IFRS 15 Pre-Contract Establishment Date activities – Important to know

Pre-Contract Establishment Date activities

or

Partially Satisfied Performance Obligations Before the Identification of a Contract

Entities sometimes begin activities on a specific anticipated contract with their customer before (1) the parties have agreed to all of the contract terms or (2) the contract meets the criteria in step 1 (see Step 1 Identify the contract) of IFRS 15. The IASB staff refer to the date on which the contract meets the step 1 criteria as the “contract establishment date” (CED) and refer to activities performed before the CED as “pre-CED activities.”

TRG Update — Pre-CED Activities

The FASB and IASB staffs noted that stakeholders have identified two issues with respect to pre-CED activities:

  • How to recognize revenue from pre-CED activities.
  • How to account for certain fulfillment costs incurred before the CED.

The TRG discussed these issues in March 2015.

TRG members generally agreed with the staffs’ conclusion that once the criteria in step 1 have been met, entities should recognize revenue for pre-CED activities on a cumulative catch-up basis (i.e., record revenue as of the CED for all satisfied or partially satisfied performance obligations) rather than prospectively because cumulative catch-up is more consistent with the new revenue standard’s core principle.

The two Q&A below demonstrates the application of the TRG’s general agreement.

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Focus definition or best trends in IFRS reporting based on IAS 1

To demonstrate what companies could do to improve the readability of their financial report and make it easier for users to find the information they need, here are some thoughts for changing your financial report. In particular:

  • Information is organised to clearly tell the story of financial performance and make critical information more prominent and easier to find.
  • Additional information is included where it is important for an understanding of the performance of the company.

For example, include a summary of significant transactions and events as the first note to the financial statements even though this is not a required disclosure.

Accounting policies that are significant and specific to the entity are disclosed along with other relevant information, in the section ‘How did we arrive at these numbers?’ While other accounting policies are listed in note 25, this is for completeness purposes. Entities should consider their own individual circumstances and only include policies that are relevant to their financial statements.

The structure of financial reports should reflect the particular circumstances of the company and the likely priorities of its report readers. There is no ‘one size fits all’ approach and companies should engage with their investors to determine what would be most relevant to them. The structure used in this publication is not meant to be used as a template, but to provide you with possible ideas. It will not necessarily be suitable for all companies.

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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.

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Electricity revenue recognition example

Electricity revenue recognition example

Application of the five-step model

Facts: Bundle Seller Co (‘Seller’) and Bundle Buyer Co (‘Buyer’) executed an agreement for the purchase and sale of 1oMW of electricity per hour and the associated renewable energy credits (‘RECs’) (one REC for each MWh) at a fixed bundled price (‘the agreement’ or ‘the PPA’). The contract term begins on 1 January 20X1 and ends on 31 December 20X4, and the fixed bundled price during each of those respective years is $200, $205, $210 and $215.

The increase in the bundled price represents the increase in the forward price of electricity and RECs over the term of Electricity revenue recognition examplethe agreement as of the acquisition date. Control, including title to and risk of loss related to the electricity, will pass and transfer on delivery at a single point on the electricity grid. Control, including title to and risk of loss related to RECs, will pass and transfer when the associated electricity is delivered.

Seller and other market participants frequently execute contracts for the purchase and sale of electricity and RECs on a stand-alone basis.

Seller concluded that this arrangement does not contain a lease (that is, no property, plant or equipment is explicitly or implicitly identified). The electricity element of this arrangement qualifies for the ‘own use’ exception and thus is not accounted for as a derivative. The REC element has no net settlement characteristics. As such, each element of this agreement is within the scope of IFRS 15.

Electricity revenue recognition – IFRS 15 step-by-step

Step 1 – Identify the contract with a customer

This agreement, including each of its elements (that is, electricity and RECs), is within the scope of the standard, and collection of the contract consideration is considered probable.

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Blockchain – Best 2 accounting for IFRS

Blockchain accounting for IFRS

Holdings of cryptocurrencies allow individuals and businesses to transact directly with each other without an intermediary such as a bank or other financial institution. These cryptocurrency transactions rely on a key technology called blockchain technology.

Digital assets or so-called cryptoassets are becoming increasingly common but what are they and how might you record them in your financial statements?

Holding cryptocurrencies – e.g. Bitcoin, Ether etc

What are the characteristics?

  • Cryptocurrencies – e.g. Bitcoin and Ether – typically exhibit some similarities to traditional currencies in that they can be traded for goods or services. They can also be held as a longer-term investment or for trading or speculation. But IFRIC and other commentators do not consider current cryptocurrencies to be cash or currency because:

    • they are a poor store of value, because their value is based on demand and supply and is highly volatile;

    • they are not sufficiently widely accepted as a medium of exchange; and

    • they are not issued by a central bank.

  • With cryptocurrencies also failing to meet the definition of a financial asset, the question is, what type of asset are they?

How might they impact your financial statements?

  • Because of their high volatility in value, many believe that cryptocurrencies are akin to derivatives and should be measured at fair value through profit or loss (FVTPL). However, IFRIC’s tentative conclusions on accounting for cryptocurrencies do not support this approach.

  • IFRIC proposes that cryptocurrencies are generally intangible assets under IAS 38 Intangible Assets – i.e. non-monetary items with no physical substance that convey economic benefits to the holder.

  • Measurement would be at cost – or potentially at fair value with movements through other comprehensive income (OCI) if, and only if, there is an active market.

  • If the cryptocurrency is held for sale in the normal course of business – e.g. if you are a broker-trader (see below) – then IAS 38 does not apply and, instead, IFRIC proposes that the cryptocurrency would be accounted for as inventory under IAS 2 Inventory.

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Example accounting policies

Example accounting policies

Get the requirements for properly disclosing the accounting policies to provide the users of your financial statements with useful financial data, in the common language prescribed in the world’s most widely used standards for financial reporting, the IFRS Standards. First there is a section providing guidance on what the requirements are, followed by a comprehensive example, easy to tailor to the specific needs of your company.Example accounting policies

Example accounting policies guidance

Whether to disclose an accounting policy

1. In deciding whether a particular accounting policy should be disclosed, management considers whether disclosure would assist users in understanding how transactions, other events and conditions are reflected in the reported financial performance and financial position. Disclosure of particular accounting policies is especially useful to users where those policies are selected from alternatives allowed in IFRS. [IAS 1.119]

2. Some IFRSs specifically require disclosure of particular accounting policies, including choices made by management between different policies they allow. For example, IAS 16 Property, Plant and Equipment requires disclosure of the measurement bases used for classes of property, plant and equipment and IFRS 3 Business Combinations requires disclosure of the measurement basis used for non-controlling interest acquired during the period.

3. In this guidance, policies are disclosed that are specific to the entity and relevant for an understanding of individual line items in the financial statements, together with the notes for those line items. Other, more general policies are disclosed in the note 25 in the example below. Where permitted by local requirements, entities could consider moving these non-entity-specific policies into an Appendix.

Change in accounting policy – new and revised accounting standards

4. Where an entity has changed any of its accounting policies, either as a result of a new or revised accounting standard or voluntarily, it must explain the change in its notes. Additional disclosures are required where a policy is changed retrospectively, see note 26 for further information. [IAS 8.28]

5. New or revised accounting standards and interpretations only need to be disclosed if they resulted in a change in accounting policy which had an impact in the current year or could impact on future periods. There is no need to disclose pronouncements that did not have any impact on the entity’s accounting policies and amounts recognised in the financial statements. [IAS 8.28]

6. For the purpose of this edition, it is assumed that RePort Co. PLC did not have to make any changes to its accounting policies, as it is not affected by the interest rate benchmark reforms, and the other amendments summarised in Appendix D are only clarifications that did not require any changes. However, this assumption will not necessarily apply to all entities. Where there has been a change in policy, this will need to be explained, see note 26 for further information.

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Startup valuation

Startup valuation

If every business starts with an idea, young companies can range the spectrum. Some are unformed, at least in a commercial sense, where the owner of the business has an idea that he or she thinks can fill an unfilled need among consumers.

Others have inched a little further up the scale and have converted the idea into a commercial product, albeit with little to show in terms of revenues or earnings. Still others have moved even further down the road to commercial success, and have a market for their product or service, with revenues and the potential, at least, for some profits.

Startup valuationSince young companies tend to be small, they represent only a small part of the overall economy. However, they tend to have a disproportionately large impact on the economy for several reasons.

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The Statement of Cash Flows

Statement of Cash Flows

IAS 7.10 requires an entity to analyse its cash inflows and outflows into three categories:

  • Operating;
  • Investing; and
  • Financing.

IAS 7.6 defines these as follows:

Operating activities are the principal revenue producing activities of the entity and other activities that are not investing or financing activities.’

Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.’

Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.’

1. Operating activities

It is often assumed that this category includes only those cash flows that arise from an entity’s principal revenue producing activities.

However, because cash flows arising from operating activities represents a residual category, which includes any cashStatement of cash flows flows that do not qualify to be recorded within either investing or financing activities, these can include cash flows that may initially not appear to be ‘operating’ in nature.

For example, the acquisition of land would typically be viewed as an investing activity, as land is a long-term asset. However, this classification is dependent on the nature of the entity’s operations and business practices. For example, an entity that acquires land regularly to develop residential housing to be sold would classify land acquisitions as an operating activity, as such cash flows relate to its principal revenue producing activities and therefore meet the definition of an operating cash flow.

2. Investing activities

An entity’s investing activities typically include the purchase and disposal of its intangible assets, property, plant and equipment, and interests in other entities that are not held for trading purposes. However, in an entity’s consolidated financial statements, cash flows from investing activities do not include those arising from changes in ownership interest of subsidiaries that do not result in a change in control, which are classified as arising from financing activities.

It should be noted that cash flows related to the sale of leased assets (when the entity is the lessor) may be classified as operating or investing activities depending on the specific facts and circumstances.

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Bill-and-hold arrangements in IFRS 15

Bill-and-hold arrangements

Bill-and-hold arrangements occur when an entity bills a customer for a product that it transfers at a point in time, but retains physical possession of the product until it is transferred to the customer at a future point in time. This might occur to accommodate a customer’s lack of available space for the product or delays in production schedules. [IFRS 15.B79]

To determine when to recognize revenue, an entity needs to determine when the customer obtains control of the product. Generally, this occurs at shipment or delivery to the customer, depending on the contract terms (for discussion of the indicators for transfer of control at a point in time, see Performance obligations satisfied at a point in time from Step 5 IFRS 15 in the link). The new standard provides criteria that have to be met for a customer to obtain control of a product in a bill-and-hold arrangement. These are illustrated below. [IFRS 15.B80–B81]

Bill-and-hold arrangements

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