Contract enforceability and termination clauses

An entity has to determine the duration of the contract (i.e., the stated contractual term or a shorter period) before applying certain aspects of the revenue model (e.g., identifying performance obligations, determining the transaction price). The contract duration under IFRS 15 is the period in which parties to the contract have present enforceable rights and obligations. An entity cannot assume that there are present enforceable rights and obligations for the entire term stated in the contract and it is likely that an entity will have to consider enforceable rights and obligations in individual contracts, as described in IFRS 15 11. Contract enforceability and termination clauses

The period in which enforceable rights and obligations exist may be affected by termination provisions in the contract. Significant judgement will be required to determine the effect of termination provisions on the contract duration. Under the standard, this determination is critical because the contract duration to which the standard is applied may affect the number of performance obligations identified and the determination of the transaction price. It may also affect the amounts disclosed in some of the required disclosures.

Termination clauses and termination payments affecting the duration of a contract

Entities need to carefully evaluate termination clauses and any related termination payments to determine how they affect contract duration (i.e., the period in which there are enforceable rights and obligations).

In general enforceable rights and obligations are considered to exist throughout the term in which each party has the unilateral enforceable right to terminate the contract by compensating the other party. For example, if a contract includes a substantive termination payment, the duration of the contract would equal the period through which a termination penalty would be due. This could be the stated contractual term or a shorter duration if the termination penalty did not extend to the end of the contract. However, the determination of whether a termination penalty is substantive, and what constitutes enforceable rights and obligations under a contract, requires judgement and consideration of the facts and circumstances. Also it should be noted that if an entity concludes that the duration of the contract is less than the stated term because of a termination clause, any termination penalty should be included in the transaction price. If the termination penalty is variable, the requirements for variable consideration, including the constraint, would be applied.

Contract enforceability and termination clauses

If each party has the unilateral right to terminate a ’wholly unperformed’ contract (as defined in IFRS 15 12) without compensating the counterparty, IFRS 15 states that, for purposes of the standard, a contract does not exist and its accounting and disclosure requirements would not apply. This is because the contracts would not affect an entity’s financial position or performance until either party performs. Any arrangement in which the entity has not provided any of the contracted goods or services and has not received or is not entitled to receive any of the contracted consideration is considered to be a ‘wholly unperformed’ contract. Contract enforceability and termination clauses

The requirements for ’wholly unperformed’ contracts do not apply if the parties to the contract have to compensate the other party if they exercise their right to terminate the contract and that termination payment is considered substantive. Significant judgement will be required to determine whether a termination payment is substantive and all facts and circumstances related to the contract should be considered. Contract enforceability and termination clauses Contract enforceability and termination clauses Contract enforceability and termination clauses

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