Interest, royalties and dividends

When others use the entity's assets yielding interest, royalties and dividends, the revenue should be recognised on the bases set out below when:

(a) it is probable that the economic benefits associated with the transaction will flow to the entity; and

(b) the amount of the revenue can be measured reliably.

The revenue is recognised on the following bases.

(a) Interest is recognised on a time proportion basis that takes into account the effective yield on the

asset

(b) Royalties are recognised on an accruals basis in accordance with the substance of the relevant

agreement

(c) Dividends are recognised when the shareholder's right to receive payment is established

It is unlikely that you would be asked about anything as complex as this in the exam, but you should be aware of the basic requirements of the Standard. The effective yield on an asset mentioned above is the

rate of interest required to discount the stream of future cash receipts expected over the life of the asset to equate to the initial carrying amount of the asset.

Royalties are usually recognised on the same basis that they accrue under the relevant agreement.

Sometimes the true substance of the agreement may require some other systematic and rational method of recognition.

Once again, the points made above about probability and collectability on sale of goods also apply here.

1.15 Disclosure

The following items should be disclosed.

(a) The accounting policies adopted for the recognition of revenue, including the methods used to

determine the stage of completion of transactions involving the rendering of services (b) The amount of each significant category of revenue recognised during the period including

revenue arising from: (i) The sale of goods

(ii) The rendering of services (iii) Interest

(iv) Royalties (v) Dividends

(c) The amount of revenue arising from exchanges of goods or services included in each significant

category of revenue

Any contingent gains or losses, such as those relating to warranty costs, claims or penalties should be

treated according to IAS 37 Provisions, contingent liabilities and contingent assets (covered in Chapter 9).

Question

Discuss under what circumstances, if any, revenue might be recognised at the following stages of a sale. (a) Goods are acquired by the business which it confidently expects to resell very quickly.

(b) A customer places a firm order for goods. (c) Goods are delivered to the customer. (d) The customer is invoiced for goods. (e) The customer pays for the goods.

Answer

(a) A sale must never be recognised before the goods have even been ordered by a customer. There is no certainty about the value of the sale, nor when it will take place, even if it is virtually certain that goods will be sold.

(b) A sale must never be recognised when the customer places an order. Even though the order will be for a specific quantity of goods at a specific price, it is not yet certain that the sale transaction will go through. The customer may cancel the order, the supplier might be unable to deliver the goods as ordered or it may be decided that the customer is not a good credit risk.

(c) A sale will be recognised when delivery of the goods is made only when: (i) the sale is for cash, and so the cash is received at the same time; or

(ii) the sale is on credit and the customer accepts delivery (eg by signing a delivery note). (d) The critical event for a credit sale is usually the despatch of an invoice to the customer. There is

then a legally enforceable debt, payable on specified terms, for a completed sale transaction. (e) The critical event for a cash sale is when delivery takes place and when cash is received; both take

place at the same time.

It would be too cautious or 'prudent' to await cash payment for a credit sale transaction before recognising the sale, unless the customer is a high credit risk and there is a serious doubt about his ability or intention to pay.

(f) It would again be over-cautious to wait for clearance of the customer's cheques before recognising sales revenue. Such a precaution would only be justified in cases where there is a very high risk of the bank refusing to honour the cheque.

Question

Revenue recognition

Caravans Deluxe is a retailer of caravans, dormer vans and mobile homes, with a year end of 30 June 20X8. It is having trouble selling one model – the $30,000 Mini-Lux, and so is offering incentives for customers who buy this model before 31 May 20X7:

(a) Customers buying this model before 31 May 20X7 will receive a period of interest free credit, provided they pay a non-refundable deposit of $3,000, an instalment of $15,000 on 1 August 20X7 and the balance of $12,000 on 1 August 20X9.

(b) A three-year service plan, normally worth $1,500, is included free in the price of the caravan. On 1 May 20X7, a customer agrees to buy a Mini-Lux caravan, paying the deposit of $3,000. Delivery is arranged for 1 August 20X7.

As the sale has now been made, the director of Caravans Deluxe wishes to recognise the full sale price of the caravan, $30,000, in the accounts for the year ended 30 June 20X7.

Required

Advise the director of the correct accounting treatment for this transaction. Assume a 10% discount rate. Show the journal entries for this treatment.

Answer

The director wishes to recognise the sale as early as possible. However, following IAS 18 Revenue, he cannot recognise revenue from this sale because the risks and rewards of ownership of the caravan have not been transferred. This happens on the date of delivery, which is 1 August 20X7. Accordingly, no revenue can be recognised in the current period.

The receipt of cash in the form of the $3,000 deposit must be recognised. However, while the deposit is termed 'non-refundable', it does create an obligation to complete the contract. The other side of the entry is therefore to deferred income in the statement of financial position.

The journal entries would be as follows:

DEBIT Cash $3,000

CREDIT Deferred income $3,000

Being deposit received in advance of the sale being recognised.

On 1 August 20X7, when the sale is recognised, this deferred income account will be cleared. In addition: The revenue from the sale of the caravan will be recognised. Of this, $12,000 is receivable in two years' time, which, with a 10% discount rate, is: $12,000/ 1.12 = _{$9,917. $15,000 is receivable on 1 August 20X7.}

The service plan is not really 'free' – nothing is. It is merely a deduction from the cost of the caravan. The $1,500 must be recognised separately. It is deferred income and will be recognised over the three year period.

The sales revenue recognised in respect of the caravan will be a balancing figure. The journal entries are as follows:

DEBIT Deferred income $3,000

DEBIT Cash (1st _{instalment) $15,000}

DEBIT Receivable (balance discounted) $9,917

CREDIT Deferred income (service $1,500

plan monies received in advance)

CREDIT Sales (balancing figure) $26,417

BPP Note. This question is rather fiddly, so do not worry too much if you didn't get all of it right. Read

through our solution carefully, going back to first principles where required.