Performance obligations satisfied over time

Performance obligations satisfied over time – IFRS 15 Revenue from Contracts with Customers (contents page is here) introduced a single and comprehensive framework which sets out how much revenue is to be recognised, and when. The core principle is that a vendor should recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the vendor expects to be entitled in exchange for those goods or services. See a summary of IFRS 15 here. Performance obligations satisfied over time

This section is part of step 5 Recognise revenue as or when each performance obligation is satisfied. A vendor satisfies a performance obligation and recognises revenue over time when one of the following three criteria is met: Performance obligations satisfied over time

  1. The customer simultaneously receives and consumes the economic benefits provided by the vendor’s performance
  2. The vendor creates or enhances an asset controlled by the customer
  3. The vendor’s performance does not create an asset for which the vendor has an alternative use and the vendor has an enforceable right to payment for performance completed to date.

i The customer simultaneously receives and consumes the economic benefits provided by the vendor’s performance

This criterion applies to certain contracts for services, and in some cases it will be straightforward to identify that it has been met. For example, for routine or recurring services (such as cleaning services) it will be clear that there is simultaneous receipt by the customer of the vendor’s performance. The concept of control of an asset applies, because services are viewed as being an asset (if only momentarily) when they are received and used. Performance obligations satisfied over time

For other performance obligations, it may be less straightforward to identify Performance obligations satisfied over time whether there is simultaneous receipt and consumption of the benefits from the vendor’s performance. In these cases, a key test is whether, in order to complete the remaining performance obligations, another vendor would need to substantially re-perform the work the vendor has completed to date. If another vendor would not need to do so, then it is considered that the customer is simultaneously receiving and consuming the economic benefits arising from the vendor’s performance.

In determining whether another entity would need substantially to re-perform the work completed to date, the vendor is required to:

  • Disregard any contractual or practical barriers to the transfer of the remaining performance obligations to another entity; and
  • Presume that any replacement vendor would not benefit from an asset that it currently controls (such as a work in progress balance).

ii The vendor creates or enhances an asset controlled by the customer Performance obligations satisfied over time

This criterion is most likely to be relevant when an asset is being constructed on the customer’s premises. The asset being sold by the vendor could be tangible or intangible (for example, a building that is being constructed on land owned by the customer, or customised software that is being written into a customer’s existing IT infrastructure).

This criterion addresses situations in which the customer controls any work in progress arising from the entity’s performance. The example used by IASB is the example in which the entity has entered into a construction contract to build on the customer’s land, stating that any work in progress arising from the entity’s performance is generally controlled by the customer. [IFRS 15 BC129] Performance obligations satisfied over time

iii The vendor’s performance does not create an asset for which the vendor has an alternative use and the vendor has an enforceable right to payment for performance completed to date

This two-step criterion may be relevant to entities in the construction and real estate sector, and also applies when a specialised asset is to be constructed that can only be used by the customer. It Construction contracts - Measuring progress Construction contracts - Measuring progress may also apply when an asset is to be constructed to a customer’s specification.

The first requirement is whether the asset contracted to deliver has an alternative use at contract inception. After the contract inception the assessment of alternative use of an asset is not updated unless the (all) contract parties approve a contract modification that substantively changes the performance obligation. Revenue recognition over time alternative use

The reasoning for including the alternative use requirement is the assumption that an asset that is specific to one customer is not easily transformed to an asset specific or more general in use for one other customer.

The second requirement, the enforceable right to payment existing for the performance completed to date, represents the (legal) claim for compensation of the work (IFRS: performance) completed to date if the customer terminates the contract for other reasons than the failure to perform as required under the contractual assumptions. The to date sales consideration is an amount that represents the selling price of the goods and services transferred, representing a recovery of costs incurred to this date and a normal profit margin. A normal profit margin is not necessarily the contract margin if the contract would have been completed in the normal finalisation of the contract, but compensates for one of the following:

  1. The anticipated profit margin for the contract that reasonably reflects the extent of the work (IFRS: performance) to date, or Revenue recognition over time alternative use
  2. if the specific contract margin is higher than the entity usually generates from similar contracts, a reasonable return on the cost of capital for similar contracts.

Performance obligations satisfied over time

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