Accounting for and auditing revenue during COVID-19

This article is part of a series on financial reporting and auditing in the shadow of COVID-19.

As a direct result of the Coronavirus pandemic, some entities are experiencing significant declines in revenue and delays in the progress and delivery of performance obligations for long-term contracts. These declines in revenue may arise from decreases in volume, amendments to contract specifications or changes in variable consideration with contingent conditions.

COVID-19 presents a number of potential issues in respect of revenue recognition for entities and gives rise to additional considerations for auditors. It is likely that, as a result of changes in the economic environment, customers will seek to modify contracts and it is also possible that the ability of customers to pay for goods may be called into question prior to delivery occurring.

This article is aimed at entities preparing accounts under FRS 102. The accounting approach under IFRS may be different.

Revenue recognition

FRS 102 Section 23 permits revenue to be recognised from the sale of goods only when all of the following conditions are satisfied:

• The entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
• The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
• The amount of revenue can be measured reliably;
• It is probable that the economic benefits associated with the transaction will flow to the entity; and
• The costs incurred in respect of the transaction can be measured reliably.

For the rendering of services, the first two bullet points are replaced with the requirement that the stage of completion of the transaction at the end of the reporting period can be measured reliably.

The main issue that COVID-19 presents in respect of revenue recognition relate to the fourth bullet point and whether the entity can reliably conclude that the economic benefits associated with the transaction will flow to the entity. Although the entity may well have entered into the transaction in good faith prior to the outbreak of the pandemic, it could be that the impact of COVID-19 has resulted in that flow of economic benefit becoming uncertain, perhaps because the customer receiving the goods or services is experiencing significant financial difficulties.

When considering the provision of services, it could be the case that the non-completion of that service to an acceptable stage of completion (perhaps due to restrictions in accessing customer premises for example) results in a reduction in the amount of revenue that can be recognised.

Understanding the customer contract terms will be crucial during the coming months, in order to understand the customer’s rights and ability to modify these terms.

Audit implications

The main audit considerations relate to ensuring that the accounting treatment is appropriate, has been correctly applied and that there is sufficient appropriate evidence. Areas that could become more challenging going forward include:

• Internal controls. Are the entity’s systems still working or have some of the risks and associated controls changed? The spread of COVID-19 resulted in the rapid adoption of home and remote working. This could require updates to systems notes and walkthrough testing.
• Whilst always essential, sufficient documentary evidence of issues such as key judgements made and significant risks will be needed.
• Analytical review procedures. Forming an expectation of performance will be more challenging.
• Robustness of stock movement records and accuracy of year-end balances.

The risks posed will vary for different industries and markets and as always, professional scepticism will be crucial. It may be that auditors place less reliance on internal controls and undertake more substantive testing procedures.

Other considerations

Some further considerations when accounting for and auditing revenue are as follows:

• Where an entity sells goods with a right of return it is important to ensure that there is a reassessment of likely returns.
• Where discounts are offered to customers they should be considered in the measurement of revenue.
• Recoverability of debtors will become a much bigger issue and may impact on going concern.

Management should carefully consider all aspects of the revenue recognition process applicable to their specific facts and circumstances, and may find additional areas that require consideration.

Please do not hesitate to contact Peter Manser or Joe Timms to discuss any accounting or auditing questions related to revenue that you may have.