Maynard: Financial Reporting

Chapter 07: Revenue

Solutions to end of chapter questions in the book

Quick test

Question 1

At the date of supply, 1 January 20X3, sales revenue is recognised and measured at fair
value, which is the cash purchase price of 1,500. For the following 3 years, interest will
be accrued until payment is made.

On 1 January 20X3: Dr Receivables 1,500
Cr Sales revenue 1,500

On 31 December 20X3: Dr Receivables 150

Cr Interest income 150
(10% x 1,500)

On 31 December 20X4: Dr Receivables 165

Cr Interest income 165
(10% x 1,650)

On 31 December 20X5: Dr Receivables 182

Cr Interest income 182
(10% x 1,815)

On 31 December 20X5: Dr Bank 2,000

Cr Receivables 2,000

20X3 20X4 20X5

Income statement
Revenue 1,500
Finance income 150 165 182

Statement of financial position

Receivables 1,650 1,815 -*

* 3 rounding difference

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 Maynard: Financial Reporting
Chapter 07: Revenue

Question 2

Revenue for the magazines should be recognised over the period in which the magazines
are despatched, provided the items are of similar value in each time period. Thus revenue
recognised in the year ended 30 June 20X1 is 54,000 4/12 = 18,000.

Question 3

The after-sales support revenue should be deferred and recognised over the two years
from the sale of the software. This will fall into financial year-ends 31 December 20X7,
20X8 and 20X9. It should include a reasonable element of profit. This is often computed
by reference to similar contracts.

Total cost of providing support 150,000
Profit element 25/75 x 150,000 50,000
After-sales support revenue 200,000
(recognised over 2 years)

Revenue to be recognised on handover of system

Price 1,800,000
Less: after-sales support revenue 200,000
1,600,000

Financial statements for year ended 31 December 20X7

Income statement
Sales revenue 1,600,000
After-sales support revenue 9/24 x 200,000 75,000

Statement of financial position

Current liability Deferred revenue 12/24 x 200,000 100,000
Non-current liability Deferred revenue 3/24 x 200,000 25,000

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 Maynard: Financial Reporting
Chapter 07: Revenue

Develop your understanding

Question 4

For sales under which the consideration is receivable in instalments, revenue attributable
to the sales price, exclusive of interest, is recognised at the date of sale. The sale price is
the present value of the consideration, determined by discounting the instalments
receivable at the imputed rate of interest. The interest element is recognised as revenue
as it is earned, using the effective interest method.

Revenue recognised from 1st instalment = 5,000
(received 1 Jan 20X7)
Revenue recognised from 2nd instalment = 5,000 x 1/1.1 = 4,545
(to be received 1 Jan 20X8)
Revenue recognised from 3rd instalment = 5,000 x 1/(1.1)2 = 4,132
(to be received 1 Jan 20X9)
Total revenue recognised on 1 Jan 20X7 13,677

To calculate the interest revenue (finance income) and the resulting receivable balance:

Initial receivable recognised on 1 Jan 20X7 13,677
1st instalment 5,000
8,677
Interest 10% x 8,677 868
Receivable at 31 Dec 20X7 9,545
2nd instalment 5,000
4,545
Interest 10% x 4,545 455
Receivable at 31 Dec 20X8 5,000
3rd instalment 5,000

Years ended 31 December 20X7 20X8 20X9

Income Statement
Sales revenue 13,677 - -
Interest received 868 455 -

Statement of financial position current assets

Receivables 9,545 5,000 -

[Note receivable is measured on a discounted cash flow basis.

At 31 December 20X7 receivable = 5,000 + 5,000/1.1 = 9,545]

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 Maynard: Financial Reporting
Chapter 07: Revenue

Question 5

(a) Substance over form means that the commercial or economic substance of a
transaction should be accounted for rather than its legal form. For sales of goods this
means the sale contact has to be examined to determine whether the risks and
rewards of ownership have passed to the buyer. In most cases the transfer of the
risks and rewards of ownership coincides with the transfer of the legal title or the
passing of possession to the buyer. However if they have not passed then IAS 18
does not permit the revenue to be recognised.

(b) In this sale and repurchase agreement, Morse is expected to repurchase the goods on
30 June 20X8. Morse will therefore bear the risks or rewards of the condition of the
goods on return and the final selling price. Revenue from the transaction cannot be
recognised, and it should be accounted for as a secured loan.

The goods should remain recognised as inventories on the statement of financial

position of Morse and valued at the lower of cost and NRV (per IAS 2).
The receipt of 500,000 is accounted for as a long-term loan, with10% compound
interest charged to Morses income statement each year until the goods are
repurchased and the repayment made.

Question 6

Franchise fees may cover the supply of initial and subsequent services, equipment and
other tangible assets, and know-how. IAS 18 specifies that franchise fees are recognised
as revenue on a basis that reflects the purpose for which the fees were charged.

The fee for initial services is therefore recognised as income when the new outlet is
opened on 1 January 20X0. The fee for marketing, managerial and other support services
is recognised as revenue as the services are rendered.

The amount recognised as revenue for these continuing services should reflect a
reasonable profit, and should therefore be based on Priestly Bakers usual service
contracts and not the actual annual fee charged.

Annual cost of similar contracts 120,000
Mark-up 25% x 120,000 30,000
Annual revenue to be recognised for continuing services 150,000
Actual annual fee charged 90,000
Annual difference 60,000

4 x 60,000 will reduce the amount recognised as initial franchise revenue.

The accounting will therefore be as follows:

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 Maynard: Financial Reporting
Chapter 07: Revenue

On 1 January 20X0:

Dr Bank 600,000
Cr Franchise revenue 600,000

Dr Franchise revenue 240,000

Cr Deferred revenue 240,000
(4 x 60,000)

Dr Bank 90,000
Cr Deferred revenue 90,000

On 31 December 20X0 to recognise revenue for support services over 20X0:

Dr Deferred revenue 150,000

Cr Franchise revenue 150,000

Income statement for the year ended 31 December 20X0

Franchise revenue
Initial sale 360,000
Support services 150,000

Statement of financial position at 31 December 20X0

Current liabilities
Deferred income (one year of support service income) 150,000

Non-current liabilities
Deferred income (balance remaining on deferred income) 30,000

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 Maynard: Financial Reporting
Chapter 07: Revenue

Question 7

The customer loyalty programme terms indicate that there are two elements to every sale
transaction. The recognition criteria in IAS 18 Revenue need to be applied to the
separately identifiable components of the transaction with the card holders.

The 6,500 received from customers needs to be allocated between the amount received
for the goods sold and the amount received for the undelivered goods (and points).
Rightstore should develop a reasonable method to determine the fair values of the two
components. Based on the previous experience:

Accrued sales from August = 90% x 6,500 points/1,000 points x 100

= 585

Augusts cash sales should be recorded as follows:

Dr Cash 6,500
Cr Revenue 5,915
Cr Deferred revenue 585

The sale value of items given to customers on redemption of points will be debited to the
deferred revenue account and credited to revenue at the time of redemption.

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 Maynard: Financial Reporting
Chapter 07: Revenue

Take it further

Question 8

This is a sale and repurchase agreement. Although the legal form of the agreement is
that a sale has occurred, the substance of the transaction seems to be a secured loan. It
is unlikely that a finance company would wish to buy this inventory, and it seems much
more likely that the finance company is expecting Triangle to repurchase the inventory in
due course. Logically Triangle will do this if the sales value of the inventory at the time of
repurchase is greater than 5m plus compound interest at 10% per annum (from 1 April
20X1) plus accumulated storage costs. Triangle is also storing the inventory and incurring
the cost of this.

Assuming this analysis is correct, the 5m should be removed from sales and recognised
as a non-current liability.
3m should be added back to closing inventory.
The storage costs of 300,000 are an expense of Triangle, and should be removed from
receivables.
Interest @ 10% per annum will be charged as an expense.

Question 9

(a) Although contract costs originally estimated at 400,000 are now estimated at
450,000 (300,000 + 150,000), the contract is still estimated to generate a profit of
75,000 (525,000 450,000). Contract revenue and expenses should be recognised
by the stage of completion method.

(i) Using the contract costs method, the stage of completion is 300,000/450,000 =
2/3, in excess of the 20% cut-off point. So 2/3 of contract revenue and contract
profit should be recognised in profit or loss, i.e. 350,000 (2/3 525,000) and
50,000 (2/3 75,000) respectively.

In the statement of financial position, gross amounts due from customers should
be presented as contract costs incurred plus recognised profits less invoices
raised to customers (see below for calculations). Trade receivables should
include 37,500 (325,000 invoiced less 287,500 payments received).

(ii) Using the certified sales value method, the stage of completion is
367,500/525,000 = 70%, again in excess of the 20% cut-off point. So contract
revenue of 367,500 should be recognised in the income statement, together with
cost of sales of 70% x 450,000 = 315,000, giving a profit of 52,500 (70% x
75,000).

In the statement of financial position, gross amounts due from customers should
be presented in the same way as for the contract costs method (see below for
calculations) and trade receivables should include the same 37,500.

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 Maynard: Financial Reporting
Chapter 07: Revenue

Income statement
Contract costs Work certified

Revenue 350,000 367,500
Cost of sales (300,000) (315,000)
Profit 50,000 52,500

Statement of financial position

Contract costs Work certified

Gross amount due from customers
Costs incurred 300,000 300,000
Recognised profits 50,000 52,500
350,000 352,500
Progress billings (325,000) (325,000)
25,000 27,500

Trade receivables 37,500 37,500

(b) The contract costs method assumes that the same profit margin is earned on all parts
of a service contract and that profit is earned as costs are incurred, which may not
necessarily be the case for a service contract. The certified sales method also
assumes that the same profit margin is earned on all parts of the contract. However
the profit is earned as the sales value is certified. Based on the above figures the
contract is further advanced by this method, and so a higher profit is recognised at this
stage.

Note
Over the life of the contract, the profit is the same under both methods; it is just its
allocation to the reporting periods in which work is done which is different.

Question 10

Murray plc
The delivery to the customer is being delayed at the buyers request. Although the buyer
has accepted billings, and implicitly the title has been passed to the customer, the goods
are kept by Murray. This is an example of bill-and-hold sale.

Sales revenue for the goods held should be recognised since:

it is probable that delivery will be made;
the item is on hand, identified and ready for delivery to the buyer at the time the sale is
recognised;
the buyer specifically acknowledges the deferred delivery instructions; and
the usual payment terms apply.

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 Maynard: Financial Reporting
Chapter 07: Revenue

Pinkerton plc
Pinkerton should recognise the service income when the logistic services are rendered.

In addition, Pinkerton should recognise the income on a net basis, i.e. only the margin of
10% on airfreight and 5% on surface transportation is recognised.

The reasons for recognising the revenue on a net basis are as follows:
Pinkerton only acts as an agent in the transaction; and
Pinkerton does not take title of the product and does not have risks and rewards of
ownership, such as the risk of loss for collection, delivery, or returns.

The payments in gross amounts alone (i.e. just taking the credit risk) do not mean that
Pinkerton is taking risks and rewards in the transaction.

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