IFRS 15 Practical alternative for similar goods or services

Practical alternative for similar goods or services

If the goods or services that the customer has a material right to acquire are similar to the original goods or services in the contract – e.g. when the customer has an option to renew the contract – then an entity may allocate the transaction price to the optional goods or services with reference to the goods or services expected to be provided and the corresponding consideration expected to be received. (IFRS 15.B43)

Case – Applying the practical alternative

Company B enters into a contract with Customer C to transfer two units of Product P for 2,000 (1,000 per unit, which is the stand-alone selling price) with an option to purchase up to two more units of P at 500 per unit (i.e. 50% discount). B concludes that each unit of P is distinct and satisfied at a point in time.

B concludes that the option for up to two additional units of P is a material right because the discount is incrementalsimilar goods or services to discounts provided to other customers in this class of customers and does not exist independently from the current contract. B also concludes that the stand-alone selling price for the two additional units of P is 1,000.

The options allow C to acquire additional units of P, which are the same as the goods purchased in the original contract, and the purchases would be made in accordance with the original terms of the contract; therefore, B uses the alternative approach to allocate the transaction price to the options.

B expects that there is a high likelihood of the customer exercising each option because of the significant discount provided. As such, B does not expect breakage and includes all of the options in the expected number of goods that it expects to provide. Therefore, B allocates the expected transaction price to the units expected to be transferred.

Expected transaction price

Therefore, in effect 1,500 of the total consideration in the original contract of 2,000 is allocated to the purchase of the original two units and the remaining 500 is allocated to the two options.

Something else -   Revenue from Contracts with Customers short version

Alternative approach not limited to renewal options

In general the alternative approach is not limited to contract renewals (e.g. a right to renew a service contract on the same terms for an additional period). (IFRS 15.B43)

It may also be applied to other types of material rights – e.g. options to purchase additional goods or services at a discounted price when the optional goods or services are similar to those offered in the contract.

For example, we believe that an entity could apply the alternative approach to a prospective volume rebate arrangement. Under the alternative approach, the entity would allocate the transaction price with reference to the total number of goods that it expects the customer to purchase under the agreement and the corresponding expected total consideration from those purchases – i.e. revenue would be recognised at the average price per unit based on total expected purchases.

More than one acceptable approach to determine the expected goods or services to be provided

IFRS 15 does not provide detailed guidance on how to determine the amount of expected goods or services to be provided. The following are acceptable approaches to determining this amount.

  • Contract-by-contract basis: Under this approach, an entity considers each option that provides theSimilar goods or services customer with a material right to be a ‘good or service that is expected to be provided’ unless it expects the customer’s right to expire unexercised. For example, if an entity includes a renewal option with a contract price of 100 and a 60 percent probability of being exercised, then the entity includes 100 in the hypothetical transaction price rather than 60. This is because 100 is the ‘corresponding expected consideration’ for the additional good or service. The entity would then allocate the hypothetical transaction price (which includes 100) to all of the expected goods or services, including the renewal option on a relative stand-alone selling price basis.
  • Portfolio approach: Under this approach, an entity estimates the number of goods or services expected to be provided based on historical data for a portfolio of similar transactions. For example, an entity enters into 100 similar annual contracts with two optional renewal periods around the same time. The entity estimates the number of expected renewals for the portfolio to estimate the transaction price and allocate consideration to the initial and renewal contracts.

Under both approaches, if the actual number of options exercised is different from what the entity expected, then the entity updates the transaction price and revenue recognised accordingly. We believe that it is acceptable to adjust the number of expected goods or services during the period(s) for which a material right exists, on either a cumulative catch-up or prospective basis, as long as the entity establishes a policy for the approach that it uses and applies it consistently.

Case – Applying the practical alternative: Contract-by-contract basis

ABC Corp enters into 100 contracts to provide equipment for 10,000 and one year of maintenance for 2,000 – both prices are equal to their stand-alone selling price. Each contract provides the customer with the option to renew the maintenance for two additional years for 1,000 per year.

ABC concludes that:

  • the equipment and maintenance are separate performance obligations; and
  • each renewal option provides a material right that the customer would not receive without entering into the contract because the discount is significant compared with what ABC charges other similar customers.

ABC does not expect the rights to go unexercised. Although it has experience with similar customers and has data that suggests there will be some breakage, historical evidence suggests that on a customer-by-customer basis neither of the options will expire unexercised. ABC therefore allocates the expected transaction price to the renewal options expected to be exercised.

Similar goods or services

In Year 1, ABC recognises 8,750 when it transfers control of the equipment to the customer and 1,750 as it satisfies the related maintenance performance obligation. The difference between the amount recognised as revenue and consideration received of 1,500 (12,000 – 8,750 – 1,750) is recognised as a contract liability. The amounts allocated to the renewal options will be recognised as the performance obligations are satisfied.

If the customer does not exercise its options, then ABC recognises as revenue the amounts allocated to all remaining options.

Case – Applying the practical alternative: Portfolio approach

Modifying the above case, ABC Corp estimates the total number of expected goods or services for the 100 contracts based on expectations for similar customers. It estimates the number of renewals and corresponding expected transaction price. It also concludes that the stand-alone selling price for each maintenance period is the same.

Based on its expectations, it allocates the transaction price to each performance obligation as follows.

Similar goods or services

Notes
1. 2,000 × 90%.
2. 2,000 × 81%.

In Year 1, ABC recognises 891,100 (8,911 × 100) when it transfers control of the equipment to the customer and 178,200 (1,782 × 100) as it satisfies the related maintenance performance obligation. The difference between the amount recognised as revenue and consideration received of 130,700 (1,200,000 – 891,100 – 178,200) is recognised as a contract liability. The amounts allocated to the renewal options will be recognised as the performance obligations are satisfied.

If the actual number of renewals is different from what was expected, then ABC’s policy is to update the transaction price and recognise revenue with a cumulative catch-up adjustment.

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