IFRS 15 -Revenue from Contracts with Customers
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Background
IFRS 15 specifies how an entity should recognize its income from goods and services and establish principles to report useful information to users of financial statements about the nature, amount, timing and uncertainty of income and cash flows arising from a contract. With a client.
This standard was issued in May 2014 and applies to an annual reporting period beginning on or after January 1, 2018, with early application permitted.
Scope
An entity shall apply this Standard to all contracts with customers, except the following:
(a) lease contracts within the scope of IFRS 16 Leases;
(b) contracts within the scope of IFRS 17 Insurance Contracts. However, an entity may choose to apply this Standard to insurance contracts that have as their primary objective the provision of services for a fixed rate in accordance with paragraph 8 of IFRS 17;
(c) financial instruments and other contractual rights or obligations within the scope of IFRS 9 Financial Instruments, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IAS 27 Separate Financial Statements and IAS 28 Investments in Associates and Joint Ventures; and
(d) non-monetary exchanges between entities in the same business line to facilitate sales to clients or potential clients. For example, this Standard would not apply to a contract between two oil companies that agree to an oil exchange to meet customer demand at different specific locations in a timely manner.
Key
definitions:
Contract:
An agreement between two or more parties that creates enforceable rights and obligations.
Customer:
A party that has contracted with an entity to obtain goods or services that are a result of the entity's ordinary activities in exchange for consideration.
Income:
Increases in economic benefits during the accounting period in the form of inflows or improvements in assets or decreases in liabilities that result in an increase in equity, other than those related to contributions from equity participants.
Performance obligation:
A promise in a contract with a client to transfer the client:
a good or service (or a package of goods or services) that is different;
or a series of different goods or services that are substantially the same and have the same pattern of transfer to the customer.
Revenue:
Income that arises in the course of the ordinary activities of an entity.
Transaction price:
The amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties.
IFRS 15 has
introduced 5 step model for revenue recognition:
1. Identify the
contract
2. Identify the
performance obligations in the contract
3. Determine
the transaction price
4. Allocate the
transaction price to the performance obligations
5. Recognize
revenue when (or as) the entity satisfies a performance obligation
Step 1: Identify the contract with the customer
A contract is an agreement between the parties that creates enforceable rights and obligations.
You must apply IFRS 15 to all contracts that have the following 5 attributes:
- The parties to the contract have approved it and agree to fulfill it;
- The rights of each party over the transferred goods / services are identified;
- The payment terms are identified;
- The contract has a commercial substance; and
- The entity is likely to collect the consideration. In assessing whether it is probable that an amount of the consideration may be collected, an entity will only consider the customer's ability and intention to pay that amount of the consideration when it is due.
What is the contract?
A contract is an agreement between two or more parties that creates enforceable rights and obligations. The enforceability of rights and obligations in a contract is a matter of law. Contracts can be written, verbal, or implied by an entity's normal business practices. The practices and processes for establishing contracts with clients vary by jurisdiction, industry and legal entity. Furthermore, they may vary within an entity (for example, they may depend on the class of customer or the nature of the promised goods or services). An entity will consider those practices and processes to determine whether and when an agreement with a customer creates enforceable rights and obligations.
There is no contract if each party to the contract has a unilateral right to terminate a totally breached contract without compensating the other party (or parties). A contract is not fulfilled if the following two criteria are met:
(a) the
entity has not yet transferred any promised goods or services to the customer;
and
(b) the
entity has not yet received, and is not yet entitled to receive, any
consideration in exchange for promised goods or services.
Note: An entity shall reassess the criteria of contact only when there is an indication of a significant change in facts and
circumstances. For instance, if a customer’s ability to pay the consideration
deteriorates significantly
IFRS 15 provides guidance about contract combinations and
contract modifications:
Contract merging occurs when you need to account for two or more contracts as for a single contract if the following criteria are met:
(a) contracts are negotiated as a package with a single business objective;
(b) the amount of the consideration to be paid in one contract depends on the price or performance of the other contract; or
(c) the goods or services promised in the contracts (or some goods or services promised in each of the contracts) are a single performance obligation.
Contract Modification:
The modification of the contract is the change in the scope, price or both approved by the parties. In the illustration, when you add certain goods or services, or provide some additional discount, you are effectively dealing with contract modification.
If the scope of the contract increases due to the addition of promised goods or services that are different and the contract price has increased for the additional promised goods and services, the change of the contract will be considered a separate contract (instead of the contract modification).
Step 2: Identify the performance obligations in the contract
Performance obligation is any good or
service that contract promised to transfer to the customer.
It can be
either:
- A
single good or service, or their bundle that is distinct; or
- A
series of distinct goods or services that are substantially the same and
have the same pattern of transfer.
A series of distinct goods or services has the same pattern of transfer to the customer if the following two criteria are met:
(a) each distinct good or service in the series that the entity promises to transfer to the customer would meet the performance obligation criteria satisfied over time; and
(b) the measurement method (developed in step 5) of the performance obligation satisfied over time would be used to measure the entity's progress towards complete satisfaction of the performance obligation to transfer each good or service other than the customer series.
Performance obligations can be both explicit (for example, written in the contract) and implicit (for example, implicit in some common practices).
Performance obligations do not include activities that an entity must perform to fulfill a contract unless those activities transfer a good or service to a customer. For example, a service provider may need to perform various administrative tasks to establish a contract. The performance of those tasks does not transfer customer service as the tasks are performed. Therefore, those setup activities are not a performance obligation.
Also, if there is no transfer to the customer, then there is no performance obligation. For example, imagine you are building a building for your customer. Before starting, build a small mobile toilet for your workers. Since this will not be delivered to your client, it is not a separate performance obligation.
Few examples of distinct goods and services:-
(a) sale of
goods produced by an entity (for example, inventory of a manufacturer);
(b) resale of
goods purchased by an entity (for example, merchandise of a retailer);
(c) resale of
rights to goods or services purchased by an entity (for example, a ticket
resold by an entity acting as a principal);
(d) performing
a contractually agreed-upon task (or tasks) for a customer;
(e) providing
a service of standing ready to provide goods or services (for example,
unspecified updates to software that are provided on a when and-if-available
basis) or of making goods or services available for a customer to use as and
when the customer decides;
(f) providing
a service of arranging for another party to transfer goods or services to a
customer (for example, acting as an agent of another party);
(g) granting
rights to goods or services to be provided in the future that a customer can
resell or provide to its customer (for example, an entity selling a product to
a retailer promises to transfer an additional good or service to an individual
who purchases the product from the retailer);
(h)
constructing, manufacturing or developing an asset on behalf of a customer;
(i) granting
licences; and
(j) granting options to purchase
additional goods or services (when those options provide a customer with a
material right).
Step 3: Determine the transaction price
The transaction price is the amount of consideration that an entity expects to be entitled to in exchange for transferring the promised goods or services to a customer, excluding amounts collected on behalf of third parties.
In determining the transaction price, an entity shall consider the effects of all of the following:
(a) variable consideration;
(b) limiting estimates of variable consideration;
(c) the existence of a significant financial component in the contract;
(d) non-monetary consideration; and
(e) consideration payable to a customer.
Variable consideration: if the promised consideration in a contract includes a variable amount, an entity will estimate (expected or more probable value) the amount of the consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer.
The promised consideration is
variable if either of the
following circumstances exists:
(a) The customer has a valid expectation derived from an entity's normal business practices, published policies, or specific statements that the entity will accept an amount of consideration less than the price stated in the contract. In other words, the entity is expected to offer a price concession. Depending on the jurisdiction, industry, or customer, this offer may be called a discount, refund, refund, or credit.
(b) other facts and circumstances indicate that the entity's intention, when entering into the contract with the customer, is to offer a price concession to the customer
Restrictive estimates of variable consideration: An entity shall include in the transaction price an estimated amount of variable consideration only to the extent that it is highly probable that a significant reversal in the amount of recognized cumulative income will not occur when the uncertainty associated with the variable consideration is subsequently resolved.
The existence of a significant financial component in the contract: An entity will adjust the promised amount of consideration for the effects of the time value of money if the timing of payments provides the customer with a significant benefit of financing the transfer of goods or services. In these circumstances, the contract contains an important financial component. There may be a significant financing component regardless of whether the financing promise is explicitly stated in the contract or implicit in the payment terms agreed by the parties to the contract.
Non-monetary consideration: The transaction price for contracts in which a customer promises consideration in a form other than cash, an entity will measure the non-monetary consideration at fair value.
Consideration payable to a customer: The consideration payable to a customer includes cash amounts that an entity pays or expects to pay the customer. The consideration payable to a customer also includes credit or other items (for example, a coupon or coupon) that can be applied to amounts owed to the entity. An entity shall account for the consideration payable to a customer as a reduction of the transaction.
Step
4: Allocate the transaction price to the performance obligations
Once you have identified the contract performance obligations and have determined the transaction price, you should divide the transaction price and assign it to the individual performance obligations.
The transaction price for each performance obligation (or different good or service) in an amount that represents the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer.
The general rule of thumb is to do it based on your relative independent selling prices, but there are 2 exceptions when you assign differently:
- By assigning discounts, and
- By assigning considerations with variable quantities.
Allocation based on independent selling price:
To allocate the transaction price to each performance obligation on a relative independent selling price basis, an entity shall determine the independent sale price at the commencement of the contract for the distinct good or service underlying each performance obligation in the contract and assign the transaction price in proportion to independent selling prices.
A stand-alone selling price is a price at which an entity would sell a promised good or a separate service to the customer (not included in the package). The best evidence of an independent sale price is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers.Few methods for
estimating the stand-alone selling price for reference:-
(a)
Adjusted market assessment approach—an entity could evaluate the market in
which it sells goods or services and estimate the price that a customer in that
market would be willing to pay for those goods or services.
(b)
Expected cost plus a margin approach—an entity could forecast its expected
costs of satisfying a performance obligation and then add an appropriate margin
for that good or service.
(c) Residual
approach—an entity may estimate the stand-alone selling price by reference to
the total transaction price less the sum of the observable stand-alone selling
prices of other goods or services promised in the contract.
Allocating discounts: A customer receives a discount for purchasing a package of goods or services if the sum of the independent sales prices of the goods or services promised in the contract exceeds the consideration promised in a contract.
Except for some conditions mentioned in the following paragraph, the discount will be assigned proportionally to all the obligations of performance of the contract.
The discount will be assigned to one or more, but not all, if the following criteria are met:
(a) the entity regularly sells each distinct good or service (or each distinct package of goods or services) in the contract independently;
(b) the entity also regularly independently sells a package (or packages) of some of those distinct goods or services at a discount to the independent sales prices of the goods or services in each package; and
(c) the discount attributable to each package of goods or services is substantially the same as the discount in the contract, and an analysis of the goods or services in each package provides observable evidence of the performance obligation (or performance obligations) to the which discount in the contract belongs.
Allocation of variable
consideration:
Variable
consideration that is promised in a contract may be attributable to the
entire contract or to a specific part of the contract, such as either of
the following:
(a)
one or more, but not all, performance obligations in the contract
(for example, a bonus may be contingent
on an entity transferring a promised good or service within a specified period
of time); or
(b)
one or more, but not all, distinct goods or services promised in a
series of distinct goods or services that forms part of a single performance
obligation
(for example, the consideration promised
for the second year of a two-year cleaning service contract will increase on
the basis of movements in a specified inflation index).
An
entity shall allocate a variable amount (and subsequent changes to that amount)
entirely to a performance obligation or to a distinct good or service
that forms part of a single performance obligation if both of the following
criteria are met:
(a)
the terms
of a variable payment relate specifically to the entity’s efforts to
satisfy the performance obligation or transfer the distinct good or service (or
to a specific outcome from satisfying the performance obligation or
transferring the distinct good or service); and
(b) allocating the
variable amount of consideration entirely to the performance obligation or the
distinct good or service is consistent with the allocation considering all of
the performance obligations and payment terms in the contract.
Changes in the transaction
price
After the start of the contract, the transaction price may change for various reasons, including the resolution of uncertain events or other changes in circumstances that change the amount of consideration an entity expects to be entitled to in exchange for the promised goods or services. . Any subsequent changes will be assigned to the transaction price on the same basis as at the beginning of the contract.
Step
5 Recognize revenue when (or as) the entity satisfies a performance obligation
Satisfaction
of performance obligations- An entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when (or as) the customer gains control of that asset.
Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits of the asset. Control includes the ability to prevent other entities from directing the use and reaping the benefits of an asset. The benefits of an asset are the potential cash flows (inflows or savings on outflows) that can be obtained directly or indirectly in many ways, such as:
(a) using the asset to produce goods
or provide services (including public services);
(b) using the asset to enhance the
value of other assets;
(c) using the asset to settle
liabilities or reduce expenses;
(d) selling or exchanging the asset;
(e) pledging the asset to secure a
loan; and
(f) holding the asset.
A performance
obligation can be satisfied either:
- Over
time – when control is passed to the customer over some period of time
(e.g. contract term); or
- At
the point of time – when control is retained by the supplier
until it is transferred at some moment.
Performance obligations satisfied over time:
An entity transfers control of a good or service over time and therefore satisfies a performance obligation and recognizes revenue over time, if one of the following criteria is met:
(a) the customer simultaneously receives and consumes the benefits provided by the entity's performance as the entity performs;
(b) the entity's performance creates or improves an asset (for example, work in progress) that the customer controls as the asset is created or improved; or
(c) the entity's performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for the performance completed to date.
Performance obligations satisfied at a point in time
If a performance obligation is not met over time, an entity meets the performance obligation at a time when the customer gains control and includes, but is not limited to, the following:
(a) The entity has a current right to pay for the asset: if a customer is currently obligated to pay for an asset, that may indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits of the asset in exchange.
(b) The customer has a legal title to the asset: The legal title can indicate which part of a contract has the ability to direct the use of an asset and obtain substantially all the remaining benefits of an asset or restrict the access of other entities to those benefits. Therefore, the transfer of legal title to an asset may indicate that the customer has obtained control of the asset. If an entity retains legal title solely as protection against the customer's failure to pay, those rights of the entity would not prevent the customer from gaining control of an asset.
(c) The customer has accepted the asset: The customer's acceptance of an asset may indicate that it has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits of the asset.
Measuring progress towards complete satisfaction of a
performance obligation
An entity will recognize revenue over time by measuring progress toward fully meeting that performance obligation. The objective in measuring progress is to represent an entity's performance in transferring control of promised goods or services to a customer.
Appropriate methods to measure progress include output methods and input methods. Standard provides guidance for using exit methods and entry methods to measure an entity's progress toward complete satisfaction of a performance obligation. In determining the appropriate method of measuring progress, an entity shall consider the nature of the good or service that the entity promised to transfer to the customer.
An entity shall recognize revenue from a performance obligation satisfied over time only if the entity can reasonably measure its progress towards complete satisfaction of the performance obligation. An entity could not reasonably measure its progress towards the complete satisfaction of a performance obligation if it lacks the reliable information that would be required to apply an appropriate method to measure progress.
Contract costs
IFRS 15 also provides
guidance about two types of costs related to the contract:
- Incremental costs of obtaining a contract: Incremental costs of obtaining a contract are those that an entity incurs to obtain a contract with a client that would not have been incurred if the contract had not been obtained (for example, legal fees, sales commissions and the like). An entity shall recognize as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs recognized as expenses.
Note: An asset recognized as above will be amortized systematically and consistently with the transfer to the customer of the goods or services to which the asset relates. The asset can be related to goods or services to be transferred under a specific advance contract
- Costs to fulfill a contract: if these costs are within the scope of IAS 2, IAS 16, IAS 38, then you must treat them according to the appropriate standard. Otherwise, you should capitalize them only if certain criteria are met.
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