The best way for IFRS 15 Measuring progress to completion

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IFRS 15 Measuring progress to completion

IFRS 15 Measuring progress to completion

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Introduction

For each performance obligation satisfied over time, revenue must be recognised over time (IFRS 15.39-45 & IFRS 15.B14-B19). To do so, an entity shall measure the progress towards complete satisfaction of the performance obligation.

The measurement of progress has the objective of faithfully depicting an entity’s performance in transferring control of the goods or services promised to the customer (that is, the extent to which the performance obligation is satisfied).

An entity shall apply a single method of measuring progress for each performance obligation satisfied over time, and shall apply that method consistently to similar performance obligations and in similar circumstances.

At the end of each reporting period, an entity shall remeasure its progress towards complete satisfaction of each performance obligation satisfied over time.

In July 2015 the Joint Transition Resource Group (TRG a combined effort by IASB and FASB to detect problems raised by the implementation of the revenue recognition standards) clarified that the principle of applying a single method of measuring progress for a given performance obligation is also applicable to a combined performance obligation, i.e. one that contains multiple non-distinct goods or services.

Hence, it is not appropriate to apply several methods depending on the stage of performance, even if these methods all belong to one of the two major categories of methods presented below (output methods vs input methods), for example a method measuring progress on the basis of hours expended, and a method measuring progress on the basis of labour costs incurred.

Further, the TRG observed that it can be challenging to identify a single measure of progress for a combined performa IFRS 15 Measuring progress to completion nce obligation. The TRG believes that judgement is required, and that entities should consider the reasons why they assessed that the goods or services are not distinct, and the nature of the overall promise.

If it appears that a single method of measuring progress towards completion is not appropriate for the combined performance obligation, this might – in some cases – be an indicator that the step 2 analysis is incorrect and that some goods and services are in fact distinct. IFRS 15 Measuring progress to completion

IFRS 15 lists two main categories of methods of measuring progress:

  • output methods: revenue is recognised on the basis of direct measurements of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract. Examples of these methods include appraisals of results achieved, important stages reached, an estimate of the time elapsed or a calculation of the units produced or delivered. However, these output methods have certain disadvantages which may prevent their use in practice ( see below Milestone method may not depict pattern of performance). A practical expedient is offered under certain conditions (see further below); IFRS 15 Measuring progress to completion
  • input methods: revenue is recognised on the basis of the entity’s efforts or inputs to date (for example, resources consumed, labour hours expended, costs incurred, time elapsed or machine hours used) relative to the total expected inputs to the satisfaction of that performance obligation. If the entity’s efforts or inputs are expended evenly throughout the performance period, it may be appropriate for the entity to recognise revenue on a straight-line basis. The use of these methods requires an entity to exclude from an input method the effects of any inputs that do not depict the entity’s performance in transferring control of goods or services to the customer (see below Cost not taken into account for measuring progress). IFRS 15 Measuring progress to completion

An entity must apply judgement to identify an appropriate method of measuring progress towards completion. As the Basis of Conclusions on IFRS 15 makes clear, an entity does not have a “free choice” (cf. IFRS 15.BC159).

It must take account of the nature of the promised good or service, while bearing in mind the objective set out above (i.e. depicting the entity’s performance in transferring control of the promised goods or services to the customer). These principles can be illustrated through the following two cases: IFRS 15 Measuring progress to completion

  • a cost-to-cost method of measuring progress for a performance obligation would generally be relevant for aircraft maintenance (i.e. costs incurred to date compared with total expected costs over the duration of the performance obligation), even if the obligation is invoiced by flight-hour. This is because control of the service is transferred to the customer as it is performed (i.e. with each actual intervention on the aircraft, it being assumed here that the aircraft remains in the customer’s control throughout the contract) and not in accordance with the pattern of use of the aircraft by the customer; IFRS 15 Measuring progress to completion

  • when the entity’s obligation consists of standing ready to perform a service (a “stand-ready obligation”) rather than the service itself, a linear method of measuring progress towards completion would generally be appropriate (i.e. pro rata temporis). An example would be a performance obligation consisting of making a sports club available to a customer. The remaining quantity of services to which the customer is entitled is indeed independent of the quantity of services he has already received.

    In January 2015 the TRG clarified that a linear method is not appropriate to a stand-ready obligation if the benefit of the service is not spread evenly throughout the contract (for example, an annual contract to clear snow from an airport runway, where the customer receives the benefits of the service only in winter). IFRS 15 Measuring progress to completion

An entity shall recognise revenue for a performance obligation satisfied over time only if the entity can reasonably measure its progress towards complete satisfaction of the performance obligation, i.e. if it has the reliable information that would be required to apply an appropriate method of measuring progress. IFRS 15 Measuring progress to completion

Where an entity is not able to reliably measure the outcome of a performance obligation (for example, at the start of the contract), but the entity expects to recover the costs incurred in satisfying the performance obligation, it must only recognise revenue to the extent of the costs incurred until it is able to reasonably measure the outcome of the performance obligation.

Practical expedient in IFRS 15 for recognition of revenue over time

As a practical expedient, if an entity has a right to invoice a customer at an amount that corresponds directly with its performance to date, then it can recognise revenue at that amount.

For example, a service contract in which an entity bills a fixed amount for each hour of service provided), the entity may recognise revenue in the amount to which the entity has a right to invoice (IFRS 15.B16).

In July 2015, the TRG clarified that this practical expedient can be also applied in the case of a long-term contract to provide goods or services in which the price per unit changes over the duration of the contract (for example, an IT contract with rates that decrease as the entity passes on the benefits of the learning curve to the customer, or an electricity contract where the annual rate reflects the market price of electricity).

An entity must nevertheless exercise judgement, taking account of the facts and circumstances, to assess whether use of this practical expedient to measure progress is possible. In particular, it may be difficult to decide whether the practical expedient can be applied in cases of advance payments, or significant retrospective price reductions. IFRS 15 Measuring progress to completion

In terms of disclosures, and by way of simplification (in addition to the expedient presented above), an entity need not provide the information required by IFRS 15 about the transaction price allocated to unsatisfied performance obligations (i.e. the “backlog” under IFRS 15) if progress towards these performance obligations is measured using the practical expedient set out above.

Selecting a method to measure progress

As stated above, for each performance obligation that is satisfied over time, an entity applies a single method of measuring progress towards complete satisfaction of the obligation. IFRS 15 Measuring progress to completion

The objective is to depict the transfer of control of the goods or services to the customer. To do this, an entity selects an appropriate output or input method. It then applies that method consistently to similar performance obligations and in similar circumstances.

Method Description Examples
OUTPUT Based on direct measurements of the value to the customer of goods or services transferred to date, relative to the remaining goods or services promised under the contract
  • Surveys of performance to date
  • Appraisals of results achieved
  • Technical milestones reached
  • Time elapsed
INPUT Based on an entity’s efforts or inputs towards satisfying a performance obligation, relative to the total expected inputs into the satisfaction of that performance obligation
  • Resources consumed
  • Costs incurred
  • Time elapsed
  • Labour hours expended
  • Machine hours used

If an entity’s performance has produced a material amount of work in progress or finished goods that are controlled by the IFRS 15 Measuring progress to completion customer, then output methods such as units-of-delivery or units-of-production as they have been historically applied may not faithfully depict progress.

This is because not all of the work performed is included in measuring the output (IFRS 15.B15, IFRS 15 BC165).

If an input method provides an appropriate basis to measure progress and an entity’s inputs are incurred evenly over time, then it may be appropriate to recognise revenue on a straight-line basis (IFRS 15.B18).

However, there may not be a direct relationship between an entity’s inputs and the transfer of control.

Therefore, an entity that uses an input method considers the need to adjust the measure of progress for uninstalled goods and significant inefficiencies in the entity’s performance that were not reflected in the price of the contract – e.g. wasted materials, labour or other resources (see Adjusting the measure of progress).

For example, if the entity transfers to the customer control of a good that is significant to the contract but will be installed later, and if certain criteria are met, then the entity recognises the revenue on that good at zero margin (IFRS 15.B19).

An entity recognises revenue over time only if it can reasonably measure its progress towards complete satisfaction of the performance obligation. However, if the entity cannot reasonably measure the outcome but expects to recover the costs incurred in satisfying the performance obligation, then it recognises revenue to the extent of the costs incurred (IFRS 15.44-45). IFRS 15 Measuring progress to completion

Here are a few worked examples to further clarify the use of one of these two methods to measure progress to completion under IFRS 15.

Time-based measure of progress: Technical support services

Company S enters into a contract to license software to Customer C and provide technical support for the three-year licence period. The terms of the support agreement specify that S’s helpdesk and web support operators are available every day other than Sundays. S concludes that the software licence and the technical support services are distinct from each other and are separate performance obligations.

The distinct software licence is satisfied at a point in time (see Licensing of IP). S concludes that the technical support services are satisfied over time.

This is because C consumes and receives benefit from having continuous access to S’s support resources throughout the three-year period. That is, the technical support is a ‘stand-ready obligation’. S determines that a time-elapsed measure of progress is appropriate.

However, if S’s contractual obligation in relation to technical support was instead to provide a specified number of support calls, then it would generally recognise revenue as C makes use of the specified calls.

Time-based measure of progress: Unspecified updates

Company U licenses software to Customer C and promises to provide unspecified updates for the full three-year licence period.

U concludes that the software licence and the unspecified updates rights are distinct from each other and are separate performance obligations. The distinct software licence is satisfied at a point in time.

U has a history of providing unspecified items to customers on a regular basis. However, the quantity and the mix of items that a customer will receive (e.g. bug fixes and updates) and the timing of releases within a given period vary.

Therefore, U concludes that:

  • the nature of its performance obligation to provide unspecified updates, upgrades and enhancements is a ‘stand-ready obligation’; and
  • it expects to expend efforts to develop and transfer unspecified items to
    the customer on a generally even basis throughout the three-year term. U determines that a time-based measure of progress is appropriate, resulting in straight-line revenue recognition for the performance obligation.

Some matters of judgement arising in using the IFRS 15 Measuring progress to completion – methods are:

IFRS 15 Measuring progress to completion

Determining which measure of progress to apply is not a free choice(IFRS 15.BC159)

The standard requires an entity to select a method that is consistent with the objective of depicting its performance. An entity The best way for IFRS 15 Measuring progress to completion 1 therefore does not have a free choice of which method to apply to a given performance obligation – it needs to consider the nature of the good or service that it promised to transfer to the customer.

The standard also provides examples of circumstances in which a particular method does not faithfully depict performance – e.g. it states that units-of- production may not be an appropriate method when there is a material amount of work in progress.

Judgement is required when identifying an appropriate method of measuring progress.

When evaluating which method depicts the transfer of control of a good or service, the entity’s ability to apply that method reliably may also be relevant.

For example, the information required to use an output method may not be directly observable or may require undue cost to obtain – in these circumstances, an input method may be appropriate.

IFRS 15 Measuring progress to completion

Single method of measuring progress is used for a performance obligation

(IFRS 15.40)

Under the standard, an entity applies a single method of measuring progress for each performance obligation. This may be difficult when a single performance obligation contains multiple promised goods or services that will be transferred over different periods of time.

For example, this might occur when a performance obligation combines a licence and a service arrangement, or a sale of goods and design or installation services.

Significant judgement may be required in some circumstances, and understanding the nature of its overall promise to the customer is key for an entity to select a reasonable measure of progress.

If the determination of a single measure of progress is challenging, then an entity may need to reconsider the assessment of performance obligations and whether there are multiple distinct performance obligations.

However, the fact that identifying a single measure of progress is challenging does not necessarily mean that the promised goods or services are not a single performance obligation.

IFRS 15 Measuring progress to completion

Certain sales agent arrangements may be over-time

Generally, when the entity is acting as a sales agent for a customer the entity satisfies its promise at a point in time. This is because the activities performed by the agent before sale typically do not transfer a good or service to a customer. If the customer receives any benefit from the entity’s activities, then that benefit is limited unless the sale is completed.

However, there may be sales agent arrangements that provide benefits to the customer over time before a sale is completed. For example, assume that an entity receives a significant non-refundable fee at the time of listing and a relatively smaller commission fee when a sale is completed.

The large non- refundable up-front fee indicates that the entity is providing the customer with a listing service and the customer is benefiting from that service over time. In this example, the entity estimates the commission fee following the guidance on variable consideration.

Judgement and evaluation of the facts will be necessary to determine whether a good or service is being transferred before the sale is completed.

IFRS 15 Measuring progress to completion

Measure of progress for stand-ready obligations is not always straight-line

(IFRS 15.26(e), IFRS 15 IE92-94, IFRS 15 BC 160)

Judgement is required to determine an appropriate measure of progress for stand-ready obligations. When making the judgement, an entity considers the substance of the stand-ready obligation to ensure that the measure of progress aligns with the nature of the underlying promise.

In assessing the nature of the obligation, the entity considers all relevant facts and circumstances, including the timing of transfer of goods or services, and whether the entity’s efforts (i.e. costs) are expended evenly throughout the period covered by the stand- ready obligation.

In many cases, a straight-line measure of progress will be appropriate for recognising revenue on a stand-ready obligation. However, a straight-line measure of progress is not always appropriate.

For example, in a contract for unspecified software upgrades (a stand-ready obligation) or a health club contract, revenue is generally recognised on a straight-line basis because the pattern of benefit to the customer as well as the entity’s efforts to fulfil the contract are generally even throughout the period.

In contrast, a straight-line basis of recognition would not generally be appropriate in an annual contract to provide snow removal services in an area where snowfall is highly seasonal. The pattern of benefit of these services, as well as the entity’s effort to fulfil the contract, would not generally be even throughout the year, because snow is only expected in the winter.

IFRS 15 Measuring progress to completion

Milestone method may not depict pattern of performance

Milestone method If control transfers to the customer over time, then the measure of progress should reflect this. Although the standard lists milestones as an example of a possible measure of progress when using an output method, it remains necessary to consider whether milestones faithfully depict performance, particularly if the milestones are widely spaced.

This is because control generally transfers continuously as the entity performs, rather than at discrete points in time. Normally, a milestone method would need to incorporate a measure of progress between milestone achievements to faithfully depict an entity’s performance.

Work in progress for an over-time performance obligation is generally expensed as a fulfilment cost when it is incurred because control of the work in progress transfers to the customer as it is produced and not at discrete intervals.

However, inventory to support multiple contracts that has an alternative use is recognised as an asset until it is dedicated to a specific contract – e.g. by being integrated into the production process.

IFRS 15 Measuring progress to completion

A performance obligation may be partially satisfied before the contract is identified

(IFRS 15.2, IFRS 15.9, IFRS 15.95, IFRS 15.99, IFRS 15.BC48)

Entities sometimes start to perform before:

  • entering into a contract with a customer; or
  • the contract with the customer meets the Step 1 criteria (e.g. collectability is not probable).

In these cases, if the work completed to date has no alternative use and the performance obligation meets the criteria for revenue to be recognised over time, then the entity recognises a cumulative catch-up adjustment at the date on which the Step 1 criteria are met.

This is because under the standard an entity recognises revenue based on progress towards complete satisfaction of the performance obligation. Therefore, because the entity has already partially satisfied the performance obligation, it recognises revenue to reflect that performance.

For example, if a developer sells an apartment to a customer when the apartment is 20 percent complete and the contract meets the criteria to recognise revenue over time, then the developer recognises 20 percent of its revenue under the contract on the date on which the contract is signed.

Additionally, fulfilment costs incurred before the existence of the contract that are not in the scope of another standard (e.g. inventory) would be capitalised as costs to fulfil an anticipated contract when the capitalisation criteria are met (see Contract costs).

These costs are expensed immediately at the date on which the Step 1 criteria are met if they relate to progress made to date on goods or services already deemed to have transferred to the customer at that date.

IFRS 15 Measuring progress to completion

Contract costs not to be taken into account for measuring progress

IFRS 15.B18-B19

Among the appropriate methods of measuring progress towards completion, IFRS 15 mentions input methods, which include the “cost-to-cost” method (under which progress is measured on the basis of the ratio of the costs incurred to date to satisfy a performance obligation over the total estimated amount of costs that will be incurred).

However, there may not be a direct and proportional relationship between an entity’s inputs and the transfer of control of goods or services to a customer. Therefore, an entity must exclude the effects of any inputs that do not depict the entity’s performance in transferring control of goods or services to the customer. These adjustments thus affect the margin recorded at the end of each reporting period over the lifetime of the performance obligation.

Therefore, when using a cost-based input method, an adjustment to the measure of progress may be required in the following circumstances:

  1. significant inefficiencies (or significant wasted materials): an entity may encounter difficulties in performing an obligation leading it to incur significant inefficiencies that are not reflected in the contract price1 (for example, the costs of unexpected amounts of wasted materials, labour or other resources that were incurred to satisfy the performance obligation). Under these circumstances, an entity must exclude these significant inefficiencies from the cost-to-cost ratio (both the numerator and denominator). This means that the recognition in expenses of these inefficiencies (unlike the costs that reflect the transfer of control to the customer) does not result in the recognition of additional revenue at the time they are recorded;
  2. “uninstalled materials” (for which there is no proportional relationship between the costs incurred and progress towards performance of the obligation): under certain conditions (see below), the cost of these materials is also excluded from the cost-to-cost ratio. Nonetheless, revenue is recognised, but only to the extent of the costs incurred (i.e. no margin is recognised for these materials at that point). The Standard states that such a measure of progress is appropriate if the entity expects at contract inception that all of the following conditions will be met:
    1. the good is not distinct;
    2. the customer is expected to obtain control of the good significantly before receiving services related to the good;
    3. the cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation;
    4. the entity procures the good from a third party and is not significantly involved in designing and manufacturing the good (but the entity is acting as a principal).

IFRS 15 does not clarify when the margin on these uninstalled materials should be accounted for. In our view, an entity can either decide to recognise all the margin once the good is installed, or allocate the margin to other elements of the performance obligation and recognise it over time, in line with the progress of these other elements.

Worked example – Significant inefficiencies

An entity concludes a contract with a customer for the development, production and installation of a specific item of equipment in three years’ time for the price of €500m. The contract is considered as including a single performance obligation satisfied over time. Progress is measured using a cost-to-cost method.

Given the nature of the activity, it appears normal and inevitable that there will be some losses of materials, labour or other resources. This has been taken into account in the initial project cost estimated by the entity (estimated at a total of €400m) and in the price agreed with the customer.

This contract therefore has a margin on completion of €100m.

Following a major IT incident, the entity accidentally loses some of the development study data, and is obliged to recreate them during the first year. The associated cost overrun is estimated at €40m. The total costs incurred at the end of the first year, including this overrun, stand at €160m. Aside from this event, there has been no significant deviation from the initial budget forecast.

Given its origin and magnitude, the €40m overrun is regarded as representing a significant inefficiency, and is therefore excluded from the calculation of progress.

At the end of the first year, the calculation of the percentage of completion is as follows: (€160m – €40m) / (€440m – €40m) = 30%
Revenue recognised at the end of the first year is therefore: 30% x €500m = €150m

The gain (loss) recognised at the end of the first year is therefore: €150m – €160m = -€10m of which:

  • €30m represents the margin calculated by stage of completion (or €150m -(€160m – €40m)); and
  • -€40m represents the cost overrun due to a significant inefficiency.

The contract remains profitable at the end of the first year (the residual contract margin to be recognised stands at: €500m – €400m – €30m = €70m), so no provision for an onerous contract needs to be recognised.

Worked example – Uninstalled materials

In March of the year N, an entity concludes a contract with a customer for construction of a factory for the price of €100m. The construction of the factory is the only performance obligation in the contract. It is satisfied over time, and progress is measured using the cost approach.

The total expected costs stand at €80m, including €30m of costs for relatively generic equipment (transformers) bought from a third party. The customer obtains control of these items when they are delivered to the construction site in December of year N. The factory is expected to be completed in June N+1.

Given this information (and in conjunction with the conditions listed in IFRS 15.B19), the equipment bought from third parties therefore has the characteristics of “uninstalled materials”. The transformers must therefore be excluded from the measurement of progress using a cost-to-cost method.

At the end of December N:

Costs incurred (excluding the equipment bought from a third party) stand at €20m.

Total costs (excluding the equipment bought from a third party) stand at €50m (€80m – €30m), so progress at December N is estimated at: €20m / €50m = 40%

The entity therefore recognises €58m in revenue, calculated as the sum of:

  • 40% x (€100m – €30m) = €28m for completed performance, excluding the supply of equipment purchased from a third party; and
  • €30m (i.e. to the extent of costs) for the transfer of control of equipment purchased from a third party.

The margin resulting from the impacts accounted for in respect of this contract at the end of December N stands at: [€58m – (€20m + €30m)] / €58m = 13.8%.

This rate is lower than is anticipated at the end of the contract (20%) because of recognition of the equipment without margin and the relative weight of the “uninstalled materials” in the completed performance to date.

IFRS 15 Measuring progress to completion

Borrowing costs when revenue is recognised over time

An entity may borrow funds to fulfil its contracts with customers. A question arises over whether directly attributable borrowing costs may be capitalised under the borrowing costs standard when control transfers to the customer over time – in particular, whether an entity may have a qualifying asset in these circumstances.

The IFRS Interpretations Committee discussed a scenario in which an entity incurs borrowing costs in relation to construction of a multi-unit real estate development. Units are marketed and sold to individual customers and control of each unit transfers to the customer over time.

Some units are sold before construction commences and some during construction – i.e. the entity recognises work in progress for unsold units as inventory. The Committee noted that any work in progress for unsold units under construction is ready for its intended sale and therefore not a qualifying asset.

This is because the entity intends to sell the part-constructed units as soon as it finds suitable customers and control of them will transfer to the customers on entering into a contract.

For example, in April 2019 Developer D undertakes a project to develop a multi- unit residential building. The construction is expected to take three years – i.e. a substantial period of time.

D borrows funds to finance the development. Under applicable laws, the land on which the building is being constructed is and will continue to be owned by the government.

D starts marketing the units and commences the construction of the building. Successful marketing efforts result in entering into sales contracts with customers straight away.

D determines that revenue from the sale of individual units will be recognised over time. As a result, D does not expect to have material inventory or work in progress on its balance sheet for units sold because control over a specific unit under construction will, from the point of entering into a sales agreement, be continuously transferred to each individual customer.

At 31 December 2019, D has completed 10% of the construction work and sold 50% of the units in the building for a total consideration of 100,000.

The actual costs incurred on the construction are 16,000. As a result, D recognises:

  • revenue in profit or loss for the units sold of 10,000 (100,000 × 10%);
  • construction costs in profit or loss for the units sold of 8,000 (16,000 × 50%); and
  • inventory in the statement of financial position for the cost of the unsold units of 8,000 (16,000 × 50%).

D assesses whether the units under construction meet the definition of a qualifying asset under the borrowing costs standard.

  • Sold units: D determines that the units sold do not meet the definition of qualifying assets, because any work in progress related to them is
    continuously sold in its existing condition to the customers and therefore recognised in profit or loss as costs are incurred.
  • Unsold units: D determines that the unsold units also do not meet the definition of qualifying assets. This is because the inventory is currently being marketed, marketing efforts are intended to result in immediate sales contracts and each unit will be subject to immediate derecognition once there is a signed contract with a customer – i.e. the units are ready for their intended sale in their existing condition.

And here are some more worked examples:

IFRS 15 Measuring progress to completion

Worked example: Cost-to-cost measure of progress: Stand-ready maintenance contract

ABC Corp enters into a maintenance contract with Truck Company T for one year. ABC provides maintenance services as needed or at specified intervals for the fleet of trucks.

ABC concludes that the nature of its performance obligation is to stand ready to provide the maintenance services and that the performance obligation is satisfied over time because T simultaneously receives and consumes the benefits from the assurance that ABC is available when and if needed.

Although ABC concludes that its performance obligation is to stand ready to maintain or service the trucks at any point during the annual period, the maintenance services do not necessarily occur evenly throughout the year.

Therefore, ABC selects a measure of progress that more closely aligns with its actual efforts and recognises revenue on an input-based measure that reflects its performance – e.g. cost-to-cost or labour hours incurred.

IFRS 15 Measuring progress to completion

Worked example: Telco: Monthly prepaid wireless contract

Telco M enters into a monthly prepaid contract with wireless Customer B for 200 minutes per month of voice services. B pays 30 per month in The best way for IFRS 15 Measuring progress to completion 2 advance. B can use the minutes to make calls at any time during the month.

Once the 200 minutes are used, the handset remains connected to the network and can accept calls. That is, incoming calls are not included in the 200 minutes per month.

M first concludes that B simultaneously receives and consumes the benefits from the service as it is provided and therefore the performance obligation is satisfied over time.

Furthermore, M determines that the nature of its promise is to provide network services to B throughout the month because incoming calls are not included in the 200 minutes. Consequently, the number of minutes used does not appear to appropriately depict the satisfaction of that promise.

Instead, the more appropriate measure of progress appears to be time elapsed. M therefore recognises revenue of 30 evenly throughout the month.

IFRS 15 Measuring progress to completion

Worked example: Wireless service contract with rollover minutes

Telco N enters into a two-year wireless contract with Customer C for prepaid voice services. The voice plan allows C to use 600 minutes each month for incoming and outgoing calls. After the 600 minutes are used, the handset can no longer be used to make or receive calls during that month. If C does not use all of the minutes, then C is able to roll over the unused minutes to the subsequent month. For the purposes of this example, breakage is ignored.

N concludes that C simultaneously receives and consumes the benefits of the minutes and therefore the performance obligation is satisfied over time. Due to C’s ability to roll over the unused minutes each month, progress towards complete satisfaction of the performance obligation is measured based on the number of minutes used each month.

Any minutes that are unused at the end of each month will be accounted for as a contract liability because C pays in advance for the following month’s 600 minutes.

Limitations on applying the units-of-delivery or units-of-production methods

An output method may not provide a faithful depiction of performance if the method selected fails to measure some of the goods or services for which control has transferred to the customer (IFRS 15.B15).

For example, if at the reporting date an entity’s performance has produced work in progress or finished goods that are controlled by the customer, then using an output method based on units produced or units delivered would distort the entity’s performance.

This is because it would not recognise revenue for the assets that are created before delivery or before production is complete but that are controlled by the customer.

Worked example: Measure progress for a performance obligation involving multiple goods and services

Company U enters into a contract to manufacture and deliver 10 units to Customer C for 10,000. U assesses that the contract contains a single performance obligation that is satisfied over time. The costs to manufacture and deliver the 10 units is estimated to be 8,000.

U considers whether it could apply the units-of-delivery method to measure progress and determines that it would not be appropriate because it would lead to material amounts of work in progress being recognised in the balance sheet. Instead, U determines that an input method based on costs (cost-to-cost) is an appropriate measure of progress.

The alternative effects on the financial statements are shown below. This illustration assumes that none of the units has been completed or delivered and Costs of 3,200 have been incurred (i.e. 40% complete) at the reporting date.

The best way for IFRS 15 Measuring progress to completion 3

IFRS 15 Measuring progress to completion

Food for thought – Design and production services

A units-of-delivery method or a units-of-production method may not be appropriate

A units-of-delivery or units-of-production method may not be appropriate if the contract provides both design and production services and they represent a single performance obligation, because in this case each item produced or delivered may not transfer an equal amount of value to the customer.

These contracts are common, for example, in the aerospace and defence, contract manufacturing, engineering and construction industries.

The clarifications provided in the standard on when certain methods for measuring progress may not be appropriate emphasise the need for an entity to consider its facts and circumstances and select the method that depicts its performance and the transfer of control of the goods or services to the customer.

IFRS 15 Measuring progress to completion

Adjusting the measure of progress

An entity applying an input method excludes the effects of any inputs that do not depict its performance in transferring control of goods or services to the customer (IFRS 15.B19). In particular, when using a cost-based input method – e.g. cost-to-cost – an adjustment to the measure of progress may be required when an incurred cost: IFRS 15 Measuring progress to completion

  • does not contribute to an entity’s progress in satisfying the performance obligation: e.g. unexpected amounts of wasted materials, labour or other resources (these costs are expensed as they are incurred); or
  • is not proportionate to the entity’s progress in satisfying the performance obligation: e.g. uninstalled materials.

For uninstalled materials, a faithful depiction of performance may be for the entity to recognise revenue only to the extent of the cost incurred – i.e. at a zero percent profit margin – if, at contract inception, the entity expects all of the following conditions to be met:

  • the good is not distinct; IFRS 15 Measuring progress to completion
  • the customer is expected to obtain control of the good significantly earlier than it receives services related to the good;
  • the cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation; and
  • the entity is acting as the principal, but procures the good from a third party and is not significantly involved in designing and manufacturing the good. IFRS 15 Measuring progress to completion

If an entity determines that the cost of uninstalled materials should be excluded from the measure of progress, then revenue and the related costs are recognised on transfer of control of the uninstalled materials to the customer. In determining when control transfers to the customer, it appears that an entity should consider all relevant indicators, including both point-in-time and over-time indicators (see Performance obligations satisfied over time and Revenue recognition at a point in time). IFRS 15 Measuring progress to completion

Worked example: Uninstalled materials

IFRS 15.IE95-IE100

In November 2019, Contractor P enters into a lump-sum contract with Customer Q to refurbish a three-storey building and install new lifts for total consideration of 5,000. The following facts are relevant.

  • The refurbishment service, including the installation of lifts, is a single performance obligation that is satisfied over time.
  • P is not involved in designing or manufacturing the lifts, but is acting as the principal. Q obtains control of the lifts when they are delivered to the site in December 2019.
  • The lifts are not expected to be installed until June 2020.
  • P uses an input method based on costs incurred to measure its progress towards complete satisfaction of the performance obligation.

The transaction price and expected costs are as follows.

The best way for IFRS 15 Measuring progress to completion 4

P concludes that including the costs of procuring the lifts in the measure of progress would overstate the extent of its performance. Consequently, it adjusts its measure of progress to exclude these costs from the costs incurred and from the transaction price, and recognises revenue for the transfer of the lifts at a zero margin.

By 31 December 2019, other costs of 500 have been incurred (excluding the lifts) and P therefore determines that its performance is 20% complete (500 / 2,500). Consequently, it recognises revenue of 2,200 (20% × 3,5002 + 1,500) and costs of 2,000 (500 + 1,500).

IFRS 15 Measuring progress to completion

Food for thought – No guidance on the timing and pattern of the recognition of margin on uninstalled materials

An entity may be entitled to a margin on the uninstalled goods that is clearly identified in the contract terms or forms part of the overall transaction price. The standard does not provide guidance on the timing of recognition for this margin – i.e. whether it is recognised when the materials are installed or incorporated into the revenue recognition calculation for the remainder of the contract – or whether the costs are excluded when a measure of progress based on input costs is used.

The Board (IFRS 15.BC171) believes that recognising a contract-wide profit margin before the goods are installed could overstate the measure of the entity’s performance and, therefore, revenue. However, requiring an entity to estimate a profit margin that is different from the contract-wide profit margin could be complex and could effectively create a performance obligation for goods that are not distinct (therefore bypassing the requirements on identifying performance obligations).

The adjustment to the cost-to-cost measure of progress for uninstalled materials is generally intended to apply to a subset of goods in a construction- type contract – i.e. only to those goods that have a significant cost relative to the contract and only if the entity is essentially providing a simple procurement service to the customer.

Judgement will be required in determining whether a customer is obtaining control of a good ‘significantly’ before receiving services related to the good. In the worked example – Uninstalled materials above, it is unclear whether the same guidance would apply if the lifts were expected to be installed in January 2020 instead of June 2020.

Food for thought – No detailed guidance on identifying inefficiencies and wasted materials

Generally, some level of inefficiency, rework or overrun is assumed in a service or construction contract and an entity contemplates these in the arrangement fee. Although the standard specifies that unexpected amounts of wasted materials, labour or other resources should be excluded from a cost-to-cost measure of progress, it does not provide additional guidance on how to identify unexpected costs.

Judgement is therefore required to distinguish normal wasted materials or inefficiencies from those that do not depict progress towards completion.

As-invoiced practical expedient

As a practical expedient, if an entity has a right to invoice a customer at an amount that corresponds directly with its performance to date, then it can recognise revenue at that amount. For example, in a services contract an entity may have the right to bill a fixed amount for each unit of service provided.

Worked example: Applying ‘as-invoiced’ practical expedient: Cleaning services

Cleaning Firm F enters into a contract with Customer C to provide cleaning services for two years. Fees for the services are based on a fixed hourly rate.

F could elect to apply the as-invoiced practical expedient because during the contract term it has a right to invoice the customer based on its performance to date – i.e. the number of hours of cleaning services provided to date.

IFRS 15 Measuring progress to completion

Food for thought – Consideration does not need to be a fixed amount per unit to recognise revenue at the amount that the entity has a right to invoice

The as-invoiced practical expedient can apply when the price per unit changes during the contract. The practical expedient is appropriate when the amount invoiced for goods or services reasonably represents the value to the customer of the entity’s performance completed to date.

This can be illustrated using the following examples.

  • A contract to purchase electricity at prices that change each year based on the observable forward market price of electricity: such a contract qualifies for the practical expedient if the rates per unit reflect the value of the provision of those units to the customer.
  • An IT outsourcing arrangement with a declining unit price that reflects decreasing levels of effort to complete the tasks: this may be the case because underlying activities performed at the outset of the contract are more complex, requiring more experienced (i.e. more costly) personnel than later activities. There may also be the effect of a learning curve – i.e. in most circumstances, personnel will become more efficient at performing the same tasks over time.

Additionally, the following considerations are relevant when assessing whether the as-invoiced practical expedient can be applied when the price per unit changes during the contract:

  • whether the reasons for the change in the price per unit are substantive: e.g. for a valid business reason, such as declining costs or changes in the relevant price index; and
  • whether the amount of the change approximates the change in value to the customer: e.g. by the change in a forward pricing curve in the case of electricity, a change in the consumer price index (CPI) or a change in labour data that is relevant to the entity’s costs of providing the goods or services.

IFRS 15 Measuring progress to completion

Food for thought – Arrangements that include a contractual minimum

It may be unclear whether the as-invoiced practical expedient can be applied when there is a contractual minimum in an arrangement. This is because in some cases the price that an entity invoices per unit may not directly correspond with the value to the customer.

In general, a contractual minimum amount that the entity expects the customer to easily surpass is not considered a substantive minimum and does not preclude the use of the as-invoiced practical expedient. This is because the contractual minimum will not affect the price per unit invoiced because it is expected to be exceeded.

In contrast, if the contractual minimum is such that there is a reasonable possibility that the customer will not exceed that minimum, then the practical expedient does not apply. Instead, the general guidance on determining the transaction price (including the constraint on variable consideration) applies and the entity needs to select an appropriate measure of progress for that performance obligation.

This is because when the contractual minimum is not exceeded, the entity will need to estimate the total number of transactions and continuously update that amount in order to apply an output method that depicts progress.

IFRS 15 Measuring progress to completion

Food for thought – Practical expedient may not be available when a contract includes a significant up-front fee

The practical expedient is designed to apply when the transaction price varies in direct proportion to a variable quantity of goods or services transferred to the customer – i.e. when the transaction price = a fixed per-unit price × a variable quantity of units (TP = P × Q).

In general, when significant fees are paid up- front, the amount invoiced typically does not correspond directly with the value to the customer of each incremental good or service that the entity transfers to the customer and therefore the practical expedient cannot be applied.

In contrast, an up-front fee that reflects the value of other distinct goods or services transferred to the customer up-front would not preclude the use of the practical expedient.

IFRS 15 Measuring progress to completion

Food for thought – Rebates, credits and refunds generally preclude application of the practical expedient

Additional application examples

Worked example: Applying ‘as-invoiced’ practical expedient: Change in rates linked to CPI

Law Firm L enters into a contract with Customer M to provide services related to a legal case that is expected to take three years to resolve. Fees for the services are based on hourly rates: starting at 500 per hour for Year 1 and then adjusting each year by an amount equal to the change in the CPI.

Even though the rate per hour will change in Years 2 and 3, L concludes that it can still apply the as-invoiced practical expedient because the change in fee results from cost of service increases commensurate with local inflation.

As a result, L concludes that the fees that it will receive during each period appropriately reflect the value to the customer of the entity’s performance of providing legal services in that period.

Applying ‘as-invoiced’ practical expedient: Change in unit price linked to a fixed change

Modifying the above example, Law Firm L charges 500 per hour for the first year and then adjusts each subsequent year by an amount equal to the greater of the change in the CPI or 7%. The CPI is currently expected to increase at 2% for the upcoming year and L’s costs are not expected to increase more than the CPI.

In this example, the price is expected to increase by 7% each year, which is not consistent with inflation or L’s historical pricing or cost trends. Therefore, L concludes that it cannot use the as-invoiced practical expedient because the change is not supported by valid business reasons – e.g. being commensurate with the increase in costs of providing the service or changes in the CPI.

Applying ‘as-invoiced’ practical expedient: Different per-unit rates within a performance obligation

Modifying Example 17A, Law Firm L charges different rates per hour over the contract term based on the type and experience of the professional providing the service.

For example, the contract provides the following rate card:

  • 750 per hour for a partner;
  • 500 per hour for a senior associate;
  • 300 per hour for an associate; and
  • 100 per hour for a paralegal.

These rates reflect observable hourly rates that L charges similar customers for its professional services on a stand-alone basis. Despite the legal services being a single performance obligation, L will bill Customer M a different hourly rate depending on which professional is performing the task generating the billing.

L concludes that it can apply the practical expedient to recognise revenue because it has the right to bill at an amount that corresponds directly with its performance to date. The practical expedient is available despite the different rates because the differences reflect substantive differences between the value that each professional provides.

Also read: IFRS Community – Revenue recognition

IFRS 15 Measuring progress to completion

IFRS 15 Measuring progress to completion Single method of measuring progress Mile stone method Output methods Input methods

IFRS 15 Measuring progress to completion Single method of measuring progress Mile stone method Output methods Input methods

IFRS 15 Measuring progress to completion Single method of measuring progress Mile stone method Output methods Input methods

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IFRS 15 Measuring progress to completion Single method of measuring progress Mile stone method Output methods Input methods

IFRS 15 Measuring progress to completion Single method of measuring progress Mile stone method Output methods Input methods

IFRS 15 Measuring progress to completion Single method of measuring progress Mile stone method Output methods Input methods

IFRS 15 Measuring progress to completion Single method of measuring progress Mile stone method Output methods Input methods

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