Complex Scenario of Revenue Recognition

Saffron Telco Ltd has a sole license to run Vermilion’s telephone system until 31 March 2017. Vermilion is a fictional country.

As a result of freeing up the Telecom market place, the Government of Vermilion decides to issue 2 or more licenses and therefore open up the market from 1 April 2012.

The Government of Vermilion agrees to compensate Saffron Telco Ltd and agrees a total compensation amounting to $1,400,000.000 which was paid on 1 April 2011.

How did Saffron Telco Ltd should classify the receipt of $1,400,000.000 in the financial statement?

Accounting for this receipt will be a matter ofjudgement and accounting policy. The receipt is to compensate Saffron Telco for future lost revenue potential as a result of opening up the telecoms market.

The current revenue standard IAS 18 is set up to deal with the accounting for revenue from an entity’s ordinary activities. Arguably this is not revenue from a sale and IAS 18 should not apply to it. From 2017 a new standard IFRS 15 becomes mandatory and that applies to revenues from contracts with customers. This is not revenue from a customer / contractual relationship so this receipt would be out of scope of that standard too.

In the absence of an applicable standard the company needs to create an accounting policy which is “relevant and reliable“, that policy can be draw on relevant pronouncements such as the revenue standards, even though the transaction is out of their scope. It these standards are used to support the accounting policy for this transaction Saffron Telco could be able to recognise the full receipt into income in 2011.

The points that would support such a treatment are:

  • Under IAS 18:
    • The amount has been received
    • Saffron Telco controls the funds and has no further risks in relation to the transaction (i.e. they cannot be compelled to do anything in return for the funds)
  • Under IFRS 15
    • The amount has been received and Saffron Telco has no remaining obligations to fulfil to the State in relation to it.

However, since no specific standard applies, they could take a more conservative approach. The funds are clearly meant to compensate them for future lost revenues. Thus, it may be appropriate to defer recognition of a portion of the receipt as deferred revenue (a liability in the balance sheet), to be released over the remaining period of the licence for which the compensation applies. Saffron Telco would need to release the revenue on a systematic basis, straight line.

Other considerations: Saffron Telco may have recognised an intangible asset at the time they were granted the licence (either at the amount paid to acquire the licence or at fair value at date of grant if freely granted). By changing the terms of the licence any asset so recognised will need to be impairment tested, by comparing the carrying amount of the licence to the expected future cash flows from operating the licence. If an impairment is booked, resulting in a loss in 2011, then the compensation received could be viewed as compensation for the impairment of the licence, lending weight to the immediate recognition of this into income.

Note that since the compensation does not fit the definition of revenue under either the current or new standard it should not be included in the revenue line but more likely be presented elsewhere in comprehensive income e.g., under other gains / losses.

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