The world today is packed with different kinds of products, services, transactions and many other activities that people and business do. Logically, it is sometimes very tough issue for accountants to determine WHEN and even WHETHER to recognize revenue in the financial statements.
That’s exactly the main aim of the standard IAS 18—to give guidance on the revenue recognition and help in the application of the revenue recognition criteria.
UPDATE 2018: Please note that for the periods starting on or after 1 January 2018, you have to apply IFRS 15 Revenue from Contracts with Customers and IAS 18 becomes superseded. I leave this article here for your information.
What is Revenue?
Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants.
Agency relationship = revenue?
Here I would like to stress that the revenue includes only the economic benefits received or receivable on the entity’s own account. However, entities often collect the amounts on behalf of the third parties, such as taxes payable to the state budget—these amounts are NOT revenue and CANNOT be recognized as such.
Also, agency transactions are very common in today’s business and sometimes it’s not easy to determine the agency relationship. In agency relationship, the agent just collects the amounts on behalf of the principal and thus cannot recognize the revenue.
For example, mobile operators often sell some additional content with their monthly prepaid calling plans, such as music or application. The relationship between 3 parties is illustrated in the following scheme:
However, it is difficult to determine the existence of agency relationship and therefore IAS 18 sets in its Appendix 4 criteria that, individually or in combination, indicate that an entity is acting as principal:
- The entity has the primary responsibility for providing the goods or services to customer or for fulfilling the order.
- The entity has the inventory risk before or after the customer order, during shipping or on return.
- The entity has latitude in establishing prices, either directly or indirectly.
- The entity bears the customer’s credit risk on the receivable due from the customer of the service.
So each transaction must be carefully assessed and if only 1 criterion is met then the entity probably acts as a principal and recognizes revenue from the transaction.
Measurement of Revenue
The revenue shall be measured at fair value of consideration received or receivable. IAS 18 specifies the following:
- Any trade discounts or rebates shall be deducted and revenue is measured net of these items.
- When the cash inflow is deferred or postponed to future, then the fair value of consideration received might be less than its nominal amount. In this case, the fair value of consideration received is determined by discounting future cash flows to their present value using the imputed rate of interest.
- With regard to exchanges of goods or services (barter transactions):
- When goods or services are of a similar nature, then the exchange is not regarded as a transaction revenue generating and the revenue cannot be recognized.
- When goods or services are of a dissimilar nature, then the exchange is regarded as a transaction revenue generating and the revenue is recognized in amount of fair value of goods/services received (adjusted by the amount of any cash transferred).
Recognition of Revenue
IAS 18 specifies revenue recognition criteria for 3 basic revenue generating scenarios:
- Sale of goods
- Rendering of services
- Interest, Royalties and Dividends
Sale of Goods
Revenue from sale of goods is recognized when all of the following conditions are satisfied:
- the entity has transferred to the buyer the significant risks and rewards of ownership of the goods
- the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold
- the amount of revenue can be measured reliably
- it is probable that the economic benefits associated with the transaction will flow to the entity
- the costs incurred or to be incurred in respect of the transaction can be measured reliably.
IAS 18 sets in its Appendix the practical guidance on recognition of revenue from various situations when selling goods. I have summarized it in the following table:
| Transaction | Revenue Recognition |
| Bill and Hold Sales | When the buyer takes title. |
| Goods Shipped Subject to Conditions | |
| – installation & inspection | When the buyer accepts delivery and installation & inspection is completed. |
| – on approval | When the buyer formally accepts the shipment |
| – with limited right of return | When the goods were delivered and time for return lapsed. |
| – consignment sales | After the buyer sells goods to the final customer. |
| – cash on delivery sales | When delivery is made and cash is received by the seller. |
| Lay Away Sales | When the delivery is made. |
| Sale and Repurchase Agreements | Look out for financing arrangement – not revenue. |
| Subscriptions to Publications | In line with the period over which the items are dispatched. |
Rendering of Services
Here, can the outcome of the transaction be estimated reliably?
- If yes, then the revenue can be recognized by the reference to the stage of completion of the transaction at the end of the reporting period.
- If not, then the revenue can be recognized only to the extent of the expenses recognized that are recoverable.
When can the outcome of the transaction be estimated reliably? It is when all the following conditions are satisfied:
- the amount of revenue can be measured reliably
- it is probable that the economic benefits associated with the transaction will flow to the entity
- the stage of completion of the transaction at the end of the reporting period can be measured reliably and
- the costs incurred for the transaction and the costs to complete the transaction can be measured reliably
IAS 18 sets in its Appendix the practical guidance on recognition of revenue from various situations when rendering services. I have summarized it in the following table:
| Transaction | Revenue Recognition |
| Installation Fees | With reference to the stage of completion. |
| Servicing Fees | If subsequent services are included, then defer the revenue for the subsequent services. |
| Advertising Commissions | |
| – Media Commissions | When the related advertisement appears before the public. |
| – Production Commissions | With reference to the stage of completion. |
| Insurance Agency Commissions | |
| – Agent Renders Further Services | Defer over the period during which the policy is in force. |
| – Agent Does Not Render Further Services | At the date of policy commencement or renewal. |
| Financial Services | |
| – Integral Part of Effective Interest Rate | Based on the classification of the related financial instrument |
| – Earned As Services Are Provided | When related service is provided. |
| – Earned On Execution of Significant Act | When related significant act has been completed. |
| Admission Fees | When the event takes place or allocate proportionally to individual events. |
| Tuition Fees | Over the period of instruction. |
| Initiation, Entrance, Membership Fees | |
| – No additional services provided | Immediately when membership starts. |
| – Additional services provided | Defer over the membership period on some reasonable basis. |
| Franchise Fees | On the basis reflecting the purpose for which the fees are charged. |
| Fees from Development of Customized Software | With reference to the stage of completion, including the post-delivery service support stage. |
Interest, Royalties and Dividends
Revenue arising from the use by others of entity assets yielding interest, royalties and dividends shall be recognized when:
- it is probable that the economic benefits associated with the transaction will flow to the entity and
- the amount of the revenue can be measured reliably.
Revenue shall be recognized on the following bases:
- interest shall be recognized using the effective interest method as set out in IAS 39
- royalties shall be recognized on an accrual basis in accordance with the substance of the relevant agreement
- dividends shall be recognized when the shareholder’s right to receive payment is established.
Current development
In May 2014, the new standard IFRS 15 Revenue from Contracts with Customers was issued and will replace IAS 18 for the periods starting on or after 1 January 2018 mandatorily.
Please watch the following video summarizing IAS 18:
