Arrangements where the identification criteria are not met

Arrangements where the identification criteria are not met – An arrangement is not accounted for using the five contract identification criteria until all of the criteria are met. Management will need to reassess the arrangement at each reporting period to determine if the criteria are met. Rebalancing hedged item hedging instrumentArrangements where the identification criteria are not met

If the criteria for contract identification are not met, then the contract does not exist for the purpose of applying the general model of the standard, and any consideration received from the customer is generally recognised as a deposit (liability). The liability is recorded as revenue from the customer when one of the following criteria is met (IFRS 15 15):

  1. the entity has no remaining obligations to transfer goods or services to the customer and all, or substantially all, of the consideration promised by the customer has been received by the entity and is non-refundable; or Arrangements where the identification criteria are not met
  2. the contract has been terminated and the consideration received from the customer is non-refundable. [IFRS 15 12] Arrangements where the identification criteria are not met

In addition, a contract does not exist when each party has the unilateral right to terminate a wholly unperformed contract without compensation. If the criteria are not initially met, then an entity continually reassesses the contract against them and applies the requirements of the standard to the contract from the date on which the criteria are met (IFRS 15 14). Any consideration received for a contract that does not meet the criteria is accounted for under the requirements above from IFRS 15 15.

ExampleArrangements where the identification criteria are not met

In an agreement to sell real estate, Seller X assesses the existence of a contract. In making this assessment, X considers factors such as:

  • the buyer’s available financial resources; Arrangements where the identification criteria are not met
  • the buyer’s commitment to the contract, which may be determined based on
  • the importance of the property to the buyer’s operations;
  • X’s prior experience with similar contracts and buyers under similar circumstances;
  • X’s intention to enforce its contractual rights; Arrangements where the identification criteria are not met
  • the payment terms of the arrangement; and Arrangements where the identification criteria are not met
  • whether X’s receivable is subject to future subordination. Arrangements where the identification criteria are not met

If X concludes that it is not probable that it will collect the amount to which it expects to be entitled, then a contract to transfer control of the real estate does not exist. Instead, X applies the guidance on consideration received before concluding that a contract exists, and initially accounts for any cash collected as a deposit (liability).

Something else -   Revenue recognition at a point in time

The liability is recognised as revenue only once performance is complete and substantially all of the promised consideration is collected and non-refundable. Arrangements where the identification criteria are not met

Revenue recognition may be deferred for a significant period

If an entity cannot conclude that a legally enforceable contract exists, then it may be difficult to evaluate when all or substantially all of the promised consideration has been received and is non-refundable. In some cases, an entity may have a deposit liability recognised for a significant period of time before it can conclude that a contract exists in the model or that the criteria for recognising the consideration as revenue are met. Arrangements where the identification criteria are not met

Free trial period offersFree trial period offers 1

In some cases, an entity will offer customers the right to obtain its services for free for a period, during which time the customer can decide to contract for future services. For example, a customer can decide to obtain a 12-month subscription to a film streaming service after the end of a free trial period. Service providers may offer additional incentives – e.g. free or discounted services or a discounted price on the service – if the customer enters into a long-term contract. Arrangements where the identification criteria are not met

In these cases, no contract exists until the customer accepts the entity’s offer to provide services after the free trial period because the customer can opt out any time during the free trial period. No enforceable right to consideration exists for the entity until the customer contracts for post-free trial period services. Once the customer accepts the entity’s offer, the entity accounts for the remaining free trial period services (from the date a contract exists) and the post-free trial services as performance obligations of the contract.

Something else -   Revenue Income Contract Customer?

Services provided during the free trial period, before the customer accepts the entity’s offer to provide services beyond the free trial period, are generally accounted for as sales incentives.

However, it may be reasonable to account for only the post-free trial period goods or services as performance obligations of the customer contract if either:

  • the customer’s right to the remaining free trial period goods or services is not enforceable; or Arrangements where the identification criteria are not met
  • on a portfolio basis, accounting for only the post-free trial period goods or services as performance obligations would not differ materially from accounting for both the remaining free trial period goods or services and the post-free trial period goods or services as performance obligations of the contract with the customer. Arrangements where the identification criteria are not met

Cumulative catch-up adjustment for consideration received before a contract exists

(IFRS 15 16) – Company C and Customer D enter into a 12-month service agreement that requires D to pay service fees of 800 per month. The agreement expires on 31 May, but C continues to deliver services and D continues to pay 800 a month. A new agreement requiring a fee of 1,000 per month is signed on 31 July, which applies retrospectively from 1 June.

C’s legal counsel advises that an enforceable obligation for D to pay C for services provided in June and July did not exist before the new agreement was executed on 31 July. C therefore concludes that a contract did not exist in June and July.

Because the existing contract was terminated on 31 May, C records the June and July payments of 1,600 received from D as revenue only once performance in those months is complete and substantially all of the promised consideration of 1,600 is collected and non-refundable.

Something else -   Performance obligations in a property management contract

Alternatively, if that was not the case then C would defer 1,600 of consideration received and recognise it as a liability until there was an enforceable contract (31 July). C would recognise 2,000 as of 31 July on a cumulative catch-up basis (1,000 for each month) once the agreement is enforceable because the pricing of 1,000 applies from 1 June. For further discussion of the timing of revenue recognition when an entity initially concludes that a contract does not exist and subsequently determines that a contract does exist.

However, if it had been determined that an enforceable contract existed as of 1 June even in the absence of a formally executed agreement on 31 July, then revenue would have continued to be recognised on a monthly basis based on a legal interpretation of the enforceable rights and obligations of the parties.

Because the monthly fee amount may be uncertain, C would be required to estimate the total amount of variable consideration (subject to the constraint) to which it would be entitled in exchange for transferring the promised services (for further discussion of variable consideration and the constraint). In this case, the signing of the contract on 31 July would be accounted for either as an adjustment to the variable consideration or, if the consideration was not deemed to be variable, as a contract modification. For further discussion of contract modifications, see link.

Arrangements where the identification criteria are not met

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Something else -   Provision matrix in the simplified approach

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