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　　revenue

　　relevant to acca qualification paper P2

　　This article looks at the contentious current issue of revenue. This is a key area of development for the International Accounting Standards Board （IASB）and the project appears within the examinable documents of Paper P2，Corporate Reporting.

　　Revenue development

　　The concept of revenue and the related IAS （IAS 18）comes to us from a period in financial reporting when the focus was on profit. This performance focus was the cornerstone of financial reporting for roughly 50 years from 1950 to 2000. You probably know this idea as the concept of matching and probably know that for many years it was the key to understanding accounting standards.

　　Since the IASB took over the development of accounting standards in 2001，its focus has been on assets and liabilities. This change of focus left IAS 18 out of step with the new ideas.

　　This probably would not have been enough to raise revenue above some of the other problems that are faced by the IASB were it not for one salient factor：the US and its dominance of financial reporting. The US government highlighted the problems with revenue recognition as a stumbling block on the road to convergence with International Financial Reporting Standards （IFRS）。

　　This article uses the vehicle of a question to illustrate how the subject might be examined. The revenue project is enormously conceptual and even the big brains on the IASB find it a challenge. So all I'll say now is good luck and here is the question.

　　Illustrative question：Ramification

　　Ramification is an engineering company. It has two contracts nearing completion at its year end. The company has made certain assumptions related to revenue recognition and wants to know if these would be acceptable under current revenue rules. Further the company is aware of a discussion paper on revenue. The company would like to know what affect the revenue proposals would have upon the revenue of Ramification should the proposals be accepted.

　　Contract X

　　This is a restoration project. Ramification has been contracted to restore an old prestigious building in a city centre. The contract provides that $1m will be payable to Ramification in two equal instalments of $500，000 each. The first instalment is payable on completion of work to the foundations，which is considered to be half the work. The final instalment is payable on completion of the work to the visible brickwork，which is considered to be the other half of the work. The first instalment is due one year from the current year end （providing the foundation work is complete）。

　　The final instalment is due two years from the current year end （provided the brickwork is complete）。

　　The contract requires that a surveyor verifies the work completed. At the year end，the surveyor has reported that the foundation work is entirely complete and that the brickwork is nearing completion. He has，therefore， reported that the whole contract is approximately 90% complete.

　　Ramification proposes to base revenue for contract X on the assumption that the contract is a construction contract. So Ramification proposes to recognise revenue using the surveyor's percentage and proposes to ignore the time value of money. The cost of capital is 10%.

　　Contract Y

　　This is a small building contract. Ramification built a small hut for housing equipment. Ramification agreed a sale price of $20，000，but also offered a three-month warranty. The building itself is finished，but the warranty is still open. The warranty is an offer to rebuild the hut should anything happen to it within three months from the date of handover. Handover took place two days before the year end and nothing has happened so far. There remains almost three full months before the warranty lapses and nothing is expected to happen.

　　Previous similar contracts have been sold at $18，000 for the hut and $3，000 for the warranty. Therefore Ramification proposes to recognise $20，000 in revenue and a provision of $3，000 representing the fair value of the obligation.

　　Required

　　（a）Discuss the problems with existing revenue recognition rules that have led to the issue of the discussion paper on revenue.

（7 marks）

　　The concept of revenue and the related IAS （IAS 18）comes to us from a peri od in financial reporting when the focus was on profit.

　　（b）Discuss the appropriateness of the assumptions utilised by Ramification in contracts X and Y above. Calculate the revenue recognised in the current year based on those assumptions.

（6 marks）

　　（c）Briefly explain the basis of the proposals put forward by the discussion paper to create a comprehensive standard for revenue recognition.

（8 marks）

　　（d）Explain how the application of the proposals would affect the revenue recognition of Ramification for contracts X and Y.

（4 marks）

（25 marks）