IPSASB Exposure Draft on Revenue with Performance Obligations (ED 181) part 4

What are compulsory transactions and how are they accounted for? 

What is a compelled transaction?

In the public sector, there may be circumstances where an entity is compelled to deliver goods or services to a purchaser, regardless of the purchaser’s ability or intention to pay for the goods or services. For example, municipalities are required to provide clean drinking water to households, irrespective of their intention or ability to pay.

How is this relevant to accounting for revenue transactions in ED 181?

ED 181 states that entities can only account for a binding arrangement if a set of criteria are met. One criterion is that it should be probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the purchaser or third-party beneficiary, by considering the purchaser’s ability and intention to pay. 

The accounting implication is that if the criterion is not met, i.e. an entity is unable to conclude initially that the purchaser has the ability and intention to pay, an entity is required to do the following:

1. Process no accounting entries initially and continue to assess whether the criterion is subsequently met. 
2. If the entity receives consideration from the purchaser before the criterion is met, recognise the consideration received as revenue if (a) or (b) is true:

(a) All of the following has occurred:

• the entity has delivered the goods or services to which the consideration relates; 
• the entity has no obligation to transfer any further goods or services for the consideration received; and
• the consideration received is non-refundable.

       OR

(b) The binding arrangement is terminated and the consideration received is non-refundable.

      3. If an entity receives consideration from the purchaser before the criterion is met and neither (2)(a) nor (2)(b) is true, the entity recognises the consideration received as a liability until the criterion is met or either (2)(a) or (2)(b) occurs.

In considering the example of a compulsory transaction above where municipalities are required to provide clean drinking water to households, ED 181 requires municipalities to assess whether households have the ability and intention to pay for their water usage before accounting for the revenue in accordance with ED 70. The effect is that some transactions will only be accounted for when cash is received. 

What information will be disclosed on compelled transactions?

Due to the potential for the delayed recognition of revenue, ED 181 requires entities to disclose specific information on compulsory transactions. 

The disclosure requirements include, among others:

(a) A description of the legislation or similar means which compels the entity to enter into the transaction.

(b) The amount of revenue that was recognised after applying (1) to (3) above.

(c) The amount that was not recognised as revenue, as the collection of consideration was not probable.

(d) Further information if the transaction price has been reduced after consideration of an implicit price concession.

How are the ED 181 requirements different to local requirements?

Currently entities consider the requirements of IGRAP 1 on Applying the Probability Test on Initial Recognition of Revenue to initially recognise revenue. IGRAP 1 states that entities should not consider the counterparty’s credit risk when initially recognising revenue. A credit risk assessment impacts the subsequent measurement of the related receivable. 

With reference to the example of municipalities providing clean drinking water to households, municipalities will initially recognise revenue based on the amount that the municipality is entitled to, irrespective of the household’s credit record. This is important in the public sector as entities need to be held accountable for collecting the revenue that they (and the wider government) are entitled to collect.

The impact that the accounting proposed in ED 181 could have on compulsory transactions locally is that entities could go from recognising revenue in accordance with IGRAP 1, i.e. the full amount when the goods and services are provided, to recognising no revenue until cash is received (worst case scenario). 

Where can the EDs be accessed and how can you provide comment?

The EDs have been published on the ASB’s website and can be accessed here: https://www.asb.co.za/comment-on-proposals/. Comment can be submitted to the Secretariat of the ASB at info@asb.co.za.