ifrs 15: revenue from contracts with customers

OVERVIEW


IFRS 15 specifies the accounting treatment and disclosures of the revenue in the financial statements. As revenue is important to figure in the financial statements therefore it is necessary that the revenue figure should be reliable for the users of the financial statements while reporting it.


The main problem in the revenue is that it is difficult to decide when to recognize the revenue in the financial statements and how to measure it in the financial statements. IFRS 15 sets out the criteria for the recognition and measurement of the revenue, which is:


=> Set out the criteria for the recognition of the revenue

=> Establish the rules for the measurement of the revenue

=> Provide the extensive application guidance


IFRS 15 was developed with the US FASB jointly to overcome the differences regarding the recognition and measurement of the revenue in the financial statements. IFRS 15 superseded the IAS 18 – Revenue and IAS 11 – Construction contracts.

Key Takeaway Points


=> IFRS 15 specifies the accounting treatment and disclosures of the revenue in the financial statements. As revenue is important to figure in the financial statements therefore it is necessary that the revenue figure should be reliable for the users of the financial statements while reporting it.


=> IFRS 15 was developed with the US FASB jointly to overcome the differences regarding the recognition and measurement of the revenue in the financial statements. IFRS 15 superseded the IAS 18 – Revenue and IAS 11 – Construction contracts.


=> IFRS 15 introduces the five-step model for the recognition and measurement of the revenue and onward entities shall follow the following five-step model while recognizing and measurement of the revenue:


Step 1: Identify the contract

Step 2: Identify the performance obligation in a contract

Step 3: Determine the traction price

Step 4: Allocate the transaction price to the performance obligation in a contract

Step 5: Recognize revenue when the entity satisfies the performance obligation

 

=> If the cost is incurred to fulfill the contract with a customer and there are other standards available for the specific issue then such contract shall be dealt with as per that specific standard. For example, direct material and labor costs are accounted for as per IAS 2 –Inventories. Likewise, the machinery used in the process to fulfill the contract with the customer then such cost of the machinery shall be either treated as per IAS 16- Property, plant, and equipment or IAS 38- Intangible assets, as the case may be.


=> If an entity satisfied the performance obligation and has transferred the goods and services to the customer then such contract cost shall be recognized as a “contract asset” in the statement of financial position.


=> When an entity received the payment in advance before the delivery of the goods and services to the customer then such advance received from the customer shall be recognized as “contract liability” in the statement of financial position.

 


SCOPE


The purpose of this standard is to set the guideline for the recognition and measurement of the revenue in the financial statements. This standard deals with the revenue that arises in the normal course of business. It does not deal with the income that does not arise due to routine activities. This standard does not apply to the following:


=> Borrowings

=> Amount contributed by the shareholders

=> Gains arise because of the revaluation or sale of fixed assets.

=> Rental income

=> Interest and dividend


However, the IFRS 15 applies to the license and intellectual property. These items include the software license, franchise and copyright license, etc.


FIVE-STEP MODEL


IFRS 15 introduces the five-step model for the recognition and measurement of the revenue and onward entities shall follow the following five-step model while recognizing and measurement of the revenue:


Step 1: Identify the contract

Step 2: Identify the performance obligation in a contract

Step 3: Determine the traction price

Step 4: Allocate the transaction price to the performance obligation in a contract

Step 5: Recognize revenue when the entity satisfies the performance obligation


Each of the above steps will be discussed in the details below:


STEP 1: IDENTIFY THE CONTRACT


IFRS 15 states that for the revenue it is important that there should be a contract between parties and contract is eligible to create enforceable rights and obligations. Such contract can be in a written, oral, or implied contract. A contract may be for simple transactions like the sales and purchase of goods and services or for complex transactions like the construction of a building.


A contract should be accounted for when all the parties to it are agreed to perform their obligation and agree to the terms and conditions of the contract it means that such contract shall be “wholly performed”. A contract shall not be accounted for it is “wholly unperformed”. A wholly unperformed contract means that one of the parties in a contract fails to satisfy its obligation or either fails to meet and fulfill the terms and conditions of the contract.


For example, a contract is said to be wholly unperformed if an entity does not transfer the goods and services to a customer and the customer also didn’t pay for the goods and services. If the payments are received from a customer in advance before fulfilling the terms and conditions of a contract then such advance payment received from the customer shall be treated as a liability in books of account rather than revenue.


Combining Contracts


IFRS 15 requires that two or more contracts that are entered into with the same customer shall be treated as a single contract if:


=> The commercial objective of all the contracts is the same.

=> The consideration payable in one contract depends upon the price or the performance of the other contract.

=> The goods or services transferred to the customer by virtue of the contracts comprise the single performance obligation.


Contract Modification


Contract modification means changes made to the contract and such changes shall be approved and agreed upon by all parties to a contract. A modification of the contract will be treated as a separate contract as per IFRS 15 if:


=> The modification leads to adding distinct goods or services to a contract.

=> The contract prices increase because of the transfer of additional goods or services.


If the contract modification does not satisfy the above two conditions then such modification will not be treated as a separate modification but modification to the existing contract.


STEP 2: IDENTIFY THE PERFORMANCE OBLIGATIONS


When a contract is made between the parties then it is necessary that parties to the contract shall identify the performance obligations that whether such obligations are about to deliver the goods or services or to construct infrastructure.


It is important that parties in a contract shall identify the performance obligation because revenue arising from each performance obligation shall be accounted for separately.  Goods or services shall be regarded as distinct if the following conditions are fulfilled:


=> The customer can either benefit from the goods or services on its own or with the help of the resources available to the customer. In other simple words, the goods or services shall be distinct. If the goods or services regularly sold are capable to be used separately then this indicates that such goods are capable to be used on their own.

=> The promise to deliver the goods or services to the customer is separately identifiable from other promises in the contract.


If promised goods or services are not distinct then the entity shall combine it with the other goods or services to form a bundle of goods or services that are distinct. This means that all the goods or services promised in a contract will be accounted for under the single performance obligation.


STEP 3: DETERMINE THE TRANSACTION PRICE


The transaction price means the revenue or the price that is collected or received by an entity in the ordinary course of business by selling goods or services or for the performance of a task for the customer. This means that sales tax collected or VAT on behalf of the customers is not revenue nor the collections by an agent on behalf of the principle is revenue for the agent but it is the revenue of the principle. The transaction price is also called the considerations payable under a contract.


The considerations or the contract price may be fixed or may vary depending upon many factors like the discounting, bonuses, penalties, incentives, price concessions refunds, etc. The variable consideration payable under the contract shall be calculated by using either the “expected value method” or by “most likely amount method”. However, an entity shall consider the method which provides the most reliable and best estimate of the variable consideration under a contract.


Expected Value Method


This is a statistical method of estimation that involves multiplying all the possible amounts of the variable consideration by their associated possibilities and then adding the weighted amounts.


Most likely amount method


This method selects the single most likely amount from the range of possible amounts of variable consideration.


If the contract falls in more than one accounting period then the transaction price shall be adjusted at the end of each accounting period to show the most reliable transaction price at the end of the accounting period.


Existence of significant financing component


A contract will contain the financing component if there is a significant difference in time between the delivery of the goods and services and to pay for it. When the payment date is later than the date of the delivery of the goods or services then the time value effect shall be considered when it is significant. In this case, the part of the consideration shall be treated as finance income, not the revenue. However, this adjustment is not required if the date between the payment of goods and services and the receipt of goods and services does not exceed one year.


STEP 4: ALLOCATING THE TRANSACTION PRICE


Once the transaction price in a contract is identified then the next step is to allocate the transaction price to the separate performance obligations in a contract. The objective of this step is to determine the consideration to which an entity is entitled to receive against the performance obligation.


However, the following points shall be noted:


=> IFRS 15 requires that the transaction price shall be allocated based on the basis of stand-alone selling price for separate performance obligations.

=> If the total transaction price is less than the sum of the stand-alone price then the customer is receiving a discount under the contract and such discount shall be allocated proportionately amongst the performance obligations.

=> If the part of the transaction price is variable then the variable amount is allocated to a single performance obligation if it specifically relates to that obligation. Otherwise, the transaction price will be allocated between the performances obligations.

=> If a transaction price changes after the inception of the contract then the amount changes are allocated amongst the performance obligations on the same basis as the allocation of the original transaction price.


STEP 5: SATISFACTION OF PERFORMANCE OBLIGATION


This is the final step to recognize the revenue when the performance obligation is satisfied and the performance obligation is satisfied when the goods or services are delivered to the customer. Amount of revenue is the price that is allocated to the separate performance obligations. Usually, the performance obligations are satisfied when the control of the goods and services is transferred to the customer.


For each performance obligation, it is necessary for the entity to determine whether the obligation will be satisfied over the period of time or point in time. The distinctions between these two concepts are very important because it governs the timing of the revenue recognition.


Performance obligations satisfied over time


An entity is considered to transfer the goods and services over time if the following conditions are satisfied:


=> A customer simultaneously receives and consumes the benefit provided by an entity's performance while the entity continues to perform its obligation. For example the recurring cleaning services.

=> The entity performance creates an asset and the customer controls it as it is created e.g. building a contract where the customer has control over the work in progress.

=> 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 that has been completed to date.


For each performance obligation that is satisfied over time then the entity should recognize over time by measuring the progress toward the date of the completion. IFRS 15 suggests alternative methods for measuring progress. This includes:


Output Method


This method measures progress on the basis of direct measurement of the goods and services transferred to date, relative to the goods and services that remain to be transferred. Such a method includes a survey of the work done to the date of appraisal of the result achieved.


Input Method


Input method the entity’s performance on the basis of the entity’s efforts or input to the date e.g. hours expended, cost incurred relative to the total expected inputs required in order to achieve the performance obligation.


In certain circumstances, it is difficult to estimate the revenue and measure the progress. However, in such cases, the progress can be measured and revenue is recognized to cover the cost incurred to date so long as the entity expects to recover the costs in order to satisfy the performance obligations.


Performance obligation satisfied in time


If a performance obligation is not satisfied over time then it must be satisfied in time. The performance obligation is considered to be satisfied in time when the customer obtains control of the promised assets or goods or services immediately on the delivery and receipt of assets or goods and services.


CONTRACT COST


If the cost is incurred to fulfill the contract with a customer and there are other standards available for the specific issue then such contract shall be dealt with as per that specific standard. For example, direct material and labor costs are accounted for as per IAS 2 –Inventories. Likewise, the machinery used in the process to fulfill the contract with the customer then such cost of the machinery shall be either treated as per IAS 16- Property, plant, and equipment or IAS 38- Intangible assets, as the case may be.


However, if the cost incurred to fulfill the contract does not fall within the scope of the above standards or under any available standard then such cost shall be treated as per IFRS 15 as an asset only if:


=> The costs are directly related to the contract with the customer.

=> The costs are generating resources that may be used in the future to satisfy the performance obligation.

=> The costs incurred under the contract are expected to be recovered.

=> Costs that do not meet the criteria of any available standard to be recognized as an asset shall be expense out in the statement of profit or loss.


RECLASSIFICATION, AMORTIZATION, AND IMPAIRMENT OF THE CONTRACT COST


Contract costs shall be recognized as an asset (Work in progress) and are reclassified as expenses when the related goods or services are transferred to the customer and revenue is recognized. However, it should be noted that:


=> If the performance obligation is satisfied in time then such contract cost shall be recognized as an expense when the obligation is satisfied.

=> If the performance obligation is satisfied over time then such contract cost will be recognized as an expense as and when the performance obligation is satisfied over the period of time.


In some of the cases, the contract cost may be amortized on a systematic basis as and when the goods or services are transferred to the customer. For example, designing cost incurred at the beginning of the contract shall be amortized over the period of years to which the contract last.


IFRS 15 also requires the entities to carry out the impairment assessment and recognize the impairment loss if the carrying amount of the contract costs that have been recognized as an asset exceeds:


=> The remaining amount of the consideration receivable by an entity in exchange for goods and services, less

=> The remaining costs will be incurred in providing those goods and services.


PRESENTATION


If an entity satisfied the performance obligation and has transferred the goods and services to the customer then such contract cost shall be recognized as a “contract asset” in the statement of financial position.


Similarly, when an entity received the payment in advance before the delivery of the goods and services to the customer then such advance received from the customer shall be recognized as “contract liability” in the statement of financial position.


DISCLOSURES


IFRS 15 requires the following minimum disclosures to help the users of the financial statements to better understand the nature, timing, and amount of the revenue and cash flows that will arise due to the contract with the customers:


=> The amount of revenue arises from the contract with the customers under its different respective categories.

=> Any impairment loss that arises on the contract with the customers.

=> The opening balances of the contract assets and contract liabilities and any addition and deletion to it together with the necessary explanation for the movement in balances during the period.

=> The descriptive information about the performance obligation of an entity in a contract with the customer and the explanation when an entity satisfies the performance obligations and what are the terms of the contract.

=> The performance obligation that remains unsatisfied during the period and the total amount of the consideration that is allocated to the unsatisfied performance obligations.

=> The significant judgments made in the applying of the requirements of the IFRS 15 shall be disclosed.

=> The methods used for the measurement of revenue for the contracts that need to be satisfied over the period of time.

=> The methods used for the measurement of revenue for the contracts that need to be satisfied at a point in time.


Other significant judgments used to determine the transaction cost, variable consideration, and allocating the transaction price to the contract shall be disclosed.