My name is Steve Chen, a fellow member of ACCA and course director at APC (www.globalapc.com), teaching ACCA online courses to students from all around the world. This article will explain variable consideration from IFRS 15 Revenue from contracts with customers which is relevant to the ACCA SBR exam.
Just a recap from my previous article about revenue recognition applied in the pre-fabricated housing industry.
According to IFRS 15 Revenue from contracts with customers, 5-step model needs to be applied, and my mnemonic for these 5-step model (which is widely copied by many study texts and lecturers) is COPAR (this can be found in my original YouTube video
Step 1 – Contract identification
Step 2 – Performance Obligation
Step 3 – Price
Step 4 – Allocate price to performance obligations
Step 5 – Recognise revenue – we are focusing on this step in this article.
Let’s see an example in practice (the company name is ‘Tonica plc’):
Tonica plc entered into a contract with a hotel company to construct a prefabricated hotel at the total contract price of $6m.
Tonica plc needs to procure a special elevator for the hotel, and the hotel took possession of the elevator on 1 April 2019. The following contract pricing and costs information are:
Contract price $6m
Subtract: Elevator costs = $(2)m
Subtract: Other expected total costs = $(3)m
Equals to Profits = $1m
The costs incurred to date regarding this contract are $3.5 million, including $2 million for elevator costs and $1.5 million for other costs.
The financial officer calculated the following revenue and costs to be recognised to date:
Percentage of completion: $3.5m costs incurred / $5m total costs = 70%
Revenue $6m x 70% = $4.2m
Subtract: Costs $5m x 70% = $(3.5)m
Equals to Profits = $0.7m
Identify mistakes made by the financial controller.
Analysis from Steve Chen (ACCA APC Course Director at www.globalapc.com):
The above input method used to calculate the stage of completion is not correct.
Per IFRS 15, the procurement cost of the elevator of $2 million should not be included in the stage of completion calculation because Tonica plc has not been involved in designing and developing it.
Tonica plc purchased from the external third party on behalf of the client. In this case, the stage of completion should be revised as follows:
% = $1.5m /$3m = 50%
The following revenue and costs should be recognised:
Revenue $6m x 50% + elevator costs $3m + $2m = $5m
Subtract costs $3m x 50% + elevator costs = $1.5m + $2m=$3.5m
Equal to Profits = $1.5m
Both revenue and costs include the elevator costs of $2m, and this is the current approach per IFRS 15, in other words, to recognise this at 0 profit. This is also known as the zero-margin approach.
This is a technical area in IFRS 15 where many finance professionals in practice may not notice. From the ACCA SBR exam’s perspective, students are required to comment on the general approach in the standard and comment on the specific applications to the company.
In addition to providing ACCA lectures online, I also wrote articles in ACCA AB magazine. Besides, I am the author of four accounting books. If you are interested in studying ACCA courses with me, please visit my website http://www.globalapc.com for further information, where you can find many of my ACCA demo video lectures.