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Cumulative catch-up approach

The cumulative catch-up approach is a method to account for contract modifications under IFRS 15. If the remaining goods or services are not distinct and are part of a single performance obligation that is partially satisfied, an entity should recognise the effect of the modification on a cumulative catch-up basis.

It is also included in IFRS 9 and IFRS 16, but not in a financial transaction or event that occurs on a regular basis:

• in IFRS 9 it could be used in a prepayment feature at amortised costs (see below), and
• at initial application of IFRS 16 IASB decided to allow an entity to apply IFRS 16 retrospectively (with some practical expedients), with the cumulative effect of initially applying IFRS 16 recognised at the date of initial application (referred to as the ‘cumulative catch-up’ transition method)

IFRS 9

A prepayment feature that may result in negative compensation changes the circumstances, and increases the frequency, in which the contractual compensation amounts could arise. If such a prepayable financial asset is measured at amortised cost, the likelihood is higher that the lender will be required to make catch-up adjustments applying IFRS 9.B5.4.6 to reflect revisions to its estimates of contractual cash flows related to the exercise of the prepayment feature.

This could include adjustments to reflect circumstances in which the lender is forced to settle the contract in a way that it would not recover its investment for reasons other than the asset’s credit quality.

The IASB observed that recognising frequent upward and downward adjustments in the gross carrying amount is generally inconsistent with the objective of the effective interest method, which is a relatively simple measurement technique that allocates interest using the effective interest rate over the relevant time period.

Recognizing more frequent adjustments in the gross carrying amount could reduce the usefulness of the interest amounts that are calculated using such a simple measurement technique and could suggest that fair value measurement would provide more useful information.

IFRS 15

If the remaining goods or services are not distinct and are part of a single performance obligation that is partially satisfied (ie a performance obligation satisfied over time), an entity should recognise the effect of the modification on a cumulative catch-up basis. This requires an entity to update the transaction price and the measure of progress towards complete satisfaction of a performance obligation, both of which may change as a result of the contract modification. That approach is particularly relevant to, and generally accepted in, the construction industry because a modification to those types of contracts would typically not result in the transfer of additional goods or services that are distinct from those promised in the existing contract.

Accounting for contract modifications

Contract modifications are accounted for as either a separate contract or as part of the existing contract, depending on the nature of the modification as summarized in the following decision tree.

Extensive explanations are provide in Contract modifications under IFRS 15.

Modification not a separate contract

A modification that does not meet both of the criteria to be accounted for as a separate contract is accounted for as an adjustment to the existing contract, either prospectively or through a cumulative catch-up adjustment. The determination depends on whether the remaining goods or services to be provided to the customer under the modified contract are distinct (see above decision tree).

Changes in the transaction price

A contract modification that only affects the transaction price is either accounted for prospectively or on a cumulative catch-up basis. It is accounted for prospectively if the remaining goods or services are distinct. There is a cumulative catch-up if the remaining goods or services are not distinct. Thus, a contract modification that only affects the transaction price is accounted for like any other contract modification (see above decision tree).

Q&A IFRS 15

If an entity transfers goods or services to a customer before a contract satisfies the criteria in the 5-step IFRS 15 model, should revenue be recognized prospectively or on a cumulative catch-up basis when the contract subsequently meets the required criteria?

An entity should recognize revenue for any promised goods or services that have already been transferred to the customer at the date the criteria for the existence of a contract are met (that is, revenue should be recognized on a cumulative catch-up basis).

Case – cumulative catch-up adjustment

Builder enters into a two-year arrangement with Customer to build a manufacturing facility for $300,000. The construction of the facility is a single performance obligation. Builder and Customer agree to modify the original floor plan at the end of the first year, which will increase the transaction price and expected cost by approximately $100,000 and $75,000, respectively.

How should Builder account for the modification?

Solution
Builder should account for the modification as if it were part of the original contract.

The modification does not create a performance obligation because the remaining goods and services to be provided under the modified contract are not distinct.

Builder should update its estimate of the transaction price and its measure of progress to account for the effect of the modification. This will result in a cumulative catch-up adjustment at the date of the contract modification.

Calculation example cumulative catch-up adjustment

On January 1, 20X8, Chemical Co enters into a one-year contract with Municipality to deliver water treatment chemicals. The contract stipulates that the price per container will be adjusted retroactively once Municipality reaches certain sales volumes, defined as follows:

Volume is determined based on sales during the calendar year. There are no minimum purchase requirements. Chemical Co estimates that the total sales volume for the year will be 2.8 million containers based on its experience with similar contracts and forecasted sales to Municipality.

Chemical Co sells 700,000 containers to Municipality during the first quarter ended March 31, 20X8 for a contract price of $100 per container.

How should Chemical Co determine the transaction price?

Solution
The transaction price is $90 per container based on Chemical Co’s estimate of total sales volume for the year, since the estimated cumulative sales volume of 2.8 million containers would result in a price per container of $90.

Chemical Co concludes that, based on a transaction price of $90 per container, it is probable (US GAAP) or highly probable (IFRS) that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty is resolved. Revenue is therefore recognized at a selling price of $90 per container as each container is sold. Chemical Co will recognize a liability for cash received in excess of the transaction price for the first one million containers sold at $100 per container (that is, $10 per container) until the cumulative sales volume is reached for the next pricing tier and the price is retroactively reduced.

For the quarter ended March 31, 20X8, Chemical Co recognizes revenue of $63 million (700,000 containers * $90) and a liability of $7 million (700,000 containers * ($100–$90)).

Chemical Co will update its estimate of the total sales volume at each reporting date until the uncertainty is resolved.

Reassessment of estimated volume discounts

Continue with the same facts as with the following additional information:

• Chemical Co sells 800,000 containers of chemicals during the second reporting period ended June 30, 20X8.
• Municipality commences a new water treatment project during the second quarter of the year, which increased its need for chemical supplies.
• In light of this new project, Chemical Co increases its estimate of total sales volume to 3.1 million containers at the end of the second reporting period. As a result, Chemical Co will be required to retroactively reduce the price per container to $85.

How should Chemical Co account for the change in estimate?

Solution
Chemical Co should update its calculation of the transaction price to reflect the change in estimate. The updated transaction price is $85 per container based on the new estimate of total sales volume. Consequently, Chemical Co recognizes revenue of $64.5 million for the quarter ended June 30, 20X8, calculated as follows:

The cumulative catch-up adjustment of $ (3,500,000) reflects the amount of revenue that Chemical Co would have recognized if, at contract inception, it had the information that is now available.

Chemical Co will continue to update its estimate of the total sales volume at each reporting date until the uncertainty is resolved.

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