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My question is : how should be treated unearned revenue when recognition as revenue is to be in 3 years, for example ? whether time value of money should be ignored or not?
I think I’m correct in saying that any benefit or expense in the future should be “time-valued” It’s not likely in an F7 exam that you will have to calculate the present value of deferred revenue – it iS likely that there will be discounting involved somewhere n the exam, but not in the context of revenue
thank you. but , any way, would it be correct : to recognize amount paid in cash : Dr – cash and Cr- deferred revenue. And after 1 year recognize finance cost on that amount similarly as if cash paid in advance was a loan. and after 3 year revenue recognized would be cash paid less fin cost for 3 year ?
If you’re going to defer the revenue, the unrolling of the discount would not be treated as an expense! It would be finance income …. and I don’t understand what you’re doing in the last part of your post! “and after 3 year revenue recognized would be cash paid less fin cost for 3 year ?”
What?
I meant to treat deferred revenue as “loan”. if I
Dr cash Cr Deferred revenue 10 000
end of 1 year: Dr Deferred revenue Cr Revenue 3000 (recognized as revenue)
Dr fin cost Cr Deferred revenue 500 (5 % of 10 000 for example ) etc.
but I was not correct , you mean in first year I should recognize as deferred revenue discounted amount of cash paid ?
what account entry would be ?“discounted amount of cash paid” – cash received?
I’m thinking on my feet here, but this might work ( I’ve never come across it and never taught it ) but here goes ….
Dr Cash with full amount received, Cr Revenue with this year’s element, Cr Deferred Revenue at discounted value and Cr Deferred Finance income ( both shown as a liability until “earned” )
Then, as each year passes, unroll the deferred Finance Income and show as Finance income and Dr Deferred Revenue Cr Revenue
It works, but whether it’s the prescribed treatment …. I don’t know
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I have something similar however it is an investment property (land) with a fair value of £500k (professional valuation).
The property has been sold with the vendor having rights to use the land for tillage for 10 years post sale
Thus the vendor has agreed to accept £450k with balance of the fair value £50k being the equivalent of 10 years rental at £5k per annum
The simplest journal to deal with this in my mind is to Dr the asset £500k being the fair value, Cr cash £450k and Cr deferred income £50k then to release / recognise the rental income of £5k pa ie Dr def inc and Cr revenue, but of course this does not take into consideration the time value of money.
Subsequently this is where it becomes tricky for me. In order to recognise the £50k as part of the fair value of the land, then would not the £50k itself be the discounted value of a greater amount subject to a relevant interest rate?
This would of course involve crediting deferred income with £50k and crediting deferred finance income with the balance of the greater amount
Which would mean my journal wouldn’t balance and I am left with a debit balace to post with my only option presumably to increase the cost of the asset?Although this would balance I am not convinced that it is the correct treatment or even that I am approaching it the correct way, plus perhaps I should be considering a different career that is less demanding on the present value of my discounted grey matter!
Can you help Mike?
I think that this is correct – what do the managers at work suggest you should do?
I believe that you’re going to have to accept that the sale price of $500,000 is technically incorrect
What you are accepting as the sale price is $450,000
Dr Cash $450,000
Cr Disposals account $450,000And there’s a separate arrangement to receive $5,000 as rental income for each of the next 10 years
So now we need to find the present value of that 10 year annuity of $5,000
So calculate the present value of $5,000 per year discounted for 1, 2, 3, … 10 years at the discount rate of the entity’s cost of capital
Dr Receivables PV of the 10 year annuity
Cr Deferred Revenue PV of the 10 year annuityThen, as each year passes, unroll the discount
Dr Receivable by the amount of discount unrolled
Cr Deferred Revenue by the amount of discount unrolledNow notionally receive ie recognise this year’s rental realised through Deferred Revenue
Dr Deferred Revenue $5,000
Cr Rental Income $5,000Repeat 9 times!
I don’t know if that’s correct, but it works and it seems to me to reflect fairly the commercial reality of the transaction
What do you think?
Clearly the Receivable will need to be separately disclosed in Current Assets (one year’s worth) with the balance in Deferred Assets just the same as the Deferred Revenue will need to be split between Current and Deferred
Does that work for you?
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Hi Mike
Many thanks for the speedy response and your advice which makes total sense however my client is the purchaser, apologies if my post was unclear.
The vendor has basically agreed to give a £50k discount to the fair value of £500k, the £50k broadly speaking, being the equivalent of 10 years rent at £5k p.a thus my thinking of debiting the asset in my clients books at the full fair value of £500k crediting cash £450k and crediting deferred income £50k
My manager was of the opinion that there should be a pv calculation involved however he has now settled on disregrading the 10 year license to till the land and the idea of deferred income and has instructed that we immediately recognise the £50k as a realised gain through P&L i.e
Dr Freehold property. £500k
Cr Cash £450k
Cr P/L. £ 50kQuite frankly I dont think I agree this approach either, it will be interesting to see if the auditors pick up on it and agree or disagree the treatment.
Once again thanks Mike, it would be interesting to hear your thoughts
Kind regards
“Dr Freehold property. £500k
Cr Cash £450k
Cr P/L. £ 50k” – oh no! That cannot be correct!Surely, if you’re the buyer, that’s just the mirror image, so:
Dr TNCA $450,000
Cr Cash $450,000Dr Deferred expense $30,000
Cr Payables $30,000Each year, unroll the discount
Dr Deferred expense $3,000
Cr Payables $3,000Dr Payables $5000
Cr Deferred expense $5,000OR ……….
Dr TNCA $480,000
Cr Cash $450,000
Cr Deferred revenue $30,000Each year, unroll the discount
Dr Finance charges $3,000
Cr Deferred revenue $3,000and recognise the rental income
Dr Deferred revenue $5,000
Cr Rental income $5,000Repeat 9 times
But a credit today of $50,000 cannot be right
My suggestions may also not be correct but they’re less wrong than your manager’s suggestion of credit PorL $50,000 immediately
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Once again thanks for the reply
I’m not too clear re your deferred expense journals
Completely agree with you re immediate recognition of the uplift of £50k to fair value as recognised gain – my manager is unwavering in his opinion that it is correct treatment I personally think it is wrong on more than one level
IAS 40 tells us investment property is initially measured at cost
It certainly doesn’t mention recognising at cost and immediately revaluing to fair value
I still hold that the 10 year tilling license is an contractual obligation
And therefore the £50k discount to market value based upon a £5k pa rent should be recognised per IAS 18 revenue recognition – incrementally on completion of performance of said obligationI go back to my original analysis crediting deferred income £50k and then debiting £5k pa and crediting rental income
I cannot get my head around discounting it to pv and unwinding the discount
Example of a discount rate of say 6% discounts the 50k to a pv of £27,919.74 but in effect we are receiving the £50k up front so not to sure where to take it from there
Still think my treatment, even disregarding the time value of money , is a more realistic analysis of the transaction than immediately recognising a £50k gain
But I’m not the boss !
Thanks Mike
“but in effect we are receiving the £50k up front so not to sure where to take it from there” – this I don’t understand!
We are the buyer, right?
OK, I’ve been giving it more thought
Dr TNCA 450,000
Cr Cash 450,000Now, that SHOULD have been an entry for 500,000 but for this tilling arrangement
And we have a obligation to allow tilling for 10 years and that’s worth 5,000 per annum
And 5,000 per annum for 10 years discounts to 27,000 (your figures)
So what about:
Dr TNCA 27,000
Cr Obligations 27,000Then, as each year rolls by, unroll the discount
Dr Finance costs 1,600
Cr ObligationsAnd record receipt of 5,000
Dr Obligations 5,000
Cr Rental income 5,000That suits me better. What about you?
I suggest that you make a memorandum note to yourself that indicates that you’re not happy with your boss’s treatment, date it, and keep it somewhere safe
Maybe even get someone to sign and date it too
You just never know what the fall-out from this could be and it’s not going to cost you anything simply to cover your own back
🙂
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Manager has now instructed me to amend journal as he has had 3rd party advice he now wants to
Dr TNCA 450k
Cr CASH 450kand to not recognise the rental amount as this is not relevant
Am inclined to agree with you as regards pv and unwinding
However am happier with this treatment than immediately recognising a £50k profit and that he has agreed that his initial analysis is incorrect
So am not going to push it any further ( but I will disclose 10 year license and rental)
Really appreciate your advice Mike .. Who said accountancy was boring?!
Kind regards
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