10.3 Special Revenue Issues under PFRS 15
Key Takeaways
A right of return is variable consideration: revenue excludes expected returns, which become a refund liability plus an asset for the right to recover products at their former carrying amount.
A principal controls the good or service before transfer and reports revenue gross; an agent reports only its commission or fee.
A right to access IP is recognized over time, a right to use IP at a point in time, and sales- or usage-based royalties only as the underlying sales or usage occur.
A forward or call repurchase at a price below the original selling price is a lease; at or above it, a financing arrangement.
Breakage on gift cards is recognized in proportion to redemptions if the entity expects to be entitled to it; bill-and-hold revenue requires all four control criteria.
Special Revenue Issues under PFRS 15
The AFAR syllabus (topic 4.1.2) lists a series of arrangements that apply the five-step model to situations where the answer is not obvious: sales with a right of return, principal-versus-agent arrangements, non-refundable upfront fees, licenses and royalties, repurchase agreements, gift cards, consignment arrangements, and bill-and-hold sales. Each has a specific rule in the application guidance of PFRS 15.
1. Sales with a Right of Return
A right of return is a form of variable consideration. At the point of sale the entity recognizes:
- Revenue only for the goods it expects to keep (applying the constraint);
- A refund liability for the consideration it expects to refund; and
- An asset for the right to recover products from customers, measured at the former carrying amount of the goods less expected recovery costs and any impairment, with cost of sales reduced accordingly.
Worked example. Davao Gadgets sells 1,000 speakers at PHP 2,000 each (cost PHP 1,200) with a 30-day right of return and expects 5% to be returned in resalable condition.
| Item | Computation | Amount |
|---|---|---|
| Revenue | 950 x 2,000 | PHP 1,900,000 |
| Refund liability | 50 x 2,000 | PHP 100,000 |
| Cost of sales | 950 x 1,200 | PHP 1,140,000 |
| Asset for right to recover products | 50 x 1,200 | PHP 60,000 |
2. Principal versus Agent
An entity is a principal if it controls the specified good or service before it is transferred to the customer, and reports revenue gross; it is an agent if it arranges for another party to provide the good or service, and reports only its commission or fee (net). Indicators of control include primary responsibility for fulfilling the promise, inventory risk before or after transfer, and discretion in establishing the price. Example: an online marketplace that collects PHP 5,000,000 from buyers for sellers' goods and keeps a 10% commission reports revenue of PHP 500,000, not PHP 5,000,000.
3. Non-Refundable Upfront Fees
Joining fees of health clubs, activation fees of telecommunication contracts, and set-up fees usually relate to an activity that does not transfer a promised good or service. The fee is an advance payment for future goods or services and is recognized as revenue when those goods or services are provided, which may extend beyond the initial contract period if the customer has a renewal option that is a material right.
4. Licensing and Royalties
| License Type | Nature | Revenue Recognition |
|---|---|---|
| Right to access intellectual property | The licensor undertakes activities that significantly affect the IP (a brand or franchise name kept current) | Over time over the license period |
| Right to use intellectual property | The IP has significant stand-alone functionality and exists as it is at the time of granting (software, a film, a drug formula) | At a point in time when the customer can use and benefit from the license |
Sales-based or usage-based royalty exception: royalties promised in exchange for a license of IP are recognized only when the later of (a) the subsequent sale or usage occurs and (b) the performance obligation is satisfied. They are not estimated in advance as variable consideration.
5. Repurchase Agreements
| Feature | Accounting |
|---|---|
| Forward or call option (the entity must or may repurchase) and repurchase price below the original selling price | Lease under PFRS 16 (unless part of a sale-and-leaseback) |
| Forward or call option and repurchase price equal to or above the original selling price | Financing arrangement: keep the asset and recognize a financial liability; the excess is interest |
| Put option (the customer may require repurchase) with a significant economic incentive to exercise | Lease or financing, as above |
| Put option without a significant economic incentive | Sale with a right of return |
6. Gift Cards and Breakage
Cash received for gift cards or vouchers is a contract liability. If the entity expects to be entitled to an amount that customers will not redeem (breakage), it recognizes that amount as revenue in proportion to the pattern of redemptions; otherwise it recognizes breakage when the chance of redemption becomes remote. Example: a retailer sells gift cards of PHP 1,000,000 and expects 10% breakage; when PHP 450,000 (half of the PHP 900,000 expected redemptions) is redeemed, it recognizes revenue of PHP 450,000 plus breakage of PHP 50,000.
7. Consignment and Bill-and-Hold Arrangements
Consignment: delivery to a dealer is not a sale if the entity keeps control, shown by indicators such as the product being controlled by the entity until a specified event (sale to an end customer), the entity being able to require return or transfer to another party, and the dealer having no unconditional obligation to pay. Revenue is recognized when the consignee sells to the end customer.
Bill-and-hold: the entity bills the customer but keeps physical possession. Control has passed only if all of these are met: the reason for the arrangement is substantive (for example, the customer requested it), the product is identified separately as belonging to the customer, the product is currently ready for physical transfer, and the entity cannot use it or direct it to another customer. Custodial services may then be a separate performance obligation.
8. Contract Costs and Presentation
PFRS 15 also governs costs that relate to contracts with customers:
- Incremental costs of obtaining a contract, such as a sales commission payable only if the contract is signed, are recognized as an asset if the entity expects to recover them, and amortized consistently with the transfer of the related goods or services. As a practical expedient, they may be expensed when the amortization period would be one year or less. Costs incurred whether or not the contract is obtained (legal fees for drafting, travel to pitch) are expensed.
- Costs to fulfill a contract that are not within another standard (such as PAS 2 or PAS 16) are capitalized only if they relate directly to a contract, generate or enhance resources used to satisfy future obligations, and are expected to be recovered.
On the statement of financial position, an entity presents a contract asset when it has performed before the customer pays and its right to consideration is conditional on something other than the passage of time, a receivable when the right is unconditional, and a contract liability when the customer has paid (or payment is due) before the entity performs.
An appliance store sells 400 air-conditioning units at PHP 30,000 each (cost PHP 22,000) with a right of return, and expects 20 units to be returned in resalable condition. What revenue and what asset for the right to recover products are recognized at the sale date?
Revenue PHP 12,000,000; asset PHP 0
Revenue PHP 11,400,000; asset PHP 440,000
Revenue PHP 11,400,000; asset PHP 600,000
Revenue PHP 12,000,000; asset PHP 440,000
A pharmaceutical company grants a license to a completed drug formula that the licensee can use as it exists, for a fixed fee paid upfront plus a royalty of 3% of the licensee's sales. The licensor has no further obligations. How is revenue recognized?
The fixed fee over the license term and the royalty when cash is received
Both amounts only when the license expires
Both the fixed fee and the estimated total royalty at the start of the license
The fixed fee at the point in time the license is granted, and the royalty as the licensee's sales occur
A company sells equipment for PHP 5,000,000 and agrees to repurchase it in two years for PHP 5,400,000. How should the company account for the arrangement?
As a sale with revenue of PHP 5,000,000
As a lease, because the company must repurchase the equipment
As a financing arrangement: keep the equipment, record a PHP 5,000,000 liability, and recognize PHP 400,000 of interest over two years
As a sale with a right of return
Sections you finish are checked off in the contents.