DETERMINING REVENUE/PURCHASES AS A RESULT OF FINANCING COMPONENTS
Comments by: Dr Steven Ronald Firer
Senior Executive – Corporate Reporting File Reference APC – ED 374
P O Box 59875
KENGRAY
2100
Dear Sir/Madam
I am very grateful for this opportunity to comment in regard the above exposure draft. I believe
that this is necessary as financial reporting is a subject that is always a matter of diverse
interpretations resulting in a wide range of practices with the resultant disastrous
consequences. I would hope and pray that once this exposure draft has been finalized and
published that all the accounting and auditing profession together with their associated
regulators accept and comply with such an accounting circular. If not the consequences in my
humble opinion will be catastrophic.
Once this exposure draft has been converted into generally accepted accounting practice
(meaning that all persons accept the circular) there should be no doubt as to its meaning and
will not result in these current diverse interpretations. That should be the theme of your
deliberations.
In addition please do not ignore how this topic influences the interpretation in regard the
application of IFRS for SMEs.
The only real question of importance in regard to these diverse interpretations is when does
a preparer of financial statements begin the discounting of revenue. There are two totally
different views. The first one being that discounting begins on the day after the recognition of
a sale. The second one allows for the concept of “extended payment terms”.
This second view is expressed in example 1 in the exposure draft: Entity A sells goods to
Entity B for CU 1 000 on 30 day payment terms and expects payment in 30 days.
Entity A does not charge its customers interest. Entity A has determined after
considering qualitative factors that a financing element does not exist. Entity A should
therefore recognise revenue for the sale of goods of CU 1000.
This example is underpinned by the qualitative factors in para .09. I do believe that this link
should be more clearly expressed. For example in factor (a): Differential pricing between the
cash payment price and the price paid on deferred settlement terms. If the selling price on
day one is no different to what the selling price would be on days 30, it is common sense that
there is no discounting, a factor completely ignored by the first viewed.
This extra comment by myself should at least be attached to example one explaining why
there is no discounting in example one. I believe there should be an example of how these
qualitative factors work in practical and numerical terms.
The same should apply to the rest of the factors to avoid any semblance of doubt.
I am extremely happy to see the following in para .10: If an entity determines that the
transaction was not intended to provide the counterparty with financing then no financing
element exists. Again this is common sense and a factor completely ignored by the first view.
Although common sense it is a crucial concept and needs to re-emhaisized.
IFRS for SME
When the inflow of cash or cash equivalents is deferred, and the arrangement constitutes in
effect a financing transaction, the fair value of the consideration is the present value of
all future receipts determined using an imputed rate of interest.
The crucial principle in regard to the meaning of “deferred” I believe can be found in IAS 16
para 23: The cost of an item of property, plant and equipment is the cash price equivalent at
the recognition date. If payment is deferred beyond normal credit terms, the difference
between the cash price equivalent and the total payment is recognised as interest over the
period of credit.
This approach is consistent with the assumption that there is no financing element when
receipt is within normal credit terms.
My interpretation of this is as follows:
When cash sales are concluded at the same selling price as those with extended
payment terms, the argument is often that the revenue to be recognised must be the same.
The contention is that the amount of cash received remains constant, irrespective of whether
a cash sale is made; and it therefore does not make sense to reflect a credit sale at the present
value of the cash alternative, because this would result in the recognition of a lower amount
of revenue than in a cash sale.
This view needs to be made very clear when interpreting IFRS for SMEs. The following
example adapted from the Auditor General’s guides and interpretations on GRAP (Guideline
9) is an excellent example on how this matter should be dealt with:
An important observation is made in this guideline: When the inflow of cash and cash
equivalents is deferred then the fair value of the goods or service may be less than the actual
cash received or receivable, as the agreement effectively represents a financing transaction.
In these instances the fair value of the transaction is determined by discounting all future
receipts using an imputed rate of interest.
Here deferral is only when the fair value of the good or service is less than the actual cash
received. This is aligned with my interpretation above ( When cash sales are concluded at
the same selling price as those with extended payment terms, the argument is often that
the revenue to be recognised must be the same. The contention is that the amount of cash
received remains constant, irrespective of whether a cash sale is made; and it therefore does
not make sense to reflect a credit sale at the present value of the cash alternative, because
this would result in the recognition of a lower amount of revenue than in a cash sale).
Example (Guideline 9)
The Entity A provides services to Entity B. The services are invoiced for R1,500 and the
payment is due in 90 days from invoice date. Invoice date is 15 June 2010. Normal credit
terms for this type of service are 30 days. Entity A does not charge Entity B any interest;
however the transaction is in substance a financing transaction due to the payment being
deferred beyond normal credit terms. Assume that the client would have paid 9% interest for
90 days payment terms if the client obtained the service from another supplier. Reporting date
is 30 June 2010.
Journal entry at transaction date:
At the transaction date Entity A should record revenue at the fair value.
15 June 2010 Debit Credit
Receivable 1,478
Revenue (R1,500/1+(9%/365))60 days 1,478
Thus the difference between the fair value (R1,478) and the nominal amount (R1,500) is
interest (R22). This interest is recognised over the deferred payment term, which in this
example is 60 days (90 days payment less 30 days normal terms).
At reporting date:
15 days has lapsed since transaction date which is still within the 30 days normal credit term
period thus no interest is recognised at reporting date.
Journal entries after reporting date:
30 days has lapsed after the 30 days normal credit term period. Normal credit term period
ended 15 July 2010. Interest should be recognised as follows:
14 August 2010 Debit Credit
Receivable 1,478
Revenue (R1,478 x (9%/365) x 30 days) 1,478
60 days has lapsed after the 30 day normal credit term and 30 days has lapsed since interest
was last recognised. Interest should now be recognised as follows:
13 September 2010 Debit Credit
Receivable 1,478
Revenue ( (R1,478 + 11) x (9%/365) x 30 da ys) 1,478
Total interest earned for the 60 day period exceeding normal credit terms is R22 (R11 + R11).
As IFRS 15 explains: Is the delay between revenue recognition and payment 12 months or
less and the entity has elected to use the practical expedient? No material financing element
exists. Recognise revenue and the related receivable at the transaction price.
But what about IFRS for SMEs and the remainder of the year while we all wait for IFRS 15 to
apply.
Please let me know if you need anything more from me.
Kind Regards
Steven Firer
Senior Executive – Corporate Reporting File Reference APC – ED 374
P O Box 59875
KENGRAY
2100
Dear Sir/Madam
I am very grateful for this opportunity to comment in regard the above exposure draft. I believe
that this is necessary as financial reporting is a subject that is always a matter of diverse
interpretations resulting in a wide range of practices with the resultant disastrous
consequences. I would hope and pray that once this exposure draft has been finalized and
published that all the accounting and auditing profession together with their associated
regulators accept and comply with such an accounting circular. If not the consequences in my
humble opinion will be catastrophic.
Once this exposure draft has been converted into generally accepted accounting practice
(meaning that all persons accept the circular) there should be no doubt as to its meaning and
will not result in these current diverse interpretations. That should be the theme of your
deliberations.
In addition please do not ignore how this topic influences the interpretation in regard the
application of IFRS for SMEs.
The only real question of importance in regard to these diverse interpretations is when does
a preparer of financial statements begin the discounting of revenue. There are two totally
different views. The first one being that discounting begins on the day after the recognition of
a sale. The second one allows for the concept of “extended payment terms”.
This second view is expressed in example 1 in the exposure draft: Entity A sells goods to
Entity B for CU 1 000 on 30 day payment terms and expects payment in 30 days.
Entity A does not charge its customers interest. Entity A has determined after
considering qualitative factors that a financing element does not exist. Entity A should
therefore recognise revenue for the sale of goods of CU 1000.
This example is underpinned by the qualitative factors in para .09. I do believe that this link
should be more clearly expressed. For example in factor (a): Differential pricing between the
cash payment price and the price paid on deferred settlement terms. If the selling price on
day one is no different to what the selling price would be on days 30, it is common sense that
there is no discounting, a factor completely ignored by the first viewed.
This extra comment by myself should at least be attached to example one explaining why
there is no discounting in example one. I believe there should be an example of how these
qualitative factors work in practical and numerical terms.
The same should apply to the rest of the factors to avoid any semblance of doubt.
I am extremely happy to see the following in para .10: If an entity determines that the
transaction was not intended to provide the counterparty with financing then no financing
element exists. Again this is common sense and a factor completely ignored by the first view.
Although common sense it is a crucial concept and needs to re-emhaisized.
IFRS for SME
When the inflow of cash or cash equivalents is deferred, and the arrangement constitutes in
effect a financing transaction, the fair value of the consideration is the present value of
all future receipts determined using an imputed rate of interest.
The crucial principle in regard to the meaning of “deferred” I believe can be found in IAS 16
para 23: The cost of an item of property, plant and equipment is the cash price equivalent at
the recognition date. If payment is deferred beyond normal credit terms, the difference
between the cash price equivalent and the total payment is recognised as interest over the
period of credit.
This approach is consistent with the assumption that there is no financing element when
receipt is within normal credit terms.
My interpretation of this is as follows:
When cash sales are concluded at the same selling price as those with extended
payment terms, the argument is often that the revenue to be recognised must be the same.
The contention is that the amount of cash received remains constant, irrespective of whether
a cash sale is made; and it therefore does not make sense to reflect a credit sale at the present
value of the cash alternative, because this would result in the recognition of a lower amount
of revenue than in a cash sale.
This view needs to be made very clear when interpreting IFRS for SMEs. The following
example adapted from the Auditor General’s guides and interpretations on GRAP (Guideline
9) is an excellent example on how this matter should be dealt with:
An important observation is made in this guideline: When the inflow of cash and cash
equivalents is deferred then the fair value of the goods or service may be less than the actual
cash received or receivable, as the agreement effectively represents a financing transaction.
In these instances the fair value of the transaction is determined by discounting all future
receipts using an imputed rate of interest.
Here deferral is only when the fair value of the good or service is less than the actual cash
received. This is aligned with my interpretation above ( When cash sales are concluded at
the same selling price as those with extended payment terms, the argument is often that
the revenue to be recognised must be the same. The contention is that the amount of cash
received remains constant, irrespective of whether a cash sale is made; and it therefore does
not make sense to reflect a credit sale at the present value of the cash alternative, because
this would result in the recognition of a lower amount of revenue than in a cash sale).
Example (Guideline 9)
The Entity A provides services to Entity B. The services are invoiced for R1,500 and the
payment is due in 90 days from invoice date. Invoice date is 15 June 2010. Normal credit
terms for this type of service are 30 days. Entity A does not charge Entity B any interest;
however the transaction is in substance a financing transaction due to the payment being
deferred beyond normal credit terms. Assume that the client would have paid 9% interest for
90 days payment terms if the client obtained the service from another supplier. Reporting date
is 30 June 2010.
Journal entry at transaction date:
At the transaction date Entity A should record revenue at the fair value.
15 June 2010 Debit Credit
Receivable 1,478
Revenue (R1,500/1+(9%/365))60 days 1,478
Thus the difference between the fair value (R1,478) and the nominal amount (R1,500) is
interest (R22). This interest is recognised over the deferred payment term, which in this
example is 60 days (90 days payment less 30 days normal terms).
At reporting date:
15 days has lapsed since transaction date which is still within the 30 days normal credit term
period thus no interest is recognised at reporting date.
Journal entries after reporting date:
30 days has lapsed after the 30 days normal credit term period. Normal credit term period
ended 15 July 2010. Interest should be recognised as follows:
14 August 2010 Debit Credit
Receivable 1,478
Revenue (R1,478 x (9%/365) x 30 days) 1,478
60 days has lapsed after the 30 day normal credit term and 30 days has lapsed since interest
was last recognised. Interest should now be recognised as follows:
13 September 2010 Debit Credit
Receivable 1,478
Revenue ( (R1,478 + 11) x (9%/365) x 30 da ys) 1,478
Total interest earned for the 60 day period exceeding normal credit terms is R22 (R11 + R11).
As IFRS 15 explains: Is the delay between revenue recognition and payment 12 months or
less and the entity has elected to use the practical expedient? No material financing element
exists. Recognise revenue and the related receivable at the transaction price.
But what about IFRS for SMEs and the remainder of the year while we all wait for IFRS 15 to
apply.
Please let me know if you need anything more from me.
Kind Regards
Steven Firer
Comments