Baker Tilly Blog

New Revenue Standard: Impact on Trading Companies

[fa icon="calendar"] 25 August 2017 07:45:00 BNT / by Susan Foong

Susan Foong

Along with the impending implementation of FRS 115 (Revenue from Contracts with Customers), comes the question: Is your company ready for the new standard?

FRS 115 is the new accounting standard on revenue arising from the revenue project of the International Accounting Standards Board (IASB). Some companies say it poses a significant challenge by drastically affecting the way revenue is recognised. Others say it is unlikely to affect the business and that an early understanding of the standard is not necessary.

For trading companies, what would the impact of the new revenue standard be? Also, will revenue continue to be recognised as it had been previously? We address the potential impact of FRS 115 on revenue recognition through the following illustrations:

1. Right to Return Goods

Although the current accounting standards require revenue to be adjusted for expected returns,
the detailed computations and accounting for the expected returns may be different for some
companies under FRS 115.

For example, Entity A sells 1,000 units of its product (costed individually at $60) for $100
each in cash and permits the customer to return any unused product within 30 days and receive a full refund. Such a policy would mean that the consideration received from the customer is variable.

Using the “expected value method”, Entity A estimates that 950 product units sold at $95,000 will not be returned, having considered including only the amounts which are highly probable that there will not be a significant revenue reversal (i.e. applying constraining estimates on variable consideration).

Under FRS 115, Entity A recognises the following in their accounts upon transferring the control of 1,000 product units:

Revenue  $95,000
Cost of sales $57,000, with derecognition of inventories of $60,000
Trade receivable $100,000
Refund liability

$5,000 ($100 X 50 product units expected to be returned)

Right to recover asset $3,000 ($60 X 50 product units)

Key Considerations

The company should take into account the following considerations:

  • Are existing estimation methodology and accounting for sales returns compliant with FRS 115?
  • Has it assessed if adjustments are required on opening balances to account for refund liability and right to recover asset upon transition to FRS 115?
  • Are existing accounting or financial systems capable of accounting for the refund liability and right to recover assets?

2. Warranties 

Product warranties are commonly provided with the sale of a product. Under FRS 115, there are two types of warranties.

The assurance-type warranty provides the customer with the assurance that the product will function as the parties intended because it complies with agreedupon specifications. It is accounted as a cost provision with no impact on revenue amount.

The service-type warranty provides the customer with a service, in addition to the assurance that the
product complies with agreed-upon specifications. Under this warranty:

  1. Transaction price is allocated to the product and the service-type warranty.
  2. Revenue allocated to the product is recognised at point of sale.
  3. Revenue allocated to the warranty is recognised over the warranty period rather than at point of sale.

Potential Impact

For companies providing service-type warranties, a portion of the sales contract’s transaction price would need to be allocated to the service-type warranty as the promised service is classified as a separate performance obligation.

Assuming that the transaction price for a sales contract with a two-year service-type warranty is $10,000, with $9,000 and $1,000 allocated to product and warranty, respectively. The revenue of $9,000 will be recognised at the point of sale of the product and $1,000 over the two-year period.

Key Considerations

The company should take into account the following considerations:

  •  What type of warranty is the company currently offering?
  • Are there potential impact and adjustments required to the company’s accounting for warranty
  • Is the accounting system ready to enable classification of service-type warranties as separate
    performance obligations?

3. Sale Contract Bundled with Installation Services


If a company enters into a contract with the customer to supply and install equipment, there is a need
to assess the goods and services promised to the customer. This is necessary to determine which goods and services are distinct in accordance with paragraph 27 of FRS 115 and accordingly, are separate performance obligations. Identifying performance obligations in a contract with more than one promised good or service could involve significant judgement. Furthermore, it may potentially impact the timing and amount of revenue recognition.

For illustration, Company XYZ sells a piece of equipment for $100,000, with free installation service included as part of the contract. The equipment is operational without any customisation or modification, with straightforward installation requirements which can be performed by several alternative service providers. However, if Company XYZ is engaged to perform standalone installation services, it will charge a fee of $5,000.

If Company XYZ identifies two performance obligations (PO), the transaction price of $100,000 is allocated to each PO, with the revenue portion recognised when each of the PO is satisfied.

Key Considerations
Has the company considered how its revenue recognition will be affected for contracts with more than one performance obligation?

As the impact of FRS 115 on entities will vary, management should gain an understanding of its requirements, and perform an early evaluation of how the new standard will affect their revenue recognition policies and practices. Preparing in advance to meet the requirements of FRS 115 is key to a successful implementation.

References have been made to FRS 115 Revenue from contracts with customers and illustrations adapted from the FRS 115 Illustrative Examples. For more information, please get in touch with Baker Tilly TFW.

Topics: Financial Reporting

Susan Foong

Written by Susan Foong

Susan Foong is Assurance Partner at Baker Tilly TFW. She specialises in audit and review engagements for businesses ranging from SGX-listed and private companies to not-for-profit organisations. She heads Baker Tilly TFW's Assurance Technical, Learning and Development team and supports the firm's Management Committee in quality assurance.

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