Revenue recognition over time alternative use

Revenue recognition over time alternative use – 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. Revenue recognition over time alternative use

This section is part of step 5 Recognise revenue as or when each performance obligation is satisfied. The performance obligation may be satisfied over time as a result of the fact that a vendor/manufacturer does not have a practical alternative use for an asset (one of three possible criteria for revenue recognition over time, the others being 1. The customer simultaneously receives and consumes the benefit provided by the entity as the entity performs and the other one being:  2. the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced). The vendor would incur significant economic losses to direct the asset for another use (see below).

This may occur in some manufacturing contracts where the basic design of the asset is the same across all contracts, yet the customization is substantial and therefore to redirect a nearly completed asset to another customer would require significant rework. Revenue recognition over time alternative use

A vendor does not consider the possibility of a contract termination in assessing whether the vendor is able to redirect the asset to another customer.

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Further explanation alternative use Revenue recognition over time alternative use

A vendor does not have an alternative use for an asset if the vendor is unable, either contractually or practically, readily to direct the asset (which may be a partially completed asset) for another use during the creation or enhancement of that asset. The assessment is made at contract inception, and takes into account the characteristics of the asset that will ultimately be transferred. It is not updated unless there is a modification to the contract that results in a substantive change to the vendor’s performance obligation(s). Revenue recognition over time alternative use

Revenue recognition over time alternative useEntity’s performance does not create an asset with an alternative use – This criterion is based on two requirements that both must met:

  1. The performance does not create an asset with an alternative use to the entity, and Revenue recognition over time alternative use
  2. An enforceable right to payment exists for the performance completed to date. Revenue recognition over time alternative use

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.

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The contractual ‘alternative use’ restriction applies if the vendor would expect the customer to enforce its rights to the promised asset if the vendor sought to direct the asset for another use.

However, a contractual restriction is not substantive if, for example, an asset is largely interchangeable with other assets that the vendor could transfer to the customer without breaching the contract and without incurring significant costs that otherwise would not have been incurred in relation to that contract. Revenue recognition over time alternative use

This might apply when the asset being sold is mass produced, and it would be straightforward for one item to be sold and another substituted. This would apply even if each of the items produced (for example, a car) could be specified individually by each customer from a range of optional extras, because it is straightforward for another car to be produced with the same options.

A vendor does not have a practical alternative use for an asset if the vendor would incur significant economic losses to direct the asset for another use, for example,

  • Incurring significant costs to rework the asset, or RevCloud computingenue recognition over time alternative use
  • Only being able to sell the asset at a significant loss. Revenue recognition over time alternative use

A vendor does not consider the possibility of a contract termination in assessing whether the vendor is able to redirect the asset to another 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.
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Revenue recognition over time alternative use

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