IFRS 15 Revenue from customer contracts

IFRS 15 Retail – the finest perfect examples

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IFRS 15 Retail revenue – finest perfect examples

Retail is the process of selling consumer goods or services to customers through multiple channels of distribution to earn a profit. Retailers satisfy demand identified through a supply chain. The term “retailer” is typically applied where a service provider fills the small orders of many individuals, who are end-users, rather than large orders of a small number of wholesale, corporate or government clientele. (Source: Wikipedia)

So what is the IFRS 15 guidance for retail?

Here are the cases covering the most significant accounting topics for retail in IFRS 15.

Case – Customer incentives Buy three, get coupon for one free

Death By Chocolate Ltd, a high street chain, is offering a promotion whereby a customer who purchases three boxes of chocolates at €20 per box in a single transaction in a store receives an offer for one free box of chocolates if the customer fills out a request form and mails it to them before a set expiration date.

Death By Chocolate estimates, based on recent experience with similar promotions, that 80% of the customers will complete the mail in rebate required to receive the free box of chocolates.

How is a ‘buy three, get one free’ transaction accounted for and presented by Death By Chocolate?

The rules

IFRS 15.22 states: “At contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either:IFRS 15 Retail

  1. a good or service (or a bundle of goods or services) that is distinct; or
  2. a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (see paragraph 23).”

IFRS 15.26 provides examples of distinct goods and services, including “granting options to purchase additional goods or services (when those options provide a customer with a material right, as described in paragraphs B39-B43)”.

IFRS 15.B40: “If , in a contract, an entity grants a customer the option to acquire additional goods or services, that option gives rise to a performance obligation in the contract only if the option provides a material right to the customer that it would not receive without entering into that contract (for example, a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer in that geographical area or market).

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IFRS 15 Real estate Revenue complete and accurate recognition

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IFRS 15 Real estate

Under IFRS 15 real estate entities recognize revenue over the construction period if certain conditions are met.

Key points

  • An entity must judge whether the different elements of a contract can be separated from each other based on the distinct criteria. A more complex judgment exists for real estate developers that provide services or deliver common properties or amenities in addition to the property being sold.
  • Contract modifications are common in the real estate development industry. Contract modifications might needIFRS 15 Real estate to be accounted for as a new contract, or combined and accounted for together with an existing contract.
  • Real estate managers may structure their arrangements such that services and fees are in different contracts. These contracts may meet the requirements to be accounted for as a combined contract when applying IFRS 15.
  • Real estate management entities are often entitled to several different fees. IFRS 15 will require a manager to consider whether the services should be viewed as a single performance obligation, or whether some of these services are ‘distinct’ and should therefore be treated as separate performance obligations.
  • Variable consideration for entities in the real estate industry may come in the form of claims, awards and incentive payments, discounts, rebates, refunds, credits, price concessions, performance bonuses, penalties or other similar items.
  • Real estate developers will need to consider whether they meet any of the three criteria necessary for recognition of revenue over time.

IFRS 15 core principle

The core principle of IFRS 15 is that revenue reflects the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

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Cloud based software in IFRS 15 Revenue

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Cloud based software

Historically, companies acquiring IT and other infrastructure have only faced one decision – buy or lease? From a financial perspective, the choice was simple: lease, because it didn’t require up-front capital and potentially allowed assets to be kept off balance sheet under the old accounting rules. A buy decision meant an up-front investment of capital and a depreciating asset on the balance sheet.

However, with the evolution of technology, a new choice has emerged – cloud services, which can be obtained without Cloud based softwarebuying or leasing. Instead of expensive data centres and IT software licenses, users can choose to simply have a provider host all of their infrastructure and services. No upfront investment is required, just a simple monthly series of payments that can be scaled up, scaled back or cancelled as needed. But what does all of this mean for income statements – and your company’s balance sheet?

Cloud accounting – a different business model

Historically, any company purchasing its IT infrastructure would capitalise the costs and amortise them over time. Under the new leases standard, a company using a lease or hire purchase arrangement to access IT infrastructure would end up with a similar capitalised asset and amortisation charge over time. However, the cloud alternative represents a fundamentally different business model, one where, unlike the legacy purchase model, a user of cloud services does not ever own the underlying assets.

While this isn’t yet another article about the leases standard, it’s useful to step through some of the sensitivities in financial metrics under the leasing standard. While cloud services are likely to result in a differing accounting treatment, the all too familiar concerns in lease accounting are still relevant.

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IFRS 15 Pre-Contract Establishment Date activities – Important to know

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Pre-Contract Establishment Date activities

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Partially Satisfied Performance Obligations Before the Identification of a Contract

Entities sometimes begin activities on a specific anticipated contract with their customer before (1) the parties have agreed to all of the contract terms or (2) the contract meets the criteria in step 1 (see Step 1 Identify the contract) of IFRS 15. The IASB staff refer to the date on which the contract meets the step 1 criteria as the “contract establishment date” (CED) and refer to activities performed before the CED as “pre-CED activities.”

TRG Update — Pre-CED Activities

The FASB and IASB staffs noted that stakeholders have identified two issues with respect to pre-CED activities:

  • How to recognize revenue from pre-CED activities.
  • How to account for certain fulfillment costs incurred before the CED.

The TRG discussed these issues in March 2015.

TRG members generally agreed with the staffs’ conclusion that once the criteria in step 1 have been met, entities should recognize revenue for pre-CED activities on a cumulative catch-up basis (i.e., record revenue as of the CED for all satisfied or partially satisfied performance obligations) rather than prospectively because cumulative catch-up is more consistent with the new revenue standard’s core principle.

The two Q&A below demonstrates the application of the TRG’s general agreement.

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Sales outside ordinary activities – best way of combining IFRS 15 IAS 16 IAS 38 and IAS 40

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Sales outside ordinary activities

Certain aspects of IFRS 15 apply to the sale or transfer of non-financial assets – e.g. intangible assets and property, plant and equipment – that are not an output of the entity’s ordinary activities.

Under IFRS 15, the guidance on measurement and derecognition applies to the transfer of a non-financial asset that is not an output of the entity’s ordinary activities, Sales outside ordinary activitiesincluding:

When an entity sells or transfers a non-financial asset that is not an output of its ordinary activities, it derecognises the asset when control transfers to the recipient, using the guidance on transfer of control in the respective standard IAS 16, IAS 38 or IAS 40 (see Transfer of control).

The resulting gain or loss is the difference between the transaction price measured under IFRS 15 (using the guidance in Step 3 of the model) and the asset’s carrying amount. In determining the transaction price (and any subsequent changes to the transaction price), an entity considers the guidance on measuring variable consideration – including the constraint, the existence of a significant financing component, non-cash consideration and consideration payable to a customer (see Step 3 – Determine the transaction price).

The resulting gain or loss is not presented as revenue. Likewise, any subsequent adjustments to the gain or loss – e.g. as a result of changes in the measurement of variable consideration – are not presented as revenue.

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Revenue recognition when or as

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Revenue recognition when or as
the entity satisfies a performance obligation

The obligation to purchase and sell electricity under a PPA generally will be viewed as a single performance obligation that is satisfied over time (when). A power and utilities entity will be required to measure its progress towards complete satisfaction of its performance obligation to deliver electricity. The objective, when measuring progress, is to depict the seller’s performance in transferring control of the electricity to the customer.

Arrangements to sell other commodities, including natural gas and physical capacity, over a contractual term, could be viewed as a single performance obligation. More judgement might be required to determine if such arrangements meet the definition of a performance obligation satisfied over time.

Different pricing conventions

Some types of sales contract are not impacted by price or volume variability but they do have different fixed pricing conventions (for example, prices per unit might be stated, but they might change over the life of the contract). Under a particular arrangement, the price per unit might step up over time, to reflect expected costs to produce or an expectation of increased market pricing over time. Alternatively, the prices might be different to reflect seasonal or time of day pricing (such as peak versus off-peak).

A contract with stated, but changing, prices for a fixed quantity delivered does not contain variable consideration, because the transaction price for the contract is known at inception and does not change. It is important for the power and utility entity to understand what is giving rise to the pricing convention. For example, the escalations might be intended to reflect the expected market price of power in the future periods which a customer would expect to pay.

The total transaction price should be recognised as revenue over time by measuring progress towards complete satisfaction of the performance obligation. The seller applies a permissible form of the ‘output’ or ‘input’ method.

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Electricity revenue recognition example

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Electricity revenue recognition example

Application of the five-step model

Facts: Bundle Seller Co (‘Seller’) and Bundle Buyer Co (‘Buyer’) executed an agreement for the purchase and sale of 1oMW of electricity per hour and the associated renewable energy credits (‘RECs’) (one REC for each MWh) at a fixed bundled price (‘the agreement’ or ‘the PPA’). The contract term begins on 1 January 20X1 and ends on 31 December 20X4, and the fixed bundled price during each of those respective years is $200, $205, $210 and $215.

The increase in the bundled price represents the increase in the forward price of electricity and RECs over the term of Electricity revenue recognition examplethe agreement as of the acquisition date. Control, including title to and risk of loss related to the electricity, will pass and transfer on delivery at a single point on the electricity grid. Control, including title to and risk of loss related to RECs, will pass and transfer when the associated electricity is delivered.

Seller and other market participants frequently execute contracts for the purchase and sale of electricity and RECs on a stand-alone basis.

Seller concluded that this arrangement does not contain a lease (that is, no property, plant or equipment is explicitly or implicitly identified). The electricity element of this arrangement qualifies for the ‘own use’ exception and thus is not accounted for as a derivative. The REC element has no net settlement characteristics. As such, each element of this agreement is within the scope of IFRS 15.

Electricity revenue recognition – IFRS 15 step-by-step

Step 1 – Identify the contract with a customer

This agreement, including each of its elements (that is, electricity and RECs), is within the scope of the standard, and collection of the contract consideration is considered probable.

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Contract modifications in power and utilities – Best IFRS 15 Revenue recognition

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Contract modifications in power and utilities

One of the most judgemental aspects of implementing IFRS 15 for power and utilities entities is applying the contract modifications guidance to arrangements, such as ‘blend and extend’ arrangements.

Blend and extend arrangements

Blend and extend arrangements are common in the power and utilities industry. In a blend and extend arrangement, the buyer and seller negotiate amended pricing of an existing contractual arrangement, including extending the term of the existing arrangement. It is common for the buyer to benefit from a lower blended price (original price blended with the extension period price which is at a lower rate per unit) and for the seller to benefit from an extended term (original term plus the extension period term).

Management will need to evaluate these types of modifications in order to determine how and when they will be accounted for under the contract modification provisions in IFRS 15.

Blend and extend modifications will typically fall into one of the following scenarios:

  1. The modification creates a separate contract from the existing arrangement. This would be the case if the modification results in an increase in the amount of distinct goods (such as units of electricity to be delivered), and the additional consideration reflects the reporting entity’s stand-alone selling price of the additional promised goods.
  2. The modification represents a termination of the existing agreement and the creation of a new agreement, to be accounted for prospectively. This would be the case if the modification results in an increase in the amount of distinct goods (such as units of electricity to be delivered), but the additional consideration does not reflect the reporting entity’s stand-alone selling price of the additional promised goods (for example, the price per unit of the new distinct goods is different from the market due to the blended price).

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Transaction price power and utilities under IFRS 15 – All best read

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Determining the transaction price power and utilities

The determination of the transaction price in many power and utilities contracts will be fairly straightforward, particularly where the contract pricing and contract quantities are fixed; however, in practice, reporting entities often enter into contracts that contain index-based pricing, variable volume, or both.

For example, Seller might enter into a requirements contract to sell electricity to Buyer at predetermined prices, but volumes are not known at contract inception. Uncertainty exists with respect to the total consideration to be received by Seller over the term of the contract. Seller might be able to elect a practical expedient to recognise revenue based on the amount invoiced, if it directly corresponds with the value to the customer of Seller’s performance completed to date.

Contracts that contain forms of variable consideration, significant financing components, non-cash consideration and/or consideration payable to a customer are likely to be more complex and will require judgement.

Variable consideration power and utilities

Variable consideration should be estimated using the expected value method or the most likely amount method. This is not a ‘free choice’. An entity needs to consider which method it expects to better predict the amount of consideration to which it will be entitled and apply that method consistently for similar types of contract.

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IFRS 15 Power purchase agreement

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IFRS 15 Power purchase agreement

It is common for customer contracts within the power and utilities industry to contain multiple performance obligations. It is essential that power and utilities entities evaluate their portfolio of customer contracts in order to identify explicit and implicit promises to transfer a distinct good or service to a customer.

A promise to transfer a series of distinct goods that are substantially the same and that have the same pattern of transfer to the customer is a performance obligation known as a ‘series’. Contracts for the sale of electricity, and many contracts for the sale of gas to residential and small commercial and industry clients, would represent such a promise.

Sometimes, two products (such as gas and electricity) are sold together. Where multiple products are sold simultaneously, generally:

  1. Gas and electricity are distinct, because (a) a customer can benefit from either gas or electricity on its own (that is, the customer can sell gas and electricity, on a stand-alone basis, into the marketplace, etc.), and (b) the promise to transfer gas or electricity is separately identifiable from other promises in the contract.
  2. The performance obligation to deliver gas and electricity, in many cases, is satisfied over time, since the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs. This conclusion might not be applicable for gas or other commodity contracts, where the customer has storage facilities and does not consume the benefits of the commodity immediately as it is delivered.
  3. Each delivery of gas or electricity in the series, that the entity promises to transfer to the customer, meets the criteria to be a performance obligation satisfied over time, and the same method will be used to measure the entity’s progress towards complete satisfaction of the performance obligation to transfer each distinct delivery of gas or electricity in the series to the customer.

Judgement is required to identify performance obligations in power and utilities contracts. In some jurisdictions, distribution and energy might be distinct performance obligations; while, in others, energy and distribution might be a single integrated performance obligation. This will depend on a number of factors, including whether the customer can choose amongst retailers and the relationships between the providers of distribution, the retailer and the end customer.

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