Revenue from contracts with customers (IFRS 15)

YouTube video

IFRS 15 has replaced the previous IFRS on revenue recognition, IAS 18 Revenue and IAS 11 Construction Contracts. It uses a principles-based 5-step approach to apply to contact with customers.

The five steps are as follows:

Identification of contracts
Identification of performance obligations (goods, services or a bundle of goods and services)
Determination of transaction price
Allocation of the price to performance obligations
Recognition of revenue when/as performance obligations are satisfied

1 Identification of contracts

The contract does not have to be a written one, it can be verbal or implied. In order for IFRS 15 to apply the following must all be met:

The contract is approved by all parties
The rights and payment terms can be identified
The contract has commercial substance
It is probable that revenue will be collected

2 Identification of performance obligations

If the goods or services that have agreed to be exchanged under the contract are distinct (i.e. could be sold alone) then they should be accounted for separately.

If a series of goods or services are substantially the same they are treated as a single performance obligation.

Illustration – Performance obligations

LiverTech is a computer business that primarily sells computer hardware. As well as selling computers, it also supplies and installs the software to its customers and provides a technical support package over a number of years. The business commonly sells the supply and installation, and technical support in a combined goods and services contract.

The combined goods and services contract has two separate performance obligations, which would need to be separated out and recognised separately.

The installation of software would be recognised once complete and the provision of technical services over the period of the support service.

3 Determination of transaction price

YouTube video

The amount the selling party expects to receive is the transaction price. This should consider the following:

Significant financing components
Variable consideration
Refunds and rebates (paid to the customer!)

Transaction price

Luckers Co. sells a car to a customer for $10,000, offering interest-free credit for a three-year period. The car is delivered to the customer immediately. The annual market rate of interest on the provision of consumer credit to similar customers is 5%.

What is the transaction price?

The three-year interest-free credit period suggests that the $10,000 selling price includes a significant financing component.

The selling price is therefore discounted to present value based on a discount rate that reflects the credit characteristics of the party (customer) receiving the financing i.e. 5%.

Therefore the transaction price is $10,000/(1.05)³ = $10,000 x 0.8638 = $8,638.

4 Allocation of the price

YouTube video

The price is allocated proportionately to the separate performance obligations based upon the stand-alone selling price.

Allocation of price

Richer Co. sells home entertainment systems including a two-year repair and maintenance package for $10,000. The price of a home entertainment system without the repair and maintenance contract is $9,000 and the price to renew a two-year maintenance package is $2,000.

How is the $10,000 contract price allocated to the separate performance obligations?

Note: Ignore any discounting and time value of money.

The performance obligations and allocation of total price are as follows:

Provision of home cinema system (9,000/11,000 × $10,000) = $8,182

Provision of maintenance contract (2,000/11,000 × $10,000) = $1,818

5 Recognition of revenue

YouTube video

Once control of goods or services transfers to the customer, the performance obligation is satisfied and revenue is recognised. This may occur at a single point in time, or over a period of time.

If a performance obligation is satisfied at a single point in time, we should consider the following in assessing the transfer of control:

Present right to payment for the asset
Transferred legal title to the asset
Transferred physical possession of the asset
Transferred the risks and rewards of ownership to the customer
Customer has accepted the asset.

IFRS 15 (1)

Telephonica sells mobile phones, selling them for “free” when a customer signs up for a 12 month contract. The contract costs the customer $45 per month.

Explain how the revenue should be recognised in Telephonica’s financial statements

Note: Vodaphone sells mobile phones without a monthly contract, selling the handset for $480. Call and data charges are $20 per month. Ignore discounting and the time value of money

Identify the contract

Signed agreement

Identify the separate performance obligations

Sale of handset
Provision of calls and data service

Determine the transaction price

$540 = $45 x 12 months

Allocate transaction price to performance obligations

Standalone prices (using Vodaphone)
$720 (= $480 + (12 months x $20))
Handset = 480/720 x 540 = $360
Calls and data = 240/720 x 540 = $180

Recognise revenue as each performance obligation is satisfied

Handset (goods) = at a point in time (on signing the contract)
Calls and data (services) = over 12 months

YouTube video

IFRS 15 (2)

LiverTech is a computer business that primarily sells computer hardware. As well as selling computers, it also supplies and installs the software to its customers and provides a technical support package over two years. The business commonly sells the supply and installation, and technical support in a combined goods and services contract.

The combined goods and services contract sells for $1,600, but if sold separately the supply and installation is sold for $1,500 and the technical support for $500.

If LiverTech sold a combined contract on 1 July 20X7, demonstrate how the transaction would be presented in the financial statements for the year ended 31 December 20X7.

Identify the contract

Signed agreement

Identify the separate performance obligations

Supply and installation service
Technical support

Determine the transaction price

Combined contract price = $1,600

Allocate transaction price to performance obligations

Standalone price (supply and installation) = $1,500
Standalone price (technical support) = $500
Supply and installation = 1,500/2,000 x 1,600 = $1,200
Technical support = 500/2,000 x 1,600 = $400

Recognise revenue as each performance obligation is satisfied

Supply and installation = on installation (1 July 20X7)
Technical support = over two years (1 July 20X7 to 30 June 20X9)

SFP (extract)		SPL (extract)
	$		$
Non-current liabilities		Revenue	1,300
Deferred income	100	= 1,200 + (6/24 x 400)

Current liabilities
Deferred income	200
= 12/24 x 400

YouTube video

If a performance obligation is transferred over time, the completion of the performance obligation is measured using either of the following methods:

Output method – revenue is recognised based upon the value to the customer, i.e. work certified.

Input method – revenue is recognised based upon the amounts the entity has used, i.e. costs incurred or labour hours.

Any costs incurred to fulfil the contract with a customer should be expensed to the statement of profit or loss as they are incurred.

YouTube video

Performance obligations over time and the statement of profit or loss (1)

Calculate the revenue and costs to be recognised in the statement of profit or loss for the year-ended 31 December 20X4.

	$m
Revenue (40% x $50million)	20
Costs (costs to date)	(15)
Profit	5

YouTube video

Performance obligations over time and the statement of profit or loss (2)

Alex commenced a three-year building contract during the year-ended 31 December X4 at a contract price of $50million. At the 31 December X4, the costs incurred to date are $15million and the contract is estimated to be 40% complete. At 31 December the costs incurred to date are $28million and the contract is estimated to be 70% complete.

Calculate the revenue and costs to be recognised in the statement of profit or loss for the year-ended 31 December 20X5.

	*Cumulative to December 20X5* $m	*Recognised to December 20X4* $m	*Profit or loss y/e 31 December 20X5* $m
Revenue (70% x $50million)	35	20	15
Costs (costs to date)	(28)	(15)	(13)
Profit	7	5	2

As contracts that span more than one accounting period progress, the company is creating an asset for the customer that needs to be recognised in the statement of financial position. The amount to be recognised is as follows:

	$
Revenue recognised to date	X
Less: amounts invoiced to date	(X)
Contract asset/(liability)	X

The contract balance is measured against what has been invoiced, not against what has been received in cash, and not against the profit recognised. Revenue recognised to date less amounts invoiced to date is the whole calculation: a positive figure is a contract asset and a negative one a contract liability. Cash received from the customer does not enter it.

Illustration – Contract asset

Ellie enters into a four-year building contract on1 March 20X1, with a contract price of $10m
At 31 December 20X3, the contract is 60% complete, and the following amounts have been recorded:

Amounts invoiced to the customers at $2.1m
Amounts received from the customer at $1.1m

The contract asset to be recognised in the statement of financial position as at 31 December 20X3 is $3.9 m

Contract asset = $3.9 m = 60% x $10m (total revenue) less $2.1m (amounts invoiced to the customer

The profit recognised is not relevant to the contract asset, nor is the amounts received.

Performance obligations over time and the statement of financial position

Rory has invoiced the customer for work completed to date as follows:

31 December 20X5	$26m
31 December 20X4	$16m

Calculate the contract asset/liability to be recognised in the statement of financial position at 31 December 20X4 and 20X5.

	*Cumulative to December 20X5* $m	*Recognised to December 20X4* $m	*Profit or loss y/e 31 December 20X5* $m
Revenue (70% x $50million)	35	20	15
Costs (costs to date)	(28)	(15)	(13)
Profit	7	5	2

	*20X5* $m	*20X4* $m
Revenue recognised to date	35	20
Less: amounts invoiced to date	(26)	(16)
Contract asset/(liability)	11	4

6 Specifics

Principal vs agent - When a third party is involved in providing goods or services to a customer, the seller is required to determine whether the nature of its promise is a performance obligation to:

Provide the specified goods or services itself (principal) or
Arrange for a third party to provide those goods or services (agent)

Agent vs. principal

Evie is a business manufacturing aircraft component parts, selling two types of components to Ben. Ben acts as a selling agent and sells component X to the public receiving 10% of commission on the selling price. Ben also sells component Y directly to its customers making a 25% gross margin on these sales.

The following relates to sales made in the month of December:

	Component X	Component Y
Revenue ($)	300,000	80,000

How much revenue should Ben recognise for the month of December?

	$
Component X revenue as agent (10% x 300,000)	30,000
Component Y revenue as principal	80,000
Total revenue	110,000

Repurchase agreements - When a vendor sells an asset to a customer and is either required, or has an option, to repurchase the asset. The legal form here is always a sale followed by a purchase at a later date. The economic substance is more likely to be a loan secured against an asset that is never actually being sold.

Illustration – Repurchase agreements

Rory runs a wood business where it holds the cut wood for several years whilst it matures, before it can then be used in the manufacture of high-quality furniture. It has recently sold a large batch of newly cut wood to a London bank for $100,000, with an option to repurchase the wood in 10-years’ time for $250,000. The wood’s current fair value is $125,000 and it is expected that it will have a fair value of $400,00 in 10-years’ time.

Although Rory has sold the wood to the London bank, the wood will remain on Rory’s premises for the 10-year duration and will still have the risks of ownership as Rory will need to cover the cost of insurance and maintain the wood in top condition.

The accounting treatment is not that of a sale as the following highlight that it is a repurchase agreement:

The initial sale at $100,000 is below the current fair value of $125,000 and the repurchase of the wood in 10-years’ time for $250,000 is below the expected fair value of $400,000, giving Rory the reward of the wood increasing in value.

The London bank bears very little risk of the inventory falling in value.

The risks remain with Rory as it bears the costs of insuring and maintaining the wood.

The wood will therefore remain in Rory’s inventory and no sale is recognised. The proceeds received of $100,000 will be recognised as a loan, within non-current liabilities. Interest will be charged on the loan using the amortised cost method of accounting, spreading the total interest of $150,000 ($250,000 - $100,000) over the ten-year period.

Bill and hold arrangements - an entity bills a customer for a product but the entity retains physical possession of the product until it is transferred to the customer at a point in time in the future

Consignments – arises where a vendor delivers a product to another party, such as a dealer or retailer, for sale to end customers. The inventory is recognised in the books of the entity that bears the significant risk and reward of ownership (e.g. risk of damage, obsolescence, lack of demand for vehicles, no opportunity to return them, the showroom-owner must buy within a specified time if not sold to public).

Exam preparation question – Sale of goods

Extracts from the trial balance of Alex Co at 30 June 20X8 are as follows:

	$000	$000
Revenue		65,270
Interest income	350

Alex Co made a large sale of goods on 31 December 20X7, which was also the date of delivery. Under the terms of the agreement, Alex Co will receive payment of $4m on 31 December 20X8. Currently, Alex Co has recorded $2m in revenue and trade receivables. The directors intend to record the remaining $2m revenue in the year ended 30 June 20X9. The costs of this sale have been accounted for correctly in the financial statements for the year ended 30 June 20X8. Alex Co has a cost of capital of 5% at which an appropriate discount factor would be 0·9524.

Prepare extracts from the statement of profit or loss for Alex Co for the year ended 30 June 20X8

Exam preparation solution – Sale of goods

Statement of profit or loss for the year ended 30 June 20X8

	$’000
Revenue (65,270 + 1,810 (w))	67,080

Interest income (350 + 95 (w))	445

Workings

Revenue = $4,000,000 / 1.05 = $3,809,524

= $3,809,524 – $2,000,000 = $1,809,524

Interest income = $3,809,524 x 5% x 6/12 = $95,238

Practice question

IFRS 15 sets criteria that must be met before an entity accounts for an arrangement as a contract with a customer.

Which TWO items are NOT required criteria?

The parties have approved the contract and are committed to perform their obligationsThe contract must be in writingThe contract has commercial substanceCollection of the consideration need only be possible, rather than probable

Answer the questions one at a time. Your progress is saved so you can leave and come back.

Open chapter practice