Various Types of Transactions – Collection from Sales or Services Rendered (Part 3)

For profit orientated entities, revenue is the “bloodline” of the businesses. The cash collected from invoicing or billing is vital in keeping the businesses up and running – meeting all sorts of daily expenses. Depending on the nature of the businesses, the sales invoices or bills issued to customers are for the sale of goods or services rendered. Generally the invoices or bills issued could be on cash term (pay on delivery of goods or services performed) or on credit term (e.g. 30 days, 60 days, 90 days etc). I have discussed in length the day book used in recording sales, the sales ledger and posting to the relevant accounts in the general ledger. The double entry for recording both the cash sales and credit sales are shown below:

Cash Sales

Balance Sheet

Income Statement

DR

CR

DR

CR

Petty cash/cash at bank

XXXX

Sales

XXXX

Credit Sales

a. Upon Recognition of Revenue

Balance Sheet

Income Statement

DR

CR

DR

CR

Trade debtors

XXXX

Sales

XXXX

b. Upon Receiving Payments from Trade Debtors

Balance Sheet

Income Statement

DR

CR

DR

CR

Petty cash/cash at bank

XXXX

Trade debtors

XXXX

The recording of collection from sales or services rendered usually is a straight forward matter. The “grey area” or issue involved usually is associated with when revenue should be recognised. This is because different industries have their own unique ways of conducting the businesses. As stated in the Objective Section of International Accounting Standard (IAS) 18: Revenue, revenue is recognised when it is probable that future economic benefits will flow to the entity and these benefits can be measure reliably.

For a typical business selling goods to its customers, the point of recognising revenue usually is at the point when the substantial risks and rewards associated with the goods have been transferred to its customers – usually when goods is delivered to and accepted by its customers. IAS 18 states the criteria of recognising revenue from sale of goods as follows: –

Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied:

(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;

(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

(c) the amount of revenue can be measured reliably;

(d) it is probable that the economic benefits associated with the transaction will flow to the entity; and

(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.

For a typical business rendering services to its customers, recognition of revenue is depending on the stage of completion of the services at the measurement point (at the balance sheet date – it could be the end of the month or the end of the year depending on the financial period determined by the entity). Stage of completion is referring to at the measurement point, the percentage of the services completed. For example, if the percentage of completion is 50% and $100,000 is to be invoiced to the customer when the job is completed, $50,000 would be recognised as revenue. Please take note that the cost associated with the revenue should also be recognised using the same percentage of completion method. IAS 18 states the criteria of recognising revenue from services rendered as follows: –

When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognised by reference to the stage of completion of the transaction at the balance sheet date. The outcome of a transaction can be estimated reliably when all the following conditions are satisfied:

(a) the amount of revenue can be measured reliably;

(b) it is probable that the economic benefits associated with the transaction will flow to the entity;

(c) the stage of completion of the transaction at the balance sheet date can be measured reliably; and

(d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.

Many small businesses rendering services to their customers would find it very challenging to comply with the requirements of recognising revenue and the costs by way of percentage of completion method. This is because this requires a detailed tracking mechanism of the costs of each job and also the stage of completion throughout the life of each project/job. Some countries may have set their own requirement as to the application of accounting standards by giving exemption to “small entities” in respect of using percentage of completion method in recognising the revenue and costs. If this is the case, revenue and costs would usually be recognised using the completed contract method – i.e. the revenue and the relevant costs would be deferred from being recognised in the income statement until when the job is completed.

I will not discuss in detail the requirements of IAS 18 here as this article is just meant to be an introduction to the recording of revenue. If you are interested to know more about the issues involved regarding revenue, please refer to IAS 18. Appendix 1 of IAS 18 shows examples of different type of sales transactions including “Bill and Hold” sales, goods shipped subject to conditions, lay away sales under which the goods are delivered only when the buyer makes the final payment in a series of instalments, installation fees, servicing fees included in the price of the product, advertising commissions & etc. that are worth reading.

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