Revenue Recognition

In order to record revenue, there is a specific accounting standard called IAS 18 Revenue Recognition. There is a complete guide as when to record revenue from the sale of goods, rendering of services and the receipt/ collection of royalties, dividends and interest.

Sale of Goods

In order to recognize the revenue from sale of goods, following conditions must be fulfilled:

  1. the significant risk and rewards of the goods have been transferred to the purchaser of the goods,
  2. the amount of revenue can be measured with sufficient reliability,
  3. the seller of the goods does not hold any control over the goods once it is sold,
  4. there is a significant probability that the buyer of the goods will pay for the goods,
  5. the cost of the goods can be measured reliably for the seller. 

Example

City Fashion is engaged in retail business industry. It has been in the business since a decade. Its junior accountant is very confused regarding the recording of the transactions. You, being the senior management accountant, advise the junior accountant as how to treat the following transactions:

  1. A customer purchased the shoes from the retail outlet using his credit card on 29th December, 2016 at a price of $500. But it received in City Fashion’s Merchant bank account on 2nd January, 2017.
  2. A corporate client placed a bulk order to the City Fashion on 15 December, 2016. The order has been fulfilled in December but the client has not paid for it until January.
  3. A corporate client requested the luxury furniture on 31st December 2016 amounting to $ 7,000. The furniture was delivered at the client's office on 2nd January, 2017.
  4. City fashion also sells prepaid vouchers at discount to mass public. This help customers pay in advance to the City Fashion and shop at their appropriate timing multiple times. The validity of these prepaid vouchers is 06 months.
  5. A client has received an advance payment for its upcoming event from a client in December. City Fashion has not received any purchase order for the said payment.

Required:

Advise junior accountant as how to account for each transaction along with reasons to educate him.

Solution

  1. Actually, the product that the customer purchased has been in the custody of the customer at the time of sale and City Fashion has no control over it. Though, the client has paid via credit card and the payment came in the next month in merchant bank account, still this would be recorded in the sale of December.
  2. In order to record sale, the product or services must be delivered to the client. The receiving of the payment is not required. As in this case, the order has been dispatched to the client and payment not received in December does not mean it should not be recognized as sale of the month of December. So, you should record this transaction as a sale of December and create a corresponding accounts receivable head.
  3. Though, the client has placed an order in the month of December. It cannot be recorded as the sale of December because the ownership of the goods is still in City Fashion and risks are also belong to it. So, it would be recorded as sale in the month of January.
  4. Prepaid vouchers are issued for the convenience of the customers and helps them in avoiding risk of cash handling while they are coming for shopping. The money received from customers is the advances and as such are not recorded as sale of the month in which they are received. The revenue will only be recognized when such amounts are consumed by the customers on shopping the City Fashion products.
  5. The advance payment received from the client is actually unearned revenue. You cannot record this amount as the sale of December. This unearned revenue is the liability of City Fashion. Once the customer places an order and goods are delivered, then you can record this amount as sale and reverse the unearned revenue liability.