Chapter 7: Revenue Recognition, Including Construction Contracts

Revenue Recognition Perspective and Issues

The IAS addressing revenue recognition principles, in general terms, is IAS 18. It prescribes the accounting treatment for revenue arising from certain types of transactions and events and, while useful, is not a comprehensive treatise on the peculiarities on all the diverse forms of revenue and of possible recognition strategies that could be encountered. The basic premise is that revenue should be measured at the fair value of the consideration that has been received when the product or service promised has been provided to the customer. Specific guidance applies to various categories of revenues.

Thus, in the normal sale of goods, revenue is presumed to have been realized when the significant risks and rewards have been transferred to the buyer, accompanied by the forfeiture of effective control by the seller, and the amount to be received can be reliably measured. For most routine transactions (e.g., by retail merchants), this occurs when the goods have been delivered to the customer.

In the case of the sale of services, IAS 18 provides that one of two permitted methods be used, which are not alternatives but rather are dependent upon the circumstances. In the normal instance, when the outcome of the service transaction can be measured reliably, IAS 18 requires that some variant of "percentage of completion" be used to recognize revenue. When that threshold condition cannot be satisfied, however, then revenue is recognized only to the extent that expenses which are probable of recovery are incurred; that is, profit is deferred and recognized only after full cost recovery is achieved.

For interest, royalties and dividends, recognition is warranted when it is probable that economic benefits will flow to the enterprise. Specifically, interest is recognized on a time proportion basis, taking into account the effective yield on the asset. Royalties are recognized on an accrual basis, in accordance with the terms of the underlying agreement. Dividend income is recognized when the shareholder's right to receive payment has been established.

In recent years, particularly with the advent of web-based "e-commerce" enterprises, there has been a large increase in the occurrence of barter transactions. The more controversial of the barter transactions involve swapping of advertising services (e.g., whereby two or more e-commerce operations "swap" display advertising on the others' websites), particularly when these were valued by reference to arbitrary prices or those seldom-equaled in cash transactions at arm's-length. The SIC has issued an interpretation, SIC 31, which establishes the requirement that, in order for revenue to be recognized in such advertising swap situations, there must be an objective measure of the value of the services provided by the entity seeking to recognize revenue. In the absence of such reliable data, no revenue can be recognized.

IAS 18 also establishes certain disclosure requirements, including the revenue recognition accounting policies of the reporting entity.

The IASB is planning to address revenue recognition as part of its Liabilities and Revenue project. It is believed that this project will attempt to craft more specific guidance on how various generic types of revenue are to be given recognition.

Sources of IAS

IASC's Framework for Preparation and Presentation of Financial Statements IAS 18, SIC 31