Receivables and Revenue

Goods (point of time)

Credit sale

1/1/X1, XYZ delivered 10 units of product #123 to ABC and issued invoice #456 payable in 30 days. Product #123 costs 500 to produce and commonly sells for 1,000 per unit.

Dr/Cr

1/1/X1 / 1.1.X1

 

 

Trade receivable: ABC: #456

10,000

 

Cost of goods sold

5,000

 

 

Revenue

 

10,000

 

Inventory: Finished goods: #123

 

5,000


1/31/X1 / 31.1.X1

 

 

Cash

10,000

 

 

Trade receivable: ABC: #456

 

10,000


Cash and charge card sales

1/1/X1, XYZ sold merchandise for 1,000 to a customer who paid cash.

Dr/Cr

1/1/X1 / 1.1.X1

 

 

Cash

1,000

 

Cost of goods sold

500

 

 

Revenue

 

1,000

 

Inventory: Merchandise

 

500


Same facts except the customer paid with a credit card. Credit card sales clear in two days.

1/1/X1 / 1.1.X1

 

 

Receivable from bank: Credit card sales

987

 

Cost of goods sold

500

 

Selling expenses: Credit card fees

3

 

 

Revenue

 

1,000

 

Inventory: Merchandise

 

500

1/3/X1 / .1.X1

 

 

Cash

987

 

 

Receivable from bank: Credit card sales

 

987


Same facts except the customer paid with a debit card. Debit cards are subject to lower charges and clear the same day. XYZ uses a separate bank account (#123) for debit card sales.

1/1/X1 / 1.1.X1

 

 

Cash: Account 123

988

 

Cost of goods sold

500

 

Selling expenses: Debit card fees

2

 

 

Revenue

 

1,000

 

Inventory: Merchandise

 

500


Consideration paid to the customer

1/1/X1, XYZ paid ABC 6,000 to register as a vendor for 5 years. It also agreed to pay an annual listing fee of 12,000 and a 1.25 per unit slotting fee. In return, ABC committed to buy 12,000 units of XYZ's products each year although it estimated annual purchases between 14,000 to 28,000 units, an estimate it shared with XYZ.

The same day, XYZ also paid 24,000 to rent the display area where its products would be presented and 12,000 to include the products in ABC's in-store catalog, both for one year. XYZ also paid 5,000 to rent floor space for a kiosk for one month and 16,000 to include the services sold through the kiosk in ABC's in store catalog for one year. Finally, XYZ and ABC agreed they would pay 36,000 to DEF to promote the products and services on social media for a year, sharing the cost evenly. DEF agreed to bill monthly, in arrears.

During January, XYZ sold ABC 1,300 products at an average price of 22 per unit. It also collected 25,000 for the services it sold through the kiosk.

This example assumes XYZ bills ABC monthly with 30 day credit.

For simplicity, it does not show XYZ's accounting for either cost of sales or inventory.

Dr/Cr

1/1/X1 / 1.1.X1

 

 

Pre-paid consideration: Registration fee

6,000

 

Pre-paid consideration: Listing fee

12,000

 

Pre-paid consideration: Shelf space arrangement

24,000

 

Pre-paid consideration: Co-advertising (products)

12,000

 

Pre-paid expenses: Advertising (services)

18,000

 

Pre-paid expenses: Rent (kiosk)

5,000

 

 

Cash

 

77,000


IFRS 15.72 | ASC 606-10-32-27 requires entities to deduct consideration payable to a customer from revenue when (a) the revenue is recognized or (b) the entity pays or promises to pay, whichever happens later.

Therefore, when the payment is made before revenue is recognized, as in this example, the payment must be accrued. However, as this payment will never the recognized as an expense, it would be inappropriate to aggregate it with pre-paid expenses. For this reason, XYZ recognized it as Pre-paid consideration (a separate account group included in Accrued assets but excluded from Pre-paid expenses).

Since this payment will be recognized as an expense, it is accrued in Pre-paid expenses.

Any agreement giving an entity the right to use an asset belonging to another entity should be evaluated using the guidance in IFRS 16 | ASC 842 (leases). In this example, as the rent did not have any term nor could XYZ estimate a term, it did not capitalize it as a financial lease. See the lease page for a discussion of this issue.

1/31/X1 / 31.1.X1

 

 

Receivable: ABC

28,600

 

Cash (kiosk services)

25,000

 

Rental expense

5,000

 

Advertising expense

2,833

 

Revenue

5,725

 

16,000 ÷ 12 + 36,000 ÷ 2 ÷ 12 = 2,833

When a company both sells goods or services to a customer and buys good or services from the customer, it should deduct the amount it paid from the amount it received in determining revenue. The only exception: it would have bought the goods or services regardless of the associated sale.

At least that was the gist of EITF 00-14 (later EITF 01-09).

According to this guidance, whenever a vendor bought a good or service from a customer, the vendor deducted the purchase price of that good or service from revenue unless the purchase was unrelated to the sale.

Unfortunately, EITF 00-14 was superseded by ASC 606 which, while having the advantage of being comparable to IFRS 15, does not provide nearly as straightforward guidance.

Previously, IFRS (IAS 18) did not address consideration payable to a customer.

To evaluate a payment as outlined in IFRS 15.70 to 72 | ASC 606-10-32-25 to 27, an entity first considers, as outlined in IFRS 15.71 | ASC 606-10-32-26, whether the good or service is distinct.

As outlined in IFRS 15.27.a | ASC 606-10-25-19.a, a good or service is distinct of the entity can benefit from its on its own (or with readily available resources).

As outlined in IFRS 15.27.b | ASC 606-10-25-19.b, to be distinct, the good or service must also be separately identifiable from other goods and services promised in the contract.

As outlined in IFRS 15.29 | ASC 606-10-25-21, to be separate, the goods and services cannot be (a) inputs to produce or deliver the combined output or outputs specified by the customer, (b) do not significantly modify or customize, or be significantly modified or customized by, another good or service or (c) one be highly interdependent or highly interrelated.

In this example, the listing and slotting fees, shelf space rent, and in store advertising did not meet condition c, so XYZ deducted those payments from revenue as outlined in IFRS 15.72 | ASC 606-10-32-27.

On the other hand, the rent associated with the kiosk was for a stand-alone service and would have been paid to ABC regardless of ABC's buying XYZ's products.

Likewise, the advertising associated with the services sold in that kiosk also had separate, stand-alone value.

Since these payments did meet condition c, they were not deducted from revenue.

In this example, it would have been pointless for XYZ to pay registration, listing or slotting fees, rent display space or, buy in-store advertising, had it not also sold ABC its products, so it deducted these from revenue.

Both IFRS 15 and ASC 606 include an example (IFRS 15.IE160 | ASC 606-10-55-253) of how to account for consideration payable to the customer.

However, in the example, the justification for deducting the payment is that the entity did not obtain control of any rights to the customer’s shelves implying that control is the criterion to be used to evaluate consideration payable to a customer.

However, as outlined in IFRS 15.70 | ASC 606-10-32-25, the criterion that should be used is distinct.

IFRS 15.70 | ASC606-10-32-25 (edited emphasis added): ... An entity shall account for consideration payable to a customer as a reduction of the transaction price and, therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service (as described in paragraphs 26–30 | 606-10-25-18 through 25-22) that the customer transfers to the entity...

Paragraphs 27 states (edited emphasis added): A good or service that is promised to a customer is distinct if both of the following criteria are met:

(a) the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (ie the good or service is capable of being distinct); ...

Note: In this example, ABC is the customer with respect to the products while XYZ is the customer with respect to the display area.

This implies that even though XYZ paid ABC a fee to ensure its product would be displayed exclusively in the agreed upon display area, giving it control over that area, this right was not distinct from the sale because XYZ could not benefit from the display area either on its own or together with other resources that are readily available to it.

In contrast, since the rent and advertising associated with the kiosk did have distinct value, it did not deduct these from revenue.

Any agreement giving an entity the right to use an asset belonging to another entity should be evaluated using the guidance in IFRS 16 | ASC 842 (leases). In this example, as the rent did not have any term nor could XYZ estimate a term, it did not capitalize it as a financial lease. See the lease page for a discussion of this issue.

6,000 ÷ 60 + 12,000 ÷ 12 + 24,000 ÷ 12 + 12,000 ÷ 12 + 1,300 x 1.25 = 5,725

 

Revenue (products)

 

28,600

 

Revenue (services)

 

25,000

 

Pre-paid consideration: Registration fee

 

100

 

Pre-paid consideration: Listing fee

 

1,000

 

Pre-paid consideration: Shelf space agreement

 

2,000

  Pre-paid consideration: Co-advertising  

1,000

 

Pre-paid expenses: Rent

 

5,000

 

Pre-paid expenses: Advertising

 

1,333

 

Cash (slotting fee)

 

1,625

 

Payable: DEF

 

1,500


Or simply

1/31/X1 / 31.1.X1

 

 

Receivable: ABC

28,600

 

Cash (kiosk services)

25,000

 

Rental expense

5,000

 

Advertising expense

2,833

 

 

Revenue (products)

 

22,875

 

Revenue (services)

 

25,000

 

Pre-paid consideration: Registration fee

 

100

 

Pre-paid consideration: Listing fee

 

1,000

 

Pre-paid consideration: Shelf space agreement

 

2,000

  Pre-paid consideration: Co-advertising  

1,000

 

Pre-paid expenses: Rent

 

5,000

 

Pre-paid expenses: Advertising

 

1,333

 

Cash (slotting fee)

 

1,625

 

Payable: DEF

 

1,500


Value added tax

Neither IFRS nor US GAAP provides any specific guidance for VAT (GST).

The US does not have a value added tax, so it would be pointless for US GAAP to address it.

IFRS, as the acronym suggests, is international and, internationally, not every jurisdiction has a VAT or GST.

Besides, the guidance provided by IFRS can be applied to any tax, including VAT.

This point was (implicitly) made by the IFRIC when it considered adding VAT (in the context of cash flows and leases) to its agenda, but decided against it (link - iasplus).

VAT does, however, appear in both IFRS and US GAAP XBRL.

ValueAddedTaxReceivables and ValueAddedTaxPayables in IFRS XBRL and ValueAddedTaxReceivable in US GAAP XBRL.

However, neither the descriptions (The amount of receivables related to a value added tax; The amount of payables related to a value added tax; and Carrying amount as of the balance sheet date of value added taxes due either from customers arising from sales on credit terms, or as previously overpaid to tax authorities) nor references (IAS 1.78.b and ASC 210-10-S99-1) are particularly useful.

In an interesting side note, while IFRS XBRL at least acknowledges that VAT can be either a payable or a receivable, US GAAP XBRL only has a receivable, illustrating the general lack of appreciation of how VAT actually works, not only in the US practitioner community, but also among US standard setters.

Value added tax (VAT) is applied throughout the European Union while Goods and services tax (GST) is applied in countries such as Canada, South Africa or India.

In short, VAT is a multiple-step sales tax.

VAT legislation can be complex and vary from jurisdiction to jurisdiction.

Consequently, this example is no substitute for a detailed study of the pertinent regulations.

Transactions between payors:

When a VAT "payor" (a company registered to collect VAT) sells goods or services to another payor in the same jurisdiction, it issues a VAT invoice (a.k.a. "tax document").

It thus collects the VAT on behalf of the taxation authority.

When a payor buys from another payor in the same jurisdiction, it receives a tax document and so pays VAT to that other payor (who collects it on behalf of the taxation authority).

If a payor buys from a non-payor, the non-payor issues a regular invoice without VAT.

Non-payors are small enterprises or individuals who have not crossed the threshold for VAT registration or registered voluntarily.

At the end of the period, generally month or quarter, each payor offsets VAT received against VAT expended and pays (the reason they are called a payors) the difference to the taxation authority or claims a refund.

Cross border transactions work differently.

When a payor sells to a payor in a different jurisdiction, it issues a "reverse charge" invoice without VAT.

While reverse charge most often applies to cross broader transactions to limit so called missing trader (a.k.a. MTIC or carousel) fraud, some jurisdictions also require reverse charge in selected domestic transactions.

Thus the buyer, not seller, is obligated to pay the VAT to its domestic taxation authority.

However, as a VAT payor may also claim a deduction, the effect is zero net tax.

VAT is not deductible in every situation. The issue was discussed by the IFRIC in the context of IFRS 17 (link - ifric).

Transactions with non-payors:

When a payor sells to a domestic non-payor (a consumer or entity not registered as a VAT payor), it proceeds in the same manner as with a payor and issues a tax document including VAT.

In some jurisdictions, VAT payors are obligated to report both sales to and purchases from other VAT payors. These reports generally include VAT ID number, invoice number and amount.

Some jurisdictions require reports on all sales, including cash sales, regardless of whether they are to payors or non-payors, though this requirement can be based on different tax legislation.

Such reports do not, however, change the amount of VAT paid or refunded.

The difference, as the non-payor cannot claim a VAT refund, the remitted tax stays with the taxation authority.

However, when a payor sells to a non-payor in a different jurisdiction (cross boarder), it is generally obligated to remit VAT not its own taxation authority, but the taxation authority in the jurisdiction where the non-payor is domiciled.

This implies that companies selling across borders generally need to register as payers in each country where they have non-payor customers, though there are exceptions.

This page outlines current EU VAT requirements and exceptions: link - europa.

See (link - gocardless) for a discussion of VAT vs. GST.

The following examples simply illustrate how VAT could be treated in an IFRS | US GAAP context.

12/14/X1, XYZ purchased goods for 5,000 from ABC. 12/15/X1, it sold goods for 10,000 to DEF. In its jurisdiction, the VAT rate is 21% and the balance must be remitted to the tax collection authority no later than the 25th day of the month following the transaction or event.

12/14/X1 / 14.12.X1

 

 

Inventory

5,000

 

Tax other than income: Q4 VAT

1,050

 

 

Accounts payable: ABC

 

5,000

 

Accrued liabilities: VAT: ABC

 

1,050


Procedurally, the same account is used for both sales and purchases in that, at the end of the taxation period, the balance is either remitted to or refunded by the taxation authority.

Note: as VAT is generally refundable, it cannot be included in the measurement of assets or expenses. However, in situations where it is not refundable, it would be treated in the same manner as a sales or excise tax.

Also note: In IFRS XBRL, VAT is presented as a sub-classification of taxes other than income (illustrating the experience international standard setters have with VAT).

In US GAAP XBRL, VAT only appears as a subclassification of non-trade receivables (illustrating the opposite).

Both IFRS and US GAAP XBRL suggest that VAT should be presented as other or non-trade receivables/payables. However, since VAT is a tax, we at ifrs-gaap.com would much rather recognize it as an accrual to keep it as far away from receivables/payables as possible.

This is the VAT to be remitted to suppliers.

As it is not consideration for goods or services acquired, it should not be classified as an account payable.

12/15/X1 / 15.12.X1

 

 

Accounts receivable: DEF

10,000

 

Accrued assets: VAT: DEF

2,100

 

 

Revenue

 

10,000

 

Tax other than income: Q4 VAT

 

2,100


Both IFRS and US GAAP XBRL suggest that VAT should be presented as other or non-trade receivables/payables. However, since VAT is a tax, we at ifrs-gaap.com would much rather recognize it as an accrual to keep it as far away from receivables/payables as possible.

Under IFRS and US GAAP, revenue is clearly measured net of VAT.

IFRS 15.47 | ASC 606-10-32-2 state: ... The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties ...

While IFRS 15.47 | ASC 606-10-32-2 does not mention VAT by name, it clearly alludes to it, which becomes clear when the reasoning behind the paragraph is examined.

In IFRS 15 BC187 | ASC 606 BC187 the boards state: The boards also clarified that the amounts to which the entity has rights under the present contract can be paid by any party (ie not only by the customer). ... However, it would not include amounts collected on behalf of another party such as some sales taxes and value added taxes in some jurisdictions.

Likewise, in IFRIC 21.BC6 the IFRIC states: ... Amounts that are collected by entities on behalf of governments (such as value added taxes) and remitted to governments are not outflows of resources embodying economic benefits for the entities that collect and remit those amounts. ...

Further, to address concerns of US practitioners who feared that ASC 606-10-32-2 would require them to evaluate VAT on a jurisdiction-by-jurisdiction basis, the FASB amended ASC 606.

In ASU_2016-12 it added ASC 606-10-32-2A: An entity may make an accounting policy election to exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue producing transaction and collected by the entity from a customer (for example, sales, use, value added, and some excise taxes). Taxes assessed on an entity’s total gross receipts or imposed during the inventory procurement process shall be excluded from the scope of the election. An entity that makes this election shall exclude from the transaction price all taxes in the scope of the election and shall comply with the applicable accounting policy guidance, including the disclosure requirements in paragraphs 235-10-50-1 through 50-6.

As a result, companies applying US GAAP need not evaluate VAT and similar taxes country by country, but can exclude all VAT and similar taxes from the measurement regardless of where they are received or paid.

For its part, the IASB concluded that companies applying IFRS internationally are accustomed to evaluating jurisdictions separately, have no trouble distinguishing principal from agent and so did not feel the need for a similar policy election.

The reason is that VAT is not an economic resource controlled by the company that collects it, but by the tax collection authority on whose behalf it is collected.

In other words, a company that collects VAT from its customers is acting an agent, collecting the tax on behalf of government.

Obviously, this only applies to VAT payors.

Companies, for example health care providers in some jurisdictions, do not collect VAT from their customers. Thus, since they are not agents of the government, they treat the VAT they pay to suppliers as a sales tax, which they include in the acquisition cost of assets / measurement of expenses.

Less clear, in the eyes of some (primarily IFRS ) accountants, is whether this also applies to the receivable.

For accountants that apply US GAAP outside of the United States, this generally is a non-issue. While a few exceptions exist, practically all US GAAP companies disaggregate VAT from both the transaction price and the receivable.

In other words, since VAT is commonly recognized as part of a receivable / payable per national GAAP, accountants accustomed applying such a GAAP would very much like to use the same procedure for IFRS | US GAAP purposes.

However, IFRS 15.108 | ASC 606-10-45-4 clearly states: A receivable is an entity's right to consideration ...

While IFRS and US GAAP do not specifically define the "consideration", its meaning is understood in law where it is the reward a company receives in exchange for delivering goods / rendering services, or whatever else it promises in a contract.

US GAAP comes closest defining:

Cash Consideration

Cash payments and credits that the customer can apply against trade amounts owed to the vendor. In addition, as indicated in Section 718-10-25, consideration in the form of share-based payment awards is recognized in the same period or periods and in the same manner (that is, capitalize versus expense) as if the entity had paid cash for the goods or services instead of paying with or using the share-based payment awards. Accordingly, guidance with respect to cash consideration is applicable to consideration that consists of equity instruments.

Consideration in the Contract

See paragraph 842-10-15-35 for what constitutes the consideration in the contract for lessees and paragraph 842-10-15-39 for what constitutes consideration in the contract for lessors.

ASC: 842-10-15-35 The consideration in the contract for a lessee includes all of the payments described in paragraph 842-10-30-5, as well as all of the following payments that will be made during the lease term:

a. Any fixed payments (for example, monthly service charges) or in substance fixed payments, less any incentives paid or payable to the lessee, other than those included in paragraph 842-10-30-5

b. Any other variable payments that depend on an index or a rate, initially measured using the index or rate at the commencement date.

In law (link: Black's law dictionary) consideration it is the inducement to a contract. The cause, motive, price, or impelling influence which induces a contracting party to enter into a contract. ...

Since a company cannot retain the VAT it collects, it is not, and cannot be, a reward.

If anything, VAT is a government's reward for allowing companies to deliver goods / render services in its territory.

This implies that recognizing VAT as a receivable is not consistent with the logic behind IFRS or US GAAP even when it does not, technically, violate its letter.

Provided an entity clearly reports receivables from contracts with customers (as defined by IFRS 15.108 | ASC 606-10-45-4) separately from other "receivables", its reporting would not be inconsistent with the letter of IFRS and US GAAP (nor with their respective XBRL taxonomies).

Nevertheless, indicating that taxes like VAT are similar to accounts receivable or accounts payable could never be called good accounting.

Procedurally, the same account is used for both sales and purchases in that, at the end of the taxation period, the balance is either remitted to or refunded by the taxation authority.

Note: as VAT is generally refundable, it cannot be included in the measurement of assets or expenses. However, in situations where it is not refundable, it would be treated in the same manner as a sales or excise tax.

Also note: In IFRS XBRL, VAT is presented as a sub-classification of taxes other than income (illustrating the experience international standard setters have with VAT).

In US GAAP XBRL, VAT only appears as a subclassification of non-trade receivables (illustrating the opposite).

1/14/X2 / 14.1.X2

 

 

Cash

12,100

 

 

Accounts receivable: DEF

 

10,000

 

Accrued assets: VAT: DEF

 

2,100


1/15/X2 / 15.1.X2

 

 

Accounts payable: ABC

5,000

 

Accrued liabilities: VAT: ABC

1,050

 

 

Cash

 

6,050


12/31/X1 / 31.12.X1

 

 


XYZ
Balance sheet
12/31/X1 / 31.12.X1

Current assets*

 

 

Trade receivables

10,000

 

Accrued assets: VAT

2,100

 

 

 

Current liabilities*

 

 

Trade payables

5,000

 

Accrued liabilities: VAT

1,050

 

Taxes other than income: Net VAT

1,050

 

 

 

* Only the pertinent items are presented.



1/25/X2 / 25.1.X2

 

 

Tax other than income: Q4 VAT

1,050

 

 

Cash

 

1,050


For illustration purposes, only the VAT remittance associated with the two transactions is presented.

Alternatively

Habits die hard and bad habits die hardest.

As a result, in countries where national GAAP recognizes gross receivables, accountants would like to do this:

12/14/X1 / 14.12.X1

 

 

Inventory

5,000

 

Value added tax

1,050

 

 

Accounts payable: ABC

 

6,050


12/15/X1 / 15.12.X1

 

 

Accounts receivable: DEF

12,100

 

 

Revenue

 

10,000

 

Value added tax

 

2,100


While hardly good accounting, provided that the receivable and VAT are clearly segregated on the balance sheet, it would not be an error.

Provided an entity clearly reports receivables from contracts with customers (as defined by IFRS 15.108 | ASC 606-10-45-4) separately from other "receivables", its reporting would not be inconsistent with the letter of IFRS and US GAAP (nor with their respective XBRL taxonomies).

Nevertheless, indicating that taxes like VAT are similar to accounts receivable or accounts payable could never be called good accounting.

Proper segregation is also in a company's best interest.

If users fail to notice that VAT and receivables are separate items, they could conclude that the company has trouble collecting on time.

For example, if XYZ had annual revenues of 120,000 and users calculated days of sales outstanding using the gross receivable, the ratio would appear to be 36.3 days, not the 30 days it actually is.

36.3 = 12,100 ÷ 120,000 x 360

Reverse charge

Same facts except ABC was an international supplier.

Since reverse charge sales are VAT free, VAT is often recognized only in reverse charge purchases.

However, reverse charge sales generally need to be reported to the taxation authority even when they are not given accounting recognition.

12/14/X1 / 14.12.X1

 

 

Inventory

5,000

 

Tax other than income: Q4 VAT

1,050

 

 

Accounts payable: ABC

 

5,000

 

Tax other than income: Q4 VAT

 

1,050


In the VAT report filed with the taxation authority, the asset and liability would be reported as separate items. Consequently, many companies keep separate accounts for VAT assets and VAT liabilities.

For IFRS | US GAAP purposes, since the amounts are offset, they would not be reported, so it makes no difference how or if they are given accounting recognition.

Also note, in some jurisdictions, all reverse charge transactions must be reported. In some jurisdictions, only transactions over a set amount. In some, jurisdiction just sales transactions. In some jurisdictions, multiple reports require the reporting of the same transactions (just on different forms and at different times). These reports generally include the VAT #, invoice # and amount.

This example is no substitute for knowledge of the specific requirements of each jurisdiction.

Advance payment

Same facts except DEF paid an advance and XYZ delivered the product 1/31/X2.

VAT is generally due when consideration is received (as in this example) or receivable (previous examples).

12/15/X1 / 15.12.X1

 

 

Cash

12,100

 

 

Deferred revenue

 

10,000

 

Tax other than income: Q4 VAT

 

2,100


1/25/X2 / 25.1.X2

 

 

Tax other than income: Q4 VAT

2,100

 

 

Cash

 

2,100


For illustration purposes, only the VAT remittance associated with this transaction is presented.

1/31/X2 / 31.1.X2

 

 

Deferred revenue

10,000

 

 

Revenue

 

10,000


Services (point of time vs. over time)

Specific performance (point of time)

XYZ provides equipment repair services. It applies a 100% markup to parts and labor to determine the price for those services.

1/1/X1, it accepted a repair and the same day a technician spent 1 hour (at 20 per hour) diagnosing the malfunction. Once the customer accepted the price and committed to the repair, an additional 4 hours (at 20 per hour) over the next two days were spent replacing parts that had cost 50.

1/4/X1, the customer picked up the repair and paid in cash.

Dr/Cr

1/4/X1 / 4.1.X1

 

 

Cash

300

 

Cost of services rendered

150

 

 

Revenue

 

300

 

Accrued wages and salaries

 

100

 

Inventory: Spare parts

 

50


In general usage, cost of sales (COS) comprises: cost of goods sold (COGS), cost of merchandise sold and cost of services rendered.

FASB XBRL includes both a CostOfRevenueAbstract and CostOfGoodsAndServicesSoldAbstract. It also includes various items including: CostDirectMaterial, CostDirectLabor, CostOfGoodsAndServicesSoldOverhead, CostMaintenance, CostOfGoodsAndServicesSoldDepreciation, CostOfGoodsAndServicesSoldAmortization CostDepletion, etc.

IASB XBRL function of expense includes just CostOfSales while nature of expense includes CostOfMerchandiseSold and CostOfPurchasedEnergySold.

Receivable

For short duration services, it is common practice to recognize revenue when payment is received. Nevertheless, a service provider should recognize revenue when the service is completed if payment is probable.

As outlined in IFRS 15.31 | ASC 606-10-25-23, an entity recognizes revenue when (as) it transfers control of the promised service to the customer. As outlined in IFRS 15.35.b | ASC 606-10-25-27.b, the entity transfers control if its performance creates or enhances an asset controlled by the customer.

As the repair enhanced the customer's equipment, XYZ recognized revenue when it completed the repair.

Probability of payment (50% + IFRS | 75% + US GAAP) is one of several conditions that must be met for a contract with a customer to be recognized.

IFRS 15.9 | ASC 606-10-25-1 outlines 5 conditions to be met before a contract can be recognized.

Among them (sub-paragraph e), it must be probable that the entity will collect the consideration to which it will be entitled.

Same facts, except XYZ completed the repair on 12/28/X1 and the customer picked up the equipment on 1/2/X2.

12/28/X1 / 28.12.X1

 

 

Accounts receivable (Unbilled revenue)

300

 

Cost of services rendered

150

 

 

Revenue

 

300

 

Accrued wages and salaries

 

100

 

Inventory: Spare parts

 

50


Instead of a receivable or contract asset, an unbilled revenue account can be used.

IFRS 15.105 | ASC 606-10-45-1 states (edited): ...An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 states (edited): ...A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due...

IFRS 15.107 | ASC 606-10-45-3 states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset...

As written, the guidance in IFRS 15.105 to 109 | ASC 606-10-45-1 to 5 gives two options.

IFRS 15.105 | ASC 606-10-45-1 states (emphasis added): When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 explains (edited, emphasis added): A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

Applied to this example, since XYZ has performed and the only condition associated with its right to consideration (the customer’s payment) is having to wait a period of time, it should present a receivable, not a contract asset.

However, IFRS 15.107 | ASC 606-10-45-3 also states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset, excluding any amounts presented as a receivable.

In practice, “before payment is due” is often interpreted to mean that the company has not only performed (transferred goods, rendered services) but has also billed (issued an invoice).

Using a separate, unbilled revenue account gives companies an option to cover the situation where they have performed but not yet billed.

At the end of the period, the unbilled revenue account can be taken directly to the balance sheet.

Although the ASC does not address unbilled revenue, FASB XBRL includes UnbilledRevenuesMember and UnbilledReceivablesCurrent. It defines the latter: "Amount received for services rendered and products shipped, but not yet billed, for non-contractual agreements due within one year or the normal operating cycle, if longer."

Although the IASB XBRL does not include a similar item, it may be extended to do so.

At the end of the period, the unbilled revenue account can be presented as a sub-classification of contract assets or receivables depending on if the right to consideration is conditional or not.

This option is especially useful for companies domiciled in (or with subsidiaries domiciled in) jurisdictions where national GAAP and/or tax law outlines different rules.

In some jurisdictions, besides IFRS and/or US GAAP, entities must apply statuary accounting (a.k.a. national GAAP). For example, in the European union two separate accounting systems exist:

IFRS (required by the IAS regulation) and national GAAP (required by the accounting directive).

While IFRS is used for financial reporting, national GAAP is often used for taxation. For example, in the Czech Republic, while IFRS is required for financial reporting purposes, it may not be used as the basis for determining taxable income, which means the two must be reconciled at the end of each period.

Using an account like unbilled revenue is helpful because it can (if the right is unconditional) be presented as a receivable for IFRS reporting purposes and as accrued revenue for statutory reporting purposes (Czech national GAAP only allows receivables to be recognized if a formal invoice has been issued).

1/2/X2 / 2.1.X2

 

 

Cash

300

 

 

Accounts receivable

 

300


Same facts except XYZ completed the diagnostic work on 12/28/X1, but began the repair work 1/1/X2.

As outlined in IFRS 15.92 | ASC 340-40-25-2, incremental costs of obtaining a contract are costs an entity incurs to obtain a contract ... (for example, a sales commission).

In this example, the contract was for a repair service and the diagnostic work was performed to gain that contract. It was, as a result, akin to a sales commission.

As outlined in IFRS 15.91 | ASC 340-40-25-1, an entity may only capitalize incremental costs if it expects to recover them.

In this example, XYZ concluded it was probable the customer would pay for the repair. Since this meant the cost was recoverable, XYZ capitalized it.

12/28/X1 / 28.12.X1

 

 

Inventory : WIP: Initial direct costs

20

 

 

Accrued wages and salaries

 

20


Neither IFRS 15.91 to 94 nor ASC 340-40-25-1 to 4 specify how companies should recognize costs to obtain a contract, only that they recognize them as assets.

Some companies prefer to recognize them as work in process, others as accruals.

Either approach would be consistent with the guidance provided by the standards.

On 12/31/X1, the customer refused the repair but was still obligated to pay for the diagnostic work.

12/31/X1 / 31.12.X1

 

 

Cash

40

 

Cost of services rendered

20

 

 

Revenue

 

40

 

Inventory : WIP: Initial direct costs

 

20


Same facts except the customer refused the repair but was not obligated to pay for the diagnostic work.

12/31/X1 / 31.12.X1

 

 

Impairment loss (unrecovered costs of obtaining a contract)

20

 

 

Inventory : WIP: Initial direct costs

 

20


As outlined in IFRS 15.91 | ASC 340-40-25-1, an entity capitalizes incremental costs of obtaining a contract if it expects to recover them.

In this example, XYZ initially determined it was probable the customer would pay for the repair, so it capitalized the cost.

Consequent, when it did not recover the cost, it recognized an impairment loss as outlined in IFRS 15.101 to 104 | ASC 340-40-35-3 to 6.

Note: unlike IFRS 15.104, ASC 340-40-35-6 does not allow impairment charges to be subsequently reversed.

Same facts except it was not probablethe customer would pay for the repair.

12/28/X1 / 28.12.X1

 

 

Expenses: Selling (potentially unrecoverable costs of obtaining a contract )

20

 

 

Accrued wages and salaries

 

20


As outlined in IFRS 15.91 | ASC 340-40-25-1, an entity may only capitalize an incremental cost of obtaining a contract if it expects to recover it.

In this example, XYZ performed the diagnostic work even though it was not probable the customer would contract for the repair.

The reason it performed the work was in the hope that the customer would contract for the repair.

Consequently, the cost incurred performing the diagnostic was analogous to a sales commission.

Full absorption costing

Although full absorption costing is required by IFRS and US GAAP, many companies, especially service providers, would prefer, for simplicity, to recognize only direct costs.

Full absorption costing (a.k.a. absorption costing or full costing) captures all of the costs that go into manufacturing a product (or providing a service).

These costs are subclassified as direct and indirect (a.k.a. overhead).

Direct costs are be further subclassified as direct material and direct wages while overhead as fixed (rent, depreciation, amortization, insurance, etc.) and variable (supervisor salaries, production supplies, utilities, quality control, repairs and maintenance, etc.)

Fixed does not necessarily mean linear.

For example, depreciation calculated using a diminishing balance method is still considered fixed. The difference between fixed and variable is that the latter correlates with production levels while the former does not.

Some overhead costs are, by their nature, always variable. For example the coke used to smelt iron or electricity used to power production machines.

Other overhead costs, for example supervisor salaries or maintenance, can be either fixed or variable (or a combination) depending on how they are determined.

For example, some companies compensate supervisors with fixed salary, others a wage, while still others combine a salary with bonuses when, for example, a production spike calls for extra hours.

Maintenance of production machinery is usually variable, while maintenance of production structures tends to be fixed.

Quality control (of products) tends to be variable, while quality inspection (of production processes) tends to be fixed.

Waste removal is also often fixed, but can become variable when extra production leads to extra trash.

The proper allocation of overheads thus requires both judgment and an accounting system sufficiently flexible to cope with the variations.

While neither IFRS nor US GAAP use the term “full absorption costing” both require its use.

IAS 2.10: The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

IAS 2.12 (edited): ... [costs of conversion] include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings, equipment and right-of-use assets used in the production process, and the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour.

While US GAAP guidance is (intentionally) less instructive, its requirements are comparable.

ASC 330-10-30-2 (emphasis added): Although principles for the determination of inventory costs may be easily stated, their application, particularly to such inventory items as work in process and finished goods, is difficult because of the variety of considerations in the allocation of costs and charges.

ASC 330-10-30-1 (edited, emphasis added): The primary basis of accounting for inventories is cost... As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location. It is understood to mean acquisition and production cost, and its determination involves many considerations.

ASC 330-10-30-3 (edited, emphasis added): For example, variable production overheads are allocated to each unit of production on the basis of the actual use of the production facilities. However, the allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facilities...

This approach would only be consistent with IFRS and US GAAP if adjustments, allocating indirect costs (overhead) to cost of sales, were made at the end of each reporting period (see: Inventory / Direct costing for an example).

However, it is also possible to recognize overhead during the period.

XYZ allocates overhead at 20% of parts and labor.

1/4/X1 / 4.1.X1

 

 

Cash

300

 

Cost of services rendered

180

 

 

Revenue

 

300

 

Accrued wages and salaries

 

100

 

Inventory: Spare parts

 

50

 

Inventory: WIP: Unallocated overhead

 

30

In this example, overhead is recognized as work in process using an Unallocated overhead account.

The same result can be reached using an accrual account.

During the period, XYZ recognizes overhead costs to the Unallocated overhead account.

For example:

1/1/X1, XYZ paid January rent and made an advance payment on first quarter electricity.

1/1/X1 / 1.1.X1

 

 

Inventory: WIP: Unallocated overhead (rent)

1,500

 

Inventory: WIP: Unallocated overhead (pre-paid electricity)

500

 

 

Cash

 

2,000

2/1/X1, it paid supervisor salaries.

2/1/X1 / 1.2.X1

 

 

Inventory: WIP: Unallocated overhead (supervisor salaries)

2,500

 

 

Cash

 

2,500

31/3/X1, it paid for natural gas used during the first quarter (in arrears) and recognized Q1 depreciation.

3/31/X2 / 31.3.X2

 

 

Inventory: WIP: Unallocated overhead (gas consumed)

250

 

Inventory: WIP: Unallocated overhead (depreciation)

3,000

 

  Cash  

250

 

Accumulated depreciation

 

3,000


At the end of the period, unallocated overhead is reported on the balance sheet as either an asset or liability depending on its balance.

If it is reported as an asset, it can be presented as a sub-classification of work in process or in accruals as a pre-paid expense. If it is a liability, it would be presented as an accrued expense.

Note: since the procedure is analogous to standard costing (see the Inventory / Standard costing), the allocation of overhead to cost of sales must be periodically reviewed and adjusted to reflect actual costs.

Completed contract (point of time)

XYZ is a freight forwarder. It completes its deliveries with the help of sub-contractors. 12/15/X1, it agreed to ship equipment from Berlin to Sacramento for ABC. ABC paid an advance of 3,000, agreeing to pay an additional 3,000 after it accepted delivery.

12/16/X1, XYZ picked up the equipment, unloading it in Hamburg on 12/17/X1. It incurred direct costs: wages (500), fuel and consumables (400). It also allocated overhead (250) and paid 200 to HIG to insure the delivery. 12/18/X1, the shipment was loaded onto a container ship by HIJ . It was unloaded in Oakland on 1/21/X2. HIJ Charged 2,000 for its services. The same day, GHI completed the delivery charging 750 for its services.

ABC inspected the equipment and accepted the delivery on 1/25/X2. The same day, XYZ issued an invoice for 6,000.

The previous example includes a discussion of overhead allocation.

Acceptance is not a criterion for revenue recognition. Neverthless, the guidance only allows revenue to be recognized after the contract has been completed.

Both IFRS 15.31 and ASC 606-10-25-23 specify that an entity shall recognize revenue when (or as) it transfers a promised good or service to a customer which is the moment the customer obtains control of that good or service.

The IFRS master glossary defines control as: The present ability to direct the use of the economic resource and obtain the economic benefits that may flow from it.

The US GAAP master glossary includes three definitions:

DEFINITION 1: The possession, direct or indirect, of the power to direct or cause the direction of the management and policies of an entity through ownership, by contract, or otherwise (topics 310, 850).

DEFINITION 2: The direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise (topics 954, 958).

DEFINITION 3: The same as the meaning of controlling financial interest in paragraph 810-10-15-8.

Unfortunately, not one of them applies to goods or services.

The best definition thus comes from the text of IFRS 15.33 | ASC 606-10-25-25:

... Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset. ...

Both IFRS 15.38 and ASC 606-10-25-30 outline "indicators" (a. right to payment, b. legal title, c. physical possession, d. risks and rewards of ownership and e. acceptance) that can be used to determine the exact point of time when control transfers.

However, indicators are not criteria. Control is.

This implies that if a company has transferred control to the customer, it should recognize revenue even if none of the indicators are present.

IFRS 15.35 | ASC 606-10-25-27 specifies that revenue can only be recognized over time if (a) customer simultaneously receives and consumes the benefits or (b) the entity’s performance creates or enhances a customer asset or (c) the entity has an enforceable right to payment for performance completed to date.

While XYZ did receive a payment from the customer, the payment was not compensation for performance, but an advance on future performance.

As outlined in IFRS 15.B9 | ASC 606-10-55-11, an entity must have a right to payment for the performance completed to date even if customer (or some other party) terminated the contract.

Obviously, no contract for a shipping service would require the customer to pay for the shipping service unless shipper delivered. This implies that any advance payment would be returnable and no other enforceable right to payment could exist prior to delivery.

While it is possible the shipper could still get paid, for example if the shipment were insured, such payment would not be from a customer for the service, but from an insurance carrier as an indemnification of losses. It would also, most likely be far exceed the amount that would have been paid for the shipping service and most, if not all, would be paid out to the customer.

As ABC would not receive the benefits until XYZ delivered the goods, as XYZ performance did not enhance any asset until XYZ delivered the goods and as ABC had no obligation to pay unless XYZ delivered the goods, XYZ's performance obligation was satisfied at the point of time it delivered the goods, no sooner.

Dr/Cr

12/15/X1 / 15.12.X1

 

 

Cash

3,000

 

 

Deferred service revenue (contract liability)

 

3,000


IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

12/16/X1 / 16.12.X1

 

 

Inventory: Work in process: Contract with ABC

1,250

 

  Liabilities: Accrued expenses: Wages payable  

500

  Inventory: Work in process: Pre-paid fuel and consumables  

300

  Inventory: Work in process: Unallocated overhead  

250

 

Cash (HIG)

 

200


The proper approach is to recognize the costs to fulfill a contract as Inventory: Work in process.

Nevertheless, many service providers prefer to recognize these costs as Accruals: Pre-paid expenses.

While both IFRS 15.97 and ASC 340-40-25-7 specify that the costs to fulfill a contract are to be recognized as assets (capitalized), neither specifies how.

This implies that either approach would be consistent with the guidance provided.

Both IFRS and US GAAP require that overhead be included in costs to fulfill a contract.

IFRS 15.97 | ASC 340-40-25-7 (emphasis added): Costs that relate directly to a contract (or a specific anticipated contract) include any of the following:

(a) direct labour (for example, salaries and wages of employees who provide the promised services directly to the customer);

(b) direct materials (for example, supplies used in providing the promised services to a customer);

(c) allocations of costs that relate directly to the contract or to contract activities (for example, costs of contract management and supervision, insurance and depreciation of tools, equipment and right-of-use assets used in fulfilling the contract);

(d) costs that are explicitly chargeable to the customer under the contract; and

(e) other costs that are incurred only because an entity entered into the contract (for example, payments to subcontractors)

Various methods, such as job costing, direct costing, standard costing can be used (see inventory for examples).

In this example, XYZ chose to allocate overhead using an Unallocated overhead account.

The previous example includes an additional discussion of this procedure.

12/18/X1 / 18.12.X1

 

 

Accrued service costs

1,000

 

 

Payable: DEF

 

1,000


1/21/X2 / 21.1.X2

 

 

Deferred service revenue

3,000

 

Unbilled service revenue: ABC

3,000

 

Cost of sales

4,000

 

 

Service revenue

 

6,000

 

Inventory: Work in process: Contract with ABC

 

1,250

 

Payable: HIJ

 

2,000

 

Payable: GHI

 

750


Instead of a receivable or contract asset, this examples uses an unbilled revenue account.

IFRS 15.105 | ASC 606-10-45-1 states (edited): ...An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 states (edited): ...A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due...

IFRS 15.107 | ASC 606-10-45-3 states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset...

As written, the guidance in IFRS 15.105 to 109 | ASC 606-10-45-1 to 5 gives two options.

IFRS 15.105 | ASC 606-10-45-1 states (emphasis added): When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 explains (edited, emphasis added): A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

Applied to this example, since XYZ has performed and the only condition associated with its right to consideration (the customer’s payment) is having to wait a period of time, it should present a receivable, not a contract asset.

However, IFRS 15.107 | ASC 606-10-45-3 also states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset, excluding any amounts presented as a receivable.

In practice, “before payment is due” is often interpreted to mean that the company has not only performed (transferred goods, rendered services) but has also billed (issued an invoice).

Using a separate, unbilled revenue account gives companies an option to cover the situation where they have performed but not yet billed.

At the end of the period, the unbilled revenue account can be taken directly to the balance sheet.

Although the ASC does not address unbilled revenue, FASB XBRL includes UnbilledRevenuesMember and UnbilledReceivablesCurrent. It defines the latter: "Amount received for services rendered and products shipped, but not yet billed, for non-contractual agreements due within one year or the normal operating cycle, if longer."

Although the IASB XBRL does not include a similar item, it may be extended to do so.

At the end of the period, the unbilled revenue account can be presented as a sub-classification of contract assets or receivables depending on if the right to consideration is conditional or not.

This option is especially useful for companies domiciled in (or with subsidiaries domiciled in) jurisdictions where national GAAP and/or tax law outlines different rules.

In some jurisdictions, besides IFRS and/or US GAAP, entities must apply statuary accounting (a.k.a. national GAAP). For example, in the European union two separate accounting systems exist:

IFRS (required by the IAS regulation) and national GAAP (required by the accounting directive).

While IFRS is used for financial reporting, national GAAP is often used for taxation. For example, in the Czech Republic, while IFRS is required for financial reporting purposes, it may not be used as the basis for determining taxable income, which means the two must be reconciled at the end of each period.

Using an account like unbilled revenue is helpful because it can (if the right is unconditional) be presented as a receivable for IFRS reporting purposes and as accrued revenue for statutory reporting purposes (Czech national GAAP only allows receivables to be recognized if a formal invoice has been issued).

As outlined in IFRS 15.B84 | ASC 606-10-55-86, acceptance is a formality provided that an entity can objectively determine it transferred control to the customer as per the terms outlined in the contract.

1/25/X2 / 25.1.X2

 

 

Account Receivable: ABC

3,000

 

 

Unbilled service revenue: ABC

 

3,000


Proportional performance, straight-line (over time)

XYZ provides technical support and maintenance (TSM) to software/hardware clients. 1/1/X1, ABC paid 12,000 for one year’s TSM. TSM is provided as needed and XYZ is unable to estimate the frequency, timing or total cost of individual acts.

In 1/X1 and 2/X1, ABC did not require any TSM. In 3/X1 it required TSM that cost 500 (wages, parts, etc.). From 4/X1 to 6/X1, ABC did not require any TSM. From 7/X1 to 8/X1 it required TSM that cost 1,500 in 7/X1 and 3,000 in 8/X1. From 9/X1 to 11/X1 it did not require any TSM. In 12/X1 it required TSM that cost 1,000.

Dr/Cr


1/1/X1 / 1.1.X1

 

 

Cash

12,000

 

 

Deferred service revenue (contract liability)

 

12,000


IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome.

While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

1/31/X1 - 31.1.X1

 

 

Deferred service revenue

1,000

 

 

Service revenue

 

1,000


2/28/X1 - 28.2.X1

 

 

Deferred service revenue

1,000

 

 

Service revenue

 

1,000


3/31/X1 / 31.3.X1

 

 

Deferred service revenue

1,000

 

Cost of services rendered

500

 

 

Service revenue

 

1,000

 

Cash / Inventory / Payroll / etc.

 

500


etc.

7/31/X1 / 31.7.X1

 

 

Deferred service revenue

1,000

 

Cost of services rendered

1,500

 

 

Service revenue

 

1,000

 

Cash / Inventory / Payroll / etc.

 

1,500


8/31/X1 / 31.8.X1

 

 

Deferred service revenue

1,000

 

Cost of services rendered

3,000

 

 

Service revenue

 

1,000

 

Cash / Inventory / Payroll / etc.

 

3,000


etc.

12/31/X1 / 31.12.X1

 

 

Deferred service revenue

1,000

 

Cost of services rendered

1,000

 

 

Service revenue

 

1,000

 

Cash / Inventory / Payroll / etc.

 

1,000


Cost plus

Same facts except, the agreement specified the number of acts and XYZ was able to determine the cost of each.

Such a scenario is not particularly realistic. Not only is it fairly uncommon for TSM contracts to specify the number of individual acts, it is also relatively difficult to accurately estimate the cost of each individual act.

On the other hand, it is often possible to estimate the total cost to be incurred during the contract period.

However, in this case, one of the POC methods (see examples below) would be appropriate.

1/1/X1 / 1.1.X1

 

 

Cash

12,000

 

 

Deferred service revenue

 

12,000


3/31/X1 / 31.3.X1

 

 

Deferred service revenue

1,000

 

Cost of services rendered

500

 

 

Service revenue

 

1,000

 

Cash / Inventory / Payroll / etc.

 

500


7/31/X1 / 31.7.X1

 

 

Deferred service revenue

3,000

 

Cost of services rendered

1,500

 

 

Service revenue

 

3,000

 

Cash / Inventory / Payroll / etc.

 

1,500


8/31/X1 / 31.8.X1

 

 

Deferred service revenue

6,000

 

Cost of services rendered

3,000

 

 

Service revenue

 

6,000

 

Cash / Inventory / Payroll / etc.

 

3,000


12/31/X1 / 31.12.X1

 

 

Deferred service revenue

2,000

 

Cost of services rendered

1,000

 

 

Service revenue

 

2,000

 

Cash / Inventory / Payroll / etc.

 

1,000


Cost-to-cost

While simple, linear revenue recognition can cause (in this example quarterly) gross profit to fluctuate dramatically.

This can be avoided by using a cost-to-cost method (see example below) instead.

Additional issues

Value added tax

Neither IFRS nor US GAAP provides any specific guidance for VAT (GST).

The US does not have a value added tax, so it would be pointless for US GAAP to address it.

IFRS, as the acronym suggests, is international and, internationally, not every jurisdiction has a VAT or GST.

Besides, the guidance provided by IFRS can be applied to any tax, including VAT.

This point was (implicitly) made by the IFRIC when it considered adding VAT (in the context of cash flows and leases) to its agenda, but decided against it (link - iasplus).

VAT does, however, appear in both IFRS and US GAAP XBRL.

ValueAddedTaxReceivables and ValueAddedTaxPayables in IFRS XBRL and ValueAddedTaxReceivable in US GAAP XBRL.

However, neither the descriptions (The amount of receivables related to a value added tax; The amount of payables related to a value added tax; and Carrying amount as of the balance sheet date of value added taxes due either from customers arising from sales on credit terms, or as previously overpaid to tax authorities) nor references (IAS 1.78.b and ASC 210-10-S99-1) are particularly useful.

In an interesting side note, while IFRS XBRL at least acknowledges that VAT can be either a payable or a receivable, US GAAP XBRL only has a receivable, illustrating the general lack of appreciation of how VAT actually works, not only in the US practitioner community, but also among US standard setters.

Value added tax (VAT) is applied throughout the European Union while Goods and services tax (GST) is applied in countries such as Canada, South Africa or India.

In short, VAT is a multiple-step sales tax.

VAT legislation can be complex and vary from jurisdiction to jurisdiction.

Consequently, this example is no substitute for a detailed study of the pertinent regulations.

Transactions between payors:

When a VAT "payor" (a company registered to collect VAT) sells goods or services to another payor in the same jurisdiction, it issues a VAT invoice (a.k.a. "tax document").

It thus collects the VAT on behalf of the taxation authority.

When a payor buys from another payor in the same jurisdiction, it receives a tax document and so pays VAT to that other payor (who collects it on behalf of the taxation authority).

If a payor buys from a non-payor, the non-payor issues a regular invoice without VAT.

Non-payors are small enterprises or individuals who have not crossed the threshold for VAT registration or registered voluntarily.

At the end of the period, generally month or quarter, each payor offsets VAT received against VAT expended and pays (the reason they are called a payors) the difference to the taxation authority or claims a refund.

Cross border transactions work differently.

When a payor sells to a payor in a different jurisdiction, it issues a "reverse charge" invoice without VAT.

While reverse charge most often applies to cross broader transactions to limit so called missing trader (a.k.a. MTIC or carousel) fraud, some jurisdictions also require reverse charge in selected domestic transactions.

Thus the buyer, not seller, is obligated to pay the VAT to its domestic taxation authority.

However, as a VAT payor may also claim a deduction, the effect is zero net tax.

VAT is not deductible in every situation. The issue was discussed by the IFRIC in the context of IFRS 17 (link - ifric).

Transactions with non-payors:

When a payor sells to a domestic non-payor (a consumer or entity not registered as a VAT payor), it proceeds in the same manner as with a payor and issues a tax document including VAT.

In some jurisdictions, VAT payors are obligated to report both sales to and purchases from other VAT payors. These reports generally include VAT ID number, invoice number and amount.

Some jurisdictions require reports on all sales, including cash sales, regardless of whether they are to payors or non-payors, though this requirement can be based on different tax legislation.

Such reports do not, however, change the amount of VAT paid or refunded.

The difference, as the non-payor cannot claim a VAT refund, the remitted tax stays with the taxation authority.

However, when a payor sells to a non-payor in a different jurisdiction (cross boarder), it is generally obligated to remit VAT not its own taxation authority, but the taxation authority in the jurisdiction where the non-payor is domiciled.

This implies that companies selling across borders generally need to register as payers in each country where they have non-payor customers, though there are exceptions.

This page outlines current EU VAT requirements and exceptions: link - europa.

See (link - gocardless) for a discussion of VAT vs. GST.

The following examples simply illustrate how VAT could be treated in an IFRS | US GAAP context.

12/14/X1, XYZ purchased goods for 5,000 from ABC. 12/15/X1, it sold goods for 10,000 to DEF. In its jurisdiction, the VAT rate is 21% and the balance must be remitted to the tax collection authority no later than the 25th day of the month following the transaction or event.

12/14/X1 / 14.12.X1

 

 

Inventory

5,000

 

Tax other than income: Q4 VAT

1,050

 

 

Accounts payable: ABC

 

5,000

 

Accrued liabilities: VAT: ABC

 

1,050


Procedurally, the same account is used for both sales and purchases in that, at the end of the taxation period, the balance is either remitted to or refunded by the taxation authority.

Note: as VAT is generally refundable, it cannot be included in the measurement of assets or expenses. However, in situations where it is not refundable, it would be treated in the same manner as a sales or excise tax.

Also note: In IFRS XBRL, VAT is presented as a sub-classification of taxes other than income (illustrating the experience international standard setters have with VAT).

In US GAAP XBRL, VAT only appears as a subclassification of non-trade receivables (illustrating the opposite).

Both IFRS and US GAAP XBRL suggest that VAT should be presented as other or non-trade receivables/payables. However, since VAT is a tax, we at ifrs-gaap.com would much rather recognize it as an accrual to keep it as far away from receivables/payables as possible.

This is the VAT to be remitted to suppliers.

As it is not consideration for goods or services acquired, it should not be classified as an account payable.

12/15/X1 / 15.12.X1

 

 

Accounts receivable: DEF

10,000

 

Accrued assets: VAT: DEF

2,100

 

 

Revenue

 

10,000

 

Tax other than income: Q4 VAT

 

2,100


Both IFRS and US GAAP XBRL suggest that VAT should be presented as other or non-trade receivables/payables. However, since VAT is a tax, we at ifrs-gaap.com would much rather recognize it as an accrual to keep it as far away from receivables/payables as possible.

Under IFRS and US GAAP, revenue is clearly measured net of VAT.

IFRS 15.47 | ASC 606-10-32-2 state: ... The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties ...

While IFRS 15.47 | ASC 606-10-32-2 does not mention VAT by name, it clearly alludes to it, which becomes clear when the reasoning behind the paragraph is examined.

In IFRS 15 BC187 | ASC 606 BC187 the boards state: The boards also clarified that the amounts to which the entity has rights under the present contract can be paid by any party (ie not only by the customer). ... However, it would not include amounts collected on behalf of another party such as some sales taxes and value added taxes in some jurisdictions.

Likewise, in IFRIC 21.BC6 the IFRIC states: ... Amounts that are collected by entities on behalf of governments (such as value added taxes) and remitted to governments are not outflows of resources embodying economic benefits for the entities that collect and remit those amounts. ...

Further, to address concerns of US practitioners who feared that ASC 606-10-32-2 would require them to evaluate VAT on a jurisdiction-by-jurisdiction basis, the FASB amended ASC 606.

In ASU_2016-12 it added ASC 606-10-32-2A: An entity may make an accounting policy election to exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue producing transaction and collected by the entity from a customer (for example, sales, use, value added, and some excise taxes). Taxes assessed on an entity’s total gross receipts or imposed during the inventory procurement process shall be excluded from the scope of the election. An entity that makes this election shall exclude from the transaction price all taxes in the scope of the election and shall comply with the applicable accounting policy guidance, including the disclosure requirements in paragraphs 235-10-50-1 through 50-6.

As a result, companies applying US GAAP need not evaluate VAT and similar taxes country by country, but can exclude all VAT and similar taxes from the measurement regardless of where they are received or paid.

For its part, the IASB concluded that companies applying IFRS internationally are accustomed to evaluating jurisdictions separately, have no trouble distinguishing principal from agent and so did not feel the need for a similar policy election.

The reason is that VAT is not an economic resource controlled by the company that collects it, but by the tax collection authority on whose behalf it is collected.

In other words, a company that collects VAT from its customers is acting an agent, collecting the tax on behalf of government.

Obviously, this only applies to VAT payors.

Companies, for example health care providers in some jurisdictions, do not collect VAT from their customers. Thus, since they are not agents of the government, they treat the VAT they pay to suppliers as a sales tax, which they include in the acquisition cost of assets / measurement of expenses.

Less clear, in the eyes of some (primarily IFRS ) accountants, is whether this also applies to the receivable.

For accountants that apply US GAAP outside of the United States, this generally is a non-issue. While a few exceptions exist, practically all US GAAP companies disaggregate VAT from both the transaction price and the receivable.

In other words, since VAT is commonly recognized as part of a receivable / payable per national GAAP, accountants accustomed applying such a GAAP would very much like to use the same procedure for IFRS | US GAAP purposes.

However, IFRS 15.108 | ASC 606-10-45-4 clearly states: A receivable is an entity's right to consideration ...

While IFRS and US GAAP do not specifically define the "consideration", its meaning is understood in law where it is the reward a company receives in exchange for delivering goods / rendering services, or whatever else it promises in a contract.

US GAAP comes closest defining:

Cash Consideration

Cash payments and credits that the customer can apply against trade amounts owed to the vendor. In addition, as indicated in Section 718-10-25, consideration in the form of share-based payment awards is recognized in the same period or periods and in the same manner (that is, capitalize versus expense) as if the entity had paid cash for the goods or services instead of paying with or using the share-based payment awards. Accordingly, guidance with respect to cash consideration is applicable to consideration that consists of equity instruments.

Consideration in the Contract

See paragraph 842-10-15-35 for what constitutes the consideration in the contract for lessees and paragraph 842-10-15-39 for what constitutes consideration in the contract for lessors.

ASC: 842-10-15-35 The consideration in the contract for a lessee includes all of the payments described in paragraph 842-10-30-5, as well as all of the following payments that will be made during the lease term:

a. Any fixed payments (for example, monthly service charges) or in substance fixed payments, less any incentives paid or payable to the lessee, other than those included in paragraph 842-10-30-5

b. Any other variable payments that depend on an index or a rate, initially measured using the index or rate at the commencement date.

In law (link: Black's law dictionary) consideration it is the inducement to a contract. The cause, motive, price, or impelling influence which induces a contracting party to enter into a contract. ...

Since a company cannot retain the VAT it collects, it is not, and cannot be, a reward.

If anything, VAT is a government's reward for allowing companies to deliver goods / render services in its territory.

This implies that recognizing VAT as a receivable is not consistent with the logic behind IFRS or US GAAP even when it does not, technically, violate its letter.

Provided an entity clearly reports receivables from contracts with customers (as defined by IFRS 15.108 | ASC 606-10-45-4) separately from other "receivables", its reporting would not be inconsistent with the letter of IFRS and US GAAP (nor with their respective XBRL taxonomies).

Nevertheless, indicating that taxes like VAT are similar to accounts receivable or accounts payable could never be called good accounting.

Procedurally, the same account is used for both sales and purchases in that, at the end of the taxation period, the balance is either remitted to or refunded by the taxation authority.

Note: as VAT is generally refundable, it cannot be included in the measurement of assets or expenses. However, in situations where it is not refundable, it would be treated in the same manner as a sales or excise tax.

Also note: In IFRS XBRL, VAT is presented as a sub-classification of taxes other than income (illustrating the experience international standard setters have with VAT).

In US GAAP XBRL, VAT only appears as a subclassification of non-trade receivables (illustrating the opposite).

1/14/X2 / 14.1.X2

 

 

Cash

12,100

 

 

Accounts receivable: DEF

 

10,000

 

Accrued assets: VAT: DEF

 

2,100


1/15/X2 / 15.1.X2

 

 

Accounts payable: ABC

5,000

 

Accrued liabilities: VAT: ABC

1,050

 

 

Cash

 

6,050


12/31/X1 / 31.12.X1

 

 


XYZ
Balance sheet
12/31/X1 / 31.12.X1

Current assets*

 

 

Trade receivables

10,000

 

Accrued assets: VAT

2,100

 

 

 

Current liabilities*

 

 

Trade payables

5,000

 

Accrued liabilities: VAT

1,050

 

Taxes other than income: Net VAT

1,050

 

 

 

* Only the pertinent items are presented.



1/25/X2 / 25.1.X2

 

 

Tax other than income: Q4 VAT

1,050

 

 

Cash

 

1,050


For illustration purposes, only the VAT remittance associated with the two transactions is presented.

Alternatively

Habits die hard and bad habits die hardest.

As a result, in countries where national GAAP recognizes gross receivables, accountants would like to do this:

12/14/X1 / 14.12.X1

 

 

Inventory

5,000

 

Value added tax

1,050

 

 

Accounts payable: ABC

 

6,050


12/15/X1 / 15.12.X1

 

 

Accounts receivable: DEF

12,100

 

 

Revenue

 

10,000

 

Value added tax

 

2,100


While hardly good accounting, provided that the receivable and VAT are clearly segregated on the balance sheet, it would not be an error.

Provided an entity clearly reports receivables from contracts with customers (as defined by IFRS 15.108 | ASC 606-10-45-4) separately from other "receivables", its reporting would not be inconsistent with the letter of IFRS and US GAAP (nor with their respective XBRL taxonomies).

Nevertheless, indicating that taxes like VAT are similar to accounts receivable or accounts payable could never be called good accounting.

Proper segregation is also in a company's best interest.

If users fail to notice that VAT and receivables are separate items, they could conclude that the company has trouble collecting on time.

For example, if XYZ had annual revenues of 120,000 and users calculated days of sales outstanding using the gross receivable, the ratio would appear to be 36.3 days, not the 30 days it actually is.

36.3 = 12,100 ÷ 120,000 x 360

Reverse charge

Same facts except ABC was an international supplier.

Since reverse charge sales are VAT free, VAT is often recognized only in reverse charge purchases.

However, reverse charge sales generally need to be reported to the taxation authority even when they are not given accounting recognition.

12/14/X1 / 14.12.X1

 

 

Inventory

5,000

 

Tax other than income: Q4 VAT

1,050

 

 

Accounts payable: ABC

 

5,000

 

Tax other than income: Q4 VAT

 

1,050


In the VAT report filed with the taxation authority, the asset and liability would be reported as separate items. Consequently, many companies keep separate accounts for VAT assets and VAT liabilities.

For IFRS | US GAAP purposes, since the amounts are offset, they would not be reported, so it makes no difference how or if they are given accounting recognition.

Also note, in some jurisdictions, all reverse charge transactions must be reported. In some jurisdictions, only transactions over a set amount. In some, jurisdiction just sales transactions. In some jurisdictions, multiple reports require the reporting of the same transactions (just on different forms and at different times). These reports generally include the VAT #, invoice # and amount.

This example is no substitute for knowledge of the specific requirements of each jurisdiction.

Advance payment

Same facts except DEF paid an advance and XYZ delivered the product 1/31/X2.

VAT is generally due when consideration is received (as in this example) or receivable (previous examples).

12/15/X1 / 15.12.X1

 

 

Cash

12,100

 

 

Deferred revenue

 

10,000

 

Tax other than income: Q4 VAT

 

2,100


1/25/X2 / 25.1.X2

 

 

Tax other than income: Q4 VAT

2,100

 

 

Cash

 

2,100


For illustration purposes, only the VAT remittance associated with this transaction is presented.

1/31/X2 / 31.1.X2

 

 

Deferred revenue

10,000

 

 

Revenue

 

10,000


Factoring and pledging

XYZ sold (factored) receivables with a book value of 100,000 payable in 90 days at a discount.

For illustration, this example assumes a 10% discount, which may or may not be realistic.

In practice, the cost of factoring, pledging and assigning varies considerably depending mostly on the quality of the receivables being factored, pledged or assigned.

Dr/Cr

Cash (received from factor)

90,000

 

Loss on sale of receivables

10,000

 

 

Accounts receivable

 

100,000


In some jurisdictions, national GAAP requires companies to recognize:

For example, some time ago an EU based company decided to list its shares on a US exchange.

After retaining an underwriter, the underwriter retained us to draft a financial report consistent with US GAAP.

After reviewing the preliminary results, the underwater decided against pursuing a listing.

Our first step was to eliminate the major differences and draft a preliminary report.

Up to then, the company had only applied CZ GAAP, the statutory accounting standards applicable in its jurisdiction, the Czech Republic.

As the company used the procedure outlined below, almost half its previously reported revenue was eliminated.

In and of itself, this would have been enough to dissuade a listing, but there was more.

  1. In addition to the revenue eliminated by applying US GAAP guidance to factored receivables, revenue further declined because, at the time, CZ GAAP required increases in inventory and self-manufactured asset costs to be capitalized with a credit to revenue.

  2. The company also did not recognize the full value of its lease assets nor any associated liabilities because CZ GAAP does not require leased assets to capitalized nor liabilities to be recognized. It only requires the capitalization of advance payments, which are amortized over the lease term.

  3. The company also did not recognize all of its leased assets because CZ GAAP does not require capitalization of operating leases even if their term is for substantially all the underlying asset's economic life.

  4. The company also did not recognize all its contingent liabilities because CZ GAAP does not generally require recognition of constructive obligations.

  5. The company also failed to distinguish between cost of sales, selling and administrative expenses as this distinction is not required by CZ GAAP.

  6. The company also capitalized both development and some research as well as employee training which, at the time, was consistent with CZ GAAP.

  7. The company also misapplied CZ GAAP guidance, for example by using tax depreciation periods for financial reporting purposes, but an examination of these issues was beyond the scope of our engagement.

A second step was not necessary.

After reviewing our preliminary report, the underwater decided to terminate its relationship with the company, which eventually wound up in receivership.

Cash

90,000

 

Expense

100,000

 

  Revenue  

90,000

 

Accounts receivable

 

100,000


This procedure is not consistent with either IFRS or US GAAP.

IFRS 9.3.2.12 (emphasis added): On derecognition of a financial asset in its entirety, the difference between:

  1. the carrying amount (measured at the date of derecognition) and
  2. the consideration received (including any new asset obtained less any new liability assumed)

shall be recognised in profit or loss.

ASC 860-20-40-1A (edited, emphasis added): Upon completion of a transfer ... to be accounted for as a sale, the transferor(seller) shall: ... (d) Recognize in earnings any gain or loss on the sale...

Doubtful accounts

Same facts except XYZ had recognized an allowance for doubtful accounts.

Cash

90,000

 

Loss on sale of receivables

10,000

 

Allowance for doubtful accounts

2,000

 

 

Accounts receivable

 

100,000

 

Bad debt expense

 

2,000


As the sale was without recourse, XYZ reversed the previously recognized expense.

As outlined in IFRS 15.113 | ASC 606-10-50-4, for each reporting period entities must disclose (b) impairments of receivables.

IFRS 9 | ASC 310 provide additional guidance on how to fulfill this requirement.

As outlined IFRS 9.5.5.15 and 16 receivables are always measured net of expected lifetime credit losses.

As outlined in ASC 310-10-35-8, a loss is accrued if it is probable it has occurred and can be estimated while, as outlined in ASC 310-10-35-9, this requirement applies to both individual receivables and groups of similar receivables.

To apply this guidance, companies generally recognize the impairments in the same period as the revenue, matching one to the other.

As matching traditionally applies to expenses (losses are recognized as incurred), the allowance should have been recognized with a debit to bad debt expense (for illustrations, go to the doubtful accounts section below).

If the allowance is no longer pertinent, proper accounting is to reverse the expense.

Alternatively

Cash

90,000

 

Loss on sale of receivables

8,000

 

Allowance for doubtful accounts

2,000

 

 

Accounts receivable

 

100,000


As outlined in IFRS 15.113 | ASC 606-10-50-4, for each reporting period entities must disclose (b) impairments of receivables.

IFRS 9 | ASC 310 provide additional guidance on how to fulfill this requirement.

As outlined IFRS 9.5.5.15 and 16 receivables are always measured net of expected lifetime credit losses.

As outlined in ASC 310-10-35-8, a loss is accrued if it is probable it has occurred and can be estimated while, as outlined in ASC 310-10-35-9, this requirement applies to both individual receivables and groups of similar receivables.

This implies that companies should match the impairment to revenue.

Traditionally, only expenses are matched (losses are recognized as incurred).

Also traditionally, the proper procedure for adjusting expenses is to reverse them.

However, both IFRS and US GAAP refer to the income statement item related to uncollectible receivables as a loss (this is also mirrored in their respective taxonomies).

IFRS XBRL: ImpairmentLossImpairmentGainAndReversalOfImpairmentLossDeterminedInAccordanceWithIFRS9

US GAAP XBRL: ProvisionForDoubtfulAccounts

Note: while US GAAP XBRL presents impairments of receivables separately from other impairments, IFRS XRBL aggregates all impairments made according to IFRS 9 including receivables.

This implies, since the accounting for losses is more flexible, simply netting the loss would not be inconsistent with the letter of the guidance.

Servicing asset

Same facts except XYZ agreed to collects payments and the factor agreed to pay a 2% servicing fee.

As outlined in IFRS 93.2.10 to 14 | ASC 860-50-25-1 to 10, if a company sells a financial asset but retains the right to service the asset for a fee, it recognizes a servicing asset.

Theoretically, it could also recognize a servicing liability if the fee does not adequately compensate the company for its service, but this is not common.

Cash

90,000

 

Loss on sale of receivables

10,000

 

Servicing asset (due from factor)

2,000

 

 

Accounts receivable

 

100,000

 

Deferred revenue (servicing fee)

 

2,000


In 90 days

Cash

2,000

 

Deferred revenue

2,000

 

  Revenue  

2,000

 

Servicing asset

 

2,000


Interest + fee

Same facts except, instead of a discount, the agreement stipulated 5,000 interest and a 5,000 fee.

For illustration, this example assumes the total cost (interest plus fee) was the same 10% as in the discount example. This may or not be realistic.

In practice, the cost of factoring, pledging and assigning varies considerably depending mostly on the quality of the receivables being factored, pledged or assigned.

In most agreements, this cost is a outlined as a benchmark rate plus points.

Note: IFRS | US GAAP uses IBOR (inter-bank offered rates) | SOFR (Secured Overnight Financing Rate) as its benchmark rate.

However, companies are free to use whatever benchmark they like in agreements they sign between themselves.

Cash

90,000

 

Interest expense

5,000

 

Factor fee

5,000

 

Allowance for doubtful accounts

2,000

 

 

Accounts receivable

 

100,000

 

Loss on doubtful receivables

 

2,000


As neither IFRS nor US GAAP specifically addresses how to classify the costs associated with factored receivable, in practice they are commonly recognized as outlined in the agreement.

Neither IFRS nor US GAAP specifically address how these fees should be classified.

Consequently, the fee is commonly treated like interest and sub-classified in non-operating (other) expense.

In US GAAP XBRL, it should thus be presented as an extension to OtherNonoperatingIncomeExpense.

As IFRS XBRL does not define a similar label, it should be presented as an extension to FinanceCosts.

Note: as this fee is akin to interest, it would not be an error to present it as an extension to InterestExpense.

While IFRS XBRL does not include an InterestExpense label under IncomeStatementAbstract, it does under AnalysisOfIncomeAndExpenseAbstract.

Pledging

Same facts except, XYZ pledged (assigned) the receivables at a 10% discount.

In general, pledging involves a pool of receivables being used as collateral for a loan.

In contrast, assigning generally involves specific receivables being assigned to a lender.

While not set in stone, receivables are usually pledged at a discount.

In contrast, receivables are generally assigned at face value plus interest and/or a fee.

For example, XYZ transferred the receivables at face value agreeing to pay 5,000 interest and a 5,000 fee in 90 days.

Cash (received from assignee)

100,000

 

 

Loan (secured by receivables)

 

100,000


In 90 days

Cash (received from customers)

100,000

 

Loan (secured by receivables)

100,000

 
Interest expense

5,000

 

Assignment fee

5,000

 

 

Receivables

 

100,000

 

Cash (paid to assignee)

 

110,000


In excel syntax: 5,000 = 100000*((1+21.55%)^(1/4)-1).

Cash (received from pledgee)

90,000

 

 

Loan (secured by receivables)

 

90,000


In 90 days

Cash (received from customers)

100,000

 

Loan (secured by receivables)

90,000

 
Loss on pledged receivables

10,000

 
 

Receivables

 

100,000

 

Cash (paid to pledgee)

 

100,000


Same facts except XYZ agreed to pay interest and a fee.

Cash

100,000

 

Loan

90,000

 
Interest expense

5,000

 

Pledging fee

5,000

 

 

Receivables

 

100,000

 

Cash

 

100,000


As neither IFRS nor US GAAP specifically addresses how to classify the costs associated with factored receivable, they are commonly recognized as outlined in the agreement.

If the agreement includes a fee, it is commonly treated like interest and sub-classified in non-operating (other) expense.

In US GAAP XBRL, it should thus be presented as an extension to OtherNonoperatingIncomeExpense.

As IFRS XBRL does not define a similar label, it should be presented as an extension to FinanceCosts.

Note: as this fee is akin to interest, it would not be an error to present it as an extension to InterestExpense.

While IFRS XBRL does not include an InterestExpense label under IncomeStatementAbstract, it does under AnalysisOfIncomeAndExpenseAbstract.

Recourse

Same facts except the factor had the right to return uncollectible receivables.

If the transferee can return the receivables to the transferor, the transferee has recourse. Recourse transaction do not generally qualify for sale accounting. Instead, they are recognized as a secured borrowings.

While they provide similar guidance, IFRS is more straight forward than and US GAAP.

As outlined in IFRS 9.3.2.6.a, if the entity transfers risks are rewards of ownership, it derecognizes the receivable and recognizes the consideration received (plus a gain or, more likely, a loss). As outlined in IFRS 9.3.2.6.b, if it does not transfer risks are rewards of ownership, it continues to recognize the receivable and to recognizes the consideration received as a liability.

To evaluate if it has transferred risk and rewards, the entity applies IFRS 9.3.2.7: "...An entity has retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the present value of the future net cash flows from the financial asset does not change significantly as a result of the transfer (eg because the entity has sold a financial asset subject to an agreement to buy it back at a fixed price or the sale price plus a lender’s return)..."

If the likelihood of default is high, the likelihood the factor will exercise its option is also high. As a result, the entity will continue to be exposed to the variability of cash flows and it cannot recognize the transfer as a sale. Instead, it would recognize the transaction as a secured borrowing.

As outlined in ASC 860-10-40-5, the transfer will recognize a sale if it surrenders control. It surrenders control if all these three conditions are met:

  1. The transferred financial assets have been isolated from the transferor and its creditors (see paragraph 860-10-55-17D)
  2. Transferee has the right to sell, exchange or pledge the transferred financial assets
  3. The transferor does maintain effective control over the transferred financial assets

When transferee has the right but not obligation to return the assets to the transferor conditions a and b are clearly met.

However, for condition c to be met the agreement would need to permit "the transferee to require the transferor to repurchase the transferred financial assets at a price that is so favorable to the transferee that it is probable that the transferee will require the transferor to repurchase them."

To interpret this guidance, additional guidance is provided by ASC 860-10-55-42D:

This implementation guidance addresses the application of paragraph 860-10-40-5(c)(3) through the following examples:

  1. A put option written to the transferee generally does not provide the transferor with effective control over the transferred financial asset under paragraph 860-10-40-5(c)(3).
  2. A put option that is sufficiently deep in the money when it is written would, under that paragraph, provide the transferor effective control over the transferred financial asset because it is probable that the transferee will exercise the option and the transferor will be required to repurchase the transferred financial asset.
  3. A sufficiently out-of-the-money put option held by the transferee would not provide the transferor with effective control over the transferred financial asset if it is probable when the option is written that the option will not be exercised.
  4. A put option held by the transferee at fair value would not provide the transferor with effective control over the transferred financial asset.

Interpreting this guidance, if the receivable(s) becomes uncollectible, its fair value will be zero, the option will be in the money and will be exercised.

Thus, if it is probable the receivable(s) will become uncollectible, the transaction is recognized as a secured borrowing, not sale.

The same guidance applies when factor has an option to return the receivables for reasons other than un-collectability.

Cash

90,000

 

 

Loan (secured by receivables)

 

90,000


In 90 days (no receivables were uncollectible)

Loan

90,000

 
Loss

10,000

 

 

Accounts receivable

 

100,000


Factoring with recourse recognized as sale

Same facts except, the default rate was insignificant.

In general, if the transferee (factor) can only return the receivables if they become uncollectible and the probability that a significant portion of the receivables will become uncollectible is low, the company may recognize the transaction as a sale rather than secured borrowing.

Note: while they provide similar guidance, IFRS is more straight forward than and US GAAP.

As outlined in IFRS 9.3.2.6.a, if the entity transfers risks are rewards of ownership, it derecognizes the receivable and recognizes the consideration received (plus a gain or, more likely, a loss). As outlined in IFRS 9.3.2.6.b, if it does not transfer risks are rewards of ownership, it continues to recognize the receivable and to recognizes the consideration received as a liability.

To evaluate if it has transferred risk and rewards, the entity applies IFRS 9.3.2.7: "...An entity has retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the present value of the future net cash flows from the financial asset does not change significantly as a result of the transfer (eg because the entity has sold a financial asset subject to an agreement to buy it back at a fixed price or the sale price plus a lender’s return)..."

If the likelihood of default is low, the likelihood the factor will exercise its option is also low. As a result, the entity will not be exposed to the variability of cash flows so it can recognize the transfer as a sale.

As outlined in ASC 860-10-40-5, the transfer will recognize a sale if it surrenders control. It surrenders control if all these three conditions are met:

  1. The transferred financial assets have been isolated from the transferor and its creditors
  2. Transferee's has the right to sell, exchange or pledge the transferred financial assets
  3. The transferor does maintain effective control over the transferred financial assets

When transferee has the right but not obligation to return the assets to the transferor conditions a and b are clearly met.

However, for condition c to be met the agreement would need to permit "the transferee to require the transferor to repurchase the transferred financial assets at a price that is so favorable to the transferee that it is probable that the transferee will require the transferor to repurchase them."

To interpret this guidance, additional guidance is provided by ASC 860-10-55-42D.

ASC 860-10-55-42D.a states: a option written to the transferee generally does not provide the transferor with effective control over the transferred financial asset.

However, ASC 860-10-55-42D.b states: a put option that is sufficiently deep in the money when it is written would, under that paragraph, provide the transferor effective control over the transferred financial asset because it is probable that the transferee will exercise the option and the transferor will be required to repurchase the transferred financial asset.

Finally, ASC 860-10-55-42D.d states: a put option held by the transferee at fair value would not provide the transferor with effective control over the transferred financial asset.

This implies that if the receivable becomes uncollectible its fair value will be zero and so the option held by the transferee is sufficiently in the money to give the transferee effective control. But this applies only if it is probable the receivable will become uncollectible.

If it is not probable the receivable will become uncollectible, the transferee does not have effective control so the transferor can recognize a sale (unless it is probable, for some other reason, the transferee will return the receivable).

Caveat: as recourse transaction can create off-balance sheet financing, they do attract regulatory attention.

Consequently, before recognizing any recourse transaction as a sale, companies should be prepared to answer questions like:

We [the SEC] note that in 2010 you engaged in factoring of specific accounts receivables and accounted for the transfer as a sale in accordance with FASB ASC 860. We note that you have credit insurance in order to mitigate credit risk related to the Company’s factoring of accounts receivable. In this regard, it appears that you are transferring the receivables with recourse. We refer you to ASC 860-10-55-46. Provide your analysis of why the transfer represents a sale under ASC 860-10-40-5. Indicate whether you recorded a recourse obligation. In addition, tell us whether you are receiving a fee for acting as the collection agent and explain why you did not recognize a service obligation. See ASC 860-50-25-1.

Link - SEC letter

Cash

90,000

 

Loss on sale of receivables

10,000

 

Allowance for doubtful accounts

2,000

 

 

Accounts receivable

 

100,000

 

Recourse provision

 

2,000


As XYZ had the obligation to reacquire uncollectible receivables, it reclassified the allowance (contra asset) as a provision (liability).

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