Identifying the contract contract extensions

Identifying the contract contract extensions Identifying the contract contract extensions – When an entity and its customer enter into a contract to renew (or extend the period of) an existing licence, the entity will evaluate whether the renewal or extension should be treated as a new licence or, alternatively, as a modification of the existing contract. A modification would be accounted for in accordance with the contract modifications requirements in paragraphs 18–21 of IFRS 15. Identifying the contract – contract extensions

Example Identifying the contract contract extensions

ServiceProvider has a 12-month agreement to provide Customer with services for which Customer pays $1,000 per month. The agreement does not include any provisions for automatic extensions, and it expires on November 30, 20X6. The two parties sign a new agreement on February 28, 20X7 that requires Customer to pay $1,250 per month in fees, retroactive to December 1, 20X6. Identifying the contract contract extensions

Customer continued to pay $1,000 per month during December, January, and February, and ServiceProvider continued to provide services during that period. There are no performance issues being disputed between the parties in the expired period, only negotiation of rates under the new contract.

Does a contract exist in December, January, and February (prior to the new agreement being signed)? Identifying the contract contract extensions

Analysis Identifying the contract contract extensions

A contract appears to exist in this situation because ServiceProvider continued to provide services and Customer continued to pay $1,000 per month according to the previous contract.

However, since the original arrangement expired and did not include any provision for automatic extension, determining whether a contract exists during the intervening period from December to February requires judgment and analysis of the legal enforceability of the arrangement in the relevant jurisdiction. Revenue recognition should not be deferred until the written contract is signed if there are enforceable rights and obligations established prior to the conclusion of the negotiations. Identifying the contract contract extensions

Consideration payable on termination can affect assessment of contract term

If a contract can be terminated by compensating the other party and the right to compensation is considered substantive, then its duration is either the specified period or the period up to the point at which the contract can be terminated without compensating the other party. Identifying the contract contract extensions

However, if a contract can be terminated by either party without substantive compensation, then its term does not extend beyond the goods and services already provided.

In making the assessment of whether the right to compensation is substantive, an entity considers all relevant factors, including legal enforceability of the right to compensation on termination. If an entity has a past practice of not enforcing a termination penalty and that practice changes the legally enforceable rights and obligations, then that could affect the contractual term.

Impairment testing of contract costs and contract extensions

The topic of impairment testing related to contract costs was discussed by the TRG at its July 2014 meeting. The specific question brought to the attention of the TRG was whether the consideration expected to be received during renewal or extension periods should be considered in the impairment analysis. Identifying the contract contract extensions

TRG members stated that IFRS 15 requires an entity to consider contract renewals and extensions in “the remaining amount of consideration the entity expects to receive”. TRG members noted that this view was supported by the discussion in the Basis for Conclusions on IFRS 15 (paragraphs BC309 and BC310) and the totality of the guidance in IFRS 15 99-104 which states that the “goods or services to which the asset relates” include goods or services from specifically anticipated future contracts such as renewals or extensions.

When testing capitalised contract assets for impairment, entities should factor in cash flows that are expected to arise in any period covered by customer options to extend or renew the contract. TRG members considered that extension and renewal periods should be taken into account if:

  • It is expected that the customer will extend or renew the contract; and
  • The contract costs capitalised relate to goods or services that would be transferred to the customer during such extension or renewal periods.

Identifying the contract contract extensions

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