The five contract identification criteria

The five contract identification criteria – These criteria are part of the first step in the application of the core principle in IFRS 15.  IFRS 15 9 Revenue from Contracts with Customers is applied to contracts with customers that meet all of the following five contract identification criteria (contract existence):Construction contract modifications Construction contract modifications

  • The contract has been approved in writing, orally, or in accordance with other customary business practices and the parties are committed to perform their obligations in the contract;
  • Each party’s rights regarding the goods or services to be transferred can be identified; The five contract identification criteria
  • The payment terms for the goods or services to be transferred can be identified; The five contract identification criteria
  • The contract has commercial substance (i.e. the risk, timing or amount of the vendor’s future cash flows is expected to change as a result of the contract);
  • It is probable that the consideration for the exchange of the goods or services that the vendor is entitled to will be collected. For the purposes of this criterion, only the customer’s ability and intention to pay amounts when they become due are considered. The five contract identification criteria

In making the collectability assessment, an entity considers the customer’s ability and intention (which includes assessing its credit-worthiness) to pay the amount of consideration when it is due. This assessment is made after taking into account any price concessions that the entity may offer to the customer (IFRS 15 9(e))

Example – Assessing the existence of a contract: Sale of real estate

In an agreement to sell real estate, Seller X assesses the existence of a contract. In making this assessment, X considers factors such as:Contract modifications Contract modifications Contract modifications

  • the buyer’s available financial resources; The five contract identification criteria
  • the buyer’s commitment to the contract, which may be determined based on the importance of the property to the buyer’s operations;
  • X’s prior experience with similar contracts and buyers under similar circumstances; The five contract identification criteria
  • X’s intention to enforce its contractual rights; The five contract identification criteria
  • the payment terms of the arrangement; and The five contract identification criteria
  • whether X’s receivable is subject to future subordination. The five contract identification criteria

If X concludes that it is not probable that it will collect the amount to which it expects to be entitled, then a contract to transfer control of the real estate does not exist. Instead, X applies the guidance on consideration received before concluding that a contract exists, and initially accounts for any cash collected as a deposit (liability).

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IFRS 15 Revenue from Contracts with Customers established a single and comprehensive framework which sets out how much revenue is to be recognised, and when. The core principle is that a vendor should recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the vendor expects to be entitled in exchange for those goods or services. The five contract identification criteria

QualityExample – A vendor sells a product to a customer in return for a contractually agreed amount of CU 1 million. This is the vendor’s first sale to a customer in the geographic region, and the region is experiencing significant economic difficulty. The vendor therefore expects that it will not be able to collect the full amount of the contract price. Despite the fact that it may not collect the full amount, the vendor believes that economic conditions in the region will improve in future. It also considers that establishing a trading relationship with this customer could help it to open up a new market with other potential customers in the region. The five contract identification criteria

This means that instead of the contract price being fixed at CU 1 million, the amount of promised consideration is variable. The vendor assesses the customer’s intention and ability to pay and, based on the facts and circumstances and taking into account the poor economic conditions, it is concluded that it is probable that it will be entitled to an estimated amount of CU 500,000 and that the customer will pay this amount.

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Assuming that the other four criteria set out above are met, the vendor concludes that it has entered into a contract for the sale of the product in return for variable consideration of CU 500,000.

The five contract identification criteria

The five contract identification criteria

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