IFRS 15 Revenue from Contracts with Customers - Summary

IFRS 15 Revenue from Contracts with Customers

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IFRS Summaries by Imad Uddin, FRM

Objective of IFRS 15

To establish the principles that an entity applies to report useful information to users of financial statements about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a contract with a customer.
Core Principle: Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

Scope

Applies To:

All contracts with customers.

Excludes:

Lease contracts within the scope of IFRS 16 Leases.
Insurance contracts within the scope of IFRS 17 Insurance Contracts.
Financial instruments and other contractual rights or obligations within the scope of IFRS 9 Financial Instruments, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IAS 27 Separate Financial Statements, and IAS 28 Investments in Associates and Joint Ventures.
Non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers.

Key Focus:

Applies only to contracts with customers. A customer is a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.
Collaboration arrangements or partnerships may not be with a 'customer' if the counterparty does not meet this definition.

5-Step Revenue Recognition Model

IFRS 15 introduces a comprehensive five-step model for revenue recognition:

Step Description
Step 1 Identify the contract(s) with a customer.
Step 2 Identify the performance obligations in the contract.
Step 3 Determine the transaction price.
Step 4 Allocate the transaction price to the performance obligations in the contract.
Step 5 Recognize revenue when (or as) the entity satisfies a performance obligation.

Step 1: Identify the Contract(s) with a Customer

Criteria for a Valid Contract (All must be met):

The contract has been approved by the parties to the contract (in writing, orally, or implied by customary business practices) and they are committed to perform their respective obligations.
The entity can identify each party's rights regarding the goods or services to be transferred.
The entity can identify the payment terms for the goods or services to be transferred.
The contract has commercial substance (i.e., the risk, timing or amount of the entity’s future cash flows is expected to change as a result of the contract).
It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services (considering customer's ability and intent to pay).
If criteria not met, consideration received is recognized as a liability until criteria are met or contract terminated and consideration non-refundable.

Combination of Contracts:

An entity shall combine two or more contracts entered into at or near the same time with the same customer (or related parties) and account for them as a single contract if one or more of the following criteria are met:
The contracts are negotiated as a package with a single commercial objective.
The amount of consideration to be paid in one contract depends on the price or performance of the other contract.
The goods or services promised in the contracts (or some goods or services promised in each contract) are a single performance obligation.

Step 2: Identify Performance Obligations

Definition:

A performance obligation is a promise in a contract with a customer to transfer to the customer either:
A good or service (or a bundle of goods or services) that is distinct; or
A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

Criteria for a Good or Service to be "Distinct":

A good or service is distinct if both of the following criteria are met:
The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer.
The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e., it is distinct within the context of the contract). Factors indicating not separately identifiable include significant integration, modification, or interdependency with other promised goods/services.
Examples: A software license might be distinct from installation services if the customer can use the license with other installation providers or if the installation doesn't significantly modify the software. If installation heavily customizes the software, they might be one PO.

Step 3: Determine the Transaction Price

The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services, excluding amounts collected on behalf of third parties (e.g., sales tax).

Components Affecting Transaction Price:

Component Explanation & Treatment
Fixed Consideration The amount explicitly stated in the contract.
Variable Consideration Consideration that can vary due to discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties, or other similar items. Estimate using either:
(a) Expected value (sum of probability-weighted amounts in a range); or
(b) Most likely amount (single most likely amount in a range).
Constraint: Include variable consideration only to the extent it is highly probable that a significant reversal in cumulative revenue recognized will not occur when uncertainty is resolved.
Significant Financing Component Adjust transaction price for the time value of money if the contract contains a significant financing component (benefit to either customer or entity). Discount rate should reflect credit characteristics of party receiving financing. Practical expedient: No adjustment if period between transfer and payment is ≤ 1 year.
Non-cash Consideration Measure at fair value at contract inception. If fair value cannot be reliably estimated, measure indirectly by reference to standalone selling price of goods/services promised.
Consideration Payable to Customer Account for as a reduction of the transaction price (and thus revenue), unless the payment is in exchange for a distinct good or service that the customer transfers to the entity. (E.g., slotting fees, cooperative advertising payments).

Step 4: Allocate the Transaction Price to Performance Obligations

Allocation Method:

Allocate the transaction price to each distinct performance obligation (identified in Step 2) in an amount that depicts the consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services for that specific PO.
Allocation is generally based on the relative standalone selling prices of each distinct good or service.

Estimating Standalone Selling Prices (if not directly observable):

Hierarchy of methods:
Adjusted market assessment approach: Evaluate the market and estimate price customers willing to pay.
Expected cost plus a margin approach: Forecast expected costs of satisfying PO and add appropriate margin.
Residual approach (limited use): Only if standalone selling price is highly variable or uncertain. Total transaction price less sum of observable standalone selling prices of other POs.

Allocating Discounts & Variable Consideration:

Allocate discounts proportionately to all POs unless evidence indicates discount relates specifically to one or more (but not all) POs.
Variable consideration may be attributable to the entire contract or specific POs. Allocate based on this assessment, subject to the constraint.

Step 5: Recognize Revenue

When to Recognize:

An entity recognizes revenue when (or as) it satisfies a performance obligation by transferring a promised good or service (an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset.

Indicators of Transfer of Control (Considered collectively):

Entity has a present right to payment for the asset.
Customer has legal title to the asset.
Entity has transferred physical possession of the asset.
Customer has the significant risks and rewards of ownership of the asset.
Customer has accepted the asset.

Methods for Recognizing Revenue:

Method Description & Criteria
Over Time Recognize revenue over time if ANY ONE of these criteria is met:
1. Customer simultaneously receives and consumes benefits as entity performs (e.g., routine cleaning services).
2. Entity's performance creates or enhances an asset (e.g., WIP) that the customer controls as the asset is created/enhanced (e.g., building on customer's land).
3. Entity's performance does not create an asset with alternative use to the entity, AND the entity has an enforceable right to payment for performance completed to date (e.g., constructing a specialized asset per customer specs).
Measure progress using output methods (e.g., milestones) or input methods (e.g., costs incurred).
Point in Time If a performance obligation is not satisfied over time, it is satisfied at a point in time. Revenue recognized when control transfers at that point (typically delivery for goods, completion for some services). Consider control indicators.

Contract Costs

Costs to Obtain a Contract:

Capitalize incremental costs of obtaining a contract (e.g., sales commissions) if the entity expects to recover those costs.
Costs that would have been incurred regardless (e.g., bid preparation costs unless specifically chargeable) are expensed. Practical expedient: expense if amortization period ≤ 1 year.

Costs to Fulfill a Contract:

If costs incurred in fulfilling a contract are not within scope of another standard (e.g., IAS 2, IAS 16), recognize an asset if costs meet ALL these criteria:
Directly relate to a contract or anticipated contract specifically identifiable.
Generate or enhance resources of the entity that will be used in satisfying POs in the future.
Are expected to be recovered.

Amortization and Impairment:

Capitalized contract costs are amortized on a systematic basis consistent with the transfer of goods/services to which the asset relates.
Subject to impairment testing under IFRS 15 guidance (carrying amount > remaining consideration less directly related costs not yet recognized).

Contract Modifications

Types & Accounting Treatment:

Type of Modification Treatment
Separate Contract If the modification adds distinct goods/services AND the price increases by an amount reflecting their standalone selling prices. Account for as a new, separate contract.
Modification of Existing Contract If not a separate contract, account for based on nature:
- Prospective (Termination of old, creation of new): If remaining goods/services are distinct from those transferred before modification. Allocate remaining transaction price to remaining POs.
- Cumulative Catch-up (Part of original): If remaining goods/services are NOT distinct and form part of a single PO that is partially satisfied. Adjust revenue recognized to date as if modification was part of original contract.

Disclosures

Objective: Enable users to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Both quantitative and qualitative information required.

Required Disclosures (Examples):

Category Examples of Disclosures
Disaggregation of Revenue Revenue disaggregated into categories that depict how nature, amount, timing & uncertainty are affected by economic factors (e.g., by geographical market, product line, contract type, timing of transfer - point in time vs over time). Reconciliation to segment revenues if IFRS 8 applies.
Contract Balances Opening and closing balances of receivables, contract assets, and contract liabilities. Revenue recognized in period included in opening contract liability balance. Explanation of significant changes.
Performance Obligations Description of POs (when satisfied, significant payment terms, nature of goods/services). Transaction price allocated to remaining POs and explanation of when revenue expected to be recognized.
Significant Judgments Judgments, and changes in judgments, made in applying IFRS 15 that significantly affect amount/timing of revenue (e.g., determining timing of PO satisfaction, determining transaction price and amounts allocated to POs). Methods, inputs, and assumptions used.
Contract Costs Assets Closing balances of assets recognized from costs to obtain/fulfill contracts. Amortization and impairment for the period. Method used for amortization.

Examples of Performance Obligations by Industry

Industry Common Performance Obligations (Examples)
Software Software license, installation services, maintenance/updates, training, hosting services. Each may be distinct.
Telecommunications Provision of handset, network connection (SIM card), monthly service plan (voice, data). Handset often distinct.
Manufacturing Sale of goods, extended warranty (if distinct service), installation, ongoing maintenance services.
Construction Design services, engineering, procurement, construction/delivery of modules or entire project. Often a single PO if highly interrelated.

Key Judgments and Estimates

Estimating variable consideration and applying the constraint (only include amounts highly probable of no significant reversal).
Determining when control passes to the customer (point in time vs. over time) and the appropriate measure of progress for "over time" recognition.
Estimating standalone selling prices for allocating the transaction price to multiple performance obligations.
Identifying whether a significant financing component exists and selecting an appropriate discount rate.
Identifying distinct performance obligations within a contract.
Determining whether costs to obtain or fulfill a contract should be capitalized and the appropriate amortization period.
Accounting for contract modifications (separate contract vs. modification of existing).

Practical Expedients

Available Options (Examples):

No need to adjust for a significant financing component if the period between transfer of good/service and customer payment is one year or less.
Expense costs to obtain a contract as incurred if the amortization period would be one year or less.
Can omit disclosure of remaining performance obligations if:
The PO is part of a contract with an original expected duration of one year or less.
The entity recognizes revenue in the amount to which it has a right to invoice (if that corresponds directly with value to customer).

Transition

Two Options for Initial Application:

Method Description
Full Retrospective Approach Apply IFRS 15 to all comparative periods presented, subject to certain practical expedients (e.g., for completed contracts, variable consideration). Adjust opening equity of earliest comparative period.
Modified Retrospective Approach Recognize the cumulative effect of initially applying IFRS 15 as an adjustment to the opening balance of retained earnings (or other equity) at the date of initial application. Comparative periods are not restated. Additional disclosures required for contracts not completed at transition.
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Imad Uddin is deeply passionate about IFRS and has founded Analyqt, a consulting firm dedicated to helping clients navigate complex accounting and financial reporting challenges. In addition to his advisory work, Imad is committed to education and knowledge-sharing, which led to the creation of IFRSMasterclass.com, a platform offering high-quality IFRS training and resources.

 

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