IFRS 15 Revenue
Revenue is normally the largest single figure a company reports, and it is the figure most often manipulated. IFRS 15 Revenue from Contracts with Customers replaced IAS 18 Revenue and IAS 11 Construction Contracts, both of which left too much to judgement, with a single principles-based five-step model applied to every contract with a customer.
Core principle
An entity recognises 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.
The five steps are as follows:
Identification of the contract
Identification of the performance obligations (goods, services, or a bundle of goods and services)
Determination of the transaction price
Allocation of the transaction price to the performance obligations
Recognition of revenue when, or as, each performance obligation is satisfied
Contract, obligations, price, allocate, recognise. Work every revenue question in that order and write the five headings down before you calculate anything — a large part of the marks in a written question is for identifying the steps at all.
Revenue – contract and performance obligations: these notes go further than the recording on Steps 1, 2 and 5 — the three over-time criteria and the two-limb distinct test in particular.
1 Step 1 — Identification of the contract
A contract is an agreement between two or more parties that creates enforceable rights and obligations. It does not have to be a written one; it can be verbal or implied by an entity's customary business practice. A normal credit sale in a shop is an implied contract.
In order for IFRS 15 to apply, all of the following must be met:
the parties have approved the contract and are committed to perform their obligations;
the entity can identify each party's rights regarding the goods or services to be transferred;
the entity can identify the payment terms;
the contract has commercial substance — the risk, timing or amount of the entity's future cash flows is expected to change as a result of it;
it is probable that the entity will collect the consideration to which it will be entitled.
If the criteria are not met, no revenue is recognised and any consideration received is held as a liability until either the criteria are met or the consideration becomes non-refundable and the entity has stopped performing.
Two or more contracts entered into at or near the same time with the same customer are combined and accounted for as one where they are negotiated as a package, where the consideration in one depends on the other, or where the goods or services in them form a single performance obligation.
2 Step 2 — Identification of the performance obligations
A performance obligation is a promise to transfer to the customer either a distinct good or service, or a series of substantially the same goods or services transferred in the same way.
A good or service is distinct only if both of the following are true:
the customer can benefit from it on its own, or together with resources readily available to the customer — it is capable of being distinct; and
the promise to transfer it is separately identifiable from the other promises in the contract — it is distinct within the context of the contract.
If the goods or services agreed to be exchanged under the contract are distinct — in other words, they could be sold alone — then they are accounted for separately. If they are not distinct, they are bundled together with other promises until a distinct bundle is identified, and the bundle is treated as a single performance obligation.
The second limb catches the case students most often get wrong. Bricks, labour and a design are each capable of being sold on their own, but in a contract to construct a building the entity is providing a significant service of integrating them into one asset — so the whole contract is a single performance obligation, not three.
Performance obligations
LiverTech is a computer business that primarily sells computer hardware. As well as selling computers, it also supplies and installs the software for its customers and provides a technical support package over a number of years. The business commonly sells the supply and installation, and the technical support, in a combined goods and services contract.
The combined goods and services contract has two separate performance obligations, which need to be separated out and recognised separately. Each is capable of being sold on its own: a customer could buy the software installation from LiverTech and take support elsewhere, or buy support for a computer bought from somebody else.
The installation of the software is recognised once complete; the provision of technical services is recognised over the period of the support service.
Revenue – transaction price: where the recording gives the remaining amount as $1,372, it is $1,362 ($10,000 − $8,638): the interest income recognised over the three years (Example 1). The figures are in dollars throughout.
3 Step 3 — Determination of the transaction price
The transaction price is the amount of consideration the entity expects to be entitled to in exchange for transferring the promised goods or services, excluding amounts collected on behalf of third parties such as sales taxes. It is not simply the invoice total: the following must be considered.
Complication | Treatment |
Variable consideration — bonuses, penalties, discounts, rebates, refunds, performance incentives | Estimate the amount, using either the expected value (probability-weighted, where there are many similar contracts) or the most likely amount (where there are only two possible outcomes). Include it only to the extent that it is highly probable that a significant reversal of revenue will not occur — the "constraint". |
Significant financing component — the customer pays substantially before or after the goods or services are transferred | Discount the consideration to its present value using the rate that reflects the credit characteristics of the customer. The difference is interest income or expense, recognised over the financing period. A practical expedient allows this to be ignored where the period is one year or less. |
Non-cash consideration | Measure at fair value. |
Consideration payable to a customer — refunds and rebates paid back to the customer | Deduct from the transaction price, and therefore from revenue, unless it is payment for a distinct good or service received from 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?
Show answerHide answer
4 Step 4 — Allocation of the transaction price
The transaction price is allocated to each performance obligation in proportion to its stand-alone selling price — the price at which the entity would sell that good or service separately.
Where a stand-alone selling price is not directly observable it must be estimated, using:
an adjusted market assessment — what the market would be willing to pay;
expected cost plus a margin; or
the residual approach — the total transaction price less the observable stand-alone selling prices of the other obligations. This is only permitted in narrow circumstances.
Because a bundle is normally sold at less than the sum of its parts, the allocation automatically spreads the discount across the obligations in proportion to their stand-alone prices.
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.
Show answerHide answer
IFRS 15 Revenue – recognition: the recording names a real competitor as its illustration, where these notes use Ternion and Vantage; and it mis-numbers a step (“step number four was to … identify the contract”). The five steps are as listed at the head of this chapter.
5 Step 5 — Recognition of revenue
Revenue is recognised when — or as — the entity satisfies a performance obligation by transferring control of the promised good or service to the customer. This may happen at a single point in time, or over a period of time.
5.1 Performance obligations satisfied over time
A performance obligation is satisfied over time, and revenue is therefore recognised over time, if any one of the following three criteria is met:
the customer simultaneously receives and consumes the benefits as the entity performs (a cleaning contract, a support service);
the entity's performance creates or enhances an asset that the customer controls as it is created (building on the customer's own land);
the entity's performance creates an asset with no alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.
If none of the three is met, the obligation is satisfied at a point in time.
5.2 Performance obligations satisfied at a point in time
Where a performance obligation is satisfied at a single point in time, the following indicators are considered in assessing when control transfers. The entity has:
a present right to payment for the asset;
transferred legal title to the asset;
transferred physical possession of the asset;
transferred the significant risks and rewards of ownership to the customer;
obtained the customer's acceptance of the asset.
No single indicator is decisive; they are weighed together to decide when control has passed.
IFRS 15 (1)
Ternion 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 Ternion's financial statements.
Note: a competitor, Vantage, sells the same handset without a monthly contract for $480. Its calls and data charges are $20 per month. Ignore discounting and the time value of money.
Show answerHide answer
IFRS 15 Revenue – Example (LiverTech): this is Example 4. The transaction price is $1,600: supply and installation takes 1,500/2,000 of it, $1,200 (said once as “$12,000”), and technical support 500/2,000 of it, $400. Where the recording says the $500 is allocated to “the $540”, read $1,600. The contract date is 1 July 20X7. Its remarks about exam sections and a “published company accounts question” do not describe the F2 exam, which is objective test.
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 for its customers and provides a technical support package over two years. The business commonly sells the supply and installation, and the 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.
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.
Show answerHide answer
5.3 Measuring progress towards completion
Where a performance obligation is satisfied over time, the completion of the performance obligation must be measured. Either of the following methods may be used, applied consistently:
Output method — revenue is recognised based on the value transferred to the customer, for example work certified:
Progress = Work certified to date ÷ Total contract revenue
Input method — revenue is recognised based on the entity's efforts or inputs, for example costs incurred or labour hours:
Progress = Costs incurred to date ÷ Total estimated costs
Revenue for the period is then the cumulative revenue to date less the revenue recognised in previous periods, and the cost of sales is found in the same way, so that the profit recognised is the total expected profit multiplied by the stage of completion, less the profit already taken.
Costs incurred are not the same as costs recognised. Materials bought and stored on site for future years are not part of the work completed: they are excluded from the progress calculation and carried as inventory.
5.4 Loss-making contracts
Where a contract that spans more than one accounting period is expected to be loss making, the whole of the expected loss is recognised immediately, in the period in which it becomes foreseeable. Prudence does not permit a loss to be spread over the remaining life of the contract in the way a profit is.
Revenue continues to be recognised by reference to the stage of completion; it is the cost of sales that is increased, by whatever balancing figure is needed to bring the whole loss into the current period.
Performance obligations over time and the statement of profit or loss (1)
Alex commenced a three year building contract during the year ended 31 December 20X4 and continued the contract during 20X5. The details of the contract are as follows:
$m | |
Total contract value | 45 |
Costs incurred to date at 31 December 20X5 | 20 |
Estimated costs to completion | 12 |
Work certified as completed in 20X5 | 15 |
Stage of completion at 31 December 20X5 | 70% |
Profit recognised to date at 31 December 20X4 | 3.3 |
Show how this contract would be dealt with in the statement of profit or loss for the year ended 31 December 20X5.
Show answerHide answer
Performance obligations over time and the statement of profit or loss (2)
Evelyn commenced a building contract in 20X5 that has seen large increases in future costs to complete. The contract will still be completed on schedule in 20X6. The details for the year ended 31 December 20X5 are as follows:
$m | |
Total contract value | 40 |
Costs incurred to date | 25 |
Estimated costs to completion | 20 |
Stage of completion | 45% |
Show how this contract would be accounted for in the statement of profit or loss for the year ended 31 December 20X5.
Show answerHide answer
6 Presentation in the statement of financial position
As a contract that spans more than one accounting period progresses, the entity builds up a claim against the customer that has to be recognised. Three balances can arise:
a receivable — an unconditional right to consideration, because the entity has invoiced the customer and only the passage of time stands between it and payment;
a contract asset — the entity has done work for which it has not yet billed, or has incurred costs that have not yet been expensed;
a contract liability — the entity has billed or been paid more than it has earned (the deferred income in Example 4).
The contract asset or liability is computed as:
$ | |
Costs incurred to date on work completed | X |
Recognised profits | X |
Recognised losses | (X) |
Progress billings to date | (X) |
Contract asset / (contract liability) | X / (X) |
Cash actually received does not enter this calculation. Amounts billed but not yet paid are a separate trade receivable; materials bought for future years are separate inventory.
Performance obligations over time and the statement of financial position
Noah has a three year contract which commenced on 1 January 20X5. At 31 December 20X5 Noah extracted the following balances from its ledger relating to the contract:
$000 | $000 | |
Total contract value | 140,000 | |
Costs incurred up to 31 December 20X5: | ||
Attributable to work completed | 60,000 | |
Inventory purchased for use in future years | 8,000 | 68,000 |
Progress billings to date | 45,000 | |
Cash received | 26,500 | |
Other information: | ||
Expected further costs to completion | 48,000 |
At 31 December 20X5, the contract was certified as 40% complete.
Prepare extracts from the statement of profit or loss and the statement of financial position for the year ended 31 December 20X5.
Show answerHide answer
7 Specific situations
Principal versus agent
When a third party is involved in providing goods or services to a customer, the seller must determine whether the nature of its promise is a performance obligation to:
provide the specified goods or services itself — it is the principal, and recognises the gross amount as revenue; or
arrange for a third party to provide those goods or services — it is the agent, and recognises only its commission or fee as revenue.
The decisive question is whether the entity controls the good or service before it is transferred to the customer. Indicators of being the principal include primary responsibility for fulfilling the promise, holding the inventory risk, and discretion in setting the price.
Repurchase agreements
A repurchase agreement arises when a vendor sells an asset to a customer and is either required, or has an option, to repurchase the asset. The legal form 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 sold. Where the vendor retains control, no sale is recognised and a financial liability is recorded instead.
Bill and hold arrangements
An entity bills a customer for a product but retains physical possession of it until it is transferred to the customer at a point in time in the future. Revenue may still be recognised, but only if the reason for the arrangement is substantive, the product is identified as belonging to the customer, is ready for physical transfer, and cannot be used or redirected to another customer.
Consignments
A consignment arrangement arises where a vendor delivers a product to another party, such as a dealer or retailer, for sale to end customers. No revenue is recognised on delivery if the vendor retains control. The inventory is recognised in the books of the entity that bears the significant risks and rewards of ownership — indicators being the risk of damage, obsolescence and lack of demand, whether the products can be returned, and whether the dealer is obliged to buy within a specified time if the goods are not sold on.
Costs of a contract
The incremental costs of obtaining a contract — costs that would not have been incurred had the contract not been won, such as a sales commission — are recognised as an asset and amortised as the related revenue is recognised, unless the amortisation period would be one year or less. Costs of fulfilling a contract are capitalised where they relate directly to the contract, generate resources that will be used to satisfy it, and are expected to be recovered.
8 Disclosure
IFRS 15 requires enough disclosure for a user to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. In particular:
revenue disaggregated into categories that show how it is affected by economic factors — by product line, geography, market, or timing of transfer;
the opening and closing balances of contract assets, contract liabilities and receivables, and the revenue recognised in the period that was included in the opening contract liability;
information about performance obligations — when they are typically satisfied, significant payment terms, and the amount allocated to obligations that are unsatisfied at the reporting date;
the judgements made in determining the timing of satisfaction, the transaction price and the amounts allocated.
IFRS 15 applies one five-step model to every contract with a customer: identify the contract, identify the distinct performance obligations, determine the transaction price, allocate it across the obligations on stand-alone selling prices, and recognise revenue as each obligation is satisfied. An obligation is satisfied over time if the customer consumes as the entity performs, or controls the asset as it is created, or the asset has no alternative use and there is an enforceable right to payment; otherwise it is satisfied at a point in time, when control passes. Progress is measured by an output or an input method, profit is taken in proportion to it — but the whole of an expected loss is recognised at once. What is earned but unbilled is a contract asset, what is billed but unearned is a contract liability, and what is billed and unpaid is a receivable.
9 Test your knowledge
IFRS 15 Revenue
22 questionsAnswer the questions one at a time. Your progress is saved so you can leave and come back.
Open chapter practice