Assessing collectibility for a portfolio of contracts

Assessing collectibility for a portfolio of contracts – In the first step in IFRS 15 Revenue from contract with customers ‘Step 1 Identify the contract with the customer’, five elements have to be present in order to have a contract (Step 1 Identify the contract with the customer), on being that it is probable that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.EffectiveAssessing collectibility for a portfolio of contracts

Recognising whether a contract exists requires some evaluation of the customer, and if collection is likely to occur. For example, the amount of consideration likely to be collected does not have to be the contractually stated amount. It can be the contractually stated amount less anticipated price concessions based on history or industry practice.

In making the collectability assessment, an entity considers the customer’s ability and intention (which includes assessing its credit-worthiness) to pay the amount of consideration when it is due. This assessment is made after taking into account any price concessions that the entity may offer to the customer. (IFRS 15 9(e))

Under the revenue standard, the collectability criterion is included as a gating question designed to prevent entities from applying the revenue model to problematic contracts and recognising revenue and a large impairment loss at the same time. The collectability criteria are likely to be met for many routine customer contracts. (IFRS 15 9)

It is not uncommon for an entity’s historical experience to indicate that it will not collect all of the consideration related to a portfolio of contracts. In this scenario, management could conclude that collection is probable for each contract within the portfolio (that is, all of the contracts are valid) even though it anticipates some (unidentified) customers will not pay all of the amounts due.

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The entity should apply the revenue model to determine transaction price (including an assessment of any expected price concessions) and recognize revenue assuming collection of the entire transaction price. Management should separately evaluate the contract asset or receivable for impairment under the applicable financial instruments standard (IFRS 9). This accounting is illustrated in the following example.

Example 1 – Assessing collectibility for a portfolio of contracts

Wholesaler sells sunglasses to a large volume of customers under similar contracts. Before accepting a new customer, Wholesaler performs customer acceptance and credit check procedures designed to ensure that it is probable the customer will pay the amounts owed. Wholesaler will not accept a new customer that does not meet its customer acceptance criteria.

In January 20X8, Wholesaler delivers sunglasses to multiple customers in exchange for consideration totaling $100,000. Wholesaler concludes that control of the sunglasses has transferred to the customers and there are no remaining performance obligations. Assessing collectibility for a portfolio of contracts

Assessing collectibility for a portfolio of contractsWholesaler concludes, based on its procedures, that collection is probable for each customer; however, historical experience indicates that, on average, Wholesaler will collect only 95% of the amounts billed. Wholesaler believes its historical experience reflects its expectations about the future. Wholesaler intends to pursue full payment from customers and does not expect to provide any price concessions.

How much revenue should Wholesaler recognize? Assessing collectibility for a portfolio of contracts

Analysis Assessing collectibility for a portfolio of contracts

Because collection is probable for each customer, Wholesaler should recognize revenue of $100,000 when it transfers control of the sunglasses. Wholesaler’s historical collection experience does not impact the transaction price in this fact pattern because it concluded that the collectibility threshold was met (that is, the contracts were valid) and it did not expect to provide any price concessions. Assessing collectibility for a portfolio of contracts

Wholesaler should evaluate the related receivable for impairment based on the relevant financial instruments standard.

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Example 2 – Assessing collectibility with a history of price concessions

Facts: Semiconductor Inc. enters into a contract to sell 100 chips to Customer for a price of $10 per unit. Therefore, the total price of the contract is $1,000. Semiconductor Inc. has a history of providing price concessions to Customer. Assessing collectibility for a portfolio of contracts

Semiconductor Inc. estimates it will provide a price concession for 20% of the contract price, such that the total amount it expects to collect in the arrangement will be $800. Based on its history with Customer, Semiconductor Inc. concludes the $800 is probable of being collected. Assume all other requirements for identifying a contract are met.

Has Step 1 of the model been achieved, such that there is a valid contract?

Analysis: Yes. Because the transaction price for the contract is $800 and Semiconductor Inc. has concluded that collection of the $800 is probable, the criteria for identifying a valid contract with a customer have been met. Semiconductor Inc. will continually reassess the estimated price concession (variable consideration) each reporting period and recognize changes to estimated price concessions as changes to the transaction price (revenue). AsseCash Money Dollarsssing collectibility for a portfolio of contracts

If the $800 subsequently becomes uncollectible, Semiconductor Inc. should evaluate the related receivable for impairment.

Example 3 – Collection not probable

Facts: Equip Co. sells equipment to its customer with three years of maintenance for total consideration of $1,000, of which $500 is due upfront and the remaining $500 is due in installments over the three-year term. At contract inception, Equip Co. determines that the customer does not have the ability to pay as amounts become due, and therefore collection of the consideration is not probable. Assessing collectibility for a portfolio of contracts

Equip Co. intends to pursue payment and does not intend to provide a price concession. Equip Co. delivers the equipment at the inception of the contract. At the end of the first year, the customer makes a partial payment of $400. Equip Co. continues to provide maintenance services, but concludes that collection of the remaining consideration is not probable.

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Can Equip Co. recognize revenue for the $400 partial payment received?

Analysis No, Equip Co. cannot recognize revenue for the partial payment received because it has concluded that collection is not probable. Therefore, Equip Co. cannot recognize revenue for cash received from the customer unless it terminates the contract or stops transferring goods or services to the customer. Assessing collectibility for a portfolio of contracts

Equip Co. should continue to reassess collectibility each reporting period. If Equip Co. subsequently determines that collection is probable, it will apply the five-step revenue model and recognize revenue accordingly. Assessing collectibility for a portfolio of contracts

Assessing collectibility for a portfolio of contracts

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