IFRS 15 Revenue from Contracts with Customers
IFRS 15 Revenue from Contracts with Customers establishes the principles use to recognize revenue from contracts with customers.
IFRS 15 can be applied to all contracts of an entity except (a) lease contracts, (b) insurance contracts, and (c) contracts representing investments and intercorporate arrangements. It applies to contracts with customers only and not with partners in a joint arrangement. However, it does not apply to non-monetary exchanges between entities in same life of business.
If a contract contains more than one component, an entity shall apply other standards to segregate the components and if those other standards do not provide any guidance, use IFRS 15 to segregates components falling within IFRS 15 and those which do not.
Recognition and measurement
IFRS 15 introduces a 5-stage model for revenue recognition which involves the following steps:
- Identifying a contract with a customer.
- Identifying performance obligations contained in a contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations identified
- Recognize revenue when/as the entity satisfies a performance obligation.
Identifying a contract with customer
An entity shall apply IFRS 15 to a contract falling within its scope if (a) the contract is approved, (b) the parties’ rights can be established, (c) payment terms are specified, (d) the contract has commercial substance, and (e) it is probable that the entity can collect the consideration.
A contract is an agreement which creates enforceable rights and obligations and it is subject to the legal framework in which an entity operates. A contract does not exist if each party has a unilateral enforceable right to cancel a wholly unperformed contract.
Any consideration received on a contract which does not meet the recognition requirements above shall be recognized as a liability initially and shall be recognized as revenue either when:
- All obligations has been performed and non-refundable consideration has been received or
- The contract has been termination and any consideration received is non-refundable.
Contracts with same customer entered at around the same time may be combined if (a) they are negotiated as a single contract, (b) consideration for one contract depends on the other, or (c) they constitute a single performance obligation.
A contract modification refers to approved change in scope. It must be accounted as a separate contract if (a) it increases the scope of the contract due to addition of distinct goods and services, and (b) the consideration increases by an amount representing the standalone selling price of the additional goods or services.
A contract modification not meeting the criteria for recognition as a new contract shall be accounted for as:
- A termination of existing contract and creation of a new contract whose total consideration shall equal to the consideration from previous contract not yet recognized as revenue, and the additional consideration arising from modification.
- As an adjustment (made on the date of modification) to revenue already recognized if the increase in scope does not constitute addition of new distinct goods or services.
Identifying performance obligations
At the inception of a contract, an entity identifies:
- Each of the promises it make to transfer distinct goods or services or
- A series of distinct goods or services which are substantially the same and which it expects to have the same pattern of transfer.
A good or services is distinct if (a) the customer can benefit from it on its own (or together with other resources readily available), and (c) the entity’s obligation to transfer it separately is separately identifiable from its other obligations under the contract. An obligation may not be separately identifiable if the entity retains significant service of integrating the goods or services, one product/service modifies the other significantly, and the goods are highly inter-dependent and integrated.
If goods are not distinct, they must be aggregate till the entity identifies the minimum level of distinct goods or service.
A series of distinct goods has the same pattern of transfer if (a) they are satisfied over time and (b) the progress towards satisfaction is measured using the same method.
Determining the transaction price
The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring goods and services excluding amounts collected on behalf of third-parties. Transaction price may include fixed amounts, variable amounts or both.
An entity shall estimate the variable consideration using either:
- The expected value method: A value determined by weighting each outcome by its relevant probability.
- The most-likely amount method: The single amount with the highest probability.
The variable consideration is constrained to include only such variable consideration for which it is highly probable that a significant reversal would not occur when the associated uncertainty is resolved. Such an assessment shall be updated at each year-end.
An entity recognizes a refund liability to the extent of consideration it expects to return to the customer due to discount, warranty, etc.
Significant financing component
An entity excludes the impact of time value of money on consideration if a contract contains significant financing component. Factor that affect such an assessment includes the difference between contract price and cash selling price of the good or service, time period between delivery and payment, prevailing interest rate, etc. An entity may choose not to adjust for significant financing component if the time involved is one year or less.
Non-cash consideration and consideration payable to customer
Any non-cash consideration is measured at its fair value and at the corresponding stand-alone selling price of the goods or services transferred if the fair value cannot be determined.
Any consideration payable to customers (other than for purchase of goods) is to be reduced from transaction price.
Allocating the transaction price to performance obligations
The objective behind allocation is to recognize revenue in an amount to which an entity would be entitled on satisfaction of the associated performance obligation. This objective is achieved by allocating transaction price to performance obligations based on stand-alone selling prices except in case of a single performance obligation satisfied over time.
Determining stand-alone selling prices
Stand-alone selling price equals the observable price of the good or service, the price the entity charges other customers in similar environment. If observable price is not available, stand-alone selling price must be estimated using either:
- Adjusted market assessment approach which involves estimating prices based on relative prices charges by competitors and other similar goods or services.
- Expected cost plus a margin approach which involves adding a specified margin to the cost of production of the good or service.
- Residual approach which determines standalone selling price of one product by subtracting observable prices of other goods and services from total transaction price.
In case of variable or uncertain stand-alone prices, a combination of methods might be needed.
Allocation discount and variable consideration
Unless an entity knows for sure that a discount relates to one or more performance obligations (in which case criteria in IFRS15.82 must be met), it must allocate the discount proportionately to all performance obligations.
Variable consideration may be allocated either to a contract as a whole or to one or more performance obligations or to more than one distinct goods or service contained in a single obligation involving transfer of a series of good and services provided the allocation objective is met.
Allocating change in consideration
Any change in consideration must be allocated based on the stand-alone selling price at the contract inception. Amounts allocated to a satisfied performance obligation are reflected in the period in which the transaction price changes.
Measuring satisfaction of performance obligations
Revenue is recognized when performance obligations are satisfied. Performance obligation is satisfied when goods or services is transferred to the customer. A good or services is considered transferred if the customer obtains its possession/control.
At contract inception, an entity determines whether it satisfies a performance obligation over time or at a point in time.
Performance obligations satisfied over time
Performance obligation is considered satisfied over time if either of the following condition is met:
- The customer simultaneously receives and consumes the good or service;
- The performance obligation enhances an asset controlled by the customer; and
- The asset created has no alternative use and the entity has enforceable right to receive payment for the performance completed.
For performance obligations satisfied over time, an entity measures revenue over time. It selects either an output method or an input method to measure progress towards complete satisfaction and applies it consistently. Output methods focus on direct measurements of the value to customer. These include surveys and appraisals of results, milestones reached, time elapsed, units produced, etc. Input methods are based the entity’s effort in satisfying a performance obligation, such as resources consumed, labor hours spent, costs incurred, etc.
Performance obligation satisfied at a point in time
If a performance obligation is not satisfied over time, it is satisfied at a point in time. This occurs when the good or service is transferred i.e. when the control transfers. Other indicators include whether the entity has a right to payment, the customer has obtained legal title to the asset, the physical possession has been transferred to the customer, the customer has significant risks and rewards related to ownership, and the customer has accepted the asset.
Revenue is recognized only when reliable information needed to make such determination is available. If at the early stage, an entity cannot determine the outcome but expects to recover costs, it recognize revenue to the extent of costs incurred.
Any incremental costs of obtaining a contract are capitalized if they are recoverable from the customer. Costs are not incremental if they would have been incurred regardless of whether the contract is obtained. However, if the amortization period is less than one year, an entity may elect to expense them out.
If costs incurred in fulfilling a contract are not within the scope of any other accounting standards, these must be capitalized only if:
- The costs related directly to the contract i.e. they can be identified to a contract;
- The costs enhance an entity’s resources to be used in satisfaction of performance obligations; and
- The costs are expected to be recovered.
Examples of capitalized costs include direct materials, direct labor, allocated manufacturing costs, etc. Costs which would typically be expensed out include general and administrative expense (unless they are recoverable), costs of wastage not reflected in the price of the contract, etc.
Such capitalized costs shall be amortized in the pattern in which the associated performance obligations are met. An entity would recognize impairment loss of the assets if their carrying amount exceeds the excess of remaining consideration on the contract minus the costs that must yet be incurred on the contract.
Presentation and disclosure
A entity shall recognize a contract asset to represent a performance obligation performed and a contract liability with respect of advance payments received.
Contract asset vs receivable
If a good or services is transferred to a customer before payment is due, it is recognized as a contract asset. IFRS 9 is applied in accounting for impairment of contract asset. Any unconditional right to receive payment is recognized as a receivable which is accounted for under IFRS 9 after initial recognition.
IFRS 15 contains extensive disclosure requirements whose objective is to provide enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.