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Island co is a manufacturer of machinery. Island co. design, constructs and installs machinery. Payment is due in three installment:50% is due when the order is confirmed (stage one), 25% on delivery of the machinery(stage 2) and 25% on successful installation on customer’s coal mine (stage 3 ). Generally it takes six months from the order being finalised until the final installation.
In line with IFRS 15 , this revenue is recognised over time as the entity create asset that is no alternative use to the entity . Am I right?
Revenue will be recognised on completion of each stage – 50%, 25% and 25%
Any contract entered into between 1 January and 30 June in any year will (generally) see 100% revenue recognition in the same year
OK?
If for example the financial year is 1.1.2007 to 31.12.2007, the contract is entered on Sep 2007 , as it will takes 6 months to complete so will it be expected to be completed by Feb 2008. In this case, how to recognise the revenue ?
50% will have been recognised on the signing of the order
Then the delivery date will determine the next 25% recognition and …
… I presume that the last 25% cannot be recognised until February – the completion of the installation stage
Early recognition of the 25% revenue on delivery
Early recognition of the 25% revenue on installation (not satisfactorily installed)
Why are you asking?
This is because if the revenue is recognised at point of time, control need to be passed include the transfer of risk and rewards of ownership. So, I wanna know whether revenue recognition in design stage could constitute transfer of rewards and risks of ownership?
The contract is signed.
Presumably the legal team has ensured that the contract is watertight and that the design stage WILL be paid for
Difficult to consider risks and rewards of ownership in a contract involving services!
I have a different opinion.
As per IFRS 15, we need to first review contract to determine if there are two separate POs given different product / services provided. One is delivery of machinery, the other is installation service.
Revenue is recognized when control is passed either as a point-in-time or over time. So the payment in advance will be recognized as deferred income. Revenue related to the first two stage will be recognized when the machinery is delivered based on the standalone selling price of the machinery. The installation service is recognized based on percentage of completion method when it is certain that the results of PO can be reliably estimated.The risk is that revenue is recognized too early, overstating profit and understating liabilities. Another risk is that the percentage of completion is wrongly determined as it involves judgement and inherently risky to audit.
I can see that argument
My answer was based on the principle that, once the contract was signed, it was enforceable in that the customer at that stage would be unable to withdraw from the written agreement
Thus, at that stage, the revenue is earned and will not be returned even though the customer does indeed decide to back out of the contract
It will be interesting to see what the examiner’s answer says should this question come up in an exam situation
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