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10 Exposure Draft: Conceptual Framework for Financial Reporting

10 Exposure Draft: Conceptual Framework for Financial Reporting

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To assist the International Accounting Standards Board (IASB) to develop Standards that are

based on consistent concepts


To assist preparers to develop consistent accounting policies when no Standard applies

to a particular transaction or event, or when a Standard allows a choice of accounting policy, and


To assist all parties to understand and interpret the Standards

The Conceptual Framework is not an IFRS, nor does it override any specific IFRS. If the IASB decides to

issue a new or revised pronouncement that is in conflict with the framework, the IASB will highlight the

fact and explain the reasons for the departure.

3.10.4 Chapter 1: The Objective of General Purpose Financial Reporting

This Chapter, together with Chapter 2, was finalised in the 2010 version of the Conceptual Framework, and

so there are only limited changes from that version.

The main change is that more emphasis is placed on the importance of providing information needed to

assess management’s stewardship of an entity’s resources.

3.10.5 Chapter 2: Qualitative characteristics of useful financial information

This Chapter, together with Chapter 1, was finalised in the 2010 version of the Conceptual Framework, and

so there are generally only limited changes from that version. However, one change that could be regarded

as important is the introduction of an explicit reference to the idea of prudence. Prudence is described

as the exercise of caution when making judgements under conditions of uncertainty. It is explicitly

stated that prudence is important in achieving neutrality, and therefore in achieving faithful

representation. Prudence had been removed from the Conceptual Framework in 2010.

The IASB has further clarified that prudence works both ways: assets and liabilities should be neither

overstated nor understated.

Another key change is to the explanation of faithful representation. The chapter contains a proposed

addition that would clarify that faithful representation means representation of the substance of an

economic phenomenon instead of representation of merely its legal form.

3.10.6 Chapter 3: Financial Statements and the reporting entity

This Chapter is not in the current version of the Conceptual Framework, and is based on the feedback

received on a 2010 Exposure Draft on the topic.

The ED states the objective of financial statements as being to provide information about an entity's

assets, liabilities, equity, income and expenses that is useful to financial statements users in assessing the

prospects for future net cash inflows to the entity and in assessing management's stewardship of the

entity's resources. It then sets out the going concern assumption, which is unchanged from the current


Definition of the reporting entity

A reporting entity is an entity that chooses, or is required, to present general purpose financial statements.

It does not need to be a legal entity and can comprise only a portion of an entity or two or more entities.

Boundary of the reporting entity

The Exposure Draft proposes to determine the boundary of a reporting entity that has one or more

subsidiaries on the basis of control. The boundary can be determined by either direct control, which

results in unconsolidated or individual financial statements or by direct and indirect control, which

results in consolidated financial statements.

Part A Regulatory and ethical framework  1: Financial reporting framework


The following diagram, taken from the IASB’s ‘Snapshot’, provides a summary of the approach:

Reporting entity

direct and







consolidated financial statements

unconsolidated financial statements

Consolidated financial statements, according to the ED, are generally more likely to provide useful

information to users than unconsolidated financial statements. If an entity prepares both, the

unconsolidated financial statements must disclose how users may obtain the consolidated financial


3.10.7 Chapter 4: The elements of financial statements

The elements of financial statements are, as in the existing Conceptual Framework, assets, liabilities,

equity, income and expense. However, the definitions have been modified

The current definitions of assets and liabilities require a probable expectation of future economic benefits

or resource outflow. The IASB argues that the definitions of assets and liabilities should not require an

expected or probable inflow or outflow as it should be sufficient that a resource or obligation can produce

or result in a transfer of economic benefits. While the IASB believes that the current definitions have

worked well in the past, it wishes to refine them in order to place more emphasis on the fact that an asset

is a resource and a liability is an obligation. In addition, the notion of probability will be removed from the

definitions. The proposed definitions are:


An asset is a present economic resource controlled by the entity because of past events.


A liability is a present obligation of the entity to transfer an economic resource because of past


An economic resource is a right that has the potential to produce economic benefits.

A present obligation is an obligation to transfer economic resources that:


The entity has no practical ability to avoid, and


Has arisen from a past event (ie economic benefits already received or activities already


For the definitions of both assets and liabilities, the IASB decided not to retain the notion of an ‘expected

inflow or outflow of resources’ in acknowledgement of concerns about varied interpretations of the term

‘expected’ and the notion of a threshold level of probability.

Equity continues to be defined as ‘the residual interest in the assets of the entity after deducting all its

liabilities’. It should be noted that while the 2013 Discussion Paper addressed problems that arise in

classifying instruments with characteristics of both liabilities and equity, the ED does not do so.

Exploring those problems has been transferred to the IASB's research project on financial instruments

with the characteristics of equity.

Income is increases in assets or decreases in liabilities that result in increases in equity, other than those

relating to contributions from holders of equity claims.

Expenses are decreases in assets or increases in liabilities that result in decreases in equity, other than

those relating to distributions to holders of equity claims.


1: Financial reporting framework  Part A Regulatory and ethical framework

3.10.8 Chapter 5: Recognition and derecognition


Recognition is the process of capturing an asset or a liability for inclusion in the statement of financial

position. The ED states that only items that meet the definition of an asset, a liability or equity are

recognised in the statement of financial position, and only items that meet the definition of income or

expenses are to be recognised in the statement(s) of financial performance.

The ED requires that recognition criteria, based on the qualitative characteristics of useful financial

information, must be met. An entity recognises an asset or liability if such recognition provides users of

the financial statements with:




Relevant information about the asset or liability

A faithful representation of the asset or liability and of any resulting income and expenses, and

Information that results in benefits exceeding the cost of providing that information

Those criteria may not always be met in the following cases:


It is uncertain whether an asset or liability exists.


There is only a low probability of future inflows (outflows) of economic benefits from the asset



The level of measurement uncertainty is so high that the resulting information has little relevance.

Whether the information provided is useful to users depends on the item and the specific facts and

circumstances. Entities may also be required to exercise judgement, and recognition may vary,

depending on the IFRS being applied.


Guidance on derecognition is new to this proposed version of the Conceptual Framework. The guidance is

driven by the requirement of faithful representation. A faithful representation must be provided of:



The assets and liabilities retained after a transaction or other event that led to derecognition, and

The change in the entity’s assets and liabilities as a result of that transaction or other event.

Decisions about derecognition are generally straightforward. However, in some cases the two aims

described above conflict with each other, making the decisions more difficult. The discussion in the

Exposure Draft focuses on these cases.

3.10.9 Chapter 6: Measurement

The guidance on measurement is an example of filling in gaps present in the existing Conceptual

Framework. While developing the ED, the IASB considered whether the Conceptual Framework should

advocate the use of a single measurement basis. Considering the different assets and liabilities being

measured, relevance and the cost constraint, the Board eventually concluded that a multiple

measurement approach is more appropriate.

The ED covers the following:


A description of various measurement bases, the information that these measurement bases

provide and their advantages and disadvantages. The measurement bases are historical cost and

current value measures (fair value and value in use/fulfilment value)


Factors to consider when selecting a measurement basis (relevance, faithful representation,

enhancing qualitative characteristics, and factors specific to initial measurement)


Situations when more than one measurement basis provides relevant information. Consideration

of the objective of financial reporting, the qualitative characteristics of useful financial information

and the cost constraint are likely to result in the selection of different measurement bases for

different assets, liabilities and items of income and expense

Part A Regulatory and ethical framework  1: Financial reporting framework



Measurement of equity

Appendix A of the ED supplements this Chapter, and describes cash-flow-based measurement techniques

for cases when a measure determined using a measurement basis cannot be observed.

3.10.10 Chapter 7: Presentation and disclosure

This Chapter discusses concepts that determine what information is included in the financial statements

and how that information should be presented and disclosed. These concepts are intended to guide the

IASB in setting presentation and disclosure requirements in individual standards and to guide entities in

providing information in financial statements.

Disclosure initiative

The IASB is also undertaking a Disclosure Initiative, a collection of implementation and research projects

aimed at improving disclosure in IFRS financial reporting. In the Disclosure Initiative, the IASB will seek to

provide additional specific guidance to support the application of the concepts. This is discussed in more

detail in Chapter 19.

Concepts and principles discussed in the ED

The ED discusses the following issues:


The balance between entities’ flexibility to provide relevant information that faithfully represents

the entity’s assets and liabilities and the transactions and other events of the period, and

comparability among entities and across reporting periods.


Entity-specific information is more useful than boilerplate language for efficient and effective



Duplication of information in various sections of the financial statements is unnecessary and

makes financial statements less understandable.

Profit or loss and other comprehensive income

This part of the ED discusses presentation disclosure in the statement of financial performance, and

provides conceptual guidance on whether to present income and expenses in profit or loss or in other

comprehensive income.

Both profit or loss and other comprehensive income would be retained and marked by subtotals or totals.

The purpose of the statement of profit or loss is to depict the return an entity has made on its economic

resources during the period and to provide information that is helpful in assessing future cash flows and

management’s stewardship of the entity’s resources. By default, therefore, all income and expense will

be shown in profit or loss unless relating to the remeasurement of assets and liabilities - these would

normally be shown in other comprehensive income. However, for an item recognised in other

comprehensive income in one period, there is a presumption that it will be included in the statement of

profit or loss in a future period, unless there is no clear basis for identifying the period in which

reclassification would enhance the relevance of the information in the statement of profit or loss.

3.10.11 Chapter 8: Concepts of capital and capital maintenance

This Chapter comprises material carried forward from Chapter 4 of the existing Conceptual Framework

with minor changes for consistency of terminology

3.11 Possible criticisms

3.11.1 EY

In a June 2015 overview, EY commented:

We support the IASB’s proposal to update the Conceptual Framework. However, there are certain

significant topics that are not addressed in the proposals, such as the distinction between equity

and liability, the content of ‘financial performance’, the characteristics of income and expenses that

should be presented in OCI, and the rationale for recycling of gains and losses in OCI to P/L. A


1: Financial reporting framework  Part A Regulatory and ethical framework

framework that does not explore such topics in more detail may have gaps that will make its

applicability less useful.

3.11.2 The Financial Reporting Council (FRC)

In a July 2015 meeting, the FRC’s Accounting Council considered the ED and produced a draft response.

While the proposals were broadly welcome, the FRC had tentative criticisms, of which the following are

the most relevant to your exam.

Exam focus



Prudence. The ED does not reflect the notion of ‘asymmetric prudence’—the recognition of losses

and liabilities at a lower level of likelihood (and hence often earlier) than gains and assets. This

notion is mentioned in the Basis for Conclusions, but ought to be part of the Conceptual

Framework itself.


Neutrality. Prudence is a way of achieving ‘neutrality’, defined as ‘without bias’. However, the FRC

believe that ‘unbiased’ would be a clearer word.


Reliability. The description of faithful representation given in the Exposure Draft does not include

the idea, which was in the discussion of reliability in a previous version of the Conceptual

Framework, that the information ‘can be depended upon by users’. The idea of reliability needs to

be reinstated.


Statement of profit or loss. Terms such as ‘profit’, ‘return’ and ‘performance’ need to be defined,

and the significance of recycling adjustments needs to be explained.


Elements. The Exposure Draft does not propose to define elements for the statement of cash


The examining team have flagged this topic as important. Keep an eye on future developments by reading

Student Accountant and www.iasplus.com/agenda/framework.htm

4 Revenue recognition


6/08, 12/08, 6/11, 12/11, 6/13, 12/13,

6/14, 12/15

Revenue recognition is straightforward in most business transactions, but some situations are more


4.1 Introduction

Accruals accounting is based on the matching of costs with the revenue they generate. It is crucially

important under this convention that we can establish the point at which revenue may be recognised so

that the correct treatment can be applied to the related costs. For example, the costs of producing an item

of finished goods should be carried as an asset in the statement of financial position until such time as it

is sold; they should then be written off as a charge to the trading account. Which of these two treatments

should be applied cannot be decided until it is clear at what moment the sale of the item takes place.

The decision has a direct impact on profit since under the prudence concept it would be unacceptable to

recognise the profit on sale until a sale had taken place in accordance with the criteria of revenue


Revenue is generally recognised as earned at the point of sale, because at that point four criteria will

generally have been met.

The product or service has been provided to the buyer.

The buyer has recognised his liability to pay for the goods or services provided. The converse of

this is that the seller has recognised that ownership of goods has passed from himself to the


Part A Regulatory and ethical framework  1: Financial reporting framework


The buyer has indicated his willingness to hand over cash or other assets in settlement of his


The monetary value of the goods or services has been established.

At earlier points in the business cycle there will not, in general, be firm evidence that the above criteria

will be met. Until work on a product is complete, there is a risk that some flaw in the manufacturing

process will necessitate its writing off; even when the product is complete there is no guarantee that it will

find a buyer.

At later points in the business cycle, for example when cash is received for the sale, the recognition of

revenue may occur in a period later than that in which the related costs were charged. Revenue

recognition would then depend on fortuitous circumstances, such as the cash flow of a company's

customers, and might fluctuate misleadingly from one period to another.

However, there are times when revenue is recognised at other times than at the completion of a sale.

For example, in the recognition of profit on long-term construction contracts (performance obligations

satisfied over time, see below). 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 year end.


Owing to the length of time taken to complete such contracts, to defer taking profit into account

until completion may result in the statement of profit or loss and other comprehensive income

reflecting, not so much a fair view of the activity of the company during the year, but rather the

results relating to contracts which have been completed by the year end.


Revenue in this case is recognised when production on, say, a section of the total contract is

complete, even though no sale can be made until the whole is complete.

4.2 IFRS 15 Revenue from contracts with customers


IFRS 15 Revenue from contracts with customers is concerned with the recognition of revenues arising

from fairly common transactions.

The sale of goods

The rendering of services

The use by others of entity assets yielding interest, royalties and dividends

Generally revenue is recognised when the entity has transferred promised goods or services to the

customer. The standard sets out five steps for the recognition process.

Income, as defined by the IASB Conceptual Framework (see above), includes both revenues and gains.

Revenue is income arising in the ordinary course of an entity's activities and it may be called different

names, such as sales, fees, interest, dividends or royalties.

IFRS 15 Revenue from contracts with customers was issued in May 2014. It is the result of a joint IASB

and FASB project on revenue recognition. It seeks to strike a balance between the IASB rules in IAS 18,

which were felt to be too general, leading to a lot of diversity in practice, and the FASB regulations, which

were too numerous.

IFRS 15 replaces both IAS 18 Revenue and IAS 11 Construction contracts. It is effective for reporting

periods beginning on or after 1 January 2017. Its core principle is that revenue is recognised to depict the

transfer of goods or services to a customer in an amount that reflects the consideration to which the entity

expects to be entitled in exchange for those goods or services.

Under IFRS 15 the transfer of goods and services is based upon the transfer of control, rather than the

transfer of risks and rewards as in IAS 18. Control of an asset is described in the standard as the ability

to direct the use of, and obtain substantially all of the remaining benefits from, the asset.

For straightforward retail transactions IFRS 15 will have little, if any, effect on the amount and timing of

revenue recognition. For contracts such as long-term service contracts and multi-element arrangements it

could result in changes either to the amount or to the timing of revenue recognised.


1: Financial reporting framework  Part A Regulatory and ethical framework

4.3 Scope

IFRS 15 applies to all contracts with customers except:

Leases within the scope of IAS 17

Insurance contracts within the scope of IAS 4

Financial instruments and other contractual rights and obligations within the scope of IFRS 9, IFRS

10, IFRS 11, IAS 27 or IAS 28.

Non-monetary exchanges between entities in the same line of business

4.4 Definitions

The following definitions are given in the standard.

Key term

Income – Increases in economic benefits during the accounting period in the form of inflows or

enhancements of assets or decreases of liabilities that result in an increase in equity, other than those

relating to contributions from equity participants.

Revenue - Income arising in the course of an entity’s ordinary activities.

Contract – An agreement between two or more parties that creates enforceable rights and obligations.

Contract asset – An entity’s right to consideration in exchange for goods or services that the entity has

transferred to a customer when that right is conditioned on something other than the passage of time (for

example the entity’s future performance).

Receivable – An entity’s right to consideration that is unconditional – ie only the passage of time is

required before payment is due.

Contract liability – An entity’s obligation to transfer goods or services to a customer for which the entity

has received consideration (or the amount is due) from the customer.

Customer – A party that has contracted with an entity to obtain goods or services that are an output of the

entity’s ordinary activities in exchange for consideration.

Performance obligation – A promise in a contract with a customer to transfer to the customer either:


A good or service (or a bundle of goods or services) that is distinct; or


A series of distinct goods or services that are substantially the same ad that have the same pattern

of transfer to the customer.

Stand-alone selling price – The price at which an entity would sell a promised good or service separately

to a customer.

Transaction price – 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


(IFRS 15)

Revenue does not include sales taxes, value added taxes or goods and service taxes which are only

collected for third parties, because these do not represent an economic benefit flowing to the entity.

4.5 Recognition and measurement of revenue

Under IFRS 15 revenue is recognised and measured using a five step model.

Step 1

Identify the contract with the customer.

A contract with a customer is within the scope of IFRS 15 only when:






The parties have approved the contract and are committed to carrying it out.

Each party’s rights regarding the goods and services to be transferred can be identified.

The payment terms for the goods and services can be identified

The contract has commercial substance

It is probable that the entity will collect the consideration to which it will be entitled.

Part A Regulatory and ethical framework  1: Financial reporting framework


The contract can be written, verbal or implied.

Step 2

Identify the separate performance obligations. The key point is distinct goods or services.

A contract includes promises to provide goods or services to a customer. Those promises

are called performance obligations. A company would account for a performance obligation

separately only if the promised good or service is distinct. A good or service is distinct if it

is sold separately or if it could be sold separately because it has a distinct function and a

distinct profit margin. Factors for consideration as to whether an entity’s promise to transfer

the good or service to the customer is separately identifiable include, but are not limited to:


The entity does not provide a significant service of integrating the good or service

with other goods or services promised in the contract.


The good or service does not significantly modify or customize another good or

service promised in the contract.


The good or service is not highly dependent on or highly interrelated with other

goods or services promised in the contract.

Step 3

Determine the transaction price. The transaction price is the amount of consideration a

company expects to be entitled to from the customer in exchange for transferring goods or

services. The transaction price would reflect the company’s probability-weighted estimate of

variable consideration (including reasonable estimates of contingent amounts) in addition

to the effects of the customer’s credit risk and the time value of money (if material).

Variable contingent amounts are only included where it is highly probable that there will not

be a reversal of revenue when any uncertainty associated with the variable consideration is

resolved. Examples of where a variable consideration can arise include: discounts, rebates,

refunds, price concessions, credits and penalties.

Step 4

Allocate the transaction price to the performance obligations. Where a contract contains

more than one distinct performance obligation a company allocates the transaction price to

all separate performance obligations in proportion to the stand-alone selling price of the

good or service underlying each performance obligation. If the good or service is not sold

separately, the company would estimate its stand-alone selling price.

So, if any entity sells a bundle of goods and/or services which it also supplies unbundled,

the separate performance obligations in the contract should be priced in the same

proportion as the unbundled prices. This would apply to mobile phone contracts where the

handset is supplied ‘free’. The entity must look at the stand-alone price of such a handset

and some of the consideration for the contract should be allocated to the handset.

Step 5

Recognise revenue when (or as) a performance obligation is satisfied. The entity satisfies

a performance obligation by transferring control of a promised good or service to the

customer. A performance obligation can be satisfied at a point in time, such as when

goods are delivered to the customer, or over time. An obligation satisfied over time will

meet one of the following criteria:

The customer simultaneously receives and consumes the benefits as the

performance takes place.

The entity’s performance creates or enhances an asset that the customer controls as

the asset is created or enhanced.

The entity’s performance does not create an asset with an alternative use to the

entity and the entity has an enforceable right to payment for performance completed

to date.

The amount of revenue recognised is the amount allocated to that performance obligation in

Step 4.


1: Financial reporting framework  Part A Regulatory and ethical framework

An entity must be able to reasonably measure the outcome of a performance obligation

before the related revenue can be recognised. In some circumstances, such as in the early

stages of a contract, it may not be possible to reasonably measure the outcome of a

performance obligation, but the entity expects to recover the costs incurred. In these

circumstances, revenue is recognised only to the extent of costs incurred.

4.5.1 Example: identifying the separate performance obligation

Office Solutions, a limited company, has developed a communications software package called CommSoft.

Office Solutions has entered into a contract with Logisticity to supply the following:


Licence to use CommSoft


Installation service. This may require an upgrade to the computer operating system, but the

software package does not need to be customized


Technical support for three years


Three years of updates for CommSoft

Office Solutions is not the only company able to install CommSoft, and the technical support can also be

provided by other companies. The software can function without the updates and technical support.


Explain whether the goods or services provided to Logisticity are distinct in accordance with IFRS 15

Revenue from contracts with customers.


CommSoft was delivered before the other goods or services and remains functional without the updates

and the technical support. It may be concluded that Logisticity can benefit from each of the goods and

services either on their own or together with the other goods and services that are readily available.

The promises to transfer each good and service to the customer are separately identifiable In particular,

the installation service does not significantly modify the software itself and, as such, the software and the

installation service are separate outputs promised by Office Solutions rather than inputs used to produce a

combined output.

In conclusion, the goods and services are distinct and amount to four performance obligations in the

contract under IFRS 15.

4.5.2 Example: determining the transaction price

Taplop supplies laptop computers to large businesses. On 1 July 20X5, Taplop entered into a contract with

TrillCo, under which TrillCo was to purchase laptops at $500 per unit. The contract states that if TrillCo

purchases more than 500 laptops in a year, the price per units is reduced retrospectively to $450 per unit.

Taplop’s year end is 30 June.


As at 30 September 20X5, TrillCo had bought 70 laptops from Taplop. Taplop therefore estimated

that TrillCo’s purchases would not exceed 500 in the year to 30 June 20X6, and would therefore

not be entitled to the volume discount.


During the quarter ended 31 December 20X5, TrillCo expanded rapidly as a result of a substantial

acquisition, and purchased an additional 250 laptops from Taplop. Taplop then estimated that

TrillCo’s purchases would exceed the threshold for the volume discount in the year to 30 June



Calculate the revenue Taplop would recognise in:



The quarter ended 30 September 20X5

The quarter ended 31 December 20X5

Your answer should apply the principles of IFRS 15 Revenue from contracts with customers.

Part A Regulatory and ethical framework  1: Financial reporting framework




Applying the requirements of IFRS 15 to TrillCo’s purchasing pattern at 30 September 20X5,

Taplop should conclude that it was highly probable that a significant reversal in the cumulative

amount of revenue recognised ($500 per laptop) would not occur when the uncertainty was

resolved, that is when the total amount of purchases was known. Consequently, Taplop should

recognise revenue of 70 x $500 = $35,000 for the first quarter ended 30 September 20X5.


In the quarter ended 31 December 20X5, TrillCo’s purchasing pattern changed such that it would

be legitimate for Taplop to conclude that TrillCo’s purchases would exceed the threshold for the

volume discount in the year to 30 June 20X6, and therefore that it was appropriate to reduce the

price to $450 per laptop. Taplop should therefore recognise revenue of $109,000 for the quarter

ended 31 December 20X5. The amount is calculated as from $112,500 (250 laptops x $450) less

the change in transaction price of $3,500 (70 laptops x $50 price reduction) for the reduction of the

price of the laptops sold in the quarter ended 30 September 20X5.

4.6 Contract costs

The incremental costs of obtaining a contract (such as sales commission) are recognised as an asset if

the entity expects to recover those costs.

Costs that would have been incurred regardless of whether the contract was obtained are recognised as an

expense as incurred.

Costs incurred in fulfilling a contract, unless within the scope of another standard (such as IAS 2

Inventories, IAS 16 Property, plant and equipment or IAS 38 Intangible assets) are recognised as an asset

if they meet the following criteria:


The costs relate directly to an identifiable contract (costs such as labour, materials, management



The costs generate or enhance resources of the entity that will be used in satisfying (or continuing

to satisfy) performance obligations in the future; and


The costs are expected to be recovered

Costs recognised as assets are amortised on a systematic basis consistent with the transfer to the

customer of the goods or services to which the asset relates.

4.7 Performance obligations satisfied over time

A performance obligation satisfied over time meets the criteria in Step 5 above and, if it entered into more

than one accounting period, would previously have been described as a long-term contract.

In this type of contract an entity has an enforceable right to payment for performance completed to date.

The standard describes this as an amount that approximates the selling price of the goods or services

transferred to date (for example recovery of the costs incurred by the entity in satisfying the performance

plus a reasonable profit margin).

Methods of measuring the amount of performance completed to date encompass output methods and

input methods.

Output methods recognise revenue on the basis of the value to the customer of the goods or services

transferred. They include surveys of performance completed, appraisal of units produced or delivered etc.

Input methods recognise revenue on the basis of the entity’s inputs, such as labour hours, resources

consumed, and costs incurred. If using a cost-based method, the costs incurred must contribute to the

entity’s progress in satisfying the performance obligation.


1: Financial reporting framework  Part A Regulatory and ethical framework

4.8 Performance obligations satisfied at a point in time

A performance obligation not satisfied over time will be satisfied at a point in time. This will be the point

in time at which the customer obtains control of the promised asset and the entity satisfies a performance


Some indicators of the transfer of control are:






The entity has a present right to payment for the asset.

The customer has legal title to the asset.

The entity has transferred physical possession of the asset.

The significant risks and rewards of ownership have been transferred to the customer.

The customer has accepted the asset.

4.9 Sale with a right of return

Where goods are sold with a right of return, an entity should not recognise revenue for goods that it

expects to be returned. It can calculate the level of returns using the expected value method (the

probability-weighted sum of amounts) or simply estimate the most likely amount. This will be shown as a

refund liability and a deduction from revenue.

The entity also recognises an asset (adjusted against cost of sales) for its right to recover products from

customers on settlement of the refund liability.

4.10 Warranties

If a customer has the option to purchase a warranty separately from the product to which it relates, it

constitutes a distinct service and is accounted for as a separate performance obligation. This would apply

to a warranty which provides the customer with a service in addition to the assurance that the product

complies with agreed-upon specifications.

If the customer does not have the option to purchase the warranty separately, for instance if the warranty

is required by law, that does not give rise to a performance obligation and the warranty is accounted for in

accordance with IAS 37.

4.11 Principal versus agent

An entity must establish in any transaction whether it is acting as principal or agent.

It is a principal if it controls the promised good or service before it is transferred to the customer. When

the performance obligation is satisfied, the entity recognises revenue in the gross amount of the

consideration for those goods or services.

It is acting as an agent if its performance obligation is to arrange for the provision of goods or services by

another party. Satisfaction of this performance obligation will give rise to the recognition of revenue in the

amount of any fee or commission to which it expects to be entitled in exchange for arranging for the other

party to provide its goods or services.

Indicators that an entity is an agent rather than a principal include the following:


Another party is primarily responsible for fulfilling the contract.


The entity does not have inventory risk before or after the goods have been ordered by a customer,

during shipping or on return.


The entity does not have discretion in establishing prices for the other party’s goods or services

and, therefore, the benefit that the entity can receive from those goods or services is limited.


The entity’s consideration is in the form of a commission.


The entity is not exposed to credit risk for the amount receivable from a customer in exchange for

the other party’s goods or services.

Part A Regulatory and ethical framework  1: Financial reporting framework


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