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Hello Sir,
for past year question Sep/Dec 2017 Q17(c)Audit risk and auditor’s responseThe examiner answer:
“These deposits should not be recognised as revenue in the
statement of profit or loss until the performance obligations
as per the contracts have been satisfied, which is likely to
be when the building is finished and the sale process is
complete. Instead, they should be recognised as deferred
income within current liabilities”why the non-refundable deposit cannot recognised as revenue as the company will not need to refund to the customer even have not satisfied their performance obligation?
and how about the last 95%?especially for the last 2.5% of revenue,which should be accrued income(receive in 6 month time) after the building complete?Thank you.
It is a fundamental principle of revenue recognition that you can’t recognise it you haven’t yet performed the obligations.
That a deposit is non-refundable means that if the customer cancels the order, they do not get their money back – it does NOT mean that the customer has no right to refund if the construction company does not perform its obligation (i.e. to supply a completed building).
Try working thinks out by putting some numbers to the problem. For example, let’s say the selling price of a property is $200,000.
A customer pays $10,000 which effectively gives them the right to purchase the property on completion:
Dr Cash/Bank $10,000
Cr Deferred income $10,000When building is complete (performance obligation fulfilled), the company can recognise revenue in full – i.e. $200,000.
So now:
1. Recognise previously deferred income:
Dr Deferred income $10,000
Cr Revenue $10,0002. Invoice customer for 92.5% now due to be paid:
Dr Receivable $185,000
Cr Revenue $185,000But that still leaves $5,000 (2.5%) revenue still to be recognised:
Dr ??? $5,000
Cr Revenue $5,000We can’t Dr Receivables (yet) because the customer isn’t due to pay for 6 months. So Dr Accrued income (i.e. we’ve earnt it).
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