bas 11 bas 18

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Practical insights intoapplication of

BAS 18 and BAS 11

Application of BAS 18

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Session overview

Level of compli ance with BFRS / BAS

Key definitions and concepts

Identification of the transaction

Sale of goods:• Revenue recognition point• Measurement of revenue

Rendering of services:• Revenue recognition point• Measuring stage of completion

Interest, royalties and dividendsRevenue recognition point

Level of compliance with BFRS – macro perspective

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Factors affecting individual reporting entities’ level of compliance with BFRS / BAS:

• Size and nature of entity

• Sector

• Regulation

• Users / purpose of financi al statements

• Stakeholders – shareholders, lenders / donors etc.

• Attitude of tax authorities

• In-house expertise / resources

BAS 18 – Key definitions and concepts

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RevenueThe gross inflow of economic benefits during the period arising in the course of the ordinary activities

of an entity when those inflows result in increases in equity, other than increases relating tocontributions from equity participants. [BAS 18 (7)]

Fair valueThe price that would be received to sell an asset or paid to transfer a l iability in an orderly transaction

between market participants at the measurement date. [BAS 18 (8)]

Measurement of revenueRevenue shal l be measured at the fair value of the consideration received or receivable. [BAS 18

(9)]

Conceptof materialityFinancial statements areto be free from material misstatement.

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BAS 18 – Identification of the transaction

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The recognition criteria in this Standard are usually applied separately to each transaction.

However, in certain circumstances, it is necessary to app ly the recognition criteria to the separatelyidentifiable components of a single transaction in order to reflect the substance of thetransaction.


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Illustrative example - Bundled arrangement

X is a mobile operator company that offers a package for of BDT 950 consisting of a mobile handsetand data service comprising the following separable components:

FairvalueBDT

Handset 900100 free MB data (valid for for a month) 100

Howshould therevenue be recognised by X?


I l lustrative example -B undled arrangement (cont’d)

As per standard

The revenue should be recognised as follows:

Revenue from the sale of the handset should be recognised when the risks and rewards of ownershippass to the buyer, which will normally be on delivery to the customer.

Free data transfer represent the rendering of services. Thus, free data transfer should be recognisedbased on actual data usage.

Revenue should be recognized by applying the discount based upon relative fair value. The bundledpackage represents a BDT 50 discount (total fair value of the individual components beingBDT 1,000 less package price of BDT 950).

FV % Discount RevenueHandset 900 90% 45 855Free data 100 10% 5 95

1000 50 950

Practical considerations• Handset are sold at cost (say 800) instead of at a margin because it is through this handset the

operator gains a voice/data cust omer and continuing future revenue stream. Revenue recognised onhandset sale at BDT 800

• Revenue recognised on data sale BDT 150 (balancing figure)

BAS 18 – Sale of goods

Point of revenue recognition

[BAS 18 (14)] Revenue from the sale of goods shal l be recognised when all the fol lowing conditionshave been satisfied:

(a) the entity hastransferredto the buyerthe significant risks andrewards of ownership of thegoods;

(b) the entity retains neither continuing managerial involvement to the degree usually associated withownershipnor effectivecontrol over thegoodssold;

(c)the amountof revenue canbe measuredreliably;

(d)it is probable that theeconomic benefits associatedwiththe transaction willflowto theentity; and

(e)the costs incurred or to be incurred in respect of thetransactioncan be measured reliably.

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BAS 18 – Sale of goods: Revenue recognition point

Illustrativeexample – recognitionpoint

FMCG company X has annual sales of BDT 1,500m. X delivers goods to its wholesale customersthrough a third party transportation agency. As per theagreement with the transportagency,in caseof anydamageincurredduringtransit theagency is to bear thefirstBDT 0.5m of theloss (per transit);theaverage value of each t ransit / consignment is BDT 2.5m. X company faced only one damageincidenceduringtransit in thelast fiveyears.

On 31 December 2015, X dispatched goods wor th of BDT 5m via the t ransport agency out to thecustomers.

At what stage should the revenue be recognized by X?

BAS 18 – Sale of goods: Revenue recognition point

I l lustrative example – recogni t ion point (cont’d)

As per standard

Significant risk and reward of ownership s eem to remain with X duri ng transit. Revenue should not berecognised until goods reach customer.

Practical considerations

• Most deliveries reach distributor within the same day• Recognising revenue based on issuance of goods received note not practicable given volume and

time lag• One day’s sale is not deemed material in context of entire year’s sales.

Accordingly, X recognises revenue upon despatch from its factory.

BAS 18 – Sale of goods: Measurement of revenue

Illustrative example – free goods

Pillar Plc is a cement manufacturing company. For every 10 bags purchased, Pill ar offers a furtherfree bag of cement to its customers. On 1 January 2016, X sold 10 bags of cement of BDT 100each.

How this transaction should be accounted for?


I l lustrative example – free goods (cont’d)

As per standard

Dr. Accounts receivable 1,000Dr. Sales Rebate 100Cr. Revenue 1,100

Presentation

Revenue 1,100

Less sales rebate 1001,000


In practice, entities treat sales rebates as marketing/promotion expense instead of asreduction of revenue.

GP margin sensitivities – Tax authorities and management KPI

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Illustrative example – volume rebate / interim financials

Company X sel ls goods and grants a 15% rebate to each customer that spends at leastBDT 100,000 during a calendar year (January to December). Usually, very fewcustomers’cumulative purchases exceeds BDT 100,000 within September and the majority of salestake place in thefourthquarter(Octoberto December).

X'sannual reporting period is also ended on 31 December. However it prepares interim 6monthsaccountsup to 30 June also.

Howshould X measure itsrevenue as at 31 Decemberand 30 June?


I l lustrative example – volume rebate / interim financials (cont’d)

As per standard

X concludes that i t is probable that a particular customer wil l buy goods worth 110,000over thefull year, reflectingits past experience andthe current year'sforecasts.

The amount of revenue recognised at the year ended 31 December should be grossrevenue less actual rebate each customer is entitled to based on their actual cumulativepurchasevalue at theyear-enddate.

For the 30 June interim financial statements, X should estimate the number or proportionof customers who wil l exceed BDT 100,000 threshold by 31 December based on pastexperience, year to date (6 months sales) and forecast sales for the rest of the year. Itshouldthen apply the15% rebateon the6 monthssalesto that manycustomers.


• Customer and product mixmay changeyear to year • Small entities may not have retained information on sales volumes per customer or by

product


Illustrative example – Right to return

Super shop retailer SR offers customersthe option to return goods within 30 daysif theyarenot fully satisfied. In December 2015, total sales was BDT 100,000. In 2014, averagesales returnwas 2% of sales.

What amount of revenue should be recognised in December 2015?


I l lustrative example – Right to return (cont’d)

As per standard

Revenue should be recognised as BDT 100,000 less returns provision of BDT 2,000, i.e.BDT 98,000.


• In practice we see that retail shops do not foll ow the above treatment. Instead, theytend to recognize returns on an actual basis and as an admi n expense. Some possiblereasons are as follows:

• Limited management information• Concern over GP margin due to challenge from the tax authority• Management concerns over KPI• Product mix and customer behavior may change over time; past trend may not

reflect the future• If returns are accounted for on an actual basis, overall impact may be mini mal


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Payment termextending beyond normal credit term

An entity may provide interest free credit to the buyer or accept a note receivable bearing a below market interest rate from

thebuyeras consideration forthe sale of goods.When thearrangement effectively constitutes a financing transaction,the

fair value of the consideration is determined by discounting all future receipts using an imputed rate of interest. T he

imputed rate of interestis the moreclearly determinable of either:

(a)theprevailing rate for a similar instrument ofan issuerwitha similar creditrating;or

(b) a rate of interest thatdiscounts the nominalamount of the instrument tothe current cashsales price of the goods or

services.

The difference between the fair value and the nominal amount of the consideration is recognised as interest revenue in

accordance withparagraphs 29and 30and inaccordancewithBAS39.


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Illustrativeexample – Interest-freecredit

SBL, a manufacturer andretailer of home appliancesand electronicgoods, sold a refrigeratorto Mr.

A for BDT 50,000 on 1 July 2015. SBL’s normal practice is to allow90 days ofinterest freecredit to

i ts customers. However, a new scheme was introduced whereby customers are offered 12 month

interest free credit.The schemewas onlyavailableon purchases madebetween 15 Juneto 15 July

2015.

Mr. A chose to avail the interest free scheme. Current interest rate based on market-participant

assumptionsfora similarlevel of riskis 25%(imputedrateof interest).

SBL hasa 31 Decemberyear end. Whatis theamountof revenue to be recognised?


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Illustrative example – Interest-free credit

As per standard

1 July 2015

Trade r eceivable Dr. 40,000 ( 50,000 d iscounted a t 10%pa)

Revenue from s ale o f goods Cr. 40,000

31 December 2015

Trade receivable Dr. 5,000

Finance income Cr. 5,00030June 2016

Trade receivable Dr. 5,000

Finance income Cr. 5,000

Bank / Cash Dr. 50,000

Trade receivable Cr. 50,000


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Practical consideration

Thecomplexities in recognising revenue from theabove kindof sale stem mainlyfrom determining aimputedrate interest / discount rate to find outthe fair value of theconsideration. In practice we seecompanies to using oneof / combinationof thefollowingvariables:

• Company’s cost of borrowingfundsfor an identical term;

• Interest rate offered in a credit card;

• Rate chargedto customers by competitors fora similarscheme;

• Movement in baddebt expense;

• Commissionpaidto sales man;

• Cost of operatingthe scheme

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BAS 18 – Rendering of services


[BAS 18 (20)] When the outcome of a t ransaction involving the rendering of services can beestimated reliably, revenue associated with the transaction shall be recognised by reference to thestage of completionof thetransactionat theend of thereportingperiod. Theoutcome of a transactioncanbe estimatedreliably when allthe followingconditionsare satisfied:

(a)the amountof revenue canbe measuredreliably;

(b)it is probable thatthe economic benefits associatedwith thetransactionwill flowto theentity;

(c) the stage of completion of the transaction at the end of the reporting period can be measuredreliably; and

(d) the costs incurred forthe transaction and thecosts to complete the transaction can be measuredreliably.


Point of revenue recognition – Financial services fees

[BAS 18 (IE14)] The recognition of revenue for financial service fees depends on the purposes forwhich the fees are assessed and the basis of accounting for any associated financi al instrument.

The description of fees for financial services may not be indicati ve of the nature and substance of theservices provided. Therefore, it is necessary to distinguish between:

(a) fees that are an integral part of the effective interest rate of a financial instrument;

(b) fees that are earned as services are provided; and

(c) fees that are earned on the execution of a signifi cant act.


Illustrative example – Financial services fees

Fee type Integral partof effective

interest

Earned asservice isprovided

Earned onexecutionof

significant act

Loan origination

Loan servicing

Investment management

Loan syndication


Illustrative example – Financial services fees (cont’d)

Loan origination / arrangement fees – Although the act of ‘origination’ is completed upfront, suchfees may include compensation for activities such as evaluating the borrower's financial condition,evaluating and recording guarantees, collateral and other security arrangements, negotiating theterms of the instrument, preparing and processing documents and closing the transaction.

Loan servicing fees - Fees charged by an entity for servicing a loan are recognised as revenue asthe services are provided.

Investment management fees - Fees charged for managing investments are recognised as revenueas the services are provided.

Loan syndication fees - A syndication fee received by an entity that arranges a loan iscompensation for the service of syndication. Such a fee is recognised as revenue when thesyndication has been completed.

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Illustrative example – Financial services fees (cont’d)

Fee type Integral partof effective

interest

Earned asservice isprovided

Earned onexecutionof

significant act

Loan origination

Loan servicing

Investment management

Loan syndication


• Not all banks have technology to automaticall y integrate fees into effective interest calculation.Minimus threshold is often applied, smaller fees are recognized upfront whilst larger fees aremanually integrated into EIR calculati on (see BAS 39 session).

• Fee income is increasingly become the focus area for banks


Measuring the stage of completion

[BAS 18 (24)] The stageof completion of a transaction may be determined by a variety of methods. An entity uses the method that measures reliably the services performed. Depending on the nature of the transaction,the methodsmay include:

(a)surveys of work performed;

(b)servicesperformed to date as a percentage of total services to be performed; or

(c) the proportion that costs incurred to date bear to the estimated total costs of the transaction. Onlycosts that reflect services performed to date are included in costs incurred to date. Only costs thatreflect services performed or to be performed are included in the estimated total costs of thetransaction.

Progress payments and advances received from custom ers often do not reflect the servicesperformed.

BAS 18 – Rendering of services: Measurement ofrevenue

Illustrative example – rendering of service

Mobile operator A irnet offers a prepaid air time package for BDT 30 whereby customers get 30minutestalktimevalid for30 days.

A customer purchases the above package on 15 December 20X5. On 31 December 20X5 thecustomer hasunusedbalance of 20 minutesremaining.

How much revenue should Airnet recognize on by 31 December 2015 with regards to the abovecustomer?

Illustrative example – rendering of service (cont’d)

As per standardRevenue should be recognized in the accounting period when the service is rendered. This should

be based on stage of completion or as in this case based on actual usage of airtime.

On 15 December 20X5

Dr. Bank/Cash 30Cr. Unearned revenue 30

On 31 December 2015

Dr. Unearned revenue 10*Cr. Revenue 10

On 15 January 20X6

If there are any unused m inutes remaining on the package’s expiry date, Airtel would recognize the

remaining revenue then as it has no remaining obligation to fulfil l towards the client nor is there anycash refund. This is referred to in the indu stry as ‘elapsed minutes revenue’.


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Illustrative example – rendering of service (cont’d)


We see that there is a mix in practices in this area. Some operators is recognise revenue onstraight-line basis (i.e. equally over the 30 day period) whilst others recognize the entirepackage price upfront at time of selling the package.

The above approaches, particularl y upfront recognition, gives rise to cut -off errors in revenuemeasurement.

Reasons include technical limitations in customer consolidating data (each operator has 2-5crore customers) on unused minutes to arrive at a total revenue / deferred revenue figure.

On a rolling basis, opening and closing cut-o ff errors somewhat offset each other.



[BAS 18 (29)] Revenue arising from the use by others of entity assets yielding interest, royaltiesand dividends shall be recognised on the bases set out in paragra ph 30 when:

(a) it is probable that the economic benefits associated with the transaction will flow tothe entity; and

(b) the amount of the revenue can be measured reliably.

[BAS 18 (29)] Revenue shall be recognised on the following bases:

(a) interest shall be recognised using the effective interest method as set out in IAS 39,paragraphs 9 and AG5 – AG8; (see BAS 39 session)

(b) royalties shall be recognised on an accrual basis in accordance with the substance of therelevant agreement; and

(c) dividends shall be recognised when the shareholder's right to receive payment is established.

BAS 18 – Interest, royalties and dividends


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Illustrativeexample – Interest income on loans

ABC Bank disburses a loan of BDT 20,000 for a year at a rate of 10% on 31 December 2010.

Principal and interest of BDT 22,000 is payable on maturi ty on 31 December 2011. At the time of

disbursementof loanthe bank chargeda loanorigination feeof BDT 500.

Customer defaults the loan on due date 31 December 2011. On impairment assessment the bank

understands that they willbe ableto recover BDT 16,000afteranother year,on 31 December 2012.

Date Particulars Amount (BDT)31 Dec 2010 Amount disbursed (net off fee) 19,500

31 Dec 2011 Scheduled repayment (including interest) 22,000

31 Dec 2012 Recoverable amount 16,000


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I l lus trat iveexample – I nte res t i ncomeon loans (cont’d)

As per Standard

Although the interest rate is 10%, the effective interest rate (EIR) is higher, i.e. 12.82%, because the

origination fee charged by the bank wasconsidered to derivethe EIR. Thecarrying amount of the loan is

amortized atEIR tobook theinterest income (Actual interest amount) over thetenor of theloan.

As at 31 Dec 2011 the bank assessed that only BDT 16,000 is recoverable of the loan. The carryingamountof theloanas atthe reportingdate will beBDT 14,182[i.e. 16,000/1.1282].The initial EIR(12.82%)

willbe applied onthe newcarryingamount to recognizeinterest income. Theimpairment loss ofBDT 7,818

will be charged toP&L,the carryvalue isadjusted toBDT 14,182

PeriodCarry value b/f

(a)

(Payment)/ Receipt in

period

(b)

Interest income (P&L)

(c) = (a) * EIR

Carrying Value c/f

(d) = (a) + (c)

2010 - (19,500) - 19,500

2011 - - 2,500 22,000

PeriodCarry value b/f

(a)

(Payment)/ Receipt in period

(b)

Interest income (P&L)

(c) = (a) * EIR

Carrying Value c/f

(d) = (a) + (c)

1 - - - 14,182

2 14,182 16,000 1,818 -

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I l lus trat ive example – I nte res t i ncomeon loans


• BPRD 14 (master circular on loan provisioning) dictates classification of loans – 60 days overdue

SMA, 90 days substandard

• Interest income accrued after loanbecomes substandard is posted to interest suspense account

(BS) insteadof to P&L

• Upon recovery, interest in suspense balance(to theextent recovered) is credited to P&L

Practical considerations - dividends

Dividends – Although the right to receive is normally established when the dividend isdeclared in the AGM, companies normally recognise dividend income when they receive it.


Application of BAS 11

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Session overview

Key definitions and concepts

Contract costs

Contract costs incurred prior to securing a contract

Recognition of contract revenue and expenses• Reliably estimating the contract outcome• Determining stage of completion

• Treatment of expected loss on contract

BAS 11 – Key definitions and concepts

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BAS11 prescribes thecriteriafor theaccounting ofrevenue andcosts in relation to constructioncontracts.

Dueto thenature of such contracts, thecommencement and completion dates areusually well separated,

often crossing reporting period ends. Thestandardfocuses on the allocation of revenue andcoststo

those reporting periods in which the construction contract is executed.

The Standard shall be applied in accounting for construction contracts in the financial statements of

contractors.

Construction contract

Contract specifically negotiated forthe construction of an assetor a combination of assets that areclosely

interrelated or interdependent in terms oftheir design, technologyand function or their ultimate purpose or

use.

Fixed price contract

Construct ion contract in which the contractor agrees to a fixed contract price, or a f ixed rate per unit of

output, which insome cases is subject tocost escalationclauses.

Cost plus contract

Constructioncontract in which thecontractor is reimbursed forallowable or otherwise defined costs, plus a

percentage of these costsor a fixed fee.

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BAS 11 – Contract costs

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Contract costsshall comprise:

(a)coststhat relatedirectlyto thespecific contract(guidancegivenin p17);

(b) costs that are attributable to contract activi ty in general and can be allocated to the contract

(guidancegiven in p18);and

(c) such other costs as are specifical lychargeable to the customer under the terms of the contract

(guidancegiven in p19).


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Coststhat areattributableto contract activity in general and canbe allocatedto thecontract

• Such costs to be allocated using methods that are systematic and rat ional and are applied

consistently – thisallows forjudgementand thus we seevariety of allocationmethods being used

• Cost s out si de o f t hose s ta ted i n para 18 (i nsurance, des ign and t echn ical assi st ance,

constructionoverheads) are often allocated to contracts

Costs that cannot be attributed to a contract and hence should be excluded from contract costs

(para 20 – general admin, sel l ing costs, R&D, depreciation of idle plant) are often allocated to

contracts.


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Contract costs incurred prior to securing a contract

[BAS 11 (21)] Contract costs include the costs attributable to a contract for the period from the dateof securing the contract to the final completion of the contract.

However, costs that relate directly to a contract and are incurred in securing the contract are alsoincluded as part of the contract costs if they can be separately identified and measured reliably and itis probable that the contract will be obtained.

When costs incurred in securing a contract are recognised as an expense in the period in which theyare incurred, they are not included in contract costs when the contract is obtained in a subsequent

period.

Practical considerationsCosts incurred prior to securing a contract are in practice included in the cost of any eventuallysecured contracts even though there is no prior certainty of securing the contract. By doing thisthese costs are built into ‘work in progress’ and thus increasing revenue in that period.

BAS 11 – recognition of contract revenue andexpenses

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When the outcome of a const ruct ion contract can be estimated reliably, contract revenue and

contract costs associated with the const ruct ion contract shall be recognised as revenue and

expenses respectively by reference to thestage of completion of the contractactivity atthe end of

the reporting period.

Whentheoutcomeof a constructioncontractcannot be estimated reliably:

(a)revenue shall be recognised only to theextent of contract costs incurred that it is probablewill be

recoverable; and

(b)contractcostsshallbe recognised as an expense in theperiodin which they areincurred.

An expected loss on the construction contract shall be recognisedas an expense immediately.

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Illustrativeexample – Contractcost and revenue recognition

NRE Ltd. is executing a project of constructing the tal lest building in the country. The project is

expected to take 3 years to complete.

Thecompany hassigneda fixed price contract of $12,000,000 forthe construction of this prestigious

tower.

Costs incurred in byend ofyear 1 yearare asfol lows:

Site labor costs $1,000,000

Cost of construction material $3,000,000

Depreciationof specialplant and equipmentused inconstruction $500,000

Marketing and selling costs to get the contract $1,000,000

Total costs incurred to date $5,500,000

Estimated cost to completion $5,500,000

What is thecontract cost, percentage of completion revenues and expenses to be recognisedat end

ofyear 1?


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I l lus trat ive example – Contrac tcos t and revenuerecogn it i on (cont’d)

a) ‘Contract cost’ incurred to date

Site labor cost $1,000,000Material cost $3,000,000Depreciation of special plant and equipment $500,000Total $4,500,000

b) Percentage of completion = 4,500,000 /(4,500,000+5,500,000)= 45%

c) Revenue, costs, and profits to be recognized at end of Year 1

Revenue = 12,000,000 × 0.45 = $5,400,000Costs = 10.000,000 × 0.45 = $4,500,000Profit = $900,000


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Reliably estimating the contract outcome• In recent years, many construction contractors have emerged with limited prior experience /

resources to carry out accurate cost estimations

• Recent unprecedented rise and then fall in commodity prices (affecting prices of cement, rod,steel etc).

• With falling property market, past prices offer limited guidance as to future selling prices

Determining stage of completion

A common approach to this is the percentage of cost incurred. This is impacted by the inherentlimitations in determining contract costs (see slides 38 and 39).

Costs incurred prior to securing a contract are in practice included in the cost of any eventuallysecured contracts even though there is no prior certainty of securing the contract.


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Treatment of expected loss on contract

When there are indications of loss on overall construction contract (particularly during current difficultmarket conditions), there is an incentive for contractors to conceal such losses with the hope that themarket will improve and an overall profit will be achieved on the contract.

The above is particularly relevant as construction projects are often heavily (debt) leveraged.Contractors would be cautious not to report anything that would influence lenders (banks) towithdraw credit lines etc.

bas 11 bas 18

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