Revenue recognition when or as

Revenue recognition when or as
the entity satisfies a performance obligation

The obligation to purchase and sell electricity under a PPA generally will be viewed as a single performance obligation that is satisfied over time (when). A power and utilities entity will be required to measure its progress towards complete satisfaction of its performance obligation to deliver electricity. The objective, when measuring progress, is to depict the seller’s performance in transferring control of the electricity to the customer.

Arrangements to sell other commodities, including natural gas and physical capacity, over a contractual term, could be viewed as a single performance obligation. More judgement might be required to determine if such arrangements meet the definition of a performance obligation satisfied over time.

Different pricing conventions

Some types of sales contract are not impacted by price or volume variability but they do have different fixed pricing conventions (for example, prices per unit might be stated, but they might change over the life of the contract). Under a particular arrangement, the price per unit might step up over time, to reflect expected costs to produce or an expectation of increased market pricing over time. Alternatively, the prices might be different to reflect seasonal or time of day pricing (such as peak versus off-peak).

A contract with stated, but changing, prices for a fixed quantity delivered does not contain variable consideration, because the transaction price for the contract is known at inception and does not change. It is important for the power and utility entity to understand what is giving rise to the pricing convention. For example, the escalations might be intended to reflect the expected market price of power in the future periods which a customer would expect to pay.

The total transaction price should be recognised as revenue over time by measuring progress towards complete satisfaction of the performance obligation. The seller applies a permissible form of the ‘output’ or ‘input’ method.

The seller might determine that an output method (such as KWh delivered) would appropriately depict the entity’s progress towards complete satisfaction of the performance obligation, for a contract with stated but changing prices for a fixed quantity delivered, which would result in a recognition pattern that reflectsRevenue recognition when or as proportional performance of the seller at the fixed price per unit. For example, assuming that power is delivered rateably (that is, equal volumes in each reporting period) over the term of the contract, this would result in a rateable revenue recognition pattern.

It might also be appropriate to use input methods for measuring progress towards complete satisfaction of a performance obligation for a contract with stated but changing prices for a fixed quantity delivered. The underlying economics and the contractual terms of the PPA, including the pricing and volume provisions, will influence the method to be selected by reporting entities.

The method of measuring progress towards complete satisfaction of a performance obligation will directly impact the revenue recognised in each reporting period. A reporting entity will need to ensure that the selected method faithfully depicts its performance towards complete satisfaction of a performance obligation. The selected method for measuring progress should be applied consistently for a particular performance obligation, and also across contracts that have performance obligations with similar characteristics.

A practical expedient allows entities to recognise revenue in the amount at which the entity has a right to invoice, if that amount corresponds directly with the value to the customer of the entity’s performance to date. [IFRS 15.B16]. This would typically be the case where an entity bills a customer a fixed amount for each hour of service or for each unit provided. It might require judgement to determine whether the invoiced amount corresponds directly with the value to the customer, particularly if a contract contains variable pricing (for example, escalating pricing over the contract period).

Particular care needs to be taken where the pricing in the contract is not indicative of the value to a customer and not consistent with expected costs or market pricing. For example, if a contract’s pricing decreases over time where both market prices and input costs are expected to rise, this would be an indicator that it is not appropriate to recognise the revenue at the unit prices stated in the contract, and that some revenue should be deferred as units earlier in the life of the contract are delivered.

Something else -   M and A

Case – Recognise revenue: measuring progress towards complete satisfaction of a performance obligation

Background

Power Seller Co (‘Seller’) and Power Buyer Co (‘Buyer’) executed a PPA for the purchase and sale of electricity over a six-year term. Buyer is obligated to purchase 10 MW of electricity per hour for each hour during the contract term (87,600 MWh per annual period) at prices that reflect the forward market price of electricity at contract inception.

The contract prices are as follows:

  • Years 1 and 2: $50/MWh
  • Years 3 and 4: $55/MWh
  • Years 5 and 6: $60/MWh

The transaction price, which represents the amount of consideration to which the seller expects to be entitled in exchange for transferring electricity to the buyer, is $28,908,000 (annual contract prices per MWh multiplied by annual contract quantities). Seller concludes that the promise to sell electricity represents one performance obligation that will be satisfied over time.

How should Seller recognise revenue under its PPA?

Analysis

Since the performance obligation will be settled over time, Seller must select the method to be used to measure its progress towards complete satisfaction of its obligation to deliver electricity during the term of the PPA.

IFRS 15 includes a practical expedient that allows an entity to recognise revenue in the amount at which the entity has a right to invoice if that amount corresponds directly with the value to the customer of the entity’s performance to date. Judgement might be required to conclude whether invoiced amounts correspond directly with the value to the customer. If Seller concludes that application of the practical expedient is appropriate, revenue would be calculated as follows:

Contract year

Revenue recognised

Calculation

Years 1 and 2

$4,380,000 per year

87,600 MWh * $50/MWh [contract price in years 1 and 2]

Years 3 and 4

$4,818,000 per year

87,600 MWh * $55/MWh [contract price in years 3 and 4]

Years 5 and 6

$5,256,000 per year

87,600 MWh * $60/MWh [contract price in years 5 and 6]

Note: Seller might measure progress, for revenue recognition purposes, based on the ‘units delivered’ method if Seller concludes that the price escalation included in the contract does not reflect the value to be delivered to the customer in each year. This method would result in the recognition of revenue on a consistent basis over the term of the contract based on progress towards complete satisfaction of the performance obligation. This might be an average price per unit, based on total transaction price over the contract and the total expected units.

Contracts with volume variability

Something else -   IFRS 15 Presentation in main statements

Power and utilities entities often enter into variable-volume contracts. Some of these contracts are structured as ‘requirements contracts’, which provide for delivery of as much electricity or gas as the customer needs. These contracts are necessary and typical for various reasons, including: to secure a source of supply sufficient to cover anticipated needs; due to limited storage ability and/or capacity; or because consumption in many cases occurs immediately on delivery.

Power and utilities entities that enter into requirements and similar contracts with variable volumes should first consider whether the arrangement contains a lease within the scope of IFRS 16, or whether it is a financial instrument accounted for under IFRS 9. The following analysis assumes that the arrangement does not contain a lease and is not accounted for as a financial instrument.

The pricing for such contracts is generally known at the time when the contract is executed. While such contracts might take different forms, including a single price for all deliveries, or different but specified prices depending on the time of day and/or season of the year, the primary unknown at the time of contract execution is generally the ultimate quantity to be delivered.

The contract provides a right to choose the quantity of additional distinct goods. An entity is not legally obligated to provide or deliver additional goods, and it does not have a contractual right to consideration until the customer exercises its option. That is, customer purchases under the variable-volume contract represent the customer contracting for a specific number of distinct goods in which each order creates a new performance obligation.

This new performance obligation arises at the time when the customer exercises the option, unless such options provide the customer with a material right. Where there is a material right, the option should be accounted for as a separate performance obligation in the original contract. A practical expedient is available in IFRS 15.B43 to simplify the accounting for certain material rights.

A power and utilities entity might have an obligation to stand ready to deliver additional volumes. Judgement is needed to determine if a separate ‘stand ready’ performance obligation exists and to determine the appropriate revenue attribution method.

Take-or-pay and similar long-term supply agreements: breakage

Identifying performance obligations

A take-or-pay contract might contain renewal or extension options. These options also need to be considered in the context of whether they provide a material right to the customer. Where such a material right exists, it is accounted for as a separate performance obligation, or an entity might elect a practical expedient to assume the renewal term in the period over which revenue is recognised. [IFRS 15.B43].

Breakage

Customers might not exercise all of their contractual rights to receive a good or service in the future. Unexercised rights are often referred to as ‘breakage’.

An entity should recognise estimated breakage as revenue in proportion to the pattern of exercised rights. Management might not be able to conclude whether there will be any breakage, or the extent of such breakage. In this case, it should consider the constraint on variable consideration, including the need to record any minimum amounts of breakage. Breakage that is not expected to occur should be recognised as revenue when the likelihood of the customer exercising its remaining rights becomes remote. The assessment should be updated at each reporting period.

In take-or-pay arrangements, this could mean that an entity might be able to recognise revenue in relation to breakage amounts in a period earlier than when the breakage occurs, provided that it can demonstrate that it expects that the customer will not exercise these rights. Given the nature of these arrangements and the inherent uncertainty in being able to predict a customer’s behaviour, it might be difficult to obtain sufficient evidence to meet this requirement.

Customer contributions and connection fees

Power and utilities entities often charge a fee to a customer when connecting that customer to the transmission/distribution network. The ‘fee’ might be monetary or involve the contribution of a non-financial customer asset. The fee might vary based on the level of work required to complete the connection, but it is often governed by regulation.

The fee could be fixed and would not directly compensate the entity for the costs of building out the network to connect the customer (that is, it might be higher or lower). This is because regulation is designed to ensure that all customers have access to the service, and it is based on a cost-sharing mechanism across all users of the network over the life of the network.

Where an entity provides both connection to a network and ongoing access to goods or services, management should determine whether these services are separate performance obligations of the arrangement for the purposes of revenue recognition. Facts and circumstances might differ between legal jurisdictions or based on the terms of different arrangements. Entities need to consider the following:

  • If the payment is received from a developer, who is the customer (for example, the developer or the homeowners)?

  • Could the connection be a stand-alone service?

  • Does the utility company that charges the connection fee have an explicit or implicit ongoing obligation to the ultimate purchasers of energy (for example, to maintain the equipment or provide an ongoing connection)?

A non-refundable upfront fee might relate to an activity undertaken at or near contract inception. However, no revenue is recognised unless that activity results in the satisfaction of a separate performance obligation. If there is no distinct performance obligation, the upfront fee is recognised as revenue when goods or services are provided to the customer in the future.

Something else -   Best guide IFRS 16 Lessee modifications

The period of revenue recognition could extend beyond the relationship with the initial customer, depending on the nature of the ongoing obligation. For example, if the obligation is to provide an ongoing connection to the owner of a home for the life of the home, this obligation might survive the transfer of the home to a subsequent buyer.

Customer renewal options and cancellation rights

Power and utilities entities might allow customers to renew their existing contracts. A cancellation option that allows a customer to cancel a multi-year contract after each year might effectively be the same as a renewal option, because a decision is made annually whether to continue under the contract. Management should assess a renewal or cancellation option, to determine if it provides a material right similar to other types of customer option.

Case – Customer renewal option

Background

Provider Co enters into an arrangement with a customer to supply electricity at US$0.15 per KW per hour for 12 months. The customer has the option, at the end of the year, to renew the contract once for an additional 12 months. The contract renewal will be under the same terms as the original contract. Provider Co typically increases its prices by 5% each year. Provider Co charges the customer a non-refundable upfront connection fee of US$50, and it has an obligation to maintain the connection until the contract terminates.

How should Provider Co account for the renewal option?

Analysis

The renewal option represents a material right to the customer, because the customer will be charged a lower price for the electricity than similar customers if it renews the contract.

Provider Co is not required to determine a stand-alone selling price for the renewal option, because both criteria for the use of the practical expedient associated with material rights have been met. Provider Co could instead elect to include the estimated total electricity consumption at US$0.15 per KW per hour for 24 months (the initial period and the renewal period) in the initial measurement of the transaction price. In this case, the upfront connection fee should also be included in the amount to be recognised as revenue over 24 months.

Gifts, vouchers, cash bonuses, bonuses in kind

An entity might grant to a customer the option to acquire additional goods or services free of charge or at a discount. These options might include customer vouchers, or other sales incentives and discounts, that will give rise to a separate performance obligation if the option provides a material right that the customer would not receive without enteringRevenue recognition when or as into the contract. The entity should recognise revenue allocated to the option when the option expires or when the additional goods or services are transferred to the customer.

An option to acquire an additional good or service at a price that is within the range of prices typically charged for those goods or services does not provide a material right, even if the option can be exercised only because of entering into the previous contract.

Consideration payable to a customer

An entity needs to determine the transaction price, which is the amount of consideration it expects to be entitled to in exchange for transferring promised goods or services to a customer. Consideration payable by an entity to a customer is accounted for as a reduction of the transaction price, unless the payment is for a distinct good or service that the customer transfers to the entity.

Case – Provider-issued coupons

Background

Provider Co supplies utilities to customers and, at the same time, it provides a coupon for a 3% discount off a furnace inspection during the next year. Provider Co intends to offer a 1% discount on all inspections as part of a promotional campaign during the same period. Provider Co estimates that 75% of customers that receive the coupon will exercise the option for the purchase of, on average, C80,000 of discounted additional services.

How should Provider Co account for the option provided by the coupon?

Analysis

Provider Co should account for the option as a distinct performance obligation, since the discount represents a material right. It is a material right, because it is incremental to the discount offered to a similar class of customers during the period (only a 1% discount is offered more widely).

The stand-alone selling price of the option is C1,200, calculated as the estimated average purchase price of additional inspection services (C80,000) multiplied by the incremental discount (2%) multiplied by the likelihood of exercise (75%).

The transaction price for the contract is allocated between utility supply and the discount based on the relative stand-alone selling price of each performance obligation. The consideration allocated to the discount will be recognised on exercise (that is, on purchase of the additional service) or expiry.

An entity should consider whether it needs to assume 100% redemption of the options if it does not have sufficient history to estimate the extent of redemption.

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Something else -   Recognition of revenue as principal or agent in IFRS 15

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