Revenue and Taxation (IFRS 15 and IAS 12)
Performance
Revenue and Taxation (IFRS 15 and IAS 12)
Syllabus tag: KASNEB CPA | Intermediate Level | CA23 Financial Reporting and Analysis | Topic 7 Revenue and Taxation
Lesson objectives
By the end of this topic, you will be able to:
- Apply the five-step revenue model of IFRS 15
- Allocate a transaction price across separate performance obligations
- Distinguish revenue recognised at a point in time from over time
- Explain why deferred tax exists and compute a temporary difference
- Compute the total tax charge from current and deferred elements
Why this matters
Revenue is the first line of the income statement and the one most often manipulated. Tax is the last. Both are governed by standards that separate what the accounts show from what the cash and the tax return show.
IFRS 15: the five steps
- Identify the contract with the customer
- Identify the performance obligations — the distinct promises in it
- Determine the transaction price
- Allocate the price to the obligations, by standalone selling price
- Recognise revenue as each obligation is satisfied
The heart of the standard is step 2. A single invoice often contains several promises, and they may be satisfied at very different times.
Allocating a bundled price
Chui Ltd sells equipment with two years of servicing for KES 5,400,000. Sold separately, the equipment goes for 4,800,000 and the servicing for 1,200,000.
| Obligation | Standalone | Share | Allocated |
|---|---|---|---|
| Equipment | 4,800,000 | 80% | 4,320,000 |
| Servicing | 1,200,000 | 20% | 1,080,000 |
| 6,000,000 | 5,400,000 |
The customer received a discount of 600,000, and it is spread across both obligations in proportion. A company may not load the whole discount onto the service in order to recognise more revenue immediately.
Revenue in year 1 = 4,320,000 (equipment, delivered) + 540,000 (half the servicing) = KES 4,860,000
The remaining 540,000 sits as a contract liability — cash received for a promise not yet performed.
Point in time or over time
Revenue is recognised over time if any one of three conditions holds: the customer receives the benefit as the work is done, the work creates an asset the customer controls as it is built, or the asset has no alternative use and the seller has an enforceable right to payment for work done.
Otherwise it is recognised at a point in time, usually on transfer of control — which is not always the same as delivery.
Construction contracts
A contract with total revenue KES 48,000,000 and expected total costs 36,000,000. Costs to date are 21,600,000.
Percentage complete = 21,600,000 / 36,000,000 = 60%
| KES | |
|---|---|
| Revenue recognised (60% × 48,000,000) | 28,800,000 |
| Cost recognised (60% × 36,000,000) | (21,600,000) |
| Profit recognised | 7,200,000 |
Where a contract is expected to make a loss, the whole loss is recognised immediately rather than spread. Prudence applies to losses in a way it does not apply to profits.
:::checkpoint A company recognises revenue over time using costs incurred as its measure of progress. It buys all the materials for a two-year contract in month one. Explain what this does to the percentage complete and why it misstates progress. :::
IAS 12: why deferred tax exists
Accounting profit and taxable profit differ, because the tax authority has its own rules. Some differences are permanent — a fine is never deductible. Others are temporary: they reverse in later periods.
The commonest is depreciation. The accounts charge depreciation; the tax authority allows capital allowances at its own rates. Over the asset's whole life the two totals are the same, but in any single year they differ.
Deferred tax records the tax effect of those temporary differences, so the tax charge in the accounts relates to the profit in the accounts.
Computing deferred tax
Temporary difference = Carrying amount − Tax base
An asset with a carrying amount of KES 7,200,000 and a tax base of 5,400,000:
Temporary difference = 1,800,000 Deferred tax liability at 30% = KES 540,000
The difference is taxable because capital allowances have run ahead of depreciation. The relief has been enjoyed early, and tax will be higher in later years — so a liability is recognised now.
Where the carrying amount is below the tax base, the difference is deductible and gives a deferred tax asset — recognised only to the extent that future taxable profit is likely to be available to use it.
The total tax charge
Deferred tax is a balance sheet figure. Only the movement goes to profit or loss.
| KES | |
|---|---|
| Current tax (30% × taxable profit of 9,000,000) | 2,700,000 |
| Increase in deferred tax (540,000 − 400,000) | 140,000 |
| Total tax charge | 2,840,000 |
A frequent error is charging the whole closing deferred tax balance of 540,000 rather than the movement of 140,000. The opening balance was charged last year.
:::checkpoint A company's capital allowances have exceeded its depreciation for five years running, and its deferred tax liability has grown each year. Does this mean the company has been underpaying tax? Explain what the liability actually represents. :::