Chapter 6 - Revenue and inventories Flashcards
Revenue is defined as
Income arising in the course of an entity’s ordinary activities (normal trading)
What is the 5 step process for identifying revenue
- Identify the contract
- Identify separate performance obligations
- Determine the transaction price
- Allocate the transaction price to performance obligations
- Recognise revenue when the performace obligation is satisfied
Step 1: Identify the contract
What are criterias required to be met?
- Parties have approved the contract and each partys rights are identified
- Payment terms can be identified
- Commercial substance
- Probable that consideration will be received by seller
Step 2: Identify performance obligations
When can we distinguish between a performance obligation or not with warranties?
Distinct goods or services must be transferred to the customer (a distinct performance obligation must be satisifed)
If a warranty provides extra services, it is treated as a seperate performance obligation.
If a warranty just covers that the item will work as intended, this is a provision
Step 3: Determining the transaction price
Some transactions will include variable consideration (e.g discounts/penalties/bonus). This variable consideration will need to be estimated by the entity in order to estimate the amount they will receive. We only recognise this if the variable consideration is?
Often there is a large gap of time between the purchase of good and the time the invoice is settled. If this time is a large amount, how should revenue be recognised?
Highly probable.
If we are sold that the variable consideration is unlikely, we do not include it within the transaction price and therefore do not recognise it as revenue.
It should be discounted with regards to time
Step 4: Allocate the transaction price
A contract may contain 2 different performance obligations. Transaction prices are the be allocated to each performance obligation. If a standalone selling price is not given, we can estimate using the expected cost plus margin approach. How would we recognise each obligation price in terms of the total contract value?
Once finding the standalone price for each obligation, we will find that the total of these will equal to a greater value than the contract price, meaning customer has received a discount.
Thus we must add the two standalone prices together and times each obligation by the proportion of how much these make up the total figure.
Revenue will be recognised when the performance obligation is recognised.
Step 5: Recognise revenue
What 2 ways can we recognise revenue?
Over a period of time
At a point of time, i.e when control of the asset transfers to the customer. An entity controls an asset if it can direct its use and obtain its remaining benefits.
Note; whilst legal title may have transferred, control may not necessarily.
What is the main disclosure required with regards to revenue?
Revenue from contracts with customers must be disclosed separately from other sources of revenue.
As a reminder, inventory is valued at the lower of?
Cost (cost of purchase + conversion costs)
NRV (selling price - all future costs to complete sale)
Conversion costs are based on?
Costs directly relating to production of inventory, that being variable production or fixed prod overheads.
3 methods of determining costs are?
Actual unit cost - only used when items of inventory are individually distinguishable and have high value
FIFO - Cost of sale is the oldest goods purchased. Thus inventory left over is valued at most recent purchases.;
AVCO Weighted average cost - appropriate when inventory mixes
Disclosure requirements for inventories?
Amount of inventories carried at NRV
Accounting policy adopted, including the cost formula used
