Chapter-3 Ifrs Revenue Recognition

Chapter Three
Revenue and Expense Recognition
3-1
PREVIEW OF CHAPTER 3
3-2
Three
Revenue Recognition
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Understand revenue recognition 6. Allocate the transaction price to the
issues. separate performance obligations.
2. Identify the five steps in the revenue 7. Recognize revenue when the company
recognition process. satisfies its performance obligation.
3. Identify the contract with customers. 8. Identify other revenue recognition

issues.
4. Identify the separate performance
obligations in the contract. 9. Describe presentation and disclosure
regarding revenue.
5. Determine the transaction price.
3-3
OVERVIEW OF REVENUE RECOGNITION
Background
Revenue recognition is a top fraud risk and regardless
of the accounting rules followed (IFRS or U.S. GAAP),
the risk or errors and inaccuracies in revenue reporting is
significant.
Recently, the IASB and FASB issued a converged standard

on revenue recognition entitled Revenue from Contracts
with Customers.
3-4 LO 1
OVERVIEW OF REVENUE RECOGNITION
New Revenue Recognition Standard

Revenue from Contracts with Customers, adopts an
asset-liability approach. Companies:
 Account for revenue based on the asset or liability arising
from contracts with customers.
 Are required to analyze contracts with customers
► Contracts indicate terms and measurement of

consideration.
► Without contracts, companies cannot know whether

promises will be met.
3-5 LO 1
New Revenue Recognition Standard
ILLUSTRATION 3-1 Key Concepts of Revenue Recognition
3-6
Performance Obligation is Satisfied LO 1
THE FIVE-STEP PROCESS
Assume that Airbus (FRA) Corporation signs a contract to sell

airpLines to Ethiopian Airlines (ETH) for Br.100 million.
ILLUSTRATION 3-2
Five Steps of Revenue Recognition
A contract is an agreement between two parties

Step 1: Identify the
that creates enforceable rights or obligations. In
contract with
this case, Airbus has signed a contract to deliver
customers.
airpLines to Ethiopia.
Step 2: Identify the Airbus has only one performance obligation—to

separate performance deliver airpLines to Ethiopia. If Airbus also agreed
obligations in the to maintain the pLines, a separate performance
contract. obligation is recorded for this promise.
3-7 LO 2
ILLUSTRATION 3-2 Five Steps of Revenue Recognition
Transaction price is the amount of consideration

Step 3: Determine that a company expects to receive from a
the transaction customer in exchange for transferring a good or
price. service. In this case, the transaction price is
straightforward—it is Br.100 million.
Step 4: Allocate the

transaction price to
In this case, Airbus has only one performance
the separate
obligation—to deliver airpLines to Ethiopia.
performance
obligations.
3-8 LO 2
ILLUSTRATION 3-2 Five Steps of Revenue Recognition
Step 5: Recognize
Airbus recognizes revenue of Br.100 million for the
revenue when
sale of the airpLines to Ethiopia when it satisfies
each performance
its performance obligation—the delivery of the
obligation
airpLines to Ethiopia.
is satisfied.
3-9 LO 2
Identify Contract with Customers—Step 1
Contract:
 Agreement between two or more parties that creates
enforceable rights or obligations.
 Can be
► written,
► oral, or
► implied from customary business practice.
Company applies the revenue guidance to a contract

according to the following criteria in ILLUSTRATION 3-3.
3-10 LO 3
Contract with Customers—Step 1
ILLUSTRATION 3-3 Contract Criteria for Revenue Guidance
Disregard Revenue
Apply Revenue Guidance to Contracts If:
Guidance to Contracts If:
 The contract has commercial substance;  The contract is wholly

 The parties to the contract have approved the unperformed, and
contract and are committed to perform their  Each party can unilaterally
respective obligations; terminate the contract
 The company can identify each party’s rights without compensation.
regarding the goods or services to be
transferred; and
 The company can identify the payment terms
for the goods and services to be transferred.
 It is probable It is probable that the company
will collect the consideration to which it will be
entitled.
3-11 LO 3
Basic Accounting
 Revenue cannot be recognized until a contract exists.
 Company obtains rights to receive consideration and
assumes obligations to transfer goods or services.
 Rights and performance obligations gives rise to an (net)
asset or (net) liability.
 Company does not recognize contract assets or liabilities until
one or both parties to the contract perform.
Contract asset = Rights received > Performance obligation
Contract liability = Rights received < Performance obligation

3-12 LO 3
Basic Accounting ILLUSTRATION 3-4
Basic Revenue Transaction
CONTRACTS AND RECOGNITION

Facts: On March 1, 2015, Abebe Company enters into a contract to transfer a
product to Helen on July 31, 2015. The contract is structured such that Helen is
required to pay the full contract price of Br.5,000 on August 31, 2015.The cost of
the goods transferred is Br.3,000. Abebe delivers the product to Helen on July
31, 2015.
Question: What journal entries should Abebe Company make in regards to
this contract in 2015?
The journal entry to record the sale and related cost of goods sold is as follows.
July 31, 2015
Accounts Receivable 5,000
Sales Revenue 5,000
Cost of Goods Sold 3,000
Inventory 3,000
3-13 LO 3
Basic Accounting ILLUSTRATION 3-4
Basic Revenue Transaction
CONTRACTS AND RECOGNITION

Facts: On March 1, 2015, Abebe Company enters into a contract to transfer a
product to Helen on July 31, 2015. The contract is structured such that Helen is
required to pay the full contract price of Br.5,000 on August 31, 2015.The cost of
the goods transferred is Br.3,000. Abebe delivers the product to Helen on July
31, 2015.
Question: What journal entries should Abebe Company make in regards to
this contract in 2015?
Abebe makes the following entry to record the receipt of cash on August 31, 2015.
August 31, 2015
Cash 5,000
3-14 LO 3
Contract Modifications
 Change in contract terms while it is ongoing.
 Companies determine
► whether a new contract (and performance
obligations) results or
► whether it is a modification of the existing contract.
3-15 LO 3
Separate Performance Obligation

 Account for as a new contract if both of the following
conditions are satisfied:
► Promised goods or services are distinct (i.e.,
company sells them separately and they are not
interdependent with other goods and services), and
► The company has the right to receive an amount of

consideration that reflects the standalone selling
price of the promised goods or services.
3-16 LO 3
Separate Performance Obligation
For example, Simon Co. has a contract to sell 100 products to a

customer for Br.10,000 (Br.100 per product) at various points in
time over a six-month period. After 60 products have been
delivered, Simon modifies the contract by promising to deliver 20
more products for an additional Br.1,900, or Br.95 per product
(which is the standalone selling price of the products at the time of
the contract modification). Simon regularly sells the products
separately.
Given a new contract, Simon recognizes an additional:
Original contract [(100 units - 60 units) x Br.100] = Br.4,000

New product (20 units x Br.95) = 1,900
Total revenue Br.5,900
3-17 LO 3
Prospective Modification
 Company should
► account for effect of change in period of change as
well as future periods if change affects both.
► not change previously reported results.
3-18 LO 3
For Simon, the amount recognized as revenue for each of the

remaining products would be a blended price of Br.98.33,
computed as shown in ILLUSTRATION 3-5.
Products not delivered under original contract
(Br.100 x Br.40) = Br.4,000

Products to be delivered under contract
modification (Br.95 x 20) = 1,900
Total remaining revenue Br.5,900
Revenue per remaining unit (Br.5,900 ÷ 60) = Br.98.33
3-19 LO 3
Under the prospective approach, a blended price (Br.98.33) is used

for sales in the periods after the modification.
ILLUSTRATION 3Comparison of Contract Modification

Approaches
3-20 LO 3
Separate Performance Obligations—Step 2
Revenue Recognition Situations

ILLUSTRATION 3-7
Sale of asset
Type of Sale of product Performing a Permitting use of
other than
Transaction from inventory service an asset
inventory
Description Revenue from

Revenue from Revenue from Gain or loss on
interest, rents,
of Revenue sales fees or services disposition
and royalties
Timing of Services As time passes

Date of sale (date Date of sale or
Revenue performed and or assets are
of delivery) trade-in
Recognition billable used
3-21 LO 4
Separate Performance Obligations—Step 2
 To determine whether a company has to account for

multiple performance obligations, it evaluates a second
condition.
 Whether the product is distinct within the contract.
► If performance obligation is not highly dependent on,

or interrelated with, other promises in the contract,
then each performance obligation should be
accounted for separately.
► If each of these services is interdependent and

interrelated, these services are combined and
reported as one performance obligation.
3-22 LO 4
Performance Obligations—Step 2
ILLUSTRATION 3-8 Identifying Performance Obligations
SoftTech Inc. licenses customer-relationship software to Abreham Company.

In addition to providing the software itself, SoftTech promises to provide
consulting services by extensively customizing the software to Abreham’s
information technology environment, for a total consideration of Br.600,000.
In this case, SoftTech is providing a significant service by integrating the
goods and services (the license and the consulting service) into one
combined item for which Abreham has contracted. In addition, the software is
significantly customized by SoftTech in accordance with specifications
negotiated by Abreham. Do these facts describe a single or separate
The license and the consulting services are distinct but interdependent, and
therefore should be accounted for as one performance obligation.
performance obligation?
3-23 LO 4
ILLUSTRATION 3-8 Identifying Performance Obligations
Ali Computer Inc. manufactures and sells computers that include a warranty
to make good on any defect in its computers for 120 days (often referred to
as an assurance warranty). In addition, it sells separately an extended
warranty, which provides protection from defects for three years beyond the
120 days (often referred to as a service warranty). In this case, two
performance obligations exist, one related to the sale of the computer and
the assurance warranty, and the other to the extended warranty (service
warranty).
The sale of the computer and related assurance warranty are one
performance obligation as they are interdependent and interrelated with each
other. However, the extended warranty is separately sold and is not
interdependent.
3-24 LO 4
Determining Transaction Price—Step 3
Transaction price
 Amount of consideration that company expects to
receive from a customer.
 In a contract is often easily determined because

customer agrees to pay a fixed amount.
 Other contracts, companies must consider:

► Variable consideration
► Time value of money
► Non-cash consideration
► Consideration paid or payable to customers
3-25 LO 5
Variable Consideration
 Price dependent on future events.
► May include discounts, rebates, credits, performance
bonuses, or royalties.
 Companies estimate amount of revenue to recognize.

► Expected value
► Most likely amount
3-26 LO 5
ILLUSTRATION 3-9 Estimating Variable Consideration
Expected Value: Probability-weighted amount in a range of possible

consideration amounts.
 May be appropriate if a company has a large number of contracts with
similar characteristics.
 Can be based on a limited number of discrete outcomes and probabilities.
Most Likely Amount: The single most likely amount in a range of possible
consideration outcomes.
 May be appropriate if the contract has only two possible outcomes.
3-27 LO 5
Variable Consideration ILLUSTRATION 3-10
Transaction Price
ESTIMATING VARIABLE CONSIDERATION

Facts: Solomon Construction Company enters into a contract with a
customer to build a warehouse for Br.100,000, with a performance bonus of
Br.50,000 that will be paid based on the timing of completion. The amount of
the performance bonus decreases by 10% per week for every week beyond
the agreed-upon completion date. The contract requirements are similar to
contracts that Solomon has performed previously, and management
believes that such experience is predictive for this contract. Management
estimates that there is a 60% probability that the contract will be completed
by the agreed-upon completion date, a 30% probability that it will be
completed 1 week late, and only a 10% probability that it will be completed 2
weeks late.
Question: How should Solomon account for this revenue
arrangement?
3-28 LO 5
Variable Consideration ILLUSTRATION 3-10
Transaction Price
Question: How should Solomon account for this revenue

arrangement?
Management has concluded that the probability-weighted method is the
most predictive approach:
60% chance of Br.150,000 = Br. 90,000
30% chance of Br.145,000 = 43,500
10% chance of Br.140,000 = 14,000
Br.147,500
Most likely outcome, if management believes they will meet the deadline
and receive the Br.50,000 bonus, the total transaction price would be?
Br.150,000 (the outcome with 60% probability)
3-29 LO 5
Variable Consideration
 Companies only allocate variable consideration if it is

reasonably assured that it will be entitled to the
amount.
 Companies only recognize variable consideration if
1. they have experience with similar contracts and are

able to estimate the cumulative amount of revenue, and
2. based on experience, they do not expect a significant

reversal of revenue previously recognized.
If these criteria are not met, revenue recognition is

constrained.
3-30 LO 5
Time Value of Money

 When contract (sales transaction) involves a significant
financing component.
► Interest accrued on consideration to be paid over

time.
► Fair value determined either by measuring the

consideration received or by discounting the payment
using an imputed interest rate.
► Company reports as interest expense or interest

revenue.
3-31 LO 5
ILLUSTRATION 3-12
Time Value of Money Transaction Price -
Extended Payment Terms
EXTENDED PAYMENT TERMS

Facts: On July 1, 2015, SEK Company sold goods to Silva Company for
Br.900,000 in exchange for a 4-year, zero-interest-bearing note with a face
amount of Br.1,416,163. The goods have a cost on SEK’s books of Br.590,000.
Questions: (a) How much revenue should SEK Company record on July 1,
2015? (b) How much revenue should it report related to this transaction on
December 31, 2015?
Entry to record SEK’s sale to Silva Company on July 1, 2015, is as follows.

Notes Receivable 1,416,163
Sales Revenue 900,000
Discount on Notes Receivable 516,163
Inventory 590,000
3-32 LO 5
ILLUSTRATION 3-12
Time Value of Money Transaction Price -
Extended Payment Terms
EXTENDED PAYMENT TERMS

Facts: On July 1, 2015, SEK Company sold goods to Silva Company for
Br.900,000 in exchange for a 4-year, zero-interest-bearing note with a face
amount of Br.1,416,163. The goods have a cost on SEK’s books of Br.590,000.
Questions: (a) How much revenue should SEK Company record on July 1,
2015? (b) How much revenue should it report related to this transaction on
December 31, 2015?
Entry to record interest revenue at the end of the year, December 31, 2015.
Interest Revenue (12% x ½ x Br.900,000) 54,000
Companies are not required to reflect the time value of money if the time period
for payment is less than a year.
3-33 LO 5
Non-Cash Consideration
Goods, services, or other non-cash consideration.
 Companies sometimes receive contributions (e.g.,
donations and gifts).
 Customers sometimes contribute goods or services,

such as equipment or labor, as consideration for goods
provided or services performed.
 Companies generally recognize revenue on the basis

of the fair value of .
 what is received.
3-34 LO 5
Consideration Paid or Payable to Customers

 May include discounts, volume rebates, coupons, free
products, or services.
 In general, these elements reduce the consideration

received and the revenue to be recognized.
3-35 LO 5
ILLUSTRATION 3-13
Consideration Paid or Payable Transaction Price –
Volume Discount
VOLUME DISCOUNT
Facts: Sansung Company offers its customers a 3% volume discount if they
purchase at least ¥2 million of its product during the calendar year. On March 31,
2015, Sansung has made sales of ¥700,000 to Artic Co. In the previous 2 years,
Sansung sold over ¥3,000,000 to Artic in the period April 1 to December 31.
Questions: How much revenue should Sansung recognize for the first 3
months of 2015?
Sansung makes the following entry on March 31, 2015.

Sansung should reduce its revenue by ¥21,000 (¥700,000 x 3%) because it is

probable that it will provide this rebate.
3-36 LO 5
ILLUSTRATION 3-13
Consideration Paid or Payable Transaction Price –
Volume Discount
Questions: How much revenue should Sansung recognize for the first 3
months of 2015?
Assuming Sansung’s customer meets the discount threshold, Sansung makes

the following entry.
Cash 679,000
If Sansung’s customer fails to meet the discount threshold, Sansung makes the
following entry upon payment.
Cash 700,000
Sales Discounts Forfeited 21,000
3-37 LO 5
Allocating Transaction Price to Separate
 Based on their relative fair values.
 Best measure of fair value is what the company could

sell the good or service for on a standalone basis.
 If not available, companies should use their best

estimate of what the good or service might sell for as a
standalone unit.
3-38 LO 6
Allocating Transaction Price to Separate
Performance Obligations—Step 4 ILLUSTRATION 3-14
Transaction Price
Allocation
3-39 LO 6
Recognizing Revenue When (or as) Each
Performance Obligation Is Satisfied-Step 5
Company satisfies its performance obligation when the
customer obtains control of the good or service.
Change in Control Indicators

1. Company has a right to payment for asset.
2. Company has transferred legal title to asset.
3. Company has transferred physical possession of asset.
4. Customer has significant risks and rewards of ownership.
5. Customer has accepted the asset.
3-40 LO 7
Recognizing revenue from a performance obligation over
time
 Measure progress toward completion
► Method for measuring progress should depict transfer
of control from company to customer.
► Most common are cost-to-cost and units-of-delivery

methods.
► Objective of methods is to measure extent of progress

in terms of costs, units, or value added.
3-41 LO 7
Step in Process Description Implementation
1. Identify the A contract is an A company applies the revenue

contract with agreement that creates guidance to contracts with
customers. enforceable rights or customers and must determine
obligations. if new performance obligations
are created by a contract
modification.
ILLUSTRATION 3-20
Summary of the
Five-Step Revenue
Recognition Process
3-42 LO 7
2. Identify the A performance obligation A contract may be comprised of

separate is a promise in a contract multiple performance
performance to provide a product or obligations.
obligations service to a customer. Accounting is based on
in the A performance obligation evaluation of whether the
contract exists if the customer can product or service is distinct
benefit from the good or within the contract.
service on its own or If each of the goods or services
together with other readily is distinct, but is interdependent
available resources. and interrelated, these goods
and services are combined and
ILLUSTRATION 3-20
Summary of the reported as one performance
Five-Step Revenue obligation.
Recognition Process
3-43 LO 7
3. Determine Transaction price is the In determining the transaction

the amount of consideration price, companies must consider
transaction that a company expects to the following factors:
price. receive from a customer 1. variable consideration,
in exchange for
2. time value of money,
transferring goods and
services. 3. Non-cash consideration, and
4. consideration paid or
payable to customer.
ILLUSTRATION 3-20
Summary of the
Five-Step Revenue
Recognition Process
3-44 LO 7
4. Allocate the If more than one The best measure of fair value
transaction performance obligation is what the good service could
price to the exists, allocate the be sold for on a standalone
separate transaction price based basis (standalone selling price).
performance on relative fair values. Estimates of standalone selling
obligation. price can be based on
1. adjusted market
assessment,
2. expected cost-plus a margin
approach, or
ILLUSTRATION 3-20 3. a residual approach.
Summary of the
Five-Step Revenue
Recognition Process
3-45 LO 7
5. Recognize A company satisfies its Companies satisfy performance

revenue performance obligation obligations either at a point in
when each when the customer time or over a period of time.
performance obtains control of the Companies recognize revenue
obligation is good or service. over a period of time if
satisfied. 1. the customer controls the
asset as it is created or
2. the company does not have
an alternative use for the
asset.
ILLUSTRATION 3-20
Summary of the
Five-Step Revenue
Recognition Process
3-46 LO 7
OTHER REVENUE RECOGNITION ISSUES
 Right of return
 Consignments
 Repurchase agreements
 Warranties
 Bill and hold
 Non-refundable upfront fees
 Principal-agent relationships
3-47 LO 8
Right of Return
 Right of return is granted for product for various

reasons (e.g., dissatisfaction with product).
 Company returning the product receives any

combination of the following.
1. Full or partial refund of any consideration paid.
2. Credit that can be applied against amounts owed,

or that will be owed, to the seller.
3. Another product in exchange.
3-48 LO 8
Right of Return ILLUSTRATION 3-21
Recognition—Right of Return
RIGHT OF RETURN
Facts: Aster Company sells 100 products for Br.100 each to Nejat Inc. for
cash. Aster allows Nejat to return any unused product within 30 days and
receive a full refund. The cost of each product is Br.60. To determine the
transaction price, Aster decides that the approach that is most predictive of
the amount of consideration to which it will be entitled is the most likely
amount. Using the most likely amount, Aster estimates that:
1. Three products will be returned.
2. The costs of recovering the products will be immaterial.
3. The returned products are expected to be resold at a profit.
Question: How should Aster record this sale?
3-49 LO 8
Aster records the sale as follows with the expectation that three products
will be returned:
Cash 10,000
Sales Revenue [Br.9,700 x (Br.100 x 97)] 9,700
Refund Liability (Br.100 x 3) 300
Aster records the cost of goods sold with the following entry.

Estimated Inventory Returns (Br.60 x 3) 180
Inventory 6,000
3-50 LO 8
When a return occurs, Aster records the following entries.
Refund Liability (2 x Br.100) 200

Accounts Payable 200
Returned Inventory (2 x Br.60) 120

Estimated Inventory Returns 120
Companies record the returned asset in a separate account from inventory

to provide transparency.
3-51 LO 8
Repurchase Agreements
 Transfer control of (sell) an asset to a customer but

have an obligation or right to repurchase.
 If obligation or right to repurchase is for an amount

greater than or equal to selling price, then
transaction is a financing transaction.
3-52 LO 8
ILLUSTRATION 3-22
Repurchase Agreements Recognition—Repurchase
Agreement
REPURCHASE AGREEMENT
Facts: Urgecha Inc., an equipment dealer, sells equipment on January 1,
2015, to Line Company for Br.100,000. It agrees to repurchase this
equipment on December 31, 2016, for a price of Br.121,000.
Question: How should Urgecha Inc. record this transaction?

Assuming an interest rate of 10 percent is imputed from the agreement,
Urgecha makes the following entry to record the financing on January 1,
2015.
Cash 100,000
Liability to Line Company 100,000
3-53 LO 8
ILLUSTRATION 3-22
Repurchase Agreements Recognition—Repurchase
Agreement
Question: How should Urgecha Inc. record this transaction?
Urgecha Inc. records interest on December 31, 2015, as follows.
Interest Expense 10,000

Liability to Line Company (Br.100,000 x 10%) 10,000
Urgecha Inc. records interest and retirement of its liability to Line Company
on December 31, 2016, as follows.
Interest Expense 11,000

Liability to Line Company (Br.110,000 x 10%) 11,000
Liability to Line Company 121,000

Cash (Br.100,000 + Br.10,000 + Br.11,000) 121,000
3-54 LO 8
Bill-and-Hold Arrangements
 Contract under which an entity bills a customer for a

product but the entity retains physical possession of
the product until a point in time in the future.
 Result when buyer is not yet ready to take delivery but

does take title and accepts billing.
3-55 LO 8
Bill-and-Hold Arrangements ILLUSTRATION 3-23
Recognition—Bill and Hold
BILL AND HOLD

Facts: Kiya Company sells Br.450,000 (cost Br.280,000) of fireplaces on
March 1, 2015, to a local coffee shop, Fruit, which is planning to expand its
locations around the city. Under the agreement, Fruit asks Kiya to retain
these fireplaces in its warehouses until the new coffee shops that will house
the fireplaces are ready. Title passes to Fruit at the time the agreement is
signed.
Question: When should Kiya recognize the revenue from this

bill-and-hold arrangement?
Kiya determines when it has satisfied its performance obligation to transfer a

product by evaluating when Fruit obtains control of that product.
3-56 LO 8

For Fruit to have obtained control of a product in a bill-and-hold arrangement,

all of the following criteria should be met:
(a) The reason for the bill-and-hold arrangement must be substantive.
(b) The product must be identified separately as belonging to Fruit.
(c) The product currently must be ready for physical transfer to Fruit.
(d) Kiya cannot have the ability to use the product or to direct it to another
customer.
In this case, it appears that the above criteria were met, and therefore
revenue recognition should be permitted at the time the contract is signed.
3-57 LO 8

Kiya makes the following entry to record the sale.

Accounts receivable 450,000
Kiya makes an entry to record the related cost of goods sold as follows.
Inventory 280,000
3-58 LO 8
Principal-Agent Relationships
 Agent’s performance obligation is to arrange for principal to
provide goods or services to a customer.
 Examples:
► Preferred Travel Company (agent) facilitates the booking
of cruise excursions by finding customers for Regency
Cruise Company (principal).
► Priceline (USA) (agent) facilitates the sale of various

services such as car rentals at Hertz (USA) (principal).
 Amounts collected on behalf of the principal are not revenue

of the agent.
► Revenue for agent is amount of commission received.

3-59 LO 8
Consignments
 Manufacturers (or wholesalers) deliver goods but retain

title to the goods until they are sold.
 Consignor (manufacturer or wholesaler) ships

merchandise to the consignee (dealer), who is to act as
an agent for the consignor in selling the merchandise.
 Consignor makes a profit on the sale.
► Carries merchandise as inventory.
 Consignee makes a commission on the sale.
3-60 LO 8
ILLUSTRATION 3-25
Consignments Recognition—Sales on
Consignment
3-61 LO 8
ILLUSTRATION 3-25
Consignments Recognition—Sales on
Consignment
3-62 LO 8
Warranties
Two types of warranties to customers:

1. Product meets agreed-upon specifications in contract at
time product is sold.
a. Warranty is included in sales price (assurance-type

warranty).
2. Not included in sales price of product (service-type

warranty).
a. Recorded as a separate performance obligation.
3-63 LO 8
ILLUSTRATION 3-26
Warranties Performance Obligations
and Warranties
WARRANTIES
Facts: Tesfaye Company sold 1,000 Rollomatics during 2015 at a total price
of Br.6,000,000, with a warranty guarantee that the product was free of any
defects. The cost of Rollomatics sold is Br.4,000,000. The term of the
assurance warranty is two years, with an estimated cost of Br.30,000. In
addition, Tesfaye sold extended warranties related to 400 Rollomatics for 3
years beyond the 2-year period for Br.12,000.
Question: What are the journal entries that Tesfaye Company

should make in 2015 related to the sale and the related warranties?
3-64 LO 8
ILLUSTRATION 3-26
Warranties Performance Obligations
and Warranties
Question: What are the journal entries that Tesfaye Company

should make in 2015 related to the sale and the related warranties?
To record the revenue and liabilities related to the warranties:

Cash (Br.6,000,000 + Br.12,000) 6,012,000
Warranty Expense 30,000
Warranty Liability 30,000
Unearned Warranty Revenue 12,000
Sales Revenue 6,000,000
To reduce inventory and recognize cost of goods sold:

Cost of Goods Sold 4,000,000
Inventory 4,000,000
3-65 LO 8
Non-Refundable Upfront Fees
 Payments from customers before

► Delivery of a product.
► Performance of a service.
 Generally relate to initiation, activation, or setup of a
good or service to be provided or performed in the
future.
 Most cases, upfront payments are nonrefundable.
► Examples include:
 Membership fee in a health club.
 Activation fees for phone, Internet, or cable.
3-66 LO 8
PRESENTATION AND DISCLOSURE
Presentation
Contract Assets and Liabilities
 Contract assets are of two types:
1. Unconditional rights to receive consideration
because company has satisfied its performance
obligation.
2. Conditional rights to receive consideration

because company has satisfied one performance
obligation but must satisfy another performance
obligation before it can bill the customer.
3-67 LO 9
ILLUSTRATION 3-29
Presentation Contract Asset Recognition
and Presentation
CONTRACT ASSET
Facts: On January 1, 2015, Hanan Company enters into a contract to
transfer Product A and Product B to Samcate Co. for Br.100,000. The
contract specifies that payment of Product A will not occur until Product B is
also delivered. In other words, payment will not occur until both Product A
and Product B are transferred to Samcate. Hanan determines that
standalone prices are Br.30,000 for Product A and Br.70,000 for Product B.
Hanan delivers Product A to Samcate on February 1, 2015. On March 1,
2015, Hanan delivers Product B to Samcate.
Question: What journal entries should Hanan Company make in

regards to this contract in 2015?
3-68 LO 9
ILLUSTRATION 3-29
Presentation Contract Asset Recognition
and Presentation
Question: What journal entries should Hanan Company make in

regards to this contract in 2015?
On February 1, 2015, Hanan records the following entry:

Contract Asset 30,000
On February 1, Hanan does not record an accounts receivable because it

does not have an unconditional right to receive the Br.100,000 unless it also
transfers Product B to Samcate. When Hanan transfers Product B on March
1, 2015, it makes the following entry.

Contract Asset 30,000
3-69 LO 9
ILLUSTRATION 3-30
Presentation Contract Liability Recognition
and Presentation
CONTRACT LIABILITY
Facts: On March 1, 2015, Helen Company enters into a contract to transfer
a product to Eden Inc. on July 31, 2015. It is agreed that Eden will pay the
full price of Br.10,000 in advance on April 1, 2015. The contract is non-
cancelable. Eden, however, does not pay until April 15, 2015, and Helen
delivers the product on July 31, 2015. The cost of the product is
Br.7,500.
Question: What journal entries are required in 2015?
No entry is required on March 1, 2015:

► Neither party has performed on the contract.
► Neither party has an unconditional right as of March 1, 2015.
3-70 LO 9
ILLUSTRATION 3-30
Presentation Contract Liability Recognition
and Presentation
Question: What journal entries are required in 2015?
On receiving the cash on April 15, 2015, Helen records the following entry.
Cash 10,000
Unearned Sales Revenue 10,000
On satisfying the performance obligation on July 31, 2015, Helen records

the following entry to record the sale.
Unearned Sales Revenue 10,000
In addition, Helen records cost of goods sold as follows.

Cost of Good Sold 7,500
Inventory 7,500
3-71 LO 9
Presentation
Costs to Fulfill a Contract

 Companies divide fulfillment costs (contract acquisition
costs) into two categories:
1. Those that give rise to an asset.
2. Those that are expensed as incurred.
3-72 LO 9
Presentation
Collectibility
 Credit risk that a customer will be unable to pay in
accordance with the contract.
► Whether a company will get paid is not a
consideration in determining revenue recognition.
► Amount recognized as revenue is not adjusted for

customer credit risk.
3-73 LO 9
Disclosure
Companies disclose qualitative and quantitative

information about the following:
 Contracts with customers.
 Significant judgments.
 Assets recognized from costs incurred to fulfill a

contract.
3-74 LO 9
Disclosure
Companies provide a range of disclosures:

 Disaggregation of revenue.
 Reconciliation of contract balances.
 Remaining performance obligations.
 Cost to obtain or fulfill contracts.
 Other qualitative disclosures.
► Significant judgments and changes in them.
► Minimum revenue not subject to variable

consideration constraint.
3-75 LO 9
APPENDIX 3A LONG-TERM CONSTRUCTION CONTRACTS
REVENUE RECOGNITION OVER TIME

Under certain circumstances companies recognize
revenue over time.
The most notable context in which revenue may be

recognized over time is long-term construction contract
accounting.
3-76 LO 10 Apply the percentage-of-completion method for long-term contracts.


Long-term contracts frequently provide that seller (builder)
may bill purchaser at intervals.
► Examples:
 Development of military and commercial aircraft
 Weapons-delivery systems
 Space exploration hardware
3-77 LO 10

A company recognizes revenue over time if at least one of
the following two criteria is met:
1. Company’s performance creates or enhances an asset
(e.g., work in process) that the customer controls as the
asset is created or enhanced; or
2. Company’s performance does not create an asset with

an alternative use. In addition…
3-78 LO 10

In addition at least one of the following criteria must be met:
a. The customer simultaneously receives and consumes the
benefits of the entity’s performance as the entity performs.
b. Another company would not need to substantially re-perform

the work the company has completed to date if that other
company were to fulfill the remaining obligation to the
customer.
c. The company has a right to payment for its performance

completed to date, and it expects to fulfill the contract as
promised.
3-79 LO 10

If criterion 1 or 2 is met, then a company recognizes
revenue over time if it can reasonably estimate its progress
toward satisfaction of the performance obligations.
 Company recognizes revenues and gross profits each

period based upon the progress of the construction—
referred to as the percentage-of-completion method.
 If criteria are not met, the company recognizes revenues

and gross profit when the contract is completed, referred
to as the cost-recovery (zero-profit) method.
3-80 LO 10
Percentage-of-Completion Method
Measuring the Progress Toward Completion
Most popular input measure used to determine the progress
toward completion is the cost-to-cost basis.
3-81 LO 10
Revenue to Recognized Cost-to-Cost Basis
ILLUSTRATION 3A-1
ILLUSTRATION 3A-2
ILLUSTRATION 3A-3
3-82 LO 10
APPENDIX 3A PERCENTAGE-OF-COMPLETION METHOD
Illustration: Hardhat Construction Company has a contract to

construct a Br.4,500,000 bridge at an estimated cost of
Br.4,000,000. The contract is to start in July 2015, and the bridge
is to be completed in October 2017. The following data pertain to
the construction period.
3-83 LO 10
ILLUSTRATION 3A-4
3-84 LO 10
ILLUSTRATION 3A-5
3-85 LO 10
Illustration: Percentage-of-Completion Revenue, Costs, and

Gross Profit by Year
ILLUSTRATION 3A-6
3-86 LO 10
ILLUSTRATION 3A-6
APPENDIX 3A
PERCENTAGE-OF-
COMPLETION
METHOD
ILLUSTRATION 3A-7
3-87 LO 10
Illustration: Content of Construction in Process Account—

ILLUSTRATION 3A-8
3-88 LO 10
Financial Statement Presentation—Percentage-

of-Completion
Computation of Unbilled Contract Price at 12/31/15
ILLUSTRATION 3A-9
3-89 LO 10

of-Completion Method (2015)
ILLUSTRATION 3A-10
3-90 LO 10

of-Completion Method (2016)
ILLUSTRATION 3A-11
3-91 LO 10
Cost-Recovery (Zero-Profit) Method

This method recognizes revenue only to the extent of costs
incurred that are expected to be recoverable. Only after all costs
are incurred is gross profit recognized.
3-92 LO 11 Apply the cost-recovery method for long-term contracts.

APPENDIX 3A COST-RECOVERY (ZERO-PROFIT) METHOD
Illustration: Hardhat Construction would report the following

revenues and costs for 2015–2017. ILLUSTRATION 3A-14
3-93 LO 11
ILLUSTRATION 3A-14
Cost-Recovery Method
Revenue, Costs, and
ILLUSTRATION 3A-15
Journal Entries—
3-94 LO 11
ILLUSTRATION 3A-14
Revenue, Costs, and
ILLUSTRATION 3A-16
Comparison of Gross
Profit Recognized under
Different Methods
3-95 LO 11
ILLUSTRATION 3A-17
3-96 Financial Statement Presentation—Cost- Recovery Method LO 11
Long-Term Contract Losses

1. Loss in Current Period on a Profitable Contract
► Percentage-of-completion method only, the estimated
cost increase requires a current-period adjustment of
gross profit recognized in prior periods.
2. Loss on an Unprofitable Contract

► Under both percentage-of-completion and cost-
recovery methods, the company must recognize in the
current period the entire expected contract loss.
3-97 LO 12 Identify the proper accounting for losses on long-term contracts.

APPENDIX 3A LONG-TERM CONTRACT LOSSES
Illustration: Loss in Current Period

2014 2015 2016
Contract price
Casper Construction Co. $675,000 $675,000 $675,000
Cost incurred current year 150,000 287,400 215,436
Estimated cost to complete
in future years 450,000 215,436 0
Billings to customer current year 135,000 360,000 180,000
Cash receipts from customer
Current year 112,500 262,500 300,000
Prepare the journal entries to record revenue and expense for 2014, 2015, and
2016 assuming the estimated cost to complete at the end of 2015 was
Br.215,436.
3-98 Advance slide in presentation mode to reveal answers. LO 12


2014 2015 2016
Costs incurred to date $ 150,000 $ 437,400 $ 652,836
Estimated cost to complete 450,000 215,436
Est. total contract costs 600,000 652,836 652,836
Est. percentage complete 25.0% 67.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 452,250 675,000
Rev. recognized prior year (168,750) (452,250)
Rev. recognized currently 168,750 283,500 222,750
Costs incurred currently (150,000) (287,400) (215,436)
Gross profit recognized $ 18,750 $ (3,900) $ 7,314
3-99 LO 12
2014 2015 2016
Construction in Process 18,750 7,314

Construction Expenses 150,000 215,436
Revenue from LT Contracts 168,750 222,750
Construction in Process 3,900

Construction Expenses 287,400
Revenue from LT Contracts 283,500
3-100 LO 12
Illustration: Loss on Unprofitable Contract

2014 2015 2016
Contract price
Casper Construction Co. $675,000 $675,000 $675,000
Cost incurred current year 150,000 287,400 246,038
Estimated cost to complete
in future years 450,000 246,038 0
Billings to customer current year 135,000 360,000 180,000
Cash receipts from customer
Current year 112,500 262,500 300,000
Prepare the journal entries for 2014, 2015, and 2016 assuming the estimated
cost to complete at the end of 2015 was Br.246,038 instead of Br.170,100.
3-101 LO 12

2014 2015 2016
Costs incurred to date $ 150,000 $ 437,400 $ 683,438
Estimated cost to complete 450,000 246,038
Est. total contract costs 600,000 683,438 683,438
Est. percentage complete 25.0% 64.0% 100.0%
Contract price 675,000 675,000 675,000
Revenue recognizable 168,750 432,000 675,000
Rev. recognized prior year (168,750) (432,000)
Rev. recognized currently 168,750 263,250 243,000
Costs incurred currently (150,000) (290,438) (243,000)
Gross profit recognized $ 18,750 $ (27,188) $ -
3-102 Br.675,000 – 683,438 = (8,438) cumulative loss LO 12

2014 2015 2016
Construction in Process 18,750 -

Construction Expenses 150,000 243,000
Revenue from LT Contracts 168,750 243,000
Construction Expenses 290,438

Revenue from LT Contracts 263,250
3-103 LO 12
For the Cost-Recovery method, companies would recognize the

following loss :
2014 2015 2016
Loss on LT Contracts 8,438

3-104 LO 12
APPENDIX 3B REVENUE RECOGNITION FOR FRANCHISES
Franchises
Four types of franchising arrangements have evolved:
1. Manufacturer-retailer
2. Manufacturer-wholesaler
3. Service sponsor-retailer
4. Wholesaler-retailer
3-105 LO 13 Explain revenue recognition for franchises.

Franchises
Two sources of revenue:
1. Sale of initial franchises and related assets or services,
and
2. Continuing fees based on the operations of franchises.
3-106 LO 13
Franchises
The franchisor normally provides the franchisee with:
1. Assistance in site selection
2. Evaluation of potential income
3. Supervision of construction activity
4. Assistance in the acquisition of signs, fixtures, and equipment
5. Bookkeeping and advisory services
6. Employee and management training
7. Quality control
8. Advertising and promotion
3-107 LO 13
FRANCHISE ACCOUNTING
Performance obligations relate to:
 Right to open a business.
 Use of trade name or other intellectual property of the

franchisor.
 Continuing services, such as marketing help, training, and

in some cases supplying inventory and inventory
management.
3-108 LO 13
FRANCHISE ACCOUNTING
Franchisors commonly charge an initial franchise fee and
continuing franchise fees:
► Initial franchise fee (payment for establishing the relationship

and providing some initial services).
► Continuing franchise fees received

 In return for continuing rights granted by the agreement.
 For providing management training, advertising and
promotion, legal assistance, and other support.
3-109 LO 13
Facts: Tum’s Pizza Inc. enters into a franchise agreement on November 1,

2015, giving Food Fight Corp. the right to operate as a franchisee of Tum’s
Pizza for 5 years. Tum’s charges Food Fight an initial franchise fee of
Br.50,000 for the right to operate as a franchisee. Of this amount,
Br.20,000 is payable when Food Fight signs the agreement, and the
balance is payable in five annual payments of Br.6,000 each on December
31. Food Fight also promises to pay ongoing royalty payments of 1% of its
annual sales (payable each January 31 of the following year) and is
obliged to purchase products from Tum’s at its current standalone selling
prices at the time of purchase. The credit rating of Food Fight indicates that
money can be borrowed at 8%. The present value of an ordinary annuity of
five annual receipts of Br.6,000 each discounted at 8% is Br.23,957. The
discount of Br.6,043 represents the interest revenue to be accrued by
Tum’s over the payment period.
3-110 LO 13
Identify the performance obligations and the point in time when the
performance obligations are satisfied and revenue is recognized.
Rights to the trade name, market area, and proprietary know-

how for 5 years are not individually distinct.
 Each one is not sold separately and cannot be used with other
goods or services that are readily available to the franchisee.
 Combined rights give rise to a single performance obligation.
 Tum’s satisfies performance obligation at point in time when

Food Fight obtains control of the rights.
3-111 LO 13
Training services and equipment are distinct because similar

services and equipment are sold separately.
 Tum’s satisfies those performance obligations when it

transfers the services and equipment to Food Fight.
Tum’s cannot recognize revenue for the royalty payments because

it is not reasonably assured to be entitled to those royalty amounts.
 Tum’s recognizes revenue for the royalties when (or as) the
uncertainty is resolved.
3-112 LO 13
Consider the following for allocation of the transaction price at

December 31, 2015.
Training is completed in January 2016, the equipment is installed in

January 2016, and Food Fight holds a grand opening on February 2,
2016.
3-113 LO 13
On December 31, 2015, Tum’s signs the agreement and receives

upfront payment and note.
Cash 20,000
Notes Receivable 30,000
Unearned Franchise Revenue 20,000
Unearned Service Revenue (training) 9,957
Unearned Sales Revenue (equipment) 14,000
3-114 LO 13
On February 2, 2016, franchise opens. Tum’s satisfies the

performance obligations related to the franchise rights, training, and
equipment.

Franchise Revenue 20,000
Unearned Service Revenue (training) 9,957
Service Revenue (training) 9,957
Unearned Sales Revenue (equipment) 14,000
Inventory 10,000
3-115 LO 13
RECOGNITION OF FRANCHISE RIGHTS

REVENUE OVER TIME
Depending on the economic substance of the rights, the
franchisor may be providing access to the right rather than
transferring control of the franchise rights.
In this case, the franchise revenue is recognized over

time, rather than at a point in time.
3-116 LO 13
APPENDIX 3B FRANCHISE REVENUE OVER TIME
Facts: Tech Solvers Corp. is a franchisor and provides a range of

computing services (hardware/software installation, repairs, data backup,
device syncing, and network solutions) on popular Apple and PC devices.
Each franchise agreement gives a franchisee the right to open a Tech
Solvers store and sell Tech Solvers’ products and services in the area for 5
years. Under the contract, Tech Solvers also provides the franchisee with a
number of services to support and enhance the franchise brand, including
(a) advising and consulting on the operations of the store;
(b) communicating new hardware and software developments, and

service techniques;
(c) providing business and training manuals; and
(d) advertising programs and training.

3-117 LO 13
Facts: As an almost entirely service operation (all parts and other supplies
are purchased as needed by customers), Tech Solvers provides few
upfront services to franchisees. Instead, the franchisee recruits service
technicians, who are given Tech Solvers’ training materials (online manuals
and tutorials), which are updated for technology changes, on a monthly
basis at a minimum. Tech Solvers enters into a franchise agreement on
December 15, 2015, giving a franchisee the rights to operate a Tech
Solvers franchise in eastern Bavaria for 5 years. Tech Solvers charges an
initial franchise fee of Br.5,000 for the right to operate as a franchisee,
payable upon signing the contract. Tech Solvers also receives ongoing
royalty payments of 7% of the franchisee’s annual sales (payable each
January 15 of the following year).
3-118 LO 13
Rights to the trade name, market area, and proprietary know-how

for 5 years are not individually distinct.
 Each one is not sold separately and cannot be used with other
goods or services that are readily available to the franchisee.
 Licensed rights and the ongoing training materials are a single

performance obligation.
 Tech Solvers is providing access to the rights and must continue

(over time) to perform updates and services.
3-119 LO 13
Tech Solvers cannot recognize revenue for the royalty payments
 Not reasonably assured to be entitled to those revenue-based

royalty amounts.
 Payments represent variable consideration.
 Recognize revenue for royalties when (or as) uncertainty is

resolved.
3-120 LO 13
Franchise agreement signed and receipt of upfront payment and note,

December 15, 2015:
Cash 5,000
Franchise begins operations in January 2016 and records Br.85,000 of

revenue for the year ended December 31, 2016.

Franchise Revenue (Br.5,000 ÷ 5) 1,000
Franchise Revenue (Br.85,000 x 7%) 5,950
3-121 LO 13

Chapter-3 Ifrs Revenue Recognition

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Chapter Three

Revenue and Expense Recognition

3. Identify the contract with customers. 8. Identify other revenue recognition

Recently, the IASB and FASB issued a converged standard

New Revenue Recognition Standard

 Are required to analyze contracts with customers

► Contracts indicate terms and measurement of

► Without contracts, companies cannot know whether

ILLUSTRATION 3-1 Key Concepts of Revenue Recognition

Assume that Airbus (FRA) Corporation signs a contract to sell

A contract is an agreement between two parties

Step 2: Identify the Airbus has only one performance obligation—to

ILLUSTRATION 3-2 Five Steps of Revenue Recognition

Transaction price is the amount of consideration

Step 4: Allocate the

ILLUSTRATION 3-2 Five Steps of Revenue Recognition

Company applies the revenue guidance to a contract

ILLUSTRATION 3-3 Contract Criteria for Revenue Guidance

 The contract has commercial substance;  The contract is wholly

Contract asset = Rights received > Performance obligation

Contract liability = Rights received < Performance obligation

CONTRACTS AND RECOGNITION

CONTRACTS AND RECOGNITION

► whether it is a modification of the existing contract.

Separate Performance Obligation

► The company has the right to receive an amount of

For example, Simon Co. has a contract to sell 100 products to a

Given a new contract, Simon recognizes an additional:

Original contract [(100 units - 60 units) x Br.100] = Br.4,000

► not change previously reported results.

For Simon, the amount recognized as revenue for each of the

Products not delivered under original contract

(Br.100 x Br.40) = Br.4,000

Revenue per remaining unit (Br.5,900 ÷ 60) = Br.98.33

Under the prospective approach, a blended price (Br.98.33) is used

ILLUSTRATION 3Comparison of Contract Modification

Revenue Recognition Situations

Description Revenue from

Timing of Services As time passes

 To determine whether a company has to account for

 Whether the product is distinct within the contract.

► If performance obligation is not highly dependent on,

► If each of these services is interdependent and

SoftTech Inc. licenses customer-relationship software to Abreham Company.

 In a contract is often easily determined because

 Other contracts, companies must consider:

 Companies estimate amount of revenue to recognize.

ILLUSTRATION 3-9 Estimating Variable Consideration

Expected Value: Probability-weighted amount in a range of possible

ESTIMATING VARIABLE CONSIDERATION

Question: How should Solomon account for this revenue

Br.150,000 (the outcome with 60% probability)

 Companies only allocate variable consideration if it is

 Companies only recognize variable consideration if

1. they have experience with similar contracts and are

2. based on experience, they do not expect a significant

If these criteria are not met, revenue recognition is

Time Value of Money

► Interest accrued on consideration to be paid over