IFRS 15 Technology sector revenue recognition – Top read

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IFRS 15 Technology sector

The technology industry comprises numerous sub-sectors, including, but not limited to, computers and networking, semiconductors, financial technology, software and internet, the internet of things, health technology, and clean technology. Each sub-sector has diverse product and service offerings and various revenue recognition issues.

Determining how to allocate consideration among elements of an arrangement and when to recognize revenue can be extremely complex and, as a result, industry-specific revenue recognition models were previously developed. IFRS 15 replaces these multiple sets of guidance with a single revenue recognition model, regardless of industry.

While the new standards (ASC 606 and IFRS 15) include a number of specific factors to consider, they are principles–based standards. Accordingly, entities should ensure that revenue recognition is ultimately consistent with the Consolidation exceptions and exemptionssubstance of the arrangement.

Since the issuance of the original standards in 2014, both the FASB and IASB issued amendments. Certain amendments, which may differ between US GAAP and IFRS, impact the technology industry.

The amendments to identifying performance obligations clarify the guidance regarding whether a good or service is separately identifiable from other promises in the contract.

This narrative summarizes some of the areas within the technology industry, broken down following the 5-steps of the IFRS 15 model, that may be significantly affected by IFRS 15s. It also highlights differences between the US GAAP and IFRS guidance. The standards are largely converged.

1. Identify the contract

Generally, any agreement with a customer that creates legally-enforceable rights and obligations meets the definition of a contract. Legal enforceability depends on the interpretation of the law and could vary across legal jurisdictions where the rights of the parties are not enforced in the same way.

Technology companies should consider any history of entering into amendments or side agreements to a contract that either change the terms of, or add to, the rights and obligations of a contract. These can be verbal or written, and could include cancellation, termination or other provisions.

They could also provide customers with options or discounts, or change the substance of the arrangement. All of these have implications for revenue recognition. Therefore, understanding the entire contract, including any amendments, is important to the accounting conclusion.

As part of identifying the contract, entities are required to assess whether collection of the consideration is probable, which is generally interpreted as a 75-80% likelihood in US GAAP and a greater than 50% likelihood in IFRS. This assessment is made after considering any price concessions expected to be provided to the customer.

In other words, price concessions are variable consideration (which affects the transaction price), rather than a factor to consider in assessing collectability.

Further, the FASB clarified in an amendment of ASC 606 that entities should consider, as part of the collectability assessment, their ability to mitigate their exposure to credit risk, for example by ceasing to provide goods or services in the event of nonpayment. The IASB did not amend IFRS 15 on this point, but did include additional discussion regarding credit risk in the Basis for Conclusions of their amendments to IFRS 15.

If management concludes collection is not probable, the arrangement is not accounted for using the five-step model. In that case, the entity will only recognize consideration received as revenue when one of the following events occurs:

  • There are no remaining obligations to transfer goods or services to the customer, and substantially all of the consideration has been received and is non-refundable
  • The contract has been terminated, and the consideration received is non-refundable
  • The entity transferred control of the goods or services, the entity stopped transferring goods or services to the customer (if applicable) and has no obligation to transfer additional goods or services, and the consideration received from the customer is non-refundable. [US GAAP only]

Case – Assessing collectability for a portfolio of contracts

How it is: Wholesaler sells network routers to a large volume of customers under similar contracts. Before accepting a new customer, Wholesaler performs customer acceptance and credit check procedures designed to ensure that it is probable the customer will pay the amounts owed. Wholesaler will not accept a new customer that does not meet its customer acceptance criteria.

In January 20X8, Wholesaler delivers routers to multiple customers for consideration totalling $100,000. Wholesaler concludes that control of the routers has transferred to the customers and there are no remaining performance obligations.

Wholesaler concludes, based on its procedures, that collection is probable for each customer; however, historical experience indicates that, on average, Wholesaler will collect only 95% of the amounts billed.

Wholesaler believes its historical experience reflects its expectations about the future. Wholesaler intends to pursue full payment from customers and does not expect to provide any price concessions.

How much revenue should Wholesaler recognize?

Consideration
Because collection is probable for each customer, Wholesaler should recognize revenue of $100,000 when it transfers control of the routers. Wholesaler’s historical collection experience does not impact the transaction price because it concluded that the collectability threshold is met and it does not expect to provide any price concessions.

Wholesaler should also evaluate the related receivable for impairment.

Case – Assessing collectibility with a history of price concessions

How it is: Semiconductor Inc. enters into a contract to sell 100 chips to Customer for a price of $10 per unit. Therefore, the total price of the contract is $1,000. Semiconductor Inc. has a history of providing price concessions to Customer.

Semiconductor Inc. estimates it will provide a price concession for 20% of the contract price, such that the total amount it expects to collect in the arrangement will be $800. Based on its history with Customer, Semiconductor Inc. concludes the $800 is probable of being collected. Assume all other requirements for identifying a contract are met.

Has Step 1 of the model been achieved, such that there is a valid contract?

Consideration
Yes. Because the transaction price for the contract is $800 and Semiconductor Inc. has concluded that collection of the $800 is probable, the criteria for identifying a valid contract with a customer have been met. Semiconductor Inc. will continually reassess the estimated price concession (variable consideration) each reporting period and recognize changes to estimated price concessions as changes to the transaction price (revenue).

If the $800 subsequently becomes uncollectible, Semiconductor Inc. should evaluate the related receivable for impairment.

Case – Collection not probable

How it is: Equip Co. sells equipment to its customer with three years of maintenance for total consideration of $1,000, of which $500 is due upfront and the remaining $500 is due in installments over the three-year term. At contract inception, Equip Co. determines that the customer does not have the ability to pay as amounts become due, and therefore collection of the consideration is not probable.

Equip Co. intends to pursue payment and does not intend to provide a price concession. Equip Co. delivers the equipment at the inception of the contract. At the end of the first year, the customer makes a partial payment of $400. Equip Co. continues to provide maintenance services, but concludes that collection of the remaining consideration is not probable.

Can Equip Co. recognize revenue for the $400 partial payment received?

Consideration
No, Equip Co. cannot recognize revenue for the partial payment received because it has concluded that collection is not probable. Therefore, Equip Co. cannot recognize revenue for cash received from the customer unless it terminates the contract or stops transferring goods or services to the customer. Equip Co. should continue to reassess collectability each reporting period. If Equip Co. subsequently determines that collection is probable, it will apply the five-step revenue model and recognize revenue accordingly.

Contract modifications

It is common for companies in the technology industry to modify contracts to provide additional goods or services, IFRS 15 Technology sectorwhich may be priced at a discount. For example, a company may sell equipment and maintenance to a customer in an initial transaction and then modify the arrangement to extend the maintenance period.

In general, any change to an existing contract is a modification per the guidance when the parties to the contract approve the modification either in writing, orally, or based on the parties’ customary business practices. Also, a new contract entered into with an existing customer could be viewed as the modification of an existing contract depending on the facts and circumstances. This determination may require judgment.

IFRS 15 provides specific guidance on the accounting for contract modifications. A modification is accounted for as either a separate contract or as part of the existing contract. This assessment is driven by (1) whether the modification adds distinct goods and services and (2) whether the distinct goods and services are priced at their stand-alone selling prices.

When service contracts are modified to renew or extend the services being provided, the added services will often be distinct. The modification is accounted for as a separate contract if the services are distinct and the price of the added services reflects stand-alone selling price, including appropriate adjustments to reflect the circumstances of the particular contract (e.g., a discount given because the company does not incur the selling-related costs it incurs for new customers).

The modification is accounted for prospectively if the services are distinct, but the price of the added services does not reflect stand-alone selling price; that is, any unrecognized revenue from the original contract and the additional consideration from the modification is combined and allocated to the remaining unsatisfied performance obligations under both the existing contract and modification.

2. Identify performance obligations

Many technology companies provide multiple products or services to their customers as part of a single arrangement. Hardware vendors sometimes sell extended maintenance contracts or other service elements with the hardware, and vendors of intellectual property (IP) licenses may provide professional services in addition to the license.

Management must identify the separate performance obligations in an arrangement based on the terms of the contract and the entity’s customary business practices. A bundle of goods and services might be accounted for as a single performance obligation in certain fact patterns.

A performance obligation is a promise in a contract to transfer to a customer either:

  • a good or service (or a bundle of goods or services) that is distinct; or
  • a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

A good or service is distinct if both of the following criteria are met:

  • The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (capable of being distinct).
  • The good or service is separately identifiable from other goods or services in the contract (distinct in the context of the contract).

Factors that indicate that two or more promises to transfer goods or services to a customer are not separately identifiable include (but are not limited to):

  1. The entity provides a significant service of integrating the goods or services with other goods or services promised in the contract.
  2. One or more of the goods or services significantly modifies or customizes the other goods or services.
  3. The goods or services are highly interdependent or highly interrelated.

ASC 606 states that an entity is not required to separately account for promised goods or services that are immaterial in the context of the contract. IFRS 15 does not include the same specific guidance; however, IFRS reporters should consider the application of materiality concepts when identifying performance obligations.

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Case – Sale of hardware and installation services – separate performance obligations

How it is: Vendor enters into a contract to provide hardware and installation services to Customer. Vendor always sells the hardware with the installation service, but the installation is not complex such that Customer could perform the installation on its own or use other third parties.

Does the transaction consist of one or more performance obligations?

Consideration
Vendor should account for the hardware and installation services as separate performance obligations.

Vendor does not sell the hardware and installation services separately; therefore, management will need to evaluate IFRS 15 Technology sectorwhether the customer can benefit from the hardware on its own or together with readily available resources.

Because Customer can either perform the installation itself or use another third party, Customer can benefit from (1) the hardware on its own and (2) the installation services in connection with the hardware already received.

The installation service does not significantly integrate, modify, or customize the equipment; therefore, Vendor’s promise to transfer the equipment is separately identifiable from Vendor’s promise to perform the installation service. Accordingly, the equipment and the installation are distinct and accounted for as separate performance obligations.

The conclusion would not change if the Vendor contractually required Customer to use Vendor’s installation services because absent the contractual requirements, Customer could perform the installation itself or use another third party.

As discussed in step 5, Vendor should recognize revenue allocated to the hardware when it transfers control of the hardware to Customer. Vendor should assess whether the performance obligation for installation services is satisfied over time or at a point time, and recognize the allocated revenue accordingly.

Case – Sale of hardware and installation services – single performance obligation

How it is: Vendor enters into a contract to provide hardware and installation services to Customer. Vendor also provides the customer with a license to software that is embedded on the hardware that is integral to the functionality of the hardware. The installation services significantly customize and integrate the hardware into Customer’s information technology environment. Only Vendor can provide this customization and integration service.

Does the transaction consist of one or more performance obligations?

Consideration
Vendor should account for the hardware with embedded software and installation services together as a single performance obligation.

The IFRS 15 guidance states that a license that (1) forms a component of a tangible good and (2) is integral to the functionality of the good is not distinct from the other promised goods or services in the contract. Therefore, the license to embedded software is not distinct from the hardware.

Vendor is also providing a significant service of integrating the hardware and the installation services into the combined item in the contract (a customized hardware system). Therefore, the hardware with embedded software and the installation services are inputs into the combined item and are not separately identifiable.

Series of distinct goods or services

IFRS 15 includes “series” guidance that does not exist in today’s revenue guidance. A contract is accounted for as a series of distinct goods or services if, at contract inception, the contract promises to transfer a series of distinct goods or services that (1) are substantially the same and (2) have the same pattern of transfer to the customer. A series hasIFRS 15 Technology sector the same pattern of transfer if:

  • Each distinct good or service in the series would be a performance obligation satisfied over time, and
  • The same method would be used to measure the entity’s progress toward complete satisfaction of the performance obligation.

Judgment will be required to assess if the underlying goods or services meet these criteria. If the criteria are met, the goods or services are combined into a single performance obligation. However, management should consider each distinct good or service in the series, rather than the single performance obligation, when accounting for contract modifications and allocating variable consideration.

Case – Accounting for a series – transaction processing

How it is: Transaction Inc. enters into a two-year contract with Customer to process credit card transactions. Customer is obligated to use Transaction Inc.’s system to process all of its transactions; however, the ultimate quantity of transactions is unknown. Transaction Inc. concludes that the nature of its promise is a series of distinct monthly processing services. Transaction Inc. charges Customer a monthly fee calculated as $0.03 per transaction processed. The fees charged by Transaction Inc. are priced consistently throughout the contract.

How should Transaction Inc. account for the contract?

Consideration
Transaction Inc. should account for the contract as a series of distinct goods or services, and therefore, as a single performance obligation.

Transaction Inc. will stand ready to process transactions as they occur. The service of processing credit card transactions for Customer each day is substantially similar since Customer is receiving a consistent benefit on a daily basis.

As discussed in step 4, Transaction Inc. should allocate variable consideration to the distinct goods or services within the series if certain criteria are met. As discussed in step 5, Transaction Inc. would likely conclude it should recognize as revenue the variable monthly fee each month as the variable fee relates to the services performed in that period.

Customer options that provide a material right

An option that provides a customer with free or discounted goods or services in the future might be a material right. A material right is a promise embedded in a current contract that should be accounted for as a separate performance obligation. If the option provides a material right to the customer, the customer, in effect, pays the entity in advance for future goods or services, and the entity recognizes revenue when those future goods or services are transferred or when the option expires.

An option to purchase additional goods or services at their standalone selling prices is a marketing offer and therefore not a material right. This is true regardless of whether the customer obtained the option only as a result of entering into the current transaction. An option to purchase additional goods or services in the future at a current stand-alone selling price could be a material right if prices are expected to increase. This is because the customer is being offered a discount on future goods compared to what others would have to pay as a result of entering into the current transaction.

Case – Customer options – discounts on additional servers

How it is: Technology Inc. enters into a contract for the sale of a server for $1,000. Technology Inc. promises the customer a 30% discount off additional servers if those servers are purchased before the end of the year. Technology Inc. typically provides a 10% discount to all customers before the end of the year as a promotional offer to drive sales volume.

Is the customer option a material right and a separate performance obligation?

Consideration
Technology Inc. should account for the promise to provide the incremental discount as a material right. As such, it is a separate performance obligation and Technology Inc. should allocate a portion of the transaction price to the material right.

Because all customers will receive a 10% discount on servers during the same time-frame, the standalone selling price of the material right should be based on the incremental 20% discount offered in the contract (i.e., 30% offered to this customer and 10% offered to other customers). Technology Inc. should also adjust the standalone selling price for the likelihood that the customer will exercise the option. The amount of the transaction price allocated to the material right is recognized as revenue when the additional servers are purchased or when the option expires.

3. Determine transaction price

The transaction price is the consideration a vendor expects to be entitled to in exchange for satisfying its performance obligations in an arrangement. Determining the transaction price is straightforward when the contract price is fixed, but is more complex when the arrangement includes a variable amount of consideration. Consideration that is variable includes, but is not limited to, discounts, rebates, price concessions, refunds, credits, incentives, performance bonuses, and royalties.

Additionally, as discussed in Step 1 (Identify the contract), management will need to use judgment to determine when amounts it will not collect from its customers are due to collectability issues (i.e., Step 1 of the model) or due to price concessions through variable consideration (i.e., Step 3 of the model). This will depend on the facts and circumstances of the arrangement.

To determine the transaction price, management will estimate the consideration to which it expects to be entitled. Variable consideration is only included in the estimate of transaction price to the extent it is probable (US GAAP) or highly probable (IFRS) of not resulting in a significant reversal of cumulative revenue in the future.

The terms “probable” under US GAAP and “highly probable” under IFRS are generally interpreted to have the same meaning (about a 75-80% likelihood). Consideration payable to a customer, right of return, non-cash consideration, and significant financing components are other important concepts to consider in determining the transaction price.

Case – Variable consideration – performance bonus

How it is: Contract Manufacturer enters into a contract with Customer to build an asset for $100,000. The contract also includes a $50,000 performance bonus paid based on timing of completion, with a 10% decrease in the bonus for every week that completion is delayed beyond the agreed-upon completion date.

Management estimates a 60% likelihood of on-time completion, a 30% likelihood of the project being one week late, and a 10% likelihood that it will be two weeks late based on relevant experience with similar contracts.

How much of the performance bonus should Contract Manufacturer include in the transaction price?

Consideration
Management concludes that the most likely amount method is the most predictive approach for estimating the performance bonus. Management believes that $45,000 ($50,000 less 10%, the bonus that will be earned with a one-week delay) should be included in the transaction price as there is a 90% probability of achieving at least this amount. Therefore, it meets the criterion that it is probable (US GAAP) or highly probable (IFRS) that including this amount in the transaction price will not result in a significant revenue reversal. Management should update its estimate at each reporting date.

Consideration payable to a customer

An entity might pay, or expect to pay, consideration to its customer. The consideration paid can be cash, either in the form of rebates or upfront payments, or a credit or other incentive that reduces amounts owed to the entity by a customer. Payments to customers can also be in the form of equity.

Management should consider whether payments to customers are related to a revenue contract even if the timing of the payment is not concurrent with a revenue transaction. Such payments could nonetheless be economically linked to a revenue contract; for example, the payment could represent a modification to the transaction price in a contract with a customer. Management will therefore need to apply judgment to identify payments to customers that are economically linked to a revenue contract.

An important step in this analysis is identifying the customer in the arrangement. Management will need to account for payments made directly to its customer, payments to another party that purchases the entity’s goods or services from its customer (that is, a customer’s customer within the distribution chain), and payments to another party made on behalf of a customer pursuant to the arrangement between the entity and its customer.

Consideration payable to a customer is recorded as a reduction of the arrangement’s transaction price, thereby reducing the amount of revenue recognized, unless the payment is for a distinct good or service received from the customer. If payment is for a distinct good or service, it would be accounted for in the same way as the entity accounts for other purchases from suppliers.

Determining whether a payment is for a distinct good or service received from a customer requires judgment. An entity might be paying a customer for a distinct good or service if the entity is purchasing something from the customer that is normally sold by that customer.

Management also needs to assess whether the consideration it pays for distinct goods or services from its customer exceeds the fair value of those goods or services. Consideration paid in excess of fair value reduces the transaction price. It can be difficult to determine the fair value of the distinct goods or services received from the customer in some situations.

An entity that is not able to determine the fair value of the goods or services received should account for all of the consideration paid or payable to the customer as a reduction of the transaction price since it is unable to determine the portion of the payment that is a discount provided to the customer.

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Right of return

Rights of return are considered a form of variable consideration, as they affect the total amount of fees that a customer will ultimately pay. Revenue recognition when there is a right of return is based on the variable consideration guidance, with revenue recognized to the extent it is probable (US GAAP) or highly probable (IFRS) that a significant reversal of cumulative revenue will not occur. Therefore, revenue is not recognized for products expected to be returned. A liability is recognized for the expected amount of refunds to customers, which is updated for changes in expected refunds.

An asset and corresponding adjustment to cost of sales is recognized for the right to recover goods from customers on settling the refund liability, with the asset initially measured at the original cost of the goods (that is, the carrying amount in inventory), less any expected costs to recover those products. The asset is assessed for impairment if indicators of impairment exist.

If an entity defers the entire amount of revenue under current US GAAP due to its inability to estimate returns, there could be a change in the timing of revenue recognition, especially if there is a cap on returns that would provide a basis to record a minimum amount under the variable consideration guidance. Another change could be in the balance sheet presentation. Under the IFRS 15 guidance, the balance sheet will reflect both the refund obligation and the asset for the right to the returned goods, which entities might not be presenting separately today.

Case – Sale of product with a return right

How it is: Vendor sells and ships 10,000 gaming systems to Customer, a reseller, on the same day. Customer may return the gaming systems to Vendor within 12 months of purchase. Vendor has historically experienced a 10% return rate from Customer.

How should Vendor account for the return right?

Consideration
Vendor should not record revenue for the gaming systems that are anticipated to be returned (10% of the systems, 1,000 systems). Vendor should record a refund liability for 1,000 gaming systems and record an asset for the right to the gaming system assets expected to be returned. The asset should be recorded at the original cost of the gaming systems.

Vendor will not derecognize the refund liability and related asset until the refund occurs or the refund right lapses (although Vendor should adjust these amounts as it revises its estimate of returns over time). The asset will need to be assessed for impairment until derecognition.

The transaction price for the 9,000 gaming systems that Vendor believes will not be returned is recorded as revenue when control transfers to the customer, assuming Vendor concludes it is probable (US GAAP) or highly probable (IFRS) that a significant reversal of cumulative revenue will not occur.

Non-cash consideration

Any non-cash consideration received from a customer needs to be included in the transaction price and measured at fair value. The measurement date, however, may differ under US GAAP and IFRS. ASC 606 specifies that the measurement date for non-cash consideration is contract inception, which is the date at which the criteria in Step 1 of the revenue model are met.

Changes in the fair value of non-cash consideration after contract inception are excluded from revenue. IFRS 15 does not include specific guidance on the measurement date of non-cash consideration and therefore, different approaches may be acceptable. Management should also consider the accounting guidance for derivative instruments to determine whether an arrangement with a right to non-cash consideration contains an embedded derivative.

Significant financing component

Technology companies should also be aware of the accounting impact of significant financing components, such as extended payment terms. If there is a difference between the timing of receiving consideration from the customer and the timing of the entity’s performance, a significant financing component may exist in the arrangement.

IFRS 15 requires entities to impute interest income or expense and recognize it separately from revenue (as interest expense or interest income) when an arrangement includes a significant financing component. However, as a practical expedient, entities do not need to account for a significant financing component if the timing difference between payment and performance is less than one year.

Management should determine if payment terms are reflective of a significant financing component or if the difference in timing between payment and performance arises for reasons other financing. For example, the intent of the parties might be to secure the right to a specific product or service, or to ensure that the seller performs as specified under the contract, rather than to provide financing.

4. Allocate transaction price

Technology companies often provide multiple products or services to their customers as part of a single arrangement. Under IFRS 15, they will need to allocate the transaction price to the separate performance obligations in one contract based on the relative stand-alone selling price of each separate performance obligation. There are certain exceptions when discounts or variable consideration relate specifically to one or more, but not all, of the performance obligations.

The transaction price is allocated to separate performance obligations based on the relative stand-alone selling price of the performance obligations in the contract. Entities will need to estimate the stand-alone selling price for items not sold separately. A residual approach may be used as a method to estimate the stand-alone selling price when the selling price for a good or service is highly variable or uncertain. Variable consideration or discounts might relate only to one or more, but not all, performance obligations in the contract.

Variable consideration is allocated to specific performance obligations if both of the following criteria are met:

  • the terms of the variable consideration relate specifically to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service (or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service)
  • the outcome is consistent with the allocation objective.

A discount is allocated to a specific performance obligation if all of the following criteria are met:

  • The entity regularly sells each distinct good or service on a stand-alone basis.
  • The entity regularly sells, on a stand-alone basis, a bundle of some of those distinct goods or services at a discount.
  • The discount attributable to the bundle of distinct goods or services is substantially the same as the discount in the contract and observable evidence supports the discount belonging to that performance obligation.

Case – Allocation of transaction price

How it is: Technology Inc. enters into an arrangement with a customer, Network Co., for a fixed fee of $10 million, which includes separate performance obligations for 100 servers (delivered at the same time), network monitoring software, installation services, and post-contract support (PCS).

Technology Inc. can earn an additional $500,000 per year for the next two years if it achieves specified performance bonuses related to the performance of the servers, which it expects to achieve based on history with similar arrangements. This type of bonus is common in Technology Inc.’s other server-only transactions. Technology Inc. has concluded its stand-alone selling prices for the performance obligations are as follows:

Performance obligation

Stand-alone price

100 servers

$10.000 million

Installation

$0.500 million

Software license

$2.500 million

Post-contract support

$1.125 million

Total

$14.125 million

How should Technology Inc. allocate the transaction price to each performance obligation?

Consideration
The total transaction price includes the fixed consideration of $10 million plus the estimated variable consideration of $1 million for a total of $11 million. Technology Inc. allocates the $10 million fixed consideration to all of the performance obligations based on relative standalone selling price.

The variable consideration, however, relates solely to the performance of the servers and management has concluded that allocating the variable consideration directly to the servers is consistent with the standard’s allocation objective (that is, the variable consideration allocated directly to the servers depicts the amount of consideration that Technology Inc. expects to be entitled to in exchange for transferring the servers to the customer).

Therefore, $8.08M (($10,000,000 * 70.8%) + $1,000,000) will be allocated to the servers, $350K will be allocated to the installation, $1.77M will be allocated to the software license and $800K will be allocated to the PCS.

If the criteria to allocate variable consideration to only one performance obligation were not met (i.e., if the terms did not relate specifically to that performance obligation or the outcome was not consistent with the allocation objective), the estimated transaction price of $11 million would be allocated to all performance obligations on a relative basis.

5. Recognize revenue

Technology companies often have contracts that include a service (installation or customization) with the sale of goods (software or hardware products). The software, hardware, and services may be delivered over multiple periods ranging from several months to several years. A performance obligation is satisfied and revenue is recognized when “control” of the promised good or service is transferred to the customer. A customer obtains control of a good or service if it has the ability to (1) direct its use and (2) obtain substantially all of the remaining benefits from it.

Directing the use of an asset refers to a customer’s right to deploy the asset, allow another entity to deploy it, or restrict another entity from using it. Management should evaluate transfer of control primarily from the customer’s perspective, which reduces the risk that revenue is recognized for activities that do not transfer control of a good or service to the customer.

Over time revenue recognition

An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognizes revenue over time, if one of the following criteria is met:

  1. The customer simultaneously receives the benefits provided by the entity’s performance as the entity performs
  2. The entity’s performance creates or enhances an asset that the customer controls as the asset is created
  3. The entity’s performance does not create an asset with an alternative use, and the entity has an enforceable right to payment for performance completed to date

Point in time revenue recognition

A performance obligation is satisfied at a point in time if none of the criteria for satisfying a performance obligation over time are met. If the performance obligation is satisfied at a point in time, indicators of the transfer of control include:

  • The entity has a right to payment for the asset.
  • The customer has legal title to the asset.

Sales to distributors

Under IAS 18, the “sell-through approach” was common in arrangements that include dealers or distributors in which revenue was recognized once the risks and rewards of ownership had been transferred to the end consumer. The effect of IFRS 15 on the sell-through approach depends on the terms of the arrangement and why sell-through accounting was applied historically. Technology companies that apply the sell-through approach today evaluate the appropriateness of this approach under IFRS 15 revenue recognition criteria.

Revenue is recognized under IFRS 15 when a customer obtains control of the product, even if the terms include a right of return or other price protection features. The transfer of risks and rewards is an indicator of whether control has transferred, but entities need to consider additional indicators.

Therefore, revenue could be recognized earlier under IFRS 15. For example, if a distributor has physical possession of the product, can direct the use of the product, and is obligated to pay the seller for the product, control of the product may have transferred to the distributor even when the seller retains some risks and rewards or the final price is uncertain. If the entity is able to require the distributor to return the product (that is, it has a call right), control likely has not transferred to the distributor.

Since many distributors are thinly capitalized, an entity will also need to consider the impact of the requirement to assess whether collection is probable (in step 1).

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Case – Sale of product to a distributor with ongoing involvement

How it is: Manufacturer uses a distributor network to supply its product to final customers. The distributor takes title to the product, but may return unsold product at the end of the contract term. Once the products are sold to the end customer, Manufacturer has no further obligations related to the product, and the distributor has no further return rights.

Because of the complexity of the products and the varied nature of how end users may incorporate them into their final products, Manufacturer supports the distributor with technical sales support, including sending engineers on sales calls with the distributor.

When should Manufacturer recognize revenue?

Consideration
Manufacturer should recognize revenue upon transfer of control of the product to its customer, the distributor. Therefore, Manufacturer should assess the point in time that control transfers based on the indicators, including transfer of title, risks and rewards, etc.

Manufacturer should also consider whether there is a separate performance obligation to provide sales support. Assuming the sale of the product and the sales support are separate performance obligations, Manufacturer should:

  • recognize revenue allocated to the products when control of the goods transfers to the distributor, subject to any anticipated returns, and provided collection of the consideration is probable
  • recognize revenue allocated to the support obligation over time as the support is provided

Case – Sale of product to a distributor with price protection clause

How it is: Manufacturer sells product into its distribution channel. In its contracts with distributors, Manufacturer provides price protection by reimbursing its distribution partner for any difference between the price charged to the distributor and the lowest price offered to any customer during the following six months.

When should Manufacturer recognize revenue?

Consideration
Manufacturer should recognize revenue upon transfer of control of the product to the distributor. The price protection clause creates variable consideration. Manufacturer should estimate the transaction price using either the expected value approach or most likely amount, whichever is more predictive.

As discussed in step 3, the estimate of variable consideration is constrained to the amount that is probable (US GAAP) or highly probable (IFRS) of not reversing. Manufacturer will need to determine if there is a portion of the variable consideration (that is, a minimum amount) that would not result in a significant revenue reversal.

Right to invoice” practical expedient

As a practical expedient, management can elect to recognize revenue based on the amount invoiced to the customer if that amount corresponds directly with the value to the customer of the entity’s performance completed to date. Such an assessment will require judgment; management should not presume that a negotiated payment schedule automatically implies that the invoiced amounts represent the value transferred to the customer.

Entities can look to the market prices or standalone selling prices of the goods or services as evidence of the value to the customer; however, other evidence could also be used to demonstrate that the amount invoiced corresponds directly with the value transferred to the customer.

The right to invoice practical expedient is described as a measure of progress, but it effectively allows entities to bypass significant portions of the revenue recognition model. If an entity elects the practical expedient, it typically does not need to determine the transaction price, allocate the transaction price, or select a measure of progress. Entities electing the right to invoice practical expedient can also elect to exclude certain disclosures about the remaining performance obligations in the contract.

Case – Right to invoice practical expedient

How it is: Technology Inc. enters into a contract with a customer to provide hosting services for a three-year period. The rates in the contract increase over time by an amount that is commensurate with future market prices for hosting services at contract inception.

Would it be appropriate for Technology Inc. to apply the right to invoice practical expedient?

Consideration
Technology Inc. could apply the right to invoice practical expedient if it concludes that the rates charged in each billing period correspond directly with the value to the customer of the entity’s performance. This conclusion would likely be supportable by the fact that the rates increase at an amount commensurate with future market prices. Additionally, an increase in the rates over time due to an increase in the number of users or amount of data hosted may also provide evidence that the rates charged correspond directly with the value to the customer.

Case – Right to invoice practical expedient

How it is: Payroll Co. enters into a contract with a customer to provide monthly payroll services over a five-year period. The billing schedule in the contract requires lower monthly payments in the first part of the contract, with higher payments later in the contract. The billing schedule escalates to provide the customer with more liquidity in the early part of the contract because the customer has current cash flow limitations. Payroll Co. provides the same service over the entire contract and market prices of the service are not expected to increase in line with the escalating billing schedule.

Would it be appropriate for Payroll Co. to apply the right to invoice practical expedient?

Consideration
No, it would not be appropriate to apply the right to invoice practical expedient because the amounts billed do not directly correspond to the value to the customer of the entity’s performance. The rising rates in the contract were negotiated to provide the customer with more liquidity, which is not related to the value to the customer of the entity’s performance.

Consulting and manufacturing service contracts

Many technology companies provide consulting and manufacturing services, including business strategy services, supply-chain management, system implementation, outsourcing services, and control and system reliance. Technology service contracts are typically customer-specific, and revenue recognition is therefore dependent on the facts and circumstances of each arrangement.

Some products recognized at a point in time on final delivery today could be recognized over time under IFRS 15. Management will need to apply judgment to assess whether the asset has alternative use and whether contract terms provide the right to payment for performance completed to date.

For performance obligations satisfied over time, entities will use the method to measure progress that best depicts transfer of control to the customer, which could be an output or an input method.

Case – Consulting services – performance obligation satisfied over time

How it is: Computer Consultant enters into a three-month, fixed-price contract to track Customer’s software usage to help Customer decide which software packages best meet its needs. Computer Consultant will share findings on a monthly basis, or more frequently if requested, and provide a summary report of the findings at the end of three months. Customer will pay Computer Consultant $2,000 per month, and Customer can direct Computer Consultant to focus on the usage of any systems it wishes to throughout the contract.

How should Computer Consultant recognize revenue in the transaction?

Consideration
Computer Consultant should recognizeC as it performs the services. Customer simultaneously receives a benefit from the consulting services as they are performed during the three-month contract because the customer is able to receive findings at any time when requested. Another vendor would not have to substantially re-perform the work completed to date to satisfy the remaining obligations.

Case – Sale of specialized equipment – performance obligation satisfied over time

How it is: Contract Manufacturer enters into a six-month, fixed-price contract with Customer for the production of highly customized equipment. Title to the equipment transfers to Customer at the end of the six-month contract term. If Customer terminates the contract for reasons other than Contract Manufacturer’s non-performance, Contract Manufacturer is entitled to payment for costs plus a margin for any work in process to date.

How should Contract Manufacturer recognize revenue in the transaction?

Consideration
Contract Manufacturer should recognize revenue over time as it manufactures the equipment. Given the highly customized nature of the equipment, Contract Manufacturer’s performance does not create an asset with an alternative use to Contract Manufacturer. Also, Contract Manufacturer has an enforceable right to payment from Customer for the performance completed to date. The performance obligation, therefore, meets the criteria for recognition over time.

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Something else -   Provision matrix in the simplified approach

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IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector

IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector

IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector IFRS 15 Technology sector

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