 Hello and welcome to this session. This is Professor Farhad and this session we would look at IFRS 15, which is the revenue recognition. This topic is covered in international accounting as well as the CPA exam and the ACC exam. As always, I would like to remind you, which is you that that's listening to me to connect with me on LinkedIn. YouTube is where you would need to subscribe. I have over 1500 plus accounting, auditing and tax lectures. If you like my lectures, please like them. Click on the like button. That's very important. Share them. Put them in the playlist. Let the world know about them. If you're benefiting from my lectures, if you're listening to me now, share the wealth. Other people might benefit as well. This is my Instagram account. This is my Facebook account. This is my website. On my website, you have the option to donate, support the channel if you chose to. I also have a Gumroad account for premium lectures. Also on my website, I do have offers right now. Becker CPA Review is offering $1,000 off of the Becker Bundle, all four parts with unlimited access. If you're studying for your CPA exam, I strongly suggest you check it out. The link is on my website. But before we start the revenue recognition, I just want to make sure you understand that to fully explain this concept, you have to go to my intermediate accounting course where I have 18 lectures on revenue recognition. In this session, I might spend 25 to 30 minutes plus. I don't know how long it's going to be, but this is basically a summary, a summary. So if you don't feel you are short change, if you really want to learn about the revenue recognition, go to my intermediate accounting. And the good news is it's the same for IFRS and USGAP. So whatever you learn here, it will apply to IFRS if you're listening to this lecture. That's the good news. Okay, so let's talk a little bit more about revenue as a general concept. Revenue is one of the most important measure in financial performance, especially when the company don't make a profit, especially when profit don't exist, especially when profit is not existing. For example, a company like Uber or Lyft, they don't have profit. All what they do is they generate revenue. So to evaluate the company, you can only look at the revenue. Therefore, revenue is very, very important. And it's also important for companies that makes profit. But what I'm trying to say, if the company don't make a profit, your only way to evaluate a company is to look at the revenue. And it's subject to fraud because when a company wants to cook their books, revenue is one of the easiest account to cook for many reasons, because they're subject to estimates. And that's why IFRS and USGAP, IASB and USGAP, they issued this convergence. That's why it's the same rules for both. This way, companies are across the globe, they use the same rules or the same standard. Most revenue transactions pass few problems or few recognition. Basically, they get initiated and completed at the same time. Like when you buy something at the store, you initiate and complete the transaction right there. However, not all transactions that simple. Just to give you a complexity, let's assume you sign up with a plan with Verizon. What's going to happen is this. Verizon is going to provide you with the phone, three minutes to talk time, data download, and text messaging. So this is going to be one deal, but it's going to have many components. In addition, they might say they will bundle with that a fixed line broadband service. They might also bundle with that service. Also, at the same time, they may give you the option to upgrade down the road at a discount. Then guess what? How do we account for this revenue transaction? It's not a one time thing where you initiate and complete the transaction. You are buying many things and you are buying many things that could affect the future revenue of that contract. So notice it's not as obvious. That's why we have to look at the rules of how do we record revenue for such transactions. So FASB and the ISP issue the converges standards on revenue recognition entitled revenue from contract with customers. Before, there was many, many, many standards for different industries. Now you would look at the standard and you should be able to apply it. OK, they gave you the rules and you should be able to the principles matter of fact, and you should be able to apply it. So the revenue from contract with customers involve five steps. And this is what we're going to be covering in this session. Five steps and guess what? I'm going to list the steps and guess what? We're going to go through each step separately. Step one, identify the contract with a customer. Step two, identify the separate performance obligation in the contract. Step three, determine the transaction price. Allocate the transaction price to the separate performance obligation. Recognize the revenue when each separate application is satisfied. And guess what? Once you see a list, once I make a list, it means I'm going to go over each component of this list separately, starting with identifying a contract with the customer. Hopefully, we all know what a contract is. It's basically an agreement between a buyer and a seller to provide goods or services and or services in exchange for some consideration. The contract, it can be written. It doesn't have to be written. It can be oral. It can be even implicit or customary. So you don't have to have an actual contract, signed contract. The contract could be shake of hand, could be implied. OK, if I walk into the store and buy something, I don't say anything. It's still a contract. OK. So we need to have five additional criteria to make sure a contract is a valid contract. First, it has to have a commercial substance. This commercial substance criteria is a protective clause. Simply put, we don't want companies to be buying and selling from each other. As sham transaction, transaction that does does not have any commercial or business use. It's just it's they're only entering into those transactions to increase revenue. This is called the protective clause. So revenue has to be legitimate in a sense. There's there's a business use. There's a commercial substance. Commitment has to be by both parties to be legal. And both parties have to be aware of their commitment. In the contract, you identify the rights of each party. What am I supposed to do? What you're supposed to do? Payments are identified. They don't have to be fixed. And we're going to look later in step three about the payment, but they don't have to be 100 percent clear, but they have to be identified. And obviously, collection is probable. If you're going into a contract and there is no way you're going to collect your money from that contract, don't go into that contract. It's it's playing games because there is no probability of collecting the money. OK, that's step one. You have to have a valid contract. Step two, identify the separate performance obligation and the contract. And this is usually the most challenging in a business because sometimes as you see in the Verizon example, you had many components to the contract. OK, and each component could be separate performance obligation. So you have to identify those separate performance obligation. A performance obligation is defined as an enforceable promise in a contract with a customer to transfer goods or services to the customer. So the entity must evaluate all the goods and or services promise in the contract to determine whether they are separate performance obligation. What are we talking about here? In other words, we have to know what is our obligation? Do we have how many obligation do we have in the product? Is it one obligation or more than one obligation? Is the product distinct? Are we selling that product? Separately, can you sell this product separately? Is it distinct? OK, or are you transferring multiple product all at the same time? OK, are you transferring an individual product or separate product? Or are you transferring many product just to kind of simplify this process? Let's look at this example. The company sold coffee and bagel. It's in the same contract. Guess what? The company can sell the bagel separately and the coffee separately, but they sold them together. Then guess what? We have one contract, but two separate independent product because each one can be sold separately. Notice that the bagel and the coffee are two separate are two separate product, but one contract or if we sell a large latte, large latte right here, it contains coffee and milk. Well, guess what? You cannot separate the coffee and the milk, then it's no longer called latte. So those two, you have only one product here. Although you have two kind of you have you have coffee and milk, but it's one product because the two products are interrelated. They cannot be separated for the purpose of this transaction. And that's why this is the most challenging because in the real world, you have to determine am I selling one product? So I have only one performance obligation or more than one performance obligation. Okay. Let's look at another example. Assume that GM Motors, GM company, the car company sells automobile to market auto dealer at a price that includes six month of telematics services such as navigation and remote diagnostics. These telematics services are regularly sold at a standalone basis by GM for a monthly fee. After six month period, the customer can renew these services on a fee basis with GM. The question is whether General Motors sold one or two product. What are you guys saying that they sell one product that they sell the automobile with the telematics or are they selling really two separate product? Well, hopefully you would not. Hopefully it's two separate product. If we look at the GM objective, it appears that they sold two separate goods because they can sell the telematics separately for somebody else. It's distinct. It doesn't come with the car. It's separable from the car itself. Okay. And it's not interdependent. And the car is not interdependent on that telematics service. They're two separate, two separate transaction. Now, once we know our obligation, the next thing we want to know is how to determine the dollar amount. So, well, if they're paying us cash, that's easy. How much cash did they pay? And that's our answer. Sometime what we do when we sell something, we may receive payments. The third payment. Well, if we have the third payment, what we do is we discount them to the present value and we have a receivable based on the present value. And that's our revenue. If we receive any non-cash consideration, they give us inventory, land, building, guess what? The fair market value of that consideration is our transaction price. Okay. And sometime what happened, what we do is we have a variable consideration. You remember, I told you the price doesn't have to be fixed. As long as you can estimate the price taken into account, discounts, rebate and anything else, that's acceptable. So what happened when the price, when the price is not fixed? It's variable. We have two methods to deal with this. We could use the expected value and we use the expected value when we have a large number of contract with similar characteristic. How does the expected value work? We'll use a weighted probability. We'll look at an example shortly. All we would use, the second method is the most likely amount. This is when we have two possible outcome and we'll take the higher outcome. When you are using those variable consideration, you have to have some sort of a past experience because you are predicting what's going to happen in the future and you're going to adjust your prices accordingly. So it must be highly probable that the statistical approach will not result in a reversal of already recognized revenue. So you don't want to recognize revenue. Then find out later, well, you book too much revenue. So you want to make sure you have a past experience with this. And some industries like the pharmaceutical, the drug industries, they offer rebate to customers. And here's how the rebate generally work. And usually they give it to a large health network, like large hospitals. That rebate increase as those customers buy more of a particular drug. So the more you buy, the lower will be the price in the future. So what's going to happen? You have to predict what is your what's your revenue? In such cases, the drug company used the probability weighted approach to downwardly adjust revenue and period when the eventual amount of the rebate is uncertain. So you have to kind of determine what did I really sell it for? Because I have to give them rebate. If they buy more, I have to give them a rebate. So how much am I really selling it for? OK, so they have to do this weighted probability or most likely outcome to determine the price because they may sell it for a price now. And if the hospital buys more from them, they have to go back and give them a rebate for that sale. So they have to kind of estimate that they don't want to book too much revenue. If they know they're going to go back and give them a rebate, means they're going to give them some money back. Let's take a look at an example to see how this work. OK, to see how this work. Let's take a look at P construction company enter into a contract with a customer to build a warehouse for 100,000 with a performance bonus of 150 that will be paid on the on the will be paid based on the timing of the completion. The amount of the performance bonus decrease by 10% per week for every week beyond the agreed upon date. So simply put, we have a contract and we could possibly make 150,000. We have 100,000 plus 50,000 bonus. So in total, we could receive up to 150,000. The amount of the performance bonus, this amount here will decrease by 10% if we are one week late. The contract requirement are similar to contract that P has performed previously and management believe that such experience is predictive for this contract. So you do have prior experience with this type of contract. Management estimate that there is a 60% chance that the contract will be completed by the agreed upon time. That's good news. If there is a 60% chance, it means 60% chance I would receive. Let me do it here. I have a 60% chance I would receive the full 150,000. OK, there's a 50% chance of that. A 30% chance it will be completed one week late. What does it mean one week late? It means I'm going to get 10% less or the 30% chance I'm going to be getting. Well, 10% less if I have 50,000, 10% of 50,000 is 5,000. It means I'm going to be getting 30% chance I'll be receiving 145,000. And only 10% chance that I will completed in two weeks, 10% chance and I'm going to be losing an additional I'm going to be losing an additional sorry, I'm going to be losing an additional $5,000 because I'm going to be losing 10%. So I'm going to be getting 140,000. There's a 10% chance. All I have to do now is add all these and this is my transaction price. So if I take 60% times 150, that's 90,000. Let's look at them here. That's 90,000 30% times 45 is 43,500. 10% chance of 140,000. All in all, the base on the probability weighted my revenue is 147,500. If I'm using the most likely outcome of the management believe that they will meet the deadline and receive the 50,000 will be 150,000. So there's 60% probability of meeting the outcome, which is 40% not meeting. Well, with the higher probability, we have two outcome either 40 or 60 will go with the higher one. The higher one is meeting. Meeting means I'm going to get the full amount. This is how we get the transaction price. Step four is to allocate the transaction price to the separate performance obligation. Remember, in in in step two, we have separate performance obligation. Now we're going to have to take the price. We determine the price, but if you have many perform many performance obligation, how are we going to separate this performance obligation? OK, so the transaction price should be allocated to the separate performance obligation in proportion to the standalone selling price of each element of the contract. So let's assume I'm going to give you a burger example. So let's assume I have a restaurant and I sell burgers. If you want to buy a cheeseburger on itself, so the burger itself, I'm going to charge you three dollars and fifty cents for the burger. Also, the fries, if you want to buy the fries, I'm going to charge you a dollar fifty and if you want to buy the soda, if you want to buy the soda separately, I'm going to charge you. I'm going to make it higher, two dollars. I don't want to discourage you from buying the soda, right? OK, so this is the price. So if you want to buy these separately, three, fifty, four, five, seven. So if you want to buy these separately, you're going to be charged seven dollars. Now, another option is to do what? I might have a combo that says if you buy those three items separately, I'm going to charge you five dollars for all three items separately. Now, guess what? If you buy all these three items in a bundle, basically in a combo, when you go to McDonald Burger King, that's what they offer you, it's five dollars. Then I have to determine how much is the burger price of the five dollars? How much is the fries of the five dollars and how much is the soda? Well, I'm going to do a proportion. And what is a proportion? I'm going to take, I'm going to need the calculator here. Well, it looks like 3.5, the burger divided by the total, the burger price represent 50. The burger represent 50 percent of the deal, 350 divided by seven. Now I'm going to have to figure out the proportion for the other two. Dollar fifty divided by seven. That's twenty one. I'm just going to make it twenty one percent for simplicity. So this is twenty one percent. The fries represent twenty one percent. And the remainder is twenty nine percent for the soda. All I have to do now is take five dollars times fifty percent, twenty one dollars times twenty one percent times five dollars and twenty nine percent times five dollars. And obviously, that says two dollars and fifty cent in five times point two point one, five times point two one. That's dollar oh five, dollar oh five and the remainder that you add up to five dollars now. And the remainder is what? Let's just do this again. Five dollars times point two nine, dollar forty five, dollar forty five and they should add up to five dollars. So this is how I would allocate based on the standalone price, because I have different performance obligations, each one can be sold separately. Let's assume we don't know how much you can sell each each item separately. Simply put, in this example, we said we know the price of the soda, the price of the burger and the price of the fries. When the goods and services are not sold separately, because we usually don't sell them separately, we don't have a standalone price, the transaction price must be allocated to the separate obligation using a reasonable approach. Now we have to use a reasonable approach. The literature recommend three approaches. The first one, the adjusted market assessment approach. Simply put, you would look at similar companies. How much are they selling something like this? If something like this is being sold on the market, I can make some adjustments. If my product is better or less of a quality, I can make certain adjustment. I can also use expected cost plus margin. Well, there's no similar product. What I can do, I can say, well, my cost is hundred dollar and I'm going to add to my cost thirty dollars in profit. So the standalone price is one thirty. So I'll take the cost plus a margin or I can use a residual approach. This is used when I know that obviously I know the total transaction price less the sum of observable standalone selling prices. So if I know if the total contract is three thousand and I was able to identify and I have let's keep it simple, I have two items. I know for sure one of them is worth two thousand. I don't know the other one. The other one must be worth a thousand. OK, if I know one of them is worth two thousand. This is the residual approach. So what's left is for the other the other the other the other price. The last step, step five is recognize the revenue when each separate obligation is satisfied. Now we have to know when is satisfaction occur? When is the obligation? When did you satisfy your obligation? You have to understand it could be a point in time or over time, but you have to understand you're looking from the customer's perspective. You're looking to see did you really pass the did you did you satisfy your performance vis-a-vis the customer? OK, control of the promise goods on services is transfer to the customer. When do we transfer to the customer? Well, when the company has the right to a payment for the asset. When you have the right means you transfer it. The company has transferred the legal title. We transfer the legal title. The company has transferred the physical item of the asset, not only the legal title, the physical item. The customer has significant risk and reward of ownership. Now the customer can do whatever they want with the with this asset. And customer did accept the asset. Obviously, if you deliver it, they also did accept it. So under those circumstances, what happened is you satisfied your obligation. OK, now we said is it could be a point in time or over time? No, most transactions are in point in time. OK, for many revenue generating transaction transfer of control will occur during a specific point in time. OK, so when you buy something from the mall, from online, that's one specific. Well, they still have to ship it, but it's a specific point in time. Sometime the transaction can be can can be transferred over a period of time. And this is where we talk about the completed contract method, the percentage of completion, so on and so forth. So when can the custom, when can we recognize revenue over time, over a period of time? When the customer receive and consume the benefit as the sellers perform, let's assume they bought 50 tons of coffee beans from you. So as you deliver, you're going to be delivering 10,000 tons at a time. As you deliver, you can recognize the revenue. OK, another way the customer controls the asset that it's created. For example, a builder construct the building on the customer's property. So if you're constructing a building and you put a foundation, well, guess what? Once you have that foundation in, you're done with the foundation. Then you satisfy that obligation. Then since the customer have control over that foundation, because if you leave that job, you cannot take the foundation with you. OK, then guess what? Then you can recognize the revenue over a period of time. Or the company does not have an alternative use for the asset created. So basically simply put, you are building an asset specifically for a customer. For example, an aircraft manufacturers build a specialty jet to customer specification. Well, as you're building it, as you're building it, as long as you have an enforceable contract, you can recognize the revenue before delivery. And and either the customer received the benefit. So you're going to give them those airplanes as they are done. Or the company has the right to payment and this right is enforceable. Usually, you know, if you're building an airplane, you have the right to the payment and the and the rights are enforceable. Therefore, you can recognize the revenue before the actual delivery. OK, because it's a specialty item and you have an enforceable contract. So those are the four steps, as I told you earlier, in my intermediate accounting, each step, I have a lecture for each step plus many examples. So if you feel this is fast or quick, well, this is not intermediate accounting. This is just to give you an idea about international revenue when it comes to international accounting revenue. If you have any questions, please email me. If you happen to visit my website, please consider donating. And if you are studying for your CPA exam, as always, study hard. It's worth it. Good luck and see you on the other side of success.