Enquiry:

It is informed that presently ‘Revenue’ is being booked by Aviation regulator on account of
various services against the billing of an airline. However, since July 2009, no dues are being paid by above airline. Per monthly billing is approx.. Rs.xxx million. Consequently the outstanding amount has been accumulated to Rs. xxx billion of December 2013

While referring IAS-18 regarding ‘Revenue Recognition’. It revealed that following conditions are requested to be fulfilled for booking of Revenue:

Quote:

Rendering of services

For revenue arising from the rendering of services, provided that all of the following criteria are met, revenue should be recognized by reference to the stage of completion of the transaction at the balance sheet date (the percentage of completion method): (IAS 18.20)

a)    The amount of revenue can be measured reliably
b)    It is probable that the economic benefits will flow to the seller (service provider):
c)    The stage of completion at the balance sheet date can be measured reliably ; and
d)    The costs incurred or to be incurred of the transaction can be measured reliably

When the above criteria are not met, revenue arising from the rendering of services should be recognized only to the extent of the expenses recognized that are recoverable (a “cost-recovery approach”. (IAS 18.26)

Un-quote:

It may be noted that condition (b) is not being fulfilled under the present scenario. Therefore, we believe that Aviation regulator should not book Revenue on accrual basis and should move to Cash basis for recognizing Revenue. It may also be noted that Aviation regulator was established under ABC Ordinance (the prevalent Ordinance) and the mandatory requirements under Companies Ordinance 1984 are not applicable for Aviation regulator. Similarly, IAS-18 is also not compulsorily applicable for Aviation regulator. In this context, it is pertinent to mention that Institute of Chartered Accountants (ICAP) also follows this policy as mentioned in the Notes of Accounts. The same is being reproduced as under:

4:14      Revenue recognition

Revenue is recognized to the extent that the economic benefits will flow to the institute and revenue can be reliably measured. Revenue from different sources is recognized on the following basis:

• Income from subscription and fee from members and students is accounted for on receipt basis. Fee/ subscription receipts relating to periods beyond the current financial year are shown as advance fee.
• Profit on investments is accrued on the basis of effective yield of respective investments.
• Profit on savings accounts is recognized on accrual basis.

Owing to the reason mentioned above, Aviation regulator is facing financial hardship as without receipt of any amount from above Airline. Aviation regulator has to pay income tax @ 35%on its billings. So far Aviation regulator has paid substantial amount on account of Income Tax i.e. Rs xxx billion.

It is clarified that the bills/invoices are raised against the airline on account of various services as per rates duly approved by aviation Board. These rates are notified to all Airlines through NOTAM (Notice to Airmen) before implementation. Since, presently, aviation regulator is following “Accrual based policy”; the “Revenue” is being recognized against these invoices. It is also clarified that there is no binding contract/terms and conditions agreed with the airline.

We feel that in view of the fact that substantial amount is not being received, and as such IAS 18’s condition of booking Revenue is not met. Hence we cannot book Revenue as per IAS 18, and will have to move to “cash basis”.

Considering the requirements of IAS 18, we desire to adopt “Cash based” policy for recognition of “Revenue”. In this regard, guidance is required to change the policy for Revenue recognition.

Opinion:

The Committee has examined your enquiry and would like to draw your attention to the following paras of IAS 18 ‘Revenue’:

18    Revenue is recognised only when it is probable that the economic benefits associated with the transaction will flow to the entity. In some cases, this may not be probable until the consideration is received or until an uncertainty is removed. For example, it may be uncertain that a foreign governmental authority will grant permission to remit the consideration from a sale in a foreign country. When the permission is granted, the uncertainty is removed and revenue is recognised. However, when an uncertainty arises about the collectibility of an amount already included in revenue, the uncollectible amount or the amount in respect of which recovery has ceased to be probable is recognised as an expense, rather than as an adjustment of the amount of revenue originally recognised.

20    When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognised by reference to the stage of completion of the transaction at the end of the reporting period. The outcome of a transaction can be estimated reliably when all the following conditions are satisfied:

(a)    the amount of revenue can be measured reliably;
(b)    it is probable that the economic benefits associated with the transaction will flow to the entity;
(c)    the stage of completion of the transaction at the end of the reporting period can be measured reliably; and
(d)    the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.

21    The recognition of revenue by reference to the stage of completion of a transaction is often referred to as the percentage of completion method. Under this method, revenue is recognised in the accounting periods in which the services are rendered. The recognition of revenue on this basis provides useful information on the extent of service activity and performance during a period. IAS 11 also requires the recognition of revenue on this basis. The requirements of that Standard are generally applicable to the recognition of revenue and the associated expenses for a transaction involving the rendering of services.

22    Revenue is recognised only when it is probable that the economic benefits associated with the transaction will flow to the entity. However, when an uncertainty arises about the collectibility of an amount already included in revenue, the uncollectible amount, or the amount in respect of which recovery has ceased to be probable, is recognised as an expense, rather than as an adjustment of the amount of revenue originally recognised.

The Committee considers that the probability of future economic benefits relates to the level of certainty that the revenue amount will be received. In some cases, revenue recognition may not be appropriate until the consideration is received or the cause of uncertainty is removed.

The Committee would further like to refer to the following para of IAS 18:

26     When the outcome of the transaction involving the rendering of services cannot be estimated reliably, revenue shall be recognised only to the extent of the expenses recognised that are recoverable.

27     During the early stages of a transaction, it is often the case that the outcome of the transaction cannot be estimated reliably. Nevertheless, it may be probable that the entity will recover the transaction costs incurred. Therefore, revenue is recognised only to the extent of costs incurred that are expected to be recoverable. As the outcome of the transaction cannot be estimated reliably, no profit is recognised.

28    When the outcome of a transaction cannot be estimated reliably and it is not probable that the costs incurred will be recovered, revenue is not recognised and the costs incurred are recognised as an expense. When the uncertainties that prevented the outcome of the contract being estimated reliably no longer exist, revenue is recognised in accordance with paragraph 20 rather than in accordance with paragraph 26.

The Committee considers that the management of the aviation regulator needs to assess all the conditions surrounding the transaction and to reach a conclusion. If the management’s conclusion is that probability of recovery is extremely remote at the time of rendering of services and any requirement of para 20 of IAS 18 is not being met; they may decide not to recognize revenue from such transactions.

In this case, the revenue recognition policy is not being changed; only management has concluded that one of the conditions for recognizing revenue is not present for the transaction or set of transactions. The amount recovered in subsequent period if any will be recognized in accordance with the requirement of relevant standards.

It is imperative to note that the basic principle remains to be accrual and recording of revenue on cash basis is not appropriate.

The Committee would also like to advise the management that while making its assessment it needs to consider that late recovery or part recovery of revenue recognized in the past may not on its own be an appropriate indicator for concluding that economic benefits of similar transactions  in future will not  flow to the entity. Further, the management also needs to consider whether both the parties to transaction are related, and the late or non-payment of revenue is for reasons other than commercial. In such a scenario non-recognition of revenue may not be appropriate.

(March 19, 2014)