any impairment.
Audit procedures
• The auditor should obtain copies of the contracts in place between Rockwye and individual
retailers to confirm the supplier arrangements in place and which party retains controls of the
watches.
• The auditor should establish the proportion of watches that are returned unsold to determine if
there are any indicators of impairment in the inventory held.
• The auditor should re-calculate revenue for a sample of months using the consignment approach
and compare to actual revenue recorded to establish if there is any material misstatement.

9 Eco-Ergonom
Memorandum
To Deborah Carroll, Finance Director
From Financial Controller
Date 15 March 20X8
Subject Accounting treatment of non-current assets
As requested, this memorandum sets out the appropriate accounting treatment for the non-current
assets detailed in today’s email.
The three lorries that were stolen should be written off at their NBV first and then the impairment test
should be performed.
£80,000 is set against goodwill and the remaining £10,000 is split pro rata between the other two
relevant assets: £2,500 against intangibles (£10,000 × 60,000/(60,000 + 180,000)) and £7,500
against vehicles (£10,000 × 180,000/(60,000 + 180,000)). There is no need here to restrict the
impairment of the intangibles.
Note: The calculation of the impairment loss is based on the carrying amount of the business
including the trade payables. Recoverable amount is the fair value less costs to sell of the business as
a whole, with any buyer assuming the liabilities. Otherwise, the impairment test would be based on
the carrying amount of the gross assets (IAS 36.76).
Fall in value of machines
An impairment review will be carried out because of the losses and the haulage business problems.
For the productive machinery

£
Carrying amount 580,000
Fair value less costs to sell 240,000
Value in use (200,000 × 3, discounted at 10%) 497,200

An impairment loss of £82,800 (580,000 – 497,200) will be recognised in profit or loss.

Development of new product
IAS 38, Intangible Assets divides a development project into a research phase and a development
phase. In the research phase of a project, an entity cannot yet demonstrate that the expenditure will
generate probable future economic benefits. Therefore expenditure on research must be recognised
as an expense when it occurs.
Development expenditure is capitalised when an entity demonstrates all the following.
(1) The technical feasibility of completing the project
(2) Its intention to complete the asset and use or sell it

564 Corporate Reporting ICAEW 2021

(3) Its ability to use or sell the asset
(4) That the asset will generate probable future economic benefits
(5) The availability of adequate technical, financial and other resources to complete the
development and to use or sell it
(6) Its ability to reliably measure the expenditure attributable to the asset
Assuming that all these criteria are met, the cost of the development should comprise all directly
attributable costs necessary to create the asset and to make it capable of operating in the manner
intended by management. Directly attributable costs do not include selling or administrative costs, or
training costs or market research. The cost of upgrading existing machinery can be recognised as
property, plant and equipment. Therefore the expenditure on the project should be treated as
follows:

Recognised in statement of financial

position
Expense (income Property, plant,
statement) Intangible assets and equipment
£m £m
Research 6
Prototype design 8
Wage costs 4
Development work 10
Upgrading machinery 6
Market research 4
Training 2 – –
12 22 6

Eco-Ergonom should recognise £22 million as an intangible asset.

Purchase of Homecare
IFRS 3, Business Combinations states that the cost of a business combination is the aggregate of the
fair values of the consideration given. Fair value is measured at the date of exchange. Where any of
the consideration is deferred, the amount should be discounted to its present value. Where there
may be an adjustment to the final cost of the combination contingent on one or more future events,
the amount of the adjustment is included in the cost of the combination at the acquisition date only if
the fair value of the contingent consideration can be measured reliably.
The purchase consideration consists of £20 million paid on the acquisition date plus a further £5
million payable on 31 December 20X8 including £3 million payable only if profits exceed forecasts.
At the acquisition date it appeared that profit forecasts would not be met. However, under IFRS 3,
contingent consideration must be recognised and measured at fair value at the acquisition date.
Therefore the cost of combination at 1 January 20X7 is £24.49 million (£20m + (£5m × 0.898)).
A further issue concerns the valuation and treatment of the ‘Homecare’ brand name. The brand name
is an internally generated intangible asset of Homecare, and therefore it will not be recognised in the
statement of financial position of Homecare. However, IFRS 3 requires intangible assets of an
acquiree to be recognised if they meet the identifiability criteria in IAS 38, Intangible Assets and their
fair value can be measured reliably. For an intangible asset to be identifiable the asset must be
separable or it must arise from contractual or other legal rights. It appears that these criteria have
been met (a brand is separable) and the brand has also been valued at £4 million for the purpose of
the sale to Eco-Ergonom. Therefore the ‘Homecare’ brand will be separately recognised in the
consolidated statement of financial position.

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566 Corporate Reporting ICAEW 2021