Step 5 Recognise the revenue when the entity satisfies each performance obligation

Step 5 Recognise the revenue

when the entity satisfies each performance obligation

– is the end of the process in revenue recognition as introduced by IFRS 15 Revenue from contracts with customers.

IFRS 15 The revenue recognition standard provides a single comprehensive standard that applies to nearly all industries and has changed revenue recognition quite significant. Step 5 Recognise the revenue

IFRS 15 introduced a five step process for recognising revenue, as follows:Step 5 Recognise the revenue

  1. Identify the contract with the customer
  2. Identify the performance obligations in the contract
  3. Determine the transaction price for the contract
  4. Allocate the transaction price to each specific performance obligation
  5. Recognise the revenue when the entity satisfies each performance obligation

INTRO Step 5: Recognize revenue when or as the entity satisfies a performance obligation – An entity recognizes revenue when or as it satisfies a performance obligation by transferring a good or service to a customer, either at a point in time (when) or over time (as).

A good or service is ‘transferred’ when or as the customer obtains control of it.

At contract inception, an entity first evaluates whether it transfers control of the good or service over time – if not, then it transfers control at a point in time.

Step 5 Recognise the revenue

For a performance obligation that is a license of intellectual property, IFRS 15 provides specific application guidance on assessing whether revenue is recognized at a point in time or over time (see licenses of IP in the link). [IFRS 15.B52–B62]

1 Transfer of control

A good or service is transferred to a customer when the customer obtains control of it. ‘Control’ refers to the customer’s ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset. It also includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset. Potential cash flows that are obtained either directly or indirectly – e.g. from the use, consumption, sale, or exchange of an asset – are benefits of an asset. [IFRS 15.31–32]

OR

Control is …

the ability

to direct the use of

Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue

  • the right enables it to:
    • deploy the asset in its activities
    • allow another entity to deploy the asset in its activities
    • prevent another entity from deploying the asset

and obtain the remaining benefits from

Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue

  • the right also enables it to obtain potential cash flows directly or indirectly – for example, through:
    • use of the asset
    • consumption of the asset
    • sale or exchange of the asset
    • pledging the asset
    • holding the asset

an asset. Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue

Use of control concept to recognize revenue aligns with the accounting for assets

IFRS 15 is a control-based model. First, an entity determines whether control of the good or service transfers to the customer over time based on the criteria in IFRS 15 and, if it does, the pattern of that transfer. If it does not, then control of the good or service transfers to the customer at a point in time, with the notion of risks and rewards being retained only as an indicator of the transfer of control (see Performance obligations satisfied at a point in time below). [IFRS 15.BC118]

Assessing the transfer of goods or services by considering when the customer obtains control may result in different outcomes – and therefore significant differences in the timing of revenue recognition. The Boards believe that it can be difficult to judge whether the risks and rewards of ownership have been transferred to a customer, so applying a control-based model may result in more consistent decisions about the timing of revenue recognition.

IFRS 15 extends a control-based approach to all arrangements, including service contracts. The Boards believe that goods and services are assets – even if only momentarily – when they are received and used by the customer. IFRS 15’s use of control to determine when a good or service is transferred to a customer is consistent with the current definition of an asset under IFRS, which principally use control to determine when an asset is recognized or derecognized.

2 Performance obligations satisfied over time

For each performance obligation in a contract, an entity first determines whether the performance obligation is satisfied over time – i.e. control of the good or service transfers to the customer over time. It does this using the following three criteria (a different approach applies if the performance obligation is a license of intellectual property – see licenses of IP in the link) [IFRS 15.32, IFRS 15.35]

1

The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue

Routine or recurring services –

e.g. cleaning or gardening services

2

The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced

Building an asset on a customer’s site

3

The entity’s performance does not create an asset with an alternative use to the entity (see below ‘Performance does not create an asset with an alternative use‘) and the entity has an enforceable right to payment for performance completed to date (see below ‘The entity has an enforceable right to payment for performance completed to date‘)

Building a specialized asset that only the customer can use, or building an asset to a customer’s specifications Step 5 Recognise the revenue Step 5 Recognise the revenue

If one or more of these criteria are met, then the entity recognizes revenue over time, using a method that depicts its performance – i.e. the pattern of transfer of control of the good or service to the customer. If none of the criteria is met, then control transfers to the customer at a point in time and the entity recognizes revenue at that point in time (see Performance obligations satisfied at a point in time below). [IFRS 15.35, IFRS 15.38–39]

Criterion 1

A customer simultaneously receives and consumes the benefits of the entity’s performance as the entity performs, and another entity would not need to substantially re-perform the work that the entity has completed to date. [IFRS 15.B3–B4, IFRS 15.BC125–BC128] Step 5 Recognise the revenue

When determining whether another party would not need to substantially re-perform, the entity also presumes that another party would not have the benefit of any asset that the entity presently controls and would continue to control if that other party took over the performance obligation.

Criterion 2

In evaluating whether a customer controls an asset as it is created or enhanced, an entity considers the guidance on control in IFRS 15, including the indicators of the transfer of control (see Performance obligations satisfied at a point in time below). [IFRS 15.B5] Step 5 Recognise the revenue

Criterion 3

In assessing whether an asset has an alternative use, at contract inception an entity considers its ability to readily direct that asset in its completed state for another use, such as selling it to a different customer. [IFRS 15.36]

Applying Criteria 1 and 3

Potential contractual restrictions or practical restrictions may prevent the entity from transferring the remaining performance obligation to another entity (Criterion 1) or directing the asset for another use (Criterion 3). IFRS 15 provides guidance on whether these facts or possible termination affect the assessment of those criteria. It provides the following guidance on the assumptions that an entity should make when applying Criteria 1 and 3: [IFRS 15.B4, IFRS 15.B6–B8, IFRS 15.BC127]

Criterion Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue

Consider contractual restrictions?

Consider practical limitations?

Consider possible termination?

Determining whether another entity would not need to substantially re- perform (Criterion 1)

No

No

Yes

Determining whether the entity’s performance does not create an asset with an alternative use (Criterion 3)

Yes

Yes

No

Worked example – Assessing if another entity would need to re-perform the work completed

Company M enters into a contract to transport equipment from Los Angeles to New York City. If Company M delivers the equipment to Denver – i.e. only part of the way – then another entity could transport the equipment the remainder of the way to New York City without re-performing Company M’s performance to date. Therefore, the other entity would not need to take the goods back to Los Angeles to deliver them to New York City. Criterion 1 is met and transportation of the equipment is a performance obligation that is satisfied over time.

Differences in assumptions used when applying Criteria 1 and 3

The consideration of contractual restrictions and practical limitations differs for the assessment of Criteria 1 and 3 because they are designed to apply to different scenarios. [IFRS 15.BC139]

Criterion 1 involves a hypothetical assessment of what another entity would need to do if it took over the remaining performance obligation. Contractual restrictions or practical limitations, which would otherwise prevent the entity from transferring the performance obligation to another entity, are not relevant when assessing whether the entity has transferred control of the goods or services provided to date.

By contrast, Criterion 3 focuses on the entity’s ability to direct the completed asset for an alternative use, assuming that the contract is fulfilled. This ability is directly affected by the existence of contractual restrictions and practical limitations.

However, the entity’s rights upon contract termination are considered when evaluating whether the entity has a right to payment under Criterion 3.

Determining whether a commodity transfers over time may depend on Criterion 1

An entity that agrees to deliver a commodity considers the nature of its promise to determine whether to recognize revenue over time or at a point in time. In many contracts to deliver commodities, an entity has promised to transfer a good and will consider the point-in-time guidance to determine when control transfers. However, there may be scenarios in which an entity has promised to provide a service of delivering a commodity that the customer immediately consumes and therefore immediately receives the benefits.

For example, a contract to deliver natural gas to temporary storage may represent a promise to deliver a good, while a contract to provide natural gas to the customer for on-demand consumption may represent a service that meets Criterion 1 for over-time recognition.

To determine whether the customer immediately consumes the assets and receives the benefits as the performance obligation is satisfied, the entity evaluates the:

  • inherent characteristics of the commodity;
  • contract terms;
  • information about the infrastructure and other delivery mechanisms; and
  • other relevant facts and circumstances.

2.1 Performance does not create an asset with an alternative use

For an asset to have no alternative use to an entity, a contractual restriction on the ability to direct its use has to be substantive – i.e. an enforceable right. If an asset is largely interchangeable with other assets and could be transferred to another customer without breaching the contract or incurring significant incremental costs, then the restriction is not substantive. [IFRS 15.B7]

A practical limitation on an entity’s ability to direct an asset for another use – e.g. design specifications that are unique to a customer – exists if the entity would:

  • incur significant costs to rework the asset; or
  • be able to sell the asset only at a significant loss. [IFRS 15.B8]

The assessment of whether an asset has an alternative use is made at contract inception and is not subsequently updated, unless a contract modification substantially changes the performance obligation (see contract modifications in the link). [IFRS 15.36]

A practical limitation on an entity’s ability to direct an asset for another use – e.g. design specifications that are unique to a customer – exists if the entity would:

  • incur significant costs to rework the asset; or
  • be able to sell the asset only at a significant loss. [IFRS 15.B8]

The assessment of whether an asset has an alternative use is made at contract inception and is not subsequently updated, unless a contract modification substantially changes the performance obligation (see contract modifications in the link). [IFRS 15.36]

Worked example – Applying the guidance on alternative use

[IFRS 15.IE73–IE76 Example 15]

Manufacturer Y enters into a contract with a customer to build a specialized satellite. Manufacturer Y builds satellites for various customers; however, the design and construction of each satellite differs substantially on the basis of each customer’s needs and the type of technology that is incorporated into the satellite.

At contract inception, Manufacturer Y assesses whether the satellite, in its completed state, will have an alternative use. Although the contract does not preclude Manufacturer Y from directing the completed satellite to another customer, Manufacturer Y would incur significant costs to rework the design and function of the satellite. In this example, the customer-specific design of the satellite restricts Manufacturer Y’s practical ability to readily direct the satellite to another customer. Therefore, the satellite does not have an alternative use to Manufacturer Y.

Many factors to consider when evaluating alternative use

Under IFRS 15, an asset may not have an alternative use due to contractual restrictions. For example, units constructed for a multi-unit residential complex may be standardized; however, an entity’s contract with a customer may preclude it from transferring a specific unit to another customer. [IFRS 15.BC136–BC139]

Protective rights – e.g. a customer having legal title to the goods in a contract – may not limit the entity’s practical ability to physically substitute or redirect an asset, and therefore on their own are not sufficient to establish that an asset has no alternative use to the entity.

In the absence of a contractual restriction, an entity considers:

  • the characteristics of the asset that will ultimately be transferred to the customer; and
  • whether the asset, in its completed form, could be redirected without a significant cost of rework.

The focus is not on whether the asset can be redirected to another customer or for another purpose during a portion of the production process – e.g. up until the point at which significant customization begins to occur. For example, in some manufacturing contracts the basic design of an asset may be the same across many contracts, but the customization of the finished good may be substantial. Consequently, redirecting the asset in its completed state to another customer would require significant rework.

2.2 The entity has an enforceable right to payment for performance completed to date

An entity that is constructing an asset with no alternative use is effectively constructing the asset at the direction of the customer. The contract will often contain provisions providing some economic protection against the risk of the customer terminating the contract and leaving the entity with an asset of little or no value. [IFRS 15.37]

Therefore, to demonstrate that a customer controls an asset that has no alternative use as it is being created, an entity evaluates whether it has an enforceable right to payment for the performance completed to date.

In performing this evaluation, the entity considers whether, throughout the contract, it is entitled to compensation for performance completed to date if the contract is terminated by the customer or another party for reasons other than the entity’s failure to perform as promised.

To meet this part of Criterion 3, the entity’s right to payment has to be for an amount that approximates the selling price of the goods or services transferred – e.g. a right to recover costs incurred plus a reasonable profit margin. The amount to which the entity is entitled does not need to equal the contract margin, but has to be based on either a reasonable proportion of the entity’s expected profit margin or a reasonable return on the entity’s cost of capital.

However, if an entity would only recover its costs, then it would not have the right to payment for performance completed to date and this part of Criterion 3 would not be met. [IFRS 15.B9–B13]

Other factors to consider include the following.

Payment terms

  • An unconditional right to payment is not required, but rather an enforceable right to demand or retain payment for the performance completed to date if the contract is terminated by the customer for convenience

Payment schedule

  • A payment schedule does not necessarily indicate whether an entity has an enforceable right to payment for the performance completed to date

Contractual terms

  • If a customer acts to terminate a contract without having a contractual right at that time to do so, then the contract terms may entitle the entity to continue to transfer the promise goods or services and require the customer to pay the corresponding consideration promised

Legislation or legal precedent Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue

  • Even if a right is not specified in the contract, jurisdictional matters such as legislation, administrative practice, or legal precedent may confer a right to payment to the entity
  • By contrast, legal precedent may indicate that rights to payment in similar contracts have no binding legal effect, or that and entity’s customary business practice not to enforce a right to payment may result in that right being unenforceable in that jurisdiction

Performance obligations satisfied over time example – Applying the over-time criteria to a consulting contract

[IFRS 15.IE69–IE72 Example 14]

Consulting Firm B enters into a contract to provide a professional opinion to Customer C based on Customer C’s specific facts and circumstances. If Customer C terminates the consulting contract for reasons other than Consulting Firm B’s failure to perform as promised, then the contract requires Customer C to compensate Consulting Firm B for its costs incurred plus a 15% margin.

The 15% margin is approximately the profit margin that Consulting Firm B earns from similar contracts.

Consulting Firm B assesses the contract against the over-time criteria, and reaches the following conclusions.

Criterion

Conclusion

Evaluation and explanation

1 Step 5 Recognise the revenue Step 5 Recognise the revenue

Not met

If Consulting Firm B did not issue the professional opinion and Customer C hired another consulting firm, then the other firm would need to substantially re-perform the work completed to date, because it would not have the benefit of any work in progress performed by Consulting Firm B. Accordingly, Customer C does not simultaneously receive and consume the benefits of its performance.

2 Step 5 Recognise the revenue Step 5 Recognise the revenue

Not met

Consulting Firm B is not creating or enhancing an asset of which Customer C obtains control as it performs because the professional opinion is delivered to Customer C only on completion.

3 Step 5 Recognise the revenue Step 5 Recognise the revenue

Met

The development of the professional opinion does not create an asset with an alternative use to Consulting Firm B, because it relates to facts and circumstances that are specific to Customer C. Therefore, there is a practical limitation on Consulting Firm B’s ability to readily direct the asset to another customer. The contract’s terms provide Consulting Firm B with an enforceable right to payment for its performance completed to date and its costs incurred plus a reasonable margin.

Because one of the three criteria is met, Consulting Firm B recognizes revenue relating to the consulting services over time.

Conversely, if Consulting Firm B determined that it did not have a legally enforceable right to payment if Customer C terminated the consulting contract for reasons other than Consulting Firm B’s failure to perform as promised, then none of the three criteria would be met. In that situation, the revenue from the consulting service would be recognized at a point in time – probably on completion of the engagement and delivery of the professional opinion.

Worked example – Applying the over-time criteria to sales of real estate

[IFRS 15.IE81–IE90 Example 17 Case B]

Developer D is developing a multi-unit residential complex. Customer Y enters into a binding sales contract with Developer D for Unit X, which is under construction. Each unit has a similar floor plan and is a similar size. The following facts are relevant.

  • Customer Y pays a non-refundable deposit on entering into the contract and will make progress payments intended to cover costs to date plus the margin percentage in the contract during construction of Unit X.
  • The contract has substantive terms that preclude Developer D from being able to direct Unit X to another customer.
  • If Customer Y defaults on its obligations by failing to make the promised progress payments when they are due, then Developer D has a right to all of the consideration promised in the contract if it completes the construction of the unit.
  • The courts have previously upheld similar rights that entitle developers to require the customer to perform, subject to the entity meeting its obligations under the contract.

At contract inception, Developer D determines that because it is contractually prevented from transferring Unit X to another customer, Unit X does not have an alternative use. In addition, if Customer Y were to default on its obligations, then Developer D would have an enforceable right to all of the consideration promised under the contract. Consequently, Criterion 3 is met and Developer D recognizes revenue from the construction of Unit X over time.

A right to payment may be established by relevant laws and regulations

When a right to payment on termination is not specified in the contract with the customer, an entity may still have a right to payment under relevant laws or regulations. [IFRS 15.B11–B12, IFRS 15.BC147]

The fact that the entity may sue a customer who defaults or cancels a contract for convenience does not in itself demonstrate that the entity has an enforceable right to payment. Generally, a right to payment exists only if taking legal actions entitles the entity to a payment for the cost incurred plus a reasonable profit margin for the performance completed to date.

Factors to consider when determining if an entity has a right to payment include:

  • relevant laws and regulations;
  • customary business practices;
  • the legal environment;
  • relevant legal precedents; and
  • legal opinions on the enforceability of rights (see below).

Each individual factor may not be determinative on its own. An entity needs to determine which factors are relevant for its specific set of circumstances. In cases of uncertainty – e.g. when the above factors are inconclusive or provide contradictory evidence about the existence of a right to payment – an entity considers all relevant factors and applies judgment in reaching its conclusion.

Use of legal opinion when assessing enforceability of right to payment

In some cases, an entity may have an apparent right to payment described in its contract with the customer, or under a relevant law or regulation, but there may be uncertainty over whether the right is enforceable. This may be the case when there is no legal precedent for the enforceability of the entity’s right.

For example, in a rising property market an entity may choose not to enforce its right to payment in the event of customer default, because it prefers to recover the property and resell it at a higher price. A practice of not enforcing an apparent right to payment may result in uncertainty over whether the contractual right remains enforceable.

In such cases, an entity may need a legal opinion to help it assess whether it has an enforceable right to payment. However, all facts and circumstances need to be considered in assessing how much weight (if any) to place on the legal opinion.

This may include an assessment of:

  • the quality of the opinion – i.e. how strong are the legal arguments that support it;
  • whether there are conflicting opinions provided by different legal experts; and
  • whether there are conflicting legal precedents for similar cases.

Agreements for the construction of real estate may have different patterns of transfer of control

Applying the criteria to real estate contracts may result in different conclusions on the pattern of transfer of control, depending on the relevant facts and circumstances of each contract. For example, the terms of some real estate contracts may prohibit an entity from transferring an asset to another customer and require the customer to pay for performance completed to date (therefore meeting Criterion 3).

However, other real estate contracts that create an asset with no alternative use may only require a customer to make an up-front deposit, and therefore would not provide the entity with an enforceable right to payment for its performance completed to date (therefore failing to meet Criterion 3).

3 Measuring progress toward complete satisfaction of a performance obligation

3.1 Selecting a method to measure progress

For each performance obligation that is satisfied over time, an entity applies a single method of measuring progress toward complete satisfaction of the obligation. The objective is to depict the transfer of control of the goods or services to the customer. To do this, an entity selects an appropriate output or input method. It then applies that method consistently to similar performance obligations and in similar circumstances. [IFRS 15.39–43, IFRS 15.B15–B19]

Method

Description

Examples

Output Step 5 Recognise the revenue Step 5 Recognise the revenue

Based on direct measurements of the value to the customer of goods or services transferred to date, relative to the remaining goods or services promised under the contract

  • Surveys of performance to date
  • Appraisals of results achieved
  • Milestones reached
  • Time elapsed

Input Step 5 Recognise the revenue Step 5 Recognise the revenue

Based on an entity’s efforts or inputs toward satisfying a performance obligation, relative to the total expected inputs to the satisfaction of that performance obligation Step 5 Recognise the revenue Step 5 Recognise the revenue Step 5 Recognise the revenue

  • Resources consumed
  • Costs incurred
  • Time elapsed
  • Labor hours expended
  • Machine hours used

As a practical expedient, if an entity has a right to invoice a customer at an amount that corresponds directly with its performance to date, then it can recognize revenue at that amount. For example, in a services contract an entity may have the right to bill a fixed amount for each unit of service provided. [IFRS 15.B16]

If an entity’s performance has produced a material amount of work in progress or finished goods that are controlled by the customer, then output methods such as units-of-delivery or units-of-production as they have been historically applied may not faithfully depict progress. This is because not all of the work performed is included in measuring the output. [IFRS 15.B15, IFRS 15.BC165]

If an input method provides an appropriate basis to measure progress and an entity’s inputs are incurred evenly over time, then it may be appropriate to recognize revenue on a straight-line basis. [IFRS 15.B18]

However, there may not be a direct relationship between an entity’s inputs and the transfer of control. Therefore, an entity that uses an input method considers the need to adjust the measure of progress for uninstalled goods and significant inefficiencies in the entity’s performance that were not reflected in the price of the contract – e.g. wasted materials, labor, or other resources (see Adjusting the measure of progress).

For example, if the entity transfers to the customer control of a good that is significant to the contract but will be installed later, and if certain criteria are met, then the entity recognizes the revenue on that good at zero margin. [IFRS 15.B19]

An entity recognizes revenue over time only if it can reasonably measure its progress toward complete satisfaction of the performance obligation. However, if the entity cannot reasonably measure the outcome but expects to recover the costs incurred in satisfying the performance obligation, then it recognizes revenue to the extent of the costs incurred. [IFRS 15.44–45]

Determining which measure of progress to apply is not a free choice

IFRS 15 requires an entity to select a method that is consistent with the objective of depicting its performance. An entity therefore does not have a free choice of which method to apply to a given performance obligation – it needs to consider the nature of the good or service that it promised to transfer to the customer. [IFRS 15.BC159]

IFRS 15 also provides examples of circumstances in which a particular method does not faithfully depict performance – e.g. it states that units-of- production may not be an appropriate method when there is a material amount of work in progress. Judgment is required when identifying an appropriate method of measuring progress.

When evaluating which method depicts the transfer of control of a good or service, the entity’s ability to apply that method reliably may also be relevant. For example, the information required to use an output method may not be directly observable or may require undue cost to obtain – in these circumstances, an input method may be appropriate.

Single method of measuring progress is used for a performance obligation

Under IFRS 15 an entity applies a single method of measuring progress for each performance obligation. This may be difficult when a single performance obligation contains multiple promised goods or services that will be transferred over different periods of time. For example, this might occur when a performance obligation combines a license and a service arrangement, or a sale of goods and design or installation services.

Significant judgment may be required in some circumstances, and understanding the nature of its overall promise to the customer is key for the entity to select a reasonable measure of progress.

If the determination of a single method of progress is challenging, then an entity may need to re-consider the assessment of performance obligations and whether there are multiple distinct performance obligations. However, just because the identification of a single measure of progress is challenging does not necessarily mean that the promised goods or services are not a single performance obligation.

Consideration does not need to be a fixed amount per unit to recognize revenue at the amount that the entity has a right to invoice

As a practical expedient, an entity may recognize revenue using the amount that it has the right to invoice, if this amount directly corresponds with the value that is transferred to the customer. The amount that the entity has the right to invoice does not need to be based on a fixed amount per unit for this practical expedient to be applied. [IFRS 15.B16]

The determination of whether the invoice amount represents the value to the customer may be more difficult in scenarios with multiple performance obligations or where the fixed amount per unit changes over time. This might occur with contracts that have declining unit prices, rates with forward market curves, rates with contractual minimums, or contracts with volume rebates. In these cases, judgment is required to determine whether the changes in pricing are in response to a change in the underlying value to the customer.

If a contract includes fixed fees in addition to per-unit invoicing, substantive contractual minimums or payments to the customer such as rebates, discounts or signing bonuses, then the use of the practical expedient may be precluded because they cause the invoiced amounts not to correspond to the value that the customer receives. Further, to apply the practical expedient to a contract, all goods and services in the contract need to qualify.

Certain sales agent arrangements may be over time

Generally, when the entity is acting as a sales agent for a customer the entity satisfies its promise at a point in time. This is because the activities performed by the agent before sale typically do not transfer a good or service to a customer. If the customer receives any benefit from the entity’s activities, then that benefit is limited unless the sale is completed.

However, there may be sales agent arrangements that provide benefits to the customer over time before a sale is completed. For example, assume that an entity receives a significant non-refundable fee at the time of listing and a relatively smaller commission fee when a sale is completed. The large non- refundable up-front fee indicates that the entity is providing the customer with a listing service and the customer is benefiting from that service over time. In this example, the entity estimates the commission fee following the guidance on variable consideration.

Judgment and evaluation of the facts will be necessary to determine whether a good or service is being transferred before the sale is completed.

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

Judgment is required to determine an appropriate measure of progress for a stand-ready obligation. When making the judgment, 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. [IFRS 15.26(e), IFRS 15.IE92–IE94, IFRS 15.BC160]

In many cases, a straight-line measure of progress will be appropriate for recognizing 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 recognized on a straight- line basis because the pattern of benefit to the customer as well as the entity’s efforts to fulfill 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 fulfill the contract, would not generally be even throughout the year, because snow is only expected in the winter.

Milestone method may not depict pattern of performance

If control transfers to the customer over time, then the measure of progress should reflect this. Although IFRS 15 lists milestones as an example of a possible measure of progress when using an output method, it remains necessary to consider whether milestones faithfully depict performance, particularly if the milestones are widely spaced.

This is because control generally transfers continuously as the entity performs rather than at discrete points in time. Normally, a milestone method would need to incorporate a measure of progress between milestone achievements to faithfully depict an entity’s performance.

Work in progress for an over-time performance obligation is generally expensed as a fulfillment cost when it is incurred because control of the work in progress transfers to the customer as it is produced and not at discrete intervals. However, inventory to support multiple contracts that has an alternative use is recognized as an asset until it is dedicated to a specific contract.

A performance obligation may be partially satisfied before the contract is identified

Entities sometimes start to perform before:

In these cases, if the work completed to date has no alternative use and the performance obligation meets the criteria for revenue to be recognized over time, then the entity recognizes a cumulative catch-up adjustment at the date on which the Step 1 criteria are met. This is because under IFRS 15 an entity recognizes revenue based on progress toward complete satisfaction of the performance obligation. Therefore, because the entity has already partially satisfied the performance obligation, it recognizes revenue to reflect that performance.

For example, if a developer sells an apartment to a customer when the apartment is 20 percent complete and the contract meets the criteria to recognize revenue over time, then the developer would recognize 20 percent of its revenue under the contract on the date on which the contract is signed.

Additionally, fulfillment costs incurred before the existence of the contract that are not in the scope of another standard (e.g. inventory) would be capitalized as costs to fulfill an anticipated contract when the capitalization criteria are met (see contract costs in the link). These costs are expensed immediately at the date on which the Step 1 criteria are met if they relate to progress made to date on goods or services already deemed to have transferred to the customer at that date.

3.2 Limitations on applying the units-of-delivery or units-of-production methods

An output method may not provide a faithful depiction of performance if the output method selected fails to measure some of the goods or services for which control has transferred to the customer. [IFRS 15.B15]

For example, if at the reporting date an entity’s performance has produced work in progress or finished goods that are controlled by the customer, then using an output method based on units produced or units delivered as it has been applied historically would distort the entity’s performance. This is because it would not recognize revenue for the assets that are created before delivery or before production is complete but that are controlled by the customer.

Design and production services – A units-of-delivery method or a units-of- production method may not be appropriate

A units-of-delivery or units-of-production method may not be appropriate if the contract provides both design and production services and they represent a single performance obligation, because in this case each item produced or delivered may not transfer an equal amount of value to the customer. These contracts are common, for example, in the aerospace and defense, contract manufacturing, engineering, and construction industries.

The clarifications provided in IFRS 15 on when certain methods for measuring progress may not be appropriate emphasize the need for an entity to consider its facts and circumstances and select the method that depicts its performance and the transfer of control of the goods or services to the customer.

3.3 Adjusting the measure of progress

An entity applying an input method excludes the effects of any inputs that do not depict its performance in transferring control of goods or services to the customer. In particular, when using a cost-based input method – e.g. cost-to-cost – an adjustment to the measure of progress may be required when an incurred cost: [IFRS 15.B19]

  • does not contribute to an entity’s progress in satisfying the performance obligation – e.g. unexpected amounts of wasted materials, labor, or other resources (these costs are expensed as they are incurred); or
  • is not proportionate to the entity’s progress in satisfying the performance obligation – e.g. uninstalled materials.

For uninstalled materials, a faithful depiction of performance may be for the entity to recognize revenue only to the extent of the cost incurred – i.e. at a zero percent profit margin – if, at contract inception, the entity expects all of the following conditions to be met:

  • the good is not distinct; Step 5 Recognise the revenue
  • the customer is expected to obtain control of the good significantly earlier than it receives services related to the good;
  • the cost of the transferred good is significant relative to the total expected costs to completely satisfy the performance obligation; and
  • the entity is acting as the principal, but procures the good from a third party and is not significantly involved in designing and manufacturing the good.

Worked example – Treatment of uninstalled materials

[IFRS 15.IE95–IE100 Example 19]

In November 2019, Contractor P enters into a lump-sum contract with Customer Q to refurbish a three-story building and install new elevators for total consideration of 5,000. The following facts are relevant.

  • The refurbishment service, including the installation of elevators, is a single performance obligation that is satisfied over time.
  • Contractor P is not involved in designing or manufacturing the elevators, but is acting as the principal. Customer C obtains control of the elevators when they are delivered to the site in December 2019.
  • The elevators are not expected to be installed until June 2020.
  • Contractor P uses an input method based on costs incurred to measure its progress toward complete satisfaction of the performance obligation.

The transaction price and expected costs are as follows.

Transaction price Step 5 Recognise the revenue

5,000

Costs Step 5 Recognise the revenue

– Elevators Step 5 Recognise the revenue

1,500

– Other costs Step 5 Recognise the revenue

2,500

Total expected costs Step 5 Recognise the revenue

4,000

Contractor P concludes that including the costs of procuring the elevators in the measure of progress would overstate the extent of its performance.

Consequently, it adjusts its measure of progress to exclude these costs from the costs incurred and from the transaction price, and recognizes revenue for the transfer of the elevators at a zero margin.

By December 31, 2019, other costs of 500 have been incurred (excluding the elevators) and Contractor P therefore determines that its performance is 20% complete (500 ÷ 2,500). Consequently, it recognizes revenue of 2,200 (20% x 3,500(a) + 1,500) and costs of 2,000 (500 + 1,500).

Note Step 5 Recognise the revenue Step 5 Recognise the revenue

a. Calculated as the transaction price of 5,000 less the cost of the elevators of 1,500.

No guidance on the timing and pattern of the recognition of margin on uninstalled materials

An entity may be entitled to a margin on the uninstalled goods that is clearly identified in the contract terms or forms part of the overall transaction price. IFRS 15 does not provide guidance on the timing of recognition for this margin – i.e. whether it is recognized when the materials are installed, or incorporated into the revenue recognition calculation for the remainder of the contract – or whether the costs are excluded when a measure of progress based on input costs is used.

The Boards believe that recognizing a contract-wide profit margin before the goods are installed could overstate the measure of the entity’s performance and, therefore, revenue. However, requiring an entity to estimate a profit margin that is different from the contract-wide profit margin could be complex and could effectively create a performance obligation for goods that are not distinct (therefore bypassing the requirements on identifying performance obligations). [IFRS 15.BC171]

The adjustment to the cost-to-cost measure of progress for uninstalled materials is generally intended to apply to a subset of goods in a construction-type contract – i.e. only to those goods that have a significant cost relative to the contract and only if the entity is essentially providing a simple procurement service to the customer.

Judgment will be required in determining whether a customer is obtaining control of a good ‘significantly’ before receiving services related to the good. In the worked example ‘Treatment of uninstalled materials above, it is unclear whether the same guidance would apply if the elevators were expected to be installed in January 2020 instead of June 2020.

No detailed guidance on identifying inefficiencies and wasted materials

Generally, some level of inefficiency, rework, or overrun is assumed in a service or construction contract and an entity contemplates these in the arrangement fee. Although IFRS 15 specifies that unexpected amounts of wasted materials, labor, or other resources should be excluded from a cost-to-cost measure of progress, it does not provide additional guidance on how to identify unexpected costs. Judgment is therefore required to distinguish normal wasted materials or inefficiencies from those that do not depict progress toward completion. [IFRS 15.BC176–BC178]

3.4 Reasonable measures of progress

In order to recognize revenue, an entity needs to have a reasonable basis to measure its progress. An entity may not be able to measure its progress if reliable information required to apply an appropriate method is not available. [IFRS 15.44]

If an entity cannot reasonably measure its progress, but nevertheless expects to recover the costs incurred in satisfying the performance obligation, then it recognizes revenue only to the extent of the costs incurred until it can reasonably measure the outcome. [IFRS 15.45]

4 Performance obligations satisfied at a point in time

If a performance obligation is not satisfied over time, then an entity recognizes revenue at the point in time at which it transfers control of the good or service to the customer. IFRS 15 includes indicators of when the transfer of control occurs. [IFRS 15.38]

Step 5 Recognise the revenue

Relevant considerations include the following.

  • In some cases, possession of legal title is a protective right and may not coincide with the transfer of control of the goods or services to a customer – e.g. when a seller retains title solely as protection against the customer’s failure to pay.
  • In consignment arrangements (see consignment arrangements in the link) and some repurchase arrangements (see repurchase agreements in the link), an entity may have transferred physical possession but still retain control. Conversely, in bill-and-hold arrangements (see bill-and-hold arrangements in the link) an entity may have physical possession of an asset that the customer controls.
  • When evaluating the risks and rewards of ownership, an entity excludes any risks that give rise to a separate performance obligation in addition to the performance obligation to transfer the asset.
  • An entity needs to assess whether it can objectively determine that a good or service provided to a customer conforms to the specifications agreed in a contract (see customer acceptance below).

Judgment may be required to determine the point in time at which control transfers

The indicators of transfer of control are factors that are often present if a customer has control of an asset; however, they are not individually determinative, nor are they a list of conditions that have to be met. IFRS 15 does not suggest that certain indicators should be weighted more heavily than others, nor does it establish a hierarchy that applies if only some of the indicators are present. However, it remains possible that in some facts and circumstances certain indicators will be more relevant than others and so carry greater weight in the analysis. [IFRS 15.BC155]

Judgment may be required to determine the point in time at which control transfers. This determination may be particularly challenging when there are indicators that control has transferred alongside ‘negative’ indicators suggesting that the entity has not satisfied its performance obligation.

Potential challenges existing in determining the accounting for some delivery arrangements

Revenue is not recognized if an entity has not transferred to the customer the significant risks and rewards of ownership. For product sales, the risks and rewards are generally considered to be transferred when a product is delivered to the customer’s site – i.e. if the terms of the sale are ‘free-on-board’ (FOB) destination, then legal title to the product passes to the customer when the product is handed over to the customer. When a product is shipped to the customer FOB shipping point, legal title passes and the risks and rewards are generally considered to have transferred to the customer when the product is handed over to the carrier.

An example of a delivery arrangement that may result in a different approach of recognition is when an entity ships a product FOB shipping point, but the seller has a historical business practice of providing free replacements of that product or waiving its invoice if the products are damaged in transit (commonly referred to as a ‘synthetic FOB destination arrangement’).

If the entity concludes that transfer of control has occurred when the product is shipped, then under IFRS 15, an entity also considers whether its business practices give rise to a separate performance obligation in addition to the performance obligation to transfer the product itself– i.e. a stand-ready obligation to cover the risk of loss if goods are damaged in transit. If a separate performance obligation is identified, then only the revenue allocated to the sale of the goods is recognized at the shipping date.

An entity will need to evaluate the facts and circumstances and apply judgment to determine whether the lack of transfer of the significant risks and rewards of ownership of an asset results in a conclusion that either:

Indirect channels and sell-in versus sell-through

Many entities sell through distributors and resellers. These transactions will require judgment to determine if the transfer of control occurs upon delivery to the intermediary (sell-in model) or when the good is resold to the end customer (sell-through model). Entities need to consider the guidance on consignment sales (see consignment arrangements in the link) and variable consideration (see variable consideration (and the constraint) in the link to step 3 to determine which model is appropriate.

5 Customer acceptance

To determine the point in time at which a customer obtains control for point-in-time performance obligations (and therefore the performance obligations are satisfied), an entity considers several indicators of the transfer of control, including whether the customer has accepted the goods or services. [IFRS 15.38(e)]

Customer acceptance clauses included in some contracts are intended to ensure the customer’s satisfaction with the goods or services promised in the contract. The table below illustrates examples of customer acceptance clauses. [IFRS 15.B83]

Event

Acceptance evaluation

Examples

If the entity can objectively verify that the goods or services comply with the specifications underlying acceptance

Then customer acceptance would normally be a formality, and revenue could be recognised before explicit acceptance

The customer acceptance clause is based on meeting objective size and weight specifications

If the entity cannot objectively determine whether the specifications have been met

Then it is unlikely that the entity would be able to conclude that the customer has obtained control before formal customer acceptance

The customer acceptance clause is based on a modified product functioning in the customer’s new production line

If the entity delivers for trial or evaluation purposes and the customer is not committed to pay any consideration until the trial period lapses

Then control of the product is not transferred to the customer until either the customer (formally) accepts the product or the trial period lapses

The customer acceptance clause specifies that the customer may use prototype equipment for a specific period of time

An entity’s experience with similar contracts may provide evidence that goods or services transferred to the customer are based on the agreed specifications. [IFRS 15.B84]

For further discussion on the accounting for consignment arrangements that may have attributes similar to customer acceptance clauses, see consignment arrangements in the link.

6 Other topics

Other topics in Step 5 discussed in the below links are:

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Something else -   Determining when promises are performance obligations

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