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UNIT 10

AUDIT OF REVENUES
Estimated Time: 2.0 HOURS
Discussion Questions 10-1:
Choose the best answer (Refer to PAS 18).
(1) Which of the following statement is not correct?
a. Revenue is the 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 to contributions from equity
participants.
b. Revenue shall be measured at the fair value of the consideration received or
receivable.
c. When goods or services are exchanged or swapped for goods or services
which are of a similar nature and value, the exchange can still be regarded as
a transaction which generates revenue.
d. Fair value is the amount for which an asset could be exchanged, or a liability
settled, between knowledgeable, willing parties in an arms length transaction.
e. For retail sale when a refund is offered if the customer is not satisfied,
revenue is recognized at the time of sale provided the seller can reliably
estimate future returns and recognizes a liability for returns based on previous
experience and other relevant factors.
(2) Revenue from the sale of goods shall be recognized when all the following
conditions have been satisfied, except:
a. the entity has transferred to the buyer the significant risks and rewards of
ownership of the goods;
b. the entity retains neither continuing managerial involvement to the degree
usually associated with ownership nor effective control over the goods sold;
c. the amount of revenue can be measured reliably;
d. it is possible that the economic benefits associated with the transaction will
flow to the entity;
e. the costs incurred or to be incurred in respect of the transaction can be
measured reliably.
(3) Revenue shall be recognized on the following bases, except:
a. interest shall be recognised using the effective interest method;
b. royalties shall be recognized on an accrual basis in accordance with the
substance of the relevant agreement;
c. dividends shall be recognized when the shareholders right to receive
payment is established.
d. all of the above statements are correct.
(4) All of the above statements are correct, except:
a. If an entity retains only an insignificant risk of ownership, the transaction is a
sale and revenue is recognised.
b. When an uncertainty arises about the collectibility of an amount already
included in revenue, the uncollectible amount, or the amount in respect of
which recovery has ceased to be probable, is treated as an adjustment of the
amount of revenue originally recognized.
c. If the entity retains significant risks of ownership, the transaction is not a sale
and revenue is not recognised.
d. SAB 104 provides four criteria (also known as CDEF) in order for revenue to
be considered realized. These are as follows: Collectibility is reasonably
assured, Delivery has occurred (services have been rendered), persuasive
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evidence of an arrangement exists, and there is a Fixed or determinable


price.
(5) Provided below are examples of significant risk of ownership except:
a. when the entity retains an obligation for unsatisfactory performance not
covered by normal warranty provisions;
b. when the receipt of the revenue from a particular sale is contingent on the
derivation of revenue by the buyer from its sale of the goods;
c. when the goods are shipped subject to installation and the installation is a
significant part of the contract which has not yet been completed by the entity;
and
d. when the buyer has the right to rescind the purchase for a reason specified in
the sales contract and the entity is uncertain about the probability of return.
e. When a seller retains legal title to the goods solely to protect the collectibility
of the amount due.
(6) When the outcome of a transaction involving the rendering of services can be
estimated reliably, revenue associated with the transaction shall be recognised
by reference to the stage of completion of the transaction at the end of the
reporting period. The outcome of a transaction can be estimated reliably when all
the following conditions are satisfied, except:
a. the amount of revenue can be measured reliably;
b. it is probable that the economic benefits associated with the transaction will
flow to the entity;
c. the stage of completion of the transaction at the end of the reporting period
can be measured reliably;
d. the costs incurred for the transaction and the costs to complete the
transaction can be measured reliably.
e. All of the above statements are correct.
Problem 10-1: Various Issues on Revenue Recognition
1. Transfer of Risk and Rewards (PAS 18, par 15): A seller pays for the insurance
on goods in transit from its factory to the buyers premises. The insurance policy
reimburses the seller for the full market value of the goods in the event of loss or
damage from the point when the goods depart from the factory to the point when
the goods arrive at the buyers premises. The legal title passes when the goods
arrive at the buyers premises one month later. With the insurance cover, can the
seller recognize sales at the point when the goods depart from the factory?
2. Bill and Hold (PAS 18, Appendix 1): AB Company entered into a contract on
December 31, 20x0 to supply video game consoles to customer A. The Contract
is for 100,000 game consoles at $500 each. The wholesaler has a stock of
120,000 consoles at December 31, 2005. The contract contains specific
instructions with regard to the timing and location of the delivery. AB Company
must deliver the consoles to the customer in the following period at a date to be
specified by the customer. AB Company cannot use the 100,000 consoles to
satisfy other sales orders. Customer A has made a deposit of $15,000 at the
time the contract was signed. Usual payment terms apply. Can AB Company
recognize revenue for the 100,000 game consoles?
3. Right to exchange for goods (PAS 18, Appendix 2): BC Company sells ties.
Customers can return any product within 28 days of the date of the purchase.
Returns will only be accepted with proof of purchase and if the ties are unused
and saleable as new. The retailer will accept returned ties, subject to the above
conditions only in exchange for other ties of the same value. 12% of the retailers
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sales are exchanged for other goods within 28 days of purchase. How should BC
Company recognize revenue in this case?
A. Recognize 100% of the value of the ties as revenues are sold or;
B. Recognize 88% of the value of ties as revenue when sold and then the
remaining 12% revenue when finally exchanged or the expiration of the 28
days.
4. Goods shipped subject to conditions (PAS 18, Appendix 2): CD Company offered
Customer A kitchen fittings at either a fixed price of P 10,000 including installation
or P 8,000 ex-works. Customer A signed for the P 10,000 where CD agreed to
deduct actual installation costs from P 10,000 should it fail to install the kitchen
fittings. A fair value of the installation cost is P 2,500 which is known to both
parties. At the balance sheet date, the kitchen fittings are delivered to Customer
As home but waiting to be installed. How much revenue from Customer A should
be recognized by CD company as of balance sheet date?
A. P 10,000
B. P 8,000
C. P 7,500 i.e., (P 10,000 2,500)
D. P 7,619 i.e., [P 10,000 x P 8000/(8000+2500)]
5. Goods shipped subject to conditions (PAS 18, Appendix 6): DE Company, a
pharmaceuticals Company, manufactures Vitamin V. It entered into an exclusive
distribution agreement with EF Pharma. Under the terms of the agreement, EF
Pharma is allowed to maintain a maximum of 60 days inventory of Vitamin V in its
warehouse. This is to ensure that delivery for orders from various retailers
around the country is assured. EF Pharma is entitled to a 5% distribution margin.
The agreement further provides a collection term of 45 days from the date EF
Pharma invoices its customers (the retailers of Vitamin V). As of balance sheet
date, EF Pharma has in its warehouse 60 days inventory. Given that these 60
days inventories were purchased this year, should DE Company recognize these
as revenue during the year?
6. Special cases Buy one get one free: EF Company is a manufacturer of
chocolate and has a sales promotion campaign to attract new customers. During
the campaign, customers are entitled to an offer of Buy One Get One Free. The
sales price of one bar is P 5 and the production costs are P 2. How should the
sale of one transaction appear in the Income Statement:
A. Revenue of P 5 and Cost of Sales of P 4 (P2 x 2)
B. Revenue of P 3 (P 5 less P 2) and Cost of Sales of P 2?
7. Special cases Fee-based Arrangement: FG & Associates is a CPA firm that
provides external audit to companies. GH Company is one of its retainers with a
fixed professional fee of Php 12 million. The fee is billed evenly over the course
of the year at Php 1 million. FG & Associates is not required to submit the actual
number of hours worked, nor is it entitled to recover cost overruns if its costs
exceeds Php 12 million. As of today, the firm has billed Php 6 million for the year,
and out of the Php 6 million receivable, it has collected Php 4 million cash. What
amount of revenue should be recognized as of today?
8. Your client, GH Company, is an IT Company developing a specialized IT platform
for a certain customer JK. Work on the IT platform commenced on January 1,
20x0. At December 31, 20x0, the hardware which is sold separately has been
installed at the customers site and the software is 50% complete. GH Company
does not anticipate any problem with the software development which should take

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another six (6) months to complete. The customer has the right to return the
hardware if the software does not work according to the customer specifications.
The Contract as a whole, is approximately 70% completed based on costs
incurred, which is a reliable measure of the services performed. Costs incurred to
date and costs to complete can be reliably measured for the hardware and
software separately and in total. The hardware and software account for 30% and
70% of the total consideration respectively.
Issues: The Revenue Recognition Policy of your client is as follows: For
Hardware, Sale of Goods under PAS 18. For Software, Rendering of Services
under PAS 18. Is this appropriate?
9. Your client, HI Company, is a real estate company that is currently developing
condominium projects. During your audit for the year, the Company is selling the
KL Condominiums project, which has 100 property units for sale to third parties.
After completing 60% of the construction, the property developer did a soft launch
and sold 50 unfinished property units. The buyers of 50 pre-completed units paid
20% as initial down payment. The buyer can choose from a limited number of
options in the final looks of the condominium (e.g. kitchen, with or without balcony
or an extra room, color of the tiles). The property developer does not anticipate
any problems with the remaining 40% development, which should take another 9
months to complete as of BS date.
Issues: The Company did not recognize any revenue for the 50 units sold. Is this
appropriate? Refer to PAS 18 par. 19 and PIC Q&A 2006-01.
10. Your client, Precious Company, is developing residential real estate and starts
marketing individual units (apartments) while construction is still in progress.
Buyers enter into a binding sale agreement that gives them the right to acquire a
specified unit when it is ready for occupation. They pay a deposit that is
refundable only if Precious Company fails to deliver the completed unit in
accordance with the contracted terms. Buyers are also required to make
progress payments between the time of the initial agreement and contractual
completion. The balance of the purchase price is paid only on contractual
completion, when buyers obtain possession of their unit. Buyers are able to
specify only minor variations to the basic design but they cannot specify or alter
major structural elements of the design of their unit. In the jurisdiction, no rights
to the underlying real estate asset transfer to the buyer other than through the
agreement. Consequently, the construction takes place regardless of whether
sale agreements exist.
Issue: When should the Company recognize the revenue? Please explain.
11. Same scenario as no. 10 but assume that in the jurisdiction, the law requires the
Company to transfer immediately to the buyer ownership of the real estate in its
current state of completion and that any additional construction becomes the
property of the buyer as construction progresses.
Issue: When should the Company recognize the revenue? Please explain.
12. Your client, LM Company, is engaged in indent sales of techno-gadgets. Under
this revenue category, there are three types of suppliers. The first supplier, AB
Supplier, prefers to deliver and bill the customer directly, while giving LM
Company a commission in the process. The second supplier, CD Supplier,
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prefers to deliver the goods to the customer directly, but the billing to the
customer will be made by LM Company. The third supplier, EF supplier, prefers
to deliver the goods to LM Company, but directly bills the customer. The delivery
will be made by LM Company.
Issues: The Company recognizes revenues from these indent sales to the
extent of the commission earned. Is this appropriate?
13.

Your client, Level Down! Corp, is engaged in online internet gaming


transactions. Assume that you are being consulted for the proper revenue
recognition policy on the sale of prepaid cards:
A. Discuss the background of Online RPG Games
B. Discuss how the company will apply the appropriate provisions of PAS 18
and other related standards for prepaid cards.

Problem 10-2:
Provided below is Gold Labels pre-audit income statement for the year ended
December 31, 2015:
Sales
Cost of goods sold
Gross income
Operating expenses:
Rent expense
Salaries expense
Utilities expense
Advertising expense
Warranty expense
Other expenses
Net income

4,464,000
2,726,000
1,738,000
250,000
345,000
219,000
105,000
14,000
35,500

968,500
769,500

You obtained the following information from the companys accounting records:
a. Some of Gold Labels customers pay for their orders in advance. At
December 31, 2015, orders paid for in advance of shipment totaled P30,000.
These have been included in the sales figure.
b. Gold Labels products are sold with a 30-day money-back guarantee.
Customers seldom returned the products during the year. Gold Label has not
included in the sales figure and in the cost of goods sold those products sold
within the last 30 days of the current year. The revenue is P146,000 and the
cost of the products is P94,900.
c. On July 1, 2015, Gold Label prepaid its office space rent for 18 months. The
amount paid, P216,000, was recorded as rent expense.
d. Gold Label paid P120,000 on July 1, 2015, for general advertising to be
completed prior to December 31, 2015. Gold Labels management believes
that the said advertising paid will benefit a 2-year period and, therefore, has
decided to charge the costs to the income statement at the rate of P5,000 per
month.
e. In prior years, Gold Label has estimated warranty expense using a
percentage of sales. Future warranty costs relating to 2015 sales are
estimated to amount to 2% of sales. However, during 2015, Gold Label
elected to charge costs to warranty expense as costs were incurred. Gold
Label spent P14,000 during 2015 to repair and replace defective products
sold in current and prior years.
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f.

Also included in the above amount for advertising is the P75,000 cost of
product posters for a sales promotional campaign in January 2016.
g. Radio advertisements broadcast during December 2010 were billed to Gold
Label on January 3, 2016. Gold Label paid the P30,000 invoice on January
15, 2016.
You also noted that the following transactions were not yet recorded in the books by
Gold Label for 2015:
h. Gold label also received dividends from its ordinary share investments during
the year ended December 31, 2015 as follows:
i. A cash dividend of P10,000 from Hermione Corporation, in which Gold
Label owns a 2% interest.
ii. A cash dividend of P65,000 from Cho-Chang Corporation, in which Gold
Label owns a 30% interest. A majority of Gold Labels directors are also
directors of Cho-Chang.
iii. A share dividend of 300 shares from Potter Corporation was received on
December 10, 2015, on which date the quoted market value of Potters
shares was P10 per share. Gold Label owns less than 1% of Potters
ordinary shares.
i.

Gold Label does not carry insurance on its office machines. On December 31,
2015, Machine A was totally destroyed by fire. The book value of Machine A,
depreciated to the date of the fire was P62,000. Disposal costs were P3,000.
On January 17, 2016, prior to the issuance of the 2015 financial statements,
Machine B was totally destroyed in an explosion. The book value of Machine
B, depreciated to the date of the explosion was P74,000. Disposal costs
were P4,000.

Required: Compute for the following as of & for the year ended December 31, 2015:
1. Correct amount of sales revenue
2. Gross income
3. Total advertising expense
4. Total amount of losses related to explosion that should be charged to income
5. Total operating expenses (exclusive of other income, if any)
6. Dividend income to be recorded by Gold Label
7. Net income

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