The general principles followed by company management in recognizing revenue should be stated in a disclosure [footnote]. An entity should disclose: (1) The accounting policies adopted for the recognition of revenue, including the methods adopted to determine the stage of completion of transactions involving the rendering of services; (2) The sale of goods; the rendering of services; interest; royalties; dividends; (3) The amount of revenue arising from exchange of goods or services included in each significant category of revenue. An entity also must disclose in accordance with IAS 37 any contingent liabilities and contingent assets that may arise from items such as warranty costs, claims, penalties, or possible losses. Footnotes can include the time span over which revenue from maintenance agreements is to be recognized, how the company handles different types of products and services bundled into the same pricing packages, and at what point revenues are to be recognized.
This post discusses IFRS-compliance revenue recognition disclosures. It is by no meant all inclusive, there maybe some very specific revenue recognition situations that I could not think of, and are not covered in this post. If so, please do write them through the comment form at the bottom of this post for further reasearch and discussions.
Disclosure of Bill and Hold Transactions
Bill and hold transactions are generally frowned on, given the risk of abuse by companies that can use this technique to inflate their current period revenues, although there are no specific rules under IFRS at this time.
Consequently, if any bill and hold transactions are used, put this information in a footnote, clearly stating that the company follows all IFRS requirements for these and all other revenue transactions. Also note the monetary amount and percentage of revenues involved and any change in the level of bill and hold revenue from the preceding year.
“During the past year, the company sold $172,000 of stoves to its restaurant customers under “bill and hold” transactions. Under these arrangements, restaurant owners asked the company to retain stoves in its warehouse facilities until new restaurants had been built to accommodate them. All these customers acknowledged in writing that they had ordered the inventory that the company was storing the stoves on their behalf, that they had taken on all risks of ownership, and that the stoves would be delivered in no more than three months. Total bill and hold transactions were $15,000 lower than the $187,000 in similar transactions that occurred in the preceding year. In both years, bill and hold transactions comprised 14% of total company revenues”.
Disclosure of Contract Revenue Recognition
If a company recognizes revenue based on the percentage-of-completion method, it should state how it makes this calculation, how it is recorded on the statement of financial position, when claims against customers are recognized, and how changes in estimates can impact reported profits or losses on contracts.
If there is a change in the method of contract revenue recognition, an explanation and the net effect of the change should be included.
3 Disclosure Examples
- “The company recognizes all revenue in its construction division using the percentage- of-completion method, under which it ascertains the completion percentage by dividing costs incurred to date by total estimated project costs. It not only revises estimated project costs regularly, but it also alters the reported level of project profitability. If project losses are calculated under this method, they are recognized in the current reporting period. Claims against customers are recorded in the period when payment is received; if billings exceed recognized revenue, the difference is recorded as a current liability, while any recognized revenues exceeding billings are recorded as a current asset”.
- “The company recognizes claims against customers when a cash receipt is probable, the claim is legally justified, and the amount of the claim can be proven. If any of these factors cannot be reasonably proven, then claims are recognized only upon the receipt of cash. Since claims involve the use of estimates, it is reasonable to record some changes to the initially reported revenue figure upon the eventual receipt of cash—or sooner if there is a firm basis for this information”.
- “The company has switched to the percentage-of-completion method from the completed-contract method for recording the results of its construction projects. Management authorized the change due to the increasingly long-term nature of its contracts, which have increased from single-month to multi-month durations. The net impact of this change was an increase in profits of $218,000 in 2008. The change was carried back to 2007, resulting in a profit increase of $12,000 in that period”.
Disclosure of Barter Revenue
Barter transactions should be recognized at the fair market value of the assets received in an exchange. The nature of any such transactions, the approximate value of the transactions, and how they are recorded in the financial statements should all be noted in a footnote.
“The company provides aerial traffic reports to a number of radio stations; in return, air time is given to the company. The company then obtains advertising to run on these free minutes and collects the proceeds. The company recognizes revenue from these barter transactions only after advertisements have been obtained and have been run on the participating radio stations. No asset is recorded on the company statement of financial position when air time is received from radio stations, since there is still significant uncertainty that the company will be able to convert the air time into paid advertisements. In 2008, the revenue recognized from these transactions was $1,745,000”.
Disclosure of Consignment Revenue
Shipments made to a distributor on consignment are not truly sales until they are sold by the distributor. The exact method of revenue recognition should be clearly stated in a footnote, so readers can be sure that revenue is not recognized too soon in the sales process. Not only that, but inventory may be shipped to a company by its customers on a consignment basis, to be included in custom products that are then sold back to the customers; however, only the value added to these custom products should be recognized as revenue.
2 Disclosure Examples
- “The company ships its eyewear products to a number of distributors, having no direct sales function of its own. All shipments to distributors continue to be recorded as inventory by the company until notification of shipment is received from distributors. In selected cases where there has been a problematic payment history by distributors, the company does not record revenue until cash has been received”.
- “The company produces custom rockets for its payload launch customers. Several customers prefer to supply rocket engines to be incorporated into the company’s rockets. Accordingly, these engines are recorded as consignment inventory when they are received and assigned a zero cost. When the completed rockets are shipped to customers, the price of the consigned engines is not included in the amount billed, thereby reducing the total revenue recognized by the company”.
Disclosure of Gain or Loss on Asset Sale
When a company recognizes a material gain or loss on the sale of an asset or a group of assets, it should disclose in a footnote the general transaction, its date, the gross amount of the sale, the amount of the gain or loss, and its presentation in the financial statements.
“The company sold its printing press in August 2008 for $5.3 million as part of a plan to reduce the capacity of its printing facilities in the United States. Net of its original cost, less depreciation and tax effects, this resulted in a net gain of $420,000, which is itemized as a Gain on Sale of Assets in the financial statements”.
Disclosure of Life Insurance Proceeds
If a company receives a payout from a life insurance policy, it should disclose in a footnote the amount of the payout, the event that caused the payout to be earned, and how the transaction was presented in the financial statements.
“The company received a payout of $20 million upon the death of a major shareholder in May 2008. The payout is recognized in the income statement under the Life Insurance Receipts line item. Under the terms of a stock buyback agreement with this shareholder, the company intends to use the proceeds to purchase all company shares held by the shareholder’s estate”.
Disclosure of Research and Development Revenue
Research and development contracts typically are accounted for in the same manner as any other construction project, though sometimes product profit-sharing terms will require a company to incur an up-front loss against the promise of future earnings. The primary disclosure is the method used to recognize revenue.
“The company’s research division enters into research and development contracts with a variety of organizations, typically on a fixed-fee basis. The company recognizes revenue from these contracts on a percentage-of-completion basis. In some instances, customers offer profit-sharing agreements from future product proceeds rather than upfront payments. In these cases, the company recognizes a loss when contracts begin, (based on anticipated costs) and updates this loss information as projects progress. The company records revenue from these profit-sharing arrangements only when profit-sharing payments are received from customers”.
Disclosure of Warranty Revenue Recognition
In the case of any long-term service revenue contract, the period over which warranty revenues are calculated should be described if there is a significant proportion of revenues. For many companies, this is a small revenue component not requiring separate disclosure. If it is disclosed, note the term over which warranty revenues are recognized and the amount of unrecognized warranty revenues.
“The company sells a one-year warranty agreement with its kitchen appliances; warranty revenues comprise approximately 8% of total revenues. These revenues are recognized ratably over their service periods, with the unrecognized balance listed as a short-term liability in the Unrecognized Warranty Revenues account. The unrecognized balance of these sales was $850,000 as of the statement of financial position date”.
Disclosure of Membership Fee Recognition
A membership organization should describe the types of membership fees charged and the method used to recognize revenue. The footnote can also reveal the amount of unrecognized revenue currently listed as a liability.
2 Disclosure Examples
- “The club charges a onetime nonrefundable membership fee of $10,000 as well as monthly dues of $300. Since members have no right to the return of the initial fee, the club recognizes this amount in its entirety when paid. Monthly dues are recognized when billed. There is no liability associated with unrecognized revenue shown on the statement of financial position”.
- “The club charges a onetime membership fee of $10,000, which can be repaid to members if they choose to resign from the club, less a $500 termination fee. The club holds all membership fees in escrow and recognizes the termination fee only when members resign from the club. The total amount of membership fees currently held in escrow is $1,620,000, and is listed under the Membership Fees Held in Reserve liability account. The club also charges $300 monthly dues, which are recognized when billed”.
Disclosure of Sales Return Allowance
There is no specific IFRS requirement that a company state its policy regarding the use of an allowance for sales returns. However, if a reserve has been created, then a footnote should detail how the amount of the reserve was derived.
“The company recorded an allowance for sales returns of $148,000. This amount is based on a historical average rate of return of 12% of the company’s subscription book sale business”.
Disclosure of Warranty Expense Allowance
If there is a history or expectation of significant warranty expenses, one should accrue an appropriate amount when related revenues are recognized. The footnote should describe the basis for the warranty expense calculation, as well as the current amount of the reserve.
2 Disclosure Example
- “The company recognizes a warranty expense when it recognizes the sale of its amusement park bumper cars. This expense is based on the most recent one year of actual warranty claims, which is currently 1.9% of sales. The current warranty expense reserve, as listed in the Warranty Reserve liability account on the statement of financial position, is $302,000”.
- “The company has just released a completely reengineered bumper car, containing 90% new parts. Given the large number of changes in this new product, there is considerable uncertainty in regard to probable future warranty claims; they could be materially larger than the amount previously reserved, and they could have a material impact on the company’s financial results in the near term”.
Disclosure of Computer Software Sales
When a company sells computer software, the sale should be split into product and service components and the service portion of the sale should be recognized ratably over the maintenance period covered by the sales contract; this information should be included in a footnote.
“Approximately 80% of the company’s sales are from computer software and related maintenance agreements. The company splits these sales into their software and maintenance components and recognizes the software portion of the sales at once. The maintenance portion of the sales are initially recorded in an Unrecognized Maintenance Service Agreements liability account and recognized ratably over the term of the agreements—either 3 or 12 months. In cases where the software and maintenance components of a sale are not clearly differentiated in a sale contract, the company estimates the relative price of each component based on its separate retail price. As of the statement of financial position date, there was approximately $725,000 of unrecognized maintenance sales in the Unrecognized Maintenance Service Agreements account”.
Disclosure of Customers
If a company has revenues from individual customers that amount to at least 10% of total revenues, then it must report the amount of revenues from each of these customers, as well as the name of the business segment with which these customers are doing business.
“The company does a significant amount of its total business with two customers. One customer, comprising 15% of total revenues for the entire company, also comprises 52% of the revenues of the Appliances segment. The second customer, comprising 28% of total revenues for the entire company, also comprises 63% of the revenues of the Government segment”.
Disclosure of Foreign Customers
If sales are concentrated in foreign locations where there are risks of sales reductions due to political issues, then the extent of these sales and the types of risks should be disclosed.
“The company sells 55% of its customer relationship management software through a distributor in Iran. Given the large proportion of company sales attributable to this supplier, any unrest in the region, such as wars, terrorist activity, or an enforced shutdown in business activities by the Iranian government would have a material impact on the company’s financial results”.
Disclosure of Installment Sales
If installment sales comprise a significant proportion of corporate sales, a footnote should be written to include the revenue recognition policy used, the amounts of gross profit recognized from the current and prior years, the total amount of deferred gross profit, and its placement in the statement of financial position.
“The company sells kitchen appliances on various installment payment plans. Given the extreme uncertainty associated with the collection of receivables under this plan, the company uses the cost recovery method to recognize profits, under which it recognizes no gross profit until all costs of goods sold have been paid back through cash receipts. In 2008, the company recognized $397,000 of gross profit earned in the current year, as well as $791,000 deferred from prior years. An additional $2,907,000 of deferred gross profits is classified as a current liability in the Unrecognized Gross Profit on Installment Sales account”.
Disclosure of Sales with Significant Rights of Return
If there is considerable uncertainty regarding the amount of potential sales returns, such as may be caused by a new product, potential product obsolescence, or heightened competition, then a company may be forced to not recognize any revenue at all until the right of product return has passed. This can cause a substantial reduction in recognized revenue; thus, a footnote describing the reason for the recognition delay is necessary.
2 Disclosure Examples
- “The company is in the beta testing phase of its new crop planting system, resulting in the decision to grant an unconditional right of return to the first 10 customers who have agreed to purchase the product. The right of return privilege extends for six months from the shipment date. Since there is no return history for this new product, the company has recorded the total amount of all 10 sales in an Unearned Sales liability account, and will not recognize the revenue until the right of return period has expired. The total amount in this account is $328,000. Of this amount, $275,000 will be recognizable in March 2008 and the remaining $53,000 in May 2008, assuming that no products are returned in the interim”.
- “The company’s light saber product is entirely new and is being introduced into a new market, so management feels that it cannot estimate potential levels of product returns. Consequently, the company has not recognized any revenues related to recent shipments of the product until the three-month right of return period has passed. The company plans to reevaluate this policy after a sufficient amount of time has passed for it to make a better estimate of potential sales returns. The initial amount of light saber revenues that would otherwise have been recognized in the first month of shipments was $1,750,000”.
Disclosure of Multiple Deliverables
IFRS has not yet dealt definitively with the accounting for transactions (such as software sales) having multiple deliverable elements. However, I would suggest that until this is addressed (perhaps as part of the ongoing revenue recognition project being conducted jointly with FASB), existing guidance under US GAAP be consulted and, as appropriate, followed.
The financial statements of a vendor are to include two disclosures, when applicable:
- The nature of the vendor’s MDAs, including provisions relative to performance, cancellation, termination, or refund
- The vendor’s accounting policy with respect to the recognition of revenue from MDAs (e.g., whether deliverables are separable into units of accounting)
“The company enters into multiple-element revenue arrangements, which may include any combination of services, software, hardware, and/or financing. A multiple-element arrangement is separated into more than one unit of accounting if all of these criteria are met:
- the delivered item has value to the client on a stand-alone basis;
- there is no objective and reliable evidence of the fair value of the undelivered item; and
- if the arrangement includes a right of return relative to the delivered item, delivery is considered probable and is under the company’s control.
If these criteria are met for each element and there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit’s relative fair value”.
There may be cases, however, when there is objective and reliable evidence of fair value of the undelivered item but no such evidence for the delivered item. In those cases, the residual method is used to allocate the arrangement consideration, meaning the amount of consideration allocated to the delivered item equals the total arrangement consideration less the aggregate fair value of the undelivered item.
The revenue policies described below are then applied to each unit of accounting, as applicable: If the allocation of consideration in a profitable arrangement results in a loss on an element, that loss is recognized at the earlier of (1) delivery of that element, (2) when the first dollar of revenue is recognized on that element, or (3) when there are no remaining profitable elements in the arrangement to be delivered.
Disclosure of Franchise Revenues
Disclosures for franchise fee transactions should include:
- The types of significant commitments resulting from franchising arrangements, as well as franchisor services not yet performed
- The franchise sale price
- The amount of deferred revenue and costs
- The periods when fees become payable by the franchisee
- The amounts of revenue initially deferred due to collectibility uncertainties, but then recognized due to resolution of the uncertainties
- The number of franchises sold, purchased, and in operation during the period (which shall segregate the number of franchisor-owned outlets in operation from the number of franchisee-owned operations)
- Segregating the reporting of initial franchise fees from other franchise fee revenue, if they are significant
- Segregating the revenues and costs of franchisor-owned outlets from those of franchisees, when practicable
- If there is no reasonable basis for estimating the ability of the franchisor to collect franchise fees, the type of accounting method used to recognize franchise fee revenue (either the installment or cost recovery method) must be disclosed
- If initial franchise fee revenue is likely to decline because of market saturation, this issue should be disclosed
3 Disclosure Examples
. “The Company’s revenues consist of sales by Company-operated restaurants and fees from restaurants operated by franchisees and affiliates. Sales by Company-operated restaurants are recognized on a cash basis. Fees from franchised and affiliated restaurants include continuing rent, service fees, initial fees, royalties received from foreign affiliates, and developmental licensees. Continuing fees and royalties are recognized in the period earned. Initial fees are recognized upon opening of a restaurant, which is when the Company has performed substantially all initial services required by the franchise arrangement”.
. “The Company enters into franchise agreements committing to provide franchisees with various marketing services and limited rights to utilize the Company’s registered trademarks. These agreements typically have an initial term of 10 years with provisions permitting franchisees to terminate after 5 years under certain circumstances. In most instances, initial franchise fees are recognized upon execution of the franchise agreement because the initial franchise fee is nonrefundable and the Company has no continuing obligations related to the franchisee. The initial franchise fee related to executed franchise agreements, which include incentives such as future potential rebates, are deferred and recognized when the incentive criteria are met or the agreement is terminated, whichever occurs first”.
. “The following are changes in the Company’s franchised locations for each of the fiscal years 2007 through 2009:
2009 2008 2007
Franchises in operation—beginning
of year 7,958 7,637 7,322
Franchises opened 355 425 470
Franchises closed (121) (122) (104)
Net transfers within the system (1) 18 (51)
Franchises in operation—end of year 8,191 7,958 7,637
Company-owned stores 1,758 1,748 1,672
Total system-wide stores 9,949 9,706 9,309
Disclosure of Motion Picture Revenues
IFRS does not explicitly address this industry’s financial reporting requirements, but guidance is available under US GAAP, which is the basis for the recommendations here. A company should disclose its methods of accounting for revenue.
3 Disclosure Examples
- “Revenue from the sales of home video units is recognized at the later of when product is made available for retail sale or when video sales to customers are reported by third parties, such as fulfillment service providers or distributors. Management calculates an estimate of future returns of product by analyzing a combination of historical returns, current economic trends, projections of consumer demand for the Company’s product, and point-of-sale data available from certain retailers. Based on this information, a percentage of each sale is reserved, provided that the customer has the right of return. Actual returns are charged against the reserve”.
- “Long-term non-interest-bearing receivables arising from television licensing agreements are discounted to present value, net of an allowance for doubtful accounts”.
- “The Company recognizes revenues from its films net of reserves for returns, rebates, and other incentives after it has retained a distribution fee of ___% and recovered all of its distribution and marketing costs on a title-by-title basis”.