Collectability as a criterion to identify a contract with a customer – IFRS 15 Revenue from Contracts with Customers (contents page is here) introduced a single and comprehensive framework which sets out how much revenue is to be recognised, and when. The core principle is that a vendor should recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the vendor expects to be entitled in exchange for those goods or services. See a summary of IFRS 15 here.
Under the old standard IAS 18 Revenue, an entity assessed collectibility when determining whether to recognize revenue. Under IFRS 15, the collectibility criterion is included as a gating question designed to prevent entities from applying the revenue model to problematic contracts and recognizing revenue and a large impairment loss at almost the same time.
Assessment of collectibility is the fifth and final criterion for identifying a contract. The nature of this assessment is similar to assessment that a company makes to determine whether certain accounts receivables have become uncollectible and subject to a bad debt provision.
If, at the outset of an arrangement, a company assesses that collectibility of the debt from a customer is questionable, it cannot recognize any revenues until it receives the amount due or the circumstances change so that collectibility becomes reasonably assured. Thus, in certain instances, a company can use a cash-basis method to satisfy the collectibility condition of identifying a contract. Collectability as a criterion to identify a contract with a customer
Inclusion of the collectability criterion in recognising an agreement with a customer as a contract with a customer in IFRS 15 is to force a reporting entity to only record real sales transactions as revenue that regularly will be received in cash. A reporting entity under IFRS 15 including ‘fake’ sales transactions in revenue is now very clearly reporting fraudulent revenue numbers. So the pressure is now much more on each reporting entity to properly account for real sales transactions in revenue, ultimately on a cash-basis for some of its sales transactions. Document the reasoning why the collectibility criterion for each customer is assessed and which customers are to be recognised on a cash-basis only.
The collectibility criterion will normally not create problems in practice if an entity has proper credit control procedures to assess the credit status of its customers or to-be customers. However, in the case of, for instance, state-owned entities that apply IFRS, this criterion could become problematic if the state-owned entities are required to provide services by law even if it is possible that the customers will not be able to settle their accounts. Collectability as a criterion to identify a contract with a customer
A real estate developer enters into a contract with a customer for the sale of a building for USD 1 million. The customer intends to open a restaurant in the building. The building is located in an area where new restaurants face high levels of competition and the customer has little experience in the restaurant business.
The customer pays a non-refundable deposit of USD 50,000 at the inception of the contract and enters into a long-term financing agreement with the real estate developer for the remaining 95% of the contracted consideration. The financing arrangement is provided on a non-recourse basis, which means that if the customer defaults, the real estate developer can repossess the building, but cannot seek further compensation from the customer, even if the collateral does not cover the full value of the amount owned. The real estate developer’s cost of the building is USD 600,000. The customer obtains control of the building at contract inception.
The criteria of a valid contract are not met because it is not probable that the real estate developer will collect the consideration to which it is entitled in exchange for the transfer of the building.
In reaching this conclusion, the real estate developer observes that the customer’s ability and intention to pay may be in doubt because of the restaurant will be facing significant risks opening at a highly competitive location, the customer’s limited experience AND the apparent lack of additional funds to finance the start-up.
Revenue recognition is deferred and the non-refundable deposit of USD 50,000 is recognised as a contract liability since the real estate developer has not received substantially all of the consideration and it has not terminated the contract.
See also: The IFRS Foundation
Collectability as a criterion to identify a contract with a customer
Collectability as a criterion to identify a contract with a customer Collectability as a criterion to identify a contract with a customer Collectability as a criterion to identify a contract with a customer Collectability as a criterion to identify a contract with a customer Collectability as a criterion to identify a contract with a customer Collectability as a criterion to identify a contract with a customer