Question Tag: Advance Payments

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  • 4 Marks

FR – Nov 2021 – L2 – Q2b – Financial Reporting Standards and Their Applications

This question requires the recognition of revenue under IFRS 15 for a contract with advance payments and the calculation of a significant financing component.

Marshall Ltd (Marshall) is a manufacturing company that prepares Financial Statements in compliance with IFRSs and has a reporting date of 31 December. During the year to 31 December 2020, Marshall entered into a contract with a customer to manufacture and sell some goods such that the goods will be delivered (control of the goods vests with the customer) in two years. The contract has two payment options:

i) The customer can pay GH¢500,000 when the contract is signed, or

ii) GH¢650,000 in two years when the customer gains control of the goods.

Marshall’s incremental borrowing rate is 10%. The customer paid GH¢500,000 on 1 January 2020, when the contract was signed. Marshall intends to recognise revenue on this contract in the financial statements.

Required:
In accordance with IFRS 15: Revenue from Contract with Customers, explain (with supporting calculations) how Marshall should account for the above transactions for the years 2020 and 2021.

Revenue Recognition Principles under IFRS 15:

  • IFRS 15 requires revenue to be recognised as each performance obligation is satisfied. An entity satisfies a performance obligation by transferring control of a promised good or service to the customer, which could occur over time or at a point in time.
  • In this contract, Marshall undertakes to transfer control of the goods in two years. Hence, the performance obligation has not been satisfied, and revenue cannot be recognised until the goods are delivered and control is transferred.

Advance Payment and Financing Component:

  • The customer made an advance payment of GH¢500,000 for goods to be delivered in two years. This represents a liability (revenue received in advance) and has a significant financing component.
  • The significant financing component must be accounted for separately. The advance payment effectively contains an implicit interest element since the customer could have alternatively paid GH¢650,000 after two years.

Calculation of the Financing Component:

  1. Finance Cost for 2020:
    • The interest rate is 10%.
    • Finance cost = GH¢500,000 x 10% = GH¢50,000.
    • This finance cost should be recognised in the statement of profit or loss for the year ended 31 December 2020.
    • The liability in the statement of financial position at the end of 2020 will be GH¢550,000 (GH¢500,000 + GH¢50,000).
  2. Finance Cost for 2021:
    • In 2021, interest is applied to the balance carried forward from 2020.
    • Finance cost = GH¢550,000 x 10% = GH¢55,000.
    • This finance cost should be recognised in the statement of profit or loss for the year ended 31 December 2021.
    • The liability in the statement of financial position at the end of 2021 will be GH¢605,000 (GH¢550,000 + GH¢55,000).

Summary:

For the year ending 31 December 2020:

  • Liability (deferred revenue): GH¢550,000
  • Finance cost: GH¢50,000

For the year ending 31 December 2021:

  • Liability (deferred revenue): GH¢605,000
  • Finance cost: GH¢55,000

Revenue recognition principle:  1 mark
Finance cost for 2020:  1 mark
Finance cost for 2021:  1 mark
Supporting calculations:  1 mark

Total: 4 marks

  • 5 Marks

CR – Mar 2024 – L3 – Q3b – IFRS 15: Revenue from Contracts with Customers

This question discusses the treatment of advance payments and significant financing components under IFRS 15 for Tieku Technologies.

On 1 December 2022, Pinto Ltd (Pinto), a public company, acquired 70% of the ordinary share capital of Manpam Inc (Manpam), a private company in Liberia. The functional currency of Pinto is the GH¢, and the functional currency of Manpam is the Liberian Dollar (LS). Pinto paid GH¢39.1 million for its investment in Manpam on 1 December 2022, when the net fair value of the identifiable assets acquired and liabilities assumed of Manpam were LS22,440 million.

Given that Manpam is a private company, Pinto decided to measure the non-controlling interests at acquisition at the proportionate share of the fair value of the identifiable net assets of Manpam. An impairment test conducted at the group level on the investment in Manpam at 31 December 2023 indicated an impairment loss on goodwill of LS357 million (attributable to Pinto). No impairment loss adjustments had been necessary at the previous year end.

Relevant exchange rates were:

  • 1 December 2022: GH¢1 = LS470
  • 31 December 2022: GH¢1 = LS478
  • 31 December 2023: GH¢1 = LS490

Required:
In accordance with IFRS, calculate the goodwill figure to be recognized in the consolidated statement of financial position of Pinto for the year ended 31 December 2023 (to the nearest GH¢0.1 million).

Computation of goodwill

  • 5 Marks

CR – Aug 2022 – L3 – Q3b – IFRS 15: Revenue from contracts with customers

This question focuses on the recognition of revenue from advance payments in line with IFRS 15 and explains the treatment for advance payment financing.

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)

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:

  1. 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)
  2. 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).

  3. 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)

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