ACCA DipIFR question papers and answers on IFRS 15 from June 2015
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All questions on IFRS 15 Revenue from contracts with customers which have appeared in ACCA DipIFR from June 2015 have been indexed here. The answers are based on the standards prevalent at the exam point in time. For questions on revenue recognition prior to IFRS 15, we recommend students to refer to the BPP practice and revision kit, as they have solved it in accordance with IFRS 15.
For the benefit of the readers, we have put the following sequentially to help them understand better
- Question - Relevant portion of the exam pertaining to the standard has been recreated
- Answer - Answers as shared by the ACCA Examination team which was required for the question
- Examiners Feedback - Feedback on answers given by the students for that exam, this is a critical part of learning as students can learn from mistakes which other students did
IFRS 15 Revenue from Contracts with Customers was issued in 2014 and replaces the previous international financial reporting standard relating to revenue.
(i) Identify the five steps which need to be followed by entities when recognising revenue from contracts with a customer.
(ii) Explain how IFRS 15 is expected to improve the financial reporting of revenue. (5 marks)
Kappa prepares financial statements to 30 September each year. During the year ended 30 September 2015,
Kappa entered into the following transactions:
(i) On 1 September 2015, Kappa sold a machine to a customer. Kappa also agreed to service the machine for a two-year period from 1 September 2015 for no additional charge. The total amount payable by the customer for this arrangement was agreed to be:
– $800,000, if the customer paid by 31 December 2015.
– $810,000, if the customer paid by 31 January 2016.
– $820,000, if the customer paid by 28 February 2016.
The directors of Kappa consider that it is highly probable the customer will pay for the products in January 2016. The stand alone selling price of the machine was $700,000 and Kappa would normally expect to receive $140,000 in consideration for providing two years’ servicing of the machine. The alternative amounts receivable are to be treated as variable consideration. (10 marks)
(ii) On 20 September 2015, Kappa sold 100 identical items to a customer for $2,000 each. The items cost Kappa $1,600 each to manufacture. The terms of sale are that the customer has the right to return the goods for a full refund within three months. After the three-month period has expired the customer can no longer return the goods and payment becomes immediately due. Kappa has entered into transactions of this type with this customer previously and can reliably estimate that 4% of the products are likely to be returned within the three-month period. (5 marks)
Explain and show how both these transactions would be reported in the financial statements of Kappa for the year ended 30 September 2015.
Note: The mark allocation is shown against both of the two transactions above.
(i) The five steps to be followed are to:
Identify the contract(s) with the customer.
Identify the performance obligations the contract(s) create.
Determine the transaction price.
Allocate the transaction price to the separate performance obligations.
Recognise the revenue associated with each performance obligation as the performance obligation is satisfied.
(ii) The IASB issued IFRS 15 because the existing criteria for revenue recognition outlined in IASs 11 and 18 were considered to be very subjective. Therefore it was difficult to verify the accuracy of the reported figures for revenue and associated costs.
One of the fundamental qualitative characteristics of useful financial information which is referred to in the IASB Conceptual Framework is faithful representation. Information needs to be verifiable in order to ensure it meets this fundamental characteristic. IFRS 15 provides a more robust framework upon which to base the revenue recognition decision, thus increasing the verifiability of the revenue figure and hence its usefulness.
b (i.) . Kappa has TWO performance obligations – to provide the machine and provide the servicing.
The total transaction price consists of a fixed element of $800,000 and a variable element of $10,000 or $20,000.
The variable element should be included in the transaction price based on the probability of its occurrence. Therefore a variable element of $10,000 should be included and the total transaction price will be $810,000.
The transaction price should be allocated to the performance obligations based on their stand alone fair values. In this case, these are $700,000:$140,000 or 5:1.
Therefore $675,000 ($810,000 x 5/6) should be allocated to the obligation to supply the machine and $135,000 ($810,000 x 1/6) to the obligation to provide two years’ servicing of the machine.
The obligation to supply the machine is satisfied fully in the year ended 30 September 2015 and so revenue of $675,000 in respect of this supply should be recognised.
Only 1/24 of the obligation to provide the servicing is satisfied in the year ended 30 September 2015 and so revenue of $5,625 ($135,000 x 1/24) in respect of this supply should be recognised.
On 30 September 2015, Kappa will recognise a receivable of $810,000 based on the expected transaction price. This will be reported as a current asset.
On 30 September 2015, Kappa will recognise deferred income of $129,375 ($810,000 – $675,000 – $5,625). $67,500 ($129,375 x 12/23) of this amount will be shown as a current liability. The balance of $61,875 ($129,375 – $67,500) will be non-current.
b (ii) When the customer has a right to return products, the transaction price contains a variable element.
Since this can be reliably measured, it is taken account of in measuring the revenue and the total revenue will be $192,000 (96 x $2,000).
$200,000 (100 x $2,000) will be recognised as a trade receivable.
$8,000 ($200,000 – $192,000) will be recognised as a refund liability. This will be shown as a current liability.
The total cost of the goods sold is $160,000) (100 x $1,600). Of this amount, only $153,600 (96 x $1,600) will be shown as a cost of sale. The other $6,400 ($160,000 – $153,600) will be shown as a right of return asset under current assets.
Part (a) was answered well by a majority of candidates. Most had clearly studied IFRS 15, were able to identify the ‘five-step’ approach to revenue recognition and make a sensible assessment of its likely impact. However a significant minority of candidates appeared unaware of the requirements of IFRS 15 and attempted to answer the question based on IAS 18 – its predecessor. Where this occurred, attempts were made by the marking team to award partial credit.
In part b(i) most candidates displayed an awareness that there were two performance obligations, one satisfied at a point in time and one satisfied over a period of time. On the whole candidates found the issue of measuring the total revenue and allocating this to the individual components more challenging and a variety of different mistakes were made here. It would be beneficial for future candidates to study the model answer to this part carefully. It should be noted that candidates who attempted to apply the provisions of IAS 18 to this scenario would not have been at a significant disadvantage since the treatment would have been much the same under the previous standard.
Answers to part b(ii) varied considerably. Candidates who had not studied IFRS 15 tended to either conclude that no revenue should be recognised until the return period expired or to conclude that revenue should be recognised in full, with a ‘provision’ for future refunds. Neither of these approaches fully accords with the IFRS 15 ‘expected value approach’. However, as with part (a) for such candidates attempts were made by the marking team to award partial credit.
A general message arising here for candidates is to ensure that they keep up to date with newly examinable standards.
Delta is an entity which prepares financial statements to 30 September each year. The financial statements for the year ended 30 September 2016 are shortly to be authorised for issue. The following events are relevant to these financial statements:
On 1 September 2016, Delta sold a product to Customer X. Customer X is based in a country whose currency is the florin and Delta has a large number of customers in that country to whom Delta sell similar products. The invoiced price of the product was 500,000 florins. The terms of the sale gave the customer the right to return the product at any time in the two-month period ending on 31 October 2016. On 1 September 2016, Delta estimated that there was a 22% chance the product would be returned during the two-month period. The product had not been returned to Delta by 15 October 2016 (the date the financial statements for the year ended 30 September 2016 were authorised for issue). On 15 October 2016, the directors estimated that there was an 8% chance the product would be returned before 31 October 2016. The directors of Delta considered that the most reliable method of measuring the price for this transaction was to estimate any variable consideration using a probability (expected value) approach. Exchange rates (florins to $1) are as follows:
– 1 September 2016 – 2 florins to $1.
– 30 September 2016 – 2·1 florins to $1.
– 15 October 2016 – 2·15 florins to $1.
– 31 October 2016 – 2·2 florins to $1.
When the customer has a right to return products, the transaction price contains a variable element. When this element can be reliably measured, it is taken account of in measuring the revenue.
The information regarding the change in likelihood of return after 30 September 2016 is an adjusting event as it gives more information about conditions existing at the reporting date.
Therefore the revenue in florins for the year ended 30 September 2016 will be 460,000 (500,000 x 92%).
This will be recognised in the financial statements of Delta using the rate of exchange in force at the date of the transaction (2 florins to $1). Therefore revenue of $230,000 will be recognised.
Delta will initially recognise a trade receivable of 500,000 florins. This will be initially recognised in $ as $250,000. At the year end, the trade receivable will be re-translated using the closing rate of 2.·1 florins to $1 because it is a monetary item. The closing trade receivable will be $238,095 (500,000/2·1).
The loss on re-translation of the trade receivable of $11,905 ($250,000 – $238,095) will be recognised in profit or loss.
The difference (in florins) of 40,000 between the revenue recognised (460,000) and the trade receivable (500,000) will be recognised as a refund liability. This liability will initially be included in the financial statements at $20,000 (40,000/2).
The refund liability is monetary so it will be re-translated to $19,048 (40,000/2·1).
The gain on re-translation of $952 ($20,000 – $19,048) will be recognised in profit or loss.
most candidates were able to correctly quote relevant sections from IFRS 15 – Revenue regarding the recognition of revenue. However a significant number of candidates were unable to correctly compute the refund liability that should have been provided for. Common errors here included applying IAS 37 - Provisions, Contingent Assets and Contingent Liabilities rather than IFRS 15. This often led to the incorrect conclusion that the refund liability was contingent and should be disclosed, rather than recognised. Even where the need to compute a refund liability was recognised, many candidates incorrectly used 22% rather than 8%, on the (incorrect) basis that the estimate made on 15th October 2016 was a non-adjusting event after the reporting date. It was pleasing to note, though, that most candidates were able to gain some marks in this part by correctly applying the requirements of IAS 21 – Foreign Currency Transactions – to this scenario.
IFRS® 15 – Revenue from Contracts with Customers – was issued in September 2015 and applies to accounting periods beginning on or after 1 January 2018. IFRS 15 replaces IAS 11 – Construction Contracts – and IAS 18 – Revenue. IFRS 15 contains principles which underpin the timing of the recognition of revenue from contracts with customers and the measurement of that revenue.
Explain the principles underpinning the TIMING of revenue recognition and the MEASUREMENT of that revenue which are outlined in IFRS 15. You should provide examples of revenue transactions to support your explanations of these key principles. (12 marks)
Delta prepares financial statements to 30 September each year. Notes 1 and 2 provide information on revenue transactions relevant to the year ended 30 September 20X7.
Note 1 – Sale of product with right of return
On 1 April 20X7 Delta sold a product to a customer for $121,000. This amount is payable on 30 June 20X9. The manufacturing cost of the product for Delta was $80,000. The customer had a right to return the product for a full refund at any time up to and including 30 June 20X7. At 1 April 20X7, Delta had no reliable evidence regarding the likelihood of the return of the product by the customer. The product was not returned by the customer before 30 June 20X7 and so the right of return for the customer expired. On both 1 April 20X7 and 30 June 20X7, the cash selling price of the product was $100,000. A relevant annual rate to use in any discounting calculations is 10%. (7 marks)
Note 2 – Sale with a volume discount incentive
On 1 January 20X6 Delta began an arrangement to sell goods to a third party – entity B. The price of the goods was set at $100 per unit for all sales in the two-year period ending 31 December 20X7. However, if sales of the product to entity B exceed 60,000 units in the two-year period ending 31 December 20X7, then the selling price of all units is retrospectively set at $90 per item.
Sales of the goods to entity B in the nine-month period ending on 30 September 20X6 totalled 20,000 units and this volume of sales per month was not expected to change before 31 December 20X7.
However, in the year ended 30 September 20X7, total sales of the goods to entity B were 35,000 and based on current orders from entity B, the estimate was revised. The directors of Delta estimated that the total sales of the goods to entity B in the two-year period ending 31 December 20X7 would be more than 60,000 units. (6 marks)
Explain and show how the transactions in notes 1 and 2 would be reported in the financial statements of Delta for the year ended 30 September 20X7.
Note: The mark allocation is shown against the two transactions in the separate notes above.
The timing of the recognition of revenue under IFRS 15 – Revenue from Contracts with Customers – depends on the type of performance obligation the entity has under the contract with the customer. A performance obligation is a distinct promise to transfer goods or services to the customer (sense of the point only required).
IFRS 15 requires that revenue should be recognised when (or as) a particular performance obligation is satisfied.
In many cases (e.g. the sale of goods in the ordinary course of business), performance obligations are satisfied at a point in time. In such cases, the revenue is recognised at the point control of the goods is transferred to the customer.
In some cases (e.g. a contract to construct an asset for use by a customer), performance obligations are satisfied over a period of time. In such cases, the proportion of the total revenue recognised is the proportion of the performance obligation which has been satisfied by the reporting date.
The measurement of revenue is based on the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring the promised goods and services to the customer.
In many cases, where the consideration for the transaction is fixed and payable immediately after the revenue has been recognised (e.g. most sales of goods), the transaction price is the invoiced amount less any sales taxes collected on behalf of third parties.
Where the due date for payment of the invoiced price is ‘significantly different’ (certainly more than 12 months) from the date of recognition of the revenue, then the time value of money should be taken into account when measuring the transaction price. This means that the revenue recognised on the sale of goods with deferred payment terms would be split into a ‘sale of goods’ component and a financing component.
Where the total consideration due from the customer contains variable elements (e.g. the possibility that the customer obtains a discount for bulk purchases depending on the total purchases in a period), then the transaction price should be based on the best estimate of the total amount receivable from the customer as a result of the contract.
Note 1 – Sale of product with right of return
Under the principles of IFRS 15, revenue cannot be recognised on 1 April 20X7 because at that date the consideration is variable and the amount of the variable consideration cannot be reliably estimated.
However, on 1 April 20X7 $80,000 would be removed from inventory and included as a ‘right to recover asset’ (any reasonable description of this would be permitted).
Revenue of $100,000 (the present value of $121,000 receivable in two years) is recognised on 30 June 20X7 when the uncertainty regarding potential returns is resolved.
On the same day, the ‘right to recover asset’ will be de-recognised and transferred to cost of sales.
Delta will also recognise finance income of $2,500 ($100,000 x 10% x 3/12) in the year ended 30 September 20X7.
At 30 September 20X7, Delta will recognise a trade receivable of $102,500 ($100,000 + $2,500)
Note 2 – Sale to a customer with a volume discount incentive
The consideration payable by the customer is variable as it depends on the volume of sales in the two-year period. However, Delta can reliably estimate the outcome and that the volume discount threshold will not be exceeded (sales for 9 months: 20,000 x 24/9 = 53,333). The revenue included for the year ended 30 September 20X6 will be booked at $100 per unit and will be $2 million (20,000
During the year ended 30 September 20X7, actual sales volumes and estimates change such that the cumulative revenue should now be booked at $90 per unit. It is now expected that the volume discount threshold will be exceeded. This means that the cumulative revenue relating to these goods at 30 September 20X7 will be $4,950,000 ((20,000 + 35,000) x $90).
The revenue which will actually be booked by Delta for the year ended 30 September 20X7 will be $2,950,000 ($4,950,000 – $2 million recognised in 20X6).
This question required candidates to:
a) Explain the principles of timing and measurement of revenue that are outlined in IFRS 15 –
Revenue from Contracts with Customers.
b) Apply the principles discussed in part (a) to the recognition and measurement (in the
financial statements of Delta) of:
The sale of a product with right of return (note 1).
The sale of a product with a volume discount incentive (note 2).
Answers to part (a) were somewhat disappointing. Many candidates did not appear to have read the requirements of the question carefully enough. Instead of describing the principles of timing and measurement of revenue a majority of candidates simply set out the 5 step revenue recognition model that is identified in IFRS 15 but made no real attempt to address the specific requirements of the question. Whilst some marks were gained for setting out the 5 step model (because it does contain some timing and measurement principles) a number of issues that were raised by simply stating the model did not attract marks because they were unrelated to the actual question requirements.
Answers to part (b) – note 1 were also disappointing. Many candidates incorrectly stated that revenue could be recognised on 1 April 20X7 (the date the goods were sold to the customer) as there was no reliable estimate available at this time of the likelihood that the goods would be returned by the customer. Therefore many candidates failed to mention that Delta would recognise a ‘right to recover’ asset on 1 April 20X7. A number of candidates also failed to appreciate that given the two-year time difference between revenue recognition and date of payment the transaction included a significant financing component.
Answers to part (b) – note 2 were on the whole rather better. Most candidates noted that the sales in the year ended 30 September 20X6 (a nine-month period from 1 January 20X6 to 30 September
20X6) would initially be recorded at $100 per unit. However marks were often lost by candidates due to:
A failure to fully use the monthly sales made in the nine-month period to 30 September 20X6 to predict the likely level of sales in the two-year period from 1 January 20X6 to 31 December 20X7.
Recording twelve months’ sales at $100 per unit in the year ended 30 September 20X6 (rather than nine months from 1 January 20X6.
The majority of candidates correctly concluded that ultimately all the goods would be sold to entity B at a price of $90 per unit. They also correctly concluded that the revenues for the year ended 30 September 20X7 would reflect a ‘catch-up’ adjustment regarding the revenues that had been booked in the previous period at $100 per unit. However it is worth noting that:
A number of candidates incorrectly concluded that there would need to be provision in the statements of Delta at 30 September 20X7 regarding the revenues initially booked at $100 per unit.
A number of candidates wasted time by making lengthy references to the provisions of IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors. Appropriate application of IFRS 15 almost negates the need to refer to IAS 8 in this question.