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ACCOUNTING STANDARDS BOARD
JULY 2001 DISCUSSION PAPER
RECOGNITION
ACCOUNTING
STANDARDS
BOARD
DISCUSSION PAPER
REVENUE
For the convenience of respondents,
the text of the Invitation to Comment
section of this Discussion Paper can be
downloaded (in Word format) from the
Revenue Recognition page in the
Current Projects section of the
ASB Website (www.asb.org.uk).
Comments should be addressed to:
Phil Barden
ACCOUNTING STANDARDS BOARD
Holborn Hall
100 Gray’s Inn Road
London
WC1X 8AL
or sent by email to:
[email protected]
and should be dispatched so as to be
received not later than 31 October 2001.
All replies will be regarded as on the
public record unless confidentiality is
requested by the commentator.
RECOGNITION
ACCOUNTING
STANDARDS
BOARD
DISCUSSION PAPER
REVENUE
©The Accounting Standards Board Limited 2001
ISBN 1 85712 105 8
REVENUE RECOGNITION
CONTENTS
page
Summary
2
Preface and invitation to comment
8
Chapter 1
What should ‘revenue’ represent?
22
Chapter 2
Revenue and contractual performance
45
Chapter 3
Accounting for incomplete
contractual performance
54
Rights of return and
post-performance options
70
Chapter 5
Measuring consideration
92
Chapter 6
Other issues relating to contracts
and performance
117
Agency
135
Chapter 4
Chapter 7
Appendix A:
Deep and liquid markets
140
Appendix B:
Accounting for ‘points schemes’
144
Appendix C:
FRS 5 and rights of return
147

REVENUE RECOGNITION
SUMMARY
At present in the UK and the Republic of Ireland, there is no
accounting standard governing the recognition and measurement
of revenue. Different entities and industries follow practices that
are in some respects inconsistent with one another; more
generally, there are different views of what revenue is or
represents, and of how financial statements should portray a
business’s operating activities.
In the longer term, it will be possible to agree on consistent
solutions to the many and varied revenue problems and issues
that arise in practice only if there is consensus on the overall
objectives. Accordingly, this Discussion Paper examines revenue
recognition and measurement from first principles. It sets out
proposals intended to provoke discussion, with the longer-term
aim of establishing a framework within which to address
consistently revenue issues that arise in different contexts.
The Paper asks first, in Chapter , what ‘revenue’—which may
be referred to by various names, including sales, fees, interest,
dividends and royalties—should represent in financial statements.
It proposes the following definitions:
In the context of a business operating cycle, revenue is the class
of gains, before deduction of associated costs, arising as a result
of benefit being transferred to a customer in an exchange
transaction (ie under a contract).
An operating cycle is a sequence of business activities, carried
out with a view to profit, which involves the transfer of benefit
to customers in exchange for consideration (ie payment).
2
SUMMARY
Chapter  develops this definition of revenue, by exploring how
benefit is transferred to customers in exchange transactions. It
concludes that benefit is transferred when the seller honours the
promises it has made under the contract—in other words,
‘performs’ its contractual obligations. In that light, the chapter
builds on the definition of revenue from Chapter :
In the context of a business operating cycle, revenue arises as a
result of benefit being transferred to a customer through the
seller’s performance under a contract.
Chapter  extends this discussion of performance to contracts
where the seller’s contractual performance is incomplete. It
concludes that full performance is only sometimes necessary for
revenue to arise, and suggests the following general principle for
determining the extent to which revenue should be recognised
on the basis of partial performance:
Where contractual performance is incomplete, revenue should
be recognised to the extent that the seller has performed and
that performance has resulted in benefit accruing to the
customer.
Chapter  then considers, at a very high level, various techniques
by which this general principle might be applied in practice. It
acknowledges, however, that dealing with incomplete
performance is likely to be the biggest single difficulty arising in
practice, and that the application of the above proposal to specific
industries will be an important part of the next stage of this
project.
3
REVENUE RECOGNITION
Chapter  considers how the approach developed above is
affected by customer rights of return, which in effect give a
customer the ability to unwind a contract after performance by
the supplier has occurred. The chapter proposes the following
two possible approaches to accounting for rights of return and
asks for views on which is more appropriate:
Expected sale approach:
Where goods are transferred along with a right of return,
revenue should be recognised on the transfer of benefit, with
an appropriate adjustment to reflect the risk of returns.
Accounting policy approach:
Where goods are transferred along with a right of return, an
entity should select and consistently apply whichever of the
following accounting policies is most appropriate to its
circumstances:
•
either revenue should be recognised on the transfer of
benefit, with an appropriate adjustment to reflect the risk
of returns
•
or revenue should be recognised on the expiry of the right
to return.
The most appropriate accounting policy should be judged by
reference to the objectives and constraints set out in  
‘Accounting Policies’, giving due weight to the objective of
comparability between entities operating within the same
industry.

SUMMARY
Whereas earlier chapters have been concerned primarily with the
recognition of revenue, Chapter  discusses measurement principles
and associated issues. It makes the following proposal for the
measurement of revenue:
Revenue should be measured as the change in fair value,
arising from the seller’s performance, of (i) assets representing
rights or other access to consideration and (ii) liabilities in
respect of consideration received in advance of performance.
By restricting revenue to gains that arise from the seller’s
performance, the Paper avoids the measurement of revenue being
distorted by the timing of payment from a customer. Chapter 
spells out in more detail that changes to the value of
consideration arising from factors other than performance—for
example, the time value of money where a customer pays a long
time in advance—do not form part of the measurement of
revenue:
Assets representing rights or other access to consideration
should be remeasured to reflect the effect of the time value of
money, where this effect is significant. Such remeasurement
does not arise from performance and does not, therefore, give
rise to revenue.
Liabilities in respect of consideration received in advance of
performance should not be remeasured to reflect changes in
the fair value of performance that has not yet occurred. They
should, however, be remeasured to reflect the effect of the time
value of money, where this effect is significant. Such
remeasurement does not arise from performance and does not,
therefore, give rise to revenue.

REVENUE RECOGNITION
Chapter  also considers different types of barter transaction, and
asks which of them should give rise to revenue. Referring back
to the discussion in Chapter , the chapter proposes that what is
important is the role that the transaction has in the entity’s
operating cycle:
A transaction is with a customer—and hence gives rise to
revenue—if, on its completion, the entity has been rewarded
for eliminating the risks previously outstanding in the relevant
operating cycle.
Chapter  draws together some other issues relating to contracts
and performance. It first asks how, in the light of Chapter ,
customer payments for options should be dealt with, setting out
the following proposals:
Where a customer pays for an option to require future
performance from a seller, that payment gives rise to a liability,
which should be released as revenue only when the future
performance to which it relates occurs. Because the number
of options that will lapse unexercised cannot be known with
certainty, the relationship between proceeds and performance
should be estimated at the outset, and estimates should be
revised over the period of performance.
The chapter next considers which activities of a seller should be
taken into account when assessing the extent to which
performance has occurred:
An activity will constitute part of the performance of a
contract only if it is a necessary part of the contract, in that it is
specific to the customer and would not have taken place had
the contract not existed.

SUMMARY
Chapter  concludes with a discussion of some issues that arise
when two parties each provide goods or services to the other:
Two contracts should be accounted for separately if they are
genuinely independent of one another, but should be treated as
one larger contract if, either legally or economically, one is
conditional or dependent on the other. Such economic
dependence may arise if, for example, contract prices are set so
far from fair value that there is no realistic prospect that the
second contract will not follow from the first.
Finally, Chapter  considers the recognition of revenue in the
context of agency agreements, making the following proposals:
When a principal transacts with a customer through a disclosed
agent, the pr incipal’s revenue should reflect the full
consideration payable by the customer in the transaction. The
principal should treat any commission or other amounts
payable to the agent separately as an expense and not as a
reduction of revenue.
When an entity acts as a disclosed agent, its revenue should
reflect the amount of commission or other income receivable
from its principal.
When an entity acts as an undisclosed agent, it should account
for revenue in the same way as a principal.

REVENUE RECOGNITION
Preface and invitation to comment
PREFACE
Revenue and financial statements
Introduction
This Discussion Paper is being published by the Accounting
Standards Board as a first step towards the development of an
accounting standard. It is expected that such development will
be conducted in consultation with the International Accounting
Standards Board and other standard-setters, and comments from
those bodies and their constituents will be particularly welcome.
For most businesses, the recognition of revenue is what triggers
the recognition of profits in financial statements. It is
unsur pr ising therefore that, in many industr ies, issues
surrounding the recognition of revenue and profit are amongst
the most important—and sometimes the most difficult—facing
accountants.
Different approaches to revenue
In the absence, in the UK and the Republic of Ireland, of an
accounting standard dealing comprehensively with revenue,1
preparers of financial statements have looked to var ious
notions—such as ‘earning’, realisation, accruals/matching and
prudence—in order to develop suitable approaches to the
recognition of revenue and, hence, profits. Unfortunately, these
notions sometimes point in opposite directions: different entities
and industries have found different solutions, and this has led to
practices that are in some respects inconsistent with one another.
1 SSAP 9 ‘Stocks and long-term contracts’ discusses the recognition of revenue for long-term contracts,
but not other contracts.

PREFACE AND INVITATION TO COMMENT
This inconsistency is not merely a practical problem. It reflects
different views of what revenue is or represents, and of how
financial statements should portray a business’s operating
activities. Moreover, the range of different views on these
matters is likely to increase as business activities become more
complex and financial reporting develops. In the longer term, it
will be possible to agree on consistent solutions to the many and
varied revenue problems and issues that arise in practice only if
there is consensus on the overall objectives.
The objective and structure of this Paper
Accordingly, this Paper examines revenue recognition and
measurement from first principles, with the aim of establishing a
framework within which to address consistently revenue issues
that arise in different contexts. It does this by considering the
following questions in turn.
•
Chapter  asks what ‘revenue’—which may be referred to by
a variety of names, including sales, fees, interest, dividends
and royalties—should represent in financial statements. It
proposes that, although gains may in principle arise, and
perhaps be recognised, at various stages in an entity’s
operating cycle, ‘revenue’ arises only when benefit is
transferred to a customer under a contract—ie in an
exchange transaction.
•
Chapter  develops the proposal from Chapter , by
considering how benefit is transferred to customers in
exchange transactions. It proposes that revenue arises as a
result of a seller’s performance of its obligations under a
contract—ie contractual performance.
•
Chapter  extends the discussion from Chapter  to
contracts where the seller’s contractual performance is
incomplete. It proposes that, in such circumstances, revenue
should be recognised to the extent that the seller has
performed and that performance has resulted in benefit

REVENUE RECOGNITION
accruing to the customer. It acknowledges that dealing with
incomplete performance is likely to be difficult in practice,
and that the application of this proposal to specific industries
will be an important part of the next stage of this project.
•
Chapter  considers the impact of the preceding discussion
on customer r ights of retur n, which in effect give a
customer the ability to unwind a contract after performance
by the supplier has occurred. The chapter proposes two
possible approaches to accounting for rights of return and
asks for views on which is more appropriate.
•
Whereas earlier chapters have been concerned primarily
with the recognition of revenue, Chapter  discusses
measurement principles and associated issues. It proposes
that revenue should be measured as the change in fair value,
arising from the seller’s contractual performance, of (i) the seller’s
assets representing rights or other access to consideration and
(ii) its liabilities in respect of consideration received in
advance of performance.
•
Chapter  considers other issues relating to contracts and
performance.
•
Finally, Chapter  considers the recognition of revenue in
the context of agency agreements.
Matters not addressed in this Paper
Although revenue recognition is often closely linked with profit
recognition, this Paper makes proposals only in respect of
revenue, and not for profit recognition in itself. This is mainly
to prevent the project becoming unmanageably large and to
ensure that the debate focuses, for the time being, exclusively on
revenue.

PREFACE AND INVITATION TO COMMENT
Similarly, although it draws on examples, the Paper does not
address revenue issues that have arisen in specific industries. This
is because the objective at this stage is to develop consistent
general principles, rather than to consider their application to
specific circumstances. In some contexts, applying the general
principles proposed in the Paper is likely to require careful and
detailed consideration of associated industry issues. Accordingly,
the Board is asking respondents for their views at this stage on
the application of the principles to industries with which they
are familiar. Such views will be valuable to the Board when
refining the Paper’s proposals.
Existing approaches to revenue recognition
The accruals concept and realisation
Existing approaches to revenue recognition in the UK and the
Republic of Ireland tend to draw on notions such as the accruals
concept and realisation. The discussion below explains why, in
the light of the Board’s Statement of Principles for Financial
Reporting,2 this Paper is driven primarily by the former and not
at all by the latter.3
The accruals concept requires the effects of transactions and
other events to be reflected, as far as is possible, in the financial
statements for the accounting period in which they occur. This
means that, where an entity trades for profit, the financial
reporting objective is for that profit to be recognised—providing
it can be measured reliably—in the period in which it arises, not
before and not after.
2 for convenience, hereafter abbreviated to the ‘Statement of Principles’.
3 In the UK and the Republic of Ireland, companies legislation includes requirements based on the
notion of realisation. Legal issues are discussed later in this Preface.

REVENUE RECOGNITION
It is not always easy to determine precisely when profit arises,
and the recognition of profit has, historically, been based on
additional criteria. Profits have been recognised only when
realised in the form either of cash or of other assets the ultimate
cash realisation of which can be assessed with reasonable
certainty. In other words, the notion of realisation has been used
to ensure that only profits that are reasonably certain and unlikely
to reverse are included in the profit and loss account.4
The use of realisation as a basis for revenue recognition is not
without difficulties. The notion can be difficult to interpret,
which increases the risk that it may be inconsistently applied,
particularly in complex situations. Moreover, use of the notion
does not always avoid difficult questions about when revenues
arise—for example, where goods or services are paid for in
advance under a binding contract. Difficulties in applying the
notion are exacerbated by the increasing use in business
transactions of consideration other than cash—such as shares and
share options—and the development of new markets.
The difficulties in understanding and applying the notion of
realisation, and the developments that call into question its
appropriateness in some circumstances, make it worth revisiting
the basis on which revenues and profits are recognised. Rather
than adopting the notion of realisation, the Statement of
Principles states that assets and liabilities—and hence gains,
which result from changes to assets and liabilities—should be
recognised when they exist and are capable of being measured
reliably. Accordingly, the main focus of this Paper is on the
process that brings revenues into existence, rather than on when
they become realised.
4 This Paper refers to the ‘profit and loss account’ to be consistent with present generally accepted
accounting practice. If proposals set out in FRED 22 ‘Revision of FRS 3 “Reporting Financial
Performance”’ (published in December 2000) are implemented, the profit and loss account will be
replaced by a statement of financial performance. However, the only effect on this Paper would be to
change the name used to refer to that primary statement.

PREFACE AND INVITATION TO COMMENT
The Statement of Principles also reflects developments in the
accruals concept that have occurred since it was discussed in
  ‘Disclosure of accounting policies’.5 In describing the
accruals concept,   referred to revenue and costs being
“matched with one another so far as their relationship can be
established or justifiably assumed, and dealt with in the profit and
loss account of the period to which they relate”. The Statement
of Principles does not refer to matching, but instead focuses on
reflecting the effects of transactions and other events in the
period in which they occur. This change of focus directly affects
the way that profits are recognised, but primarily in terms of
when expenses are recognised rather than revenues. As such, it
has rather less impact on this Paper than does the change in the
role played by the notion of realisation.
Revenue recognition outside the UK and the Republic of Ireland
Although there is much accounting literature outside the UK
and the Republic of Ireland dealing with revenue recognition, it
may be particularly helpful to draw attention to the positions
under International Accounting Standards (IASs) and in the
USA.
International Accounting Standards
The main body of IAS  (revised ) ‘Revenue’ includes
both a revenue recognition objective and detailed application
rules, and an appendix illustrates the application of the standard
to a number of commercial situations. In the absence of a
relevant accounting standard in the UK and the Republic of
Ireland, IAS  has often been used as a source of guidance.
5 SSAP 2 has since been superseded by FRS 18 ‘Accounting Policies’. The discussion of the accruals
concept in FRS 18 is based on that in the Statement of Principles.

REVENUE RECOGNITION
The discussion in this Paper is broadly consistent with the
objective descr ibed in IAS . However, although the
application rules in IAS  reflect generally accepted accounting
practice, the mechanism by which they were derived from
IAS ’s objective is not always precisely clear. Accordingly, this
Paper focuses on underlying principles, seeking to demonstrate
how its proposals are built up from them.
As noted earlier, this Paper is intended to contribute to an
international debate, which may involve a revision of IAS .
Revenue recognition in the USA
Although revenue is defined in a concepts statement ,6 revenue
recognition in the USA is governed primarily by a number of
accounting standards, most of which are industry-specific. In
contrast, the Board’s preference at this stage is to seek to develop
a single accounting standard setting out general principles for
revenue recognition; if necessary, industry-specific issues can be
dealt with in Application Notes or industry guidance.
In addition to the accounting standards mentioned above, SEC
Staff Accounting Bulletin No.  ‘Revenue Recognition in
Financial Statements’ (SAB ) identifies four criteria for the
recognition of revenue.
“The staff believes that revenue generally is realized or realizable
and earned when all of the following criteria are met:
•
Persuasive evidence of an arrangement exists,
•
Delivery has occurred or services have been rendered,
•
The seller’s price to the buyer is fixed or determinable, and
•
Collectibility is reasonably assured.”
6 The US Financial Accounting Standards Board’s Statement of Financial Accounting Concepts
No. 6 ‘Elements of Financial Statements’.

PREFACE AND INVITATION TO COMMENT
The principles underlying these criteria are discussed in this
Paper, though it approaches some of them in a slightly different
way. The Paper proposes that a contract must exist before
revenue can be recognised—and generally a contract is not
enforceable in law unless it specifies a price that is either fixed or
determinable. The Paper also links the recognition of revenue to
contractual performance, which will generally encompass
delivery or the rendering of services. Finally, collectability is
implicitly a factor in the proposal in Chapter  that consideration
receivable should be measured at fair value.7
It should, however, be emphasised that, although the Paper
focuses on pr inciples that are in essence similar to those
identified in SAB , the two documents will not always be
consistent in their detailed application.
Other matters
Terminology
In the Statement of Principles, the terms ‘gains’ and ‘losses’ refer,
broadly speaking, to inflows and outflows of economic benefit.
Thus, in the context of the sale of an item of stock, the
Statement of Principles refers to the sale proceeds and the cost of
the item sold as a gain and a loss respectively. In other contexts,
however, ‘gain’ is commonly used to refer to a net increase in
total assets less total liabilities; for example, in a contractual
exchange, ‘gain’ is often used to refer to the net of the sale
proceeds and the cost of the item sold.
Generally this Paper uses ‘gain’ (or ‘profit’, where that term is
more comfortable) to mean a net increase in total assets less total
liabilities. In other words, ‘gain’ is most often used to mean
either the net of sale proceeds and the cost of an item sold or,
where operating activities increase the value of an asset still held,
7 The term ‘fair value’ is discussed later in this Preface.

REVENUE RECOGNITION
the excess of that increase over associated expenses. However, in
the Paper’s proposed definition of ‘revenue’, ‘gain’ should be
understood in the ‘gross’ sense of the Statement of Principles, eg
before deducting the cost of the item sold.
The Paper uses the term ‘fair value’ when discussing both the
measurement of incomplete contractual performance (in Chapter )
and the measurement of consideration (in Chapter ). However,
it does not enter into a detailed discussion of the meaning of the
term. This is in part because the Board does not think such a
discussion necessary for the Paper’s examination of general
principles; moreover, the interpretation of ‘fair value’ is still a
matter for discussion between standard-setters. Accordingly, for
the purposes of this Paper, the term ‘fair value’ should be
understood in the sense in which it is defined in  
‘Derivatives and other Financial Instruments: Disclosures’:
“The amount at which an asset or liability could be exchanged in
an arm’s length transaction between informed and willing parties,
other than in a forced or liquidation sale.”
FRS 5 ‘Reporting the Substance of Transactions’
Some of the discussion in this Paper, particularly that in Chapter 
dealing with rights of return, is concerned with matters also
falling within the scope of   ‘Reporting the Substance of
Transactions’. The approach taken in the Paper, like that in  ,
is to ask what effect a transaction has had on assets and liabilities.
Generally, however, the Paper does not draw in more detail on
the analysis in  . Appendix C briefly summarises how  
deals with rights of return.

PREFACE AND INVITATION TO COMMENT
Reliable measurement
A necessary condition for the recognition of revenue and/or
profit is that reliable measurement is possible. Reliable
measurement is discussed in Chapter , but the condition that
reliable measurement is possible should be taken as applying
throughout the Paper, including where, for ease of reading, it is
not made explicit.
Legal issues
The Paper is concerned primarily with the principles underlying
revenue recognition, rather than their detailed application, and its
proposals have been developed with an international context in
mind. Accordingly, the Paper does not consider legal issues that
might arise if its proposals were to be implemented as a standard
in the UK and the Republic of Ireland. Such issues will be
addressed in a future exposure draft of a standard dealing with
revenue recognition.
Not-for-profit entities
The Paper discusses revenue recognition in the context of
entities trading for profit. It does not focus directly on not-forprofit entities, and in particular it does not consider nonreciprocal transactions, such as donations. Nevertheless, the
discussion in the Paper may have some relevance for not-forprofit entities.
INVITATION TO COMMENT
The Board would welcome comments on any aspect of the
Discussion Paper. Respondents’ views are especially sought on
the matters set out below. It would be helpful if respondents
could support their views with reasons and, where applicable,
preferred alternatives.

REVENUE RECOGNITION
Chapter 1: What should ‘revenue’ represent?
Q1 Do you agree that revenue should be a measure of exchanges
with customers, irrespective of the extent to which gains
may be recognised in advance of such exchanges? (If not,
and if you would favour a wider ‘value added’ definition of
revenue, how would you respond to the associated
difficulties highlighted under paragraph .?)
Q2 Do you agree that revenue should be defined in the context
of the business operating cycle being presented?
Chapter 2: Revenue and contractual performance
Q3 Do you agree that revenue recognition should be driven by a
seller’s performance under a contract in transferring benefits
to a customer?
Chapter 3: Accounting for incomplete contractual performance
Q4 Do you agree that, where contractual performance is
incomplete, revenue should be recognised to the extent that
the performance has resulted in benefit accruing to the
customer?
Q5 The Board envisages that measur ing incomplete
performance will be one of the most difficult issues arising.
What practical problems do you foresee with the approaches
to measuring incomplete performance, such as unbundling,
proposed in Chapter ? Could these approaches be
amended or refined in order to deal with any difficulties that
you foresee?

PREFACE AND INVITATION TO COMMENT
Chapter 4: Rights of return and post-performance options
Q6 When discussing how to account for goods transferred with
a right of return, Chapter  considers and rejects an
approach that would never recognise revenue until the
option to return lapses. Do you agree that this approach
should be rejected?
Q7 Chapter  suggests two approaches that might be acceptable
where goods are transferred with a right of return—an
expected sale approach and an accounting policy approach.
Which of these approaches, if either, do you favour? If you
favour neither approach, how would you account where
goods are transferred with a right of return?
Chapter 5: Measuring consideration
Q8 Do you agree that revenue should reflect the amount to
which a seller becomes entitled under a contract as a result
of perfor mance, rather than the fair value of that
performance? If so, do you agree that revenue should be
measured as the change in fair value, arising from the seller’s
contractual performance, of (i) the seller’s assets representing
rights or other access to consideration and (ii) its liabilities
in respect of consideration received in advance of
performance?
Q9 Do you agree that revenue should not include changes in
the fair values described in question 8 above arising from
the time value of money rather than from performance?
Q10 Chapter  proposes two possible approaches—an expected
sale approach and an accounting policy approach—where
the amount of revenue is determinable by a factor within
the control of a customer. These alternative approaches are
based on those discussed in Chapter  (see question 
above). Which of these approaches do you favour, if either?
If your answer to question  was different, what are the
important aspects of each scenario that led you to different
conclusions?

REVENUE RECOGNITION
Q11 Do you agree with the analysis of the principles applicable
to barter transactions in Chapter ? In particular, do you
ag ree that whether a transaction (such as a barter
transaction) forms part of revenue should depend on
whether, on its completion, the seller has been rewarded for
eliminating the risks previously outstanding in the relevant
operating cycle?
Chapter 6: Other issues relating to contracts and performance
Q12 Do you agree with the proposal in Chapter  that, where a
customer pays for an option to require future performance
from a seller, revenue relating to that payment should be
recognised only when that future performance occurs? If
so, do you also agree that, because the level of future option
lapses cannot be known with certainty, the relationship
between proceeds and performance should be estimated at
the outset and revised over the period of performance?
Q13 Do you agree that an activity should constitute part of the
performance of a contract only if it is a necessary part of the
contract, in that it is specific to the customer and would not
have taken place had the contract not existed?
Q14 Do you agree with the proposal that two contracts should
be accounted for separately if they are genuinely
independent of one another, but should be treated as one
larger contract if, either legally or economically, one is
conditional or dependent on the other?
Chapter 7: Agency
Q15 Where a principal transacts with a customer through a
disclosed agent, do you agree that the principal’s revenue
should reflect the full consideration payable by the
customer, with any commission or other amounts payable
to the agent being treated as an expense and not as a
reduction of revenue?

PREFACE AND INVITATION TO COMMENT
Q16 Where an entity acts as a disclosed agent, do you agree that
its revenue should reflect the amount of commission or
other income receivable from its principal?
Q17 Where an entity acts as an undisclosed agent, do you agree
that it should account for revenue in the same way as a
principal?
Other matters
Q18 The objective of this Paper is to explore general principles
of revenue recognition, which can be refined and applied to
a variety of specific industry issues. Do you have any
comments at this stage on difficulties that may be
encountered in applying this Paper’s proposals to specific
industry issues?
Q19 The Board would welcome examples illustrating particular
problems of revenue recognition that may or may not be
dealt with by the proposals set out in this Paper. Could you
provide the Board with examples that you believe it would
be useful to consider?

REVENUE RECOGNITION
Chapter 1
What should ‘revenue’ represent?
Summary
1.1 This chapter asks what ‘revenue’—which may be referred
to by various names, including sales, fees, interest, dividends and
royalties—should represent in financial statements. In discussing
this question, the Paper considers how revenue, which is
generally reported gross (ie before deducting associated
expenses), might be distinguished from other gains, which are
often reported net. Before this, however, the chapter considers:
•
how revenue has been seen in a historical cost context,
and the role it plays within financial statements
•
when and how gains associated with operating
activities come into existence
•
how gains generally are recognised under current value
and historical cost principles
•
two different views of how gains arising from operating
activities should be reported.
1.2 Based on the discussion of these matters, the chapter puts
forward the following proposals, which are developed in
subsequent chapters.

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
In the context of a business operating cycle, revenue is the class
of gains, before deduction of associated costs, arising as a result
of benefit being transferred to a customer in an exchange
transaction (ie under a contract).
An operating cycle is a sequence of business activities, carried
out with a view to profit, which involves the transfer of benefit
to customers in exchange for consideration (ie payment).
1.3 Although this Paper is concerned with the recognition of
revenue rather than gains generally, much of this chapter focuses
on gain recognition. This is necessary because one of the most
important aspects of revenue, at least under historical cost
accounting, is as a potential trigger for gain recognition.
1.4 Although the discussion considers how both revenues and
gains generally might be recognised under current value
principles,8 this does not imply that the Board favours requiring
entities to report using such an approach. The discussion of
current value principles is included for the light it casts on how
revenue should be recognised under historical cost principles.
The Board expects that, as at present, most entities will continue
to report revenues, and associated net gains, under historical cost
principles.
8 For the avoidance of doubt, the current value principles discussed are not those of current cost
accounting (CCA). Whereas CCA, in essence, updates a historical cost framework for changing prices
(holding gains and losses), the current value principles discussed in this Paper are concerned with how
gains arise from an entity’s activities.

REVENUE RECOGNITION
What should ‘revenue’ represent?
How has revenue been seen in a historical cost context?
Revenue and exchange
1.5 In the past, revenue recognition questions have most often
been concerned with when to recognise revenue, rather than
asking what revenue is for a particular business. This is because for
most businesses the answer to the second question has appeared
obvious—indeed, often so obvious that the question has not
even needed asking. Nevertheless, it might be suggested, rather
crudely, that revenue has been seen in terms of ‘what you get
paid for selling things’. Identifying revenue often seems obvious,
in that the ‘what’ is usually cash, and ‘selling things’ is easily
distinguished from ‘buying things’ because in the latter case a
business usually parts with cash rather than receiving it.
1.6 Later, this chapter will consider why and how such an
approach to revenue would need to be refined in order to be
workable in less straightforward transactions.9 At this stage, the
main point to observe is that revenue recognition has been seen
as linked to a process of exchange. The seller gives something to
the customer (goods, services, rights) and, in exchange, becomes
entitled to consideration, triggering the recognition of revenue.
9 For example, the answers may not always seem so obvious when attempting to apply such a
‘commonsense’ approach to barter transactions.

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
1.7 This notion of exchange has also been reflected in the
balance sheet, in that the event of exchange has caused new assets
to be recognised. For example, on the sale of goods a company
has ceased to recognise stocks as an asset and has instead
recognised cash or a debtor. Similarly, on the supply of services,
although there was no asset in the balance sheet to derecognise,
the supplier has nevertheless recognised a new asset: cash or a
right to cash (ie a debtor) from the customer.
Revenue and profit recognition
1.8 In a histor ical cost context, 10 the point of revenue
recognition has also been the earliest point at which profits
arising from the transaction have been recognised. In effect,
before revenue has been recognised, any costs associated with the
transaction have either been accumulated (as part of the cost of
the asset to be exchanged) or charged as an expense; but because
the carrying amount of the asset has not been remeasured, no
profits have been recognised. For example, a manufacturer
producing goods for stock has valued that stock by reference to
historical costs associated with it, but has not recorded any ‘gain’
arising from manufacturing activities until such time as the goods
are exchanged.
10 References in this Paper to the recognition of revenues and profits in a historical cost context mean,
in particular, a context in which stocks are carried at their historical cost and are not remeasured except to
net realisable value, if lower. This is the norm for most businesses in the UK and the Republic of
Ireland.

REVENUE RECOGNITION
1.9 Another way of thinking about this is to say that, in a
historical cost context, profits have not arisen before the point of
revenue recognition because this is the first point at which asset
measurement may cease to be ‘backward-looking’ and instead
become ‘forward-looking’. Thus, stocks have been valued by
reference to outflows (usually of cash) that have occurred in the
past;11 however, debtors have usually been valued by reference to
inflows to be received in the future. In a sense, therefore,
debtors have ‘included profits’ whereas stocks have not.12
The role of revenue in financial statements
1.10 The significance of revenue recognition is not limited to
asset classification and the timing of profit recognition. In
particular, when revenues and associated profits are reported
under historical cost principles, the presentation of a revenue
figure (such as sales or turnover) in the profit and loss account
can help users of financial statements in two ways.
11 or outflows to which the business has become committed as a result of a past event.
12 For completeness, it should be noted that stock valuation in a historical cost context is not purely
‘backward-looking’, in that a ‘forward-looking’ measure (net realisable value) is substituted if lower.
This does not detract from the main point, however, which is that in a historical cost context the point of
revenue recognition is the first point at which profits may be recognised.
The inclusion of ‘profit’ in the valuation of debtors is so generally accepted as to appear entirely obvious.
Nevertheless, it should be noted that, in principle, historical cost accounting could have developed in a
way that would have required cash to be received before profits could be recognised. Under such an
approach, debtors would be measured at the historical cost (if any) of goods or services supplied, and asset
measurement would cease to be ‘backward-looking’ only on the receipt of cash. Equally, historical cost
accounting could in principle have developed so that profits would be recognised on entering into a
contract with a customer (though some strong arguments against this are discussed in Chapter 2). Under
such an approach, the measurement of stocks would, like debtors, become ‘forward-looking’ when a
customer entered into a binding agreement to buy them. These points are picked up in the discussion of
revenue and unexpired risk in Chapter 2.

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
•
For many businesses, the revenue figure is a key
measure of economic activity during the period, in
that it reflects the extent to which the business has
supplied goods or services to customers. Revenue for
a period can be compared with that for earlier periods,
and with that of competitors, as part of an assessment
of the business’s performance.
•
The separate disclosure of revenue and of costs enables
users to compare a business’s g ross marg in in
percentage terms with that in earlier periods, and with
that of competitors, and also to assess the sensitivity of
gross profits to volume and price changes.
1.11 The usefulness of revenue information will of course vary
from business to business. Nevertheless, to summarise the
preceding discussion, it has been noted that in a historical cost
context:
•
revenue has traditionally been associated with
‘exchanges’ with customers
•
the point of revenue recognition is also the earliest
point at which profits may be recognised
•
the gross revenue figure presented in the profit and loss
account may be useful as a measure of economic
activity
•
the separate g ross presentation of revenue and
associated costs may be useful when assessing trends in,
and the quality of, profitability.

REVENUE RECOGNITION
How and when do gains come into existence?
1.12 So far, this chapter has summarised how revenue has
traditionally been seen in a historical cost context. Accordingly,
the focus has been on how and when revenues and associated
profits have been recognised in financial statements, but has not
been on how and when gains may be thought to arise in the
underlying business. The following paragraphs are therefore
concerned with how and when gains come into existence.13
1.13 Accountants are not accustomed to distinguishing
existence from recognition in the context of revenue, but such a
distinction is familiar for another class of gains. Specifically,
where a tangible fixed asset such as a building increases in value,
the gain will be recognised only if the business has a policy of
revaluing such assets. Nevertheless, the gain exists irrespective of
whether it is recognised.
1.14 It may of course be argued that there is an important
difference between such a gain and a trading profit. Where a
building increases in value, the gain will often be unrelated to
any activity of the owner; it will simply reflect changing prices in
the property market. It may therefore be described as a holding
gain, in the sense that the property is still the same asset after the
gain has arisen: it simply has a different value.
1.15 The gains that arise in a revenue context, however, are not
for the most part holding gains. They are operating gains, in the
sense that they arise as a result of the business’s activities, rather
than external price changes. Accordingly, in order to determine
when gains arise in the operating cycle, it will be necessary to
consider more carefully the factors that br ing them into
existence.
13 Although assets and liabilities can be said to ‘exist’ in time, gains arise from changes to assets and
liabilities and are by their nature of the instant. Nevertheless, for the sake of brevity, the following
discussion refers to gains coming into existence, rather than referring always to changes in existing assets
and liabilities.

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
The role of risk
1.16 The view outlined below, which is drawn on later in this
Paper, is that in principle profits (ie operating gains) can be
expected to come into existence only as a result of taking and
eliminating risk.
1.17 This is of course a very imprecise statement, and there is
much about it that must immediately be clarified. It is not the
case that a business should, except by chance, expect to earn
profits by taking unnecessary risks. Furthermore, a business that
takes only necessary risks may still not be rewarded with profit.
The following example may help to illustrate what is meant.
Example 1.17: a component-testing business
Suppose that the most efficient manufacturing process for a
particular type of component results in a relatively high
proportion that do not work—on average, about  per cent.
Suppose also that history has shown the skills needed to test
such components are very different from those needed to be a
manufacturer, so that manufacturers choose only to sell
untested components. Thus separate businesses buy untested
components, test them, throw away those that do not work
and sell those that do. How does such a component-testing
business make profits?
To answer this question, it is necessary to consider how much
someone will rationally pay for a tested component. The
component-tester’s potential customers have two choices; they
can either buy untested components and do the testing
themselves, or they can buy working components from a
component-tester.

REVENUE RECOGNITION
Suppose a potential customer chooses the former option. If
the price of untested components is £., and the failure rate
is on average  per cent, then over the longer term the
average cost per working tested component will be £. plus
the cost (say a further £.) of testing two components—a
total of £..
However, if the potential customer chooses to buy tested
components rather than test them itself, it will rationally pay
more than £. for a tested component. This is because the
two situations are not directly comparable. If it tests the
components itself, it is still bearing the risk that the failure rate
will be higher (or lower) than the average of  per cent; if it
buys tested components, it is not bearing that risk.14
There is an analogy here with the rate of return that will be
required on a risky investment. If an entity is choosing
between two investments that are expected to generate the
same rate of return, and one is more risky than the other, the
entity will rationally choose the less risky investment. In order
to choose the more risky investment, it will need to be offered
a higher rate of return.
Accordingly, the component-testing business can expect to
receive more than £. for each tested component it sells.
Over the longer term, however, its costs per tested component
should not exceed £..15 It is making profits by taking and
eliminating risks—one of those risks being that the component
failure rate will deviate from expectations.
14 In other words, the price that a customer will pay for tested components is the ‘certainty equivalent’
that adjusts the expected failure rate for risk.
15 Economies of scale may mean that its testing costs are less than the £1.00 that the potential
customer would incur, but this does not detract from the rest of the argument.

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
1.18 Accordingly, this Paper argues that gains arise over a
business’s operating cycle, as it takes and eliminates necessary
risks. Of course, those necessary risks may fall at different stages
of the operating cycle for different entities. For some entities,
such as pharmaceutical companies perhaps, a large element of
risk may be concentrated at the development and trial stage. For
others, predicting levels of demand may be one of the chief risks.
Nevertheless, to the extent that an entity has eliminated
necessary risks before entering into an exchange transaction,
gains associated with those risks may be said to have come into
existence, even if they have not yet been recognised.
How might gains be recognised under current value and historical
cost principles?
1.19 The following discussion is intended only as a very broad
outline of how gain recognition might operate under current
value principles. In practice, many difficult issues might be
expected to arise over how to apply current value principles, not
least because of differing views of how current value and fair
value should be defined.16
1.20 Rather than dealing with those issues, the discussion below
illustrates the broad differences that might be expected between
gain recognition under histor ical cost and cur rent value
principles. Thus, purely for the sake of illustration, it is assumed
that gain recognition under current value principles would be
broadly equivalent to the continuous remeasurement of assets and
liabilities to ‘fair value’, in the sense in which that term is
described in the Preface.
16 The Statement of Principles explains the Board’s view that the deprival value model provides the
most relevant measure of current value. Under that model, current value is the lower of replacement cost
and recoverable amount, which is itself the higher of value in use and net realisable value.

REVENUE RECOGNITION
Gain recognition under current value principles
1.21 Paragraph . discussed how, at the point of revenue
recognition, asset measurement ceases to be ‘backward-looking’
and instead becomes ‘forward-looking’, so that debtors, for
example, are valued by reference to future cash inflows. No
matter how it is defined, fair value is inherently a ‘forwardlooking’ measure. For example, where an asset’s fair value is
determined by reference to a market, the market price will
reflect market participants’ assessments of the uses to which the
asset can be put (and, ultimately, the cash flows associated with
those uses) and the degree of risk associated with those uses.
1.22 Thus, although there may be different views as to which
future cash flows to include and the appropriate perspective from
which those cash flows and risks should be assessed,17 fair value
may in principle be thought of as equivalent to the value of
future cash flows discounted for risk.
1.23 When an entity carries out operating activities, thereby
taking and eliminating necessary risks, the risks associated with
future cash flows will have reduced, no matter whose perspective
they are judged from. Thus if assets and liabilities are
continuously remeasured to fair value, gains will be recognised as
the entity moves through its operating cycle.
17 for example, a market perspective or the perspective of the transacting entity.

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
1.24 This can be illustrated by continuing the example from
paragraph ..
Example 1.24: manufacturers using components
Suppose the facts about component testing are the same as in
Example ., and that A and B both use components in their
manufacturing processes; however, A buys tested components
whereas B buys untested components and tests them itself.
Thus B incurs average expenditure of £. per tested
component whereas the market price paid by A for a tested
component is higher than this—say £.—for the reasons
explained in Example .. Ultimately, therefore, A makes
£. less profit than B, and we can say that this is because it is
exposed to less risk in its operations.
Suppose A and B both value stocks at current value, rather
than at historical cost. If A has tested components in stock,
they will be included in A’s balance sheet at their current value
of £.—and the same is true for B, in respect of those
components that it has successfully tested, even though B’s
expenditure will be lower than this (on average, £.).
Unlike A, B has taken and eliminated component-testing risk,
and the gain of £. is its reward. (It is perhaps worth
emphasising that this is not a holding gain, in the sense
discussed in paragraph .. Rather, it is an operating gain, in
that it arises as a result of B’s activities, ie testing components,
rather than external price changes.)18
18 Another way of thinking about this is to say that A and B have precisely the same core operations,
but that B has, in addition, a component-testing business. Although the component-testing business
does not sell to third parties, it is nevertheless profitable.

REVENUE RECOGNITION
1.25 The kind of approach illustrated in the preceding example
is also required, for entities complying with International
Accounting Standards, by IAS  ‘Agriculture’. IAS  requires
both biological assets and agricultural produce (ie biological
assets that have been harvested) to be measured at fair value (less
estimated point-of-sale costs), except where it is not possible to
measure fair value reliably. Thus entities complying with IAS 
will recognise gains over the period that biological assets are
growing, rather than deferring gain recognition until those assets
have been sold.
1.26 It is worth emphasising that gain recognition under
current value principles does not result in all stocks being valued
at expected selling price, because that ignores selling risk, which
is usually an important risk. Thus, except where a deep and
liquid market exists for a product (so that there is, in effect, no
selling risk), an element of profit would still be recognised on
sale under current value principles.
Gain recognition under historical cost principles
1.27 The recognition of gains under historical cost principles
has already been discussed under paragraph .. As noted there,
the earliest point at which profits will be recognised under such
principles is on an exchange with a customer. Before that,
measurement will be ‘backward-looking’, in that assets (such as
stocks) will be measured at amounts not exceeding the costs
actually incurred to date. (Thus in Example ., B will record
tested components in stock at £., and will recognise the
associated gain of £. only on sale of the items into which the
components are installed.)
1.28 When an exchange with a customer occurs, the
consideration received or receivable from the customer will be
measured at its fair value, just as it would be under current value
principles. Accordingly, the profit recognised on the exchange
will be equal to the cumulative gains that have arisen to date but

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
have not previously been recognised. In effect, therefore,
whereas current value gains may be recognised for various
activities in the operating cycle, no historical cost gains will be
recognised until there is an exchange with a customer, at which
point the historical cost gains will ‘catch up’.
1.29 Thus, although this is not how it actually developed, this
type of historical cost accounting can be seen as a simplification
of its current value equivalent. Instead of recognising gains (and
sometimes losses) over various activities in the operating cycle,
historical cost accounting in effect recognises cumulative profit at
a particular point in that cycle—namely, on exchange with a
customer. This idea of historical cost as a simplification of
current value gain recognition principles is discussed further in
the following paragraphs.
Different views of how profits should be reported
1.30 The historical cost and current value approaches to gain
recognition discussed in the preceding paragraphs correspond
reasonably well to two different (and in essence incompatible)
views of how profits should be recognised in accounts. These
views differ primarily over how unexpired risk should affect the
recognition of profit.
•
Many believe that no profit should be recognised until
the risks in the operating cycle have been substantially
eliminated. (This might broadly correspond to gain
recognition under historical cost principles.)
•
Others believe that profits should be recognised as risk
is reduced over the various stages of a business’s
operating cycle—including stages that precede a
contract with a customer—reflecting the ‘value added’
by the business’s activities. (This might broadly
correspond to gain recognition under current value
principles.)

REVENUE RECOGNITION
1.31 The former approach is more familiar to accountants in
the UK and the Republic of Ireland. Supporters might argue
that it is more prudent—and conversely that it is imprudent to
recognise profits before the operating cycle is substantially
complete. They might note that, if substantial operating risks
remain, there is a substantial risk that profits recognised under
current value principles may subsequently have to be reversed.
They might also argue that profits reported under historical cost
principles are more reliable, because they are measured by
reference to a value established in an exchange with a third party,
namely the agreed sale proceeds. By contrast, profits measured
under current value principles will not generally be based on
such an exchange and may therefore involve more subjective
judgements about future cash flows and unexpired risks.
1.32 On the other hand, supporters of a ‘value added’ approach
might argue that, as outlined earlier in this chapter, such an
approach better reflects how gains arise as a result of a business’s
activities. In particular, they might argue that a historical cost
approach, which arguably ignores profits until they are ‘in the
bag’, has more to do with issues of solvency and paying
dividends than with a business’s performance. Turning to the
detailed arguments from the preceding paragraph, they might
agree that there is more chance under a ‘value added’ approach
that profits recognised will subsequently reverse; however, they
will not see this as a flaw if it in fact reflects what is happening
within the business. In support of this, they might note that,
even under historical cost principles, bad debts will cause the
reversal of profits previously recognised. They might also reject
the argument that historical cost profits are necessarily more
reliable, noting for example that significant subjective judgements
can be involved when recognising revenues and profits for an
incomplete long-term contract under  .

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
1.33 It is not the objective of this Paper to choose between
these two approaches. Moreover, although this chapter has
suggested that a current value approach might better reflect how
profits ar ise in a business’s operating cycle, it does not
automatically follow that it is always appropriate to recognise
profits on this basis in financial statements.19 As illustrated in the
preceding discussion, any approach to profit recognition will
need to balance issues of relevance and reliability, and the
appropriate balance is likely to vary depending on the nature of
the underlying business.
What should ‘revenue’ represent?
1.34 Earlier in this chapter it was noted that, historically, the
recognition of revenue has been linked to the recognition of an
asset receivable from a customer in the context of an exchange
transaction. This approach works well when a business reports
under historical cost principles and, as noted earlier, the
presentation of a revenue figure may enable some information to
be derived about:
•
the scale of economic activity during the period (at
least insofar as that activity relates to supplying goods
or services to customers)
•
gross margins (if associated costs are also presented
gross).
19 That said, certain circumstances in which a current value approach is clearly preferable are discussed
in Appendix A.

REVENUE RECOGNITION
1.35 However, where an entity reports under current value
principles, it may recognise some (or indeed all) of its profits
before an exchange transaction has taken place. As a result, the
information that can be derived from an ‘exchange-based’
revenue figure (called ‘turnover’ below, for convenience 20) is
arguably less useful when an entity reports under current value
principles.
•
It might be argued that the most useful measures of
economic activity will have some relationship with
profit, but whereas profit and turnover are recognised
simultaneously under historical cost principles, this is
not the case under current value principles.
•
To the extent that profits are recognised before an
exchange transaction occurs, they will not give rise to
turnover and will instead be reported net, making
sensitivity analysis more difficult. Conversely, to the
extent that profits are reported when an exchange
transaction occurs, the costs reported will include some
‘mark-up’ for the profits already recognised, so that the
gross margin shown will be less than that made overall
from activities.
20 In Great Britain, the Companies Act 1985 defines ‘turnover’ as “the amounts derived from the
provision of goods and services falling within the company’s ordinary activities, after deduction of(i) trade discounts,
(ii) value added tax, and
(iii) any other taxes based on the amounts so derived.”

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
1.36 These shortcomings are highlighted most clearly in the
case of assets, such as some commodities, for which a deep and
liquid market exists.21 Under current value principles, all profits
relating to such assets will have been recognised before an
exchange transaction occurs, so there need be no direct
relationship between turnover and profit: production and sale
could fall into different periods. Moreover, the problem is likely
to be exacerbated in industries where the same production may
change hands more than once. For example, in the oil industry
it is not uncommon for a cargo of oil to be sold many times
while in transit. Such buying and selling is essentially a shortterm investment type of activity but, if reflected in turnover, it
could lead to a huge disparity in reported turnover between
entities that are essentially similar, at least insofar as production
levels are concerned.
Should ‘revenue’ mean something wider than turnover?
1.37 These problems with turnover arise because, under current
value principles, gains arise over various economic activities of an
entity, but turnover is traditionally reported only on the
economic activity of exchange with a customer. This begs the
question of whether revenue might be defined more widely, so as
to encompass gains on all economic activities in the operating
cycle, rather than just exchange.
1.38 One obvious way to do this might be to focus on the assets
that are remeasured when profits are recognised under current
value principles. Specifically, revenue could be derived from the
amounts to which those assets are remeasured. However, such an
approach would seem to have serious flaws, as illustrated by the
following example.
21 As explained in Appendix A, the absence of selling risk for such assets means that their current
value will be the same as their expected selling price. Thus the sale of such an asset will never of itself
generate a profit; it will merely crystallise a gain that already exists and would already have been
recognised under current value principles.

REVENUE RECOGNITION
Example 1.38: can revenue be defined more widely?
Suppose that C manufactures a product with a selling price of
£, and associated costs of £; however, when the product
is part-complete and costs of £ have been incurred, its value
can be measured under current value principles at £. 22
Accordingly, if C reports under current value principles, £
of profit will be recognised when the product is part-complete,
with the balance of £ being recognised on sale.
If revenue of £ were to be reported when the product is
part-complete, with associated costs of £, the revenue figure
would provide a measure of economic activity linked to the
recognition of profit. In addition, it would be possible to
consider sensitivities associated both with revenue and with
costs: margin information would be available. This might
seem, therefore, to be an improvement on the information
given by turnover in the same situation.
However, some difficulties with this approach come into focus
when attempting to account for the subsequent sale. If
revenue on the subsequent sale were still reported as £,
then C would in due course report total revenue of £
relating to the product—a number with no apparent meaning.
Moreover, if C subsequently concluded that reliable
measurement was also possible at a second intermediate stage,
say when the product had a value of £, it would instead
report total revenue of £ in respect of exactly the same
activities.
22 An example might be a business that grows coffee beans, which it uses to make instant coffee.
When the beans are harvested it will be possible to measure their market value (assumed in the
numerical example to be £75, though of course this figure would fluctuate).

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
For this sort of approach to be workable, therefore, it would be
necessary instead to measure revenue incrementally at each
stage. In the original example discussed above, revenue of £
would be recognised when the product was part-complete,
with the balance of £ (ie £ - £) being recognised on
sale. If the example is modified, so that profit is also measured
at the second intermediate stage, the revenue recognised at
each stage would instead be £, £ and £.
Nevertheless, such an approach would still lead to some
strange-looking results. For example, suppose D sells the same
product as C, but car r ies out only the second stage of
manufacturing itself; in other words, it buys part-complete
products (for £ each), finishes them off (at a cost of £)
and sells them (for £). If C and D start a period with the
same number of part-complete units in stock, finish them all
off and sell them all, they will have had exactly the same
economic activity as each other in the period. Yet C will
report revenue of £ for each unit sold,23 while D will report
four times that figure. This is an unattractive result, and it
seems doubtful that it would help users to compare the
activities of C and D.
1.39 IASC faced essentially this problem when developing
IAS , which, as mentioned earlier, requires gains to be
recognised over the period that biological assets are growing.
However, the approach taken by IAS  does not involve
widening the definition of revenue; although the standard
requires the increase in the fair value of biological assets to be
reported separately on the face of the income statement, it is not
described as revenue.
23 having already reported the first £75 of revenue in previous periods, when the stock was
manufactured.

REVENUE RECOGNITION
1.40 Certainly it would be possible to widen the meaning of
‘revenue’ (at least for the purpose of financial statements) so as to
include gains—such as gains from remeasuring assets—that do
not result from an exchange with a third party. However, as
argued below, this seems on balance to be both unwise and
unnecessary.
1.41 Dictionary definitions of revenue refer to ‘receipts’ or
‘income’, with a clear implication that revenue is ‘something
coming into a business from outside’. In addition, revenue is
widely understood by users of financial statements,
internationally as well as in the UK and the Republic of Ireland,
to involve a ‘sale’ or exchange rather than merely the
remeasurement of an existing asset. 24 Accordingly, it is
questionable whether any benefits associated with a wider
meaning for revenue would outweigh the confusion that might
result.
1.42 Moreover, even if there would be benefits in defining
revenue more widely, there must be some doubt whether a
definition could be found that would be robust and would cater
adequately for all situations, for the reasons illustrated in
Example .. Finally, as IAS  shows, it is not necessary to
widen the definition of revenue to give useful information about
economic activity in financial statements. Remeasurement gains
(and losses) could be presented gross on the face of the profit and
loss account, where this would be useful, without having to be
reported as revenue.
1.43 For these reasons, this Paper proposes that the meaning of
revenue should not be widened to encompass the remeasurement
of assets and liabilities, but should continue to relate to exchange
transactions.
24 For example, although the definitions of revenue used in IAS 18 and in FASB Concepts
Statement 6 do not refer to an exchange, the conditions for recognising revenue in effect require an
exchange to have taken place.

CHAPTER 1: WHAT SHOULD ‘REVENUE’ REPRESENT?
Which exchange transactions give rise to ‘revenue’?
1.44 It was suggested above that a ‘commonsense’ view might,
rather crudely, describe revenue in terms of ‘what you get paid
for selling things’. But if the presentation of revenue in the
profit and loss account is to be of most value to users of financial
statements, care is needed in developing this approach.
1.45 First, it does not seem appropriate to limit a definition of
revenue by reference to the nature of ‘what you get paid’.
Although most revenue transactions give rise either to cash or to
the promise of cash, it is generally accepted that barter
transactions can g ive r ise to revenue, at least in some
circumstances.25
1.46 Secondly, it is common for businesses to sell fixed assets
once they are no longer required. For most businesses, however,
it is generally accepted that the income from such sales is not
revenue. Accordingly, a definition of revenue should not simply
focus on the fact of a sale, but will also need to take account of
what is sold. Moreover, income that is largely incidental to one
entity may be the main type of revenue for another. Thus if
revenue is to be defined in terms of ‘what is sold’, such a
definition must be capable of varying from entity to entity, in
that it will depend upon the nature of the business concerned. It
should therefore be based on the sequence of activities—the
operating cycle—that an entity undertakes with a view to profit.
25 The subject of barter is discussed later in this Paper in Chapter 5. Without anticipating that
discussion, the Paper is at this stage merely looking for a revenue definition that will not necessarily
exclude barter transactions.

REVENUE RECOGNITION
1.47 In the light of these points, this Paper makes the following
proposals, which will be developed further in subsequent
chapters.
In the context of a business operating cycle, revenue is the class
of gains, before deduction of associated costs, arising as a result
of benefit being transferred to a customer in an exchange
transaction (ie under a contract).
An operating cycle is a sequence of business activities, carried
out with a view to profit, which involves the transfer of benefit
to customers in exchange for consideration (ie payment).
1.48 In the preceding definition, ‘gains’ should be understood
in the sense of the Statement of Principles, which refers, in the
context of the sale of an item of stock, to the sale proceeds and
the cost of the item sold as a gain and a loss respectively.

CHAPTER 2: REVENUE AND CONTRACTUAL PERFORMANCE
Chapter 2
Revenue and contractual performance
Summary
2.1 This chapter develops the proposal from Chapter  that,
although gains may arise over various activities that a business
undertakes, revenue should be defined in relation to exchange
transactions with customers. It examines exchange transactions
in more detail, with the aim of identifying which events within
such transactions should cause revenue to be recognised.
2.2 The chapter makes the following proposal, which is built
upon in subsequent chapters.
In the context of a business operating cycle, revenue arises as a
result of benefit being transferred to a customer through the
seller’s performance under a contract.
Revenue and exchange transactions
2.3 Although the buyer and seller will not always think of
them in so formal a way, the exchange transactions that give rise
to revenue are, legally speaking, contracts. Thus it is helpful to
consider the various stages involved in a contract. These can be
broken down as follows.

REVENUE RECOGNITION
Pre-contract stage
The seller and customer may discuss contract terms, but no
binding agreement exists between them.
Formation
The seller and customer enter into a contract, which is a
binding agreement.26 For a contract to be enforceable, there
must be agreement over what each party will do (or, failing
that, about how what each party will do is to be determined).
In the context of a revenue transaction, the seller will usually
agree to supply goods, rights or services, and the customer will
agree to provide consideration (generally cash) in return.
Although many contracts are documented in writing, this is
not a necessary feature of a contract.27
26 Some contracts allow the customer the option to withdraw at some time after formation, usually
returning the assets of both parties to the position before the contract existed; for example, a customer
paying for goods may be entitled to return them and claim a full refund. Contracts lacking such an
option are sometimes described as ‘binding contracts’, in the sense that the customer is unable to back
out. However, it is perhaps worth emphasising that, in a legal sense, all contracts are binding on both
parties. Where a customer has the ability to return goods, that is a term of the contract: it does not
demonstrate that no contract exists. Rights of return make the analysis of revenue transactions more
complicated. For this reason, they are discussed separately, in Chapter 4, while the material in the rest
of this chapter and in Chapter 3 is concerned with contracts where no such option exists.
27 The extent to which a contract is documented in writing will vary greatly depending on the nature of
the contract. A large construction contract is likely to be documented in some detail and signed by each
party; a large retailer may display terms of trade in its stores, without explicitly agreeing them with each
customer; and there is unlikely to be any written documentation where a customer buys a newspaper
from a newsagent. Nevertheless, all are valid contracts.

CHAPTER 2: REVENUE AND CONTRACTUAL PERFORMANCE
Performance
The seller and customer fulfil their promises: for example, the
seller delivers goods, rights or services and the customer pays
for them. Note that, for each party, performance may be
instantaneous or may occur over a period of time. In addition,
depending upon what has been agreed, the customer may pay
in advance or in arrears, or may make stage payments at various
times.
Completion
Once the seller and customer have fulfilled their promises, the
contract is complete. Note, however, that it will not always be
apparent to either party whether a seller has in fact fulfilled its
promises. For example, goods sold may later transpire to have
been faulty, demonstrating with hindsight that, although
neither party was aware of this at the time of delivery, the seller
had not fulfilled its promises and thus the contract was not
complete.
2.4 The following paragraphs consider how the rights and
obligations of customer and seller change as a contract progresses,
based on the simple example of a seller supplying sports
equipment to a customer. Before formation of a contract, the
seller has an asset of sports equipment, while the customer has no
r ights whatsoever in respect of that equipment. After
completion of the contract, the customer has an asset of sports
equipment, while the seller has no rights whatsoever in respect
of that equipment; instead, the seller has an asset of, say, cash
received from the customer.

REVENUE RECOGNITION
2.5 Thus between formation and completion of the contract,
the seller and customer have exchanged assets. To determine
when this exchange took place, it is helpful to think about the
nature of the seller’s and the customer’s assets at each stage—and
to be able to do this, it is necessary to assume that formation and
completion are not simultaneous.28
Does exchange occur on formation?
2.6 Before formation of the contract, the seller has an item of
property, namely sports equipment; however, the rights that
make this property an asset of the seller are, primarily, the rights
to offer the property to a third party in exchange for cash.
When does the seller give up these rights?
2.7 Certainly, the position of seller and customer is different
after formation of the contract, as discussed below. However,
despite the promises each has made, the seller has not at this
point given up its ability to sell the equipment to someone else.
The seller could still sell the equipment to someone other than
the customer; if as a result it was unable to fulfil its promise to
the customer, it would be in breach of contract, and the
customer might be able to claim compensation in the form of
damages.29 But the customer could not, in general, insist on
delivery of the equipment, because for most contracts a court
will not insist on specific performance by the seller as a remedy
for breach of contract.30
28 A situation in which formation and completion are simultaneous is then just a simplification of that
discussed below.
29 It may be unlikely that the seller would wish to breach the contract in this way, but there might be
circumstances in which it would choose to do so, perhaps because a third party was prepared to offer a
significantly higher price. The objective of this discussion is to identify at what point rights change,
rather than how likely they are to change.
30 Where a contract is of a type for which a court is prepared to order specific performance, the effect may
be that the customer receives certain rights on formation of the contract. However, the transfer of those
rights would itself be an act of contractual performance in the sense discussed later in this chapter (and
elsewhere in the Paper). Thus such contracts would not be exceptions to the proposals discussed below.

CHAPTER 2: REVENUE AND CONTRACTUAL PERFORMANCE
2.8 Formation of the contract does not in general give the
seller the right to insist that the customer takes and pays for the
equipment. If the customer refuses to honour its promise, it will
be in breach of contract and the seller may be able to claim
compensation in the for m of damages. As noted above,
however, a court will not usually insist on specific performance.
Thus, although the seller may be compensated for lost profits, it
will retain the equipment and will not therefore have given up
the right to offer it to a third party in exchange for cash.
2.9 Moreover, any damages that a court might be prepared to
award to the seller may fall some way short of the profit that the
seller would have recognised on the transaction. This is because
the court will, in awarding damages, take into account what the
seller could have done to mitigate its loss. For example, if the
equipment could be sold to someone other than the customer at
the same price, no (or only nominal) damages may be awarded—
irrespective of whether the equipment is, in fact, subsequently
sold to a third party. 31
2.10 To summarise, although formation of a contract changes
the position of both seller and customer, it does not in itself
mean that exchange has occurred. Remedies may be available to
each party if the other does not honour promises made, but the
equipment has not yet become an asset of the customer; it
remains an asset of the seller.
31 The underlying principle here, which is sometimes referred to as the ‘plaintiff’s duty to mitigate’, is
also referred to in paragraph 6.28.

REVENUE RECOGNITION
Does exchange occur if and when the customer pays in advance of
delivery?
2.11 Suppose that, immediately after formation of the contract
but before delivery by the seller, the customer pays in full
(perhaps because, by agreeing to do so, it was able to secure a
better price from the seller) but does not obtain any form of title
in return.32 Has exchange occurred at this point?
2.12 The answer is again no, because the analysis in
paragraphs .-. still applies. The seller has not given up its
ability to sell the equipment to a third party, nor has the
customer yet obtained the right to insist on delivery. All that has
changed is that any damages the customer could claim would be
at least equal to the amount paid in advance.33
Exchange and performance by the seller
2.13 The position changes as the seller delivers the equipment
to the customer, irrespective of whether the customer has paid in
advance. Generally, on delivery the seller ceases to have access to
the economic benefits inherent in the equipment; the seller
cannot reclaim the equipment from the customer in order to sell
it to a third party. Instead, the customer now generally has full
access to the economic benefits inherent in the equipment.
2.14 Accordingly, following performance by the seller, the
seller’s assets are different. It no longer has the ability to sell
equipment to a third party; instead, it has the right (usually
unconditional) to receive consideration from the customer.
32 If title did pass on payment, this would instead be a ‘bill and hold’ transaction, as discussed under
paragraph 3.30 below.
33 This is not to suggest that the timing of payment by a customer is of no significance in a revenue
context. However, its significance lies in determining the amount at which revenue is measured, rather
than in determining the point at which revenue is recognised. A promise of cash (ie payment in arrears)
is worth less than the same amount of cash already held (ie payment in advance), because of credit risk
and because of the time value of money.

CHAPTER 2: REVENUE AND CONTRACTUAL PERFORMANCE
2.15 Thus, the exchange of assets described in paragraph .
occurs when the seller honours its promises—ie performs—
under the contract; this is the point at which benefits are
transferred from the seller to the customer. The first proposal
under paragraph . can therefore be developed as follows.
In the context of a business operating cycle, revenue arises as a
result of benefit being transferred to a customer through the
seller’s performance under a contract.
2.16 Chapter  considers the position where a seller has only
partly performed under a contract. However, before addressing
that issue, it is helpful to develop further the discussion begun
under paragraph .. In particular, it is now possible to say
more about how the recognition of revenue by reference to a
seller’s performance fits in with the idea of risks in the operating
cycle being substantially eliminated.
Revenue and unexpired risk
2.17 Chapter  acknowledged that, although revenue
recognition has historically been linked to a notion of exchange,
it could in principle have been linked either to formation or to
completion of a contract.34 Given the wide range of contracts
that arise in different businesses and the very different risks
associated with each, it is possible to make only general
statements about how the different stages of a contract relate to
risk. Nevertheless, the following analysis is possible for contracts
that do not give the customer a right of return.35
34 See footnote 12.
35 Customer rights of return are discussed in Chapter 4.

REVENUE RECOGNITION
Stage of contract:
Seller’s unexpired risks:
On formation
Credit risk (including default risk and
the risk that payment will not be
received on time).
Performance risk (including the risk
that the seller will fail to become
entitled to payment from the customer
on time, as a result of failing to honour
its promises either in the agreed way
or on time).
After performance
by the seller
Credit risk (as above) if customer
payment is in arrears, otherwise none.
On completion (ie
after full performance
by both parties)
None. (Note that warranty risk is not
a post-completion risk; rather, a valid
warranty claim indicates that the seller
has not fully performed and that the
contract is not therefore complete.)
2.18 As mentioned above, a decision for the generality of
businesses on when in this process to recognise revenue would
involve balancing relevance and reliability. Recognising revenue
only on completion of a contract would mean complete
reliability, but would be unacceptably late in many circumstances,
because it is generally possible to allow for the impact of credit
risk in measuring future cash flows.
2.19 On the other hand, recognising revenue on formation of a
contract would involve adjusting future cash flows for the impact
of performance risk. The extent of performance risk is likely to
vary far more from business to business than the extent of credit
risk; it is correspondingly likely to be much harder to assess.
Moreover, whereas it might be argued that for the generality of
businesses, credit risk is not substantial, the same cannot be true
of performance risk; for many businesses performance risk will
be the most significant risk.

CHAPTER 2: REVENUE AND CONTRACTUAL PERFORMANCE
2.20 To summarise, it may be argued that for businesses in
general the earliest point at which risks in the operating cycle
have been substantially eliminated is after performance by the
seller in a contractual exchange with a third party. This analysis
of revenue and r isk will be relevant in Chapter  when
considering customers’ rights of return.

REVENUE RECOGNITION
Chapter 3
Accounting for incomplete
contractual performance
Summary
3.1 Chapter  proposes that revenue should be recognised
when a seller performs under a contract. This chapter considers
how to account for revenue when the seller’s contractual
performance is incomplete, for example over a period-end.
Although the chapter discusses principles concerning how
revenue should be recognised, the measurement of revenue is
discussed in Chapter .
3.2 The chapter first considers, and rejects, the possibility that
revenue should always be recognised only on full performance.
It then suggests a principle for determining the extent to which
revenue should be recognised on the basis of par tial
performance, and considers various techniques by which that
principle might be applied in practice.36 Finally, it considers the
application of the principle to full performance contracts and to
‘bill and hold’ sales.
3.3 The main proposal discussed in this chapter is set out
below.
Where contractual performance is incomplete, revenue should
be recognised to the extent that the seller has performed and
that performance has resulted in benefit accruing to the
customer.
36 It acknowledges, however, that dealing with incomplete performance is likely to be the biggest single
difficulty arising in practice, and that the application of this principle to specific industries will be an
important part of the next stage of this project.

CHAPTER 3: ACCOUNTING FOR INCOMPLETE CONTRACTUAL PERFORMANCE
General principle in respect of incomplete contractual
performance
Is full performance always necessary?
3.4 The first possibility to consider is that, as a general
principle, revenue should not be recognised until a business has
fully performed all of its promises under a contract. This would
be a major change from existing practice. For example,  
‘Stocks and long-term contracts’ requires that for long-term
contracts turnover is recognised as contract activity progresses.
3.5 Paragraph . of the Statement of Principles comments
on this subject, using the term ‘critical event’ to refer to an event
that causes a gain (ie revenue) to be recognised:
“For many types of transaction, the critical event in the operating
cycle is synonymous with full performance. In such cases a gain
will be recognised when the entity providing the service or
goods has fully performed. That need not, however, be the
case: the critical event could occur at other times in the cycle
and there could be more than one critical event in the cycle.”
3.6 Several arguments may be made against a full performance
approach. It may be argued, as in  , that turnover should
reflect contract activity rather than contract completion. In
addition, a full performance approach will sometimes seem
excessively prudent in that, for example, it is the norm in longterm construction contracts for work to be certified, invoiced
and settled as activity progresses.

REVENUE RECOGNITION
3.7 Probably the strongest argument against a full performance
approach is that it places undue weight on the legal form of a
transaction and insufficient weight on its economic substance.
To illustrate this, suppose a household wishes, like many others
in the same street, to have a newspaper delivered daily for a
month, and suppose also that there are several newsagents already
delivering to that street. The household and newsagent could, in
theory, at the start of the month enter into  separate
contracts—one for each day—or into one contract covering the
entire month.37 If the former, the newsagent would recognise
revenue daily; if the latter, only at the end of the month. Yet,
economically speaking, any differences between the two
situations may be very slight indeed.38 As discussed later in this
chapter, the single monthly contract is, in substance,  daily
contracts ‘bundled’ together.
How should incomplete contractual performance be accounted for?
3.8 If an approach always requiring full performance of a
contract is to be rejected, it is necessary to identify how revenue
should be recognised in respect of part-performance.   is
not specific on this point, but seems to imply that, providing
estimates are made on a prudent basis and the contract outcome
can be assessed with reasonable certainty, revenue should be
recognised by reference to the work done, or costs incurred, on
the contract to date.
3.9 However, it is argued in Chapters  and  that revenue should
be a measure of exchange with a customer. In particular, for the
reasons discussed in those chapters, revenue is defined by reference
to the transfer of benefit to customers. For consistency with this
37 In practice, it is of course unlikely that there would be any written documentation of the
arrangement, but this does not alter the underlying principle.
38 If after, say, 20 days of supply, either party refused to continue with the contract(s), this would be a
breach. Nevertheless, for the reasons discussed in paragraph 2.9, it seems unlikely that a court would
order anything other than nominal damages for such a breach, because the newsagent can find other
customers, while the household can find other suppliers.

CHAPTER 3: ACCOUNTING FOR INCOMPLETE CONTRACTUAL PERFORMANCE
approach, it seems appropriate, rather than focusing on the costs
incurred by the seller, to focus on the extent to which benefit has
accrued to the customer as a result of the seller’s performance. The
following general principle is therefore proposed.
Where contractual performance is incomplete, revenue should
be recognised to the extent that the seller has performed and
that performance has resulted in benefit accruing to the
customer.
Applying the principle in practice
3.10 Accounting for partly performed contracts is one of the
trickiest aspects of revenue recognition arising in practice.
Accordingly, although the principle above is more specific than
 , it would be foolish to imagine that this will of itself
reduce the many practical difficulties that arise in connection
with incomplete performance: having a more precise goal does
not necessarily make it easier to achieve the goal.
3.11 Nevertheless, before discussing how the principle might be
applied in practice, it is worth clarifying some aspects of what is
proposed. The reference to benefit accruing should not be taken
to mean that the customer must necessarily have title to, or physical
custody of, any property involved in the contract. It is well
established that benefits can be received by a customer without title
passing at any stage, as in the case of an asset held under a finance
lease.39 In addition, the discussion of ‘bill and hold’ sales later in
this chapter 40 suggests that benefits can pass with title to goods,
before a customer has obtained possession of them.
39 or before title has passed, where goods are supplied with a retention of title clause (ie title does not
pass until the goods are paid for).
40 under paragraph 3.30.

REVENUE RECOGNITION
3.12 Rather than necessarily involving either a physical event
(eg delivery) or a legal event (eg transfer of title), the accruing of
benefit to a customer is in essence an economic event. To take
an example familiar from  , if a seller is constructing a
building to a customer’s design, the customer may gain neither
title nor physical custody until construction is complete;
nevertheless, the benefit of construction activity is accruing to
the customer. The main change of emphasis arising from the
principle proposed in this Paper is that, in assessing the extent of
contract activity, the focus would be not on the cost of work
done to date, but rather on the value to the customer of what has
been done.41
Different approaches to measuring benefit transferred
3.13 To measure incomplete contractual performance, entities
will need to develop suitable techniques for estimating value
transferred to a customer. Three possible techniques are
discussed below, in decreasing order of preference:
•
unbundling
•
value to date assessment
•
value outstanding assessment.
3.14 In the following discussion, it is important to note that
values are measured by reference to prices and circumstances
prevailing at the time the contract was originally formed;
otherwise, changed prices may distort the allocation of overall
revenue from the contract.42
41 Thus a distinction that will be drawn later is whether the benefit from a particular activity of a seller
accrues to the customer or to the seller. (See the discussion of generic products and specificity under
paragraph 6.26.)
42 This follows from the view, supported by this Paper, that, although revenue is recognised when
benefits are transferred to a customer, the amount at which revenue is measured relates to the
consideration received or receivable from a customer, rather than the benefits transferred. The discussion
under paragraph 5.6 below is concerned with this issue.

CHAPTER 3: ACCOUNTING FOR INCOMPLETE CONTRACTUAL PERFORMANCE
Unbundling
3.15 Where practical, the best technique to use in measuring
incomplete contractual performance is that of unbundling. This
in effect reverses the process discussed in paragraph .; it asks
whether the value of a large incompletely performed contract
can be broken down into smaller stages or elements that might
otherwise have been contracted for separately. Where this can be
done, those elements will often be either complete or wholly
unperformed, so that the revenue allocated to them is recognised
in full or not at all.
Assigning fair values to elements
3.16 Two key issues tend to arise in the unbundling process.
The first is the assignment of fair values to the elements
identified. The aim should be to use prices for those elements
that have been agreed in similar transactions, but this may still
involve a degree of estimation. Further, a measurement issue
may arise if the sum of estimated element fair values does not
equal the total value of the contract. In this situation, the
following approaches may be considered:
•
If the contract value exceeds the total of the elements,
this may suggest that a fair value should be attributed
to the activity of managing the other elements. (An
example of this will arise if a building contractor
delegates all the physical work to subcontractors. The
amount charged by the building contractor to its
customer will exceed the amount paid to
subcontractors, because the building contractor is
being paid to manage the contract.)
•
If the contract value is less than the total of the
elements, it may be that an element of performance
has been double-counted. For example, there may be
economies of scale that arise from combining elements,
such as set-up time that does not need to be
duplicated. However, a discount may remain after any

REVENUE RECOGNITION
double-counting has been eliminated. As a purely
practical approach, it may be sensible to allocate such a
discount between the various elements in proportion
to the revenue estimated for each element.
Example 3.16: a mobile phone package
A mobile phone retailer may package within a single contract
supply of a handset, some line rental and some prepaid calls. If
those three elements are also available separately, their standalone prices will be the starting point for allocating the total
contract value between them.
At the very beginning of the contract, the handset will have
been delivered to the customer, but provision of a line and calls
will still be outstanding. Thus, no revenue will be recognised
in respect of the latter elements.43
Are elements independent?
3.17 The second issue arising in the unbundling process, which
is related to the first, lies in determining whether elements are in
fact independent of one another. The unbundling process is
based on the idea that elements are substantially independent of
one another, so that there is no significance in the fact that they
have been contracted for together. Thus, in the example
discussed in paragraph ., it was implicitly assumed that the
value each day of having a newspaper delivered was not affected
by whether another would be delivered the next day. However,
if elements are not entirely independent, some care will be
needed when allocating fair values to them.
43 The extent to which revenue is recognised in respect of the handset will depend on its value when
separated from the associated provision of line rental and calls. If the handset is capable of being used
with more than one network, it has a value to the customer when separated from the associated line
rental; the customer could reasonably have bought just the handset. However, if the handset could be
used only in conjunction with the associated line rental, it would have no stand-alone value. (See also
Example 3.17 below.)

CHAPTER 3: ACCOUNTING FOR INCOMPLETE CONTRACTUAL PERFORMANCE
Example 3.17: computer hardware and software
If a customer contracts with a computer supplier to have
delivered both a personal computer and certain games to be
run on it, it may be reasonable to assume that these two
elements are substantially independent. Having many other
uses, the computer will have significant value when separated
from those games; moreover, the customer would probably
have little difficulty obtaining them elsewhere.
On the other hand, if a business contracts with a computer
supplier to develop a combined package of hardware and
software to perform a specialised task, it may be much less
likely that the hardware and software can be seen as
substantially independent elements. The hardware may in fact
have little or no use other than in conjunction with the
software.
3.18 Unbundling will often help in assessing the extent to
which revenue should be recognised in respect of incomplete
contractual performance, but it may not provide all the answers.
It may be that some material elements of a contract (or indeed a
contract itself) cannot be broken into smaller elements. In that
case, it will be necessary to consider the alternative techniques
discussed below.
Value to date assessment
3.19 If (further) unbundling is not possible, the best alternative
is to attempt to assess directly the value 44 that has accrued to a
customer in respect of a seller’s performance to date.
44 measured by reference to prices and circumstances prevailing at the time the contract was originally
formed.

REVENUE RECOGNITION
3.20 In some industries, such as construction, an independent
third party periodically assesses the value of contract work
performed. Where such an assessment corresponds to a fair and
realistic assessment of the benefit accruing to the customer, it will
provide suitable evidence of the extent to which revenue should
be recognised.45
3.21 The main practical problem with this approach will arise
where no such independent assessment is available. In these
circumstances, there may be little reliable evidence from which
to estimate the value accruing to the customer, and it may be
necessary to consider the third technique below.
Value outstanding assessment
3.22 The third technique available when dealing with
incomplete contractual performance is to assess the value of
benefit that has not yet accrued to a customer. In effect, this asks
the question: if there was no further performance from the seller,
what value would the customer have to pay a third party in order
to take over and complete the contract?
3.23 Once again, when making this assessment, it is important
that it is based on prices and circumstances that would have
prevailed at the time the contract was originally formed;
otherwise, changed prices may distort the allocation of overall
revenue from the contract.
3.24 A difficulty with this approach arises where a third party
taking over the contract would have to duplicate some of the
work already done by the seller, for example in terms of
familiarisation. There is a risk, therefore, that it will tend to
overstate the revenue relating to unperformed activities and
hence to understate the revenue that should be recognised.
45 Of course, if the independent assessment preceded the period-end and further work had been
performed in the interim, this would not preclude the recognition of the appropriate amount of additional
revenue as a result of that further work.

CHAPTER 3: ACCOUNTING FOR INCOMPLETE CONTRACTUAL PERFORMANCE
Applying these techniques in practice
3.25 In practice, a combination of these techniques may be used
as appropriate. In addition, once a reasonable population of
similar revenue transactions is established, it may be practical to
develop specific estimation techniques that approximate the
results from using those described above. For example, many
industries already use percentage of completion methods when
accounting for incomplete contracts; such methods would
continue to be appropriate providing they are properly weighted
to the fair values of different parts of a contract and reasonably
reflect how benefits are received by customers.46
Full performance contracts and ‘trigger events’
3.26 Although the preceding paragraphs discuss var ious
techniques that may be used when accounting for incomplete
contractual performance, it must be emphasised that, under some
contracts, revenue should be recognised only on full
performance. This is unlikely to be a significant issue where
performance takes little time, such as in most retail transactions,
but there may also be longer-term contracts for which full
perfor mance will be a necessar y condition for revenue
recognition. Such contracts will be those under which no
benefit (or none of any significance) accrues to the customer
until full performance has occurred. They may be structured so
that, unless and until full performance occurs, the customer will
pay nothing.
46 Percentage of completion methods often assess the costs incurred by a business as a proportion of the
total costs expected on a contract. Such methods will remain appropriate where it is reasonable to assume
a correlation between the costs incurred by the business and the benefits received by the customer.

REVENUE RECOGNITION
3.27 More generally, there may be contracts under which no
benefit of any significance accrues to the customer until an
identified significant act of performance has occurred. For
convenience, the specified act of performance (which may, as
above, be full performance) is referred to below as a ‘trigger
event’. Under such contracts, no revenue will be recognised
until the trigger event occurs. In addition, the contract may
often specify that the customer pays nothing unless and until the
trigger event occurs.
Trigger events and payment terms
3.28 Many contracts specify a payment schedule, sometimes
linked to acts of performance. This does not imply that all such
contracts contain trigger events, because trigger events relate to
how benefit accrues to the customer, rather than the customer’s
payment obligations. To identify trigger events, it may be
helpful to consider whether, before a particular event in a
contract, a seller’s activity accrues benefit not to the customer,
but rather to the seller—primarily in that it contributes to the
likelihood that the contract will ultimately be successfully
performed.
3.29 As a general comment, a contract is perhaps more likely to
contain trigger events where there is a high level of risk that the
contract will not be successfully performed. Such risks may be
present if there is a significant element of contract performance
that is exposed to circumstances outside the control of either
party.

CHAPTER 3: ACCOUNTING FOR INCOMPLETE CONTRACTUAL PERFORMANCE
‘Bill and hold’ sales 47
3.30 ‘Bill and hold’ sales are sales in which a customer takes title
to goods but the seller continues to hold them, 48 at the
customer’s request, for later delivery or collection. They are
incompletely performed contracts because the seller still has
outstanding contractual promises—namely to retain custody of
the goods for a specified period and, perhaps, to deliver them.
For the purposes of the following discussion, it is assumed that
the goods in question are not made to the customer’s order.49
3.31 Care is needed when deter mining the appropr iate
accounting for bill and hold sales, because it is not always clear
whether revenue should be recognised. To illustrate this,
suppose that, before a seller’s year-end, a customer places an
order for goods to be delivered in the next accounting period,
with payment to be made some time after delivery. At the yearend, this contract will be executory, and no revenue will be
recognised. However, if all the facts are unchanged except that
the customer agrees to take title before the year-end, the contract
may be described as a bill and hold sale. Should this necessarily
make the accounting different?
3.32 At this stage, two factors may be identified that are
necessary (but not automatically sufficient) for a bill and hold sale
to be distinguished from an executory contract.
47 Although the analysis in this section is not drawn from FRS 5, it has broadly the same objective in
that it focuses on the extent to which benefits (and the risks underlying those benefits) have accrued to
the customer and, hence, the extent to which the customer has an asset.
48 Some transactions in which title passes but not possession are not sales at all but are simply
financing arrangements. They are not considered here.
49 See paragraph 6.26 below for a discussion of specificity.

REVENUE RECOGNITION
•
The seller must, before the transaction, have held title
to the goods—otherwise title could not validly have
been transferred to the customer. The goods must
therefore exist and be in stock.
•
The arrangement to retain stocks after they have been
sold must have been at the customer’s request, and
must not simply reflect the seller’s inability to deliver.
3.33 The second factor is necessary because, under the
proposals in this Paper, revenue will be recognised only where a
customer receives benefit as a result of a seller’s contractual
performance. Thus the transfer of title to goods before delivery
will need to be an agreed element of the contract, and the
customer will need to obtain benefit from it; it must be a
contract term and must have economic substance.
3.34 If these conditions are met, revenue will be recognised to
the extent that benefits have been received by the customer as a
result of the seller’s incomplete performance. The customer has
received title to the goods but not possession. Accordingly, the
question to consider is which economic benefits, if any, the
customer has received—and, correspondingly, to which risks of
variation in those economic benefits the customer is exposed—as
a result of the seller’s incomplete performance.
3.35 One possibility to consider is that, through the bill and
hold transaction, the price of the goods has been fixed,50 thus
relieving the seller of price risk. However, if benefits are to be
attributed to the seller’s incomplete performance, it must be shown
that they were not already present before that performance took
place. Generally, a price will be fixed not on performance but
rather on formation of a contract, so that the benefit of a fixed
price cannot be attributed to performance.
50 This may not be the case; it is possible to transfer title without having fixed a price so long as the
contract specifies how the price is to be determined.

CHAPTER 3: ACCOUNTING FOR INCOMPLETE CONTRACTUAL PERFORMANCE
3.36 Another possibility is that the customer may have agreed
to bear the risk that the goods will become damaged. In practice
it may be difficult to determine whether this should be regarded
as persuasive, since it may be difficult to ascertain the real
economic effect of such an agreement. For example, because the
seller has contracted to retain custody of the goods, it will
probably have a duty to ensure that they are not damaged, and
might therefore have to reimburse the seller anyway if damage
occurred as a result of its negligence.
Benefits of title—risks relating to future possession
3.37 One benefit that may pass with title relates to the risk that
the customer will not ultimately obtain possession of the goods.
It would be simplistic to relate this ‘possession risk’ entirely to
transfer of title—because before title has passed under a contract,
the seller has nevertheless promised to transfer possession. Thus,
even in a non-bill and hold sale (ie one in which title passes only
on delivery), the customer’s ‘possession risk’ is reduced greatly
on formation of a contract.
3.38 Nevertheless, the transfer of title may in some
circumstances affect the risks associated with the customer’s
future possession. Suppose a customer enters into an executory
contract to have product X delivered in one month’s time. The
seller may or may not have product X in stock at the time the
contract is made, but if it does it is still entitled to sell any such
stocks to someone else; it can honour its contractual promises by
obtaining replacements. However, there remains a risk that the
contract may subsequently become frustrated if the seller is
unable to obtain replacement supplies of product X.
3.39 Accordingly, in some circumstances, a customer may
receive benefit as a result of obtaining title, in the form of greater
assurance that possession will ultimately be achieved. However,
the value of this benefit will be significant only where there is a
significant risk that goods could not be replaced—for example,
because they are unique or because supply may be restricted.

REVENUE RECOGNITION
Benefits of title—ability to control
3.40 The other respect in which benefits may pass with title is if
the transfer of title gives the customer effective control of the
goods. This will be the case where the goods are held to the
customer’s order, unless the contract restricts the customer’s
ability to obtain access to the goods. An example of such a
restriction might arise if the contract would not allow the
customer to collect or request delivery of the goods before a
specified later date.
3.41 In practice, it may be very difficult to distinguish bill and
hold sales from executory contracts, and careful attention will
need to be paid to the facts in each case. However, the overall
principle should be that revenue is recognised in respect of bill
and hold sales only to the extent that the customer has received
benefits—and, correspondingly, accepted risks—as a result of the
transfer of title. The preceding discussion suggests that this will
be the case if
•
without transfer of title there would be a significant
risk that the customer might not ultimately obtain
possession—ie either the goods are unique or
replacements may not be available within the relevant
timescale—or
•
the transfer of title gives the customer effective control
of the goods, so that there are no significant restrictions
on its access to them.
Applying the principle in practice—summary
3.42 This chapter has proposed as a principle that, where
contractual performance is incomplete, revenue should be
recognised to the extent that the seller has performed and that
performance has resulted in benefit accruing to the customer.
The chapter has then considered different approaches whereby
that principle might be applied in practice, and the implications
of the principle for full performance contracts and bill and hold
sales.

CHAPTER 3: ACCOUNTING FOR INCOMPLETE CONTRACTUAL PERFORMANCE
3.43 As this Paper has already acknowledged, dealing with
incomplete performance is likely to be the biggest single
difficulty arising in practice, and the application of the Paper’s
proposals to specific industries will be an important part of the
next stage of this project. Nevertheless, the Board encourages
respondents to consider now how the proposals might be applied
to industries with which they are familiar. Views on difficulties
that may arise will be valuable to the Board when refining the
Paper’s proposals.

REVENUE RECOGNITION
Chapter 4
Rights of return and
post-performance options
Summary
4.1 The preceding chapters have considered how revenue
arises as a result of a seller’s performance under a contract. In
particular, they have focused on how that performance enables
the seller to recognise rights in respect of the consideration
specified in the contract. This chapter considers the impact on
the preceding discussion of customer rights of return, which in
effect give a customer the ability to unwind a contract after
performance by the supplier has occurred.
4.2 The chapter proposes two possible approaches to
accounting for rights of return, summarised below, and asks for
views on which is more appropriate.
Expected sale approach:
Where goods are transferred along with a right of return,
revenue should be recognised on the transfer of benefit, with
an appropriate adjustment to reflect the risk of returns.
Accounting policy approach:
Where goods are transferred along with a right of return, an
entity should select and consistently apply whichever of the
following accounting policies is most appropriate to its
circumstances:

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
•
either revenue should be recognised on the transfer of
benefit, with an appropriate adjustment to reflect the risk
of returns
•
or revenue should be recognised on the expiry of the right
to return.
The most appropriate accounting policy should be judged by
reference to the objectives and constraints set out in  
‘Accounting Policies’, giving due weight to the objective of
comparability between entities operating within the same
industry.
Post-performance options
4.3 Under some contracts, a customer can choose not to
proceed even after performance has occurred, thereby becoming
entitled to a refund of all or part of any consideration already
paid (or ceasing to have an obligation in respect of some or all of
any consideration not yet paid).
4.4 Sometimes contract terms with this effect are required by
statute, but often they are intended as an incentive to potential
customers who might not otherwise have chosen to contract.
Some common examples arise:
•
in the financial services industry, where customers are
allowed a ‘cooling off ’ period (eg  days) in which to
revoke an agreement
•
where retailers sell goods with a right of return,
enabling customers to reclaim in full any amounts paid
•
where goods are supplied on a sale or return basis (for
example by manufacturers to dealers), so that the
receiving party may avoid paying for the goods by
instead returning them.

REVENUE RECOGNITION
4.5 This chapter considers how the analysis in earlier chapters
is affected by the existence of such customer options.51
Which options is this chapter concerned with?
4.6 Options are implicit in most contracts. For example, in
most cases both parties to a contract that is still executory can in
principle decline to proceed with it, even though no such option
is explicitly acknowledged in the contract. 52 The price of
exercising this option will be the damages, if any, payable to the
other party for breach of contract (see paragraph .).
4.7 The options with which this section is concer ned,
however, are contract terms that, in effect, allow one or other
party to ‘reverse’ the contracted transaction, such as:
•
a customer’s option to return goods supplied and claim
a refund of amounts paid (or the discharge of a liability
to pay)
•
a supplier’s option to require the return of goods
supplied.
4.8 The existence of such options can make it difficult to
determine how a transaction should be accounted for. The
effects of options held by a supplier are discussed under
paragraph . below, but this chapter considers first the more
difficult issues that arise from customers’ options. The example
in paragraph . below may help to demonstrate the potential
difficulties, and will also be referred to when further analysing
the effects of such options.
51 Note that the chapter is concerned only with customer options that exist after performance has
occurred. Thus it is not concerned with, for example, a customer’s ability to return a faulty product,
because the fact that the product is faulty means that the supplier has not properly performed.
52 An exception is the limited range of contracts for which a court is prepared to order specific
performance.

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
‘Sale’ with right of return
4.9 Suppose that X transfers a number of assets to Y in
exchange for cash, but the terms of the deal allow Y to return as
many (or as few) of those assets as Y wishes within seven days
and claim a refund of the cash paid for each. Should X account
for a sale at the initial point of exchange—and if so, precisely
what has been sold?
4.10 If X is a retailer, and the assets are items of clothing, then
under present accounting practice it would be common to treat a
sale as having occurred, making provision for the expected level
of returns.53 In effect, the transaction is regarded as a sale but
with a return option attached.
4.11 Present accounting practice may be different, however, if
X is a wine merchant and the assets are wineglasses. It is
common for wine merchants to provide a free glass loan service
to customers, with both parties expecting that most (if not all) of
the glasses will be returned. The transaction may be given the
legal form of a sale (with a guaranteed offer to ‘repurchase’), but
under present accounting practice it may be more likely that X
will initially account for it as a loan, recognising sales (if any)
only at the point that glasses are not returned. In effect, the
transaction is regarded as a loan with an option to buy attached.54
53 Indeed, Example 4 in Appendix III to FRS 12 ‘Provisions, Contingent Liabilities and
Contingent Assets’ proposes accounting in this way for a very similar transaction.
54 It is important to note at the outset that although the wine merchant expects very few of the
wineglasses to be ‘sold’, this does not imply that such sales will be unprofitable. The wine merchant
will set the deposit/sale price at a level high enough to provide adequate recompense in the minority of
cases in which glasses are not returned.

REVENUE RECOGNITION
4.12 The fact that the two transactions are accounted for
differently, even though they are both based on the contract
terms described in paragraph ., suggests that either
•
the present accounting is inappropriate for at least one
of them, or
•
there is a difference between the two that justifies the
different accounting.
4.13 The first of these possibilities is considered below; the
second under paragraph ..
Is the present accounting inappropriate?
4.14 To assess whether the present accounting is inappropriate,
it seems sensible to consider the consequences of accounting for
both transactions in the same way, ie either
•
as a sale with an option to return attached, or
•
as a loan with an option to buy attached.
Sale with an option to return
4.15 What if the wine merchant accounted for its transaction as
a sale of wineglasses with an option to return attached? The
change from the wine merchant’s present accounting might be
quite small, because the likelihood of the return option being
exercised would be very high. Only a very small level of revenue
would be recognised, reflecting the small proportion of glasses
not expected to be returned. Almost all of the ‘deposit’ received
from the customer would give rise to a liability, reflecting the
amount to be paid out under the option. This possibility is
considered again later.55
55 as approach (b) under paragraph 4.49.

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
Loan with an option to buy
4.16 What if the clothing retailer accounted for its transaction
as a loan of items of clothing with an option to buy attached?
Under this approach, it would not account for any revenue until
the customer ‘exercised the option’. This would be at the point
when the customer lost the ability to return the clothing and
claim a refund, and this point would vary depending on what
had been agreed between the retailer and the customer. Often
the option would lapse when the customer ‘adopted’ the
clothing by wearing it. In some cases there might be a limited
period—say, one month—in which returns could be made; in
others, the return period might be open-ended. Thus the
impact of this accounting would vary from retailer to retailer, but
it might be rather more pronounced than the impact described
in paragraph ..
4.17 There are some who believe that, in principle, all sales
with a right of return should be regarded as loans until the return
option lapses, because they believe that such an approach reflects
how the seller’s liabilities are extinguished. They believe that,
where a customer pays in advance, the seller has a liability—an
obligation to transfer economic benefits—and that this liability is
extinguished only when the customer loses the ability to claim a
refund. They would in principle always measure a seller’s
liabilities in respect of customer return options at the maximum
amount that customers could reclaim. The likelihood of that
happening is not, in their view, relevant.
4.18 Others argue that the amount at which the seller’s liability
should be measured changes as a result of the seller’s
performance. They believe that once the seller has supplied
clothing, its liability in respect of customer return options should
be measured at fair value, taking account of how likely it is that
customers will seek refunds. In support of this view, they argue
that from the perspective of the seller there is no inherent difference
between the risk that a customer will seek a refund and the risk
that goods supplied will prove, with hindsight, to have been
faulty. They believe that both risks should give rise to a liability
reflected at fair value.

REVENUE RECOGNITION
4.19 This Paper does not support the view that all sales with a
right of return should be accounted for as ‘loans with an option
to buy’, in part because of the arguments in the preceding
paragraph and in part because of the discussion in the rest of this
chapter. Accordingly, it is appropriate next to consider whether
there are differences between the clothing retailer and wine
merchant examples that justify their being accounted for
differently.
Is the present accounting justified?
4.20 If the two transactions are properly accounted for
differently, what is the difference that justifies this? An initial
reaction may be to say that, ignoring the legal form of each, the
substance of the former is a sale whereas the substance of the
latter is a loan. However, there are differences between these
transactions and ‘normal’ sales and loans that appear, at least at
first glance, not insignificant.
•
In a ‘normal’ sale, unless the goods sold are defective, a
customer cannot insist on a refund—but the clothing
retailer’s customer can insist on one here. Although, at
the initial point of exchange, the recognition of sales
reflects the extent to which goods are expected to be
returned, until the option expires (which will be later
than that initial exchange) the customer can demand a
refund in respect of all items.
•
In a ‘normal’ loan, the lender can insist on the return
of the item loaned at the end of the loan period—but
the wine merchant cannot do so here. The wine
merchant expects the glasses to be returned, but has no
right to insist on it; the customer can instead give up
his right to a refund.
4.21 Accordingly, when looking at the substance of each
transaction, it is not true that the former is just like a sale and the
latter is just like a loan; both transactions have elements that are
not necessarily consistent with that substance.

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
4.22 Nevertheless, many might see the clothing retailer’s
transaction as having more in common with a sale than it does
with a loan, and the wine merchant’s as having more in common
with a loan than it does with a sale. In both cases this may be
because they do not see the existence of the option as
fundamentally changing what the character of the transaction
would have been without it:
•
the clothing retailer expects customers to exercise the
return option only in a minority of cases—it is seen as
a remedy for the small number of customers who may
subsequently regret their purchases, rather than as a
feature regarded as essential by all customers;
•
the wine merchant expects most glasses to be returned,
with the option to buy being exercised only in a small
number of cases (primarily as a result of breakages).
4.23 If it is right, however, that the two situations can be
distinguished by focusing on the character of the transaction, it is
necessar y to consider how the different aspects of each
transaction enable its character to be determined. Certainly, the
two transactions have many aspects in common, because each is
based on the example in paragraph .. For example, in both
cases the customer is entitled to claim a refund on any (or all) of
the assets if he wishes, but is not obliged to return any of the
assets. There are no restrictions on what the customer can do
with the assets, but he is exposed to any risk of damage while
they are in his custody. What then are the differences between
the two transactions?
4.24 An initial reaction may be to say that the two main
differences lie first in the intentions of the transacting parties and
secondly in their expectations of what will occur. It is worth
considering this more carefully if these apparent differences are to
be used to determine the appropriate accounting in each case.

REVENUE RECOGNITION
Distinguishing between transactions on the basis of intent
4.25 Standard-setters are generally reluctant to distinguish
between transactions purely on the basis of intent, because they
believe that intent does not alter the underlying economic
position that financial statements should report.
4.26 Leaving this concern to one side, in the examples discussed
above it is true that both the clothing retailer and the wine
merchant will know what their intent is in entering into the
transaction. The clothing retailer intends to sell goods to the
customer, thereby making a profit. By contrast, the wine
merchant intends to lend wineglasses to the customer, expecting
to make no profit on that particular transaction but to generate
goodwill that may result in sales of wine.
4.27 However, because the options are exercisable by the
customer, the intentions of the seller are not directly relevant.
Having entered into the transaction, the seller is not in a position
to influence its final outcome. If any intentions are relevant, it is
those of the customer—but the seller will not usually know what
the customer’s intentions are. For example, the clothing retailer’s
customer may have bought several items as alternatives, with the
intention of choosing one and retur ning the others.
Alternatively, the customer may have bought items speculatively
for someone else, knowing that they can be returned if they are
not suitable. Similarly, the wine merchant’s customer may intend
from the outset to retain the glasses; if so, there is no particular
reason why the wine merchant should be aware of this.
4.28 The seller may be able to make a reasonable guess about
the intentions of buyers when considered in aggregate, by
considering the outcomes of previous similar transactions. In
that case, however, he is no longer concerned with intent as
such, but is instead considering the second difference identified
in paragraph ., being the parties’ expectations of what will
occur. This is discussed below.

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
Distinguishing between transactions on the basis of expected outcomes
4.29 It must of course be acknowledged that the seller is no
more able to assess the buyer’s expectations about the transaction’s
final outcome than he is the buyer’s intentions when entering
into the transaction. Nevertheless, where the seller has entered
into similar transactions in the past, it is certainly true that he
may be able to make an assessment of the expected outcome of a
current transaction. Indeed, in the clothing retailer’s case, this
assessment is already made under present practice and used to
determine the extent to which a provision is required.
4.30 How might expected outcomes be used to determine
whether a particular transaction should be treated as a sale with a
right of return or as a loan? The expected outcome will suggest
an estimate of the percentage of assets that will be returned.
Where this is very low (as may be the case for the clothing
retailer) it does not seem unreasonable to treat transactions as
sales with a right of return. Where this is very high (as may be
the case for the wine merchant’s glasses) it does not seem
unreasonable to treat transactions as loans.
4.31 However, to be able to classify all transactions either as
sales or as loans, it will be necessary to specify a threshold at
which one is distinguished from the other. Although in practice
this could be done, as an approach it has a number of undesirable
qualities:
•
any such threshold will be somewhat arbitrary
•
transactions that are very similar to one another and
have very similar expected outcomes will nevertheless
be accounted for quite differently if those outcomes
fall either side of the arbitrary threshold
•
as a consequence, given the potential degree of
subjectivity involved in assessing expected outcomes,
there may be scope for sellers to achieve significantly
different accounting simply by making small changes to
estimates of expected outcome.

REVENUE RECOGNITION
4.32 To sum up, customers’ options to return goods are at
present accounted for differently (ie as sales or as loans) in
different circumstances. However, the preceding discussion has
not identified a principle capable of objective application that
would enable all transactions to be allocated to one or other of
those categories. It therefore seems appropriate to consider the
problem from another perspective.
What is the nature of the seller’s asset?
4.33 The discussion above sought to identify criteria that would
determine whether particular transactions should be classified
either as sales or as loans. Nevertheless, it was acknowledged
earlier (in paragraph .) that these transactions do not have
precisely the same characteristics as ‘normal’ sales or loans. It
may therefore be helpful to give more thought to the asset that
the seller has as a result of entering into such transactions.
4.34 Suppose the transaction described in paragraph . is
modified, so that X transfers a number of articles to Y in
exchange for Y’s promise to pay cash in seven days. Once again,
the terms of the deal allow Y to return as many (or as few) of
those articles as Y wishes within seven days, so that at the end of
that period Y will pay only for those articles that have not been
returned.56
4.35 Clearly, before X contracts with Y, all the articles belong
to X. At the end of seven days, X may once again have all the
articles (if Y returns all of them), or X may just have cash (if Y
returns none of them) or X may have some articles and some
cash.
56 This example differs from that in paragraph 4.9 only with regard to the timing of payment. This
Paper proposes that the recognition of revenue should not, in general, be affected by the timing of cash
flows, except to the (generally relatively small) extent that credit risk affects measurement and except for
the impact of the time value of money. In this example, the timing of payment has been varied
primarily to make the discussion more straightforward.

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
4.36 But what are X’s assets at the point immediately after the
initial exchange (ie before any articles have been returned by Y)?
X physically holds neither articles nor cash. Does X have a claim
against Y for articles? No, because X cannot insist that Y returns
any of them. Does X have a claim against Y for cash? No,
because X cannot insist that Y buys any of the articles.
4.37 Nevertheless, X does have a claim against Y, because X can
insist that at the end of seven days Y returns either articles or
cash. It is simply the case that X cannot specify which; that
choice lies with Y. X’s asset does not therefore fall naturally
under either of the headings ‘stocks’ or ‘trade debtors’. It is a
hybrid of the two, and X does not control its make-up. (For
convenience, this asset is referred to below as X’s ‘either/or’
asset.)
4.38 Now that X’s asset has been identified, it is helpful briefly
to step aside from a historical cost framework and to consider
how the either/or asset’s fair value is related both to the fair
values of unsold articles and to the selling price agreed with Y.57
If the selling price agreed with Y is the fair value of the articles,
the future cash flows to be discounted will be the same for:
•
unsold articles
•
the either/or asset
•
debtors in respect of articles sold.
4.39 What will vary is the extent to which risk is associated
with those cash flows. The following table illustrates some of
those risks (but does not claim to be comprehensive).
57 This discussion takes the same broad approach to measurement as the current value approach
discussed in Chapter 1. In other words, it focuses on the future cash flows expected to be associated with
an asset and, in particular, on the risks associated with those cash flows.

REVENUE RECOGNITION
Asset held:
Expected future cash flows to be
adjusted for:
Debtors in respect of
articles sold
Credit risk (including default risk and
the risk that payment will not be
received on time)
Unsold articles
Credit risk (as above), plus
Selling/performance risk (including the
risk that articles will be sold for a price
other than that expected and the risk
that sales will not occur when forecast,
or at all)
4.40 Where does the fair value of the either/or asset fall? It can
be seen that, broadly speaking, it depends on the proportion of
articles expected to be returned. In particular,
•
if almost all of the articles are expected to be returned,
the fair value will tend to be close to that of unsold
articles,58 whereas
•
if very few of the articles are expected to be returned,
the fair value will tend to be close to that of debtors in
respect of articles sold.
4.41 Thus if assets were being measured on the fair value basis
described above, then gains (or perhaps losses) might in principle
be recognised on entering into any transaction of the type
described in paragraph .. Moreover, the extent of the gain or
loss would depend on the likelihood that articles would be
returned.
58 It could in principle be lower, because all the time that Y is holding the articles, X will be unable to
sell them to someone else. If in fact there is more chance that X will sell the articles by keeping them in
stock, then X could make a loss (in fair value terms) by transferring them to Y. However, it seems
rather unlikely that X would in that case enter into the transaction described.

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
4.42 Of course, the fact that gains or losses might in principle
be recognised does not indicate whether revenue should be
recognised. But it is now possible to ask what effect the
existence of customer return options has in the context of the
discussion of revenue and unexpired risk under paragraph ..
The discussion notes that under historical cost accounting the
point of revenue recognition broadly corresponds, for businesses
in general, to the point at which the risks associated with future
cash flows have been substantially eliminated (ie reduced to an
acceptable level). The way that historical cost accounting has
evolved suggests that credit risk is generally seen as sufficiently
low to be ‘acceptable’, but that selling/performance risk is
generally seen as too high.
4.43 As noted in paragraph ., the degree of risk remaining
where customer return options exist is related to the likelihood
that those options will be exercised. Broadly speaking, where
most return options are not exercised (as in the clothing retailer
example), the degree of risk remaining for the seller is only
slightly higher than credit risk; thus it might reasonably be
argued that risks have been substantially eliminated. In contrast,
where the level of returns is expected to be significant, the
degree of risk remaining for the seller is much higher; a
significant element of selling/performance risk may remain.
Thus it might reasonably be argued that risks have not yet been
substantially eliminated.
4.44 If the view described above is taken, it suggests that where
customer return options exist no general statement can be made
about when risks will have been substantially eliminated.
Rather, the degree of risk associated with those options will be a
relevant factor.

REVENUE RECOGNITION
Three possible approaches
4.45 The preceding discussion has illustrated the difficulties that
arise when dealing with customer return options in a historical
cost framework. This final section discusses three possible
approaches that could be taken, under the headings of:
(a)
a threshold approach,
(b)
an expected sale approach, and
(c)
an accounting policy approach.
(a) A threshold approach
4.46 This approach has already been discussed under
paragraph .. As explained earlier, it would involve specifying
a threshold at which sales are distinguished from loans. Thus if
the threshold was set at  per cent, say, a company supplying
goods with a customer return option would record a sale (and a
return provision) if the expected level of returns was less than
 per cent, but would record a loan if it was more than  per
cent. 59
4.47 This approach would maintain present accounting practice
for the clothing retailer and wine merchant examples described
earlier in this chapter. It also has the advantage of consistency
between entities, in that all entities would apply the same criteria
(which would not be the case for approach (c) described below).
Nevertheless it has significant disadvantages, as described under
paragraph .. In particular, where an entity’s expected level of
returns was close to the threshold, there would be a lack of
consistency in reporting very similar transactions, and the
approach might also give scope for manipulating reported sales.
59 The choice of 20 per cent in this example is for illustration only, and should not be taken to imply
that this is necessarily thought an appropriate level.

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
4.48 On balance, therefore, the Paper does not favour this
approach.
(b) An expected sale approach
4.49 A second option is to require the ‘sale with an option to
return’ treatment (as described in Appendix III to   and in
the clothing retailer example in paragraph .) to be applied in
all circumstances. Thus, in the wine merchant example, the
wine merchant would provide for the amount of cash likely to
be refunded for glass returns and would treat the balance as a sale
of the proportion of glasses not expected to be returned.
4.50 Like approach (a), this has the advantage that all entities
would apply the same criteria. It also has the benefit that it seeks
to reflect the fair values of the assets and liabilities resulting from
the initial exchange.
4.51 On the other hand, the approach would probably represent
a change to present accounting practice. In addition, some may
dislike the fact that under this approach an entity may book
‘sales’ that are subsequently reversed. This is of course already
the case for the clothing retailer accounting under  , in that
the level of returns may be higher than forecast. Nevertheless, to
apply this approach in situations where the expected level of
returns is both relatively high and relatively uncertain increases
the risk that a subsequent ‘reversal of sales’ may be significant
when compared with the level of sales originally booked.

REVENUE RECOGNITION
(c) An accounting policy approach
4.52 A third approach is to permit two different accounting
policies: sales could be recognised either on initial exchange (as
for the clothing retailer) or on exercise/lapse of the customer
option (as for the wine merchant). Entities would then be
required to assess which of these policies was most appropriate to
their particular circumstances, and to apply that policy
consistently to all similar transactions.60 The expected level of
returns would be a very significant factor in determining the
appropriate policy and it seems likely that, in practice, the choice
would often be clear-cut.
4.53 This approach would allow present accounting practice to
be maintained in the clothing retailer and wine merchant
examples described earlier in this chapter. It does not, however,
have the disadvantages associated with a threshold approach.
4.54 The main risk with approach (c) is that different entities
with similar transactions might choose different policies, thus
reducing comparability. However, this risk should be largely
mitigated if entities give due weight to the objective of
comparability when making that choice, as required by  .61
Choosing between these three approaches
4.55 This Paper does not favour approach (a), for the reasons
already set out above. However, approaches (b) and (c) both
appear to have merits, and this Paper does not favour one over
the other. Thus the Board would particularly welcome views on
which of the following approaches is thought more appropriate.
60 Where an entity had two different types of transaction, with different characteristics, it might be
necessary to choose a different policy for each.
61 FRS 18 requires entities to adopt, from the range of acceptable accounting policies, those most
appropriate to their particular circumstances, based on objectives of relevance, reliability, comparability
and understandability. The standard notes that, in selecting accounting policies, an entity will assess
whether accepted industry practices are appropriate to its particular circumstances.

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
Expected sale approach:
Where goods are transferred along with a right of return,
revenue should be recognised on the transfer of benefit, with
an appropriate adjustment to reflect the risk of returns.
Accounting policy approach:
Where goods are transferred along with a right of return, an
entity should select and consistently apply whichever of the
following accounting policies is most appropriate to its
circumstances:
•
either revenue should be recognised on the transfer of
benefit, with an appropriate adjustment to reflect the risk
of returns
•
or revenue should be recognised on the expiry of the right
to return.
The most appropriate accounting policy should be judged by
reference to the objectives and constraints set out in  
‘Accounting Policies’, giving due weight to the objective of
comparability between entities operating within the same
industry.
Suppliers’ call options
4.56 The issues of principle surrounding suppliers’ rights to
require the return of goods supplied (suppliers’ call options) are
not as complex as those relating to customer options, discussed
above. Nevertheless, care is required when analysing suppliers’
call options, for the reasons considered below.

REVENUE RECOGNITION
4.57 At the outset, it is worth noting an important difference
between suppliers’ call options in a revenue context and in the
context of financial instruments. In a revenue context, a
supplier’s right to demand the return of an item supplied is
generally specific to the thing sold.62 This need not, however, be
the case in a financial instruments context. For example, a call
option over a share in a listed company can generally be satisfied
by buying the appropriate type of share in the market; it is not
necessary to return the same share as was originally transferred,
because all shares of the same class are identical.
4.58 It is also helpful to adopt some terminology to distinguish
between different types of call option. Accordingly, for the
purposes of the discussion below:
•
a call option is described as ‘unconditional’ if the
supplier is entitled to exercise it irrespective of whether
certain conditions are met
•
a call option is described as ‘conditional’ if the supplier
is entitled to exercise it only if certain conditions are
met
•
a call option is described as ‘fixed’ if, at the time the
option is created, the assets to which it will apply can
be known with certainty
•
a call option is described as ‘determinable’ if, at the
time the option is created, the assets to which it will
apply will not be known until some later determining
event occurs.
62 and for this reason, it will be assumed to be specific to the thing sold throughout the discussion in
this section.

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
Unconditional fixed call options
4.59 An item of property, such as a car, is for accounting
purposes seen as consisting of rights or other access to future
economic benefits. Where an entity has custody of an item of
property, however, it does not follow that it has rights or other
access to all—or even any—of the economic benefits inherent in
that property.
4.60 Consider a car on short-term hire. The customer may be
severely restricted in terms of the future economic benefits to
which he has access. Generally, he will be able, under the terms
of the lease, neither to sell the car to someone else nor to carry
on using it beyond the agreed hire period, and he may also be
restricted in how he uses the car during the hire period. In these
circumstances, it would be wrong to say that the customer has an
asset of the car; rather, the customer’s asset is restricted to certain
of the future economic benefits inherent in the car.
4.61 Similarly, where a supplier has an unconditional fixed call
option over part of an item of property, the effect of the option is
to restrict the receiving party’s access to some of the benefits
inherent in the item.63 Thus, if the short-term hire agreement
described above had instead taken the legal form of a sale, giving
both supplier and customer the unconditional right to insist on a
repurchase after a specified period, the customer would not at
the outset have an asset of the car. Rather, the customer’s asset
would be the right to use the car for that specified period. By
the same logic, therefore, the supplier would not have disposed
of the car, but would have disposed only of the right to use the
car for that specified period.
63 unless either (i) there is no realistic prospect that the option will be exercised or (ii) any penalties
payable by the receiving party would be insufficient to compel it to honour the option if exercised. For
the purposes of the discussion in this section, these exceptions are assumed not to apply.

REVENUE RECOGNITION
4.62 Thus, where a supplier has an unconditional fixed call
option over part of a non-fungible item of property passed to
another party, and thereby denies that party access to the
associated future economic benefits, that part of the item remains
the supplier’s asset and has not, therefore, been sold.
Other supplier call options
4.63 Other supplier call options may not be so straightforward,
as shown by the examples below.
•
A manufacturer may supply goods to a dealer on a sale
or return basis, with the manufacturer retaining a
conditional call option over the goods. If to exercise
the call option the supplier must first offer the dealer
unconditional rights to the goods, it may be argued
that this negates the effect of the call option—because
the dealer’s access to the future economic benefits in
the goods is not restricted.
•
Similarly, the manufacturer may have a call option over
any goods that have been neither sold nor otherwise
disposed of by the dealer at a specified date. The
subject of the option is determinable rather than fixed,
because it will not be possible to know at the outset
which goods will remain. Moreover, the subject of the
option is largely determinable by the dealer rather than
the manufacturer; the dealer, rather than the
manufacturer, has the ability to determine whether
goods are sold or otherwise disposed of. In this case,
therefore, the dealer’s access to future economic benefits
is restricted (in that it cannot choose to hold the goods
beyond the specified date), but this restriction may be
of little significance if, for example, the dealer is likely
to have sold the goods by then anyway.

CHAPTER 4: RIGHTS OF RETURN AND POST-PERFORMANCE OPTIONS
4.64 To sum up, in a revenue context the effect of a supplier
retaining a call option is to restr ict what has been sold.
However, care is needed when determining the effect of such a
restriction, particularly where a supplier’s call option is either
conditional or determinable, as is illustrated above.

REVENUE RECOGNITION
Chapter 5
Measuring consideration
Summary
5.1 Whereas earlier chapters have been concerned primarily
with the recognition of revenue, this chapter first considers the
general principles of how revenue should be measured, and then
discusses particular measurement issues under the headings of:
•
reliable measurement
•
consideration that is determinable rather than fixed
•
barter transactions.
5.2 The main proposals discussed in this chapter are set out
below.
Revenue should be measured as the change in fair value,
arising from the seller’s performance, of (i) assets representing
rights or other access to consideration and (ii) liabilities in
respect of consideration received in advance of performance.
Assets representing rights or other access to consideration
should be remeasured to reflect the effect of the time value of
money, where this effect is significant. Such remeasurement
does not arise from performance and does not, therefore, give
rise to revenue.

CHAPTER 5: MEASURING CONSIDERATION
Liabilities in respect of consideration received in advance of
performance should not be remeasured to reflect changes in
the fair value of performance that has not yet occurred. They
should, however, be remeasured to reflect the effect of the time
value of money, where this effect is significant. Such
remeasurement does not arise from performance and does not,
therefore, give rise to revenue.
A transaction is with a customer—and hence gives rise to
revenue—if, on its completion, the entity has been rewarded
for eliminating the risks previously outstanding in the relevant
operating cycle.
General principles for measuring revenue
5.3 Earlier chapters have discussed how revenue arises as part
of a process of exchange with a customer, with revenue being
the class of gains arising under a contract as a result of a seller’s
performance. In a very simple example, the process of exchange
can be nearly instantaneous; for example, a newsagent hands over
a newspaper and immediately receives cash in return.
5.4 In such a straightforward example, the appropriate measure
of revenue is obvious—it is the value of the cash received. The
seller’s contractual performance gives rise to an asset, namely
cash, and revenue is the gain, before deduction of associated
costs, arising from recognition of that asset.
5.5 The measurement of revenue, and of the assets and
liabilities arising from the contract, can be more difficult where
exchange is not instantaneous. Accordingly, the discussion
below considers together the measurement of revenue and the
measurement of related assets and liabilities.

REVENUE RECOGNITION
Benefits transferred or consideration accruing?
5.6 When a transaction at fair value is entered into, it is to be
expected that the fair value of goods or services to be supplied
will be the same as the fair value of consideration receivable. But
if there is a delay between entering into the contract and its
performance, these values may move out of line with each other
because of changing prices. It is therefore fundamental to ask
which aspect of the exchange revenue is measuring: the benefit
being transferred to the customer, or the consideration accruing
to the seller as a result of that performance.
5.7
This issue is perhaps best illustrated with an example.
Example 5.7: measuring revenue
Suppose that a company contracts to supply services in
exchange for consideration of £, being the fair value of
those services at the time. However, in the interval between
entering into the contract and its performance, the normal
selling price for those services (which is the same as fair value)
falls to £.
From a purely arithmetical point of view, there are two
different ways in which the revenue side of the transaction
might be presented in the profit and loss account:
•
revenue might be presented as £ (the fair value of the
consideration)
•
revenue might be presented as £ (the fair value of the
services), with a separate gain of £ recorded in relation
to the executory contract.

CHAPTER 5: MEASURING CONSIDERATION
Which of these is correct?
Another way of expressing exactly the same issue is to focus on
the balance sheet. Suppose the consideration of £ was
received at the outset, giving rise to a liability of that amount.
Will that liability change in value in the interval between
formation and performance? The answer seems to depend on
precisely what the liability is seen as representing:
•
if it is a liability to refund amounts paid in advance (‘on
deposit against future performance’) then it will remain at
£ (except for effects due to the time value of money,
which are discussed under paragraph . below)
•
if it is a liability to provide specified services, then
presumably its value will change (to £) with the fair
value of those services.
5.8 This Paper favours the view that revenue reflects the
amount to which a seller becomes entitled under a contract as a result
of performance, rather than the fair value of that performance.
Certainly this view is more consistent with the natural meaning
of ‘revenue’; as noted in Chapter , dictionary definitions have a
clear implication that revenue is ‘something coming into a
business from outside’. In addition, this view seems more
consistent with the whole focus on exchange, discussed earlier in
the Paper, in that the alternative view seems implicitly to assume
that exchange has already occurred.

REVENUE RECOGNITION
5.9 It follows from this that a payment in advance by a
customer gives rise to a liability in respect of the amount received,
rather than in respect of the goods or services to be provided.
That liability will generally be extinguished by subsequent
performance, but will not be remeasured for changing prices of
goods or services in the interval before performance occurs.64
General principles for revenue measurement
5.10 In the light of the preceding discussion, proposals for
measuring revenue can now be set out.
Revenue should be measured as the change in fair value,
arising from the seller’s performance, of (i) assets representing
rights or other access to consideration and (ii) liabilities in
respect of consideration received in advance of performance.
5.11 These proposals are developed further below. Some of
their implications are discussed in later sections of this chapter.
Fair value of rights or other access to consideration
5.12 Contracts will usually specify, at least in broad terms, when
payments are to be made by a customer. Often, as in many
construction contracts, those payments will be timed to coincide
with performance, but this need not be the case; payments may
fall entirely before or after performance.
64 Of course, a contract may specify that consideration is to be denominated in a currency other than the
seller’s reporting currency; for example, an entity reporting in sterling may enter into a contract to sell a
product for US$10,000. In this situation, any payment in advance will give rise to a monetary
liability denominated in a foreign currency. Although that liability will not be remeasured in dollar
terms, the sterling amount to which it is translated will need to be remeasured in order to be kept up to
date for changes in the exchange rate.

CHAPTER 5: MEASURING CONSIDERATION
5.13 Rights or other access to consideration are not restricted to,
and should not be confused with, a seller’s rights to raise invoices
in accordance with a contract-specified payment schedule. The
latter will reflect only the agreed timing of payment, whereas this
Paper proposes that the former should arise as benefit accrues to a
customer through a seller’s contractual performance. Where a
contract allows invoices to be raised only on full performance, but
a seller’s incomplete performance has resulted in benefit accruing
to a customer, the bridge between revenue and invoice will be an
asset of accrued income.
5.14 Accrued income does not represent a contractual right to
demand payment from a customer. Seller and customer are free
to agree whatever payment schedule they wish, and to allow this
to dictate the recognition of revenue would lead to a lack of
comparability and allow wide discretion over reporting revenues.
Rather, in accordance with this Paper’s principles, accrued
income is a measure of the extent to which performance has
occurred in advance of contractual rights to payment. It may
therefore be better understood as a conditional right to payment
from a customer,65 but—importantly—for benefits that have
already been transferred.
5.15 Where there is a significant interval between performance
and a customer being required to pay, the contract pricing will in
principle reflect not only the fair value of benefits transferred but
also the time value of money. Thus, where the effect of the time
value of money is significant, this should be taken into account
in measuring rights or other access to consideration and, hence,
revenue.
65 It will most often be conditional on further performance under the contract.

REVENUE RECOGNITION
5.16 Accordingly, the following principle is proposed.
Assets representing rights or other access to consideration
should be remeasured to reflect the effect of the time value of
money, where this effect is significant. Such remeasurement
does not arise from performance and does not, therefore, give
rise to revenue.
Fair value of liabilities where consideration is received in advance of
performance
5.17 As explained under paragraph ., the approach to revenue
proposed in this Paper means that liabilities for customer
payments in advance will not be remeasured for changing prices;
rather, they will generally be released when performance occurs.
Nevertheless, a customer paying significantly in advance of
performance should be able to negotiate a lower price than
would have been payable at the time of performance, because of
the time value of money. It would seem wrong to ignore this
effect when accounting for revenue.
5.18 Accordingly, the following principles are proposed.
Liabilities in respect of consideration received in advance of
performance should not be remeasured to reflect changes in
the fair value of performance that has not yet occurred. They
should, however, be remeasured to reflect the effect of the time
value of money, where this effect is significant. Such
remeasurement does not arise from performance and does not,
therefore, give rise to revenue.

CHAPTER 5: MEASURING CONSIDERATION
Reliable measurement
5.19 The discussion above and in earlier chapters has concluded
that a seller should recognise revenue as a result of performing its
contractual promises. However, like other assets and liabilities,
assets and liabilities relating to consideration will be recognised in
financial statements only if they can be measured with sufficient
reliability.
5.20 At this point, it is worth noting paragraph . of the
Statement of Principles, which suggests that, where measurement
uncertainty exists, there will in almost all cases be a minimum
amount for an asset or liability that is reasonably assured.
Therefore, it will be very rare for measurement uncertainty to be
so significant as to prevent the recognition of revenue. Rather,
an asset relating to consideration will be stated at no less than the
minimum amount (which in some cases may be nil), with a
higher amount being used if that is a better estimate.
Consideration that is determinable rather than fixed
5.21 For a contract to be effective, there must be agreement
between the seller and the customer concer ning the
consideration. Usually, a contract will specify a fixed price, but
this is not always necessary. For example, fees for professional
services are sometimes agreed by specifying that the hours
worked—which may be highly uncertain—will be charged at
particular rates. The important point is that the amount of the
consideration is determinable.
5.22 In principle, there is nothing to prevent the seller and
customer agreeing that the consideration shall be whatever one
of the parties subsequently decides. However, such an
agreement exposes the other party to significant risk. It is more
common, therefore, where consideration is not a fixed amount,
for the parties to have less discretion than this.

REVENUE RECOGNITION
5.23 If consideration is to be determinable, it follows that a
contract must specify what is to determine it. For the purposes
of the following discussion, the determining factor or factors
specified can be divided into three classes:
•
determining factors that are within the control of
neither seller nor customer
•
determining factors that are within the control of the
seller
•
determining factors that are within the control of the
customer.
Determining factors within the control of neither seller nor
customer
5.24 The following paragraphs discuss how to measure revenue
where the amount of consideration is uncertain, but will be
determined by factors that are external to the seller and the
customer. At the outset, it is worth emphasising that the degree
of uncertainty might be very small or very large. For example, if
the consideration is to be a fixed amount adjusted by reference to
an index, such as the retail price index, the degree of uncertainty
may be relatively small. On the other hand, the consideration
might be ‘all or nothing’ depending on whether a particular
event 66 occurs, in which case the degree of uncertainty may be
very large—particularly if the two possible outcomes are roughly
equally likely.
5.25 Three possible approaches are discussed below.
66 that is not under the control of either the seller or the customer.

CHAPTER 5: MEASURING CONSIDERATION
Approach (1): defer revenue recognition until the amount is determined
(the ‘deferral’ approach)
5.26 One approach is to wait until the amount payable is
determined before recognising a consideration asset. In effect,
this is to recognise revenue not on performance but rather when
the amount payable is determined (for convenience, this is called
the ‘determining event’ below).
5.27 However, such an approach does not seem to cope well
where only a little uncertainty exists (eg the retail price index
example in paragraph .). In addition, it is inconsistent in
principle with the arguments expressed earlier in this Paper; once
a seller has fully performed its contractual promises, it is entitled
to receive the consideration specified in the contract. This is no
less true where the amount specified in the contract is
determinable rather than fixed, even if it has not yet been
determined. The seller is entitled to whatever that amount turns
out to be. In other words, the seller has a consideration asset and,
although there is uncertainty over the amount at which that asset
should be measured, there is no uncertainty over its existence.
5.28 If full performance occurs before the determining event,
and if reliable measurement is possible at the time of full
performance,67 then the ‘deferral’ approach will result in revenue
being recognised later than it should be. Accordingly, the Paper
rejects this approach.
5.29 Unlike the ‘defer ral’ approach, the two remaining
approaches (which are discussed below) both acknowledge that
once the seller has fully performed it is entitled to receive
consideration. However, they differ in the extent to which they
would reflect that entitlement as an asset. To illustrate how these
approaches work, it may be helpful to refer to an example.
67 As noted in paragraph 5.20, based on discussion in the Statement of Principles, it will be very rare
for measurement uncertainty to prevent the recognition of consideration.

REVENUE RECOGNITION
Example 5.29: determinable consideration
Suppose that a seller has fully performed under a contract and
as a result is entitled to receive consideration. That
consideration will be determined by a future event outside the
control of the seller and the customer. There are four possible
outcomes,68 and their associated probabilities are as follows:
Outcome
Probability
Consideration
I
1%
£1,000
II
9%
£10,000
III
10%
£20,000
IV
80%
£50,000
100%
In this example, the most likely outcome is that the seller will
receive £,, but there is a one in five chance that the
amount received will be less than this. Nevertheless, the seller
is certain to receive at least £, and  per cent certain to
receive at least £,.
68 This example is of course artificial, but its aim is to illustrate the underlying principles. For the sake
of simplicity, it is assumed that consideration will be received in the near future, so that the effect of the
time value of money is not significant.

CHAPTER 5: MEASURING CONSIDERATION
Approach (2): recognise whatever element of consideration is virtually
certain (the ‘virtually certain’ approach)
5.30 This approach is similar to the approach taken to the
recognition of contingent assets in  .69 Under the ‘virtually
certain’ approach, the seller would recognise consideration only
to the extent that it is virtually certain to be received.
5.31 If this approach is applied to the example, consideration of
either £, or £, will probably be recorded, depending
on whether the threshold corresponding to ‘virtual certainty’ is
judged to be above or below  per cent (the probability that at
least £, will be received).
Approach (3): recognise a fair value for the consideration asset (the ‘fair
value’ approach)
5.32 Under this approach, the consideration asset would be
measured on recognition at fair value. It might sometimes be
possible to measure this fair value directly (if, for example, the
consideration is linked directly to a quoted index or share price).
Otherwise, fair value would be determined by reference to
expected future cash flows, discounted so as to take account of
associated risks.
5.33 In the example, the fair value cannot be determined
directly. The weighted average of all possible outcomes is
approximately £,, but the fair value will be less than this
because it will reflect risk. Nevertheless, fair value will exceed
the figure that is judged ‘virtually certain’, probably by a
significant amount.
69 FRS 12 defines a contingent asset in terms of uncertainty over its existence rather than over the
amount at which it should be measured. Technically, therefore, a consideration asset is not within the
FRS 12 definition of a contingent asset because, although the amount of consideration is uncertain, the
existence of the consideration asset is not.

REVENUE RECOGNITION
Advantages and disadvantages of the ‘virtually certain’ and ‘fair value’
approaches
5.34 Some may be attracted to the ‘virtually certain’ approach
because under that approach it is always virtually certain that the
amount of consideration actually received will not fall short of
the amount recorded. By contrast, although the fair value will
reflect the risk of variation in outcome, there will be more
chance under the ‘fair value’ approach that consideration may
need to be adjusted downwards.
5.35 However, this is not a particularly powerful criticism of the
‘fair value’ approach, because consideration is likely to need
subsequent adjustment under both approaches (in that the
estimate made at the outset will usually differ from the amount
subsequently received). On the other hand, there are two quite
strong criticisms of the ‘virtually certain’ approach, which
suggest that it could often produce results that are misleading.
5.36 The first criticism is that the ‘virtually certain’ approach
acknowledges no possibility that the seller may be able to close
out some or all of the risks associated with fair value. For
example, suppose that a seller of goods will receive consideration
in one month’s time, equal to the value at that time of a specified
number of shares in a quoted company. The fair value of that
consideration at present will be very close to whatever is the
present quoted price for that number of shares—say, £,.
Moreover, irrespective of how volatile the share price is, the
seller can close out the risks of variation by ‘going short’ in the
shares; in effect, the seller freezes the consideration at its present
fair value of £,. However, under the ‘virtually certain’
approach the seller might find it very difficult to estimate an
amount below which the share price would be virtually certain
not to fall, particularly if the price is volatile.

CHAPTER 5: MEASURING CONSIDERATION
5.37 The second criticism of the ‘virtually certain’ approach
stems from the first. If the seller in the above example knows
that it can close out the risks of variation in share price, this will
influence its agreement with the buyer over the consideration.
For example, the goods being sold in the preceding paragraph’s
example might have cost the seller £,, resulting in a profit of
£, which can be frozen by going short in the shares. Under
the ‘virtually certain’ approach, however, unless the seller can be
virtually certain that the share price will stay above £,—
which may be very unlikely—the seller will report a loss that
need not in fact be incurred.
5.38 Although these criticisms are particularly powerful where
consideration is linked directly to a quoted index or share price,
they point up a more general failing inherent in the ‘virtually
certain’ approach. A seller is not compelled to enter into a
contract with determinable rather than fixed consideration: even
where determinable consideration is the norm for a particular
transaction, a customer should rationally be prepared to agree to
a fixed price if that price is set appropriately. Therefore, a seller
should take on the r isks associated with deter minable
consideration only if it is rational to do so. The ‘virtually
certain’ approach distorts the economic reality by reducing the
‘real’ gain associated with the seller’s perfor mance and,
conversely, by pretending that any subsequent upside associated
with the determinable consideration comes at no cost. By
contrast, the ‘fair value’ approach better depicts the underlying
economic position.
5.39 For these reasons, this Paper favours the ‘fair value’
approach. When, as a result of contractual performance, a seller
becomes entitled to receive an uncertain amount of
consideration, to be determined by factors outside the control of
both the seller and the customer, the consideration asset arising
should be recorded at its fair value.

REVENUE RECOGNITION
Determining factors within the control of the seller
5.40 The second category to consider is where consideration
will be determined by factors within the control of the seller.
Before going further, however, it is worth clarifying the position
where the parties to a contract do not specify how a price is to
be determined. In effect, for such a contract to be valid, it must
have an implied term that the price is to be fair; otherwise, there
is no valid contract. The effect of the implied term is that
consideration is not determinable but rather is fixed at whatever
that fair price should be.70 Accordingly, such situations do not
fall into this second category.
5.41 The aspect of perfor mance used to deter mine
consideration is usually time of completion. This is common in
construction contracts, where the price that the seller will
receive often depends on when work is completed. The
different outcomes may be characterised as penalties for late
completion and/or bonuses for early completion; nevertheless,
from the seller’s point of view, some work is to be done and the
consideration to be received will depend on when it is
completed.
5.42 Where consideration depends on when performance is
completed, the accounting issue that arises is how to measure the
amount of consideration to be recognised when performance is
incomplete. Once again, it may be helpful to refer to an
example.
70 In practice, of course, the ‘fair price’ may be arrived at by subsequent negotiation between the parties.

CHAPTER 5: MEASURING CONSIDERATION
Example 5.42: construction of a hospital
A company is constructing a new hospital. The first stage of
work is now complete, and it has been determined that the
value to date of the work represents  per cent of the total
contract value. However, the amount that will be payable for
the hospital as a whole will depend on when it is completed: 71
Date of completion
Consideration
Before 30 September 2001
£45 million
1-31 October 2001
£40 million
After 31 October 2001
Subtract £500,000 for
each extra day
5.43 Several different approaches might be taken, and these are
considered below.
(a)
‘Contract price’: the amount of consideration to be
recognised should be based on the ‘contract price’.
Bonuses for early completion should be recognised only if
and when early completion is achieved; similarly, penalties
for late completion should be recognised only to the
extent that they become unavoidable.
(b)
‘Best outcome’: since the time of completion is within the
builder’s control, the amount of consideration to be
recognised should be based on the best outcome that the
builder can achieve. If the builder subsequently fails to meet
this timetable, the losses associated with that failure should
be reported in the periods in which the failure occurs.
71 Once again, a somewhat artificial example has been chosen in order to illustrate the principles
involved. For simplicity, assume that no stage payments are made and, hence, that such payments
cannot be used to estimate the value of the consideration asset.

REVENUE RECOGNITION
(c)
‘Worst outcome’: the amount of consideration to be
recognised should be based on the lowest amount that is
virtually certain to be received. Any excess over this
amount is achieved only when the builder performs better
than this, and should be reported at that time.
(d)
‘Fair estimate’: the amount of consideration to be
recognised should be arrived at by reviewing the various
possible outcomes, assessing the most likely and adjusting it
for the risk of variations from it.
5.44 The ‘contract price’ approach is unsatisfactory because
contracts that are economically identical may be drafted in
different ways and would then lead to different amounts of
revenue being reported. In the example, the ‘contract price’
might have been specified as £ million, with a bonus of
£ million for early completion and penalties of £, per
day for late completion. However, the ‘contract price’ might
equally have been specified as £ million, with penalties of
£ million for the first  days of late completion and £,
per day after that.
5.45 Most will probably find the ‘best outcome’ approach
unattractive in that it involves recognising consideration that will
very often subsequently be written back and, as such, seems both
biased and imprudent. However, it is also based on questionable
logic. Just because the builder has the ability to control the
outcome, it does not follow that it will necessarily choose to
exercise control so as to achieve the highest amount of
consideration; for example, it may be that the incremental costs
associated with early completion exceed the incremental
revenues.

CHAPTER 5: MEASURING CONSIDERATION
5.46 At the other extreme, the ‘worst outcome’ approach is also
unattractive. There is always some risk associated with contracts
and, accordingly, there may be relatively few in respect of which
it is virtually certain that no loss can arise. Under the ‘worst
outcome’ approach, it seems likely that losses would be reported
on most incomplete contracts, even though it might be unlikely
that such losses would be sustained. (In the example, there is no
minimum amount of consideration specified; the penalties are
open-ended.)
5.47 Consequently, the ‘fair estimate’ approach seems to lead to
the most appropriate accounting. To arrive at a fair value for the
consideration asset to be recognised in respect of performance to
date, the builder should first realistically assess when the
remaining performance is most likely to be completed. The
consideration associated with that timescale then represents the
most likely outcome for the contract as a whole, but this needs
to be adjusted to reflect any risk that the actual outcome will be
different. The consideration asset to be recognised for
incomplete performance is then derived from this risk-adjusted,
most likely outcome.
5.48 This can be illustrated by reference to the example.
Suppose that the builder’s best estimate is that the work will be
finished on or around  October. In that case, the most likely
consideration is £ million. The builder then needs to assess
the effect on this amount of any delay in completion. If the
builder thinks it unlikely that any delay beyond  October will
be more than  days, then the amount of £ million could be
reduced by up to £ million (four days beyond  October at
£, per day). Therefore the r isk-adjusted total
consideration will probably lie somewhere between £ million
and £ million; since in the example the work is  per cent
complete, the amount to be recognised will lie between
£ million and £ million.

REVENUE RECOGNITION
Determining factors within the control of the customer
5.49 The final category to examine is where consideration will
be determined by factors within the control of the customer.
For the purposes of the following discussion, such consideration
can be seen as consisting of two elements: a fixed element, which
is the minimum that is certain to be paid (but which may be nil),
and a further variable element. Accounting for the former is
relatively straightforward. Following the principles discussed
elsewhere in this Paper, the fixed element of consideration will
be reflected as revenue when the seller performs the contractual
promises to which it relates.72
5.50 As regards the variable element, the position is more
difficult. From an   perspective, the customer has no
obligation in respect of any variable element (which may be the
entire fee) until he becomes committed to paying it. Some
might suggest therefore that no revenue should be recognised in
respect of the variable element until such time as the customer
ceases to control the amount, if any, that will be paid. However,
this would not necessarily be consistent with Chapter , which
suggests that revenue recognition is sometimes possible in
circumstances where the customer nevertheless still has the right
not to proceed. Moreover, although the fair value of a
consideration asset relating to a variable element may sometimes
be small, it will not be zero; the seller is better off with such an
asset than without it.
72 As discussed in Chapter 3, revenue will be recognised for some contracts only on full performance.
When dealing with consideration to be determined by factors within the control of a customer, particular
care should be taken to ensure that revenue is recognised only to the extent that performance has already
occurred.

CHAPTER 5: MEASURING CONSIDERATION
5.51 The discussion in Chapter  suggests that, where
performance by a seller has taken place but the customer still has
discretion over whether to proceed, the likelihood of
consideration being received is relevant in determining the
treatment. In some circumstances it may be very likely that the
customer will proceed; in others, there may be much
uncertainty. Chapter  favours one of two possible approaches to
such situations:
•
an expected sale approach (discussed under
paragraph .)
•
an accounting policy approach (discussed under
paragraph .).
5.52 It therefore seems sensible to consider similar approaches
where, following performance by a seller, factors determining
the amount of consideration remain within the control of a
customer. The Board would again particularly welcome views
on which approach is the more appropriate.
Barter transactions
5.53 Although the consideration receivable by a seller is usually
cash, entities sometimes enter into barter transactions, where the
consideration receivable is something other than cash—for
example, the right to receive goods or services.
5.54 Two particular issues of pr inciple ar ise with barter
transactions and are discussed below:
•
should they be treated as giving rise to revenue?
•
how is consideration to be measured?

REVENUE RECOGNITION
Should barter transactions be treated as giving rise to revenue?
5.55 If a gas producer wishes to buy steel and a steel producer
wishes to buy gas, they may enter into separate transactions with
one another for cash. In such circumstances, each will record
revenue as a result of the transaction. Equally, however, they
might agree to swap gas for steel. From a legal perspective, this
may raise a question of whether any profit arising from the barter
transaction can be regarded as realised; nevertheless, there seems
no reason in principle to account differently depending on
whether there is legally one transaction or two.
5.56 On the other hand, suppose two gas producers enter into a
transaction. One has surplus gas stocks in North America, but
needs gas in Europe; the other has surplus gas stocks in Europe,
but needs gas in North America. They therefore agree to swap
gas in one location for gas in the other. This may seem rather
less like a revenue transaction; in particular, it may seem more
akin to a transaction with a supplier—such as exchanging
unwanted goods for others—than a transaction with a customer.
5.57 The main difference between these examples lies in the
effect that each transaction has within the entities’ operating
cycles. In the first example, each entity has, as a result of the
transaction, reached the end of its operating cycle, in the sense
that it has been rewarded for eliminating risks previously
outstanding in that cycle. For both producers, a sale transaction
has simply been bundled with a purchase having nothing to do
with that operating cycle. This is not the case in the second
example; the position of both suppliers is substantially unchanged
as a result of the transaction.
5.58 The definition of revenue in Chapter  is linked to an idea
of business activities carried out with a view to profit, but it does
not focus on the nature of the consideration received from a

CHAPTER 5: MEASURING CONSIDERATION
customer. Thus, where a barter transaction involves a seller
providing goods or services that would, if sold for cash, give rise
to revenue, the fact that the consideration is other than cash need
not of itself prevent revenue from arising. Rather it will be
necessary to consider the substance of the transaction and, in
particular, its role in the entity’s relevant operating cycle—ie the
cycle that involves providing the goods or services in question.
5.59 Where the consideration receivable by a seller is not
directly connected with that operating cycle, the view supported
by this Paper is that revenue should arise. The consideration
receivable may be intended for general use in the entity’s
business—for example a fixed asset or consumable; it may be an
input to a different operating cycle; or it may be a surplus asset,
which the business will then seek to realise. Nevertheless, in all
such cases the transaction is in substance a revenue transaction, in
the sense that the seller has been rewarded for eliminating the
outstanding risks in its operating cycle: it has provided goods to a
customer and been rewarded for that activity.
5.60 The position is more difficult where the consideration
receivable by a seller is directly connected with its operating
cycle, because the substance of the transaction may be different.
•
Where a seller exchanges goods with a supplier or
competitor, and receives in return goods having a
similar role in its operating cycle, the transaction may
not put the entity in a substantially different position.
Afterwards, the entity continues to have goods on
which outstanding operating cycle risks have not been
eliminated. Moreover, because of the nature of the
other party involved, the transaction is unlikely to be
undertaken directly with a view to profit. Thus the
entity has neither eliminated risks nor been rewarded.

REVENUE RECOGNITION
•
Where a seller supplies goods in exchange for goods at
a later stage in its operating cycle, the transaction may
in substance be the outsourcing, or subcontracting, of
part of the seller’s production process. To take a
somewhat artificial example, a coffee supplier wishing
to outsource the manufacture of instant coffee from
coffee beans might also pay for that manufacturing
service with coffee beans. The transaction would then
be a barter transaction; the coffee supplier would
deliver beans to the other party, some would be
returned in the form of instant coffee, and others
would be retained as payment.
5.61 Nevertheless, transactions in which the consideration
receivable by a seller is directly connected with its operating
cycle may in some circumstances have the substance of revenue
transactions. This will most often be the case where the other
party does not have the same access to markets as the seller, and
will therefore be prepared to barter on terms more favourable to
the seller. For example, a dealer in second-hand compact discs
may be prepared to enter into a barter transaction with an
individual who has received a gift of unwanted compact discs.
That transaction may involve exchanging second-hand compact
discs for other second-hand compact discs, but the exchange will
take place only on terms favourable to the dealer. The dealer
will require a reward—an increase in the value of assets—just as
in a sale for cash.
5.62 Thus, where the consideration receivable in a barter
transaction is directly connected with the operating cycle in
question, it will be necessary, as illustrated above, to consider the
substance of the transaction in order to determine whether
revenue has arisen. In that light, the following development of
the definitions from Chapter  is proposed.
A transaction is with a customer—and hence gives rise to
revenue—if, on its completion, the entity has been rewarded
for eliminating the risks previously outstanding in the relevant
operating cycle.

CHAPTER 5: MEASURING CONSIDERATION
How is consideration in a barter transaction to be measured?
5.63 From the discussions earlier in this chapter, it seems
reasonable to conclude that consideration in a barter transaction
should be measured at fair value, just as it would be in a nonbarter transaction.
5.64 In principle at least, fair value may sometimes be easy to
assess. For example, where an entity receives as consideration
assets that it would otherwise have bought, it may be relatively
straightforward to determine the fair value by reference to the
price that would otherwise have been paid.
5.65 Rather more difficulty may arise however where, in the
absence of the associated sale transaction, the entity would not
have chosen to purchase the assets received as consideration.
This may be the case, for example, where trade with a third party
is subject to currency restrictions, so that consideration must be
other than in cash. If an entity supplies machinery and receives
shoes in return then, assuming it is not in the business of selling
shoes, it will upon supplying the machinery recognise revenue at
the fair value of the shoes it has received. However, in the
absence of a reliable external measure of that fair value, it may be
necessary to assess the amount for which it may be able to sell
the shoes and to discount this for associated risks, including
selling risk. When it subsequently disposes of the shoes, that
disposal may give rise to a gain but not to revenue, because the
sale of shoes is not part of an operating cycle for the entity.
UITF Abstract 26 ‘Barter transactions for advertising’
5.66 UITF Abstract  73 is concerned with the amount of
tur nover, and expense, that should be recognised when
advertising is exchanged in a barter transaction. It reflects the
consensus of the UITF that turnover and costs should not be
recognised unless there is persuasive evidence of the value at
which, if the advertising had not been exchanged, it would have
been sold for cash in a similar transaction.
73 issued on 9 November 2000.

REVENUE RECOGNITION
5.67 In the advertising exchanges considered in the Abstract,
each party will generally consume the benefits of the advertising
received, rather than selling the advertising space provided by the
other party on to someone else. In other words, although each
party will generally be in the business of selling its own
advertising space, it will not be in the business of selling others’
advertising space. Thus, in the context of the discussion above,
such exchanges will in principle give rise to revenue.
5.68 Nevertheless, although the Abstract discusses whether
revenue should be recognised, it may equally be seen as asking
what reliable evidence exists to support the value at which
revenue should be measured. Since advertising space expires
without value unless it is sold before the time at which it will be
used, an entity will rationally accept any amount, no matter how
small, in exchange for space that will not otherwise be sold. In
effect, therefore, the approach taken in the Abstract may be
reconciled to that proposed above by returning to a point made
earlier in this chapter. Paragraph . notes that, where
measurement uncertainty exists, revenue will be stated at no less
than the minimum amount that is assured (which in some cases
may be nil), with a higher amount being used if that is a better
estimate.

CHAPTER 6: OTHER ISSUES RELATING TO CONTRACTS AND PERFORMANCE
Chapter 6
Other issues relating to contracts
and performance
Summary
6.1 This chapter considers various other issues relating to
contracts and performance. In particular, it discusses:
•
pre-performance options
•
which activities constitute performance
•
‘two-way’ trading arrangements.
6.2 The main proposals discussed in this chapter are set out
below.
Where a customer pays for an option to require future
performance from a seller, that payment gives rise to a liability,
which should be released as revenue only when the future
performance to which it relates occurs. Because the number
of options that will lapse unexercised cannot be known with
certainty, the relationship between proceeds and performance
should be estimated at the outset, and estimates should be
revised over the period of performance.
An activity will constitute part of the performance of a
contract only if it is a necessary part of the contract, in that it is
specific to the customer and would not have taken place had
the contract not existed.

REVENUE RECOGNITION
Two contracts should be accounted for separately if they are
genuinely independent of one another, but should be treated as
one larger contract if, either legally or economically, one is
conditional or dependent on the other. Such economic
dependence may arise if, for example, contract prices are set so
far from fair value that there is no realistic prospect that the
second contract will not follow from the first.
Pre-performance options
6.3 Whereas Chapter  was concerned with options giving
either the customer or the seller the right to reverse a transaction
after performance has occurred, the following paragraphs are
concerned with options giving a customer the right to enter into
a transaction on particular terms.
6.4 Options ar ise in a number of different revenue
transactions, although they are not always explicitly so described.
For example, if a customer cannot yet decide whether to buy a
particular item, the seller may agree for a time not to sell it to
anyone else providing the customer pays a non-refundable
deposit. That deposit is in effect an option to purchase the
item.74
6.5 In the preceding example the customer paid for the
option, but that need not always be the case. A supermarket may
distribute money-off coupons that customers can use towards the
price of particular items; if so, those coupons may, in effect, also
be options to purchase those items at a reduced price.75 The
following paragraphs consider the appropriate accounting where
74 The term ‘layaway sales’ is used to describe some transactions meeting this description.
75 Though they may not be legally binding, as discussed under paragraph 6.21 below, and they may
not guarantee availability.

CHAPTER 6: OTHER ISSUES RELATING TO CONTRACTS AND PERFORMANCE
an entity issues options, first for consideration and secondly free
of charge. (Unless stated otherwise, the discussion assumes prices
are set so that the exercise of the option will not give rise to a
loss; for example, where money-off coupons are issued, the
product is still being sold for more than its previous carrying
value.)
Options granted in exchange for consideration
6.6 If a customer pays for an option to buy a product, this
gives rise to a contract under which the seller must supply the
product at the customer’s request. The seller has not yet
performed its potential obligations under that contract, and if it
subsequently failed to supply the specified product, the customer
would be entitled to a refund of the option price.76 Accordingly,
the option payment is not yet revenue, but instead gives rise to a
liability.77 It may be seen as equivalent to a payment in advance.
6.7 In a sense, this is the opposite of unbundling. Whereas the
discussion in Chapter  is concerned with whether a contract
may be broken down into smaller independent elements, the sale
of an option must be considered together with the further
contract to which it will give rise if exercised; the two are not
independent. Thus revenue from the sale of an option will
generally arise when the seller performs under the further
contract—ie supplies goods or services on exercise of the option.
76 Although the option payment/deposit is ‘non-refundable’, this usually means only that the customer
cannot subsequently cancel the contract and ask for a refund; it does not mean that there are no
circumstances in which a refund would have to be given. For example, a refund would certainly have to
be provided if the seller failed to honour its contractual promises.
77 Paragraph 6.10 below discusses how this liability is affected by expectations that options will lapse
unexercised.

REVENUE RECOGNITION
6.8
Two particular questions arise from this.
•
If options lapse unexercised, how should this affect
accounting for revenue?
•
Will it always be possible to determine the extent to
which a supplier’s performance has taken place?
6.9 The first of these questions is considered below, the second
under paragraph ..
Options lapsing unexercised
6.10 The proportion of options that will lapse unexercised will
vary significantly depending on the situation; nevertheless, it is in
the nature of options that they may not be exercised. Some
might argue, therefore, that the receipt of option proceeds should
give rise to a gain, rather than a liability, to the extent that
options may be expected to lapse. However, if options have
been granted at fair value, that fair value should already reflect
the possibility of lapse, and the fair value of the seller’s liability at
the date of grant should still be the same as the option proceeds.
6.11 If the rate of lapse could be known with certainty—which
will not be the case—accounting for the option proceeds would
be straightforward. The proceeds would be attributed to the
proportion of options expected to be exercised, and would be
recognised as revenue when, following exercise, the seller’s
performance occurred. The following example illustrates this
entirely hypothetical situation.

CHAPTER 6: OTHER ISSUES RELATING TO CONTRACTS AND PERFORMANCE
Example 6.11: options lapsing (1)
A sells , options for £ each, which enable the optionholder on exercise to buy product X for £. Accordingly, A
will recognise a liability of £, on receipt of the option
proceeds, and no gain will arise at this point.
If A could know with certainty that precisely  per cent of
the options would be exercised and  per cent would lapse, it
would reduce the option liability by £ (being £ divided by
 per cent) each time an option was exercised and product X
was sold. Thus it would recognise total revenue of £ for
each sale of product X.
6.12 In practice, it will never be possible to know with certainty
the rate of lapse that will occur, though it may be possible to
estimate it with a greater or lesser degree of confidence. It will
therefore be necessary to consider how to deal with variations
from the expected rate of lapse. In particular, should the liability
in respect of unexercised options be remeasured—and if so, how
should gains and losses arising be treated?
6.13 A first reaction may be to say that remeasurement seems
appropriate, because the seller’s position is clearly different if the
rate of lapse is different. However, it is proposed in Chapter 
that where consideration is received in advance of performance,
the resulting liability should not be remeasured to reflect changes
in the fair value of performance that has not yet occurred. The
following paragraphs illustrate why remeasurement is generally
inappropriate for pre-performance options.
6.14 Although the seller’s position is different if the rate of lapse
is different, the seller will not necessarily be worse off in the
longer term if more options are exercised than originally
expected. Rather, this will depend on whether any additional
outflows of benefit arising from the higher exercise rate are
covered by any additional inflows also arising. This can be
illustrated by returning to the example under paragraph ..

REVENUE RECOGNITION
Example 6.14: options lapsing (2)
As before, A sold , options for £ each, enabling the
option-holder on exercise to buy product X for £, and
recognised a liability of £, on receipt of the option
proceeds.
Estimating that  per cent of the options would be exercised
(ie  in total) and  per cent would lapse, A reduced its
option liability by £ (being £ divided by  per cent) each
time an option was exercised and product X was sold.
However, after  options had been exercised (and the option
liability stood at £,), A revised its estimates and concluded
that a further  options (rather than ) would be exercised.
What effect will this have on A, and should it record a loss on
revising this estimate?
Certainly, when the additional options are exercised A will
incur higher costs in respect of product X, because it will have
to supply a further  products. However, it will also receive
an additional £, of sale proceeds. Thus it will only be
worse off in the long run if the cost of product X exceeds £;
otherwise it should be pleased that more options will be
exercised.
Moreover, even if the cost of product X exceeds £, A will
first be affected only by recognising lower profits on future
sales. If A could now know with certainty that no more than a
further  options would be exercised, it would have to
provide for expected future losses only if the cost of product X
exceeded £ (being £ further proceeds per item plus
£, allocated over  options).

CHAPTER 6: OTHER ISSUES RELATING TO CONTRACTS AND PERFORMANCE
6.15 If all the options are considered together, they are rather
like a long-term contract under  . Uncertainty over the
number of options that will be exercised means that neither total
revenues nor total costs can be predicted with certainty.
Nevertheless, revised estimates of those total amounts do not
crystallise a gain or loss in respect of performance to date; rather,
they are taken into account over the remaining performance of
the contract.
6.16 A similar approach is proposed here. Like payments in
advance, liabilities in respect of option proceeds should be
recognised as revenue only when the future performance to
which they relate occurs. The relationship between proceeds
and performance cannot be known with certainty, because of the
unknown level of future option lapses; thus it should be
estimated at the outset and estimates should be revised over the
period of performance.
Example 6.16: options lapsing (3)
Using the same facts as in Example ., upon issuing options
A estimates that  per cent will be exercised (ie  in total)
and  per cent will lapse. Accordingly, as the first  options
are exercised A reduces its option liability by £ (being £
divided by  per cent) each time an option is exercised and
product X is sold. As a result it records revenue as £ for
each of the first  sales.
After  options have been exercised (and the option liability
stands at £,), A revises its estimates and concludes that a
further  options (rather than ) will be exercised.
Accordingly, as the remaining  options are exercised A
reduces its option liability by £ (being £, divided by
) each time an option is exercised and product X is sold. It
therefore records revenue as £ for each of the last  sales.

REVENUE RECOGNITION
‘Open-ended’ options
6.17 The second question under paragraph . asks whether it
will always be possible to determine the extent to which a
supplier’s performance has taken place. To illustrate the problem,
consider an option that is not described as such. A nonrefundable joining fee for a sports club is in effect the sale of an
option: it gives a member the option to pay regular membership
fees and thereby obtain rights of access to the club’s facilities.
When should the joining fee be recognised as revenue?
6.18 Applying the same principles as discussed above, the sports
club should recognise the joining fee as income when it
performs by providing access to its facilities. 78 However, a
practical issue arises if membership is open-ended (ie it does not
have a fixed expir y date): how is the extent to which
performance has occurred to be assessed?
6.19 The problem here is in essence the same as that discussed
above in the context of options lapsing unexercised; 79
accordingly, this Paper favours the same approach. Liabilities in
respect of joining fees should be recognised as revenue only
when the future performance to which they relate occurs, which
will be over the period of membership. The relationship
between proceeds and performance cannot be known with
certainty, because the period of membership cannot be known;
thus it should be estimated for members in aggregate at the
outset and estimates should be revised over the period of
performance.
6.20 In the light of the preceding discussions, this Paper makes
the following proposals.
78 The discussion in paragraphs 6.37-6.43 is also relevant to a club that makes facilities available to
members over time.
79 The difference is merely that in the preceding discussion an option would either be exercised or lapse,
whereas the issue here is the extent to which an option will be exercised.

CHAPTER 6: OTHER ISSUES RELATING TO CONTRACTS AND PERFORMANCE
Where a customer pays for an option to require future
performance from a seller, that payment gives rise to a liability,
which should be released as revenue only when the future
performance to which it relates occurs. Because the number
of options that will lapse unexercised cannot be known with
certainty, the relationship between proceeds and performance
should be estimated at the outset, and estimates should be
revised over the period of performance.
Options granted without consideration
6.21 The preceding paragraphs have considered options granted
in exchange for consideration but, as noted earlier, some
options—such as super market money-off coupons—are
distributed free of charge. In legal terms these options may be
somewhat different, because a contract requires consideration in
order to be binding. Accordingly, these options may merely
constitute an invitation to tender for a product at a reduced
price; in the absence of consideration, the supermarket may have
no obligation, because such an invitation is not binding.80
6.22 If the transaction will be profitable, the appropriate
accounting is the same irrespective of whether distributing the
coupons gives rise to an obligation towards the coupon-holders.
From the supermarket’s perspective, an obligation to reduce the
price of a future transaction is not an obligation to transfer
economic benefits; on the contrary, there will be a net inflow of
economic benefits if the option is exercised. Accordingly, no
liability is recognised in respect of the coupons. If and when a
transaction occurs, the revenue recorded will be the amount that
is actually paid for the product (ie after deducting the discount
set out on the coupon). This is of course consistent with the
treatment of options issued for consideration, where the
consideration received is recorded as a liability—it is simply the
case that the consideration (and hence the liability) is nil.
80 though it may have a constructive obligation, as discussed below.

REVENUE RECOGNITION
6.23 The situation is different if exercise of the coupons will
result in products being sold at a loss. Where this is the case, it
will be necessary to consider further whether the coupons
actually give rise to an obligation on the part of the supermarket,
which might be the case if, for example, the supermarket has a
constructive obligation not to withdraw the offer.81 Where an
entity becomes obliged to supply goods or services at a loss, that
is an onerous contract and provision will need to be made in
accordance with  . Nevertheless, the revenue recorded will
still be the amount that is actually paid for the product (ie after
deducting the coupon discount).
6.24 Of course, it is important to distinguish options that are
genuinely granted free of charge from those that are granted as
part of another transaction. If, by buying a packet of cereal, a
customer becomes entitled to buy another at a reduced price,
that option is not free of charge; rather, part of the amount paid
for the first packet represents the price of the option. If the
effect was material, it would be necessary to allocate the
consideration between the packet of cereal and the option. The
allocation of consideration between contract elements is
discussed further in Chapter .
6.25 One common way in which options are sold with other
goods or services is in the form of ‘points schemes’. Such
schemes are operated by many airlines (in the form of air miles)
and by credit card companies and supermarkets. Although they
do not give rise to separate issues of principle, such schemes raise
practical accounting issues, and these are discussed further in
Appendix B.
81 If the supermarket does not guarantee that the products will be available, it might be argued that the
obligating event is putting the product on the shelf. On the other hand, if the supermarket does have a
constructive obligation not to withdraw its offer, it may also have a constructive obligation to make the
product available where possible.

CHAPTER 6: OTHER ISSUES RELATING TO CONTRACTS AND PERFORMANCE
Which activities constitute performance?
Generic products/specificity
6.26 This Paper argues that an entity should recognise revenue as
it performs its contractual promises and, as a result, accrues
benefit to its customers. Accordingly, it is appropriate to consider
which of the business’s activities are part of that contractual
performance, particularly if revenue is to be recognised using an
estimation method based on that performance, such as percentage
of completion.
6.27 To highlight why this may be an issue, contrast two
different contracts:
•
a stationer y supplier contracts with a paper
manufacturer for the manufacture and delivery of a
lorryload of plain white photocopier paper. (This is
one of the paper manufacturer’s main product lines.)
•
a firm of accountants contracts with a stationery
supplier to have the accountants’ address and logo
printed on fifty reams of paper, which are then to be
delivered. (For simplicity, assume that the stationery
supplier performs this printing in-house, using plain
paper that it would otherwise sell.)
6.28 In both cases, a manufacturing process (printing in the
second example) precedes delivery. However, is that process to
be regarded as part of the performance of the contract? To
answer this question, it is necessary to return to a concept
mentioned in paragraph .—that of the ‘duty to mitigate’.
6.29 If the stationer y supplier cancelled its order for
photocopier paper immediately before delivery was due, it would
be in breach of contract. However, it is likely that the paper
manufacturer would be entitled only to nominal damages,
because it could mitigate its loss by selling the photocopier paper
to someone else.

REVENUE RECOGNITION
6.30 By contrast, if the accountants cancel the order for headed
paper immediately before delivery is due, the stationery supplier
will be unable to mitigate its loss by selling the headed paper to
someone else. It will be entitled to seek damages from the
accountants for the full value of the order.
6.31 The difference between these examples is that the paper
manufacturer would have manufactured photocopier paper
irrespective of whether the particular contract with the stationery
supplier existed. Without the contract with the accountants, the
stationery supplier would not have arranged for the headed paper
to be printed.
6.32 Accordingly, this Paper makes the following proposal.
An activity will constitute part of the performance of a
contract only if it is a necessary part of the contract, in that it is
specific to the customer and would not have taken place had
the contract not existed.
6.33 This means, in particular, that where a business produces
generic products not specific to a customer, that manufacturing
activity will not be regarded as part of its contractual
performance.
6.34 A manufacturing activity specific to a customer should be
distinguished from one that is merely specified by a customer.
For example, when a customer orders a new car, there are
typically many choices available in respect of colour, optional
extras and accessories. These choices are specified by the
customer, but they are not specific to the customer; the customer
is selecting from a standard range of choices, and the car could
still be sold to someone else. However, if a customer required a
special purpose vehicle to be built to its specifications, that
activity would be specific to the customer.

CHAPTER 6: OTHER ISSUES RELATING TO CONTRACTS AND PERFORMANCE
Other activities that are not specific to a contract
6.35 From the proposal set out under paragraph ., it follows
that administrative, indirect and pre-contract activities and
expenditure do not form part of the performance of a contract.
They will not, therefore, be taken into account when
determining the extent to which revenue should be recognised.
6.36 This is not to imply that associated costs must be written
off as expenses as they are incurred; they may be recognised as
assets if they satisfy the necessary recognition criteria. The most
obvious example arises where an entity manufactures generic
products. For the reasons outlined above, that manufacturing
will not form part of contractual performance; nevertheless, the
goods so manufactured will be recognised as assets until such
time as they are disposed of or otherwise appropriated to a
particular contract.
Contractual performance: transfer and consumption of benefits
6.37 Under many contracts, particularly those for the provision
of services, a supplier’s performance takes place over time.
Nevertheless, it should not be assumed that this is true for all
contracts with an apparent time element. To illustrate this,
consider two examples.
(a)
A business that has developed some proprietary software
sells to X for £, the right to use it, with payment to
be made immediately in full. The business does not
undertake to upgrade the software or to provide any
further services or support whatsoever.

REVENUE RECOGNITION
(b)
The same business sells to Y for £, the right to use
the same software, but only for a period of five years.82
Once again, payment is to be made immediately in full
and the business does not undertake to upgrade the
software or to provide any further services or support
whatsoever.
6.38 No element of time is involved in example (a), and many
would accept that revenue should be recognised in full when the
business has installed the software and, hence, fulfilled its
promises.83 However, example (b) appears to involve a time
element. Does this mean that the recognition of revenue should
be different?
6.39 Some might argue that the revenue in example (b) should
be recognised over the period of five years specified in the
contract. But this seems to produce a strange result when
example (b) is compared with example (a). Immediately after
delivery, the business will have recognised £, of revenue in
example (a) but almost nothing in example (b); yet it might be
argued that there is no difference between the two examples in
terms of what the business is required to do under the contracts.
6.40 On that basis, some might argue that the treatment of
example (a) should be modified, so that the revenue of £,
is spread over the software’s expected useful life. However, it is
not only software that has an expected useful life; applying such
an approach elsewhere would apparently mean that car dealers,
builders of hospitals and many other suppliers would also have to
spread revenue, sometimes over very long periods.
82 The very small difference in price between examples (a) and (b) reflects that the software is expected
to have little value in five years’ time.
83 If the software is faulty in some way, the supplier will not have fully performed its promises in either
example. However, for the sake of illustration, assume that there is no such fault.

CHAPTER 6: OTHER ISSUES RELATING TO CONTRACTS AND PERFORMANCE
6.41 This Paper rejects an approach that spreads revenue over
time without considering whether the deferred element can be
considered a liability. Such a liability exists where a business has
been paid in advance for performance that has not yet taken
place; however, in these examples there is no performance
outstanding. If the business chose to wind itself up immediately
after successfully installing the software, neither X nor Y could
have grounds to object. Following the principles set out in this
Paper, the business would recognise revenue in full on
successfully installing the software, because that is when full
performance has occurred.
6.42 What these examples highlight is that, in some
circumstances, a time element in a contract may not relate to the
supplier’s performance. In example (b) the time element relates
to when Y will get benefit from using the software—but this is
inherently no different from a buyer of a car getting benefits over
the car’s life. It does not alter the fact that the seller fully
performed its obligations at the outset and that, as a result, Y
obtained full access to the software from the outset and was from
that point on required to pay for it in full. 84
6.43 The previous paragraphs have illustrated that care is needed
when considering any time element of a contract. A focus on
two questions should now help to identify when the supplier’s
performance occurs and when revenue should be recognised.
•
What is the subject of the contract? In example (b) the subject
of the contract was the right to use the software for five
years, and the customer was obliged to pay for this
irrespective of whether it actually used the software for five
years. However, if the contract gave the customer the
r ight to cancel after, say, two years and receive a
proportionate refund, the subject of the contract, and
84 The analysis might of course be different if Y could stop using the software at any point and claim a
refund in proportion to the time not yet elapsed, but the contract does not allow this option.

REVENUE RECOGNITION
hence the customer’s asset, might be different as a result of
the customer’s right of return. It would then be necessary
to consider the issues discussed in Chapter  in order to
determine the extent to which the transaction should be
treated as a sale.
•
Now that the economic benefits that are the subject of the
contract have been identified, to what extent have they been
transferred to the customer and, conversely, to what extent does the
customer’s access to them depend upon the supplier’s future
performance? In both the software examples discussed
above, full access is provided to the customer at the outset
and hence there is no outstanding performance. However,
a customer paying for one year’s use of a bank safety
deposit box remains dependent on the bank for access; if
the bank closes down, he cannot get to the box. In this
situation, access to economic benefits depends upon the
bank’s future performance, so the bank will recognise
revenue over the period of the contract (as performance
occurs) rather than at the outset.85
‘Two-way’ trading arrangements
6.44 It is not uncommon for two entities to trade so that each
sells to the other in separate transactions. For example, an
electricity company may supply power to a wholesaler from
which it also buys stationery.
6.45 Where the two transactions are unconnected, they give
rise to no accounting difficulties. Issues can arise, however,
where the transactions may be connected. For example:
•
A may sell components to B and then purchase
manufactured goods incorporating those components.
85 Another way of looking at this is to say that the bank still has unfulfilled promises under the
contract. It will breach those promises if, for example, it fails to grant the customer access at the times
specified in the contract.

CHAPTER 6: OTHER ISSUES RELATING TO CONTRACTS AND PERFORMANCE
•
A retailer that buys products from a manufacturer may
be paid by the manufacturer to promote those
products, for example by displaying advertisements
around its store.
6.46 Under the first of these examples, the goods manufactured
by B might use components from many other suppliers apart
from A, and B might sell those goods to many customers other
than A. On the other hand, the two parties might agree that A
must supply all the components from which the goods are
manufactured, and must buy all the goods manufactured by B.
In the latter circumstances, there may be some doubt whether A
should treat the transfer of components to B as a sale.
6.47 The appropriate accounting in situations like this will
depend upon the precise circumstances, but the important
question to address is whether the arrangements should be
accounted for as two separate contracts, or bundled together as
one larger contract. If the former, then both parties will account
for a sale; if the latter, it will be necessary to consider the terms
of the combined contract to determine whether this is still true,
or whether only one party should record a sale.
6.48 Accordingly, this Paper proposes the following.
Two contracts should be accounted for separately if they are
genuinely independent of one another, but should be treated as
one larger contract if, either legally or economically, one is
conditional or dependent on the other. Such economic
dependence may arise if, for example, contract prices are set so
far from fair value that there is no realistic prospect that the
second contract will not follow from the first.
6.49 To take again the first example under paragraph ., A
will treat components transferred to B as sold only if it is neither
contractually nor economically obliged to repurchase them as
part of the finished goods.

REVENUE RECOGNITION
6.50 Similarly, to take the second example under
parag raph ., the ‘promotion contract’ will not be
independent of the supply of products if it is conditional on a
minimum level of purchases by the retailer. However, this
second example is more complex than the first, because even if
the two contracts are to be treated as one, there is still an element
of non-cash consideration involved (ie barter). Specifically, there
will be an extent to which the retailer is providing a promotional
service in exchange for products. It will therefore be necessary
to assess the fair value to the manufacturer of this promotional
service in order to determine
•
the extent, if any, to which promotional activity should
be treated as giving rise to service revenue for the
retailer, and
•
the extent to which the promotional payment should
be treated as a reduction in the price of the products
bought by the retailer.
6.51 Barter transactions are considered in more detail in
Chapter  under paragraph ..

CHAPTER 7: AGENCY
Chapter 7
Agency
Summary
7.1 This chapter considers certain aspects of agency
arrangements. The main proposals discussed are set out below.
When a principal transacts with a customer through a disclosed
agent, the pr incipal’s revenue should reflect the full
consideration payable by the customer in the transaction. The
principal should treat any commission or other amounts
payable to the agent separately as an expense and not as a
reduction of revenue.
When an entity acts as a disclosed agent, its revenue should
reflect the amount of commission or other income receivable
from its principal.
When an entity acts as an undisclosed agent, it should account
for revenue in the same way as a principal.
Introduction
7.2 Sometimes, rather than transacting directly with a customer,
a seller transacts through an agent. In such a transaction, the seller
is known as the principal and, although all the customer’s dealings
are with the agent, the transaction is legally between the customer
and the principal. The agent is providing a service to the
principal, and any remuneration for that service is a matter to be
agreed between the principal and the agent. That remuneration
could be a flat fee, unconnected with any transactions the agent
enters into on the principal’s behalf. Often, however, the agent’s
remuneration is linked in some way to the transactions entered
into, for example as a flat rate per transaction or as a percentage of
the value of each transaction. In these circumstances, the agent’s
remuneration is often referred to as commission.

REVENUE RECOGNITION
7.3 Agency is a complex subject, in part because it may take
many forms.
•
It is possible for an agent to transact with a customer
without disclosing that it is doing so in its capacity as
an agent. This does not alter the fact that the agent is
acting on behalf of the pr incipal, but in such
circumstances an agent will have the same liabilities as a
principal in respect of any obligations to the customer
ar ising out of the transaction. This situation is
described as an ‘undisclosed agency’.86
•
Although the risks and rewards arising directly from an
agency transaction will, in the first instance, lie with
the principal and the customer, there is nothing to stop
the agent and principal agreeing that the agent shall be
exposed to some of the principal’s risks and rewards.
One example of this is a ‘del credere’ agent, where the
agent accepts any credit r isk associated with a
transaction; however, at the extreme, there seems
nothing to prevent an agent agreeing to be exposed to
all the risks and rewards associated with a transaction.
Exposure to risks and rewards
7.4 Although, as explained above, agency takes many forms,
one common form is a disclosed agency in which the agent’s
exposure to risks and rewards is limited to the amount of its
commission. The agent will receive or retain its full commission
if the transaction proceeds successfully; it may receive or retain a
lesser amount or nothing if something goes wrong; but whatever
happens the agent’s maximum potential liability arising from the
transaction is to refund to the principal any commission received.
86 This should be distinguished from the situation where a customer transacts, via an agent, with a
principal whose identity is not disclosed.

CHAPTER 7: AGENCY
7.5 An accepted way of accounting in such circumstances is
for the agent to record as revenue the amount of its commission,
rather than any gross amount received from the customer. Such
a treatment appears consistent with the principles discussed in
this Paper. Although the cash flows may follow a slightly
different route, both the legal position and the economic
substance are that the principal has sold goods or services to the
customer for the full contract price, and the agent has sold
agency services to the principal for the amount of commission.
Thus the following principles are proposed.
When a principal transacts with a customer through a disclosed
agent, the pr incipal’s revenue should reflect the full
consideration payable by the customer in the transaction. The
principal should treat any commission or other amounts
payable to the agent separately as an expense and not as a
reduction of revenue.
When an entity acts as a disclosed agent, its revenue should
reflect the amount of commission or other income receivable
from its principal.
Accounting by entities other than disclosed agents
7.6 Sometimes, an entity that is not legally a disclosed agent
appears nevertheless to have much in common with such an
agent. For example, a retailer may hold goods on sale or return
from a manufacturer, having agreed that  per cent of the price
paid by a customer will be passed to the manufacturer. Such a
retailer will not be exposed to obsolescence risk or to selling risk
and, correspondingly, its rewards from a sale will be limited to
‘commission’ of  per cent. This prompts the question: if an
entity that is not legally a disclosed agent is nevertheless exposed
in a transaction to the same risks and rewards that such an agent
would be, how should it account?

REVENUE RECOGNITION
7.7 However, it is important to note that it is unusual for an
entity other than a disclosed agent to be exposed to precisely the
same risks and rewards as such an agent. To demonstrate why,
consider the retailer described above. The arrangement with the
manufacturer has a number of similarities with a disclosed agency
arrangement, but it has one significant difference. If the goods
turn out to be faulty, the customer will seek redress from the
retailer, not the manufacturer—and for the full price, not just the
 per cent ‘commission’. The retailer may then seek
reimbursement from the manufacturer, but that will not alter the
existence of the retailer’s liability to the customer.87
7.8 Accordingly, to have precisely the same risks and rewards as
a disclosed agency arrangement, it appears necessary for the sales
contract to be between three parties—the supplier, the retailer
and the customer—and for the contract explicitly to limit the
retailer’s liability. Provided that (i) the customer has no right of
action against the retailer and (ii) the retailer’s liability to the
supplier is limited to its  per cent ‘commission’, it would seem
appropriate for the retailer to account as a disclosed agent,
because that is the economic substance of its role.
7.9 These conditions will not be met, however, in an
undisclosed agency. Such an agency differs from a disclosed
agency in that the customer is not made aware of the agreement
between the principal and its agent. Thus the principal is not a
party to the sales contract between the undisclosed agent and the
customer; so far as the customer is concerned, the agent is acting
as a principal. This has an important effect on the legal position,
in that the agent’s exposure to risks and rewards is not limited to
the amount of its commission. Although it will receive or retain
no more than its commission if the transaction proceeds
successfully, it is potentially exposed to the full amount paid by
the customer.
87 It follows that, where a retailer charges a customer for delivery but subcontracts that delivery to a
third party, the retailer will treat delivery charged to the customer as part of its revenue except where it is
acting as the third party’s disclosed agent.

CHAPTER 7: AGENCY
7.10 An accepted way of accounting in such circumstances is to
treat the undisclosed agent as a principal, and such a treatment
appears consistent with the principles discussed in this Paper.
Thus the following principle is proposed.
When an entity acts as an undisclosed agent, it should account
for revenue in the same way as a principal.

REVENUE RECOGNITION
Appendix A
Deep and liquid markets
Balancing relevance and reliability
A1 The discussion under paragraph . in Chapter 
contrasts historical cost and current value approaches to profit
recognition and notes that any approach to profit recognition
will need to balance issues of relevance and reliability.
A2 The appropriate balance is likely to vary according to the
nature of the underlying business. However, there are certain
circumstances in which this balance will clearly favour a current
value approach. They are where a deep and liquid market exists
for an entity’s products.
What is a deep and liquid market?
A3 This appendix does not seek to define a deep and liquid
market. Nevertheless, such a market is likely to possess the
following characteristics:
•
the assets in question (ie the products) will be
homogeneous
•
there will be frequent trading in those assets
•
the quoted market price will be a reliable indicator of
the price that would be achieved were assets to be
bought or sold
•
there will be willing buyers and sellers at all times
during normal business hours at the quoted market
price.88
88 Similar criteria are already reflected in FRSs 10, 11 and 13.

APPENDIX A: DEEP AND LIQUID MARKETS
A4 Where an entity holds an asset, such as a commodity, for
which a deep and liquid market exists, its current value can be
determined by reference to the quoted market price. The
characteristics set out above ensure that the quoted price is
reliable; ie where a deep and liquid market exists, it is always
possible to measure the current value of the asset reliably.
A5 Accordingly, where an entity’s business is to produce 89 (and
in due course sell) assets for which a deep and liquid market
exists, the current value of those assets can be measured reliably
as soon as they are ready for market. It is not necessary for an
exchange transaction to occur. Under current value principles,
the entity will always be able to measure reliably the profits or
losses that have arisen in making the asset ready for market.
A6 In effect, this is the case because there is no selling risk for
such assets; the existence of a deep and liquid market means they
can always be sold at the market price. In other words, no profit
arises from selling such assets (as distinct from producing or
holding them) because there is no risk.
A7 Of course, an entity may choose to hold the assets that it
has produced in the hope that the market price will improve.
However, this is an investment decision, unconnected with
production activities; a non-producer could do exactly the same
thing by buying assets and holding them. Therefore, although
any holding gains or losses should be reported as and when they
arise, there is no argument to support deferring the recognition
of the gains or losses that have arisen from production.
89 In this context, production is intended to cover any and all activities that result in an asset for which
a deep and liquid market exists, such as growing, harvesting, extracting, refining, distilling, cultivating,
originating and other such processes.

REVENUE RECOGNITION
A8 Accordingly, this Paper’s conclusion is that, where a deep
and liquid market exists for an entity’s products, those products
should be remeasured at market price, and any production gains
or losses recognised, as soon as they are ready for market.90
When is an asset ‘ready for market’?
A9 Many activities may be necessary in making an asset ready
for market, some significant and others trivial. An asset will not
be ready for market if significant business risks remain to be
eliminated.91 However, sometimes an asset may be ready for
market in all but a trivial respect. An example might arise where
the market requires the asset to be stored in a particular location,
such as an approved warehouse; if in fact the asset is at present
stored nearby, any time and risk involved in moving it may be
quite insignificant.
A10 Accordingly, this Paper proposes that an asset should be
regarded as ‘ready for market’ once any risks attaching to the
activities still necessary to bring it to market are insignificant.
A11 Such risks will be significant if they bring into doubt the
entity’s ability to obtain the quoted market price for the asset.
Accordingly, two particular risks may be singled out. One is the
risk that the asset will not satisfy the standards set by the market;
this would be the case if, for example, an outstanding activity
involved a significant risk of damage to the asset. The other is
the risk that the market price could move significantly in the
time required for any remaining activities to be performed; it is
therefore necessary that the time needed for such activities is not
significant.
90 This is not to argue that revenue should be recognised when products are ready for market; as
explained in Chapter 1, this Paper proposes that revenue should continue to arise from exchange
transactions. Where an entity’s main activity is to produce an asset for which a deep and liquid market
exists, however, revenue may not be a particularly useful figure to report, and an alternative presentation
in the profit and loss account may be more appropriate, as discussed in paragraph 1.42 in Chapter 1.
91 The fact that an asset is not ready for market does not imply that a current value approach should
not be used; rather, it will be necessary to consider the balance between relevance and reliability, as
discussed in Chapter 1.

APPENDIX A: DEEP AND LIQUID MARKETS
A12 One of the outstanding activities may be some form of
inspection or certification. Where an entity has, at its periodend, assets that have not yet been inspected and/or certified,
those assets will nevertheless be of either an adequate or
inadequate standard for the market. Subsequent inspection
and/or certification will merely confirm the condition of those
assets at the period-end, and the fact that assets have not been
inspected and/or certified will not necessarily prevent assets of an
adequate standard from being ready for market.
A13 Nevertheless, if the process of inspection and/or
certification will necessarily take a significant amount of time,92
so that market prices could move significantly before the process
can be completed, the assets will not be ready for market.
Applying a current value approach in other circumstances
A14 At present, most entities report operating gains under a
historical cost approach, but the appropriate balance between
relevance and reliability may change over time, both as markets
develop and as the requirements of users of financial statements
change.
A15 One situation in which a current value approach is
adopted has already been discussed in Chapter . IAS  requires
both biological assets and agricultural produce (ie biological
assets that have been harvested) to be measured at fair value (less
estimated point-of-sale costs), except where it is not possible to
measure fair value reliably. Although deep and liquid markets
may exist for some biological assets, IAS  acknowledges that
such markets do not exist for all biological assets. Nevertheless,
it is clear that a significant element of the profit (or loss) that
ultimately arises on agricultural produce is attributable to the
growing process, rather than to the activity of selling.
92 This might be the case, for example, where inspection/certification is available only at certain
specified times.

REVENUE RECOGNITION
Appendix B
Accounting for ‘points schemes’
B1 As mentioned in paragraph . in Chapter , ‘points
schemes’ are commonly operated by airlines (in the form of air
miles) and by credit card companies and supermarkets. When
purchasing goods or services, customers become entitled to
‘points’ which, depending on the scheme, can be used towards
part or all of the cost of future purchases or can in due course be
redeemed for cash. This appendix briefly discusses how the
proposals set out in this Paper might be applied to such schemes.
Arriving at a value for points
B2 When a customer purchases goods or services in a
transaction that also entitles him to points, the amount paid by
the customer needs to be allocated between an amount paid for
the goods or services and the amount paid for the points. Using
the unbundling principles discussed in Chapter , the total
consideration will be allocated by reference to the fair values to
the customer of the goods/services and the points.93
B3 Of course, the amount that the customer would be
prepared to pay for the points will depend upon what they can
be exchanged for (and, perhaps, when they can be exchanged if
they cannot be redeemed immediately). Under many points
schemes, quite a wide range of goods and services is available,
and it would not be practical to assess on a customer-bycustomer basis what value should be attributed to the points.
Instead, it may be better to derive a fair value for the points by
93 This fair value will be affected by how likely it is that points will lapse without being used, but it is
nevertheless a measure of the fair value to the customer. It will not, therefore, be measured by reference
to the expected cost to the entity of supplying goods or services.

APPENDIX B: ACCOUNTING FOR ‘POINTS SCHEMES’
considering, as a starting point, the fair values of the goods or
services for which points can be exchanged. This can be used to
deduce an ‘exchange rate’ for each of the goods or services, from
which an average exchange rate can be derived. 94 (In effect, the
points can be thought of as analogous to a foreign currency.)
Points schemes run by third parties
B4 Often, the points scheme will not be run by the entity
with which the customer transacts but will instead be operated
by a third party; the transacting entity will make a payment to
that third party in respect of points issued. In this situation, the
transacting entity is acting as agent for the points scheme
operator when it ‘sells’ points to a customer.
B5 This should not in principle alter the way in which the
transacting entity measures the proportion of income attributable
to the ‘sale’ of points; it should continue to measure them by
reference to their fair value to the customer. However, if that
fair value is very close to the amount that the transacting entity
must pay the operator, it may be simpler to use the latter as a
surrogate. 95
B6 If the agency arrangement is disclosed, the customer will
not have recourse to the transacting entity in respect of
unredeemed points, and the transacting entity’s only liability will
be to make the necessary payment to the operator. In this
situation, the proportion of income attributable to the ‘sale’ of
points will not be revenue in the hands of the transacting entity,
because it belongs instead to the principal. The transacting
entity’s revenue in respect of points will be the commission it
receives from the principal.
94 If a scheme is properly designed, it seems likely that most of the individual exchange rates will be
close to the average. If an individual exchange rate deviates significantly, it suggests that the associated
goods or services are either underpriced or overpriced, and the demand for them is likely to be affected
accordingly.
95 In the hands of the operator, of course, the proceeds in respect of the points will be treated as a
payment in advance.

REVENUE RECOGNITION
B7 It may be rather more likely, however, that the agency
arrangement is undisclosed. In this situation, income attributable
to the ‘sale’ of points will be revenue in the hands of the
transacting entity. However, the customer will also have recourse
to the transacting entity in respect of unredeemed points, and the
transacting entity’s liabilities will therefore need to be considered
carefully.
Benefit schemes other than points schemes
B8 A scheme that is similar to a points scheme in many ways
arises where a customer can become entitled to benefits (such as
free products) as a result of satisfying certain criteria. Those
criteria may involve exceeding a cumulative level of purchases.
Alternatively, they may be time-based—for example, a customer
may become entitled to benefits simply by continuing to be a
member of a scheme for a specified period.
B9 Criteria based on a cumulative level of purchases may be
seen as directly analogous to points, and it is therefore argued
that they should be accounted for in the same way: the benefit to
which a customer can become entitled should be recognised
incrementally as purchases occur.
B10 Where criteria are based on continuing to be a ‘member’
for a specified period, it will be necessary to consider whether
these require any act of ‘performance’ by a customer or whether
they are purely time-based. Criteria that are purely time-based
might be expected to arise infrequently, and they may often be
more properly regarded as linked to some other act by the
customer, such as payment of a membership fee or subscription.
However, where benefits genuinely arise only as a result of time,
so that the customer is not required to spend money or perform
any other act in order to achieve entitlement, the obligation to
the customer arises in full at the outset and should be recorded at
that point.96
96 It may need to be discounted, however, to reflect the fact that benefits cannot be claimed until some
time in the future.

APPENDIX C: FRS 5 AND RIGHTS OF RETURN
Appendix C
FRS 5 and rights of return
C1 Chapter , which is concerned primarily with customer
rights of return, considers issues also touched upon in two
Application Notes to   ‘Reporting the Substance of
Transactions’. Application Note A to   deals with
consignment stock, while Application Note B is concerned with
sale and repurchase agreements.
C2 The transactions discussed in Chapter  have important
elements in common with those discussed in the Application
Notes, and this appendix considers how the former would be
dealt with under those Application Notes. Nevertheless, it
should be emphasised that, although there are important
common elements, there may also be differences, both in terms
of which r isks are significant and where those r isks lie.
Accordingly, this appendix does not represent a comprehensive
analysis of the transactions from the perspective of  , and is
intended only for the purposes of illustrating the issues involved.
Application Note A—Consignment Stock
C3 Application Note A describes consignment stock in the
following terms.
“Consignment stock is stock held by one party (the ‘dealer’) but
legally owned by another (the ‘manufacturer’), on terms that give
the dealer the right to sell the stock in the normal course of its
business or, at its option, to return it unsold to the legal owner.”
C4 The Application Note explains that the various features of
a consignment stock agreement will determine where the
associated benefits and risks lie. It concludes that consignment
stock should be included on the dealer’s balance sheet if it is in
substance an asset of the dealer, ie where the dealer has access to
its principal benefits and bears the principal risks inherent in
those benefits. A table, reproduced below, summarises how the
different characteristics of a consignment stock agreement will
influence the required accounting.

REVENUE RECOGNITION
Indications that the stock
is not an asset of the dealer
at delivery
Indications that the stock is
an asset of the dealer at
delivery
Manufacturer can require the
dealer to return stock (or transfer
stock to another dealer) without
compensation, or
Manufacturer cannot require
dealer to return or transfer
stock, or
Penalty paid by the dealer to
prevent returns/transfers of stock
at the manufacturer’s request.
Financial incentives given to
persuade dealer to transfer
stock at manufacturer’s request.
Dealer has unfettered right to
return stock to the manufacturer
without penalty and actually
exercises the right in practice.
Dealer has no right to return
stock or is commercially
compelled not to exercise its
right of return.
Manufacturer bears obsolescence
risk, eg:
Dealer bears obsolescence risk,
eg:
- obsolete stock is returned to
the manufacturer without
penalty; or
- penalty charged if dealer
returns stock to
manufacturer; or
- financial incentives given by
manufacturer to prevent stock
being returned to it (eg on a
model change or if it
becomes obsolete).
- obsolete stock cannot be
returned to the manufacturer
and no compensation is paid
by manufacturer for losses
due to obsolescence.
Stock transfer price charged by
manufacturer is based on
manufacturer’s list price at date
of transfer of legal title.
Stock transfer price charged by
manufacturer is based on
manufacturer’s list price at date
of delivery.

APPENDIX C: FRS 5 AND RIGHTS OF RETURN
Manufacturer bears slow
movement risk, eg:
Dealer bears slow movement
risk, eg:
- transfer price set
independently of time for
which dealer holds stock,
and there is no deposit.
- dealer is effectively charged
interest as transfer price or
other payments to
manufacturer vary with time
for which dealer holds stock;
or
- dealer makes a substantial
interest-free deposit that
varies with the levels of
stock held.
C5 The paragraphs below summarise how these characteristics
are reflected in Chapter .
Manufacturer’s ability to secure return of goods (suppliers’ call options)
C6 The discussion under paragraph . concludes that, in a
revenue context, the effect of a supplier retaining a call option is
to restrict what has been sold. It notes, however, that care is
needed when determining the effect of such a restriction,
particularly where a supplier’s call option is either conditional or
determinable.
C7 In most of the situations discussed in Chapter  the seller
will not have the right to insist on the return of goods sold.
Dealer’s ability to return goods
C8 The situations discussed in Chapter  are those where a
customer can, without penalty, return goods received. Thus in
all the situations discussed there will be a right of return without
penalty that is actually exercised in practice from time to time.

REVENUE RECOGNITION
Obsolescence risk
C9 Because Chapter  is concerned only with situations
where a customer can without penalty return goods received, it
follows that the supplier will in all the situations discussed bear
any obsolescence risk.
Date on which transfer price is set
C10 Chapter  is concerned only with situations where
delivery of goods by a supplier constitutes performance under a
contract—and in order for a contract to exist, a price must have
been agreed that is either fixed or determinable. In most of the
situations discussed in Chapter  the price will have been fixed at
or before the point of delivery.
Slow movement risk
C11 In terms of the discussion in Chapter , slow movement
risk is concerned with whether the fair value of consideration
received or receivable by the supplier is affected by the length of
time that elapses before a customer gives up a right of return.
Generally, this will not be the case for the situations discussed in
Chapter , because in most of those situations the customer will
pay either on delivery or within an agreed period after delivery.
Summarising benefits and risks
C12 To summarise the preceding paragraphs, the situations
discussed in Chapter  would generally be analysed under
Application Note A as follows:

APPENDIX C: FRS 5 AND RIGHTS OF RETURN
Indications that
the stock is not
an asset of the
customer at
delivery
Supplier unable to
secure return of goods
Indications that
the stock is an
asset of the
customer at
delivery
✔
Customer able to
return goods
✔
Obsolescence risk
with supplier
✔
Transfer price set
at delivery
✔
Slow movement
risk with customer
✔
C13 Application Note A includes further guidance where, as
above, different features of an agreement point to different
conclusions. It makes clear that it will be necessary to look at all
the features of an agreement, giving greater weight to those that
are more likely to have a commercial effect in practice. The
interaction between the features will also need to be considered,
and the arrangement will need to be evaluated as a whole.
Application Note B—Sale and Repurchase Agreements
C14 In the context of a sale and repurchase agreement, the
purpose of the analysis in Application Note B is
“... to determine both whether the seller has an asset (and what
is the nature of that asset), and whether the seller has a liability
to repay the buyer some or all of the amounts received from the
latter.”

REVENUE RECOGNITION
C15 In effect, the approach taken in the Application Note is to
ask whether the agreement is in substance a secured loan, or
whether it results in the seller having a different asset. The
Application Note identifies benefits and risks that may be
relevant in determining the appropriate accounting. A table,
reproduced below, summarises how the different characteristics
of a sale and repurchase agreement will influence the required
accounting.
Indications of sale of original
asset to buyer (nevertheless,
the seller may retain a
different asset)
Indications of no sale of
original asset to buyer
(secured loan)
Sale price does not equal market
value at date of sale.
No commitment for seller to
repurchase asset, eg:
Commitment for seller to
repurchase asset, eg:
- call option where there is a
real possibility the option will
fail to be exercised.
- put and call option with the
same exercise price;
- either a put or a call option
with no genuine commercial
possibility that the option will
fail to be exercised; or
- seller requires asset back to
use in its business, or asset is
in effect the only source of
seller’s future sales.

APPENDIX C: FRS 5 AND RIGHTS OF RETURN
Risk of changes in asset value
borne by buyer such that buyer
does not receive solely a lender’s
return, eg:
Risk of changes in asset value
borne by seller such that buyer
receives solely a lender’s return,
eg:
- both sale and repurchase price
equal market value at date of
sale/purchase.
- repurchase price equals sale
price plus costs plus interest;
- original purchase price
adjusted retrospectively to
pass variations in the value of
the asset to the seller;
- seller provides residual value
guarantee to buyer or
subordinated debt to protect
buyer from falls in the value
of the asset.
Nature of the asset is such that it
will be used over the life of the
agreement, and the seller has no
rights to determine its use.
Seller has no rights to determine
asset’s development or future sale.
Seller retains right to determine
asset’s use, development or sale,
or rights to profits therefrom.

REVENUE RECOGNITION
C16 When the analysis above is applied to the transactions with
a right of return discussed in Chapter , the majority of factors
indicate, not surprisingly, that the transactions are not in
substance simply secured loans.97 However, to the extent that the
transaction has given rise to new assets and liabilities of the seller,
Application Note B requires them to be recognised on a prudent
basis. Where doubts exist regarding the amount of any gain or
loss arising, the Application Note requires full provision to be
made for any expected loss but recognition of any gain, to the
extent that it is in doubt, to be deferred until it is realised.
97 In the wine merchant example from Chapter 4, it is possible that the ‘deposit’ paid for wineglasses
may exceed their market value. All the other factors, however, will tend to indicate that the original
asset has been sold to the buyer.

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