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Question Title: CR – Nov 2018 – L3 – SC – Q7 – Segment Reporting and Revenue Recognition for Long-Term Contract
Level: Level 3
Professional Bodies: ICAN
Programs: Professional Program
Subjects: Corporate Reporting
Topics: Operating Segments (IFRS 8), Revenue Recognition (IFRS 15)
Series: Nov. 2018
Section: C
Total Marks: 15
Question Tags: Segment Reporting, Chief Operating Decision Maker, Revenue Recognition, Long-Term Contracts, Government Contracts
Question Short Summary:
Guidance on segment reporting and revenue recognition for long-term contracts for Agbero Plc’s operating and contract revenue.
Question:
a. Agbero plc is a public company rendering services to the Lagos State Government, primarily in public transport. Listed on the Lagos Stock Exchange, Agbero plc identified three operating segments in its annual financial statements for the year ended March 31, 2018:
- Segment 1: Local bus operations
- Segment 2: Inter-city bus operations
- Segment 3: Road constructions
The company disclosed two reportable segments. Segments 1 and 2 were aggregated into a single reportable operating segment, based on similar business characteristics, and the nature of their products and services. In the local bus operations market, the Lagos State Transport Authority awards the contract and pays Agbero for its services. Contracts for local bus operations are awarded via a competitive tender process, and ticket prices are set and paid to the Lagos State Transport Authority. In the inter-city bus operation market, Agbero sets the ticket prices, and passengers pay Agbero directly for the service.
Required:
i. Advise Agbero plc on how the above accounting issues should be dealt with in its financial statements. (6 Marks)
ii. Although the company is satisfied with IFRS 8 – Operating Segment, it is unclear who to designate as the chief operating decision maker (CODM) under the standard. Define the chief operating decision maker in line with IFRS 8 – Operating Segment and identify who this should be in Agbero plc. (2 Marks)
b. Agbero Plc entered a contract with the Lagos State Government on April 1, 2016, to construct a new light railway line. The contract total revenue is N5 billion over a three-year period. The contract specifies that N1 billion will be paid at the start of the contract, but subsequent payments will be settled only upon completion of the project. Invoices have been sent as follows:
- Year ended March 31, 2017: N2.8 billion
- Year ended March 31, 2018: N1.2 billion
- Remaining balance to be invoiced on March 31, 2019
To date, Agbero Plc has only recognized the initial payment in the financial statements up to March 31, 2017, as no subsequent payments are due until March 31, 2019. The invoiced amounts reflect the work completed in each period.
Required:
Agbero Plc. wishes to know how to account for the revenue on the contract in the financial statements to date. Advise Agbero Plc. Market interest rates are currently at 6%. (7 Marks)
Answer:
a.
i. Accounting Treatment for Segment Aggregation:
- Under IFRS 8 – Operating Segments, segments may be aggregated if they have similar economic characteristics, product types, production processes, customer types, and regulatory environments. While Segment 1 (local bus operations) and Segment 2 (inter-city bus operations) both involve passenger transport services, the regulatory environment and revenue sources differ. The local bus segment depends on Lagos State contracts with set ticket prices, while the inter-city segment is a market-driven operation where Agbero controls pricing and receives direct revenue from passengers.
- Recommendation: Given these operational and revenue differences, Segments 1 and 2 may not meet the IFRS 8 aggregation criteria, and it is advisable for Agbero to report them separately to provide clearer financial insights for stakeholders.
ii. Chief Operating Decision Maker (CODM) Definition and Identification:
- Definition: According to IFRS 8, the CODM is the individual or group responsible for allocating resources and assessing segment performance. This role is typically held by the CEO, COO, or a similar executive team, focusing on strategic and financial decisions.
- Identification for Agbero Plc: In Agbero’s case, the CODM could be the CEO or an executive team overseeing segment performance and making resource allocation decisions. This role should be identified formally in financial reporting.
b. Revenue Recognition for the Construction Contract
- Applicable Standard: IFRS 15 – Revenue from Contracts with Customers, states that revenue should be recognized over time if the entity satisfies a performance obligation over the contract duration.
- Revenue Recognition Method: Agbero should use the percentage-of-completion method to recognize revenue progressively as work is performed and completed, rather than waiting until final payment. This is based on work progress and customer acceptance criteria.
- Interest Rate Application: Since payments are deferred until project completion, Agbero should discount future receivables using the 6% market rate to reflect the time value of money, aligning with IFRS 15.
- Adjusted Revenue Recognition: Revenue for each period should reflect the present value of work completed. Agbero should adjust previously recognized revenue for under or overstatements, ensuring financial statements reflect the contract’s economic substance accurately.
