Under IAS 18 revenue is measurable at ‘the fair value of the consideration received or receivable’.
In essence, this is the fair market price less any discounts or rebates received.
- If a sale is a cash sale, the revenue is the immediate proceeds of the sale.
- If a sale is a credit sale, the revenue is the expected future receipt.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
When customers can negotiate a price downwards or haggle, the revenue recognised is the lower price, this is also the same for discounts given at the time of negotiation or sale.
One thing to keep in mind though, settlement discounts, where a customer gets to pay less if they pay early, should be recorded as an expense in the period.
The revenue in this instance is measured at the full amount.
Working Example 1
Westport Limited supplies Castlebar Limited with goods with €200,000 during the period.
Castlebar Limited goes into liquidation and still owes €40,000 to Westport Limited.
In the financial statements for the period, you should recognise
- €200,000 as revenue, and
- €40,000 as a bad debt
Working Example 2
Belmullet Limited is a service company and provided services to Knock Limited, for which it received a car as payment.
The car had a carrying value of €14,000 in the accounts of Knock Limited, but its market value is €16,000.
In this instance, Belmullet Limited should recognise revenue as €16,000 which is the fair value of the vehicle.
If Belmullet Limited received cash for the services provided, it should record the cash received as revenue.
Extended Payment Terms
In some cases payment may be deferred for over twelve months, say for example when someone buys a sofa from a retailer and gets 18 months interest free to pay it back.
In these cases the fair value might be less than the amount of cash that will actually be received.
When a company gives interest free credit, the credit is a financing transaction and the revenue should be recognised on the discounted present value of future receipts.
The difference between the nominal sale value and the fair value of the consideration is recognised as interest.
The price is effectively:
- Payment price for the goods, and
- Interest on the deferred payment terms
When determining the present value, the imputed rate of interest is the more clearly determinable of either:
- the prevailing rate for a similar instrument of an issuer with a similar credit rating:
- a rate of interest that discounts the nominal amount of the instrument to the current cash sales price of the goods or services
Working Example 3
Ballina Limited sells a machine to Swinford Limited for €105,000 on 31 December 2013 and gives them 12 months interest free credit.
The discount rate appropriate for the transaction is 5%, and the discounted present value of the future receipt is €100,000.
Q: How should this be treated in the financial statements of Ballina Limited for the year end 31 December 2013?
A: In this situation, the revenue from the sale will be recorded as €100,000 and in the next year there will be interest income of €5,000 recorded in the financial statements.
Barter / Exchange
Sometimes a business will exchange goods or services for other goods and services.
When this happens, they are categorised into
- similar in nature: this is one where revenue is not generated
- dissimilar in nature: revenue is generated
When the exchange is for activities dissimilar in nature, the revenue is measured at the fair value of the goods or services received, plus or minus any cash or cash equivalents transferred.
If the fair value cannot be measured reliably, the revenue is measured at the fair value of the goods given up, plus or minus any cash of cash equivalents transferred.
Keep in mind though, different rules apply for
- plant and equipment (see IAS 16 – Property, Plant and Equipment)
- Intangible assets (IAS 38 – Intangible Assets)
Often a company will receive money in advance, say for example if a tenant pays rent in advance, or someone places a deposit with them.
Since the goods have not been supplied, and services have not been rendered, revenue should not be recognised.
Instead they are called unearned revenue and classified as a liability.
The entity has a present obligation to transfer future economic benefits at a later date.
The journal entry to recognise an amount earned in advance is:
Once the goods are actually supplied, or the services rendered, the journal entries to reverse the advance payment liability are: