IFRS 15

IFRS 15: Revenue from Contracts with Customers

IFRS 15 replaces both IAS 11 and IAS 18 as well as SIC 31, IFRIC 13, IFRIC 15 and IFRIC 18 and establishes a single, comprehensive framework for revenue recognition.

The objective of IFRS 15 is to establish the principles that an entity shall apply to report useful information to users of financial statements about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a contract with a customer.

Definition of income

Income are increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants.

Core principle

Its core principle is that revenue is recognised to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services.

Revenue is recognised when an entity satisfies a performance obligation by transferring a promised good or service to a customer. However, a good or service is only considered transferred when the customer obtains control of that good or service.

Usually the following criteria will be met:

• A contract has been agreed between the parties. This may be orally, in writing or otherwise;
• The value of the goods or services has been established;
• The product or service has been provided to the buyer (control has transferred);
• The buyer has indicated willingness to hand over cash or other assets in settlement.

Scope

IFRS 15 Revenue from Contracts with Customers applies to all contracts with customers except for:

• Leases within the scope of IFRS 16 Leases;
• 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;
• Insurance contracts within the scope of IFRS 4 Insurance Contracts; and
• Non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers.

A contract with a customer may be partially within the scope of IFRS 15 and partially within the scope of another standard. In that scenario:

• If other standards specify how to separate and/or initially measure one or more parts of the contract, then those separation and measurement requirements are applied first. The transaction price is then reduced by the amounts that are initially measured under other standards;

• If no other standard provides guidance on how to separate and/or initially measure one or more parts of the contract, then IFRS 15 will be applied.

Measurement

Revenue should be measured at the fair value of the consideration received or receivable. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price) per IFRS 13 Fair Value Measurement.

Performance obligations

A promise in a contract with a customer to transfer to the customer either:

• A good or service (or a bundle of goods or services) 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

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.

Five step approach

The core principle of IFRS 15 is that an entity will recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This core principle is delivered in a five-step model framework:

1. Identify the contract(s) with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations in the contract
5. Recognise revenue when (or as) the entity satisfies a performance obligation

Application will depend on the facts and circumstances present in a contract with a customer and will require the exercise of judgment.

Step 1: Identify the contract with the customer

A contract with a customer will be within the scope of IFRS 15 if all the following conditions are met:

• The contract has been approved by the parties to the contract;
• Each party’s rights in relation to the goods or services to be transferred can be identified;
• The payment terms for the goods or services to be transferred can be identified;
• The contract has commercial substance; and
• It is probable that the consideration to which the entity is entitled to in exchange for the goods or services will be collected.

If a contract with a customer does not yet meet all of the above criteria, the entity will continue to re-assess the contract going forward to determine whether it subsequently meets the above criteria. From that point, the entity will apply IFRS 15 to the contract.

A contract need not be in writing, as a valid contract can be oral or implied. The key requirements are that the contract has commercial substance, identifies each party’s rights and makes clear the payment terms. It must be probable that the consideration(payment) will be collected.

Contact modifications

The standard provides detailed guidance on how to account for approved contract modifications. If certain conditions are met, a contract modification will be accounted for as a separate contract with the customer. If not, it will be accounted for by modifying the accounting for the current contract with the customer. Whether the latter type of modification is accounted for prospectively or retrospectively depends on whether the remaining goods or services to be delivered after the modification are distinct from those delivered prior to the modification.

IFRS 15 sets out three different approaches to accounting for a contract modification. To determine which approach is required you have to ask:

• Are the additional goods or services distinct from those in the original contract? and
• Does the modification reflect the standalone selling price of the additional goods or services?

Different combinations of answers to the question can result in the change being treated as either:

1. A separate contract in addition to the original contract,
2. The termination of the original contract and the creation of a new contract (which will include the unsatisfied performance obligations from the original terminated contract) or
3. As part of the original contract.

For example,

• A new separate contract will normally arise if the modification relates to distinct goods and if the price at which the goods are sold amounts to a stand-alone price at which the goods are normally sold on the market. If this is not the case, there is likely to be some form of contract modification.

• If the modification relates to distinct goods but the price at which the goods are sold is at a significant discount, the original contract is likely to be terminated / extinguished, and a new contract created for the new units (plus any unfulfilled units of the original contract), accounted for prospectively after the date of modification.

• If the modification does not create a separate promise of distinct goods, the old contract would continue and no new contract would be created. For example, if no additional units are ordered, but instead a retailer negotiated a discount on the original price to units already delivered, due to unsatisfactory quality, an adjustment to revenue already recognised would modify the old contract retrospectively.

Step 2: Identify the performance obligations in the contract

This refers to whatever the seller is obliged to do under the contract. The performance obligation may be single or multiple depending on the situation. A straightforward retail sale of goods is an example of a single obligation. Once the seller provides the goods to the buyer, it has satisfied its performance obligation.

Sometimes a contract may have multiple performance obligations. An example here is a seller that agrees to supply and install a heating system for a customer. The supply of the goods is one deliverable, and the installation of the system is another. Each portion capable of being sold separately must be identified.

At the inception of the contract, the entity should assess the goods or services that have been promised to the customer, and identify as a performance obligation:

• A good or service (or bundle of goods or services) 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.

The following are examples of circumstances which do not give rise to a performance obligation:

• Providing goods at scrap value
• Activities relating to internal administrative contract set-up

Series of Goods or Services

A series of distinct goods or services is transferred to the customer in the same pattern if both of the following criteria are met:

• Each distinct good or service in the series that the entity promises to transfer consecutively to the customer would be a performance obligation that is satisfied over time (see below); and
• A single method of measuring progress would be used to measure the entity’s progress towards complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.

Distinct Goods or Services

A good or service is distinct if both of the following criteria are met:

• The customer can benefit from the good or services on its own or in conjunction with other readily available resources; and
• The entity’s promise to transfer the good or service to the customer is separately idenitifable from other promises in the contract

Unbundling

Unbundling a contract may apply when incentives are offered at the time of sale, such as free servicing or enhanced warranties. In this case servicing and warranties are performance obligations that are distinct and revenue relating to them needs to be recognised separately from the goods or services promised on the contract to which they relate.

Circumstances which could result in contracts being combined:

• It is negotiated as a package with a single commercial objective
• Consideration for one contract depends on the price or performance of the other contract

Factors for consideration as to whether a promise to transfer goods or services to the customer is not separately identifiable include, but are not limited to:

• The entity does provide a significant service of integrating the goods or services with other goods or services promised in the contract;
• The goods or services significantly modify or customise other goods or services promised in the contract;
• The goods or services are highly interrelated or highly interdependent.

Step 3: Determine the transaction price

The transaction price is the amount to which an entity expects to be entitled in exchange for the transfer of goods and services. When making this determination, an entity will consider past customary business practices.

Normally the agreed price is clear from the agreement. It should be taken to be the fair value (at the transaction date) of the consideration expected to be received. If there are uncertainties, the transaction price should be estimated using probabilities. The price should be considered net of VAT, trade discounts and rebates (but is not net of settlement discounts).

Variable Consideration

Where a contract contains elements of variable consideration, the entity will estimate the amount of variable consideration to which it will be entitled under the contract. Variable consideration can arise, for example, as a result of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties or other similar items. Variable consideration is also present if an entity’s right to consideration is contingent on the occurrence of a future event.

The standard deals with the uncertainty relating to variable consideration by limiting the amount of variable consideration that can be recognised. Specifically, variable consideration is only included in the transaction price if, and to the extent that, it is highly probable that its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved.

However, a different, more restrictive approach is applied in respect of sales or usage-based royalty revenue arising from licences of intellectual property. Such revenue is recognised only when the underlying sales or usage occur.

Variable consideration is measured by reference to two methods

• Expected value for the contract portfolio (for a large number of contracts), or
• Single most likely outcome amount (if there are only two potential outcomes)

Time Value of Money

If there are delayed payment terms agreed to one year or more, the provision of credit is considered an additional deliverable, and separated from the supply of goods by discounting the amount receivable to present value.

Adjustments for the effects of the time value of money (a ‘financing component’):

• If a financing component is significant, IFRS 15 requires an adjustment to be made for the effect of implicit financing
  • Cash received in advance from buyer – vendor to recognise finance cost and increase in deferred revenue
  • Cash received in arrears from buyer – vendor to recognise finance income and reduction in revenue

• No adjustment for a financing component is needed if payment is settled within one year of goods or services transferred

• The following do not give rise to a financing component (and hence no adjustment is needed):
  • Customer has discretion over the timing of the transfer of control of the goods or services
  • Consideration is variable and the amount or timing depends on factors outside of parties’ control
  • The difference between the consideration and cash selling price arises for other non-financing reasons (ie performance protection)

Step 4: Allocate the transaction price to the performance obligations in the contracts

This step is only relevant if multiple deliverables exist in the contract. If there is only one deliverable, the entire price is allocated to that. If there are multiple deliverables, the transaction price is allocated to the deliverables in the ratio of the standalone selling prices of each individual deliverable as at the contract date.

Where a contract has multiple performance obligations, an entity will allocate the transaction price to the performance obligations in the contract by reference to their relative standalone selling prices.

If a standalone selling price is not directly observable, the entity will need to estimate it. IFRS 15 suggests various methods that might be used, including:

• Adjusted market assessment approach
• Expected cost plus a margin approach
• Residual approach (only permissible in limited circumstances)

Any overall discount compared to the aggregate of standalone selling prices is allocated between performance obligations on a relative standalone selling price basis. In certain circumstances, it may be appropriate to allocate such a discount to some but not all of the performance obligations.

Where consideration is paid in advance or in arrears, the entity will need to consider whether the contract includes a significant financing arrangement and, if so, adjust for the time value of money. A practical expedient is available where the interval between transfer of the promised goods or services and payment by the customer is expected to be less than 12 months.

Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation

A performance obligation is normally deemed to be satisfied when control of the goods or services is transferred to the customer.

• The point of revenue recognition is the point when performance obligation is satisfied, per each distinctive obligation
• May result in revenue recognition at a point in time or over time

Control of an Asset

Control of an asset is defined as the ability to direct the use of and obtain substantially all of the remaining benefits from the asset. This includes the ability to prevent others from directing the use of and obtaining the benefits from the asset. The benefits related to the asset are the potential cash flows that may be obtained directly or indirectly. These include, but are not limited to:

• Using the asset to produce goods or provide services;
• Using the asset to enhance the value of other assets;
• Using the asset to settle liabilities or to reduce expenses;
• Selling or exchanging the asset;
• Pledging the asset to secure a loan; and
• Holding the asset

Revenue over time

An entity recognises revenue over time if one of the following criteria is met:

• The customer simultaneously receives and consumes all of the benefits provided by the entity as the entity performs;
• The entity’s performance creates or enhances an asset that the customer controls as the asset is created; or
• 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 performance completed to date.

Revenue at point in time

If an entity does not satisfy its performance obligation over time, it satisfies it at a point in time. Revenue will therefore be recognised when control is passed at a certain point in time. Factors that may indicate the point in time at which control passes include, but are not limited to:

• The entity has a present right to payment for the asset;
• The customer has legal title to the asset;
• The entity has transferred physical possession of the asset;
• The customer has the significant risks and rewards related to the ownership of the asset; and
• The customer has accepted the asset.

Recognising revenue over time

To the extent that each of the performance obligations has been satisfied. This can be established using two methods:

• Output method - direct measurement of the value of goods or services transferred to date for example per surveys of completion to date, appraisals of results achieved, milestones reached, units produced/delivered; or

• Input method - based on measures such as resources consumed, costs incurred (but see below re. contract set up costs), number of hours per time sheets or machine hours, which are directly related to the vendor’s performance

Contract set up activities and preparatory tasks necessary to fulfil a contract do not form part of revenue, and may meet capital recognition asset requirements.

Contract costs

The incremental costs of obtaining a contract must be recognised as an asset if the entity expects to recover those costs. However, those incremental costs are limited to the costs that the entity would not have incurred if the contract had not been successfully obtained (e.g. ‘success fees’ paid to agents - include, but costs of running a legal department proving an across-business legal support function - exclude).

A practical expedient is available, allowing the incremental costs of obtaining a contract to be expensed if the associated amortisation period would be 12 months or less.

Costs incurred to fulfil a contract are recognised as an asset if and only if all of the following criteria are met:

• The costs relate directly to a contract (or a specific anticipated contract);
• The costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the future; and
• The costs are expected to be recovered.

These include costs such as direct labour, direct materials, and the allocation of overheads that relate directly to the contract.

The asset recognised in respect of the costs to obtain or fulfil a contract is amortised on a systematic basis that is consistent with the pattern of transfer of the goods or services to which the asset relates.

Other topics

The standard also includes implementation guidance on other areas, such as:

• Performance obligations satisfied over time
• Methods for measuring progress towards complete satisfaction of a performance obligation
• Sale with a right of return
• Warranties
• Principal versus agent considerations
• Customer options for additional goods or services
• Customers’ unexercised rights
• Non-refundable upfront fees
• Licensing
• Repurchase arrangements
• Consignment arrangements
• Bill-and-hold arrangements
• Customer acceptance
• Disclosures of disaggregation of revenue

Other considerations

• Selling costs directly incurred in earning a sales contract are capitalised and recognised over the period revenue from that contract is recognised. Example – sales commission paid to an agent by a phone company for securing a 12-month phone service contract.
• Goods expected to be returned are not to be recognised as revenue. An estimate should be made of the amount expected to be returned.
• A warranty is often a separate deliverable in a sales contract. As such it is treated as a component of the deal. The revenue is separated, and the portion relating to the warranty is recognised over the warranty period. If the warranty is inseparable from the goods supplied (i.e. if cost information is not separately available), then a provision should be made under IAS 37, as was the previous practice for all warranties.
• If goods are sold as agent rather than as principal, only the commission receivable is recognised as revenue. For example, if an estate agent sells a house on behalf of a client for £300,000, earning 1.5% commission. The revenue of the agent is £4,500, not £300,000.

Presentation

Contracts with customers will be presented in an entity’s statement of financial position as a contract liability, a contract asset, or a receivable, depending on the relationship between the entity’s performance and the customer’s payment.

• A contract liability is presented in the statement of financial position where a customer has paid an amount of consideration prior to the entity transferring the related good or service to the customer.

Where the entity has performed by transferring a good or service to the customer and the customer has not yet paid the related consideration, a contract asset or a receivable is presented in the statement of financial position, depending on the nature of the entity’s right to consideration.

• A contract asset is recognised when the entity’s right to consideration is conditional on something other than the passage of time, for example future performance of the entity.

• A receivable is recognised when the entity’s right to consideration is unconditional. A right is unconditional if nothing other than the passage of time is required before payment of that consideration is due.

The significance of the distinction between contract asset and receivable is that the contract asset carries not only the credit risk, but other risks as well (e.g. performance risk).

Unconditional Right & receivables

The standard requires that receivables be presented separately from contract assets as the receivables and contract assets are subject to different levels of risk. Although both are subject to credit risk, contract assets are also subject to other risks (e.g., performance risk). Once an entity’s right to consideration becomes unconditional, the contract asset should be reclassified as a receivable – even if the entity has not generated an invoice (i.e., a scenario that would result in an unbilled receivable).

• In most cases, when a contract is cancellable, a receivable will be recognised after the entity has performed all obligations, and an invoice has been raised. A pro-rated receivable could also be recognised if this was allowed for in the contract (e.g. if there unconditional payments in installments, as a portion of performance obligations have been met by the entity, before the final end date of the contract)

• If invoices are generated much after a contract has finished (i.e. in arrears), since all performance obligations have been met, payment amounts become unconditionally due, and a receivable can be recognised, even if no invoice has yet been sent (this is an unbilled receivable)

• An unconditional right to payment may also arise before any performance obligations have been fulfilled, or before any invoices have been raised. This can happen, for example with non-cancellable contracts if its due date is before the entity has transferred any goods or services to the customer.

Contract Assets and Contract Liabilities

Generally speaking, contract assets and contract liabilities are based on past performance. Whether to record a contract asset or a contract liability depends on which party acted first.

For example, when a customer prepays, the receiving entity records a contract liability — an obligation that must be fulfilled to “earn” the prepaid consideration. Once the entity performs by transferring goods or services to the customer, the entity can recognize revenue and adjust the liability downward.

On the other hand, an entity could perform first by transferring goods or services to the customer, recognizing a contract asset and revenue for their work even though they are not yet legally entitled to payment. Once the entity is legally entitled to payment, the entity can record a receivable and remove the contract asset from their books.

Non-Cancellable contracts (advance payments)

As mentioned above, a possible exception to the past performance rule is with non-cancellable contract when an entity records a contract liability before payment is received.

For example, suppose an entity enters into a contract to deliver goods to a customer. The contract is non-cancellable, and the entity and customer agree upon a payment schedule. If the date for a customer’s prepayment arrives, but the customer fails to pay on time, the entity should still recognize a receivable because non-cancellable contract payments are treated as guaranteed.

In this situation, recognition of the receivable is based on the contract’s payment schedule rather than the timing of revenue recognition. In conjunction with the receivable, the entity will also recognize a contract liability to deliver goods. This liability will be reversed, and revenue will be recognized once the entity fulfills the performance obligation by delivering goods to the customer.

It should be noted, however, that there is a general resistance to “grossing up” the balance sheet in this manner. If a payment is due but has not been received, a company will likely consider other factors before recognizing a receivable (e.g., concerns about the relationship with the customer, enforceability of the arrangement, and collectability of the enforcement).

Customer Deposits - Cash Payment before Unconditional Right to Payment

If a Cash payment is received before the date for unconditional payment, you are likely to do the following:

• Dr Cash and Cr Customer Refundable Deposit on the date the cash is received.

The Refundable Deposit would then be reversed on the date for unconditional payment

• Dr Customer Refundable Deposit and Cr Receivable

• Dr Receivable and Cr …(e.g. Contract Liability)

The Contract Liability would then be reversed as performance obligations are fulfilled.

Customer Deposits - Cash Payment after Unconditional Right to Payment

If a Cash payment is made after the date for unconditional payment, you are likely to do the following:

• Dr Receivable and Cr …, on the the date for unconditional payment,

• Cr Receivable and Dr Cash, when the cash payment is received later

Cancellable contracts (advance payments)

Cancellable contracts are different, and the right to unconditional payment usually happens on % completion dates of the performance obligation, regardless of when the invoice date and when it is billed (e.g. before, during, or after the contract).

The following describes what you might do if there is an advanced cash payment:

Customer Deposits - Cash Payment before Unconditional Right to Payment

For cancellable contracts, if payment is received before the performance of any obligations, and before any invoice has been billed - then instead of doing:

• Dr Cash; Cr Receivable the date the cash is received, and Dr Receivable; Cr …, on the date of the invoice, the mere issuance of an invoice here does not indicate an unconditional right to payment.

Instead, you are likely to do the following:

• Dr Cash and Cr Customer Refundable Deposit on the date the cash is received.

The Customer Deposit would then usually be reversed, and netted off when payment becomes unconditionally due, as the performance obgliation is met, and when a receivable can be recognised. When this happens, you would likely make the following journal entry:

• Dr Customer Refundable Deposit and Cr Receivable

• Dr Receivable and Cr …(e.g. Income, as performance obligations are eventually met)

Customer Deposits - Cash Payment after Unconditional Right to Payment

Similarlly, if a cash payment is received before the performance of any obligation, but this time after any invoice has been billed, the early issuance of the invoice still does not indicate unconditional right to receive payment (compared to as it might do for a non-cancellable contract) as the performance of any obligations have still not yet started.

Thus, instead of doing:

• Dr Receivable Cr Contract Liability, on the date invoice is issued, and Dr Cash Cr Receivable on the date the cash is received,

Instead, You are likely to do the following:

• Dr Cash and Cr Customer Refundable Deposit, on the date the cash is received.

The Customer Deposit would then usually be reversed, and netted off when payment becomes unconditionally due, as the performance obgliation is met, and when a receivable can be recognised. When this happens, you would likely make the following journal entry:

• Dr Customer Refundable Deposit and Cr Receivable

• Dr Receivable and Cr …(e.g. Income, as performance obligations are eventually met)

Impairments

Contract assets and receivables should be accounted for in accordance with IFRS 9. Any impairment relating to contracts with customers should be measured, presented and disclosed in accordance with IFRS 9. Any difference between the initial recognition of a receivable and the corresponding amount of revenue recognised should also be presented as an expense, for example, an impairment loss.

Disclosures

The disclosure objective stated in IFRS 15 is for an entity to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Therefore, an entity should disclose qualitative and quantitative information about all of the following:

• Its contracts with customers;
• The significant judgments, and changes in the judgments, made in applying the guidance to those contracts; and
• Any assets recognised from the costs to obtain or fulfil a contract with a customer

Entities will need to consider the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the requirements. An entity should aggregate or disaggregate disclosures to ensure that useful information is not obscured.

Further Information