Question

In each of the following situations, state at which date(s), if any, revenue will be recognised. Explain your reasoning.                                                 

(a) A contract for the rendering of services is entered into on 1 May 2023. The services are delivered on 15 May 2023. The buyer pays for the services on 30 May 2023. The services are covered by a special warranty which expires on 30 June 2023. The special warranty allows for the goods to be returned and a refund received.

(b) A contract for the sale of goods is entered into on 1 May 2023. The goods are delivered to the buyer for one month’s evaluation on 15 May 2023. If the buyer is happy with the goods the contract provides for further sales each month. The buyer pays for the evaluation goods on 3 May 2023. The evaluation goods are returnable under normal warranty conditions until 30 June 2023.           

(c) A contract for the rendering of services is entered into on 1 May 2023. The services are delivered continuously over a 1-year period commencing on 15 May 2023. The buyer pays for the services on a monthly basis, commencing on 15 May 2023. The buyer may revoke the agreement at any time.

Answer 1

Answer to part A

Reveue recognization is a generally accepted accounting principle ( GAAP ) that states how and when revenue is to be recognized. The revenue recognition principle using accrual accounting requires that revenue is recognized when a critical event has occured, and the amount is easily measurable to the company.
In case (a) the services were delivered on 15 May. Accordingly, the revenue will be recognised on 15 May.
The right of special warranty for the goods shall not affect the accouting principle for the recognisation of revenue.

Answer to part B

For revenue recognition there is a primary condition which needs to be satisfied and that is “the transfer of ownership of the goods.”

When a company sends goods for the evaluation to a cus­tomer, it cannot be treated as sales and thus can not be recorded as sales. Mere delivery of goods on evaluation basis implies a change of posses­sion only and not a transfer of ownership unless the specified period expires without return or the customer earlier informs of his approval.

Accordingly the ownerships vests with the company till the evaluation period expires or the buyer gives his approval.

In the present case, sales shall be recognised on 15 June ( the expiry of one month evaluation period ). We have come across that the buyer neither showing his consent nor disqualified the goods. Further, the advance payment on 03 May would not affect the revenue recognition.

Answer to part C

As per the priciples of revenue recognition, in a case of long term contract for rendering services, the revenue should be recognised on pro rata basis over long term period.

In the present case, the services are delivered continuously over a 1 – year period commencing from 15-May 2023. Accordingly, Revenue is recognised on a straight-line basis over the year commencing 15 May 2023.

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