IFRS 15 – Revenue from Contracts with Customers Summary Report

By Mushfiq Mazhar

IFRS 15 Impact to other Standards

1. Prominent for companies who run the long-term contracts or complex transactions.
2. In May 2014, Board issued IFRS 15 which was a huge change to the existing revenue recognition guidance.
3. Before IFRS 15 standards, the revenue recognition guidance was spread over the standards and there were various interpretations too. For Example:

• IAS 18 Revenue.
• IAS 11 Construction Contracts.
• SIC 31 Revenue – Barter Transaction involving Advertising Services.
• IFRIC 13 Customer Loyalty Programs.
• IFRIC 15 Arrangements for the Construction of Real Estate.
• IFRIC 18 Transfers of Assets from Customers.

4. The introduction of IFRS 15 is meant to avoid confusion and conflicting situations which were caused due to existence of revenue standards as listed in 3(a).
5. International Accounting Standards Board (IASB) collaborated with Financial Accounting Standards Board (FASB) to develop a new revenue recognition standard, IFRS 15 Revenue from Contracts with Customers.

• In September 2015, the Board issued a mandatory Effective Date of IFRS 15 on or after January 1, 2018 and from that date all previous guidance will no longer apply.
• Financial Accounting Standards Board (FASB) issued almost identical standard, FAS Topic 606, which had minor difference compared to IFRS 15.

IFRS 15 applies to all contracts with customers with some exceptions

6. The following is the list where an entity will apply IFRS 15 Standard to all contracts, except the following:

• Lease Contracts under IFRS 16 Leases.
• Insurance Contracts under IFRS 4 Insurance Contracts.
• Financial Instruments and other contractual rights or obligations within the scope of: IAS 39 – Financial Instruments: Recognition and Measurement, 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.
• These are all kinds of investments from subsidiary’s, joint arrangements to associates and other investments.

7. IFRS 15 is not applied to non-monetary exchanges of assets between entities within the same line of business in order to facilitate sales to customers. For example:

• Two companies exchange oil or other commodities in order to meet demand.

8. IFRS 15 is only applied to contract with customers. Example, the standard is not applied to collaborating parties.

IFRS 15 introduces 5 Step Model for Revenue Recognition

9. The 5 step model is to determine how and when to account for revenue in a particular situation or transaction.

• Step 1: Identify the contract with a customer.
• Step 2: Identify individual performance obligations (PO) in the contract.
• Step 3: Determine the transaction price (TP).
• Step 4: Allocating the transaction price (TP) to the individual performance obligation (PO) in the contract.
• Step 5: Recognize revenue when (or as) an entity satisfies a performance obligation (PO).

10. Each of these 5 stages has its own considerations. IFRS 15 analyzes and provides guidance in every single step.

Step 1: Identify the contract with the customer

11. The contract is an agreement between two or more parties that creates enforceable rights and obligations.
12. The contract can be in both written and oral form, however, it must be enforceable and this will depend on the legislation in a particular country.
13. Every contract must have 5 attributes that are assessed at the inception of the arrangement. They are as follows:

• The parties have approved the contract and are committed to perform their obligations.
• Each party’s rights surrounding the goods or services to be transferred can be identified.
• The payment terms for the goods or services can be identified.
• The contract has commercial substance.
• It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. Customer’s ability and intention to pay needs to be evaluated.

14. The standard also prescribed when we need to combine two or more contracts into one contract for the purpose of revenue accounting which is called combination of contracts.
15. IFRS 15 deals with contract modification which is what happens if we modify, amend or change existing contract. While contact modification is a change in the scope, or price, or both which must be approved by the parties of that contract.
16. Contract modification is accounted based on the character and the price of additional goods or services. Contract modification is accounted as for a separate contract or as a catch-up adjustment or termination of old contract or start of the new one or some combination.

Step 2: Identify individual performance obligations (PO) in the contract

17. Performance obligation is a promise in a contract to transfer the customer either:

• Some good or service (or bundle) that is distinct; or
• A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. Example – when monthly cleaning services or monthly accounting services are signed up and they are same each month. In this case, you would need to treat this series as one single performance obligation that is satisfied over time and not as a lot of small individual performance obligations.

18. Contracts usually explicitly state the goods or services that should be transferred to a customer.
19. At times, there could also be implicit performance obligations that are implied by entities customary business practices. Example – guarantee which is usually provided to all customers.
20. When there is no transfer to the customer, then, there is no performance obligation.
21. The crucial aspect is to assess whether the performance obligations should be treated separately for accounting purposes or whether they are distinct.
22. IFRS 15 provides guidance regarding distinct and not distinct.

Step 3: Determine the Transaction Price (TP)

23. Transaction price is the amount of consideration to which the entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding the amounts collected on behalf of third parties such as sales taxes.
24. It is important to understand how to determine the transaction price. Usually the original contract is seen, however, it is not always the whole case. Sometimes, the transaction price can be variable and at other times it can be fixed. Thus, we need to take into account the nature and timing of consideration from the customer.
25. When we determine the transaction price, we need to consider the effect of all the following factors:

• Variable consideration – the amount of consideration can vary because of some discounts, bonuses or rebates.
• Constraining estimates in variable consideration.
• Existence of significant financing component in the contract.
• When the contract involves a non-cash consideration in the form of goods or services, then the entity includes that it is a fair value. IFRS 13 deals with fair value measurement.
• Consideration payable or amount paid to a customer is important. It can include either the cash amount paid or payable to the customer.

Step 4: Allocate the Transaction Price to the individual Performance Obligations (PO)

26. The basic allocation objective is to allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration which the entity expects to be entitled in exchange for transferring promised goods or services to the customer.
27. The general rule to allocate the transaction price is to do it in proportion to relative stand-alone selling prices.
28. There are only two exceptions from this general rule:

• Allocating discounts.
• Allocating variable consideration.

29. Stand-alone selling price is the price at which the entity would sell promised good or a service separately on a standalone basis at contract inception to the customer. In order to allocate the transaction price to the performance obligations we must therefore determine the stand-alone selling prices first.
30. The best method to determine the stand-alone selling price is to take the observable price of goods or services which is sold separately. However, the stand-alone selling prices might not always be readily observable so in these cases we need to make professional judgement. Various approaches are allowed for estimates such as:

• Adjusted market assessment approach.
• Expected cost plus margin.
• Residual approach.
• Combination.

Step 5: Recognize revenue when (or as) an entity satisfies a Performance Obligation (PO)

31. Performance obligation is satisfied when a promised good or service is transferred to a customer and this happens when the control over the good or service is transferred. Thus, when a customer receives control, he/she has the sole possession of the right to use the good or service for the rest of its economic life.
32. IFRS 15 introduces two concepts surrounding how performance obligation can be satisfied:

• Recognize revenue over time.
• Recognize revenue at the point of time.

IFRS 15 gives guidance on Contract Costs

33. IFRS 15 specifies the accounting treatment of the following:

• Costs to obtain a contract.
• Costs to fulfill a contract.

34. Costs to obtain a contract are incremental costs. These are the costs that would not have been incurred without obtaining the contract. For Example:

• Sales commission paid for the acquisition contract.
• Legal fees.
• Bonuses to employees given to obtain a contract.

35. IFRS 15 requires capitalizing these costs and amortizing them on a systematic basis consistent with transfer of goods or services under the contract to the customer.
36. Costs of fulfilling a contract are costs incurred in connection with satisfying performance obligation.
37. The standard dictates that if these costs are in the scope of other standards such as IAS 2 (Inventories), IAS 16 (Property, Plant, and Equipment), or IAS 38 (Intangible Assets), then an entity needs to treat these costs in line with the relevant standards.
38. If these costs are not within the scope of other standards then the costs should be capitalized or recognized as an asset if certain criteria’s are met such as:

• Costs relate directly to contract.
• Costs generate or enhance resources used in satisfying performance obligations in the future.
• Costs are expected to be recovered.

Citation:

“IFRS 15 Revenue from Contracts with Customers.” IFRS, http://www.ifrs.org/issued-standards/list-of-standards/ifrs-15-revenue-from-contracts-with-customers/