1 best study Stand ready obligations

Stand ready obligations – In step two of IFRS 15, an entity is required to identify all of the performance obligations promised in a contract with a customer. In many cases, the performance obligations are readily apparent in the contract. In other cases, promises implicit in the contract may qualify as performance obligations. Stand ready obligations

One type of promise mentioned explicitly in the standard is the obligation to stand ready to provide a good or stand ready to provide a service. There has been significant discussion about when these promises constitute a performance obligation, as well as the appropriate pattern of recognition for revenue related to these obligations. Stand ready obligations

IFRS 15 26 (e) reads: ‘providing a service of standing ready to provide goods or services (for example, unspecified updates to software that are provided Stand ready obligationson a when-and-if-available basis) or of making goods or services available for a customer to use as and when the customer decides’. Stand ready obligations

The standard provides the example of an entity that owns and manages a chain of health clubs (Measuring progress when making goods or services available). The entity enters into a one-year contract with a customer to provide unlimited access to the health club facilities.

In this example, the customer benefits from the entity’s service of making the health club available, and the customer’s use of the facilities does not affect the remaining goods and services that the entity has contracted to provide. The standard concludes that the entity should recognize revenue on a straight-line basis throughout the year. Stand ready obligations

Other fact patterns might not lead to straight-line or ratable recognition throughout the period of the contract, however. For example, if it is more likely that the entity will be required to stand ready and perform at certain points in the contract, then revenue should be allocated to the periods when the entity expects to be required to perform. Stand ready obligations

An entity should consider which method of allocating revenue best reflects the satisfaction of the performance obligations in the contract. It may be useful to consult the guidance on Input and Output Methods to assist in determining how revenue should be allocated across the life of the contract (for more information, see Measuring progress toward completion of a performance obligation). Stand ready obligations Stand ready obligations

Example

The Transition Resource Group (TRG) memo on stand ready obligations gives the example of a company that contracts to clear the snow off of the runways of an airport for a year. Assume in addition to these facts that the airport provided consideration of $1,200 for this service. Although the airport does receive some benefit from the promise of standing ready to clear the snow from the runways, the airport is receiving more benefits during the winter months when it is more likely to snow.

Additionally, during these months the company is more likely to be obligated to perform. For these reasons, the company could conclude that it is appropriate to allocate significantly more revenue to the winter months. For example, the company might allocate $300 per month to December through February, and only $33 per month to the other months of the year.

Diversity In Thought

In the TRG memo on stand ready obligations, the Financial Accounting Standards Board (FASB) staff describes four types of scenarios that respondents thought would qualify as stand ready obligations. The four types of scenarios are:

  • Type A – The entity has control over when the goods or services are delivered, but needs to develop those goods or services further. For example, a software vendor promises to transfer unspecified software upgrades at the vendor’s discretion. A pharmaceutical company promises to provide when-and-if-available updates to previously licensed intellectual property based on advances in research and development.
  • Type B – Neither the entity nor the customer has control over the delivery of the obligation. For example, a company promises to remove snow from an airport’s runways for a fixed yearly fee.
  • Type C – The customer has control over the delivery of the goods or services. Certain maintenance arrangements would fall into this category. An entity agrees to provide periodic maintenance, when-and-if-needed, to customer’s equipment after a pre-established amount of usage by the customer.
  • Type D – The entity is obligated to make a good or service continually available, as is the case with health club chains.

The health club example discussed above falls under Type D. As discussed, the revenue in this case should be recognized straight-line over the contract. The TRG agreed that in arrangements B, C, and D above, the entity promises to provide an uncertain quantity of goods or services and therefore the entity is “standing ready” to perform. With regard to Type A, an entity needs to evaluate whether its promise is for specified or unspecified updates.

As noted in the example above, the nature of the entity’s promise is to “stand ready” when its promise is to transfer unspecified upgrades or to provide when-and-if-available updates if the entity is unable to predict the timing of when those upgrades or updates will be made available. On the other hand, an entity should account for its promise to dUpgradeeliver a specified update as it would any other license of intellectual property. Determining whether a promise is for a specified or an unspecified update can be challenging and an entity may conclude that an arrangement includes both specified and unspecified updates.

In BC160 of ASU 2014-09, the Boards noted that in a typical health club contract, the entity’s promise is to stand ready by making the health club available for a period of time, rather than providing a service only when a member requests it. That is, the member benefits from the entity’s service of making the health club available on a continuous basis. The extent to which the member uses the health club does not, in itself, affect the amount of the remaining goods or services to which the member is entitled.

Further, the member must pay for the health club membership regardless of whether, or how often, it uses the club. As a result, for a stand ready obligation, an entity should select a measure of progress (Section 7.1.2) based on its service of making goods or services available instead of when customers use the goods or services made available to them.

Stand ready obligations Stand ready obligations Stand ready obligations Stand ready obligations Stand ready obligations

Example – Enterprise service contract with usage fee treated as variable consideration

Telco A enters into a contract with enterprise Customer C to provide call center services. These services include providing dedicated infrastructure and staff to stand ready to answer calls. Telco A receives consideration of 0.50 per minute for each call answered.

Telco A observes that Customer C does not make separate purchasing decisions every time a user places a call to the center. Therefore, Telco concludes that its performance obligation is the overall service of standing ready to provide call center services, rather than each call answered being the promised deliverable. It therefore concludes that the per-minute fee is variable consideration.

Telco A has separately concluded that its performance obligation is the overall service of standing ready to provide call center services each day, rather than each call answered. Furthermore, Telco A has concluded that the per-minute fee is variable consideration. In assessing the appropriate pattern of transfer (i.e. measure of progress in satisfying the performance obligation), Telco A considers whether the variable consideration needs to be estimated at contract inception.

Because Customer C simultaneously receives and consumes the benefits of the service of standing ready each day the service is provided, the performance obligation is satisfied over time. Telco A also observes that the arrangement meets the series guidance because each day (or each month) of standing ready to provide call center services is distinct, is essentially the same and has the same pattern of transfer.

Telco A expects its performance to be fairly consistent during the contract and observes that the pricing in this contract is consistent with pricing in similar contracts with similar customers. Telco A also observes that the variable consideration for each day (i.e. the per-minute fee) relates to the entity’s effort to satisfy the promise of standing ready each day. Furthermore, Telco A observes that it has a right to consideration from the customer for each day of minutes used (for practical reasons these amounts may be invoiced on a monthly basis).

In addition, Telco A concludes that the per-minute usage corresponds directly with the value to the customer of the service provided by Telco A (i.e. the service of standing ready). Therefore, Telco A concludes that revenue can likely be recognized based on the contractual right to bill.

Measure of progress for stand-ready obligations is not always straight-line

(IFRS 15.26(e)IFRS 15 IE92-94, IFRS 15 BC 160)

Judgement is required to determine an appropriate measure of progress for a stand-ready obligation. When making the judgement, an entity considers the substance of the stand-ready obligation to ensure that the measure of progress aligns with the nature of the underlying promise.

In assessing the nature of the obligation, the entity considers all relevant facts and circumstances, including the timing of transfer of goods or services, and whether the entity’s efforts (i.e. costs) are expended evenly throughout the period covered by the stand- ready obligation.

In many cases, a straight-line measure of progress will be appropriate for recognising revenue on a stand-ready obligation. However, a straight-line measure of progress is not always appropriate.

For example, in a contract for unspecified software upgrades (a stand-ready obligation) or a health club contract, revenue is generally recognised on a straight-line basis because the pattern of benefit to the customer as well as the entity’s efforts to fulfil the contract are generally even throughout the period.

In contrast, a straight-line basis of recognition would not generally be appropriate in an annual contract to provide snow removal services in an area where snowfall is highly seasonal. The pattern of benefit of these services, as well as the entity’s effort to fulfil the contract, would not generally be even throughout the year, because snow is only expected in the winter.

When Is It Appropriate For An Entity To Recognize Revenue For A Stand Ready Obligation?

View A. Revenue associated with stand ready obligations should be recognized on a straight-line basis. Proponents of this view note that a stand ready obligation requires providing a service of standing ready to provide goods or services to a customer. In a stand ready obligation of either type B or C, the customer benefits from the assurance that the goods or services will be available, not solely from the actual delivery of the goods or services. Stand ready obligations

Proponents of this view would also argue that obligations of type A are providing assurance to customers against obsolescence of their goods or services (particularly for intellectual property licenses). Inasmuch as these stakeholders believe that the customer benefits from each of these obligations, they would argue that these obligations are distinct, and should be accounted for separately. Stand ready obligations Stand ready obligations

Furthermore, since the benefit received by the customer is a function of time, stand ready obligations should be recognized on a straight-line basis over the period of time that the company is obligated to stand ready. Proponents of this view would apply the treatment recommended in Example 18 for all four types of stand ready obligations.

View B. Revenue associated with many stand ready obligations will not be recognized on a straight-line basis. Proponents of this view argue that few performance obligations will primarily constitute a stand ready obligation. Although the customer does receive benefit from the assurance that the goods and services will be available when they need them, most stand ready obligations will likely be difficult to separate from the delivery of the underlying goods and services. Stand ready obligations

In cases where the two performance obligations are not distinct, the straight-line method of recognition would likely not be representative of the actual transfer of benefits to the customer. Even in cases where the stand ready obligation is distinct, it would be inappropriate to default to a straight-line pattern of recognition for a stand ready obligation unless that pattern best reflected the pattern of transfer of benefits. Stand ready obligations Stand ready obligations

In discussion at the TRG, the majority of TRG members agreed more strongly with view B. One particular weakness that was noted in these deliberations is the fact that applying view A would lead to a significant increase in performance obligations that the Board did not intend to create, as was reaffirmed by a board member present at the TRG meeting.

Additionally, the treatment in view A of accounting for many stand ready obligations as distinct would sometimes run afoul of the guidance on distinctness both inside and outside of the contract (for more information about distinct performance obligations, see Identify the performance obligations in the contract). Stand ready obligations

Furthermore, there was some discussion that similar performance obligations could reasonably be accounted for differently. For example, some TRG members expressed the view that unspecified upgrades, or when-and-if available upgrades, for software could be accounted for differently according to the facts and circumstances of the entity. Stand ready obligations

For example, if a software company knows that it intends to release major updates, then straight-line recognition would be less appropriate, and more revenue should be allocated to the periods where the new release is being developed. However, if that company was instead periodically providing bug fixes and incremental improvements, straight-line recognition might be appropriate. stand ready obligation not distinct

Comparison To IAS 18

Stand ready obligations were not specifically addressed under IAS 18, but some of the transactions that stakeholders identified as potentially including stand ready obligations did have related guidance. Accounting for Type D performance obligations will likely remain relatively unchanged, as revenue from these kinds of membership services was already recognized ratably over the life of the contract. Stand ready obligations

On the other hand, the accounting for software contracts including unspecified upgrades is likely to change significantly. In software contracts under IAS 18, companies were required to have standalone sales for every deliverable in a contract in order to allocate revenue; if any deliverable did not have standalone sales, then revenue from the whole contract would be deferred until the last deliverable was delivered. Stand ready obligations

In contracts with post-contract customer support (PCS), which included when-and-if available upgrades, this often meant that the revenue was recognized ratably throughout the period where PCS was being provided. This led to a significant deferral of revenue in software companies. While the when-and-if available upgrades might still be recognized ratably, the fact that they could now be distinct will require much earlier revenue recognition for other obligations included in the contract. Stand ready obligations stand ready obligation not distinct

Summary

Stand ready obligations are a new concept in IFRS 15. However, they will not necessarily result in different accounting treatments in all cases. In many cases, entities may decide that the stand ready obligation is not distinct, and therefore will not allocate any revenue to it. Stand ready obligations

In situations where a stand ready obligation is distinct, the entity will need to exercise judgment in determining whether the customer benefits equally from having the contract in place throughout the life of the contract, or whether the customer benefits more at certain periods or points during the contract. Stand ready obligations stand ready to provide a service

Revenue will need to be recognized accordingly. While many companies will have to adjust their accounting slightly, this could be a more significant change for software companies. stand ready to provide a service stand ready obligation not distinct

Also read: IFRS Community – Stand ready obligations

Stand ready obligations

Stand ready obligations

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Something else -   Extra disclosures IFRS 15 contracts

Stand ready obligations stand ready to provide a good stand ready to provide a service measure of progress stand ready obligation not distinct

Stand ready obligations stand ready to provide a good stand ready to provide a service measure of progress stand ready obligation not distinct

Stand ready obligations stand ready to provide a good stand ready to provide a service measure of progress stand ready obligation not distinct

Stand ready obligations stand ready to provide a good stand ready to provide a service measure of progress stand ready obligation not distinct

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