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- 5 Marks
Question
Tieku Technologies (Tieku) imports customized equipment from Europe and China for onward delivery in Ghana. It is the policy of Tieku that customers make payment for their supplies one year before delivery. Tieku does not offer discounts for advance payments. The advance payment allows Tieku to manage its import levels and to communicate delivery of supply to its customers. On 1 April 2021, Tieku received GH¢5 million from a customer to supply a customized equipment, and on 31 March 2022, Tieku delivered the equipment. Tieku’s incremental borrowing rate on 1 April 2021 was 10%.
Required:
In line with IFRS 15: Revenue from Contracts with Customers, provide an explanation (with calculations and entries, if necessary) as to how the above scenario would be treated by Tieku during the year ended 31 March 2022. (5 marks)
Answer
In accordance with IFRS 15, revenue is recognized when an entity satisfies a performance obligation by transferring control of a good or service to a customer. In cases where a customer makes an advance payment, the payment should not be recognized as revenue until the performance obligation is fulfilled (i.e., when the goods or services are delivered).
In this scenario, Tieku Technologies received an advance payment of GH¢5 million on 1 April 2021, but the equipment was not delivered until 31 March 2022. This creates a contract liability at the time the payment is received, as Tieku has an obligation to deliver the equipment in the future.
Step-by-Step Treatment:
- Advance Payment and Contract Liability
On 1 April 2021, when the GH¢5 million is received from the customer, Tieku should recognize it as a contract liability:- Debit: Bank (GH¢5 million)
- Credit: Contract liability (GH¢5 million)
- Significant Financing Component
IFRS 15 requires entities to assess whether a contract includes a significant financing component when there is a significant period between the payment and the delivery of goods or services. The objective is to reflect the time value of money.In this case, the advance payment was made one year before delivery, and Tieku’s incremental borrowing rate on 1 April 2021 was 10%. Therefore, the transaction has a financing component.
The financing effect should be accounted for by recognizing interest expense over the period from 1 April 2021 to 31 March 2022. The calculation of the interest can be done as follows:
Interest on the advance payment = GH¢5,000,000 x 10% = GH¢500,000
Tieku should recognize an interest expense and increase the contract liability by this interest amount:
- Debit: Finance cost (GH¢500,000)
- Credit: Contract liability (GH¢500,000)
The total contract liability at 31 March 2022 would be GH¢5,500,000 (GH¢5 million + GH¢500,000).
- Recognition of Revenue
On 31 March 2022, when Tieku delivers the customized equipment, it satisfies the performance obligation and can recognize the revenue. The total amount to be recognized as revenue is the total contract liability (GH¢5,500,000).The journal entry for the recognition of revenue will be:
- Debit: Contract liability (GH¢5,500,000)
- Credit: Revenue (GH¢5,500,000)
- Tags: Advance Payments, Financial Liabilities, Revenue Recognition
- Level: Level 3
- Topic: IFRS 15: Revenue from contracts with customers
- Series: AUG 2022
- Uploader: Theophilus