IFRS 15 the new revenue model – The best read

A closer look at IFRS 15 the new revenue model – IFRS 15 establishes principles that an entity shall apply to report useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from a contract with a customer. A closer look at IFRS 15 the new revenue model

The revenue model applies to all contracts with customers except leases, insurance contracts, financial instruments, guarantees and certain non-monetary exchanges. The sale of non-monetary financial assets, such as property, plant and equipment, real estate or intangible assets will also be subject to some of the requirements of IFRS 15.

A contract with a customer may be partially within the scope of IFRS 15 and partially within the scope of another standard, in which case:

• If the other standards specify how to separate and/or initially measure one or more parts of the contract, then an entity shall apply those separation and measurement requirements first. The transaction price is then reduced by the amounts that are initially measured under other standards.
• If other standards do not provide guidance on how to separate and/or initially measure one or more parts of the contract, then IFRS 15 will be applied.

The revenue model

The standard introduces a revenue model in which the core principle is that an entity should recognise revenue to depict the transfer of promised goods or services to the customer in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. A closer look at IFRS 15 the new revenue model

To recognise revenue the following five steps should be applied: A closer look at IFRS 15 the new revenue model

Step 1: Identify the contract(s) with the customer

A contract can be oral, written or implied by an entity’s business practice. A contract with a customer will fall within the scope of IFRS 15 when all the following criteria are met:

• The parties to the contract have approved the contract; A closer look at IFRS 15 the new revenue model
• Each party’s rights in relation to the goods or services to be transferred can be identified; A closer look at IFRS 15 the new revenue model
• The payment terms and conditions for the goods or services to be transferred can be identified; A closer look at IFRS 15 the new revenue model
• The contract has commercial substance; and A closer look at IFRS 15 the new revenue model
• The collection of an amount of consideration to which the entity is entitled to in exchange for the goods or services is probable.

If the above criteria are met, a contract shall not be re-assessed unless there is an indication of a significant change in facts or circumstances, however if the contract does not meet the above criteria the entity will continue to re-assess the contract going forward to determine whether the criteria are subsequently met.

Assessing the existence of a contract

In an agreement to sell real estate, Seller X assesses the existence of a contract. In making this assessment, X considers factors such as: the buyer’s available financial resources; the buyer’s commitment to the contract, which may be determined based on the importance of the property to the buyer’s operations; X’s prior experience with similar contracts and buyers under similar circumstances; X’s intention to enforce its contractual rights; the payment terms of the arrangement; and whether X’s receivable is subject to future subordination. If X concludes that it is not probable that it will collect the amount to which it expects to be entitled, then a contract to transfer control of the real estate does not exist. Instead, X applies the guidance on consideration received before concluding that a contract exists, and initially accounts for any cash collected as a deposit (liability).

The model is to be applied on an individual contract basis. However, as a practical expedient, a portfolio approach is permitted for contracts with similar characteristics provided it is reasonably expected that the impact on the financial statements will not be materially different from applying this model to the individual contracts.

A contract modification shall be accounted for as a separate contract if the following conditions are met: A closer look at IFRS 15 the new revenue model

• There is an addition of promised goods or services that are distinct and which increases the scope of the contract; and
• The price of the goods of the contract increases by an amount of consideration that reflects the entity’s stand-alone selling prices of the additional goods or services and any appropriate adjustments to that price to reflect the circumstances of the particular contract. A closer look at IFRS 15 the new revenue model

If the above conditions are not met, a contract modification will be accounted for prospectively or retrospectively (depending on whether the remaining goods or services to be delivered after the modification are distinct from those delivered prior to the modification) by modifying the accounting for the current contract with the customer.

At contract inception, an entity shall assess the goods or services that have been promised to the customer, and shall identify as a performance obligation:

• A good or a service (or a bundle of goods or services) that is distinct; or A closer look at IFRS 15 the new revenue model
• 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 the following criteria are met: The customer can benefit from the good or service on its own or together with other readily available resources; and The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.

A series of distinct goods or services has the same pattern of transfer to the customer if the following criteria are met: Each distinct good or service that the entity promises to transfer consecutively to the customer would be a performance obligation that is satisfied over time; and The same method of measuring progress would be used to measure the entity’s progress towards the complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.

Factors for consideration as to whether an entity’s promise to transfer the good or service to the customer is separately identifiable include, but are not limited to:

• The entity does not provide a significant service of integrating the good or service with other goods or services promised in the contract.
• The good or service does not significantly modify or customize another good or service promised in the contract.
• The good or service is not highly dependent on or highly interrelated with other goods or services promised in the contract.

Multiple performance obligations in a contract

Telco T has a contract with Customer R that includes the delivery of a handset and two years of voice and data services. The handset can be used by R to perform certain functions – e.g. calendar, contacts list, email, internet access, accessing apps via Wi-Fi and to play music or games. Additionally, there is evidence of customers reselling handsets on an online auction site and recapturing a portion of the selling price of the phone. T also regularly sells its voice and data services separately to customers, through renewals or sales to customers who acquire handsets from an alternative vendor – e.g. a retailer. T concludes that the handset and the wireless services are two separate performance obligations based on the following reasoning. The customer can benefit from the good or service on its own or together with other readily available resources R can benefit from the handset either on its own (i.e. because the handset has stand-alone functionalities and can be resold for more than scrap value and has substantive, although diminished, functionality that is separate from T’s network) or together with the wireless services, which are readily available to R because T sells those services separately. R can benefit from the wireless services in conjunction with readily available resources – i.e. either the handset is already delivered at the time of contract set-up, it could be purchased from alternative retail vendors or the wireless service could be used with a different handset. The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. The handset and the wireless services are separable in this contract because they are not inputs into a single asset (i.e. a combined output), which demonstrates that T is not providing a significant integration service. Neither the handset nor the wireless service significantly modifies or customises the other. R could purchase the handset and the voice/data services from different parties (e.g. R could purchase the handset from a retailer), which provides evidence that the handset and voice/data services are not highly dependent on, or highly inter-related with, each other.

Step 3: Determine the transaction price

The transaction price is the amount of consideration that an entity expects to be entitled to in exchange for transferring promised goods or services to a customer. An entity will consider the terms of the contract and past customary business practices when making this determination. A closer look at IFRS 15 the new revenue model

If a contract contains a variable amount, the entity estimates the amount to which it will be entitled under the contract. The consideration can also vary if an entity’s right to consideration is contingent on the occurrence of a future event. The variable consideration is only included in the transaction price to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved.

Variable consideration

Discounts	Refunds	Rebates	Price concessions
Penalties	Incentives	Credits	Performance bonuses

An adjustment for the time value of money is made to a transaction price for the effects of financing, if present and significant to the contract, for example, where a consideration is paid in advance or in arrears (see significant financing component). A practical expedient is available where the interval between the transfer of promised goods or services and the payment by the customer is expected to be less than 12 months.

Variable consideration – over-time revenue recognition

A construction company enters into a contract to build a bridge for €10m with an expected completion date of July 2019. The company determines that the over-time revenue recognition criteria of IFRS 15 have been met. The contract contains award / penalty clauses depending on the date of completion as follows: Date of Completion Award (Penalty) Due to the presence of the €1m penalty clause, the fixed consideration is €9m with any additional revenue being variable consideration. At the start of the contract, the construction company determines with a high degree of certainty that the bridge will be completed on time and therefore, using the most likely outcome method and applying the constraint, no awards or penalty deductions are included when estimating contract consideration (€10m). At their reporting date of 31 December 2018 they reassess their variable consideration estimate. At this point, it is most likely that the bridge will be completed in August 2019 but there is a reasonable chance that it will not be completed until September 2019 so they determine that the date by which completion is highly probably is September 2019. June 2019 or earlier 200,000 July or August 2019 0 September 2019 or later (1,000,000) Variable consideration to be recognised is therefore estimated to be constrained to €nil due to the penalty. Previously, the penalty deduction may only have been accounted for when incurred. If at 31 December 2018 the most likely date of completion is June 2019, with the date by which completion is highly probably being determined as July 2019, then the variable consideration to be recognised would be estimated as €1m giving total consideration of €10m. Previously this may have been €10.2m, including receipt of the award based on the most likely completion date.

A closer look at IFRS 15 the new revenue model A closer look at IFRS 15 the new revenue model A closer look at IFRS 15 the new revenue model

Variable consideration – point in time recognition

A manufacturing company (the ‘supplier’) enters into a contract to sell the product ‘A Biscuit’ to a supermarket chain. The pricing in this contract is such that each pack is sold for €10, with a rebate being offered at the end of the year based upon the total number of packs sold in 12 months. Revenue is recognised for each pack upon delivery of that pack to the supermarket. Number of packs sold per year Price Start of the contract The variable consideration is the €3 per pack that reflects the difference between the €10 and €7 selling prices. To determine how much of this variable consideration it can recognise on the sale of the packs to the supermarket chain throughout the year, the supplier must estimate how many packs of A Biscuit it expects to sell. At the start of the contract, based upon normal sale volumes to businesses similar to the supermarket chain it estimates that it will sell 1,200 packs (so consideration of €8 per pack) and it is highly probable that they will not sell more than 1,500 packs. The variable consideration of €3 is therefore constrained to €1 – giving a transaction price per pack of €8. During the year Upon sale of each pack of A Biscuit to the supermarket chain during the year, the supplier recognises €8 revenue. The difference of €2 between the invoice amount and revenue recognised is recorded as a contract liability. 1 – 1,000 10/pack 1,001 – 1,500 8/pack 1,501 or more 7/pack At year end At their reporting date of 31 December 2018 they reassess their variable consideration estimate. At this point, based upon volumes sold to date and the remaining period of the contract, they estimate that they will now sell 2,000 packs to the supermarket chain in total. The variable consideration is now constrained to €nil – giving a transaction price and revenue per pack of €7. Stepped pricing The above example shows a reduction in the price of each pack sold in the year. If the pricing were stepped rather than cumulative (ie first 1,000 at €10, the next 500 at €8, and all the rest at €7) the process of estimating variable consideration would still be the same: During the year: recognise revenue of €9.67 for each pack sold as they estimate sales of 1,200 packs and it is highly probable that they will not sell more than 1,500 packs [(1,000 x €10 + 200 x €8)/1,200] At year end: recognise revenue of €8.75 for each pack sold as they estimate sales of 2,000 [(1,000 x €10 + 500 x €8 + 500 x €7)/2,000]. This will result in a cumulative adjustment of (€0.92) reduction in revenue for each pack sold to date.

Step 4: Allocate the transaction price

An entity shall allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer. A closer look at IFRS 15 the new revenue model

Where a contract has many performance obligations, an entity shall allocate the transaction price to the performance obligations in the contract by reference to their relative stand-alone selling prices. A closer look at IFRS 15 the new revenue model

If a stand-alone selling price is not directly observable, an entity will need to estimate it. IFRS 15 suggests various methods that may be used, including:

• Adjusted market assessment approach; A closer look at IFRS 15 the new revenue model
• Expected cost plus a margin approach; or A closer look at IFRS 15 the new revenue model
• Residual approach (only permissible in limited circumstances). A closer look at IFRS 15 the new revenue model

Sometimes the transaction price may include a discount. Any overall discount is allocated between the performance obligations on a relative stand-alone selling price basis. In some circumstances it may be appropriate to allocate the discount to some but not all of the performance obligations.

Allocating the transaction price

Telco T enters into a 12-month phone contract in which a customer is provided with a handset and a plan that includes data, calls and texts (the wireless plan) for a price of 35 per month. T has identified the handset and the wireless plan as separate performance obligations. T sells the handset separately for a price of 200, which provides observable evidence of a stand-alone selling price. T also offers a 12-month service plan without a phone that includes the same level of data, calls and texts for a price of 25 per month. This pricing is used to determine the stand-alone selling price of the wireless plan as 300 (25 × 12 months). T allocates the transaction price of 420 (35 × 12 months)1 to the performance obligations based on their relative stand-alone selling prices as follows. Performance obligation Stand-alone selling prices Selling price ratio Price allocation Calculation Handset 200 40% 168 = 420 x 40% Wireless plan 300 60% 252 = 420 x 60% Total 500 100% 420 Note In this example, the entity does not adjust the consideration to reflect the time value of money. This could happen if the entity concludes that the transaction price does not include a significant financing component or if the entity elects to use the practical expedient.

Step 5: Recognise revenue when a performance obligation is satisfied

An entity shall recognise revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer, which is when control is passed, either over time or at a point in time. A closer look at IFRS 15 the new revenue model

Control of an asset means having the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.

If one or more of the following 3 criteria are met, the entity recognises revenue over time. If none of these 3 criteria are met, then control transfers to the customer at a point in time and the entity recognises revenue at that point in time. A closer look at IFRS 15 the new revenue model

Criterion	Example
1. The customer simultaneously receives and consumes the benefit provided by the entity as the entity performs.	Routine or recurring services – e.g. cleaning services
2 The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced	Building an asset on a customer’s site
3 The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for the performance completed to date	Building a specialised asset that only the customer can use or building an asset to a customer’s specifications

For a performance obligation satisfied over time, an entity would select an appropriate measure of progress to determine how much revenue should be recognised as the performance obligation is satisfied. A closer look at IFRS 15 the new revenue model

Factors which may indicate that control is passed at a point in time include, but are not limited to: A closer look at IFRS 15 the new revenue model

• The entity has a present right to payment for the asset; A closer look at IFRS 15 the new revenue model
• The customer has legal title to the asset; A closer look at IFRS 15 the new revenue model
• The entity has transferred physical possession of the asset; A closer look at IFRS 15 the new revenue model
• The customer has significant risks and rewards related to the ownership of the asset; and A closer look at IFRS 15 the new revenue model
• The customer has accepted the asset. A closer look at IFRS 15 the new revenue model

Applying the over-time criteria

Company C enters into a framework agreement to manufacture bottles for Customer B under the following terms. The design of the bottles is the IP of B. The sales price is cost plus 10%. There is no stated minimum purchase quantity. C is required to maintain a specific level of inventory of raw materials and finished goods If B terminates the framework agreement, then it is required to purchase inventory of raw materials at cost and work in progress and finished goods on hand at the agreed sales price at the date of termination. The manufacturing process does not result in material amounts of work in progress. C determines that the nature of the promise to B under the framework agreement is to manufacture bottles for use in B’s operation. C applies the over-time criteria and determines that it does not create an asset with an alternative use because C is legally prevented from selling the asset to another customer. The contract’s termination clause provides C with an enforceable right to payment for its performance completed to date – i.e. for costs incurred plus a reasonable margin. C therefore determines that Criterion 3 is met. Because Criterion 3 is met, C recognises revenue over time as it manufactures bottles.

A closer look at IFRS 15 the new revenue model

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