Acca f3 Financial Accounting (int) Study Text

Part F  Preparing basic financial statements

  21:  Preparation of basic financial statements for companies

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Interest is the charge for the use of cash or cash equivalents or amounts due to the entity. 

Royalties are charges for the use of long-term assets of the entity, eg patents, computer software and 

trademarks.

Dividends are distributions of profit to holders of equity investments, in proportion with their holdings, of 

each relevant class of capital. 

The standard specifically 

excludes various types of revenue arising from leases, insurance contracts, 

changes in value of financial instruments or other current assets, natural increases in agricultural assets 

and mineral ore extraction. 

6.4 Definitions 

The following definitions are given in the standard. 

Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary 

activities of an entity when those inflows result in increases in equity, other than increases relating to 

contributions from equity participants. 

Fair value is the amount for which an asset could be exchanged, or a liability settled, between 

knowledgeable, willing parties in an arm's length transaction. 

(IAS 18) 

Revenue

does not include sales taxes, value added taxes or goods and service taxes which are only 

collected for third parties, because these do not represent an economic benefit flowing to the entity. The 

same is true for revenues collected by an agent on behalf of a principal. Revenue for the agent is only the 

commission received for acting as agent. 

6.5 Measurement of revenue 

When a transaction takes place, the amount of revenue is usually decided by the 

agreement of the buyer 

and seller. The revenue is actually measured, however, as the fair value of the consideration received,

which will take account of any trade discounts and volume rebates. 

6.6 Disclosure 

The following items should be disclosed. 

(a) The 

accounting policies adopted for the recognition of revenue, including the methods used to 

determine the stage of completion of transactions involving the rendering of services 

(b) 

The amount of each 

significant category of revenue recognised during the period including 

revenue arising from the sources below 

(i) 

The sale of goods 

(ii) 

The rendering of services 

(iii) Interest 

(iv) Royalties 

(v) Dividends 

(c) 

The amount of revenue arising from 

exchanges of goods or services included in each significant 

category of revenue 

Any

contingent gains or losses, such as those relating to warranty costs, claims or penalties should be 

treated according to IAS 10 Events after the reporting period (see 

Chapter 22

). 

Key terms 

Key terms 

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21: Preparation of financial statements for companies   Part F  Preparing basic financial statements 

Question

Prudence

Given that prudence is the main consideration, discuss under what circumstances, if any, revenue might 

be recognised at the following stages of a sale. 

(a) 

Goods are acquired by the business which it confidently expects to resell very quickly. 

(b) 

A customer places a firm order for goods. 

(c) 

Goods are delivered to the customer. 

(d) 

The customer is invoiced for goods. 

(e) 

The customer pays for the goods. 

(f) 

The customer's cheque in payment for the goods has been cleared by the bank. 

Answer

 (a) 

A sale must never be recognised before the goods have even been ordered by a customer. There is 

no certainty about the value of the sale, nor when it will take place, even if it is virtually certain that 

goods will be sold. 

(b) 

A sale must never be recognised when the customer places an order. Even though the order will be 

for a specific quantity of goods at a specific price, it is not yet certain that the sale transaction will 

go through. The customer may cancel the order, the supplier might be unable to deliver the goods 

as ordered or it may be decided that the customer is not a good credit risk. 

(c) 

A sale will be recognised when delivery of the goods is made only when: 

(i) 

the sale is for cash, and so the cash is received at the same time. 

(ii) 

the sale is on credit and the customer accepts delivery (eg by signing a delivery note). 

(d) 

The critical event for a credit sale is usually the despatch of an invoice to the customer. There is 

then a legally enforceable debt, payable on specified terms, for a completed sale transaction. 

(e) 

The critical event for a cash sale is when delivery takes place and when cash is received; both take 

place at the same time. 

It would be too cautious or 'prudent' to await cash payment for a credit sale transaction before 

recognising the sale, unless the customer is a high credit risk and there is a serious doubt about 

his ability or intention to pay. But in that case, why would the business risk dispatching the goods? 

(f) 

It would again be over-cautious to wait for clearance of the customer's cheques before recognising 

sales revenue. Such a precaution would only be justified in cases where there is a very high risk of 

the bank refusing to honour the cheque. 

7 Published accounts 

Now work through this example to give you practice in preparing financial statements in accordance with 

IAS 1. You have already met part of this question in the previous chapter (section 3.6), when you prepared 

the SOCIE (statement of changes in equity). 

Note that very little detail appears in the income statement – all items of income and expenditure are 

accumulated under the standard headings. Write out the standard proformas and then go through the 

workings, inserting figures as you go. 

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