4.1.2.3 Accounting rules for determining whether a supply is made for consideration

Revenue is a crucial concept for users of financial statements in assessing an entity’s financial performance and position. The primary issue in accounting for revenue is determining when to recognise revenue.1 For the purpose of revenue recognition, revenue must be measured,2 transactions must be identified, and revenue must be allocated to the relevant transactions.3

Revenue recognition requirements in International Financial Reporting Standards (IFRSs) differ from those in US generally accepted accounting principles (US GAAP). US GAAP comprises broad revenue recognition concepts and numerous requirements for particular industries or transactions that can result in different accounting for economically similar transactions. Although IFRSs have fewer requirements on revenue recognition, the revenue recognition standard most relevant for this research, IAS 18 Revenue, can be difficult to understand and apply. In addition, IAS 18 provides limited guidance on important topics such as revenue recognition for multiple-element arrangements.4

At the time of conception of this Section of my research, the proposed new rules regarding revenue recognition were not yet applicable (earlier application of the proposed rules is not allowed for entities that fall under the FASB rules5 but is allowed for the entities that apply the IASB rules6). Therefore, I have also included an elaborate description of the rules as applicable before 1 January 2017 (the date on which the proposed rules were supposed to come into effect). Even though the current rules as set out by the two regulatory bodies differ and because they are not always completely clear, I have chosen to elaborate on these (current) rules to provide an insight in how the question of determining whether a ‘free’ supply is actually a free supply is answered from a current accounting perspective.

I will start with the proposed new rules. From a (proposed, see Section 4.1.2.4) accounting perspective, I consider the following two steps most relevant for this research, because these are similar to the two steps taken under the EU VAT rules for determining whether a transaction is made for consideration, and for determining how to allocate the total consideration to the various elements of the transaction (I will elaborate on that in Section 4.6).

The first step is designed to decide whether the free elements of a supply may be considered separate supplies. For this purpose, first it has to be determined whether the ‘free’ supply is made as part of an existing contract or not. If the ‘free’ supply is part of an existing contract, part of the overall consideration should be allocated to it, which means that the supply is never actually ‘free’ from an accounting perspective. If the ‘free’ supply is not part of an existing contract, no part of the consideration paid for the agreed supply can be allocated to it, making it a real ‘free’ supply from an accounting perspective.

The second step is designed to decide what part of the transaction price should be allocated to the relevant separate supplies that form the composite supply. For this purpose, the calculations should be relatively straightforward and intuitive.