Revenue from Contracts with Customers – IFRS 15

Objective

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. [IFRS 15:1] Application of the standard is mandatory for annual reporting periods starting from 1 January 2018 onwards. Earlier application is permitted.

Scope

IFRS 15 Revenue from Contracts with Customers applies to all contracts with customers except for: leases within the scope of IAS 17 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. [IFRS 15:5]

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: [IFRS 15:7]

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.

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 an output 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 enhancements of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants.

Performance obligation

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.

Revenue

Income arising in the course of an entity’s ordinary activities.

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.

Accounting requirements for revenue

The five-step model framework

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: [IFRS 15:IN7]

Identify the contract(s) with a customer Identify the performance obligations in the contract Determine the transaction price Allocate the transaction price to the performance obligations in the contract Recognise revenue when (or as) the entity satisfies a performance obligation.
Application of this guidance 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: [IFRS 15:9]

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. [IFRS 15:14]

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. Further details on accounting for contract modifications can be found in the Standard. [IFRS 15:18-21].

Step 2: Identify the performance obligations in the contract

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: [IFRS 15.22]

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.
A series of distinct goods or services is transferred to the customer in the same pattern if both of the following criteria are met: [IFRS 15:23]

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.
A good or service is distinct if both of the following criteria are met: [IFRS 15:27]

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.
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: [IFRS 15:29]

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. [IFRS 15:47]

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. [IFRS 15:50] 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. [IFRS 15:51]

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. [IFRS 15:56]

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. [IFRS 15:B63]

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

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. [IFRS 15:74] 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: [IFRS 15:79]

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. [IFRS 15:81]

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. [IFRS 15:60] 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. [IFRS 15:63]

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

Revenue is recognised as control is passed, either over time or at a point in time. [IFRS 15:32]

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: [IFRS 15:31-33]

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.
An entity recognises revenue over time if one of the following criteria is met: [IFRS 15:35]

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.
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: [IFRS 15:38]

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.

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). 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. [IFRS 15:91-94]

Costs incurred to fulfil a contract are recognised as an asset if and only if all of the following criteria are met: [IFRS 15:95]

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. [IFRS 15:97]

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. [IFRS 15:99]

Further useful implementation guidance in relation to applying IFRS 15

These topics include:

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
These topics should be considered carefully when applying IFRS 15.

Presentation in financial statements

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. [IFRS 15:105]

A contract liability is presented in the statement of financial position where a customer has paid an amount of consideration prior to the entity performing by transferring the related good or service to the customer. [IFRS 15:106]

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 except for the passage of time.

Contract assets and receivables shall 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. [IFRS 15:107-108]

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: [IFRS 15:110]

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. [IFRS 15:111]

In order to achieve the disclosure objective stated above, the Standard introduces a number of new disclosure requirements. Further detail about these specific requirements can be found at IFRS 15:113-129.

Effective date and transition

The standard should be applied in an entity’s IFRS financial statements for annual reporting periods beginning on or after 1 January 2018. Earlier application is permitted. An entity that chooses to apply IFRS 15 earlier than 1 January 2018 should disclose this fact in its relevant financial statements. [IFRS 15:C1]

When first applying IFRS 15, entities should apply the standard in full for the current period, including retrospective application to all contracts that were not yet complete at the beginning of that period. In respect of prior periods, the transition guidance allows entities an option to either: [IFRS 15:C3]

apply IFRS 15 in full to prior periods (with certain limited practical expedients being available); or retain prior period figures as reported under the previous standards, recognising the cumulative effect of applying IFRS 15 as an adjustment to the opening balance of equity as at the date of initial application (beginning of current reporting period).