Accounting for Revenue 3 June 2011 by Manchi and James

1. Accounting for Revenue3 June 2011 by Manchi and James HKAS 18 Revenue HK(IFRIC) 15 Agreements for the Construction of Real Estate 物業建築協議 HKAS 20Accounting for Government Grants and Disclosure of Government Assistance 政府補助的會計處理及政府資助的披露 HK(IFRIC) 13 Customer Loyalty Programmes 客戶維繫計劃 including Improvements to HKFRS 2010 related to IFRIC 13 (by Manchi Kong)

2. HKAS 18 Revenue • Scope of HKAS 18 1. Revenue from sale of goods 2. Revenue from services rendered 3. Revenue from use of entity’s other assets (interest, dividend, royalties)

3. Exclusion from HKAS 18 • Lease agreement (HKAS17 Leases) “Lease income from/expense under operating leases shall be recognised in income on a straight-line basis over the lease term……” • dividend arising from investments which are accounted for under the equity method (HKAS28 Investments in Associates) – share of profits • insurance contracts (HKFRS4 Insurance Contracts) • changes in the fair value of financial assets and financial liabilities or their disposal (HKAS39 Financial Instruments: Recognition and Measurement) • changes in the value of the other current assets • initial recognition and changes in the fair value of biological assets related to agricultural activity (HKAS41 Agriculture) • initial recognition of agricultural produce (HKAS41 Agriculture) • the extraction of mineral ores

4. Definition of Revenue • Grossinflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows results in increases in equity. • Exclude contributions from equity participants, eg.consideration on allotment of company shares. • Exclude amounts which do not result in increases in equity, eg. sales taxes collected on behalf of government.

5. Gross Inflow Trade/early settlement discount: • The amount of revenue recognised for a transaction is net of any trade discounts or volume rebates given, since those discounts and rebates are not received as consideration by the seller. • Early settlement discount is not deducted from revenue in full HKFRS and SMEFRS but is deducted in HKFRS for PE. Agent: • gross amounts collected by the agent on behalf of the principal are not benefits that flow to the agent and therefore, they are not revenue. Agent’s revenue is the amount of commission.

6. Determining whether an entity is acting as a principal or as an agent(2009 amendment, HKAS18 Appendix Example 21) The entity is acting as a principal when it has exposure to significant risks and rewards associated with the sales of goods or the rendering of services. Key indicators to consider include: • The entity is the primary responsibility for the customer • The entity has general inventory risk • The entity has latitude in establishing price • The entity bears the customer’s credit risk Quiz: Whether a re-invoicing company incorporated by a manufacturer in Mainland China is acted as principal or agent?

7. Measurement of revenue • Revenue is measured at the fair value of the consideration received or receivable. • Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. • If the inflow of cash or cash equivalents is deferred, the fair value of the consideration may be less than the normal amount of cash received or receivable. Part of the revenue should be the interest income which should be separated and recognised during the credit period. Usual methods for separation: 1. Prevailing rate for a similar instrument of an issuer with a similar credit rating. 2. Discounting the nominal amount of the instrument to the current cash sales price.

8. Measurement of revenue • Exchange of goods – 1. If exchange for similar nature and value, no revenue is recognized, oil or milk. 2. If exchange for different nature and value, a) The revenue is measured at the fair value of the goods or services received, adjusted for any cash payments made by either buyer or seller b) if the fair value of the goods or services received cannot be measured reliably, revenue is recognised at the fair value of the goods or services given up, adjusted for any cash payments made or received

9. Sale of goods All of the following criteria have to be met: • Significant risks and rewards of ownership of the goods transferred • Retains neither continuing managerial involvement nor effective control over the goods sold • The amount of revenue can be measured reliably • Probable that 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

10. Sale of goods Risks and rewards of ownership • The time that the risks and rewards is transferred requires an examination of the circumstances of the transaction. • Normally, the transfer of the risks and rewards of ownership coincides with the transfer of the legal title or the passing of possession to the buyer, eg. retail sales. • For international trade, the risks and legal title are passed basically according to the trade term, eg. FOB. Reference of the trade term can be referred to The International Commercial Terms developed by International Chamber of Commercial, http://www.iccwbo.org/incotermsrules/ eg. EXW, DAT, DAP, FAS

11. Sale of goods Risks and rewards of ownership • If significant risks of ownership are retained by the seller the transaction is not a sale and revenue is not recognised, examples: - when the seller retains an obligation for unsatisfactory performance not covered by normal warranty provisions - when receipt of the revenue from a particular sale is contingent on the derivation of revenue by the buyer from its sale of the goods (similar to consignment) - when goods are shipped subject to installation and the installation is a significant part of the contract which has not yet been completed by the entity - when the buyer has the right to rescind the purchase for reason specified in the sales contract and the seller is uncertain about the probability of return

12. Sale of goods Risks and rewards of ownership • If only an insignificant risk of ownership is retained by the seller, the transaction is a sale and revenue is recognised, examples: - an insignificant risk of ownership may be retained by the seller in a retail sale when a refund is offered if the customer is not satisfied. Revenue in such cases is recognised at the time of sale provided the seller can reliably estimate future returns and recognises a liability and corresponding reduction for returns based on previous experience and other relevant factors

13. Sale of goods Inflow of Future Economic Benefits - Revenue not recognised if inflow is not probable • For examples, it may be uncertain that a foreign governmental authority will grant permission to remit the consideration from a sale in a foreign country • When an uncertainty arises about the collectibility of an amount already included in revenue, the uncollectible amount, or the amount in respect of which recovery has ceased to be probable, is recognised as an expense. No adjustment to revenue is allowed. Reliable Measurement for Revenue and Cost (Matching Concept) - If the corresponding cost of the revenue cannot be measured reliably, any consideration already received for the sale of the goods is recognised as a liability

14. Sale of goods - Examples: • Trading of property Whether the revenue is recognised upon the completion of sale and purchase agreement or upon the completion of assignment? Why? How to present in the income statement? Analysis:

15. Sale of goods - Examples: • Warranty provision - An entity manufactures an item of customised machinery and gives a 3-months warranty covering the cost of any adjustments or repair subsequent to delivery, - The product is likely to have some serious problems that will need to be remedied after the delivery, due to the need to suit the particular customer’s environment - Under the terms of the sales contract, title passes on delivery Whether revenue cannot recognised upon the delivery? Why? Analysis:

16. Sale of goods - Examples: • Machine sold subject to right of return - A manufacturer sells a machine to a customer who is anticipating being awarded a contract from the Government and the machine is used for such specific contract - The manufacturer allows the customer the right to return the machine if the customer does not win the contract from Government - The contract states that title is passed upon the delivery Whether revenue can be recognised upon the delivery? Why? Analysis:

17. Sale of goods - Examples: • Goods kept in the seller warehouse - Contract states that title of goods is passed on delivery - Requested by customer, goods are not delivered until further notice - Consideration is settled by the customer Whether revenue can be recognised? When? Why? Analysis:

18. Sale of goods - Examples: • Forever guarantee - A retailer offers a lifetime guarantee on its products - A customer may return any item for any reason at any time and have its money refunded - Based on their internal data, 1% of sales are returned under this policy How and when to recognise the revenue? Why? Analysis:

19. Sale of goods - Examples: 6. Retention of title - A manufacturer prescribes in the sales contract the retention of title clause, ie the legal title does not pass on delivery but when consideration for the goods is received When is the revenue recognised? Analysis:

20. Rendering of services All of the following criteria have to be met: • Amount of revenue can be measured reliably • Probable that the economic benefits associated with the transaction will flow to the entity (note) • Stage of completion can been measured reliably (HKAS 11 Construction Contract also requires the stage of completion method to be applied) • Cost incurred and to complete can be measured reliably (note) like sale of goods, if it is uncertain about the collectibility of an amount already included in the revenue, the uncollectible amount, or the amount in respect of which recovery has ceased to be probable, is recognized as an expense. No offset to revenue is allowed.

21. Rendering of services Recognition criteria Can outcome of transaction be estimated reliably? Yes No Are expenses incurred likely to be recovered? Revenue associated with the transaction is recognised by reference to the stage of completion of the transaction at the end of the reporting period (ie using the percentage of completion method) No Yes Revenue is recognised to the extent of expenses incurred that are likely to be recovered. Thus, no profit is recognised on the transaction No revenue is recognised and the costs incurred are recognised as an expense

22. Rendering of services Examples of methods for determining Stage of completion: • surveys of work performed • services performed to date as a percentage of total services to be performed • the proportion that costs incurred to date bear to the estimated total costs of the transaction Progress payments and advances received from customers often do not reflect the services performed

23. Rendering of services Examples: Insurance agency commissions Insurance agency commissions received or receivable which do not require the agent to render further service are recognised as revenue by the agent on the effective commencement or renewal dates of the related policies. However, when it is probable that the agent will be required to render further services during the life of the policy, the commission, or part thereof, is deferred and recognised as revenue over the period during which the policy is in force.

24. Rendering of services Examples: Initiation, entrance and membership fees Revenue recognition depends on the nature of the services provided. If the fee permits only membership, and all other services or products are paid for separately, or if there is a separate annual subscription, the fee is recognised as revenue when no significant uncertainty as to its collectibility exists. If the fee entitles the member to services or publications to be provided during the membership period, or to purchase goods or services at prices lower than those charged to non-members, it is recognised on a basis that reflects the timing, nature and value of the benefits provided.

25. Interest, Royalties and Dividend Basic requirement: • 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 Interest revenue Interest revenue should be recognised using the effective interest (When unpaid interest has accrued before the acquisition of an interest-bearing investment, the subsequent receipt of interest is allocated between pro-acquisition portion [offset the amount recognised at acquisition for interest receivable] and post-acquisition portion [recognised as interest income]

26. Interest, Royalties and Dividend Basic requirement: • 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 Royalty income Royalty revenue should be recognised on an accrual basis in accordance with the substance of the relevant agreement

27. Interest, Royalties and Dividend Basic requirement: • 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 Dividend revenue - Dividend revenue should be recognised when the shareholder’s right to receive payment is established - If dividend is received from newly investment, dividend revenue is recognised in profit or loss irrespective of whether it is declared from pre- or post-acquisition profits. (if pre-acquisition profits are recognised, it is necessary to consider whether the equity investment is impaired)

28. Disclosure • Accounting policies adopted for the recognition of revenue including the methods adopted to determine the stage of completion of transactions involving the rendering of services; b. Amount of each significant category of revenue recognised during the period including revenue arising from; • Sale of goods • Rendering of services • Interest • Royalties • Dividend • Amount of revenue arising from exchanges of goods or services included in each significant category of revenue.

29. HK(IFRIC) 15 Agreement for the Construction of Real Estate Scope of HK(IFRIC) 15 The interpretation applies to agreements for the construction of real estate, and to entities that undertake that construction directly or through sub-contractors It addresses whether the agreement is within the Scope of HKAS 11 or HKAS 18 and when revenue from the construction of real estate should be recognised In addition to the construction of real estate, such agreements may include the delivery of other goods or services

30. Accounting for the Construction of Real Estates The appropriate accounting for an agreement to construct real estate depends on whether the agreement: - meets the definition of a construction contract; or - is only for the rendering of services; or - is for sale of goods, in which case it is necessary to consider whether the criteria for recognising revenue from the sale of goods are met on a continuous basis Whether an agreement is within the scope of HKAS11 or HKAS 18 depends on the terms of the agreement and all the surrounding facts and circumstances, and judgement will be required with respect to each agreement

31. Construction contract HK(IFRIC)-15 states that an agreement for the construction of real estate will meet the definition of a construction contract when the buyer is able to: - specify the major structural elements of the design of the real estate before construction begins; and/or - specify major structural changes once construction is in progress, In contrast, if buyers have only limited ability to influence the design, HK(IFRIC)-15.2 states that the agreement will be for the sale of goods, and within the scope of HKAS 18

32. Rendering of services If an agreement does not meet the definition of a construction contract, it will be within the scope of HKAS18 HK(IFRIC)-15 provides further guidance on how to determine whether the agreement is for the rendering of services or for the sale of goods Where the entity is not required to acquire and supply construction materials because they will be sourced directly by the buyer, the agreement may be only an agreement for the rendering of services, revenue will be recognised using the percentage of completion method providing the criteria in HKAS 18.20 are met

33. Sale of goods If the entity is required to provide services together with construction materials in order to perform its contractual obligation to deliver real estate to the buyer, assuming it does not qualify as a construction contract, the agreement is for sale of goods If an agreement is determined to be for the sale of goods, the timing of revenue recognition will depend on when control and the significant risks and rewards of ownership are transferred to the buyer, 2 possibilities:

34. Sale of goods 1) The entity may transfer to the buyer control and the significant risks and rewards of ownership of the real estate in its entirely at a single time, eg. at completion, upon or after delivery. In this case, revenue will be recognised only when the criteria HKAS 18.14 are satisfied 2) The entity may transfer to the buyer control and the significant risks and rewards of ownership of the work in progress in its current state as construction progresses. In this case, if all the criteria in HKAS18.14 are met continuously as construction progresses, revenue will be recognised using the percentage of completion method Please refer to annex 1 for flowchart

35. HKAS 20-Accounting for Government Grants and Disclosure of Government Assistance Hong Kong Financial Reporting Standards • Government refers to government, government agencies and similar bodies whether local, national or international. (It is not limited to grant from Government) • Government grants are sometimes called by other names such as subsidies, subventions, or premiums. • Government grants shall not be recognised until there is reasonable assurance that: • (a) the entity will comply with the conditions attaching to them; and • (b) the grants will be received.

36. Government Grants Hong Kong Financial Reporting Standards • Government grants shall be recognised as income in profit or loss on a systematic basis over the periods in which the entity recognises as expenses the related costs for which they the grants are intended to compensate. • (Method 1) A government grant may take the form of a transfer of a non-monetary asset, such as land or other resources, for the use of the entity. In these circumstances it is usual to assess the fair value of the non-monetary asset and to account for both grant and asset at that fair value, (like the deferred income method considered below). (Method 2) An alternative course that is sometimes followed is to record both asset and grant at a nominal amount.

37. Government Grants Hong Kong Financial Reporting Standards • Presentation of grants related to assets Government grants related to assets, including non-monetary grants at fair value, shall be presented in the statement of financial position either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset. • Presentation of grants related to income Grants related to income are sometimes presented as a credit in the statement of comprehensive income, either separately or under a general heading such as "Other income"; alternatively, they are deducted in reporting the related expense.

38. Government Grants Hong Kong Financial Reporting Standards for Private Entity • Grant is recognized if no specified future performance conditions. • Grant with specified future performance conditions is recognised as deferred income and released to income when the performance conditions are met. • Not specially mention the recognition and measurement of grant relating to assets

39. New Standard - IASB scheduled to issue the new accounting standard on revenue recognition end of this year. • It is a project jointly performed together with US FASB. • The new standard intends to consolidate IAS 11, 18 and IFRICs related to revenue. • Recognition emphazised mainly on the transfer of control of good and service.

40. Quiz materials Recognition of sale of property • Cheung Kong (Holdings) Limited • (o) Revenue recognition • When properties under development are sold, income is recognised when the property development is completed with the relevant occupation permit issued by the Authorities and the significant risks and rewards of the properties are passed to the purchasers. Payments received from purchasers prior to this stage are recorded as customers’ deposits received. Trading Terms • EXW       Ex Works • DAT        Delivered At Terminal • DAP        Delivered At Place • FAS         Free Alongside Ship

41. Quiz materials Recognition of dividend income The Community Chest • Recognition of Income • Income from donations is recognised when cash is received and includes all sums received up to the balance sheet date. • Dividend income from unlisted investments is recognised only when the shareholder’s right to receive payment is established. • Dividend income from listed investments is recognised when the share price of the investment goes ex-dividend.

42. Quiz materials Recognition of dividend income - Final dividend is recognised when it is approved by the shareholders - Interim dividend is recognised when it is approved by the board of directors Table A of Companies Ordinance 115. The company in general meeting may declare dividends, but no dividend shall exceed the amount recommended by the directors. 116. The directors may from time to time pay to the members such interim dividends as appear to the directors to be justified by the profits of the company.

43. HK(IFRIC)-13 Customer Loyalty Programmes including Improvements to HKFRS 2010 related to IFRIC 13 by Manchi Kong