IABFM Articles

IABFM Articles > > Financial Management > IFRS 15 Revenue from Contracts with Customers Could Signal Major Changes to Contracts

IFRS 15 Revenue from Contracts with Customers Could Signal Major Changes to Contracts

By Geoffrey Baring

29 June, 2014

In late May, 2014, the International Accounting Standards Board (IASB) issued the new accounting standard IFRS 15 Revenue from Contracts with Customers which is to be operative from the beginning of 2017.  As this is some 30 months away it does not appear, at first glance, to have any immediate major impact.  However, on reading the standard it is evident that there is the potential for major impacts and that many entities may need the full 30 months to put the systems in place to deal with the issues the standard raises.

The objective of the standard is to provide information about contracts, but specifically contracts spanning more than one time period, and the cash flows generated by those contracts.  The standard specifically excludes contracts falling within the scope of IAS 17, IAS 27, IAS 28, IFRS 4, IFRS 9, IFRS 10, and IFRS 11.  The standard introduces a 5 step model for analysing contracts.  The model requires the entity to: 

• Identify if a contract exists
  
• Identify the performance obligations in the contract
  
• Determine the transaction priceAllocate the transaction price to the performance obligations in the contract
• Recognise the revenue when (or as) the entity satisfies a performance obligation

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

The standard provides guidance of the treatment of where contracts do not currently exist and the method of treatment of contract variations.

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

The standard then identifies conditions under which a good or service is distinct and can be separately identifiable.

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 then addresses the issues of uncertainty of variable consideration and the approach to be adopted in relation to royalties.

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). 

The standard then addresses the issue of discounts and their treatment and consideration paid in advance and its treatment.

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

The standard also addresses the issue of when control passes to the other entity.

Who is going to be affected by the standard?

The short answer is that all entities will be impacted by the introduction of IFRS 15.  However, some industries will be more directly impacted than others.  Those industries that have long term contracts such as software, telecoms, real estate and other industries with long term contracts will be most affected.  In the long run it will not have any effect on the income received but it may have a significant impact on the recognition of that income.