Receivables & Revenue Text

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Goods (point of time)

Credit sale

1/1/X1, XYZ delivered 10 units of product #123 to ABC and issued invoice #456 payable in 30 days. Product #123 costs 500 to produce and commonly sells for 1,000 per unit.

Dr/Cr

1/1/X1 / 1.1.X1
Trade receivable: ABC: #456		10,000
Cost of goods sold		5,000
	Revenue		10,000
	Inventory: Finished goods: #123		5,000

 

1/31/X1 / 31.1.X1
Cash		10,000
	Trade receivable: ABC: #456		10,000

Cash and charge card sales

1/1/X1, XYZ sold merchandise for 1,000 to a customer who paid cash.

Dr/Cr

1/1/X1 / 1.1.X1
Cash		1,000
Cost of goods sold		500
	Revenue		1,000
	Inventory: Merchandise		500

 

Same facts except the customer paid with a credit card. Credit card sales clear in two days.

1/1/X1 / 1.1.X1
Receivable from bank: Credit card sales		987
Cost of goods sold		500
Selling expenses: Credit card fees		3
	Revenue		1,000
	Inventory: Merchandise		500

 

1/3/X1 / .1.X1
Cash		987
	Receivable from bank: Credit card sales		987

 

Same facts except the customer paid with a debit card. Debit cards are subject to lower charges and clear the same day. XYZ uses a separate bank account (#123) for debit card sales.

1/1/X1 / 1.1.X1
Cash: Account 123		988
Cost of goods sold		500
Selling expenses: Debit card fees		2
	Revenue		1,000
	Inventory: Merchandise		500

Services (point of time vs. over time)

Specific performance (point of time)

XYZ provides equipment repair services. It applies a 100% markup to parts and labor to determine the price for those services.

1/1/X1, it accepted a repair and the same day a technician spent 1 hour (at 20 per hour) diagnosing the malfunction. Once the customer accepted the price and committed to the repair, an additional 4 hours (at 20 per hour) over the next two days were spent replacing parts that had cost 50.

1/4/X1, the customer picked up the repair and paid in cash.

Dr/Cr

1/4/X1 / 4.1.X1
Cash		300
Cost of services rendered		150
	Revenue		300
	Accrued wages and salaries		100
	Inventory: Spare parts		50

 

In general usage, cost of sales (COS) comprises: cost of goods sold (COGS), cost of merchandise sold and cost of services rendered.

FASB XBRL includes both a CostOfRevenueAbstract and CostOfGoodsAndServicesSoldAbstract. It also includes various items including: CostDirectMaterial, CostDirectLabor, CostOfGoodsAndServicesSoldOverhead, CostMaintenance, CostOfGoodsAndServicesSoldDepreciation, CostOfGoodsAndServicesSoldAmortization CostDepletion, etc.

IASB XBRL function of expense includes just CostOfSales while nature of expense includes CostOfMerchandiseSold and CostOfPurchasedEnergySold.

Receivable

For short duration services, it is common practice to recognize revenue when payment is received. Nevertheless, a service provider should recognize revenue when the service is completed if payment is probable.

As outlined in IFRS 15.31 | ASC 606-10-25-23, an entity recognizes revenue when (as) it transfers control of the promised service to the customer. As outlined in IFRS 15.35.b | ASC 606-10-25-27.b, the entity transfers control if its performance creates or enhances an asset controlled by the customer.

As the repair enhanced the customer's equipment, XYZ recognized revenue when it completed the repair.

Probability of payment (50% + IFRS | 75% + US GAAP) is one of several conditions that must be met for a contract with a customer to be recognized.

IFRS 15.9 | ASC 606-10-25-1 outlines 5 conditions to be met before a contract can be recognized.

Among them (sub-paragraph e), it must be probable that the entity will collect the consideration to which it will be entitled.

Same facts, except XYZ completed the repair on 12/28/X1 and the customer picked up the equipment on 1/2/X2.

12/28/X1 / 28.12.X1
Accounts receivable (Unbilled revenue)		300
Cost of services rendered		150
	Revenue		300
	Accrued wages and salaries		100
	Inventory: Spare parts		50

 

Instead of a receivable or contract asset, an unbilled revenue account can be used.

IFRS 15.105 | ASC 606-10-45-1 states (edited): ...An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 states (edited): ...A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due...

IFRS 15.107 | ASC 606-10-45-3 states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset...

As written, the guidance in IFRS 15.105 to 109 | ASC 606-10-45-1 to 5 gives two options.

IFRS 15.105 | ASC 606-10-45-1 states (emphasis added): When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 explains (edited, emphasis added): A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

Applied to this example, since XYZ has performed and the only condition associated with its right to consideration (the customer’s payment) is having to wait a period of time, it should present a receivable, not a contract asset.

However, IFRS 15.107 | ASC 606-10-45-3 also states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset, excluding any amounts presented as a receivable.

In practice, “before payment is due” is often interpreted to mean that the company has not only performed (transferred goods, rendered services) but has also billed (issued an invoice).

Using a separate, unbilled revenue account gives companies an option to cover the situation where they have performed but not yet billed.

At the end of the period, the unbilled revenue account can be taken directly to the balance sheet.

Although the ASC does not address unbilled revenue, FASB XBRL includes UnbilledRevenuesMember and UnbilledReceivablesCurrent. It defines the latter: "Amount received for services rendered and products shipped, but not yet billed, for non-contractual agreements due within one year or the normal operating cycle, if longer."

Although the IASB XBRL does not include a similar item, it may be extended to do so.

At the end of the period, the unbilled revenue account can be presented as a sub-classification of contract assets or receivables depending on if the right to consideration is conditional or not.

This option is especially useful for companies domiciled in (or with subsidiaries domiciled in) jurisdictions where national GAAP and/or tax law outlines different rules.

In some jurisdictions, besides IFRS and/or US GAAP, entities must apply statuary accounting (a.k.a. national GAAP). For example, in the European union two separate accounting systems exist:

IFRS (required by the IAS regulation) and national GAAP (required by the accounting directive).

While IFRS is used for financial reporting, national GAAP is often used for taxation. For example, in the Czech Republic, while IFRS is required for financial reporting purposes, it may not be used as the basis for determining taxable income, which means the two must be reconciled at the end of each period.

Using an account like unbilled revenue is helpful because it can (if the right is unconditional) be presented as a receivable for IFRS reporting purposes and as accrued revenue for statutory reporting purposes (Czech national GAAP only allows receivables to be recognized if a formal invoice has been issued).

1/2/X2 / 2.1.X2
Cash		300
	Accounts receivable		300

 

Same facts except XYZ completed the diagnostic work on 12/28/X1, but began the repair work 1/1/X2.

As outlined in IFRS 15.92 | ASC 340-40-25-2, incremental costs of obtaining a contract are costs an entity incurs to obtain a contract ... (for example, a sales commission).

In this example, the contract was for a repair service and the diagnostic work was performed to gain that contract. It was, as a result, akin to a sales commission.

As outlined in IFRS 15.91 | ASC 340-40-25-1, an entity may only capitalize incremental costs if it expects to recover them.

In this example, XYZ concluded it was probable the customer would pay for the repair. Since this meant the cost was recoverable, XYZ capitalized it.

12/28/X1 / 28.12.X1
Inventory : WIP: Initial direct costs		20
	Accrued wages and salaries		20

 

Neither IFRS 15.91 to 94 nor ASC 340-40-25-1 to 4 specify how companies should recognize costs to obtain a contract, only that they recognize them as assets.

Some companies prefer to recognize them as work in process, others as accruals.

Either approach would be consistent with the guidance provided by the standards.

On 12/31/X1, the customer refused the repair but was still obligated to pay for the diagnostic work.

12/31/X1 / 31.12.X1
Cash		40
Cost of services rendered		20
	Revenue		40
	Inventory : WIP: Initial direct costs		20

 

Same facts except the customer refused the repair but was not obligated to pay for the diagnostic work.

12/31/X1 / 31.12.X1
Impairment loss (unrecovered costs of obtaining a contract)		20
	Inventory : WIP: Initial direct costs		20

 

As outlined in IFRS 15.91 | ASC 340-40-25-1, an entity capitalizes incremental costs of obtaining a contract if it expects to recover them.

In this example, XYZ initially determined it was probable the customer would pay for the repair, so it capitalized the cost.

Consequent, when it did not recover the cost, it recognized an impairment loss as outlined in IFRS 15.101 to 104 | ASC 340-40-35-3 to 6.

Note: unlike IFRS 15.104, ASC 340-40-35-6 does not allow impairment charges to be subsequently reversed.

Same facts except it was not probable the customer would pay for the repair.

12/28/X1 / 28.12.X1
Expenses: Selling (potentially unrecoverable costs of obtaining a contract)		20
	Accrued wages and salaries		20

 

As outlined in IFRS 15.91 | ASC 340-40-25-1, an entity may only capitalize an incremental cost of obtaining a contract if it expects to recover it.

In this example, XYZ performed the diagnostic work even though it was not probable the customer would contract for the repair.

The reason it performed the work was in the hope that the customer would contract for the repair.

Consequently, the cost incurred performing the diagnostic was analogous to a sales commission.

Full absorption costing

Although full absorption costing is required by IFRS and US GAAP, many companies, especially service providers, would prefer, for simplicity, to recognize only direct costs.

Full absorption costing (a.k.a. absorption costing or full costing) captures all of the costs that go into manufacturing a product (or providing a service).

These costs are subclassified as direct and indirect (a.k.a. overhead).

Direct costs are be further subclassified as direct material and direct wages while overhead as fixed (rent, depreciation, amortization, insurance, etc.) and variable (supervisor salaries, production supplies, utilities, quality control, repairs and maintenance, etc.)

Fixed does not necessarily mean linear.

For example, depreciation calculated using a diminishing balance method is still considered fixed. The difference between fixed and variable is that the latter correlates with production levels while the former does not.

Some overhead costs are, by their nature, always variable. For example the coke used to smelt iron or electricity used to power production machines.

Other overhead costs, for example supervisor salaries or maintenance, can be either fixed or variable (or a combination) depending on how they are determined.

For example, some companies compensate supervisors with fixed salary, others a wage, while still others combine a salary with bonuses when, for example, a production spike calls for extra hours.

Maintenance of production machinery is usually variable, while maintenance of production structures tends to be fixed.

Quality control (of products) tends to be variable, while quality inspection (of production processes) tends to be fixed.

Waste removal is also often fixed, but can become variable when extra production leads to extra trash.

The proper allocation of overheads thus requires both judgment and an accounting system sufficiently flexible to cope with the variations.

While neither IFRS nor US GAAP use the term “full absorption costing” both require its use.

IAS 2.10: The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

IAS 2.12 (edited): ... [costs of conversion] include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings, equipment and right-of-use assets used in the production process, and the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour.

While US GAAP guidance is (intentionally) less instructive, its requirements are comparable.

ASC 330-10-30-2 (emphasis added): Although principles for the determination of inventory costs may be easily stated, their application, particularly to such inventory items as work in process and finished goods, is difficult because of the variety of considerations in the allocation of costs and charges.

ASC 330-10-30-1 (edited, emphasis added): The primary basis of accounting for inventories is cost... As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location. It is understood to mean acquisition and production cost, and its determination involves many considerations.

ASC 330-10-30-3 (edited, emphasis added): For example, variable production overheads are allocated to each unit of production on the basis of the actual use of the production facilities. However, the allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facilities...

This approach would only be consistent with IFRS and US GAAP if adjustments, allocating indirect costs (overhead) to cost of sales, were made at the end of each reporting period (see: Inventory / Direct costing for an example).

However, it is also possible to recognize overhead during the period.

XYZ allocates overhead at 20% of parts and labor.

1/4/X1 / 4.1.X1
Cash		300
Cost of services rendered		180
	Revenue		300
	Accrued wages and salaries		100
	Inventory: Spare parts		50
	Inventory: WIP: Unallocated overhead		30

In this example, overhead is recognized as work in process using an Unallocated overhead account.

The same result can be reached using an accrual account.

During the period, XYZ recognizes overhead costs to the Unallocated overhead account.

For example:

1/1/X1, XYZ paid January rent and made an advance payment on first quarter electricity.

1/1/X1 / 1.1.X1
Inventory: WIP: Unallocated overhead (rent)		1,500
Inventory: WIP: Unallocated overhead (pre-paid electricity)		500
	Cash		2,000

2/1/X1, it paid supervisor salaries.

2/1/X1 / 1.2.X1
Inventory: WIP: Unallocated overhead (supervisor salaries)		2,500
	Cash		2,500

31/3/X1, it paid for natural gas used during the first quarter (in arrears) and recognized Q1 depreciation.

3/31/X2 / 31.3.X2
Inventory: WIP: Unallocated overhead (gas consumed)		250
Inventory: WIP: Unallocated overhead (depreciation)		3,000
	Cash		250
	Accumulated depreciation		3,000

At the end of the period, unallocated overhead is reported on the balance sheet as either an asset or liability depending on its balance.

If it is reported as an asset, it can be presented as a sub-classification of work in process or in accruals as a pre-paid expense. If it is a liability, it would be presented as an accrued expense.

Note: since the procedure is analogous to standard costing (see the Inventory / Standard costing), the allocation of overhead to cost of sales must be periodically reviewed and adjusted to reflect actual costs.

Completed contract (point of time)

XYZ is a freight forwarder. It completes its deliveries with the help of sub-contractors. 12/15/X1, it agreed to ship equipment from Berlin to Sacramento for ABC. ABC paid an advance of 3,000, agreeing to pay an additional 3,000 after it accepted delivery.

12/16/X1, XYZ picked up the equipment, unloading it in Hamburg on 12/17/X1. It incurred direct costs: wages (500), fuel and consumables (400). It also allocated overhead (250) and paid 200 to HIG to insure the delivery. 12/18/X1, the shipment was loaded onto a container ship by HIJ. It was unloaded in Oakland on 1/21/X2. HIJ Charged 2,000 for its services. The same day, GHI completed the delivery charging 750 for its services.

ABC inspected the equipment and accepted the delivery on 1/25/X2. The same day, XYZ issued an invoice for 6,000.

The previous example includes a discussion of overhead allocation.

Acceptance is not a criterion for revenue recognition. Nevertheless, the guidance only allows revenue to be recognized after the contract has been completed.

Both IFRS 15.31 and ASC 606-10-25-23 specify that an entity shall recognize revenue when (or as) it transfers a promised good or service to a customer which is the moment the customer obtains control of that good or service.

The IFRS master glossary defines control as: The present ability to direct the use of the economic resource and obtain the economic benefits that may flow from it.

The US GAAP master glossary includes three definitions:

DEFINITION 1: The possession, direct or indirect, of the power to direct or cause the direction of the management and policies of an entity through ownership, by contract, or otherwise (topics 310, 850).

DEFINITION 2: The direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise (topics 954, 958).

DEFINITION 3: The same as the meaning of controlling financial interest in paragraph 810-10-15-8.

Unfortunately, not one of them applies to goods or services.

The best definition thus comes from the text of IFRS 15.33 | ASC 606-10-25-25:

... Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset. ...

Both IFRS 15.38 and ASC 606-10-25-30 outline "indicators" (a. right to payment, b. legal title, c. physical possession, d. risks and rewards of ownership and e. acceptance) that can be used to determine the exact point of time when control transfers.

However, indicators are not criteria. Control is.

This implies that if a company has transferred control to the customer, it should recognize revenue even if none of the indicators are present.

IFRS 15.35 | ASC 606-10-25-27 specifies that revenue can only be recognized over time if (a) customer simultaneously receives and consumes the benefits or (b) the entity’s performance creates or enhances a customer asset or (c) the entity has an enforceable right to payment for performance completed to date.

While XYZ did receive a payment from the customer, the payment was not compensation for performance, but an advance on future performance.

As outlined in IFRS 15.B9 | ASC 606-10-55-11, an entity must have a right to payment for the performance completed to date even if customer (or some other party) terminated the contract.

Obviously, no contract for a shipping service would require the customer to pay for the shipping service unless shipper delivered. This implies that any advance payment would be returnable and no other enforceable right to payment could exist prior to delivery.

While it is possible the shipper could still get paid, for example if the shipment were insured, such payment would not be from a customer for the service, but from an insurance carrier as an indemnification of losses. It would also, most likely be far exceed the amount that would have been paid for the shipping service and most, if not all, would be paid out to the customer.

As ABC would not receive the benefits until XYZ delivered the goods, as XYZ performance did not enhance any asset until XYZ delivered the goods and as ABC had no obligation to pay unless XYZ delivered the goods, XYZ's performance obligation was satisfied at the point of time it delivered the goods, no sooner.

Dr/Cr

12/15/X1 / 15.12.X1
Cash		3,000
	Deferred service revenue (contract liability)		3,000

 

IFRS 15.105 | ASC 606-10-45-1 specifies that, depending on the relationship between the entity’s performance and the customer’s payment, either a contract asset or a contract liability is presented on the balance sheet.

In practice, when a liability is presented, it is generally labeled as deferred (or unearned) revenue. This practice is reflected in the FASB XBRL where DeferredRevenue comprises ContractWithCustomerLiability and DeferredIncome. While the IASB XBRL does not include similar labels, as it would not contradict IFRS 15's guidance, it can be extended to do so.

12/16/X1 / 16.12.X1
Inventory: Work in process: Contract with ABC		1,250
	Liabilities: Accrued expenses: Wages payable		500
	Inventory: Work in process: Pre-paid fuel and consumables		300
	Inventory: Work in process: Unallocated overhead		250
	Cash (HIG)		200

 

The proper approach is to recognize the costs to fulfill a contract as Inventory: Work in process.

Nevertheless, many service providers prefer to recognize these costs as Accruals: Pre-paid expenses.

While both IFRS 15.97 and ASC 340-40-25-7 specify that the costs to fulfill a contract are to be recognized as assets (capitalized), neither specifies how.

This implies that either approach would be consistent with the guidance provided.

Both IFRS and US GAAP require that overhead be included in costs to fulfill a contract.

IFRS 15.97 | ASC 340-40-25-7 (emphasis added): Costs that relate directly to a contract (or a specific anticipated contract) include any of the following:

(a) direct labour (for example, salaries and wages of employees who provide the promised services directly to the customer);

(b) direct materials (for example, supplies used in providing the promised services to a customer);

(c) allocations of costs that relate directly to the contract or to contract activities (for example, costs of contract management and supervision, insurance and depreciation of tools, equipment and right-of-use assets used in fulfilling the contract);

(d) costs that are explicitly chargeable to the customer under the contract; and

(e) other costs that are incurred only because an entity entered into the contract (for example, payments to subcontractors)

Various methods, such as job costing, direct costing, standard costing can be used (see inventory for examples).

In this example, XYZ chose to allocate overhead using an Unallocated overhead account.

The previous example includes an additional discussion of this procedure.

12/18/X1 / 18.12.X1
Accrued service costs		1,000
	Payable: DEF		1,000

 

1/21/X2 / 21.1.X2
Deferred service revenue		3,000
Unbilled service revenue: ABC		3,000
Cost of sales		4,000
	Service revenue		6,000
	Inventory: Work in process: Contract with ABC		1,250
	Payable: HIJ		2,000
	Payable: GHI		750

 

Instead of a receivable or contract asset, this example uses an unbilled revenue account.

IFRS 15.105 | ASC 606-10-45-1 states (edited): ...An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 states (edited): ...A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due...

IFRS 15.107 | ASC 606-10-45-3 states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset...

As written, the guidance in IFRS 15.105 to 109 | ASC 606-10-45-1 to 5 gives two options.

IFRS 15.105 | ASC 606-10-45-1 states (emphasis added): When either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. An entity shall present any unconditional rights to consideration separately as a receivable.

IFRS 15.108 | ASC 606-10-45-4 explains (edited, emphasis added): A right to consideration is unconditional if only the passage of time is required before payment of that consideration is due.

Applied to this example, since XYZ has performed and the only condition associated with its right to consideration (the customer’s payment) is having to wait a period of time, it should present a receivable, not a contract asset.

However, IFRS 15.107 | ASC 606-10-45-3 also states (edited, emphasis added): If an entity performs by transferring goods or services to a customer before the customer pays consideration or before payment is due, the entity shall present the contract as a contract asset, excluding any amounts presented as a receivable.

In practice, “before payment is due” is often interpreted to mean that the company has not only performed (transferred goods, rendered services) but has also billed (issued an invoice).

Using a separate, unbilled revenue account gives companies an option to cover the situation where they have performed but not yet billed.

At the end of the period, the unbilled revenue account can be taken directly to the balance sheet.

Although the ASC does not address unbilled revenue, FASB XBRL includes UnbilledRevenuesMember and UnbilledReceivablesCurrent. It defines the latter: "Amount received for services rendered and products shipped, but not yet billed, for non-contractual agreements due within one year or the normal operating cycle, if longer."

Although the IASB XBRL does not include a similar item, it may be extended to do so.

At the end of the period, the unbilled revenue account can be presented as a sub-classification of contract assets or receivables depending on if the right to consideration is conditional or not.

This option is especially useful for companies domiciled in (or with subsidiaries domiciled in) jurisdictions where national GAAP and/or tax law outlines different rules.

In some jurisdictions, besides IFRS and/or US GAAP, entities must apply statuary accounting (a.k.a. national GAAP). For example, in the European union two separate accounting systems exist:

IFRS (required by the IAS regulation) and national GAAP (required by the accounting directive).

While IFRS is used for financial reporting, national GAAP is often used for taxation. For example, in the Czech Republic, while IFRS is required for financial reporting purposes, it may not be used as the basis for determining taxable income, which means the two must be reconciled at the end of each period.

Using an account like unbilled revenue is helpful because it can (if the right is unconditional) be presented as a receivable for IFRS reporting purposes and as accrued revenue for statutory reporting purposes (Czech national GAAP only allows receivables to be recognized if a formal invoice has been issued).

As outlined in IFRS 15.B84 | ASC 606-10-55-86, acceptance is a formality provided that an entity can objectively determine it transferred control to the customer as per the terms outlined in the contract.

1/25/X2 / 25.1.X2
Account Receivable: ABC		3,000
	Unbilled service revenue: ABC		3,000

Additional issues

Value added tax

Neither IFRS nor US GAAP provides any specific guidance for VAT (GST).

The US does not have a value added tax, so it would be pointless for US GAAP to address it.

IFRS, as the acronym suggests, is international and, internationally, not every jurisdiction has a VAT or GST.

Besides, the guidance provided by IFRS can be applied to any tax, including VAT.

This point was (implicitly) made by the IFRIC when it considered adding VAT (in the context of cash flows and leases) to its agenda, but decided against it (link - iasplus).

VAT does, however, appear in both IFRS and US GAAP XBRL.

ValueAddedTaxReceivables and ValueAddedTaxPayables in IFRS XBRL and ValueAddedTaxReceivable in US GAAP XBRL.

However, neither the descriptions (The amount of receivables related to a value added tax; The amount of payables related to a value added tax; and Carrying amount as of the balance sheet date of value added taxes due either from customers arising from sales on credit terms, or as previously overpaid to tax authorities) nor references (IAS 1.78.b and ASC 210-10-S99-1) are particularly useful.

In an interesting side note, while IFRS XBRL at least acknowledges that VAT can be either a payable or a receivable, US GAAP XBRL only has a receivable, illustrating the general lack of appreciation of how VAT actually works, not only in the US practitioner community, but also among US standard setters.

Value added tax (VAT) is applied throughout the European Union while Goods and services tax (GST) is applied in countries such as Canada, South Africa or India.

In short, VAT is a multiple-step sales tax.

VAT legislation can be complex and vary from jurisdiction to jurisdiction.

Consequently, this example is no substitute for a detailed study of the pertinent regulations.

Transactions between payors:

When a VAT "payor" (a company registered to collect VAT) sells goods or services to another payor in the same jurisdiction, it issues a VAT invoice (a.k.a. "tax document").

It thus collects the VAT on behalf of the taxation authority.

When a payor buys from another payor in the same jurisdiction, it receives a tax document and so pays VAT to that other payor (who collects it on behalf of the taxation authority).

If a payor buys from a non-payor, the non-payor issues a regular invoice without VAT.

Non-payors are small enterprises or individuals who have not crossed the threshold for VAT registration or registered voluntarily.

At the end of the period, generally month or quarter, each payor offsets VAT received against VAT expended and pays (the reason they are called a payors) the difference to the taxation authority or claims a refund.

Cross border transactions work differently.

When a payor sells to a payor in a different jurisdiction, it issues a "reverse charge" invoice without VAT.

While reverse charge most often applies to cross broader transactions to limit so called missing trader (a.k.a. MTIC or carousel) fraud, some jurisdictions also require reverse charge in selected domestic transactions.

Thus the buyer, not seller, is obligated to pay the VAT to its domestic taxation authority.

However, as a VAT payor may also claim a deduction, the effect is zero net tax.

VAT is not deductible in every situation. The issue was discussed by the IFRIC in the context of IFRS 17 (link - ifric).

Transactions with non-payors:

When a payor sells to a domestic non-payor (a consumer or entity not registered as a VAT payor), it proceeds in the same manner as with a payor and issues a tax document including VAT.

In some jurisdictions, VAT payors are obligated to report both sales to and purchases from other VAT payors. These reports generally include VAT ID number, invoice number and amount.

Some jurisdictions require reports on all sales, including cash sales, regardless of whether they are to payors or non-payors, though this requirement can be based on different tax legislation.

Such reports do not, however, change the amount of VAT paid or refunded.

The difference, as the non-payor cannot claim a VAT refund, the remitted tax stays with the taxation authority.

However, when a payor sells to a non-payor in a different jurisdiction (cross boarder), it is generally obligated to remit VAT not its own taxation authority, but the taxation authority in the jurisdiction where the non-payor is domiciled.

This implies that companies selling across borders generally need to register as payers in each country where they have non-payor customers, though there are exceptions.

This page outlines current EU VAT requirements and exceptions: link - europa.

See (link - gocardless) for a discussion of VAT vs. GST.

The following examples simply illustrate how VAT could be treated in an IFRS | US GAAP context.

12/14/X1, XYZ purchased goods for 5,000 from ABC. 12/15/X1, it sold goods for 10,000 to DEF. In its jurisdiction, the VAT rate is 21% and the balance must be remitted to the tax collection authority no later than the 25th day of the month following the transaction or event.

12/14/X1 / 14.12.X1
Inventory		5,000
Tax other than income: Q4 VAT		1,050
	Accounts payable: ABC		5,000
	Accrued liabilities: VAT: ABC		1,050

 

Procedurally, the same account is used for both sales and purchases in that, at the end of the taxation period, the balance is either remitted to or refunded by the taxation authority.

Note: as VAT is generally refundable, it cannot be included in the measurement of assets or expenses. However, in situations where it is not refundable, it would be treated in the same manner as a sales or excise tax.

Also note: In IFRS XBRL, VAT is presented as a sub-classification of taxes other than income (illustrating the experience international standard setters have with VAT).

In US GAAP XBRL, VAT only appears as a subclassification of non-trade receivables (illustrating the opposite).

Both IFRS and US GAAP XBRL suggest that VAT should be presented as other or non-trade receivables/payables. However, since VAT is a tax, we at ifrs-gaap.com would much rather recognize it as an accrual to keep it as far away from receivables/payables as possible.

This is the VAT to be remitted to suppliers.

As it is not consideration for goods or services acquired, it should not be classified as an account payable.

12/15/X1 / 15.12.X1
Accounts receivable: DEF		10,000
Accrued assets: VAT: DEF		2,100
	Revenue		10,000
	Tax other than income: Q4 VAT		2,100

 

Both IFRS and US GAAP XBRL suggest that VAT should be presented as other or non-trade receivables/payables. However, since VAT is a tax, we at ifrs-gaap.com would much rather recognize it as an accrual to keep it as far away from receivables/payables as possible.

Under IFRS and US GAAP, revenue is clearly measured net of VAT.

IFRS 15.47 | ASC 606-10-32-2 state: ... The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties ...

While IFRS 15.47 | ASC 606-10-32-2 does not mention VAT by name, it clearly alludes to it, which becomes clear when the reasoning behind the paragraph is examined.

In IFRS 15 BC187 | ASC 606 BC187 the boards state: The boards also clarified that the amounts to which the entity has rights under the present contract can be paid by any party (ie not only by the customer). ... However, it would not include amounts collected on behalf of another party such as some sales taxes and value added taxes in some jurisdictions.

Likewise, in IFRIC 21.BC6 the IFRIC states: ... Amounts that are collected by entities on behalf of governments (such as value added taxes) and remitted to governments are not outflows of resources embodying economic benefits for the entities that collect and remit those amounts. ...

Further, to address concerns of US practitioners who feared that ASC 606-10-32-2 would require them to evaluate VAT on a jurisdiction-by-jurisdiction basis, the FASB amended ASC 606.

In ASU_2016-12 it added ASC 606-10-32-2A: An entity may make an accounting policy election to exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue producing transaction and collected by the entity from a customer (for example, sales, use, value added, and some excise taxes). Taxes assessed on an entity’s total gross receipts or imposed during the inventory procurement process shall be excluded from the scope of the election. An entity that makes this election shall exclude from the transaction price all taxes in the scope of the election and shall comply with the applicable accounting policy guidance, including the disclosure requirements in paragraphs 235-10-50-1 through 50-6.

As a result, companies applying US GAAP need not evaluate VAT and similar taxes country by country, but can exclude all VAT and similar taxes from the measurement regardless of where they are received or paid.

For its part, the IASB concluded that companies applying IFRS internationally are accustomed to evaluating jurisdictions separately, have no trouble distinguishing principal from agent and so did not feel the need for a similar policy election.

The reason is that VAT is not an economic resource controlled by the company that collects it, but by the tax collection authority on whose behalf it is collected.

In other words, a company that collects VAT from its customers is acting an agent, collecting the tax on behalf of government.

Obviously, this only applies to VAT payors.

Companies, for example health care providers in some jurisdictions, do not collect VAT from their customers. Thus, since they are not agents of the government, they treat the VAT they pay to suppliers as a sales tax, which they include in the acquisition cost of assets / measurement of expenses.

Less clear, in the eyes of some (primarily IFRS ) accountants, is whether this also applies to the receivable.

For accountants that apply US GAAP outside of the United States, this generally is a non-issue. While a few exceptions exist, practically all US GAAP companies disaggregate VAT from both the transaction price and the receivable.

In other words, since VAT is commonly recognized as part of a receivable / payable per national GAAP, accountants accustomed applying such a GAAP would very much like to use the same procedure for IFRS | US GAAP purposes.

However, IFRS 15.108 | ASC 606-10-45-4 clearly states: A receivable is an entity's right to consideration ...

While IFRS and US GAAP do not specifically define "consideration", its meaning is generally understood to be the reward a company receives in exchange for delivering goods / rendering services, or whatever else it promises in a contract.

Interestingly, while both US GAAP and IFRS use the term consideration, neither define it.

This is not because its general meaning is unclear: it is the cash (or something of value like shares) paid in a transaction for something else of value (a product, service or, in this case, a company).

It is because its precise meaning is surprisingly difficult to pin down.

For example, entering "consideration" into Black's online law dictionary (link: thelawdictionary.org) brings up a blank page while Britannica (link: britannica.com), although it does define it, quickly goes off on a tangent about, among other things, love and affection.

... This definition, however, leaves unanswered the question of what is sufficient consideration. During certain periods of history, nominal consideration was held to be sufficient—even a cent or a peppercorn. Gradually, the courts came to require that the consideration be valuable, although not necessarily equal in value to what is received. The courts have had to decide specifically whether acts of forbearance on the faith of a promise, the giving of a counterpromise, money payments, preexisting duties to the promisor, preexisting duties to third parties, moral obligations, love and affection, surrender of another legal claim, or performance of a legal duty were sufficient, and the answer has varied considerably over time...

Fortunately, a quick google search (link: google.com) quickly brings up perhaps the best definition "Consideration is a promise, performance, or forbearance bargained by a promisor in exchange for their promise. Consideration is the main element of a contract. Without consideration by both parties, a contract cannot be enforceable." (link: law.cornell.edu).

US GAAP comes closest defining:

Cash Consideration

Cash payments and credits that the customer can apply against trade amounts owed to the vendor. In addition, as indicated in Section 718-10-25, consideration in the form of share-based payment awards is recognized in the same period or periods and in the same manner (that is, capitalize versus expense) as if the entity had paid cash for the goods or services instead of paying with or using the share-based payment awards. Accordingly, guidance with respect to cash consideration is applicable to consideration that consists of equity instruments.

Consideration in the Contract

See paragraph 842-10-15-35 for what constitutes the consideration in the contract for lessees and paragraph 842-10-15-39 for what constitutes consideration in the contract for lessors.

ASC: 842-10-15-35 The consideration in the contract for a lessee includes all of the payments described in paragraph 842-10-30-5, as well as all of the following payments that will be made during the lease term:

a. Any fixed payments (for example, monthly service charges) or in substance fixed payments, less any incentives paid or payable to the lessee, other than those included in paragraph 842-10-30-5

b. Any other variable payments that depend on an index or a rate, initially measured using the index or rate at the commencement date.

Since a company cannot retain the VAT it collects, it is not, and cannot be, a reward.

If anything, VAT is a government's reward for allowing companies to deliver goods / render services in its territory.

This implies that recognizing VAT as a receivable is not consistent with the logic behind IFRS or US GAAP even when it does not, technically, violate its letter.

Provided an entity clearly reports receivables from contracts with customers (as defined by IFRS 15.108 | ASC 606-10-45-4) separately from other "receivables", its reporting would not be inconsistent with the letter of IFRS and US GAAP (nor with their respective XBRL taxonomies).

Nevertheless, indicating that taxes like VAT are similar to accounts receivable or accounts payable could never be called good accounting.

Procedurally, the same account is used for both sales and purchases in that, at the end of the taxation period, the balance is either remitted to or refunded by the taxation authority.

Note: as VAT is generally refundable, it cannot be included in the measurement of assets or expenses. However, in situations where it is not refundable, it would be treated in the same manner as a sales or excise tax.

Also note: In IFRS XBRL, VAT is presented as a sub-classification of taxes other than income (illustrating the experience international standard setters have with VAT).

In US GAAP XBRL, VAT only appears as a subclassification of non-trade receivables (illustrating the opposite).

1/14/X2 / 14.1.X2
Cash		12,100
	Accounts receivable: DEF		10,000
	Accrued assets: VAT: DEF		2,100

 

1/15/X2 / 15.1.X2
Accounts payable: ABC		5,000
Accrued liabilities: VAT: ABC		1,050
	Cash		6,050

 

12/31/X1 / 31.12.X1

 

XYZ Balance sheet 12/31/X1 / 31.12.X1
Current assets*
	Trade receivables	10,000
	Accrued assets: VAT	2,100
Current liabilities*
	Trade payables	5,000
	Accrued liabilities: VAT	1,050
	Taxes other than income: Net VAT	1,050
* Only the pertinent items are presented.

 

1/25/X2 / 25.1.X2
Tax other than income: Q4 VAT		1,050
	Cash		1,050

 

For illustration purposes, only the VAT remittance associated with the two transactions is presented.

Alternatively

Habits die hard and bad habits die hardest.

As a result, in countries where national GAAP recognizes gross receivables, accountants would like to do this:

12/14/X1 / 14.12.X1
Inventory		5,000
Value added tax		1,050
	Accounts payable: ABC		6,050

 

12/15/X1 / 15.12.X1
Accounts receivable: DEF		12,100
	Revenue		10,000
	Value added tax		2,100

 

While hardly good accounting, provided that the receivable and VAT are clearly segregated on the balance sheet, it would not be an error.

Provided an entity clearly reports receivables from contracts with customers (as defined by IFRS 15.108 | ASC 606-10-45-4) separately from other "receivables", its reporting would not be inconsistent with the letter of IFRS and US GAAP (nor with their respective XBRL taxonomies).

Nevertheless, indicating that taxes like VAT are similar to accounts receivable or accounts payable could never be called good accounting.

Proper segregation is also in a company's best interest.

If users fail to notice that VAT and receivables are separate items, they could conclude that the company has trouble collecting on time.

For example, if XYZ had annual revenues of 120,000 and users calculated days of sales outstanding using the gross receivable, the ratio would appear to be 36.3 days, not the 30 days it actually is.

36.3 = 12,100 ÷ 120,000 x 360

Reverse charge

Same facts except ABC was an international supplier.

Since reverse charge sales are VAT free, VAT is often recognized only in reverse charge purchases.

However, reverse charge sales generally need to be reported to the taxation authority even when they are not given accounting recognition.

12/14/X1 / 14.12.X1
Inventory		5,000
Tax other than income: Q4 VAT		1,050
	Accounts payable: ABC		5,000
	Tax other than income: Q4 VAT		1,050

 

In the VAT report filed with the taxation authority, the asset and liability would be reported as separate items. Consequently, many companies keep separate accounts for VAT assets and VAT liabilities.

For IFRS | US GAAP purposes, since the amounts are offset, they would not be reported, so it makes no difference how or if they are given accounting recognition.

Also note, in some jurisdictions, all reverse charge transactions must be reported. In some jurisdictions, only transactions over a set amount. In some, jurisdiction just sales transactions. In some jurisdictions, multiple reports require the reporting of the same transactions (just on different forms and at different times). These reports generally include the VAT #, invoice # and amount.

This example is no substitute for knowledge of the specific requirements of each jurisdiction.

Advance payment

Same facts except DEF paid an advance and XYZ delivered the product 1/31/X2.

VAT is generally due when consideration is received (as in this example) or receivable (previous examples).

12/15/X1 / 15.12.X1
Cash		12,100
	Deferred revenue		10,000
	Tax other than income: Q4 VAT		2,100

 

1/25/X2 / 25.1.X2
Tax other than income: Q4 VAT		2,100
	Cash		2,100

 

For illustration purposes, only the VAT remittance associated with this transaction is presented.

1/31/X2 / 31.1.X2
Deferred revenue		10,000
	Revenue		10,000

Related parties

IFRS and US GAAP give substantially different related party guidance.

IFRS requires disclosure of related parties even if there have been no transactions and the entities are consolidated.

Edited, emphasis added: IAS 24.3: This Standard requires disclosure of related party relationships, transactions and outstanding balances, including commitments; IAS 24.13: Relationships between a parent and its subsidiaries shall be disclosed irrespective of whether there have been transactions between them; IAS 24.14: ... it is appropriate to disclose the related party relationship when control exists, irrespective of whether there have been transactions between the related parties. IAS 24.15: The requirement to disclose related party relationships between a parent and its subsidiaries is in addition to the disclosure requirements in IAS 27 and IFRS 12 Disclosure of Interests in Other Entities.

IAS 24.9:

1. A person or a close member of that person’s family is related to a reporting entity if that person:
   1. has control or joint control of the reporting entity;
   2. has significant influence over the reporting entity or
   3. is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.
2. An entity is related to a reporting entity if any of the following conditions applies:
   1. The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others).
   2. One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member).
   3. Both entities are joint ventures of the same third party.
   4. One entity is a joint venture of a third entity and the other entity is an associate of the third entity.
   5. The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity.
   6. The entity is controlled or jointly controlled by a person identified in (a).
   7. A person identified in (a)(i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity).
   8. The entity, or any member of a group of which it is a part, provides key management personnel services to the reporting entity or to the parent of the reporting entity.

IAS 24.3 (edited, emphasis added): This Standard requires disclosure of related party relationships, transactions and outstanding balances, including commitments, in the consolidated and separate financial statements of a parent....

US GAAP only requires disclosure of transactions between relate parties and only when not eliminated.

ASC 850-10-50-1 (edited, emphasis added): Financial statements shall include disclosures of material related party transactions, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business...

ASC 850-10-20:

 

ASC 850-10-20: A party that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with an entity.

1. Affiliates of the entity
2. Entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section 825-10-15, to be accounted for by the equity method by the investing entity
3. Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management d. Principal owners of the entity and members of their immediate families e. Management of the entity and members of their immediate families
4. Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests
5. Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.

ASC 850-10-50-1 (edited, emphasis added): ... However, disclosure of [related party] transactions that are eliminated in the preparation of consolidated or combined financial statements is not required in those statements....

While these differences effect practice, they are not as pronounced as the guidance suggests they should be.

While IFRS companies do disclose more related party transactions than US GAAP companies, none disclose a list of related party relationships.

For example:

- Siemens
- SAP
- Deutsche Telekom

These files have been downloaded to a local server to avoid potential broken links.

Visitors to this site are advised to search for and download the originals from their source.

For example:

- Berkshire Hathaway
- Oracle
- AT&T

These files have been downloaded to a local server to avoid potential broken links.

Visitors to this site are advised to search for and download the originals from their source.

Edited, emphasis added: IAS 24.3: This Standard requires disclosure of related party relationships, transactions and outstanding balances, including commitments; IAS 24.13: Relationships between a parent and its subsidiaries shall be disclosed irrespective of whether there have been transactions between them; IAS 24.14: ... it is appropriate to disclose the related party relationship when control exists, irrespective of whether there have been transactions between the related parties. IAS 24.15: The requirement to disclose related party relationships between a parent and its subsidiaries is in addition to the disclosure requirements in IAS 27 and IFRS 12 Disclosure of Interests in Other Entities.

Similarly, the model financial statements published by audit firms also focus on transactions, suggesting that listing all individual related parties is unnecessary.

- Deloitte
- KPMG
- E & Y
- PwC
- Grant Thorton

These files have been downloaded to a local server to avoid potential broken links.

Visitors to this site are advised to search for and download the originals from their source.

Related person recognized as if arm's length.

1/1/X1, XYZ lent the wife of its CEO 100,000 for two years at 2%. The interest and principal were payable at the end of the term. XYZ elected to recognize the loan as if were at arm's length so it could disclose this fact. As neither the nominal (2%) nor implicit (1.91%) rates were reasonable, it imputed a discount rate by determining a bank would have required 12% for a similar loan without any guarantee from XYZ.

A loan to a close family member of key management personnel as outlined in IFRS 24.9 | ASC 850.10.20.

Both IFRS and US GAAP presume related party transactions are not made at arm's length.

IAS 24.23 (emphasis added): Disclosures that related party transactions were made on terms equivalent to those that prevail in arm’s length transactions are made only if such terms can be substantiated.

ASC 850-10-50-5 (emphasis added): Transactions involving related parties cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated.

However, if they are recognized as if they were made at arm's length, this fact can be disclosed in addition to the disclosures required by the standards.

IAS 24.18: If an entity has had related party transactions during the periods covered by the financial statements, it shall disclose the nature of the related party relationship as well as information about those transactions and outstanding balances, including commitments, necessary for users to understand the potential effect of the relationship on the financial statements. These disclosure requirements are in addition to those in paragraph 17. At a minimum, disclosures shall include:

1. the amount of the transactions;
2. the amount of outstanding balances, including commitments, and:
   1. their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement; and
   2. details of any guarantees given or received;
3. provisions for doubtful debts related to the amount of outstanding balances; and
4. the expense recognised during the period in respect of bad or doubtful debts due from related parties.

ASC 850-10-50-1: Financial statements shall include disclosures of material related party transactions, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business. However, disclosure of transactions that are eliminated in the preparation of consolidated or combined financial statements is not required in those statements. The disclosures shall include:

1. The nature of the relationship(s) involved
2. A description of the transactions, including transactions to which no amounts or nominal amounts were ascribed, for each of the periods for which income statements are presented, and such other information deemed necessary to an understanding of the effects of the transactions on the financial statements
3. The dollar amounts of transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period
4. Amounts due from or to related parties as of the date of each balance sheet presented and, if not otherwise apparent, the terms and manner of settlement
5. The information required by paragraph 740-10-50-17.

While some companies try to mitigate the stigma attached to off market, related party transactions by disclosing they have been accounted for as if arm’s length, the preferred strategy is avoiding them in the first place.

As outlined in ASC 310-10-30-6, an entity must use an imputed interest rate when the rate stated or implied in the contract is unreasonable.

ASC 310-10-30-6 states: Paragraph 835-30-25-11 explains that, in the absence of established exchange prices for the related property, goods, or services or evidence of the fair value of the note (as described in paragraph 835-30-25-2), the present value of a note that stipulates either no interest or a rate of interest that is clearly unreasonable shall be determined by discounting all future payments on the notes using an imputed rate of interest as described in Subtopic 835-30...

Note: ASC 835-30-25-11's text is practically identical to ASC 310-10-30-6.

While IFRS does not include guidance specifically addressing interest imputation, IFRS 9.B5.1.1 requires loans and receivables carrying no interest to be discounted using prevailing market (a.k.a. reasonable) rates. By implication, the guidance also applies to loans and receivables carrying unreasonable interest.

As unreasonable interest rates are often encountered in intercompany loans and receivables (between parent and subsidiary, between parent and associate, between and among subsidiaries and associates, etc.) or situations where companies lend to or borrow from insiders (management, family members, etc.), these transactions should always be evaluated to confirm that the associated implicit or explicit interest rates are reasonable.

1/1/X1 / 1.1.X1
Loan		100,000
Deferred related party compensation		17,092
	Cash		100,000
	Deferred interest income		17,092

 

17,092 = 100,000 - 104,000 ÷ (1 + 12%)²

12/31/X1 / 31.12.X1
Deferred interest income		7,949
Interest receivable		2,000
Related party compensation		8,546
	Interest income		9,949
	Deferred related party compensation		8,546

 

P	Discount rate	Net loan amount	Interest income	Interest receivable	Discount amortization
A	B	C=C(C+1)+F	D = C x B	E=100,000 x 2%	F=D-E
1	12%	82,908	9,949	2,000	7,949
2	12%	92,857	11,143	2,000	9,143
			21,092	4,000	17,092

As the off-market loan made provided compensation to the related party, XYZ would need to outline the service it received in exchange.

12/31/X2 / 31.12.X2
Deferred interest income		9,143
Interest receivable		2,000
Related party compensation		8,546
	Interest income		11,143
	Deferred related party compensation		8,546
Cash		104,000
	Loan		100,000
	Interest receivable		4,000

 

Loss		104,000
	Loan		100,000
	Interest receivable		4,000

Related entity recognized as if arm's length.

1/1/X1, XYZ lent XYZ-A 100,000 for two years at 2%. The interest and principal were payable at the end of the term. XYZ elected to recognize the loan as if were at arm's length so it could disclose this fact. As neither the nominal (2%) nor implicit (1.91%) rates were reasonable, it imputed a discount rate by determining a bank would have required 12% for a similar loan to an entity not affiliated with XYZ.

To illustrate, this example uses a loan to an associate | (unconsolidated) affiliate as outlined in IFRS 24.9.b.ii | ASC 850.10.20.a

IFRS 24.9.b.ii: One entity is an associate or joint venture of the other entity ...

ASC 850.10.20: A party that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with an entity.

Both IFRS and US GAAP presume related party transactions are not made at arm's length.

IAS 24.23 (emphasis added): Disclosures that related party transactions were made on terms equivalent to those that prevail in arm’s length transactions are made only if such terms can be substantiated.

ASC 850-10-50-5 (emphasis added): Transactions involving related parties cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated.

However, if they are recognized as if they were made at arm's length, this fact can be disclosed in addition to the disclosures required by the standards.

IAS 24.18: If an entity has had related party transactions during the periods covered by the financial statements, it shall disclose the nature of the related party relationship as well as information about those transactions and outstanding balances, including commitments, necessary for users to understand the potential effect of the relationship on the financial statements. These disclosure requirements are in addition to those in paragraph 17. At a minimum, disclosures shall include:

1. the amount of the transactions;
2. the amount of outstanding balances, including commitments, and:
   1. their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement; and
   2. details of any guarantees given or received;
3. provisions for doubtful debts related to the amount of outstanding balances; and
4. the expense recognised during the period in respect of bad or doubtful debts due from related parties.

ASC 850-10-50-1 (emphasis added): Financial statements shall include disclosures of material related party transactions, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business. However, disclosure of transactions that are eliminated in the preparation of consolidated or combined financial statements is not required in those statements. The disclosures shall include:

1. The nature of the relationship(s) involved
2. A description of the transactions, including transactions to which no amounts or nominal amounts were ascribed, for each of the periods for which income statements are presented, and such other information deemed necessary to an understanding of the effects of the transactions on the financial statements
3. The dollar amounts of transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period
4. Amounts due from or to related parties as of the date of each balance sheet presented and, if not otherwise apparent, the terms and manner of settlement
5. The information required by paragraph 740-10-50-17.

While some companies try to mitigate the stigma attached to off market, related party transactions by disclosing they have been accounted for as if arm’s length, the preferred strategy is avoiding them in the first place.

As outlined in ASC 310-10-30-6, an entity must use an imputed interest rate when the rate stated or implied in the contract is unreasonable.

ASC 310-10-30-6 states: Paragraph 835-30-25-11 explains that, in the absence of established exchange prices for the related property, goods, or services or evidence of the fair value of the note (as described in paragraph 835-30-25-2), the present value of a note that stipulates either no interest or a rate of interest that is clearly unreasonable shall be determined by discounting all future payments on the notes using an imputed rate of interest as described in Subtopic 835-30...

Note: ASC 835-30-25-11's text is practically identical to ASC 310-10-30-6.

While IFRS does not include guidance specifically addressing interest imputation, IFRS 9.B5.1.1 requires loans and receivables carrying no interest to be discounted using prevailing market (a.k.a. reasonable) rates. By implication, the guidance also applies to loans and receivables carrying unreasonable interest.

As unreasonable interest rates are often encountered in intercompany loans and receivables (between parent and subsidiary, between parent and associate, between and among subsidiaries and associates, etc.) or situations where companies lend to or borrow from insiders (management, family members, etc.), these transactions should always be evaluated to confirm that the associated implicit or explicit interests rates are reasonable.

1/1/X1 / 1.1.X1
Loan		100,000
Deferred related party compensation		17,092
	Cash		100,000
	Deferred interest income		17,092

 

17,092 = 100,000 - 104,000 ÷ (1 + 12%)²

12/31/X1 / 31.12.X1
Deferred interest income		7,949
Interest receivable		2,000
Related party compensation		8,546
	Interest income		9,949
	Deferred related party compensation		8,546

 

P	Discount rate	Net loan amount	Interest income	Interest receivable	Discount amortization
A	B	C=C(C+1)+F	D = C x B	E=100,000 x 2%	F=D-E
1	12%	82,908	9,949	2,000	7,949
2	12%	92,857	11,143	2,000	9,143
			21,092	4,000	17,092

As the off-market loan made provided compensation to the related party, XYZ would need to outline the service it received in exchange.

12/31/X2 / 31.12.X2
Deferred interest income		9,143
Interest receivable		2,000
Related party compensation		8,546
	Interest income		11,143
	Deferred related party compensation		8,546
Cash		104,000
	Loan		100,000
	Interest receivable		4,000

 

Loss		104,000
	Loan		100,000
	Interest receivable		4,000

Factoring and pledging

XYZ sold (factored) receivables with a book value of 100,000 payable in 90 days at a discount.

For illustration, this example assumes a 10% discount, which may or may not be realistic.

In practice, the cost of factoring, pledging and assigning varies considerably depending mostly on the quality of the receivables being factored, pledged or assigned.

Dr/Cr

Cash (received from factor)		90,000
Loss on sale of receivables		10,000
	Accounts receivable		100,000

 

In some jurisdictions, national GAAP requires companies to recognize:

For example, some time ago an EU based company decided to list its shares on a US exchange.

After retaining an underwriter, the underwriter retained us to draft a financial report consistent with US GAAP.

After reviewing the preliminary results, the underwater decided against pursuing a listing.

Our first step was to eliminate the major differences and draft a preliminary report.

Up to then, the company had only applied CZ GAAP, the statutory accounting standards applicable in its jurisdiction, the Czech Republic.

As the company used the procedure outlined below, almost half its previously reported revenue was eliminated.

In and of itself, this would have been enough to dissuade a listing, but there was more.

1. In addition to the revenue eliminated by applying US GAAP guidance to factored receivables, revenue further declined because, at the time, CZ GAAP required increases in inventory and self-manufactured asset costs to be capitalized with a credit to revenue.


2. The company also did not recognize the full value of its lease assets nor any associated liabilities because CZ GAAP does not require leased assets to capitalized nor liabilities to be recognized. It only requires the capitalization of advance payments, which are amortized over the lease term.


3. The company also did not recognize all of its leased assets because CZ GAAP does not require capitalization of operating leases even if their term is for substantially all the underlying asset's economic life.


4. The company also did not recognize all its contingent liabilities because CZ GAAP does not generally require recognition of constructive obligations.


5. The company also failed to distinguish between cost of sales, selling and administrative expenses as this distinction is not required by CZ GAAP.


6. The company also capitalized both development and some research as well as employee training which, at the time, was consistent with CZ GAAP.


7. The company also misapplied CZ GAAP guidance, for example by using tax depreciation periods for financial reporting purposes, but an examination of these issues was beyond the scope of our engagement.

A second step was not necessary.

After reviewing our preliminary report, the underwater decided to terminate its relationship with the company, which eventually wound up in receivership.

Cash		90,000
Expense		100,000
	Revenue		90,000
	Accounts receivable		100,000

 

This procedure is not consistent with either IFRS or US GAAP.

IFRS 9.3.2.12 (emphasis added): On derecognition of a financial asset in its entirety, the difference between:

1. the carrying amount (measured at the date of derecognition) and
2. the consideration received (including any new asset obtained less any new liability assumed)

shall be recognised in profit or loss.

ASC 860-20-40-1A (edited, emphasis added): Upon completion of a transfer ... to be accounted for as a sale, the transferor(seller) shall: ... (d) Recognize in earnings any gain or loss on the sale...

Doubtful accounts

Same facts except XYZ had recognized an allowance for doubtful accounts.

Cash		90,000
Loss on sale of receivables		10,000
Allowance for doubtful accounts		2,000
	Accounts receivable		100,000
	Bad debt expense		2,000

 

As the sale was without recourse, XYZ reversed the previously recognized expense.

As outlined in IFRS 15.113 | ASC 606-10-50-4, for each reporting period entities must disclose (b) impairments of receivables.

IFRS 9 | ASC 310 provide additional guidance on how to fulfill this requirement.

As outlined IFRS 9.5.5.15 and 16 receivables are always measured net of expected lifetime credit losses.

As outlined in ASC 310-10-35-8, a loss is accrued if it is probable it has occurred and can be estimated while, as outlined in ASC 310-10-35-9, this requirement applies to both individual receivables and groups of similar receivables.

To apply this guidance, companies generally recognize the impairments in the same period as the revenue, matching one to the other.

As matching traditionally applies to expenses (losses are recognized as incurred), the allowance should have been recognized with a debit to bad debt expense (for illustrations, go to the doubtful accounts section below).

If the allowance is no longer pertinent, proper accounting is to reverse the expense.

Alternatively

Cash		90,000
Loss on sale of receivables		8,000
Allowance for doubtful accounts		2,000
	Accounts receivable		100,000

 

As outlined in IFRS 15.113 | ASC 606-10-50-4, for each reporting period entities must disclose (b) impairments of receivables.

IFRS 9 | ASC 310 provide additional guidance on how to fulfill this requirement.

As outlined IFRS 9.5.5.15 and 16 receivables are always measured net of expected lifetime credit losses.

As outlined in ASC 310-10-35-8, a loss is accrued if it is probable it has occurred and can be estimated while, as outlined in ASC 310-10-35-9, this requirement applies to both individual receivables and groups of similar receivables.

This implies that companies should match the impairment to revenue.

Traditionally, only expenses are matched (losses are recognized as incurred).

Also traditionally, the proper procedure for adjusting expenses is to reverse them.

However, both IFRS and US GAAP refer to the income statement item related to uncollectible receivables as a loss (this is also mirrored in their respective taxonomies).

IFRS XBRL: ImpairmentLossImpairmentGainAndReversalOfImpairmentLossDeterminedInAccordanceWithIFRS9

US GAAP XBRL: ProvisionForDoubtfulAccounts

Note: while US GAAP XBRL presents impairments of receivables separately from other impairments, IFRS XRBL aggregates all impairments made according to IFRS 9 including receivables.

This implies, since the accounting for losses is more flexible, simply netting the loss would not be inconsistent with the letter of the guidance.

Servicing asset

Same facts except XYZ agreed to collects payments and the factor agreed to pay a 2% servicing fee.

As outlined in IFRS 93.2.10 to 14 | ASC 860-50-25-1 to 10, if a company sells a financial asset but retains the right to service the asset for a fee, it recognizes a servicing asset.

Theoretically, it could also recognize a servicing liability if the fee does not adequately compensate the company for its service, but this is not common.

Cash		90,000
Loss on sale of receivables		10,000
Servicing asset (due from factor)		2,000
	Accounts receivable		100,000
	Deferred revenue (servicing fee)		2,000

 

In 90 days

Cash		2,000
Deferred revenue		2,000
	Revenue		2,000
	Servicing asset		2,000

Interest + fee

Same facts except, instead of a discount, the agreement stipulated 5,000 interest and a 5,000 fee.

For illustration, this example assumes the total cost (interest plus fee) was the same 10% as in the discount example. This may or not be realistic.

In practice, the cost of factoring, pledging and assigning varies considerably depending mostly on the quality of the receivables being factored, pledged or assigned.

In most agreements, this cost is a outlined as a benchmark rate plus points.

Note: IFRS | US GAAP uses IBOR (inter-bank offered rates) | SOFR (Secured Overnight Financing Rate) as its benchmark rate.

However, companies are free to use whatever benchmark they like in agreements they sign between themselves.

Cash		90,000
Interest expense		5,000
Factor fee		5,000
Allowance for doubtful accounts		2,000
	Accounts receivable		100,000
	Loss on uncollectible receivables		2,000

 

As neither IFRS nor US GAAP specifically addresses how to classify the costs associated with factored receivable, in practice they are commonly recognized as outlined in the agreement.

Neither IFRS nor US GAAP specifically address how these fees should be classified.

Consequently, the fee is commonly treated like interest and sub-classified in non-operating (other) expense.

In US GAAP XBRL, it should thus be presented as an extension to OtherNonoperatingIncomeExpense.

As IFRS XBRL does not define a similar label, it should be presented as an extension to FinanceCosts.

Note: as this fee is akin to interest, it would not be an error to present it as an extension to InterestExpense.

While IFRS XBRL does not include an InterestExpense label under IncomeStatementAbstract, it does under AnalysisOfIncomeAndExpenseAbstract.

Pledging

Same facts except, XYZ pledged (assigned) the receivables at a 10% discount.

In general, pledging involves a pool of receivables being used as collateral for a loan.

In contrast, assigning generally involves specific receivables being assigned to a lender.

While not set in stone, receivables are usually pledged at a discount.

In contrast, receivables are generally assigned at face value plus interest and/or a fee.

For example, XYZ transferred the receivables at face value agreeing to pay 5,000 interest and a 5,000 fee in 90 days.

Cash (received from assignee)		100,000
	Loan (secured by receivables)		100,000

 

In 90 days

Cash (received from customers)		100,000
Loan (secured by receivables)		100,000
Interest expense		5,000
Assignment fee		5,000
	Receivables		100,000
	Cash (paid to assignee)		110,000

 

In excel syntax: 5,000 = 100000*((1+21.55%)^(1/4)-1).

Cash (received from pledgee)		90,000
	Loan (secured by receivables)		90,000

 

In 90 days

Cash (received from customers)		100,000
Loan (secured by receivables)		90,000
Loss on pledged receivables		10,000
	Receivables		100,000
	Cash (paid to pledgee)		100,000

 

Same facts except XYZ agreed to pay interest and a fee.

Cash		100,000
Loan		90,000
Interest expense		5,000
Pledging fee		5,000
	Receivables		100,000
	Cash		100,000

 

As neither IFRS nor US GAAP specifically addresses how to classify the costs associated with factored receivable, they are commonly recognized as outlined in the agreement.

If the agreement includes a fee, it is commonly treated like interest and sub-classified in non-operating (other) expense.

In US GAAP XBRL, it should thus be presented as an extension to OtherNonoperatingIncomeExpense.

As IFRS XBRL does not define a similar label, it should be presented as an extension to FinanceCosts.

Note: as this fee is akin to interest, it would not be an error to present it as an extension to InterestExpense.

While IFRS XBRL does not include an InterestExpense label under IncomeStatementAbstract, it does under AnalysisOfIncomeAndExpenseAbstract.

Recourse

Same facts except the factor had the right to return uncollectible receivables.

If the transferee can return the receivables to the transferor, the transferee has recourse. Recourse transaction do not generally qualify for sale accounting. Instead, they are recognized as a secured borrowings.

While they provide similar guidance, IFRS is more straight forward than and US GAAP.

As outlined in IFRS 9.3.2.6.a, if the entity transfers risks are rewards of ownership, it derecognizes the receivable and recognizes the consideration received (plus a gain or, more likely, a loss). As outlined in IFRS 9.3.2.6.b, if it does not transfer risks are rewards of ownership, it continues to recognize the receivable and to recognizes the consideration received as a liability.

To evaluate if it has transferred risk and rewards, the entity applies IFRS 9.3.2.7: "...An entity has retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the present value of the future net cash flows from the financial asset does not change significantly as a result of the transfer (eg because the entity has sold a financial asset subject to an agreement to buy it back at a fixed price or the sale price plus a lender’s return)..."

If the likelihood of default is high, the likelihood the factor will exercise its option is also high. As a result, the entity will continue to be exposed to the variability of cash flows and it cannot recognize the transfer as a sale. Instead, it would recognize the transaction as a secured borrowing.

As outlined in ASC 860-10-40-5, the transfer will recognize a sale if it surrenders control. It surrenders control if all these three conditions are met:

1. The transferred financial assets have been isolated from the transferor and its creditors (see paragraph 860-10-55-17D)
2. Transferee has the right to sell, exchange or pledge the transferred financial assets
3. The transferor does maintain effective control over the transferred financial assets

When transferee has the right but not obligation to return the assets to the transferor conditions a and b are clearly met.

However, for condition c to be met the agreement would need to permit "the transferee to require the transferor to repurchase the transferred financial assets at a price that is so favorable to the transferee that it is probable that the transferee will require the transferor to repurchase them."

To interpret this guidance, additional guidance is provided by ASC 860-10-55-42D:

This implementation guidance addresses the application of paragraph 860-10-40-5(c)(3) through the following examples:

1. A put option written to the transferee generally does not provide the transferor with effective control over the transferred financial asset under paragraph 860-10-40-5(c)(3).
2. A put option that is sufficiently deep in the money when it is written would, under that paragraph, provide the transferor effective control over the transferred financial asset because it is probable that the transferee will exercise the option and the transferor will be required to repurchase the transferred financial asset.
3. A sufficiently out-of-the-money put option held by the transferee would not provide the transferor with effective control over the transferred financial asset if it is probable when the option is written that the option will not be exercised.
4. A put option held by the transferee at fair value would not provide the transferor with effective control over the transferred financial asset.

Interpreting this guidance, if the receivable(s) becomes uncollectible, its fair value will be zero, the option will be in the money and will be exercised.

Thus, if it is probable the receivable(s) will become uncollectible, the transaction is recognized as a secured borrowing, not sale.

The same guidance applies when factor has an option to return the receivables for reasons other than un-collectability.

Cash		90,000
	Loan (secured by receivables)		90,000

 

In 90 days (no receivables were uncollectible)

Loan		90,000
Loss		10,000
	Accounts receivable		100,000

 

Factoring with recourse recognized as sale

Same facts except, the default rate was insignificant.

In general, if the transferee (factor) can only return the receivables if they become uncollectible and the probability that a significant portion of the receivables will become uncollectible is low, the company may recognize the transaction as a sale rather than secured borrowing.

Note: while they provide similar guidance, IFRS is more straight forward than and US GAAP.

As outlined in IFRS 9.3.2.6.a, if the entity transfers risks are rewards of ownership, it derecognizes the receivable and recognizes the consideration received (plus a gain or, more likely, a loss). As outlined in IFRS 9.3.2.6.b, if it does not transfer risks are rewards of ownership, it continues to recognize the receivable and to recognizes the consideration received as a liability.

To evaluate if it has transferred risk and rewards, the entity applies IFRS 9.3.2.7: "...An entity has retained substantially all the risks and rewards of ownership of a financial asset if its exposure to the variability in the present value of the future net cash flows from the financial asset does not change significantly as a result of the transfer (eg because the entity has sold a financial asset subject to an agreement to buy it back at a fixed price or the sale price plus a lender’s return)..."

If the likelihood of default is low, the likelihood the factor will exercise its option is also low. As a result, the entity will not be exposed to the variability of cash flows so it can recognize the transfer as a sale.

As outlined in ASC 860-10-40-5, the transfer will recognize a sale if it surrenders control. It surrenders control if all these three conditions are met:

1. The transferred financial assets have been isolated from the transferor and its creditors
2. Transferee's has the right to sell, exchange or pledge the transferred financial assets
3. The transferor does maintain effective control over the transferred financial assets

When transferee has the right but not obligation to return the assets to the transferor conditions a and b are clearly met.

However, for condition c to be met the agreement would need to permit "the transferee to require the transferor to repurchase the transferred financial assets at a price that is so favorable to the transferee that it is probable that the transferee will require the transferor to repurchase them."

To interpret this guidance, additional guidance is provided by ASC 860-10-55-42D.

ASC 860-10-55-42D.a states: a option written to the transferee generally does not provide the transferor with effective control over the transferred financial asset.

However, ASC 860-10-55-42D.b states: a put option that is sufficiently deep in the money when it is written would, under that paragraph, provide the transferor effective control over the transferred financial asset because it is probable that the transferee will exercise the option and the transferor will be required to repurchase the transferred financial asset.

Finally, ASC 860-10-55-42D.d states: a put option held by the transferee at fair value would not provide the transferor with effective control over the transferred financial asset.

This implies that if the receivable becomes uncollectible its fair value will be zero and so the option held by the transferee is sufficiently in the money to give the transferee effective control. But this applies only if it is probable the receivable will become uncollectible.

If it is not probable the receivable will become uncollectible, the transferee does not have effective control so the transferor can recognize a sale (unless it is probable, for some other reason, the transferee will return the receivable).

Caveat: as recourse transaction can create off-balance sheet financing, they do attract regulatory attention.

Consequently, before recognizing any recourse transaction as a sale, companies should be prepared to answer questions like:

We [the SEC] note that in 2010 you engaged in factoring of specific accounts receivables and accounted for the transfer as a sale in accordance with FASB ASC 860. We note that you have credit insurance in order to mitigate credit risk related to the Company’s factoring of accounts receivable. In this regard, it appears that you are transferring the receivables with recourse. We refer you to ASC 860-10-55-46. Provide your analysis of why the transfer represents a sale under ASC 860-10-40-5. Indicate whether you recorded a recourse obligation. In addition, tell us whether you are receiving a fee for acting as the collection agent and explain why you did not recognize a service obligation. See ASC 860-50-25-1.

Link - SEC letter

Cash		90,000
Loss on sale of receivables		10,000
Allowance for doubtful accounts		2,000
	Accounts receivable		100,000
	Recourse provision		2,000

 

As XYZ had the obligation to reacquire uncollectible receivables, it reclassified the allowance (contra asset) as a provision (liability).

Doubtful accounts

Under IFRS and US GAAP, doubtful accounts are recognized in the period a loss is expected.

As outlined in IFRS 9.5.5.15, a loss allowance equal to lifetime expected credit losses is recognized for trade receivables, lease receivables and contract assets.

As outlined in IFRS 9.5.4.4, when a receivable is deemed uncollectible, it is derecognized against this allowance.

These requirements generally lead to the charge being recognize in the same period as the associated revenue.

US GAAP (ASC 310-10-35-47, 326-20-30-1, 362-20-15-2-a.3, 326-20-35-8, etc.) provides comparable guidance.

In contrast to IFRS and US GAAP, many national GAAPs/tax codes only allow a charge to earnings if a receivable is deemed legally uncollectible.

In a jurisdiction where tax law does not apply the same criteria to bad debts as IFRS and US GAAP, the issue of deferred tax will need to be addressed.

For example:

12/31/X1, XYZ’s net trade receivable balance was 1,086,312.

For IFRS | US GAAP purposes, it estimated uncollectible receivable of 32,875.

The income and value added tax rates in XYZ’s jurisdiction are 20% and 21% respectively.

 

Trade Receivables Aging Schedule
Age in days	0 > 30	30 > 60	60 > 90	90 > 180	Over 180	Σ
Balance	1,000,000	60,000	14,400	6,336	5,576	1,086,312
Factor	2.00%	5.00%	20.00%	40.00%	80.00%
Allowance	20,000	3,000	2,880	2,534	4,461	32,875

Dr/Cr

IFRS / US GAAP book: 12/31/X1 / 31.12.X1
Loss on uncollectible receivables		32,875
	Allowance for doubtful accounts		32,875
Deferred income tax: X1		7,956
	Income tax expense		7,956

 

National GAAP book: 12/31/X1 / 31.12.X1
--		--
	--		--

 

In XYZ's jurisdiction, creditors may recognize a tax-deductible expense for uncollectible accounts over a three-year period provided they have initiated formal, legal collection proceedings against the debtor.

If they have not initiated these proceedings, they may only recognize a tax-deductible expense of 20%, unless bankruptcy proceedings against the debtor have been initiated, in which case they may recognize 100%.

VAT remitted to taxation authorities but not collected from the debtor is not generally refundable. In limited circumstances, it is refundable if bankruptcy proceedings against the debtor have been initiated.

In all cases, the measurement basis is the gross invoiced amount including VAT.

To cope with these requirements, XYZ maintains separate accounts for national GAAP purposes.

The national GAAP in XYZ's jurisdiction prescribes a chart of accounts, financial statement formats and accounting procedures that are, in many cases, fundamentally at odds with IFRS | US GAAP guidance.

To cope with the conflicting requirements and avoid potential errors, XYZ employs separate recognition, measurement and disclosure policies for each standard, the optimal approach to dealing with this situation.

Another approach is to maintain one set of accounts and make reconciliations.

However, since this policy opens the door to material errors, it is not recommended by this web site.

As does the hybrid approach of using separate accounts only for those items that are subject to differing IFRS | US GAAP and national GAAP recognition and measurement requirements.

Another option (permissible in some jurisdictions) is to maintain an IFRS book as a primary set of accounts and make adjustments to national GAAP.

As this procedure starts with IFRS , there is little potential for errors so it is not objectionable.

This procedure does, however, open the door to errors in applying the national GAAP.

However, the focus of this web site is not national GAAP, so this issue is not relevant to this discussion.

For companies applying US GAAP outside of the United States, local legislation must explicitly permit reconciling US GAAP to national GAAP for this policy to be appropriate.

2/15/X2, XYZ deemed receivable # 123 for 300 (363 including VAT) to be uncollectible.

IFRS / US GAAP book: 2/15/X2 / 15.2.X2
Allowance for doubtful accounts		300
	Accounts receivable: # 123		300

 

Under IFRS and US GAAP, revenue is measured net of VAT/GST.

IFRS 15.47 | ASC 606-10-32-2: ... The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). ...

A separate example, including a discussion of why VAT/GST is a form of sales tax, is provided below.

The same logic should be applied to the associated receivable.

National GAAP book: 2/15/X2 / 15.2.X2
--		--
	--		--

 

During X2, XYZ initiated formal collection proceedings, filing the required legal motions.

National GAAP book: 12/31/X2 to 12/31/X4 / 31.12.X2 to 31.12.X4
558 - Creation and clearing of legal allowances in operating activities		121
	391 - Allowance to receivables: Invoice # 123		121

 

As noted above, in XYZ's tax jurisdiction, companies are allowed to claim a tax deduction over a three-year period provided they initiate formal collection proceedings.

The prescribed national GAAP accounting procedure is to debit account 558 (the "legal" in its title signifies that it is recognizable per tax law) and credit account 391 (which must be associated with the particular receivable by invoice number).

Account 558 is taken to the national GAAP P&L, where it is presented as an expense.

This is done in each of the three years over which the expense may be claimed for tax purposes.

121 = 300 x 1.21 ÷ 3

In XYZ’s tax jurisdiction, while companies cannot claim a refund of the VAT remitted on uncollectible accounts, the gross invoiced amount (including VAT) serves as the measurement basis for this expense.

IFRS / US GAAP book: 12/31/X2 to 12/31/X4 / 31.12.X2 to 31.12.X4
Income tax payable		24
	Deferred income tax: X1		24

 

24 = 363 x 20% ÷ 3

National GAAP book: 12/31/X4 / 31.12.X4
558 - Creation and clearing of legal allowances in operating activities		363
391 - Allowance to receivables: Invoice # 123		363
	558 - Creation and clearing of legal allowances in operating activities		363
	311 - Receivables from business relationships: Invoice # 123		363

 

In the third year, the prescribed national GAAP accounting procedure is to debit account 558 (presented as an expense in the P&L) and also credit account 558 (presented as revenue in the P&L).

The receivable (account 311) is then written off against the allowance (account 391).

Why not simply debit account 391, credit account 311 and omit account 558 altogether?

Besides feeling no need to match the original revenue and expense, XYZ's national GAAP has no qualms with double counting that revenue and expense, even throwing in some tax, just for good measure.

One of the quirks that makes reconciling national GAAP to IFRS  | US GAAP interesting, though not for the timid.

Obviously, as national GAAPs vary by jurisdiction, a detailed discussion of all their quirks is far beyond the scope of this web site.

This is generally accomplished one of two ways:

ASC 326-20-30-3 states: The allowance for credit losses may be determined using various methods. For example, an entity may use discounted cash flow methods, loss-rate methods, roll-rate methods, probability-of-default methods, or methods that utilize an aging schedule...

This guidance, however, applies to financial assets in general.

When it comes to accounts receivable, an aging schedule is the preferred alternative although the percentage of sales method, mostly do to its relative simplicity, is more popular,.

For its part, IFRS 9.5.5.17 only requires companies make unbiased, probability-weighted estimates reflecting the time value of money using reasonable and supportable information acquired without undue cost or effort.

Since it does not explicitly single out any particular approach, both the aging schedule and percentage of sales methods would be consistent with this guidance.

Aging-schedule method

12/31/X1, XYZ’s trade receivable balance was 1,086,312.

Using an aging schedule, it estimated uncollectible receivables at 32,875.

 

Trade receivables aging schedule: X1
Age in days	0 > 30	30 > 60	60 > 90	90 > 180	Over 180	Σ
X1 Balances	1,000,000	60,000	14,400	6,336	5,576	1,086,312
Factor	2.00%	5.00%	20.00%	40.00%	80.00%
Allowance	20,000	3,000	2,880	2,534	4,461	32,875

 

XYZ based its estimates on its own historical experience.

In evaluating this experience, its accounts receivable manager considered that, over the last three years, 2% of all invoiced amounts had become uncollectible. Of the amounts not collected in 30 days, 5% had become uncollectible. Of the amounts not collected in 60 days, 20% had become uncollectible and so on.

How many periods should be examined when evaluating historical experience is not specified. Three to five years generally lead to acceptably accurate results. However, once a pattern of collectability has been established, the schedule need only be adjusted if it fails to yield acceptably accurate results.

Dr/Cr

12/31/X1 / 31.12.X1
Bad debt expense (loss on uncollectible accounts)		32,875
	Allowance for doubtful accounts		32,875

 

IFRS 15 and ASC 606 both stipulate that uncollectible accounts should be recognized as losses.

IFRS 15.113 (edited, emphasis added): An entity shall disclose ... any impairment losses recognised (in accordance with IFRS 9) on any receivables or contract assets arising from an entity’s contracts with customers, which the entity shall disclose separately from impairment losses from other contracts.

ASC 606-10-50-4 (edited, emphasis added): An entity shall disclose all of the following amounts ... Credit losses recorded (in accordance with Subtopic 326-20 on financial instruments measured at amortized cost) on any receivables or contract assets arising from an entity's contracts with customers, which the entity shall disclose separately from credit losses from other contracts.

This is mirrored in the respective XBRL taxonomies:

ImpairmentLossImpairmentGainAndReversalOfImpairmentLossDeterminedInAccordanceWithIFRS9

ProvisionForDoubtfulAccounts

Note: while US GAAP XBRL presents impairments of receivables separately from other impairments, in IFRS XRBL all impairments made according to IFRS 9 (including receivables) are presented in aggregate.

However, as these losses are recognized at each reporting date, they are generally matched with revenue as if they were expenses.

Further, many companies consider uncollectible accounts be expenses.

The difference between expenses and losses is explored in the Accounting elements section.

Specifically, if a company wants to avoid bad debts, it can sell COD.

Many companies avoid this because the drop in revenue will often more than offset any savings.

For the same reason, they also classify the expense as selling or distribution.

Nevertheless, since both IFRS and US GAAP state that these losses are losses, many companies report them as such.

Consequently, both approaches are encountered in practice (example one, example two).

Note: these annual reports have been copied to a local server to avoid potentially broken links.

Readers are advised to download the originals from the company pages.

Both US GAAP and IFRS require companies to estimate credit losses (doubtful accounts, uncollectible accounts, bad debts) and recognize an allowance whenever there is any indication that a credit loss has occurred.

In other words, if historical experience shows that some accounts become uncollectible every period, an allowance is estimated and recognized in every period.

More importantly, this shall be done on a collective (pool) basis even if individual impaired accounts cannot be identified.

The only real difference between, US GAAP gives more detailed guidance than IFRS .

ASC 326-20-30-1: The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net amount expected to be collected on the financial asset. At the reporting date, an entity shall record an allowance for credit losses on financial assets within the scope of this Subtopic. An entity shall report in net income (as a credit loss expense) the amount necessary to adjust the allowance for credit losses for management's current estimate of expected credit losses on financial asset(s).

The previous guidance on Impairment of Loans and Receivables (ASC 310-10-35-1 to 43) was superseded by Accounting Standards Update No. 2016-13 (ASC 326).

ASC 326-20-30-2 (emphasis added): An entity shall measure expected credit losses of financial assets on a collective (pool) basis when similar risk characteristic(s) exist (as described in paragraph 326-20-55-5). If an entity determines that a financial asset does not share risk characteristics with its other financial assets, the entity shall evaluate the financial asset for expected credit losses on an individual basis. If a financial asset is evaluated on an individual basis, an entity also should not include it in a collective evaluation. That is, financial assets should not be included in both collective assessments and individual assessments.

ASC 326-20-30-3: The allowance for credit losses may be determined using various methods. For example, an entity may use discounted cash flow methods, loss-rate methods, roll-rate methods, probability-of-default methods, or methods that utilize an aging schedule. An entity is not required to utilize a discounted cash flow method to estimate expected credit losses. Similarly, an entity is not required to reconcile the estimation technique it uses with a discounted cash flow method.

ASC 326-20-35-1: At each reporting date, an entity shall record an allowance for credit losses on financial assets (including purchased financial assets with credit deterioration) within the scope of this Subtopic. An entity shall compare its current estimate of expected credit losses with the estimate of expected credit losses previously recorded. An entity shall report in net income (as a credit loss expense or a reversal of credit loss expense) the amount necessary to adjust the allowance for credit losses for management's current estimate of expected credit losses on financial asset(s). The method applied to initially measure expected credit losses for the assets included in paragraph 326-20-30-14 generally would be applied consistently over time and shall faithfully estimate expected credit losses for financial asset(s).

Writeoffs and Recoveries of Financial Assets

ASC 326-20-35-8: Writeoffs of financial assets, which may be full or partial writeoffs, shall be deducted from the allowance. The writeoffs shall be recorded in the period in which the financial asset(s) are deemed uncollectible. Recoveries of financial assets and trade receivables previously written off shall be recorded when received.

IFRS 15: Simplified approach for trade receivables, Contract assets and lease receivables

IFRS 15.5.5.15: Despite paragraphs 5.5.3 and 5.5.5, an entity shall always measure the loss allowance at an amount equal to lifetime expected credit losses for:

IFRS 9.5.3: ... at each reporting date, an entity shall measure the loss allowance for a financial instrument at an amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since initial recognition.

IFRS 9.5.5.5 ... at the reporting date, the credit risk on a financial instrument has not increased significantly since initial recognition, an entity shall measure the loss allowance for that financial instrument at an amount equal to 12-month expected credit losses.

(a) trade receivables or Contract assets that result from transactions that are within the scope of IFRS 15, and that:

     (i) do not contain a significant financing component in accordance with IFRS 15 (or when the entity applies the practical expedient in accordance with paragraph 63 of IFRS 15); or

     (ii) contain a significant financing component in accordance with IFRS 15, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all such trade receivables or Contract assets but may be applied separately to trade receivables and Contract assets.

(b) lease receivables that result from transactions that are within the scope of IFRS 16, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all lease receivables but may be applied separately to finance and operating lease receivables.

1/16/X2, XYZ determined that it had no reasonable expectations of recovering receivable #123 for 300 from ABC.

In other words, the receivable had become uncollectible.

1/16/X2 / 16.1.X2
Allowance for doubtful accounts		300
	Trade receivable: ABC: 123		300

 

ASC 326-20-35-8: Writeoffs of financial assets, which may be full or partial writeoffs, shall be deducted from the allowance. The writeoffs shall be recorded in the period in which the financial asset(s) are deemed uncollectible. Recoveries of financial assets and trade receivables previously written off shall be recorded when received.

IFRS 9.5.4.4: An entity shall directly reduce the gross carrying amount of a financial asset when the entity has no reasonable expectations of recovering a financial asset in its entirety or a portion thereof. ...

Note, even though paragraph 5.4.4 states "directly reduce", this should not be intenerated to mean that an allowance is not necessary, since paragraph 5.5.15 specifies that an allowance is necessary.

IFRS 9.5.5.15 ... an entity shall always measure the loss allowance at an amount equal to lifetime expected credit losses for: (a) trade receivables or contract assets that result from transactions that are within the scope of IFRS 15 ...

1/24/X2, XYZ determined that receivable #456 for 750 from DEF was impaired.

1/24/X2 / 24.1.X2
Allowance for doubtful accounts		750
	Trade receivable: DEF: 456		750

 

etc.

Even though it had been written off on 1/16/X2, receivable #123 was collected on 20/6/X2.

Dr/Cr

XYZ reversed the write-off.

6/20/X2 / 20.6.X2
Trade receivable: ABC: 123		300
	Allowance for doubtful accounts		300
Cash		300
	Trade receivable: ABC: 123		300
	Alternatively
	Alternatively

 

Although a reversal is clearly the best procedure, crediting the recovery to the allowance account is not inconsistent with the guidance.

ASC 326-20-35-8: Writeoffs of financial assets, which may be full or partial writeoffs, shall be deducted from the allowance. The writeoffs shall be recorded in the period in which the financial asset(s) are deemed uncollectible. Recoveries of financial assets and trade receivables previously written off shall be recorded when received.

ASC 326-20-35-9: Practices differ between entities as some industries typically credit recoveries directly to earnings while financial institutions typically credit the allowance for credit losses for recoveries. The combination of this practice and the practice of frequently reviewing the appropriateness of the allowance for credit losses results in the same credit to earnings in an indirect manner.

As IFRS guidance is less detailed than US GAAP, it does not specifically address the procedure that should be used to recognize recoveries.

However, since the above is not disallowed, it is allowed.

Nevertheless, it is not recommended by this web site.

Cash		300
	Allowance for doubtful accounts		300

 

Similarly, crediting recoveries directly to earnings (presumably as gain) is downright ugly accounting and highly unrecommended by this web site.

Cash		300
	Gain (recovered uncollectible accounts)		300

Voiding entries, common procedure under some national GAAPs, while not explicitly disallowed, are :-(

Allowance for doubtful accounts		(300)
	Trade receivable: ABC: 123		(300)
Cash		300
	Trade receivable: ABC: 123		300

During X2, receivables with a total carrying value of 30,417 were written off leaving a 2,458 balance on the allowance account.

Dr/Cr

As this balance (at 7.48%) was deemed to be insignificant (less than 10%), XYZ simply re-used the X1 uncollectability estimates.

 

Trade Receivables Aging Schedule: X2
Age in days	0 > 30	30 > 60	60 > 90	90 > 180	Over 180	Σ
X2 Balances	1,100,000	66,000	15,840	6,970	6,133	1,194,943
Factor	2.00%	5.00%	20.00%	40.00%	80.00%
Allowance	22,000	3,300	3,168	2,788	4,907	36,162

12/31/X2 / 31.12.X2
Loss on uncollectible receivables		33,704
	Allowance for doubtful accounts		33,704

 

33,704 = 36,162 - 2,458

Same facts except only 23,899 was written off during X2.

As the difference (8,976) was (at 27.30%) significant, XYZ not only carried forward the balance, but adjusted the collectability assessment to reflect its new experience.

 

Trade Receivables Aging Schedule: X2
Age in days	0 > 30	30 > 60	60 > 90	90 > 180	Over 180	Σ
X2 Balances	1,100,000	66,000	15,840	6,970	6,133	1,194,943
Factor	1.50%	3.00%	14.00%	25.00%	60.00%
Allowance	16,500	1,980	2,218	1,742	3,680	26,120

 

While an annual adjustment is generally sufficient, the schedule should also be adjusted in any interim period where it becomes evident that the collectability of receivables has significantly changed.

12/31/X2 / 31.12.X2
Loss on uncollectible receivables		17,144
	Allowance for doubtful accounts		17,144

 

17,144 = 26,120 - (32,875 - 23,899)

 

Same facts except only 5,000 was written off during X2.

The difference was not only material but also due to a misuse of facts, so XYZ corrected the prior period.

IAS 8 (definitions): Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that:

(a) was available when financial statements for those periods were authorised for issue; and

(b) could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those financial statements. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud. ASC 250-10

ASC 250-10-20: An error in recognition, measurement, presentation, or disclosure in financial statements resulting from mathematical mistakes, mistakes in the application of generally accepted accounting principles (GAAP), or oversight or misuse of facts that existed at the time the financial statements were prepared. A change from an accounting principle that is not generally accepted to one that is generally accepted is a correction of an error.

12/31/X2 / 31.12.X2 correction of error: 12/31/X1 / 31.12.X1
Allowance for doubtful accounts		32,875
	Loss on uncollectible receivables		32,875
Loss on uncollectible receivables		5,000
	Allowance for doubtful accounts		5,000

 

IAS 8.42 ... an entity shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by:

(a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or ...

ASC 250-10-45-23: Any error in the financial statements of a prior period discovered after the financial statements are issued or are available to be issued (as discussed in Section 855-10-25) shall be reported as an error correction, by restating the prior-period financial statements. ...

Percentage of sales method

During X1, XYZ sold goods worth 13,035,744 on credit.

Applying a factor of 0.252%, it estimated uncollectible receivables at 32,875.

The aging schedule method is superior because leads to better results.

In practice, a simple percentage of receivables method is also occasionally used.

However, this method is so unreliable that no example of how it should be applied is presented.

Its additional advantage is that it is specifically mentioned in the guidance.

ASC 326-20-30-3: The allowance for credit losses may be determined using various methods. For example, ... aging schedule. ...

Since ASC 326 deals with more than just trade receivables, paragraph 30-3 gives more guidance than needed for just trade receivables.

ASC 326-20-30-3: The allowance for credit losses may be determined using various methods. For example, an entity may use discounted cash flow methods, loss-rate methods, roll-rate methods, probability-of-default methods, or methods that utilize an aging schedule. An entity is not required to utilize a discounted cash flow method to estimate expected credit losses. Similarly, an entity is not required to reconcile the estimation technique it uses with a discounted cash flow method.

It also mentions loss-rate methods (commonly used by insurance providers), roll-rate methods (credit card issuers) and probability-of-default methods (banks).

As IFRS provides less procedural guidance than US GAAP, it does not give any examples of the methods that should be used to determine expected credit losses.

Simplified approach for trade receivables, contract assets and lease receivables

IFRS 15.5.5.15: Despite paragraphs 5.5.3 and 5.5.5, an entity shall always measure the loss allowance at an amount equal to lifetime expected credit losses for:

IFRS 9.5.3: ... at each reporting date, an entity shall measure the loss allowance for a financial instrument at an amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since initial recognition.

IFRS 9.5.5.5 ... at the reporting date, the credit risk on a financial instrument has not increased significantly since initial recognition, an entity shall measure the loss allowance for that financial instrument at an amount equal to 12-month expected credit losses.

(a) trade receivables or contract assets that result from transactions that are within the scope of IFRS 15, and that:

    (i) do not contain a significant financing component in accordance with IFRS 15 (or when the entity applies the practical expedient in accordance with paragraph 63 of IFRS 15); or

    (ii) contain a significant financing component in accordance with IFRS 15, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all such trade receivables or contract assets but may be applied separately to trade receivables and contract assets.

(b) lease receivables that result from transactions that are within the scope of IFRS 16, if the entity chooses as its accounting policy to measure the loss allowance at an amount equal to lifetime expected credit losses. That accounting policy shall be applied to all lease receivables but may be applied separately to finance and operating lease receivables.

The percentage of sales method is thus not recommended by this web site, even though it is common in practice.

32,875 = 13,035,744 x 0.25219%

Dr/Cr

12/31/X1 / 31.12.X1
Bad debt expense (loss on uncollectible accounts)		32,875
	Allowance for doubtful accounts		32,875

 

IFRS 15 and ASC 606 both stipulate that uncollectible accounts should be recognized as losses.

IFRS 15.113 (edited, emphasis added): An entity shall disclose ... any impairment losses recognised (in accordance with IFRS 9) on any receivables or contract assets arising from an entity’s contracts with customers, which the entity shall disclose separately from impairment losses from other contracts.

ASC 606-10-50-4 (edited, emphasis added): An entity shall disclose all of the following amounts ... Credit losses recorded (in accordance with Subtopic 326-20 on financial instruments measured at amortized cost) on any receivables or contract assets arising from an entity's contracts with customers, which the entity shall disclose separately from credit losses from other contracts.

This is mirrored in the respective XBRL taxonomies:

ImpairmentLossImpairmentGainAndReversalOfImpairmentLossDeterminedInAccordanceWithIFRS9

ProvisionForDoubtfulAccounts

Note: while US GAAP XBRL presents impairments of receivables separately from other impairments, in IFRS XRBL all impairments made according to IFRS 9 (including receivables) are presented in aggregate.

However, as these losses are recognized at each reporting date, they are generally matched with revenue as if they were expenses.

Further, many companies consider uncollectible accounts be expenses.

The difference between expenses and losses is explored in the Accounting elements section.

Specifically, if a company wants to avoid bad debts, it can sell COD.

Many companies avoid this because the drop in revenue will often more than offset any savings.

For the same reason, they also classify the expense as selling or distribution.

Nevertheless, since both IFRS and US GAAP state that these losses are losses, many companies report them as such.

Consequently, both approaches are encountered in practice (example one, example two).

Note: these annual reports have been copied to a local server to avoid potentially broken links.

Readers are advised to download the originals from the company pages.

During X2, it actually wrote off receivables of 35,875. To reflect this, it adjusted the factor to 0.275%.

The procedure for writing off individual receivables is the same as in the above example.

0.275% = 35,875 ÷ 13,045,635.

The factor should be re-examined each period, adjusted to reflect the actual uncollectible accounts from the previous period. Unless the situation begins to change significantly, an annual adjustment should be sufficient to prevent materially inaccurate results.

Its X2 sales were 14,340,000.

12/31/X2 / 31.12.X2
Loss on uncollectible receivables		39,435
	Allowance for doubtful accounts		39,435

 

39,435 = 14,340,000 x 0.275%