It is important to note that Manfredi’s individual customer account is not part of the general ledger. It is sometimes referred to as a ‘subsidiary ledger’ and will only include the detailed transactions which relate to Manfredi. This way Ingrid can have a full understanding of the amounts owed individually by Manfredi, rather than just the amounts owed by all of her customers as would be reflected by the trade receivables figure in the general ledger.
Manfredi’s individual customer account shows a debit balance. This is an asset because it ‘is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits’ (IASB Conceptual Framework for Financial Reporting, paragraph 4.3 – 4.4).
Here the ‘entity’ is Ingrid’s business, the ‘past event’ is the sale, and the ‘economic benefits’ are represented by the cash which will be received from Manfredi when he settles the invoice.
The effect on the accounting equation is that inventory will decrease by the cost of the goods sold and trade receivables will increase by the selling price of the goods sold. So total assets increase by the profit made on the sale. This also increases equity.
The profit on this transaction is therefore taken when the goods are sold even though no money has changed hands yet. This is because this transaction meets all of the requirements of IFRS 15 Revenue from Contracts with Customers.
The key principle of IFRS 15 is that revenue is recognised to depict the transfer of promised goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services.
This is achieved by applying a five-step model:
- Identify the contract(s) with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognise revenue when (or as) the entity satisfies a performance obligation
Applying the five-step model, you can see all the criteria have been met:
1. Identify the contract(s) with a customer:
Manfredi placed an order that was confirmed by Ingrid. This represents a contract to supply the materials.
2. Identify the performance obligations in the contract:
There is one performance obligation, the delivery of the materials as ordered.
3. Determine the transaction price:
This is the price agreed as per the order, ie $6,450. Note that if there were sales tax on the sale, this would not be included since transaction price as defined by IFRS 15 does not include amounts collected on behalf of third parties. Therefore, although the total trade receivable and the amount included in Manfredi’s individual customer account would include the sales tax, the transaction price used to determine revenue recognition would be the total sales price net of sales tax. The sales tax would be recorded in a separate account in the general ledger.
4. Allocate the transaction price to the performance obligations in the contract:
There is one performance obligation, therefore the full transaction price is allocated to the performance of the obligation on the delivery of the materials on 17 March 20X0.
5. Recognise revenue when (or as) the entity satisfies a performance obligation:
Since Manfredi has signed a delivery note to confirm acceptance of the materials as satisfactory, this is evidence that Ingrid has fulfilled its performance obligation and can therefore recognise $6,450 of revenue on 17 March 20X0.
Note: The timing of the payment by Manfredi is not relevant to when the revenue is recognised.
What happens now?
If all goes well, Manfredi will keep to the terms of the agreement and Ingrid will receive payment within 30 days. If Manfredi pays on 16 April 20X0, Ingrid will debit the bank account and credit the trade receivables account in the general ledger. The payment will also be credited to Manfredi’s individual customer account, as shown in Table 2 below:
Table 2: Manfredi's individual customer account (post-payment)