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How to account for provision

03. Jun 2022
7

Hi,

We are charging a fee for demoing our product, this fee is creditable if the client buys the product 90 days after the demo.

I wondered how to keep track of the fee in the chart of accounts

Let's say the fee is 100$ and the products demoed are sold for 1000$, Client pay with cash

1) Demo: The client is invoiced for the demo. 100$ Credited to Revenues Account | 100$ Debited to Cash Account | 100$ credited to Client Provision Account
2a) Product purchased before the 90 days: 1000$ Credited to Revenues Account | 100$ Debited to Revenues Ajustement (Contra) Account | 900$ Debited to Cash Account | 100$ Debited to Client Provision Account
2b) Provision expired after 90 days: 100$ Debited to Client Provision Account

Is it the right way to do it, It seems like Debit|Credit is not in balance when doing it this way for the time between steps 1 and 2?

Regards,

VP

Submitted by Mladek on Fri, 06/03/2022 - 07:05

hello,

Yes, your entries don't balance and you seem to be overcomplicating the procedure.

From your example it seems the demo fee is non-refundable.

If this is the case, you should consider the  demo a separate performance obligation (IFRS 15.22 to 30) and recognize: Dr. Cash 100 / Cr. Revenue 100.

If the customer buys the product, Dr. Cash 900 / Cr. Revenue 900. 

If the customer does not buy the product, no additional entry is required.

If the demo fee is refundable (variable per IFRS 15.50), you cannot recognize revenue for it unless there is a probability of 75% to 80% or more that it will not be refunded. 

Assuming the probability of refund is high, you would recognize Dr. Cash 100 / Cr. Refund liability 100 (IFRS 15.55).

IFRS 15 includes additional instructions for estimating the amount if the probability of refund is low, which I won't go into.

If the customer buys the product Dr. Cash 900, Refund liability 100 / Cr. Revenue 1000.

If the amount is refunded, Dr. Refund liability 100 / Cr. Cash 100

Best

RM

Submitted by accounts.admin on Fri, 06/03/2022 - 17:33

Hi Mladek, thanks for your quick answer.

To clarify what I meant by creditable is that the demo fee can be deducted from the purchased price of the product (in the future). I think it could be considered as a voucher (Working in french here, so my English is not 100% accurate), and like you said it's non-refundable.

I see 2 different ways the situation could be approached :
1) refund probability low: demo fee is considered as revenue right away (like in your first example):
(+)it's easy to implement/(-)provision for discount is not tracked

2) refund (equivalent to a reduction on the product sale price?) probability high: demo fee is considered as a voucher that expires after 90 days, it's being used on the purchase of a product. Revenue for the demo fee is taken on the sale of the product, or when the voucher expires (similar to your second example except for the situation when the voucher expires it's not refunded) :
(+)Track provision for discount/(-) harder to implement

If I take your second scenario does it make sense to do it this way:
1) (Moment of Demo ) Dr. Cash 100 / Cr. Voucher's liability 100
2a) (Purchased of Product) Dr. Cash 900, Voucher's liability 100, Revenue.Product.Ajustement 100 / Cr. Revenue.Product 1000, Revenue.Services 100
2b) (Expiration of voucher) Dr. Voucher's liability 100 / Cr. Revenue.Services 100

Kinda feels weird not to record revenues at the moment of the demo, but could this be an acceptable solution?

Best,

VP

Submitted by Mladek on Fri, 06/03/2022 - 20:07

Hello,

If it is never refunded, the "demo" revenue is revenue when received.

If it is (or may be) refunded, it is not revenue when received (unless the probability of refund is less than approximately 25%). 

It only becomes revenue after it is no longer refundable (the 90 day period expires).

Unfortunately, your suggested entry: 2a) Dr. Cash 900, Voucher's liability 100, Revenue.Product.Ajustement 100 / Cr. Revenue.Product 1000, Revenue.Services 100 double counts some revenue (resulting in 1,100 in total).

If you eliminate the Revenue.Product.Ajustement 100 and Revenue.Services 100 accounts, the entry should be OK (unless the Revenue.Product.Ajustement and Revenue.Services accounts are offset and not reported, in which case it does not really make any difference).

In any event, total revenue should be 1,000.  The 100 associated with the (non-refundable) voucher is recognized immediately, the remaining 900 when the product is sold.

Submitted by accounts.admin on Sat, 06/04/2022 - 00:59

Hi,
Sorry for being insistent but I really want to be sure I get this, I think we are almost there.

No reasonable expectation to refund demo fee = non-refundable, revenue should be recognized at the moment of the demo (It seems like it's not possible to record a liability doing it this way?)
Revenue.Product.Ajustement is an offset account to Revenue.Product (I really like offset accounts)
Revenue.Services is a normal revenue account
1000 in total revenue (situation 2a)
100 in total revenue (situation 2b)

Could this situation be similar to a client buying a gift card (instead of him paying for a service)?
How to make the entry for a gift card?
- Revenue account needs to be credited at the sale of the gift card since it's non-refundable.
- Liability account needs to be credited, nature of gift card.
These seem to be in opposition

Thanks,

VP

Submitted by Mladek on Sat, 06/04/2022 - 09:57

no problem. 

Let me try again,

If you were transferring the product to the customer, the contract includes two distinct deliverables: 1. Allowing the customer to use the product during the demo period 2. Standing ready to sell the product if the customer decides to buy.

Specifically, IFRS 15.27 a good or service (a.k.a. performance obligation, deliverable or promise) is distinct if: a. the customer can benefit from the good or service on its own and b. the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.

Since the customer can benefit from the use the asset during the demo period, this deliverable is distinct from promise to stand ready to sell the product.

Now, if you did not transfer the asset to the customer, the contract would only have one deliverable: standing ready to sell the product. In this scenario, the customer is in effect paying the 100 for your promise to stand ready so it would be comparable to a voucher.

If the demo fee is non-refundable, it should be recognized as revenue when received from the customer.

If the demo fee is refundable but the probability of refund is low (the probability that the customer will not receive a refund is high) you could also recognize the revenue when the demo fee is paid by the customer.

This probability can be determined by looking at historical transactions.  If, in the past, customers ended up buying the product 75% to 80% of the time, it is highly probable the fee will not be refunded.

In either case (fixed or highly probable), the 100 fee can be recognized as revenue when received from the customer. 

The only way you should recognize a liability in the scenario you describe is if it is 25% or more probable the customer will demand a refund of the fee.

In this case you would recognize cash 100 / refund obligation 100 in period one and (if the customer bought) cash 900, refund obligation 100 / revenue 1000 in period two.

However, as you state the demo fee is non-refundable, this would not be consistent with IFRS guidance since, being non-refundable, makes the demo fee fixed.

However, since IFRS focuses on reporting not accounting, if you really, really want to recognize a liability in period one, and then offset it in period two, it would not be a violation of IFRS as long as 100 net revenue is reported on the P&L in period one and 900 net revenue is reported on the P&L in period two.

What would be a problem would be if 0 revenue was reported in period one and 1000 in period two.  That would not be consistent with IFRS guidance, because it does not fit with the scenario you describe.

Much worse would be if 100 revenue was reported in in period one and 1000 in period two.  That would be a gross violation of IFRS under any conceivable scenario.

Submitted by accounts.admin on Mon, 06/13/2022 - 21:43

Ok, thank you for the explanation.

The demo is just 1h, the tech show up with the product, takes some measurements, explains how it work, then we make a quote for the product and wait for the PO.
Since there is no transfer of assets and the client won't be able to benefit from the product, I will apply scenario b.

"Now, if you did not transfer the asset to the customer, the contract would only have one deliverable: standing ready to sell the product. In this scenario, the customer is paying the 100 for your promise to stand ready so it would be comparable to a voucher: cash 100 / liability 100 (this liability is not, technically, a refund liability IFRS 15.55, but rather a provision IAS 37)."

Best,

VP

Submitted by Mladek on Tue, 06/14/2022 - 06:17

Hello,

To do it as simply as possible:

fee non-refundable: 100 revenue and cash recognized when the customer pays the fee. 900 revenue and cash when the customer buys the product

 

fee refundable: 100 refund liability and cash recognized when the customer pays the fee.

1000 revenue 900 in cash or receivable and 100 refund liability when the customer buys the product.

 

No revenue should be recognized when the customer pays the fee if it is refundable unless there is practically no chance it will be refunded.

That would be consistent with IFRS.

 

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