IFRS 15 Revenue from Contracts with Customers (contents page is here) introduced 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. See a summary of IFRS 15 here.
Contracts with customers generally state explicitly the goods or services that an entity promises to transfer to a customer. However, promised goods or services in a contract may also be implied by an entity’s customary business practices, published policies, or specific statements if those promises create a reasonable expectation of the customer that the entity will transfer a good or service to the customer. It should be noted that entities are not required to assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer.
Below are examples of promises that, depending on the contract, could be considered performance obligations under IFRS 15:
- Sale of goods produced by an entity (e.g. inventory of a manufacturer),
- Resale of goods purchased by an entity (e.g. merchandise of a retailer),
- Resale of rights to goods or services purchased by an entity (e.g. a ticket resold by an entity acting as a principal),
- Performing a contractually agreed-upon task (or tasks) for a customer,
- Standing ready to provide goods or services (e.g. unspecified updates to software that are provided on a when and if available basis),
- Providing a service of arranging for another party to transfer goods or services to a customer (for example, acting as an agent of another party)
- Constructing, manufacturing, or developing an asset on behalf of a customer (e.g. building an asset for the specifications of a customer),
- Granting licenses or rights to use intangible assets,
- Granting options to purchase additional goods or services (when those options provide the customer with a material right),
- Granting rights to goods or services to be provided in the future that the customer can resell or provide to its customer.
An option to purchase additional goods or services to a customer is a separate performance obligation if it constitutes a material right beyond a marketing offer. IFRS 15 contains specific guidance on how to make this determination which is based on assessing whether that customer has acquired a right to purchase a good or service at a price that it otherwise wouldn’t have been entitled to absent entering into the contract. This is tested by comparing the option price to the standalone selling price of the good or service.
Whether or not shipping and handling activities are considered promised services to a customer depend on the terms. If the shipping and handling activities are performed before the customer obtains control of the good, then the shipping activities are not a promised service to the customer. Rather, they are considered fulfillment activities. If the shipping and handling activities are performed after a customer obtains control of the good, then the entity may elect to account for the activities as fulfillment costs vs as a separate performance obligation. The policy election should also be disclosed in the financial statement footnotes.
IFRS 15 states that activities that an entity must undertake to fulfill a contract, but do not transfer a good or service to a customer, do not represent performance obligations. Examples include the various administrative tasks that are needed to set up a contract.
The identification of each of the distinct goods or services in contracts may require a detailed analysis of contractual terms, and linkage to IFRS 15’s requirements on whether a promise in a contract is a distinct good or service (and hence constitutes a performance obligation), or needs to be combined (’bundled’) with other promises in the contract to create a single performance obligation. Subtle differences in contractual terms and conditions, as well as individual and facts and circumstances, can impact the analysis. The importance of appropriately identifying the performance obligations in a contract cannot be underestimated as they each form a separate ‘unit of account’ for the purposes of determining how much revenue should be recognised and when revenue should be recognised.