1
ADVANCED FINANCIAL
ACCOUNTING PRACTICE
AND THEORY
Omiros Georgiou
Revenue recognition 2 - critical issues and challenges
in international standard setting
Lecture outline
2
1. Conceptual foundations of revenue
recognition
2. Inconsistencies within IFRS 15
3. The real effects of IFRS 15
4. FRC thematic review of IFRS 15
5. Exam paper style question
6. Revision of the topics we learned
together
Conceptual foundations of revenue
3
recognition (Wagenhofer, 2014)
Economic earnings cycle
Different risks are resolved in each stage of an activity, transaction, or
event.
Recognition as information aggregation procedure
Including particular pieces of info and excluding others / weighing
pieces of info and averaging them
A single revenue recognition principle? But business models, firms, and
industries can differ in their economic characteristics, and so can the most
useful recognition criteria
Alternative concepts of revenue recognition
Revenue-expense (matching) and asset-liability approaches
Measurement bases
Fair value measurement (with day-1 profits) and cost-based
measurement
Inconsistencies – the concept of control
4
A single universal revenue recognition principle:
when the promised goods or services are
transferred to the customer – when the customer
obtains control of the asset
Yet the criteria b (customer controls the asset as it is
created) and c (entity has right to payment for
performance completed to date) of the
performance obligation satisfied over time: do not
imply transfer of control. The entity retains the
product risks
Inconsistencies – asset-liability
5
approach
Requirement to recognise costs to fulfil a contract -
amortisation and impairment costs when contract
assets are subsequently measured
These recognition rules are not consistent with an
asset-liability approach, but include elements of a
revenue- expense approach
Inconsistencies – stand-alone prices
6
Adjusted market assessment approach and
expected cost plus a margin approach resemble
approaches for determining fair values
But, what about the residual approach?
Inconsistencies – conservatism
7
E.g. onerous contracts – if the unavoidable expected
cost to satisfy the performance obligation exceeds the
consideration expected to be received – test for
impairment – difference in values is recognised as a
liability for the onerous contract and remeasured at
each reporting period
While… favourable changes in circumstances should not
be reflected in financial statements
But… the risk of collectability of the consideration
attributable to customer credit risk is not included in the
transaction price
Reflection
8
Determining the critical event that triggers
recognition – this is not necessarily the event at
which the greatest risk is resolved, but that one
which allows users to learn most about the
company’s performance
So: striving for a single revenue recognition
principle is unlikely to be successful
But… are inconsistencies undesirable?
The real effects of IFRS 15 (Napier
9
and Stadler, 2020)
Effects of new and amended accounting standards:
Accounting effects: changes in how companies
recognise, measure, present, and disclose their revenues
Information effects: changes in how companies and
their transactions are understood, both internally and
externally
Capital market effects: changes in security prices
Real effects: changes in how companies operate, and
their costs and cash flows
Revised standard on revenue
10
recognition
New standard stimulated by:
A sense that existing standards provided inadequate
guidance for entities entering the twenty-first century
Fears, evidenced in some cases by financial scandals, that
entities were able to engage in ‘earnings management’
Key change:
IAS 18 – revenues recognised when the risks and rewards of
ownership of goods had been substantially transferred from
seller to buyer
IFRS 15 – revenues recognised as and when an entity
performs obligations included in a contract with a customer
But does this lead to companies changing how they structure
contracts and to substantially modify their business models?
Effects of IFRS 15
11
Direct accounting effects:
No major recognition and measurement changes as measured by
changes in reported earnings, revenue, and profit in the annual
reports of STOXX Europe 50 companies in 2018.
Increased amount of disclosures but concerns with boilerplate
information.
Information effects:
Internal users saw the new standard as both a compliance
exercise and as an opportunity for improved understanding of
the transactions
Concerns about negative effects for external users’ understanding
of transactions
12
Real effects:
Implementation and application costs
◼ Investmentsin information systems and related processes
◼ Increased audit fees
Potential contractual changes
◼ E.g.changes to certain aspects of contracts to allow
recognition of revenue over time
Potential behavioural effects
◼ E.g. changes to sales and remuneration structures
Potential tax effects
◼ E.g. bringing revenue forward and paying tax earlier
FRC 2020 – thematic review of IFRS
13
15 – key findings
14
Exam style question
15
McCabe Enterprises sells manufacturing equipment to the sports equipment
manufacturing industry and their flagship machine KM1500 retails for £285,000. The
machine is not expected to last for more than 5 years, and during that time, the
machine is serviced twice: once in Year 2 and once in either Year 3 or Year 4.
Customers could also obtain the servicing separately from other providers for £28,000
per service. This year, McCabe Enterprises are offering a machine and servicing bundle
for £300,000.
If a customer opts for the bundled product, what is the transaction price allocated to
the performance obligation of providing the machinery to the customer?
a) £250,733
b) £240,050
c) £285,000
d) £313,000
16
WORKINGS:
Machinery 285,000
Service 1 28,000
Service 2 28,000
Total 341,000
Package price £300,000
Discount £41,000
Machinery £250,733.14
Service 1 £24,633.43
Service 2 £24,633.43
£300,000.00
Revision of the topics we learned
17
together
▪ Leases
▪ Explain what is meant by a lease under IFRS 16
▪ Determine whether a contract is a lease
▪ Be able to prepare the lease accounts for:
▪ Lessees
▪ Provisions
▪ Explain key concepts of provisions, contingent liabilities and contingent assets
▪ Understand and discuss what is meant by the climate change emergency and its
impact on financial reporting practices
▪ Be able to explain how contingent liabilities and provisions relate to this -
Provisions for BP’s Deepwater Horizon case
▪ Understand and discuss the importance of preparing appropriate disclosures
when it comes to uncertainty – FRC thematic review of IAS 37
Fair value accounting (1)
18
▪ Concepts, definitions, and practice – apply key
concepts of IFRS 13
▪ Arguments for and against fair values
▪ Historical development of fair values – fair
value idealism prior to the 2008 financial crisis
▪ Fair value measurement for non-financial assets
Fair value accounting (2)
19
▪ Fair value accounting in the 2008 crisis:
▪ What was the controversy about?
▪ What changes were made due to political
interference?
▪ What is the available evidence?
▪ How to make sense of the debate?
▪ Fair value accounting in the Covid-19 crisis
▪ Fair values for cryptocurrency
▪ How are fair values evaluated by investors and
analysts?
Revenue recognition (1)
20
▪ Describe the five-step approach to revenue recognition
under IFRS 15
▪ Identify separate performance obligations in a contract
▪ Determine the transaction price and consider how
variable consideration and significant financing
components need to be accounted for
▪ Allocate the transaction price to separate performance
obligations using appropriate methods
▪ Recognise revenue at the appropriate time
Revenue recognition (2)
21
▪ Conceptual foundations of revenue recognition
▪ Inconsistencies within IFRS 15
▪ The real effects of IFRS 15
▪ FRC thematic review of IFRS 15
Office hours
22
Tuesdays 13.30-15.00
Fridays 10.30-12.00
a meeting
Happy revision
23
