Show me the money!

So, you enter into a sales/service agreement with another party and they keep promising to pay, but nothing is coming in… can you still recognise the revenue?

There is an unsettling trend for contracts to be entered into, esp. in government departments, and through the process there tends to be scope creep, with more work performed here and there, on request from management very often. When the invoices come through, they go through the accounts department, and the additional work is not paid as it wasn’t included in the original contract. I’ve even come across cases where this has gone on for years with management stringing the supplier along that it is just some small approval that needs to happen, and it will be paid… it never does and probably never will.

We’ve also come across situations where the relationships have soured, and the supplier is sticking to the contract in fear of reprisals… and the customer simply withholds payments… for years!

Here’s the thing, in many of these instances, the contract, and even the scope creep is entered into in good faith, but the first step of revenue recognition is not always considered… or reconsidered. Step 1: Identify the contract. There are a few requirements to this, including that the contract be approved, and the parties are committed to perform their obligations, as well as that each party’s rights are identifiable, and the important one in this instance:

It must be probable that the entity will collect the consideration to which they are entitled.

Usually, it is assumed at the beginning of a contract that you will receive the consideration, and usually this is not reassessed unless there is an “indication of a significant change in facts and circumstances.” (paragraph 13 of International Financial Reporting Standard 15 Revenue from Contracts with Customers (IFRS 15))

Where there is no payment for a few months, that might not be considered significant, but once it hits a year… or two… that can become significant. This is a judgement that must be made by management; but is it being looked at? Once you start looking at your expected credit losses and calculate it at 100%, you should be looking at the revenue standard too and considering whether the revenue should still be recognised.

If you don’t recognise revenue, what do you do? Weird as it looks, if you make sales of R150 at a gross profit of 50% these should be the journal entries:

Dr Debtor                     Rnil

Cr Revenue                  Rnil

Still invoice, but can’t recognised revenue

Dr Deferred tax asset    R42

   Cr Deferred tax expense        R42

Calculated at 28% of the invoice amount. There is no carrying amount for the debtor, but it has a tax base on issue of the invoice

Dr Cost of sales                        R100

   Cr Inventory                          R100

Inventory left the premises and must be derecognised

The debtor is not recognised on the statement of financial position, but the invoice is sent for this good or service, there is therefore deferred tax to be recognised on this temporary difference. This difference will be reversed when payment is received, or the debtor is written off.

If the company did recognise revenue, it must be reversed, with judgement applied determining how far back it should be reversed.

According to IFRS 15 when a contract can’t be identified, it must be continually assessed until it does.

Where things get interesting is that a contract with a customer that doesn’t meet the requirements to ‘identify the contract’ doesn’t simply rectify and meet the requirement on receipt of the payments. The amount received can only be recognised as revenue either when:

1. you have no remaining obligations to transfer goods or services to the customer AND all, or substantially all, of the consideration promised is received; AND the amount is not refundable; or
2. the contract has been terminated AND the amount received is not refundable.

Until one of these requirements are met, any amounts received must be recognised as a liability. The liability is measured at the consideration received and will either be for the goods or services still to be delivered or for a refund of the amounts received.

If you’ve got one of these contracts, it’s time to reassess it; you might find your revenue is overstated.

29/03/2022