Revenue Income Contract Customer?

Revenue Income Contract Customer? is about IFRS 15 ‘Revenue from contracts with customers’. What is revenue?, What is a contract?, and what is a customer? Here are some of the explanations……

What is revenue?

Revenue has stepped reasoning with regards to the definition of revenue. Revenue is defined as ‘Income arising in the course of an entity’s ordinary activities’. It is something but not the end, income on its own is defined as ‘Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants’.

Income has been defined in the Conceptual Framework for Financial Reporting 2018, Revenue in IAS 18 Revenue, the standard preceding IFRS 15. Income is defined in a much broader and universal sense. Revenue Income Contract Customer

The distinction between revenue and other types of income, such as gains, is important as many users of financial statements focus more on revenue than other types of income. Income comprises revenue and gains and includes all benefits (enhancements of assets or settlements of liabilities) other than contributions from equity participants. Revenue Income Contract Customer

Revenue is a subset of income that arises from the sale of goods or rendering of services as part of an entity’s ongoing major or central activities, also described as its ordinary activities. Transactions that do not arise in the course of an entity’s ordinary activities do not result in revenue. For example, gains from the disposal of the entity’s fixed assets are not included in revenue. The distinction between revenue and other income is not always clear. Determining whether a transaction results in the recognition of revenue will depend on the specific circumstances. Here is a simple example…. Revenue Income Contract Customer

The distinction between revenue and income:

A car dealership has cars available that can be used by potential customers for test drives (“demonstration cars”). The cars are used for more than one year and then sold as used cars. The dealership sells both new and used cars. Revenue Income Contract Customer

Is the sale of a demonstration car accounted for as revenue or as a gain? Revenue Income Contract Customer

Analysis 

The car dealership is in the business of selling new and used cars. The sale of demonstration cars is, therefore, revenue since selling used cars is part of the dealership’s ordinary activities.

The revenue model under IFRS 15 means that revenue may be recognised over time for some goods (for example some contract manufacturing) and revenue may be recognised at a point in time for some services (for example some construction contracts). Revenue Income Contract Customer

The recognition of interest revenue and dividend revenue are not within the scope of IFRS 15. These matters are dealt with under IFRS 9 Financial Instruments.

Core principle Revenue Income Contract Customer

The core principle underlying the IFRS 15 model is that an entity should recognise revenue in a manner that depicts the pattern of transfer of goods and services to customers. The amount recognised should reflect the amount to which the entity expects to be entitled in exchange for those goods and services. Revenue Income Contract Customer

The timing of revenue and profit recognition

Whereas previously IFRSs allowed significant room for judgement in devising and applying revenue recognition policies and practices, IFRS 15 is more prescriptive in many areas. Applying these new rules may result in significant changes to the profile of revenue and, in some cases, cost recognition, as well as wider business impacts.

Accounting when the criteria for a contract are not met

If the criteria for revenue recognition in IFRS 15 9 are not met, but consideration is received from the customer, that consideration should be recognised as revenue only when either of the following events has occurred: [IFRS 15 15] Revenue Income Contract Customer

  • 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 Revenue Income Contract Customer
  • the contract has been terminated and the consideration received from the customer is non-refundable. Revenue Income Contract Customer

When the entity has received consideration from a customer, but is unable to recognise revenue until either (1) one of the events in IFRS 15 15 occur, or (2) the criteria in IFRS 15 9 are subsequently met, the consideration should be presented as a liability until such point that the entity is entitled to recognise the balance as revenue. Depending on the specific facts and circumstances, the liability recognised represents an obligation of the entity to either transfer goods or services in the future or refund the consideration received. In both cases, the liability should be measured at the amount of consideration received from the customer. [IFRS 15 16] Revenue Income Contract Customer

What is a contract?

Again, a contract is defined as ‘An agreement between two or more parties that creates enforceable rights and obligations’.

Many revenue transactions are straightforward, but some can be highly complex. For example, software arrangements, licenses of intellectual property, outsourcing contracts, barter transactions, contracts with Revenue Income Contract Customer? multiple elements, and contracts with milestone payments can be challenging to understand. It might be difficult to determine what the entity has committed to deliver, how much and when revenue should be recognized.

Contracts often provide strong evidence of the economic substance, as parties to a transaction generally protect their interests through the contract. Amendments, side letters, and oral agreements, if any, can provide additional relevant information.

Other factors, such as local legal frameworks and business practices, should also be considered to fully understand the economics of the arrangement. An entity should consider the substance, not only the form, of a transaction to determine when revenue should be recognized.

The revenue standard provides principles that an entity applies to report useful information about the amount, timing, and uncertainty of revenue and cash flows arising from its contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to in exchange for those goods or services.

Reassessing the criteria for identifying a contract

If, at the inception of a contract, the criteria to qualify for revenue recognition set out in IFRS 15 9 are met, an entity should not reassess those criteria unless there is an indication of a significant change in facts and circumstances. For example, if a customer’s ability to pay the consideration deteriorates significantly, an entity would reassess whether it is probable that the entity will collect the consideration to which the entity will be entitled in exchange for the remaining goods or services that will be transferred to the customer. [IFRS 15 13] Revenue Income Contract Customer

Combining contracts

Two or more contracts entered into at or near the same time with the same customer (or related parties of the customer) should be combined and accounted for as a single contract if one or more of the following criteria are met: [IFRS 15 17] Revenue Income Contract Customer

  • the contracts are negotiated as a package with a single commercial objective; Revenue Income Contract Customer
  • the amount of consideration to be paid in one contract is dependent on the price or performance of the other contract; or
  • the goods or services promised in the contracts (or some of the goods or services promised in each of the contracts) are a single performance obligation.

Modifying contracts

A contract may be modified after an entity has already accounted for some or all of the revenue relating to that contract. The impact on revenue recognition will depend on how that contract has been modified. Revenue Income Contract Customer

Contract that is wholly unperformed

A contract does not exist if each party to the contract has a unilateral enforceable right to terminate a wholly unperformed contract without compensating the other party (or parties). A contract is wholly unperformed if both of the following criteria are met: [IFRS 15 12] Revenue Income Contract Customer

  • any promised goods or services have not yet been transferred to the customer; and Revenue Income Contract Customer
  • the entity has not yet received, and is not yet entitled to receive, any consideration in exchange for promised goods or services

Collectability assessed at individual contract level

If an entity has a portfolio of contracts that are all similar, including in terms of collectability, and historical evidence suggests that a proportion of the consideration due from contracts in the portfolio will not be collected, the collectability criterion should be assessed at the individual contract level and not by assessing the expected level of collectability for the portfolio to estimate the number of contracts that will not meet the criterion. For each individual contract, if it is considered probable that the entity will collect the consideration to which it will be entitled, the general requirements of IFRS 15 should be applied. Revenue Income Contract Customer

For example, if an entity has a portfolio of 100 similar contracts and historical experience has indicated that the entity will only collect amounts due on 98 of those contracts, this does not suggest that there are two contracts that should not be accounted for under the general requirements of IFRS 15. Rather, the entity should consider collectability in the context of the individual contracts. If there is a 98 per cent probability that amounts due under each individual contract will be collected, then each contract will meet the criterion in IFRS 15 9(e).

Consideration should, however, be given to any evidence that collection of amounts due under any specific contract is not probable. If that is considered to be the case, that specific contract does not meet the collectability criterion and should be accounted for in accordance with IFRS 15 15. Revenue Income Contract Customer

Consideration should, however, be given to any evidence that collection of amounts due under any specific contract is not probable. If that is considered to be the case, that specific contract does not meet the collectability criterion and should be accounted for in accordance with IFRS 15 15. Revenue Income Contract Customer

When a contract meets the criteria in IFRS 15 9, including collectability, the entity recognises revenue as it satisfies its performance obligations under the contract based on the amount of consideration to which the entity expects to be entitled (rather than the amount it expects to collect). Therefore, for example, if the entity expects to be entitled to consideration of CU500 from each of its contracts, it should recognise that CU500 as revenue, notwithstanding its historical experience of a 2 per cent level of default.

Any associated receivable or contract asset would then be evaluated for impairment, with any difference between the measurement of the contract asset or receivable and the corresponding amount of revenue being presented as an expense in accordance with IFRS 9 Financial Instruments. Revenue Income Contract Customer

In the circumstances under consideration, this will result in revenue recognised of CU50,000 (CU500 × 100) and, assuming the estimated 98 per cent collection rate proves accurate, impairment (bad debts) of CU1,000 (CU50,000 × 2%). Revenue Income Contract Customer

Approval/enforceability

A contract is an agreement between two or more parties that creates enforceable rights and obligations. Enforceability of the rights and obligations in a contract is a matter of law. As noted at IFRS 15 9(a), contracts can be written, oral or implied by an entity’s customary business practices. Practices and processes for establishing contracts with customers vary across legal jurisdictions, industries and entities. They may also vary within an entity (e.g. they may depend on the class of customer or the nature of the promised goods or services). Such practices and processes will need to be considered to determine whether and when an agreement with a customer creates enforceable rights and obligations. [IFRS 15 10] Revenue Income Contract Customer

In some cases, contracts with customers may have no fixed duration and may be capable of being terminated or modified by either party at any time. Alternatively, contracts may automatically renew on a periodic basis that is specified in the contract. IFRS 15 should be applied for the duration of the contract (i.e. the contractual period) in which the parties to the contract have present enforceable rights and obligations. [IFRS 15 11] Revenue Income Contract Customer

What is a customer?

It is getting boring but there is a definition: A customer is defined in IFRS 15 as: ‘A party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration’. Characteristics of the customers are: Size, type, creditworthiness, geographical location, sales channel

In transactions involving multiple parties, it could be less clear which counterparties are customers of the entity. For some arrangements, multiple parties could all be considered customers of the entity. Depending on the specific facts and circumstances, the customer can be identified. Revenue Income Contract Customer

In certain transactions, a counterparty may not always be a ‘customer’ of the entity but a collaborator or partner that shares in the risks and benefits of developing a product to be marketed. This is common in the pharmaceutical, bio-technology, oil and gas, and health care industries. However, depending on the facts and circumstances, these arrangements may also contain a vendor-customer relationship component. Such contracts could still be within the scope of IFRS 15, at least partially, if the collaborator or partner meets the definition of a customer for some, or all, aspects of the arrangement. Entities will need to use judgement to determine whether transactions are between partners acting in their capacity as collaborators or reflect a vendor-customer relationship.

IFRS 15 focuses on when control of the good or service passes to the customer, which may be over time or at a point in time. Revenue Income Contract Customer

A performance obligation is defined as “[a] promise in a contract with a customer to transfer to the customer either: Revenue Income Contract Customer

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

The stand-alone selling price of a good or service is defined as “[t]he price at which an entity would sell a promised good or service separately to a customer”.

The transaction price for a contract with a customer is defined as “[t]he amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties”. Revenue Income Contract Customer

Scope limited to contracts with ‘customers’

IFRS 15 applies to a contract (other than a contract listed in IFRS 15:5) only if the counterparty to the contract is a customer; a customer is defined as “[a] party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration”. [IFRS 15 6 and IFRS 15 Appendix A]

As an example of a counterparty to a contract that is not a customer, the Standard cites a counterparty that has contracted with the entity to participate in an activity or process in which the parties to the contract share in the risks and benefits that result from the activity or process (such as developing an asset in a collaborative arrangement) rather than to obtain the output of the entity’s ordinary activities. [IFRS 15 6] Revenue Income Contract Customer

Contracts partially within the scope of IFRS 15

A contract with a customer may be partially within the scope of IFRS 15 and partially within the scope of the other Standards [IFRS 15 7]

  • If the other Standards specify how to separate and/or initially measure one or more parts of the contract, then an entity first applies the separation and/or measurement requirements of those The amounts of the parts of the contract that are initially measured in accordance with other Standards are excluded from the transaction price. The requirements of IFRS 15 73 – 86 are then applied to allocate the amount of the transaction price that remains (if any) to each performance obligation within the scope of IFRS 15 and to any other parts of the contract identified by IFRS 15 7(b).
  • If the other Standards do not specify how to separate and/or initially measure one or more parts of the contract, then IFRS 15 is applied to separate and/or initially measure the part (or parts) of the contract

Revenue Income Contract Customer

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