IFRS 15 establishes 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.
The application of the core principle in IFRS 15 is carried out in five steps:
The five-step model is applied to individual contracts. However, as a practical expedient, IFRS 15 permits an entity to apply the model to a portfolio of contracts (or performance obligations) with similar characteristics if the entity reasonably expects that the effects would not differ materially from applying it to individual contracts.
This practical expedient will often be applied to situations involving measurement estimates where an entity may have many contracts which are affected by a particular issue and an estimate is more appropriately made on the population of contracts rather than on each contract individually. For example, in a retail sale which gives the customer a right of return, it may be more appropriate to estimate the aggregate level of returns on all such retail transactions, rather than at the contract level (which is each individual retail sale on which a right of return is granted).
Step 1 Identify the contract
To apply the model in IFRS 15, an entity must first identify the contract, or contracts, to provide goods and services to customers. Any contracts that create enforceable rights and obligations fall within the scope of the standard. Such contracts may be written, oral or implied by the entity’s customary business practice.
For example, an entity’s past business practices may influence its determination of when an arrangement meets the definition of a contract with a customer. An entity that has an established practice of starting performance based on oral agreements with its customers may determine that such oral agreements meet the definition of a contract. [IFRS 15.10].
In the Basis for Conclusions, the Boards acknowledge that the determination of whether an arrangement has created enforceable rights is a matter of law and the factors that determine enforceability may differ among jurisdictions. [IFRS 15.BC32].
The Boards also clarified that, while the contract must be legally enforceable to be within the scope of the standard, the performance obligations within the contract can be based on the valid expectations of the customer, even if the promise is not enforceable. In addition, the standard clarifies that some contracts may have no fixed duration and can be terminated or modified by either party at any time.
Other contracts may automatically renew on a specified periodic basis. Entities are required to apply IFRS 15 to the contractual period in which the parties have present enforceable rights and obligations. [IFRS 15.11].
As a result, an entity may need to account for a contract as soon as performance begins, rather than delay revenue recognition until the arrangement is documented in a signed contract as is often the case under current practice. Certain arrangements may require a written contract to comply with jurisdictional law or trade regulation. These requirements must be considered when determining whether a contract exists.
Case – Oral contract
IT Support Co. provides online technology support for customers remotely via the internet. For a flat fee, IT Support Co. will scan a customer’s personal computer (PC) for viruses, optimise the PC’s performance and solve any connectivity problems. When a customer calls to obtain the scan services, IT Support Co. describes the services it can provide and states the price for those services.
When the customer agrees to the terms stated by the representative, payment is made over the telephone. IT Support Co. then gives the customer the information it needs to obtain the scan services (e.g. an access code for the website). It provides the services when the customer connects to the internet and logs onto the entity’s website (which may be that day or a future date).
In this example, IT Support Co. and its customer are entering into an oral agreement, which is legally enforceable in this jurisdiction, for IT Support Co. to repair the customer’s PC and for the customer to provide consideration by transmitting a valid credit card number and authorisation over the telephone. The required criteria for a contract with a customer (see Attributes of a contract) are all met. As such, this agreement would be within the scope of IFRS 15 at the time of the telephone conversation, even if the entity has not yet performed the scanning services.
Attributes of a contract
To help entities determine whether (and when) their arrangements with customers are contracts within the scope of the standard, the Boards identified certain attributes that must be present. These criteria are assessed at the inception of the arrangement. If the criteria are met at that time, an entity does not reassess these criteria unless there is an indication of a significant change in facts and circumstances. [IFRS 15.13].
For example, if the customer’s ability to pay significantly deteriorates, an entity would have to reassess whether it is probable that the entity will collect the consideration for which it is entitled in exchange for transferring the remaining goods and services under the arrangement. The updated assessment is prospective in nature and would not change the conclusions associated with goods and services already transferred.
If the criteria are not met, the arrangement is not considered a revenue contract and the requirements discussed at in No contract under IFRS 15 below must be applied. However, entities are required to continue assessing the criteria throughout the term of the arrangement to determine if they are subsequently met. [IFRS 15.14].
Once met, the model in IFRS 15 would apply, rather than the requirements discussed in No contract under IFRS 15 below. IFRS 15 requires an entity to account for a contract with a customer that is within the scope of the Standard only when all of the following criteria are met: [IFRS 15.9]
- the parties to the contract have approved the contract (in writing, orally or in accordance with other customary business practices) and are committed to perform their respective obligations;
- the entity can identify each party’s rights regarding the goods or services to be transferred;
- the entity can identify the payment terms for the goods or services to be transferred;
- the contract has commercial substance (i.e. the risk, timing or amount of the entity’s future cash flows is expected to change as a result of the contract); and
- it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer. In evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer’s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession.
No contract under IFRS 15
If an arrangement does not meet the criteria to be considered a contract under the standard, the standard specifies how it must be accounted for. The standard states that when a contract with a customer does not meet the criteria discussed in Attributes of a contract and an entity receives consideration from the customer, the entity shall recognise the consideration received as revenue only when either of the following events has occurred: [IFRS 15.15]
- the entity has no remaining obligations to transfer goods or services to the customer and all, or substantially all, of the consideration promised by the customer has been received by the entity and is non-refundable; or
- the contract has been terminated and the consideration received from the customer is non-refundable.
The standard goes on to specify that an entity shall recognise the consideration received from a customer as a liability until one of the events described above occurs or until the contract meets the criteria to be accounted for within the revenue model. [IFRS 15.16].
As noted in the Basis for Conclusions, the Boards decided to include these requirements to prevent entities seeking alternative guidance or improperly analogising to the model in IFRS 15 in circumstances in which an executed contract does not meet the criteria to be a contract within IFRS 15 (as discussed in Attributes of a contract). [IFRS 15.BC47].
Consequently, the Boards specified that, in cases in which the contract does not the meet the criteria, an entity only recognises non-refundable consideration received as revenue when one of the events outlined above has occurred (i.e. full performance and substantially all consideration received or the contract has been terminated) or the contract subsequently meets the criteria to be a contract within the standard.
Until that happens, any consideration received from the customer is initially accounted for as a liability (not revenue) and the liability is measured at the amount of consideration received from the customer.
In the Basis for Conclusions, the Boards indicated they intended this accounting to be ‘similar to the “deposit method” that was previously included in US GAAP and applied when there was no consummation of a sale.’ [IFRS 15.BC48] The standard includes the following example to illustrate this concept:
Case – Collectability of the consideration
An entity, a real estate developer, enters into a contract with a customer for the sale of a building for CU1 million. The customer intends to open a restaurant in the building. The building is located in an area where new restaurants face high levels of competition and the customer has little experience in the restaurant industry.
The customer pays a non-refundable deposit of CU50,000 at inception of the contract and enters into a long-term financing agreement with the entity for the remaining 95 per cent of the promised consideration. The financing arrangement is provided on a non-recourse basis, which means that if the customer defaults, the entity can repossess the building, but cannot seek further compensation from the customer, even if the collateral does not cover the full value of the amount owed. The entity’s cost of the building is CU600,000. The customer obtains control of the building at contract inception.
In assessing whether the contract meets the criteria in IFRS 15.9, the entity concludes that the criterion in paragraph 9(e) of IFRS 15 is not met because it is not probable that the entity will collect the consideration to which it is entitled in exchange for the transfer of the building. In reaching this conclusion, the entity observes that the customer’s ability and intention to pay may be in doubt because of the following factors:
Because the criteria in IFRS 15.9 are not met, the entity applies IFRS 15.15-16 to determine the accounting for the non-refundable deposit of CU50,000. The entity observes that none of the events described in paragraph 15 have occurred – that is, the entity has not received substantially all of the consideration and it has not terminated the contract. Consequently, in accordance with paragraph 16, the entity accounts for the non-refundable CU50,000 payment as a deposit liability.
The entity continues to account for the initial deposit, as well as any future payments of principal and interest, as a deposit liability, until such time that the entity concludes that the criteria in paragraph 9 are met (i.e. the entity is able to conclude that it is probable that the entity will collect the consideration) or one of the events in paragraph 15 has occurred. The entity continues to assess the contract in accordance with paragraph 14 to determine whether the criteria in paragraph 9 are subsequently met or whether the events in paragraph 15 of IFRS 15 have occurred.
Step 2 Identify separate performance obligations
After identifying the contract(s) with the customer for accounting purposes, in step 2 a vendor identifies its separate ‘performance obligations’. A performance obligation is a vendor’s promise to transfer a good or service that is ‘distinct’ from other goods and services identified in the contract.
Goods and services (either individually, or in combination with each other) are distinct from one another if the customer can benefit from one or more goods or services on their own (or in combination with resources readily available to the customer).
Two or more promises (such as a promise to supply materials (such as bricks and mortar) for the construction of an asset (such as a wall) and a promise to supply labour to construct the asset are combined if they represent one overall performance obligation.
Step 3 Determine the transaction price
The transaction price is the amount of consideration that a vendor expects to be entitled to in exchange for the goods or services. This will often be the amount specified in the contract. However, the vendor is also required to consider its customary business practices and, if these indicate that a lower amount will be accepted, then this would be the transaction price.
Although a number of estimates about the future may need to be made when determining the transaction price, these are based on the goods and services to be transferred in accordance with the existing contract. They do not take into account expectations about whether the contract will be cancelled, renewed or modified.
The vendor must also consider the effects of the following:
- Variable consideration
- Constraining estimates of variable consideration
- The existence of a significant financing component
- Non-cash consideration
- Consideration payable to a customer.
Step 4 Allocate the transaction price to performance obligations
The objective is to allocate an amount to each performance obligation that reflects the consideration to which a vendor expects to be entitled in exchange for transferring the distinct goods or services (comprising each identified performance obligation in step 2) to the customer. The starting point for the allocation is to determine the stand-alone selling prices of each of those performance obligations.
Step 5 Recognise revenue as or when each performance obligation is satisfied
Having allocated in step 4 the transaction price (as determined in step 2) to the performance obligations (identified in step 3) it is then necessary to determine when the revenue allocated to each performance obligation should be recognised. A vendor recognises revenue when (or as) goods or services are transferred to a customer. A vendor satisfies a performance obligations (that is, it fulfills each promise to the customer) by transferring control of the promised good(s) or service(s) underlying that performance obligation to the customer.
Existing requirements for revenue recognition are based on an assessment of whether the risks and rewards of ownership of a good or service have been transferred to a customer. The application of the control criterion to all types of transactions for providing goods or services is one of the main changes in IFRS 15 compared with current practice. Under the control model, an analysis of risks and rewards is only one of a number of factors to be considered and this may lead to a change in the timing and profile of revenue recognition in certain industries.
Control in the context of IFRS 15 is the ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset. It includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset. Indicators that control has passed include that the customer has:
- A present obligation to pay
- Physical possession of the asset(s)
- Legal title
- Risks and rewards of ownership
- Accepted the asset(s).
The benefits of an asset are the potential cash flows (inflows or savings in outflows) that can be obtained directly or indirectly, such as by:
- Using the asset to produce goods or provide services (including public services)
- Using the asset to enhance the value of other assets
- Using the asset to settle liabilities or reduce expenses
- Selling or exchanging the asset
- Pledging the asset to secure a debt liability
- Holding the asset.
For each performance obligation, a vendor determines at contract inception whether control is transferred over time or at a point in time. If it is determined that a vendor does not satisfy a performance obligation over time, the performance obligation is deemed to be satisfied at a point in time.
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