Accounting for Revenue

OR
Revenue Recognition
Introduction
• What is a business cycle ?
• Duration may differ for different business activities
• Firms need to communicate performance periodically
• Could be annually, quarterly, monthly…
• Accounting principles and standards helps in periodic measurement –
Standard of Revenue Recognition
Introduction
• How to measure and report performance – important job of an
accountant
•  Landscaping company completes a one time landscaping job for a
normal fee of Rs.15,000
• When will it reflect as revenue for the landscaping company if the
customer does not pay for weeks?
• What if the landscaper is offered Rs.90,000 up front to maintain all
the landscaping over a three-year period ?
• What if the landscaper were to doubt that any payment will be
received or suspect a major risk
Importance of Revenue Recognition
• ‘Revenue’ is typically an entity’s most important financial
performance indicator and keenly scrutinized by analysts , lenders and
investors,
• One major reason the revenue recognition principle can be so
important is that the financial health of the company can greatly
affect its ability to attract investors
Revenue Recognition
• Accounting for revenue requires answers to two related questions:
• how much revenue to be recognized ?
• when should it be recognized?
What is Revenue
• Consideration earned by an enterprise by sale of goods or provision of
services in the ordinary course of business
• Revenue may also be earned by an enterprise by letting others use
resources owned by it ( Interest, dividend, rent )
• Gains from peripheral activities – profit on sale of asset
• Revenue or earnings for a period- when would they be treated of
high quality ?
What are Expenses
• Expenses – cost of providing goods and services- incurred to earn
revenue
• COGS, advertisement, salary, travel, bank interest
• Loss from activities – loss of stock, loss on sale of asset
Measurement of Income
• Income = Net Profit = Revenue- Expenses
• Loss = Net Loss= Expenses – Revenue

• Matching of Revenue with expenses is important

Quantum of Revenue
• Charges paid or agreed to be paid by the customer for buying the
goods or services from the enterprise or for use of enterprises
resources is recorded as revenue or income.
Quantum of Revenue - Discount
• Trade Discount – Certain
categories of customers on
invoice price
• Revenue should be recorded at
net sales value ( after
deducting trade discount )
• Trade discount is not shown
separately but are taken as
reduction of revenue.
• Cash discount given for prompt
payment in credit sale - At the
time of sale – revenue recorded
at gross value
• On payment by customer,
discount will be shown
separately as an expense
Illustration 1
• Quick Fox Trading ltd usually sells its goods at the invoice value. In
case of bulk orders (exceeding 1,000 units) it offers a quantity
discount of 2% on the invoice value. The customers are allowed 45
days credit period however if the payment is made within 15 days, an
additional discount of 1% is given. The company received an order for
supply of 1,500 units at an invoice price of Rs. 2,000 per unit. The
customer paid on the 15th day and availed cash discount.
• How will the transaction be recorded?
• Trade Receivables Dr. 29,40,000
To Sales 29,40,000(1960*1500units)

• Bank A/c Dr. 29,10,600

Cash Discount Dr. 29,400
To Trade Receivables 29,40,000
Sales Return
• If a customer is not satisfied with the goods bought by him, he may be permitted
by the enterprise to return the goods.
• A credit note is issued – balance in the customers account is reduced
• On sales return, the following accounting entry will be passed:

• Sales Return A/c Dr ***

To Customer A/c ***

• How is Sales Return treated?

• How useful is the information of sales return to the management?
GST
• GST is an indirect tax levied on the manufacturer/seller of goods.
Being an indirect tax it is levied on manufacturer/seller but borne by
customer

• Sales will be recorded exclusive of taxes

Illustration 2
• A company has the following data for a quarter:
• Goods at catalogue price – Rs.53,000 (excluding taxes)
• Trade discount – 10,600
• GST - 9600
• Cash discount – 1000
• What will be the value of sales in the profit and loss account ?
• Trade Receivables Dr.52,000
To Sales 42,400 (53,000-10,600)
To GST Payable 9600

• Cash Dr. 51000

Cash Discount Dr. 1000
To Trade Receivables 52,000
Agency Relationship
• Entity engaged in agency business, e.g. real estate agents, insurance
brokers, stock brokers, etc. ., would record amount of commission as
revenue and not the entire amount of the transaction.
• Illustration 3 –
• Small Bull Brokers Limited is a stock broking firm. It bought shares on behalf
of one of his clients for Rs. 50 million charging 1% brokerage .It paid Rs. 50
million to the stock exchange and collected Rs.50.5 million (including
brokerage) from its client .What amount should be recorded as revenue ?
• As small brokers Limited is acting in the capacity of a broker, only the
amount of commission i.e. Rs.0.50 million will be recognized as revenue
representing the increase in equity.
Illustration 4
• XYZ limited exported goods invoiced at $7,00,000. On the date of the
sale the prevailing exchange rate was $1 = Rs. 44. The customer was
allowed 30 days to make the payment. The payment was duly received
from the customer on due date. The exchange rate on the date of
receipt was $1 = Rs. 43.50. What will be the impact of the above sale in
the profit and loss account of the company?
• Debtors account Dr 3,08,00,000
To sales account 3,08,00,000 (Sales in P/L )
• Bank Account Dr 3,04,50,000
Exchange Loss account Dr 3,50,000 (P/L A/C)
To Debtors Account 3,08,00,000
Sale of Goods – Timing
• Revenue will be recognized when the seller has performed his part of
obligation as per the agreement with the buyer
• The property in goods has been transferred from the seller to the
buyer for a price or all significant risk and rewards of ownership have
been transferred to the buyer.
• No effective control over the goods usually associated with the
ownership has been retained by the seller.
• No significant uncertainty exists regarding the amount of
consideration or its ultimate collection.
• The amount of revenue can be measured reliably
Specific Sale Situation
• Consignment sales: Revenue will be recognized only when goods are
sold by the consignee to a third party.
• Cash on Delivery sales: Revenue will be recognized only when cash is
received.
• Sale on approval basis: Sale is considered to be complete only when
goods are explicitly approved by the buyer or on the lapse of
approved period.
Specific Sale Situation
• Installment sales: Revenue is recognized on the date of sale by the
normal selling price of the goods. Interest component in installments
is recognized separately.

• Internal sale: As there is no transfer of ownership, no sale can be

recorded.
Other Sources of Income
• Interest : Interest accrues on a day-to- day basis on the amount
outstanding at the agreed rate of interest.

• Royalty: Royalties accrued in accordance with the terms of the

relevant agreement and are usually recognized on that basis

• Dividend: Dividend on shares is recorded when the right to receive

dividend is established – Record Date (not on time basis)
Illustration 5
• Hiro Hooda Limited invests its surplus cash in debt instruments to earn
interest.
• It made a fixed deposit of Rs. 100 crore on 1st July 2019 with SBI for a
period of one year. The FD will mature on 30th June 2020 with interest
at 9% per annum.
• It also brought treasury bills for Rs. 95 crore on 1st January 2020 which
will mature for Rs. 100 crore on 30th June 2020. No interest will be
received on these T- Bills.
• The company follows financial year as the accounting period.
• When will the interest income be recognized?
• Total Interest earned: 9% of Rs. 100 crore = Rs. 9 crore

• On time proportionate basis 9/12 of interest, that is, Rs. 6.75 crore
will be recorded as an income for the year 2019-20
• and 3/12 of interest, that is, Rs. 2.25 crore will be recorded as income
of the year 2020-21.

• On 31st March 2020, the following entry will be passed:

Interest Accrued but not Due Dr. 6.75 crore (Current Asset)
Interest Income 6.75 crore (P/L A/c)
ACCOUNTING FOR RECEIVABLES
Customer/ Debtors Account Dr XXXXX
To Sales/ Income from Services Account XXXXX

• On due date when the payment is received, the following entry is

passed:
Bank Account Dr XXXXXX
To Customer/ Debtors Account XXXXX
ACCOUNTING FOR RECEIVABLES
Amount Outstanding at the end of the Accounting period.- shown in the
balance sheet as a current asset under the heading ‘Sundry Debtors’ or
‘Account Receivables’.

Provision of Doubtful debts

Bad debt Expense Account Dr XXXXX
To, Provision for Doubtful Debts XXXXX
Bad debt expenses account will be transferred to the P/L Account and
accordingly the profit for the period will get reduced. In the Balance sheet, the
provision for doubtful debts is shown as a deduction from the sundry debtors.
Illustration 6:
• Strong Plastics Limited usually provides a credit period of 90 days to
its customers. During the year 2018-19 the total sales of the -
company amounted Rs.325 million. Out of this , amounts aggregating
to Rs.220 million were collected from the customers. Based upon the
past experience, the company estimated that about 5 % of the
amount outstanding will not be recovered and may have to be written
off.
• How will this information appear in the profit and loss statement for
the year ending on 31st March 2019 and the balance sheet as on that
date.
Cash Account Dr 220mn
Debtors Account Dr 105mn
To Sales Account 320mn

Bad debt Expense Account Dr 5.25mn

To Provision for Doubtful Debts 5.25mn

Provision for Doubtful Debts Account Dr 5.25mn

To Debtors Account 5.25mn
• Statement of Profit and Loss
Income (Rs. In Million)
Sales 325.00
Expenses
Bad debts (Provision for doubtful debts) 5.25(5%of 105 Million)

• Balance Sheet
Current Assets
Debtors/Trade Receivables 105.00 (Rs. 325 mn - Rs. 220 mn)
Less: Provision for doubtful Debts 5.25
Net 99.75
• Practical Exercise -1
• Satyam Machines Ltd is a manufacturer of high tech fabrication
machines. Each machine is sold on cash down price of Rs 3 million.
The company also offers the same machine on installment payment
basis. The customers buying on installment basis can pay the amount
in 3 equated annual installments of Rs 1.3 million each at the end of
next 3 years. The company sold a machine on 1st April 2019.

• When will the revenue from sales be recorded and by how much?
• How will you treat the difference between the cash down price (Rs 3
million) and installment price (Rs 3.9 million)
• Revenue from two sources: Sale of machine and Interest on instalment
sales
• Sale of machine recorded on 1.4.2019 at Rs. 3 million (2019-20)

• Difference between cash down price and instalment price = 3.9-3

million= 0.9 million ( Interest earned)

• As instalments are paid annually, interest can be apportioned in 3 years

in the ratio 3:2:1

• Interest income will be recognized as 0.45 mn in 2019-20, 0.30mn in

2020-21 and 0.15 mn in 2021-22
on 1.4.2019
Trade Receivables Dr. 3 mn
To Sales 3 mn
On 31.3.2020
Bank Dr. 1.30 mn
Accrued Interest Dr. 0.15mn
To Trade Rec1mn
To Interest 0.45mn
On 31.3.2021
Bank Dr. 1.30mn
To Trade Rec1mn
To Interest 0.30mn
On 31.3.2022
Bank Dr. 1.30mn
To Trade Rec1mn
To Interest 0.15mn
• Practical Exercise -2
Exercise
• RS Finance Limited is a non banking finance company in the business of
providing loans. On 1st October 2018 it gave a loan of Rs 10 lakhs to Mr
Ram at 10% per annum to be repaid after 3 years.
• Interest is to be paid quarterly. Mr Ram duly paid interest on 31st
December 2018.
• However, it failed to pay interest due for the next 2 Quarters.
• On 1st July 2019, the company classified the account as delinquent and
decided to create a provision for the same.
• How will this transaction appear in the profit and loss account for the
year 2018-19 and 2019-20 and the balance sheet on 31st March 2019
and 31st March 2020?
• In Profit and Loss A/c of 2018-19
• Interest of 2 quarters will be recorded on accrual basis – Rs.50,000 will
appear as interest income
Bank Dr. 25,000
Interest Accrued Dr. 25,000
To Interest Income 50,000 (P/L A/C)

• In Balance Sheet :
• Assets – Loans and Advances:
• Loan Rs.10,00,000
• Add: Interest accrued but not received Rs.25,000
Rs. 10,25,000
• In 2019-20
Profit and Loss A/c of 2019-20 Interest Accrued Dr. 25,000
To Interest Income 25,000
• Income
Interest Rs.25,000

• Expense Bad Debt Dr.10,50,000

• Bad debt (loan)Rs.10,50,000 To Provision for bad loan 10,50,000
Loan as on 31.3.2019 Rs.10,25,000
(+) Int acc (1st quarter) Rs.25,000
• Balance Sheet for 2019-20 Loan as on 30.6.2019 Rs. 10,50,000
• Assets – Loans and Advances:
• Loan Rs.10,50,000
• Less: Provision for bad loans Rs. 10,50,000
NIL
Practical Exercise -3
Asia Computers Limited: Accounting Policy for Revenue Recognition
• Asia Computers Ltd. is a newly established company in the information technology sector. This
company has plans to gradually enter BPO and software development activities. In the initial
phase the company plans to concentrate on the following revenue recognition activities:
• Sale of computers: The Company buys computers of reputed brands and sells them for
personal and official uses. To retail customers, computers are sold on cash basis, whereas
commercial customers are given 60 days credit.
• Maintenance services: The company provides maintenance services for computers either on
call basis or by entering annual maintenance contracts with the customers. In the former case,
the customer pays every time maintenance service is provided. The cost of spares in such cases
is also charged to the customer. In case of AMC, fee is charged yearly in advance The AMC fee
covers the service charges as well as the cost of parts that may have to be replaced.
• The surplus funds are kept either in fixed deposits with banks or invested in mutual funds.
• Please help the company in framing suitable accounting policies for revenue recognition for the
above mentioned activities.
Solution
• Sale of computer – revenue recognition on accrual basis – when ownership
of goods sold is transferred to the buyer and there is no uncertainty about
the consideration
• Maintenance Services – Call basis – recognize immediately upon completion
of service, both for service charges as well as charges for spares. For Annual
Maintenance Contracts – revenue recognition on time proportionate basis.
• Fixed deposit – accrual on the basis of amount of deposit, rate of interest
and time.
• Dividends on mutual funds – once the dividend is declared and the right to
receive dividend has been established.
Practical Exercise -4
• During the year 2019-20, the invoice value of goods sold by Avon
Corporation amounted to Rs. 325 million .The company offered trade
discount aggregating to Rs. 10 Million. In addition, GST @18% of the
invoice price was collected by the company and paid to the
Government. The company normally sells goods on credit of 60 days
and offers a cash discount of 1% if payment is made by the customer
within 10 days of sales.
• How will the revenue from sales be shown in the profit and loss
account for the year 2019-20?
• Trade Receivables Dr.372
To Sales 315
To GST Payable 57

On the date of Payment

• Cash Dr. 368
Cash Discount Dr. 4
To Trade Receivables 372
• Revenue to be recorded:

• Sales at invoice price: 325 million

• Less: Trade discount 10 million
315 million

• GST collected is not revenue- It will be collected and paid to the

Government
• Cash discount if and when availed by the customer by making prompt
payment will be shown separately as expense
Practical Exercise -5
• Fair White limited is an FMCG company largely catering to domestic
markets. During the year 2019-20, it received its maiden export order
for $2 million for supply of fairness cream to the US. The order was
duly executed on 1st November 2019. The supplier was allowed a
credit period of 90 days for making payment. The rate of exchange on
1st November 2019 was Rs 45, whereas by the payment was received
on 30th January 2020 at Rs 45.30.
• How will the above transaction appear in the profit and loss account
for the year 2019-20?
• Customer account Dr 90 mn
To sales account 90mn (Sales in P/L )
• Bank Account Dr 90.6mn
To Customer Account 90mn
To Exchange Gain 0.6 mn (P/L A/c)
• Profit and Loss A/c of 2019-20:

• Sales ( ($2 million @ Rs.45) 90million

• Gain on account of foreign exchange difference 0.60 million
• { $2 million (45.30-45.00)}

• Sales will be recorded at exchange rate prevailing at the time of sales

• Exchange fluctuation gain or loss will be recorded later without
altering the revenue
• Practical Exercise -6

• Ram Bharose Ltd, Steel trader follows a very liberal credit policy of allowing 120 days to its
customer to pay against their purchases. This policy has helped the company in attracting
new customers but at the same time results in a high incidence of bad debts. As on 31 st
March 2020, the company has total debtors of Rs. 15 Million. The company classifies its
customers in 3 categories.
• A, B & C based upon their credit worthiness. The breakup of Rs 15 million of sundry
debtors is as follows:
Category Amount ( Rs in Million)
A 8.00
B 5.50
C 1.50

• Based upon the past experience, it is estimated that 2% of Category A, 3% of Category B

and 5% of category C may not pay when due and have to be provided for. What will be
impact of the above in the profit and loss account for the yearend balance sheet as on 31 st
March 2020?
• Provision for doubtful debts:
2% of 8 million + 3% of 5.5 million + 5% of 1.5 million = 0.40 million

Bad Debt Expense Dr. 0.40 million

To Provision for Doubtful Debts 0.40 million
In the P/L A/C for the year, Bad debt expense will appear at 0.40 million

Balance Sheet:
Trade Receivables 15 million
Less: Provision for Doubtful Debts 0.4 million
14.60 million
• Practice Questions
• In which financial year , will revenue be recognized in each of the
following cases:

• Advance received from a customer on 31st December 2016. The goods

are manufactured and invoiced on 1st April 2017 .
• Though the advance was received from a customer on 31st December
2016, the sales will be recorded when the goods have been identified
and invoiced i.e. on 1st April 2017
• Goods sent to a commission agent on 15th January 2017. Goods sold
by the commission agent on 28th April 2017.
• Sale of Goods is recorded when the ownership passes. When goods
are sent to a commission agent there is no transfer of title.
Accordingly the sale will be recorded when goods are sold by the
commission agent i.e. on 28th April 2017.
• Loan of Rs. 10 million given to another company at 10 % per annum on 1st
March 2017 for a period of one year. The interest amount of Rs. 1 million
deducted upfront from the loan amount. The loan is repaid in full on 1st
March 2018.
• Interest income is recorded on time proportionate basis considering the
amount of loan and rate of interest. The timing of payment is not relevant.
Accordingly interest for 1 month amounting to Rs.83,333 will be recorded in
2016-17 and for 11 months amounting to Rs.916,667 will be recorded in
2017-18.