IFRS 15 Revenue from contracts with customers in the Telecommunications-industry main impact lies in the following areas:
- Significant Financing Component
- Non-refundable upfront fees
- Warranty or additional services
- Costs to obtain a contract
- Amortization of contract cost assets
However, here is a short overview (Revenue and the five-step model), followed by the discussion of the above mentioned financial events or transactions.
Many revenue transactions are straightforward, but some can be highly complex. For example, software arrangements, licenses of intellectual property, outsourcing contracts, barter transactions, contracts with multiple elements, and contracts with milestone payments can be challenging to understand. It might be difficult to determine what the entity has committed to deliver, how much and when revenue should be recognized.
Contracts often provide strong evidence of the economic substance, as parties to a transaction generally protect their interests through the contract. Amendments, side letters, and oral agreements, if any, can provide additional relevant information.
Other factors, such as local legal frameworks and business practices, should also be considered to fully understand the economics of the arrangement. An entity should consider the substance, not only the form, of a transaction to determine when revenue should be recognized.
The revenue standard provides principles that an entity applies to report useful information about the amount, timing, and uncertainty of revenue and cash flows arising from its contracts to provide goods or services to customers. The core principle requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration that it expects to be entitled to in exchange for those goods or services.
The five-step model
IFRS 15 includes a five-step model for recognizing revenue from contracts with customers:
Certain criteria must be met for a contract to be accounted for using the five-step model in the revenue standard. An entity must assess, for example, whether it is “probable” it will collect the amounts it will be entitled to before the guidance in the revenue standard is applied.
A contract contains a promise (or promises) to transfer goods or services to a customer. A performance obligation is a promise (or a group of promises) that is distinct, as defined in the revenue standard. Identifying performance obligations can be relatively straightforward, such as an electronics store’s promise to provide a television. But it can also be more complex, such as a contract to provide a new computer system with a three-year software license, a right to upgrades, and technical support. Entities must determine whether to account for performance obligations separately, or as a group.
The transaction price is the amount of consideration an entity expects to be entitled to from a customer in exchange for providing the goods or services. A number of factors should be considered to determine the transaction price, including whether there is variable consideration, a significant financing component, noncash consideration, or amounts payable to the customer.
The transaction price is allocated to the separate performance obligations in the contract based on relative stand-alone selling prices. Determining the relative stand-alone selling price can be challenging when goods or services are not sold on a stand-alone basis. The revenue standard sets out several methods that can be used to estimate a stand-alone selling price when one is not directly observable. Allocating discounts and variable consideration must also be considered.
Revenue is recognized when (or as) the performance obligations are satisfied. The revenue standard provides guidance to help determine if a performance obligation is satisfied at a point in time or over time. Where a performance obligation is satisfied over time, the related revenue is also recognized over time.
Significant Financing Component
The objective when adjusting the promised amount of consideration for a significant financing component is that revenue recognized should reflect the “cash selling price” of the particular good or service at the time the good or service is transferred.
Contracts in which payment by the customer and performance by the entity occur at significantly different times will need to be assessed to determine whether the contract contains a significant financing component.
In assessing whether a significant financing component exists, IFRS 15 requires an assessment of the relevant facts and circumstances. Factors that should be considered in this assessment include both of the following:
- the difference, if any, between the amount of promised consideration and the cash selling price of the promised goods or services [IFRS 15.61(a)]; and
- the combined effect of both of the following [IFRS 15.61(b)]:
However, entities may still encounter a situation in which both the above factors exist (as per IFRS 15 Ex 29), but nevertheless may conclude that a significant financing component does not exist. In order for this to be the case, at least one of the following factors must be present:
- the customer paid for the goods or services in advance and the timing of the transfer of those goods or services is at the discretion of the customer (for example, in telecommunications, when a customer purchases a prepaid phone card) [IFRS 15.62(a)].
- a substantial amount of the consideration promised by the customer is variable and the amount or timing of that consideration varies on the basis of the occurrence or non-occurrence of a future event that is not substantially within the control of the customer or the entity (for example, if the consideration is a sales-based royalty) [IFRS 15.62(b)].
- the difference between the promised consideration and the cash selling price of the good or service arises for reasons other than the provision of finance to either the customer or the entity, and the difference between those amounts is proportional to the reason for the difference (for example, the payment terms might provide the entity or the customer with protection from the other party failing to adequately complete some or all of its obligations under the contract) [IFRS 15.62(c)].
Non-refundable upfront fees
Many contracts include non-refundable upfront fees such as joining fees (common in health club memberships, for example), activation fees (common in telecommunications contracts, for example), or other initial/set-up fees. An entity should assess whether the activities related to such fees satisfy a performance obligation. When those activities do not satisfy a performance obligation, because no good or service is transferred to the customer, none of the transaction price should be allocated to those activities. Rather, the upfront fee is included in the transaction price that is allocated to the performance obligations in the contract.
Warranty or additional services
Telecommunications enters into a contract with Customer to sell a smart phone and provide a one-year warranty against both manufacturing defects and customer-inflicted damages (for example, dropping the phone into water). The warranty cannot be purchased separately.
How should Telecommunications account for the warranty?
This arrangement includes the following goods or services: (1) the smart phone; (2) product warranty; and (3) repair and replacement service.
Telecommunications will account for the product warranty (against manufacturing defect) in accordance with other guidance on product warranties, and record an expense and liability for expected repair or replacement costs related to this obligation. Telecommunications will account for the repair and replacement service (that is, protection against customer-inflicted damages) as a separate performance obligation, with revenue recognized as that obligation is satisfied.
If Telecommunications cannot reasonably separate the product warranty and repair and replacement service, it should account for the two warranties together as a single performance obligation.
Costs to obtain a contract
Case – Incremental costs of obtaining a contract — Telecommunications industry
Telecommunications sells wireless mobile phone and other telecom service plans from a retail store. Sales agents employed at the store signed 120 customers to two-year service contracts in a particular month. Telecommunications pays its sales agents commissions for the sale of service contracts in addition to their salaries. Salaries paid to sales agents during the month were $12,000, and commissions paid were $2,400. The retail store also incurred $2,000 in advertising costs during the month.
How should Telecommunications account for the costs?
The only costs that qualify as incremental costs of obtaining a contract are the commissions paid to the sales agents. The commissions are costs to obtain a contract that Telecommunications would not have incurred if it had not obtained the contracts. Telecommunications should record an asset for the costs, assuming they are recoverable.
All other costs are expensed as incurred. The sales agents’ salaries and the advertising expenses are expenses Telecommunications would have incurred whether or not it obtained the customer contracts.
Amortization of contract cost assets
Amortization of contract cost assets — renewal periods without additional commission
Telecom sells prepaid wireless services to a customer. The customer purchases up to 1,000 minutes of voice services and any unused minutes expire at the end of the month. The customer can purchase an additional 1,000 minutes of voice services at the end of the month or once all the voice minutes are used. Telecom pays commissions to sales agents for initial sales of prepaid wireless services, but does not pay a commission for subsequent renewals. Telecom concludes the commission payment is an incremental cost of obtaining the contract and recognizes an asset.
What period should Telecom use to amortize the commission costs?
Telecom should amortize the costs to obtain the contract over 17 months in this example (the initial contract term and expected renewal periods). Management needs to use judgment to determine the period that the entity expects to provide services to the customer, including expected renewals, and amortize the asset over that period. In this fact pattern, Telecom cannot expense the commission payment under the practical expedient because the amortization period is greater than one year.
Amortization of contract cost assets — renewal periods with separate commission
Assume the same facts as in the above example, except Telecom also pays commissions to sales agents for renewals.
What period should Telecom use to amortize the commission costs?
Telecom should assess whether the commission paid on the initial contract relates only to the goods or services provided under the initial contract or to both the initial and renewal periods. If concludes the renewal commission is commensurate with the commission paid on the initial contract, this would indicate that the initial commission relates only to the initial contract and should be amortized over the initial contract period (unless Telecom elects to apply the practical expedient). The renewal commission would be amortized over the related renewal period.
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