04 May 2020
The outbreak of coronavirus is likely to have an adverse impact on the demand for goods and services and supply chain cycles are likely to be disrupted. The knock-on impact on working capital could result in customers being unable to pay for goods or services.
What does FRS 102 say?
General recognition principles
Two general recognition principles apply to all revenue streams under FRS 102:
- it is probable that any future economic benefit associated with the transaction will flow to the entity; and
- the amount of revenue can be measured with reliability.
Sale of goods
In addition to the general recognition principles, revenue from the sale of goods is recognised when the following additional conditions have been met:
- 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; and
- the costs incurred or to be incurred in respect of the transaction can be measured reliably.
Generally, the transfer of the risks and rewards of ownership is at the same time as the transfer of the legal title to the buyer. However, in other cases, the transfer of risks and rewards of ownership occurs at a time different from the transfer of legal title or the passing of possession, with the timing of the transfer depending on the specific terms and conditions of the contract. For example:
- when the receipt of the revenue from a particular sale is contingent on the buyer selling the goods;
- when the goods are shipped subject to installation and the installation is a significant part of the contract that has not yet been completed; and
- when the buyer has the right to rescind the purchase for a reason specified in the sales contract, or at the buyer’s sole discretion without any reason, and the entity is uncertain about the probability of return.
Provision of services
For the rendering of services, revenue is recognised when the services are transferred. When the outcome of a transaction can be estimated reliably, revenue is recognised based on the stage of completion of the transaction at the end of the reporting period.
The outcome of a transaction can be estimated reliably when, in addition to the general recognition principles, both of the following conditions are satisfied:
- 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.
If the outcome of the transaction involving the rendering of services cannot be estimated reliably, revenue is recognised only to the extent of the expenses recognised that it is probable will be recovered.
For construction contracts, when the outcome can be estimated reliably, contract revenue and contract costs associated with the construction contract are recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the end of the reporting period. Reliable estimation of the outcome requires reliable estimates of the stage of completion, future costs and collectability of billings.
In addition, costs that relate to future activity on the transaction or contract, such as for materials or prepayments, are recognised as an asset if it is probable that the costs will be recovered. For any costs whose recovery is not probable, these must be expensed.
When the outcome of a construction contract cannot be estimated reliably, revenue is recognised only to the extent of the probable recoverable contract costs; and contract costs are recognised as an expense in the period in which they are incurred. If it is expected that total contract costs will exceed total contract revenue the expected loss is recognised as an expense immediately, with a corresponding provision for an onerous contract.
If the collectability of an amount already recognised as contract revenue is no longer probable, the uncollectible amount is recognised as an expense rather than as an adjustment of the amount of contract revenue.
Practical impact and interpretation for preparers
General recognition principles
Entities will need to carefully consider whether the recognition principles have been met. In particular, the degree of uncertainty associated with the receipt of the consideration which will allow the economic benefits associated with the transaction to flow to the entity.
- This assessment is undertaken on the basis of available evidence when the financial statements are prepared, based on the conditions that existed at the balance sheet date. It may no longer be probable that the economic benefits will flow to the entity until the consideration is received, or the uncertainty associated with the coronavirus situation is removed.
- Where uncertainty arises about the collectability of an amount that has already been recognised in revenue, any provision as a result of the uncertainty is recognised as an expense and not a reduction in revenue.
- Entities which have a reporting date between the first noted case of coronavirus on 17 November 2019 and the announcement of coronavirus as a global pandemic on 11 March 2020 have a more difficult conclusion to reach and will need to consider the requirements of Section 32 Events after the reporting period.
The second principle states that it must be possible to reliably measure the amount of revenue. Generally, concerns about the reliability of revenue measurement arise from the rendering of services and construction activities, rather than the sale of goods. However, goods are often sold with trade discounts, prompt settlement discounts or volume rebates. These are taken into account in the fair value of the consideration recognised as revenue. Given the current coronavirus situation, estimating the volume of sales or settlement discounts may prove difficult. Generally, if no reliable estimate can be made, the revenue recognised on the transaction should not exceed the maximum amount of consideration that would be received if the maximum discounts were taken. Other implications include:
- Reduced demand leading to an increase in expected returns, additional price concessions, penalties for late delivery or a reduction in prices, affecting the measurement of revenue.
- Expected returns being higher as a result of coronavirus which will also impact inventory.
- Customers being offered deferred payment terms (beyond normal credit terms) which may need to be accounted for as a financing transaction, depending on how long the payment is likely to be deferred.
Sale of goods
There are other implications for the sale of goods that may result in revenue no longer being recognised:
- for bill and hold sales it needs to be probable that delivery will be made, which may no longer be possible;
- where revenue is recognised only where the buyer subsequently sells the goods to a third party, the current coronavirus lockdown may mean that the subsequent sale is unlikely to take place;
- where goods are shipped subject to installation, which is a significant part of the contract, it may not be possible to complete the installation due to coronavirus restrictions.
Provision of services and construction contracts
- For provision of services and construction contracts, the percentage stage of completion calculation may be more difficult as costs to complete may not be readily estimated.
- Provisions may be required in respect of costs recognised in relation to a future activity, such as for materials or prepayments, if there are uncertainties whether these will now be recovered.
- Consider whether the two general recognition principles can be applied to the entity’s revenue streams ie is it probable that economic benefit will flow to the entity as a result of a transaction and can the amount be measured with reasonable certainty.
- For the sale of goods:
- consider the likelihood and impact of a higher level of returns due to coronavirus; and
- consider the likelihood of a customer being able to sell on any goods where revenue is dependent on this transaction occurring.
- For services provided:
- consider whether it is possible to determine the costs to complete; and
- ensure the stage of completion calculation includes any new costs that may arise as a result of coronavirus.
- For construction contracts:
- consider whether it is possible to determine all of the future costs;
- review any assets held in relation to the construction contract to determine whether any provisions for impairment are required.