Explain with a example the meaning of Revenue Recognition

Revenue recoganation is fully discused in IAS11 and which means how much revenue must be recognaised specially in long term and big projects where the completion of the project takes more than a year. Specially construction projects. Main methods used to calculate revenus recognation are Cost to Complete (CTC) Percentage of Completion (POC) for details check IAS11  

Usually , revenue is recognized at the point of sale , when the customer pays for and receives the item . 

or when the exchange is done whether in cash or on account  

to recognize the revenue for completion of percentage of profit

MEANING OF ‘REVENUE’

IAS18 defines revenue as ‘the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants’ (1). The following implications flow from this definition:

(a) Revenue should be stated before deduction of costs of sale.  For example if goods are sold for $100 that cost the seller $60 to manufacture the revenue is $100, not $40.(b) Revenue is recognised on the provision of goods and services that relate to the ordinary activities of the entity. If an entity disposes of property, plant and equipment at the end of its useful economic life the proceeds of disposal are not revenue for the entity. Instead the profit or loss on disposal is treated as a deduction from operating expenses (or as a separate line item in the statement of profit or loss, if it is sufficiently material).(c) Sales taxes that are collected from the customer and remitted to the relevant authorities are not ‘revenue’.  For example if goods are sold for $110, inclusive of recoverable sales taxes of10%, the revenue is $100, not $110.(d) If the seller is acting as agent, rather than as the principal, in a transaction, the revenue the seller should recognise is the amount of commission receivable rather than the gross amount collected from the customer. For example, if a travel agent sells a holiday to a customer for $1,000 plus a commission of $100, so that the customer pays $1,100 and the travel agent remits $1,000 to the entity actually providing the holiday, then the travel agent recognises revenue of $100.

PRINCIPLES UNDERPINNING RECOGNITION OF REVENUE

IAS18 outlines the recognition principles in three parts:1.  Sale of goods:Revenue is recognised when all the following conditions have been satisfied (2):

(a) The seller has transferred the significant risks and rewards of ownership of the goods to the buyer.(b) The seller does not retain control over the goods or managerial involvement with them to the degree usually associated with ownership.(c) The amount of revenue can be measured reliably.(d) It is probable that the economic benefits associated with the transaction will flow to the seller(e) The costs incurred or to be incurred by the seller in respect of the transaction can be measured reliably.

As far as these conditions are concerned, it is notable that:

• A number of the conditions ((a) and (b) particularly) are subject to a degree of interpretation and therefore there can be some uncertainty about whether or not revenue should be recognised.
• The conditions are such that all are likely to be satisfied at a particular point in time and so there is a critical point at which all the revenue from the sale of goods would be recognised. This approach contrasts with the approach taken to the recognition of revenue from the provision of services (see below):

2. Provision of services:As stated above, there is a different approach taken to the recognition of revenue from the provision of services. IAS18 states that ‘where the outcome of a transaction involving the rendering of services can be estimated reliably, associated revenue should be recognised by reference to the stage of completion of the transaction at the end of the reporting period’ (3). In other words, the revenue is recognised gradually, rather than all at one ‘critical point’, as is the case for revenue from the sale of goods. IAS18 further states that the outcome of a transaction can be estimated reliably when all the following conditions are satisfied (3): (a) The amount of revenue can be measured reliably.(b) It is probable that the economic benefits associated with the transaction will flow to the seller.(c) The stage of completion of the transaction at the end of the reporting period can be measured reliably.(d) The costs incurred to date for the transaction and the costs to complete the transaction can be measured reliably.IAS18 does not prescribe one single method that should be used for determining the stage of completion of a service transaction. However the standard does provide some examples of suitable methods (4):(a) Surveys of work performed.(b) Services performed to date as a percentage of total services to be performed.(c) The proportion that costs incurred to date bear to the estimated total costs of the transaction.If it is not possible to reliably measure the outcome of a transaction involving the provision of services (perhaps because the transaction is in its very early stages) then revenue should be recognised only to the extent of costs incurred by the seller, assuming these costs are recoverable from the buyer (5).

Construction contractsIAS18 does not adequately address the issue of revenue recognition on a construction contract. However, IAS11 applies the basic principles we have already identified to such contracts, which are defined in IAS11 as follows (6):

‘Contracts specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use’.Most construction contracts are ‘fixed price contracts’.  In such contracts the seller agrees to a fixed contract price, or a fixed rate per unit of output, which in some cases could be subject to cost escalation clauses (6).Whilst a construction contract relates to the supply of goods, the ‘critical event basis’ used in IAS18 as a means of determining the timing of the recognition of revenue on the supply of goods is not really suitable. This is because the ‘supply’ by the seller in the case of a construction contract takes place gradually over the term of the contract. Therefore IAS11 basically requires that, where the outcome of a construction contract can be recognised reliably, revenue on such contracts should be recognised according to the stage of completion of the contract (7).  IAS11 imposes conditions very similar to the ones included in IAS18 for the provision of services (3) that need to be satisfied before the outcome of a construction contract can be recognised reliably(8):(a) Total contract revenue can be measured reliably.(b) It is probable that the economic benefits associated with the contract will flow to the seller.(c) Both the seller’s costs to complete the contract and the stage of contract completion at the end of the reporting period can be measured reliably.(d) The seller’s costs to date attributable to the contract can be clearly identified and measured reliably so that actual costs incurred can be compared with prior estimates.As is the case with service revenue recognition in IAS18, IAS11 does not prescribe one single method of computing the stage of completion of a construction contract. IAS11 provides the following examples of methods that might be suitable (9): (a) The proportion that contract costs incurred for work performed to date bear to total estimated contract costs.(b) Surveys of work performed.(c) Completion of a physical proportion of the contract work.In another similarity with the treatment of revenue from the rendering of services under IAS18, IAS11 states that (10):‘Where the outcome of a construction contract cannot be estimated reliably revenue shall be recognised only to the extent of contract costs incurred that it is probable will be recoverable’.In summary, then, IAS11 very much applies the principles set out in IAS18 (for the recognition of revenue on the rendering of services) to the recognition of revenue from construction contracts.

3. Interest, royalties and dividendsIAS18 states that entities should recognise revenue from the use of their assets yielding interest, royalties and dividends when (11):(a) It is probable that the economic benefits associated with the transaction will flow to the entity.(b) The amount of the revenue can be measured reliably.The exact basis for the recognition of revenue from the use by others of the ‘seller’s’ assets depends on the type of transaction (12):(a) Interest revenue should be recognised on the ‘effective interest’ basis.(b) Royalties should be recognised on an accruals basis in accordance with amounts receivable as a result of ‘asset use’ up to the reporting date.(c) Dividend revenue should be recognised when the right to receive payment is established. Often this does not happen in the case of dividends until the shareholder actually receives the dividend.

PRINCIPLES UNDERPINNING MEASUREMENT OF REVENUE

IAS18 states that ‘Revenue shall be measured at the fair value of the consideration received or receivable’ (12). In determining fair value it would be necessary to take into account any trade discounts or volume rebates granted by the seller.

In most cases, ‘fair value’ will represent the cash or cash equivalents received or receivable by the seller.  However, where the consideration is deferred, IAS18 explains that the arrangement effectively constitutes a financing transaction and the substance of the transaction is a supply of goods or services plus the provision of finance. In such circumstances, the amount receivable is split into (13):(a) An amount receivable for the supply of goods or services. This is arrived at by discounting the future cash receivable by the seller. The imputed rate of interest is the prevailing borrowing rate of the buyer or, if more easily determinable, the rate that discounts the future cash receivable to the current cash price of the goods or services. This is recognised immediately.(b) An amount receivable for the supply of finance to the buyer, recognised over the implied term.ExampleA retail entity supplies products to the public on three year deferred payment terms. On1 January2013 the entity supplies a product for a total price of $13,310, payable on1 January2016. The credit rating of the customer is such that a relevant imputed annual rate of interest is10%. The entity’s year end is31 December.On1 January2013 the total revenue from the sale would be split into:(a) Revenue from the sale of goods of $10,000 ($13,310/(1.10) (3). This is recognised immediately by crediting revenue and debiting receivables.(b) Interest revenue of $3,310 ($13,310 - $10,000). This is recognised over the three years as shown in the table below:

On1 January2016, the cash is received and the receivable derecognised.IAS11 uses similar principles to measure revenue from construction contracts, stating that ‘Contract revenue is measured at the fair value of the consideration received or receivable’ (14).

Todays the accounting methodology is based on accural  basis, therefore, Revenue is recognized when  possession of goods transfered to the buyer, and or services are rendered.

Exmaple: Let a firm A  enters into a contract to buy goods from an other firm B on account. The credit terms is60 days.it means Firsm A will pay his dues after60 days regarding every purchased.For instance, But firm B will recongnize the revenue when it delliver the goods to the Firm A.

Supplose Firm A places an order on1 January of2014, and Firm B deliver goods to A on07th of Jnauary2014, so Firm B will be recognized his revenue on07th of January2014. Although the firm B will receive payment on07 of march2014. The same is in case of Services rendered. All the employees get salary after one month, as  services have been already rendered.

Revenue Recognition means when the required part of obligations been performed. its does't includes wheather payment received or not.

The revenue recognition principle is a cornerstone of accrual accounting together with matching principle. They both determine the accounting period, in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realized or realizable, and are earned (usually when goods are transferred or services rendered), no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.