IFRS 15 – Revenue from Contracts with Customers
International Financial Reporting Standard (IFRS) 15 provides a comprehensive revenue recognition model for every type of contract with customers. It aims at improving comparability within and across capital markets. The main objective of the standard is to establish procedures and principles to be applied by entities while reporting information to the financial statement users regarding the amount, nature, timing and uncertainty of cash flows and revenue arising from customers’ contracts.
Effective Date, Supersession, and Adaptation
The rules of this standard became effective from 1st January 2018 and supersede the below-listed interpretations and standards:
- IFRIC 13 Customer Loyalty Programmes,
- SIC-31 Revenue – Barter Transactions Involving Advertising Services,
- IAS 11 Construction contracts,
- IFRIC 15 Agreements for the Construction of Real Estate,
- SIC-31 Revenue – Barter Transactions Involving Advertising Services
- IAS 18 Revenue.
The entities are required to present comparative figures too, hence the financial results are presented for the periods starting on 1st January 2017 also.
IFRS 15 allows two methods for adaptation:
1. Modified Retrospective Approach: At the initial application date cumulative effect of IFRS 15 adaptation is recognized as a one-off adjustment to the opening equity whereas the comparative figures remain the same under previously reported standards.
2. Full Retrospective Approach: IFRS 15 is adopted fully (with some exceptions) to all prior reporting periods.
The scope of IFRS 15 extends to ALL contracts with customers. Where contracts are with parties other than customers, IFRS 15 does not apply. Hence the establishment of the fact that whether the contact is with a customer or just a collaborating party is basic essential.
A contract with a customer may at times be partially within the scope of IFRS 15 and partially within the scope of any other standard. In this case, IFRS 15 guides as follows: [Ref. IFRS 15:7]
a) If there are guidelines on separation and initial measurement of one or more parts of the contract, then these are applied first along with reduction of the transaction price by the same amount,
b) In case of no guidance available, principles of IFRS 15 are applied.
Customer: A party that has contracted to receive goods and services in an exchange for a promised consideration to the entity.
Performance Obligation: A promise as per an agreement (Contract) to transfer either:
> Series of distinct services and goods with the same pattern of transfer or
> A single good or service or a bundle of goods and services that are distinct
Revenue: Income or an inflow of cash from an entity’s activities in the ordinary course.
Income: Enhancement of assets, decrease in liabilities or inflows of economic benefits resulting in an increase in equity.
Standalone Selling Price: Price at which a promised service or good can be sold separately.
Impact on Initial Recognition
It replaces the concept of ‘risk and reward transfer’ with ‘control’. It introduces ‘performance obligations’ along with extensive detailed disclosures. Further significant impacts are as follows:
- Bundled goods and services may require separation, accelerating or deferring of revenue,
- Change in the timing of recognition of revenue from licensing contracts,
- May require separation of provision of free goods and services and other incentives as part of a sale or purchase contract,
- More assets may be recognized from the guidance issued on contract costs,
- Long-term contracts may require modifications over the term of the contract.
Accounting Requirements for Revenue Under IFRS 15
IFRS 15 works on the core principle that:
‘The entity should recognize revenue that represents the value it expects to be entitled to in exchange of goods and services transferred to the customers.’
IFRS 15 has devised a 5 step model framework for revenue recognition. An entity should apply the principles in accordance with circumstances and facts present in a contract along with the exercise of judgment. The core steps of this framework are:
- Identification of the contract(s) with the customer,
- Identification of performance obligation within the contract(s),
- Determination of transaction price of the contract(s),
- Allocation of the transaction price to separate performance obligation,
- Recognition of revenue upon satisfaction of performance obligation.
The Five-Step Model Framework
After the effective date, entities in every industry must apply the principles of IFRS 15 for revenue recognition. The details of 5 step model framework are as under:
Step 1 – Identification of the Contract(s) with Customer
A contract may be oral, written, or implied by customary business practice, creating enforceable obligations and rights.
IFRS 15 enlists the following criteria that have to be met for the identification of a contract:
- Both parties approve and are committed to the contract,
- Each party’s rights and obligation as per the contract can be clearly identified,
- The contract has clear payment terms and contains ‘commercial substance’,
- Consideration should be established taking into account the intention and ability to pay i.e. the collection of consideration by the entity is probable.
Step 2 – Identification of Performance Obligation Within the Contract(s)
Promises in a contract to transfer goods or provide services, are assessed at the contract inception and are known as a performance obligation(s). A performance obligation is identified as a separate performance obligation if the goods and services promised are distinct. A good or service is distinct if:
- The item can be consumed by the customer either with a combination of other available items or on its own,
- The promise of transfer of goods and services is separately identified (separable) from any other goods or services in the same contract.
Unbundling a Contract: into separate performance obligation may be required when incentives are offered to the customer at the time of sale such as enhanced warranties or free services.
Combining a Contract: contracts may be combined if negotiated as a single package with one commercial objective or consideration of one contract is dependent upon the performance/price of another.
Step 3 – Determination of Transaction Price of the Contract(s)
This is the price that the entity is entitled to receive in exchange for satisfaction of the performance obligation.
Fixed Consideration: transaction price is the price fixed in the contract.
Variable Consideration: this includes but is not limited to discounts, credits, rebates, refunds, performance bonuses, incentives, price concessions, etc. In such a case, the transaction price is based on the most likely (highly probable) amount or expected value based on the weighted average of possible amounts.
The above are estimates and changes in such estimates are prospectively accounted for under IFRS 8. Non-cash considerations are measured in terms of IFRS 13 Fair Value Measurement.
Step 4 – Allocation of Transaction Price to Separate Performance Obligation
The transaction price is allocated to each separate performance obligation in the contract relative to the standalone selling price.
The standalone selling price may be estimated through the following methods:
- Expected cost plus margin approach,
- Residual approach (permissible in limited circumstances),
- Adjusted market assessment approach.
Allocation of an Overall Discount:
a) Relative standalone selling price is used to allocate discounts between separate performance obligations (Proportionate basis).
b) To specific performance obligation if:
- Observation evidence is present for the same,
- The amount of discount is substantially the same given for that specific performance obligation,
- Goods and services in the performance obligation are usually sold as standalone with a discount.
Allocation of Variable Consideration:
Allocated entirely to a performance obligation if both:
a) The allocation is consistent with the principle that the transaction price allocation is based on what the entity expects to obtain for performance obligation satisfaction,
b) The variable consideration terms relate specifically to the performance obligation satisfaction.
Modification to the contracts may require a subsequent reassessment of the allocation of the transaction price.
Step 5 – Recognition of Revenue Upon Satisfaction of Performance Obligation
Revenue is recognized at the time when goods and services are transferred to the customer and the control is passed.
Control: it is the ability to obtain substantially ALL the remaining benefits or to direct the use of the asset. It also means that the entity prevents others from obtaining advantage or direct use from the asset.
The revenue recognition process could either be:
a) At a Point in Time: Revenue is recognised at the specific time of passing of control. Factors indicating passing of control may include:
- Physical possession of the asset has been transferred,
- Acceptance of the asset by the customer,
- Entity has obtained present right to payment in relation to the asset,
- Significant risks and rewards in relation to the asset have been transferred to the customer and,
- Legal title of the asset has been passed to the customer.
b) Over Time: An entity will recognize revenue over time if any one of the below criteria is met:
• For each performance completed to date the entity has an enforceable right to payment and an asset with an alternate use to the entity has not been created by the entity’s performance,
• The asset created by the entity’s performance is controlled by the customer as it is created or enhanced,
• As the entity performs, the customer simultaneously consumes and receives the benefits provided by the entity,
• Any of the two methods below can be used to establish the extent of satisfaction of performance obligation:
> Output Method: goods and services transferred to date are measured directly e.g. achieved milestones, units delivered/produced, completion to date surveys, results achieved/appraised etc.
> Input Method: based on measures directly associated to the performance of the vendor such as incurred costs, consumed resources, machine hours etc.
Other Useful Implementation Guidance in Relation to IFRS 15
• Modification: Contract modification could result in any of the following:
a) New Contract:
When a new performance obligation is included or additional units are added at a later date that are considered distinct (even if identical) and are at a price that represents the standalone selling price of the units.
b) Continuation of Existing Contract:
Goods and services provided are NOT distinct. The new performance obligation can be satisfied at the date of modification.
• Significant Financing Component in a Contract: This concept is used to reflect the time value of money, when the payment(s) is made by the customer is with delay. When the control of the goods and services are transferred, the transaction price is adjusted to reflect the selling price at that point in time.
An entity should account for:
a) Combined effect of length of time between payment and transfer of control and the relevant market interest rate,
b) Difference between the selling price and the actual consideration.
• Contract Costs (set-up costs, binding costs, sales commission, direct labor, direct material, etc.):
Preparatory tasks and activities of set-up necessary in fulfilling a contract do not become part of revenue recognized. They may be capitalized if they meet the capitalization criteria of an asset.
The following criteria is applied to the capitalization of costs in connection to a sale contract:
> Only those costs are capitalized that are expected to generate profit and are expected to be recovered,
> Costs incremental or directly attributed to obtaining a contract are considered,
> The amortization should be on a systematic basis consistent with the goods and services transferred under the contract,
> Impairment may also exist when the remaining consideration receivable (excluding directly related costs to be incurred) is less than the contract carrying amount.
The following costs are expensed out as incurred:
> Administrative and general expenses,
> Cost related to or unable to be separated from past obligations,
> Unanticipated costs that are not included into contract pricing such as wastage and scrap.
• Non-refundable Upfront Fee:
This is the additional fee that is charged at or near the contract inception (E.g. set-up fee, activation fee, joining fee etc.). The treatment of additional fee is as follows:
> If the fee relates to the performance obligation under the contract, revenue is recognized under IFRS 15 i.e. when or as the goods are transferred.
> If the fee DOES NOT relate to the performance obligation under the contract, it is treated as an advance.
• Licensing (of Intellectual property IP):
There are two possible scenarios for the same:
a) License is distinct from the rest of the goods and services:
> Accounted as a single performance obligation,
> Over the time recognition of revenue, if and only if,
i) The expectation of an Entity to those activities that will have a significant effect on the IP,
ii) No transfer of goods and services to the customer as a result of (i) above,
iii) Positive or negative impacts of the activities in (i) above will be exposed to the customer’s right to IP.
> If the above criteria are not met, revenue is recognized at a point in time. Revenue is recognized when the control in relation to the license is granted or transferred to the customer.
b) License is not distinct from the rest of the goods and services:
> License and other promised goods are accounted for as a single performance obligation.
License is distinct either if:
> The customer can take benefit from the license separately and not in conjunction with any related services,
> It is NOT an intellectual component to the functionality of any tangible good.
• Onerous (loss-making) Contracts:
For such contracts, the requirements of IAS 37 are applied as there are no specific provisions in IFRS 15 for the same. If a contract contains several performance obligations, a provision is recognized when a contract is an onerous contract as a whole.
Service type warranties are accounted for under IFRS 15 as separate performance obligations.
Where it is not possible to distinguish separately assurance type warranty and service type warranty, both shall be taken as a single performance obligation.
Accounting Treatment of Some Important Elements of Revenue:
|Transfer of control or satisfaction of performance obligation with:|
|Ø unconditional right to payment||a) Dr. Accounts Receivable at sale price
b) Cr. Revenue account at sale price
c) Dr. COS at inventory price
d) Cr. Inventory account
e) Difference is the profit or loss
|Ø conditional right to payment||a) Dr. Contract asset
b) Cr. Revenue account
|Vouchers and coupons:|
|Ø Not in exchange for goods and services from the customer||a) Reduction in transaction price|
|Ø In exchange for goods and services from the customer||a) Consideration paid exceeds the value of goods and services received : difference is set against the transaction price
b) Fair value of goods and services cannot be reliably determined : full amount taken against the transaction price
|Customer taking advantage of discount and paying less than the original invoice amount||Value of discount:
a) Dr. sales discount account
b) Cr. Accounts receivable
|Sale return:||a) Dr. Sale return account
b) Cr. Accounts receivable
c) Sales return is deducted from the reported gross sales to give net sales
|Initial entry||a) Dr. Warranty expense account
b) Cr. Warranty payable account
|Warranty exercised||a) Dr. Warranty payable account
b) Cr. Cash account
Financial Statement Presentation
Statement of Financial Position
- Entity’s performance or transfer of goods or services in advance to the payment or pending payment yet to be made by the customer
(i) Unconditional rights to consideration – Receivables
(ii) Conditional rights to consideration – Contract asset
- Where a customer pays in advance of entity’s performance or transfer of goods and services – Contract liability
Statement of Profit and Loss
- Revenue / Impairment – Presented as separate line items in accordance with IAS 1.
IFRS 15 has an overall objective to sufficiently disclose to the users of the financial statements the amount, nature, timing and uncertainty of the entity’s cash flows and revenue arising from contracts with customers.
Following are some important disclosures that are required to be made:
Information Regarding Contracts with Customers:
- Contract liabilities and assets,
- Revenue disaggregation,
- Performance obligations
- Capitalized contract costs determination,
- Satisfaction of performance obligation,
- Transaction price including allocation
Capitalized Contract Costs:
- Closing balances – by each type of asset,
- Impairment and amortization,
- Amortization methods
Practical Expedient Uses:
- Contract costs with 12-month amortization,
- Significant financing component (period of 12 months)