Accounting Quick Update IFRS 16 Leases and IFRS 15 Revenue PDF

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IFRS 16 Notes...

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AUGUST STUDY SCHOOL FAC4863/4861 LEASES & REVENUE

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YUMNA ABED CA(SA)

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Topics  IFRS 15 Revenue from contracts customers

 IFRS 16 Leases

IFRS 15 Revenue from Contracts with Customers

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Revenue

IFRS 15 = single framework for revenue: • Recognition and • Measurement Types of questions? • Discussion • Journal entries • Statement of P/L and OCI, Statement of Financial Position

Replac standa • IA • IAS • IFRI • IFRI • IFRI • SIC-31

Construction Contracts Customer Loyalty Programmes Agreements for the Construction of Real Transfer of assets Barter Estate transactions from Customers involving advertising services

5 – Step revenue model

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• Identify the contract(s) with the customer • Identify the performance obligations in the contract • Determine the transaction price

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• Allocate the transaction price to the performance obligations

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• Recognise revenue as/when the entity satisfies a performance obligation

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5 – Step revenue model

1. Identify the contract(s) with the customer

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A contract is an agreement between two or more parties that creates enforceable rights and obligations. {.10}

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. {.6}

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Approval can be written, oral or implied. Contract exists i a) Parties to con perform their respective obligations {.10} b) Each party’s rights can be identified (regarding the goods or services to be transferred) c) The payment terms for goods or services to be transferred can be identified d) Contract has commercial substance (risk, timing or amount of future cash flows of entity is expected to change as result of the contract) e) The collection of consideration probable (consider only the customer’s ability and intention To pay)

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Does a cash sale transaction meet the requirements for a contract?

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a) Approved contract – yes agreeing to offer of goods or services is a sign (implied) of acceptance of contract (contract can be oral, written agreement or implied by an entity’s customary business practices {.10}) b) Parties rights – customer entitled to goods or services, entity entitled to receive payment c) Payment terms – payment on receipt of goods, either cash or on credit card etc d) Commercial substance – entity receives cash and makes profit from sale e) Collectability of consideration probable – payment in cash upon receipt of goods = probable

ILLUSTRATIVE EXAMPLE 1

• A real estate developer enters into a contract with a customer for the sale of a building for R1 million. • The customer intends to open a restaurant in the building in an area where new restaurants face high levels of competition and the customer has little experience in the restaurant industry. • The customer pays a non-refundable deposit of R50,000 at inception of the contract and enters into a long-term financing agreement with the entity for the remaining 95 per cent of the promised consideration. • The financing arrangement is provided on a non-recourse basis, which means that if the customer defaults, the entity can repossess the building, but cannot seek further compensation from the customer, even if the collateral does not cover the full value of the amount owed. • The entity’s cost of the building is R600,000. • The customer obtains control of the building at contract inception.

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Contract exists if ALL of following criteria are met {.9}: a) Parties to contract have approved contract and are committed to perform their respective obligations {.10} b) Each party’s rights can be identified (regarding the goods or services to be transferred) c) The payment terms for goods or services to be transferred can be identified d) Contract has commercial substance (risk, timing or amount of future cash flows of entity is expected to change as result of the contract) e) The collection of consideration probable (consider only the customer’s ability and intention to pay) ???

ILLUSTRATIVE EXAMPLE 1 Solution 1) Does a contract exist in terms of IFRS 15?

 The customer’s ability and intention to pay is in doubt due to following reasons: •

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Customer intends to repay loan from income derived from restaurant business (significant risks due to high competition and limited experience); Customer lacks other income or assets that could be used to repay loan; and Customer’s liability i.t.o loan is limited (nonrecourse).

To conclude, criteria is not met, and thus contract does not exist as it is not probable that entity will collect consideration it is entitled to in exchange for the building (all five criteria has to be met).

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ILLUSTRATIVE EXAMPLE 1 Solution 2) How should the non-refundable CU50,000 be recognised?

deposit

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 {.15} If contract criteria is not met and consideration is received it can be recognised as revenue if: a) the entity has no remaining obligation to transfer goods or services and all of consideration promised by customer has been received and is non-refundable; or b) the contract has been terminated and consideration received is non-refundable (IFRS 15.15). Neither one of the above criteria is met, thus can’t be recognised as revenue, should recognise as deposit liability.

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Contract

Combined contract (accounted for as a single contract) {.17}

Contract modification (Level1) {.18 - .21}

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5 – Step revenue model

2. Identify the performance obligations in the contract

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At contract inception an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either {.22}: (a) A good or service (bundle of goods/services) that is distinct or

(b) Series of distinct goods or services that are substantially the same with same pattern of transfer to the customer {.23}

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Promises in a contract with customers {.24} • A contract with a customer generally explicitly states the goods or services that an entity promises to transfer to a customer. • Promises may not be limited to those goods and services explicitly stated in the contract. • Promises can also be implied by an entity’s customary business practices, published policies or specific statements made and create a valid expectation for a transfer of a promise to the customer. {IE 12 – Free maintenance services}

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A good or service promised is distinct if both of the following criteria are met {.27}:

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 {.28}. (If an entity regularly sells a good or service separately it indicates that a customer can benefit from the good or service on its own or with other readily available resources.)

The entity’s promise to transfer the good or service to the customer is

separately identifiable from other promises in the contract {.29}.

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Exam technique approach DISCUSSION QUESTIONS

- Planning and layout is important - Firstly refer to the applicable IFRS that your argument or discussion will be on - Prepare a well-focused answer by applying the information in the scenario to the abovementioned IFRS you base your argument or discussion on: - Avoid just repeating facts in the scenario, you need to indicate why these facts are important to your argument. - Using contradicting statement - Always conclude your argument - Don’t use SMS style writing

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Tut 105: Question 2 On 1 November 20.14 Builder Ltd entered into a contract with Green Ltd to refurbish an old office building in Sandton, which is owned by Green Ltd. The refurbishment on all floors of the building includes the following: -

Overall management of the project; Installation of new elevators; Providing electrical services; and Providing carpentry services.

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Tut 105: Question 2 Builder Ltd regularly provides each of the above refurbishment services separately to other customers. The total consideration payable by Green for the refurbishment in terms of the contract amounts to R15,000,000. In terms of the contract the consideration must be paid by Green based on the progress of the refurbishment up until the completion date. The date of completion of the refurbishment as per contract is 31 March 20.15.

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Tut 105: Question 2 required (a) Identify and discuss the performance obligation/(s) present in the contract entered into between Builder Ltd and Green Ltd on 1 November 20.14. You are not required to discuss the satisfaction of the performance obligation/(s). (8) Communication skills: Logical flow and conclusion. (1)

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(Application and theory) In terms of the contract Builder Ltd agreed to provide refurbishment services, which includes the overall management of the project, installation of elevators and providing electrical and carpentry services. As a result this is an approved contract (½) (Theory) At contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either:

a) a good or service (or a bundle of goods or services) that is distinct; or b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (IFRS 15.22). (1)

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(Application) In order for these goods and services to each be accounted for as separate performance obligations, one has to determine if they are distinct (IFRS15.22(a)). (½) (Theory) A good or service that is promised to a customer is distinct if both of the following criteria are met: (a) the customer can benefit from the good or service either on its own or together with other resources that are readily available; and (b) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (IFRS 15.27). (1)

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(Application) Green can benefit from the refurbishment services either on their own or together with other readily available resources. This is evidenced by the fact that Builder regularly sells or provides these refurbishment services separately to other customers (IFRS 15.28). (1) (Application) In addition, Green could generate economic benefits from the individual goods and services by using, consuming, selling or holding those goods or services (IFRS 15.28). Therefore the first criterion is met for the goods and services to be distinct (IFRS 15.27(a)).(1)

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(Application) However, the second criterion for the goods and services to each be distinct is not met since they are not separately identifiable. They are not separately identifiable as Builder provides a significant service of integrating the different goods and services into one combined output (the refurbished office building) for which Green has contracted Builder for (IFRS 15.27(a)). (2) (Application) Because both criteria of IFRS 15.27 are not met, the different goods and services provided are not distinct. (1)

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(Theory) If a promised good or service is not distinct, an entity shall combine that good or service with other promised goods or services until a distinct bundle of goods or services is identified (IFRS 15.30). (½) (Application) Thus each different good or service provided by Builder is not separately distinct on its own but if it is combined into one output (the refurbished office building) it becomes a distinct bundle of goods or services. (1) Conclusion: TD should account for all of the goods and services provided in the refurbishment contract as a single performance obligation. (1) (10.5)

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Tut 105: Question 6 3. 12-month warranty A smartphone or tablet granted by Cellular to customers is covered by a 12-month warranty provided by Cellular. If a faulty device is returned within seven days of purchase, the customer receives a new device as a replacement. If it is returned after seven days, Cellular will repair the device at Cellular’s expense. The warranty only covers manufacturing defects and excludes liquid contact damage and cosmetic damage such as scratches, dents and broken screens or ports as required by the Consumer Protection Act. Defective devices returned after the 12-month warranty period are still repaired, but at the cost of the customer.

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Tut 105: Question 6 3. 12-month warranty Every smartphone has its own unique serial number. Cellular’s systems link the serial number to the warranty, the date of purchase and the customer’s details. Customers do not have the option of purchasing the 12-month warranty separately from Cellular.

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Tut 105: Question 6 required (a)(i) Discuss the following with regard to a MyLife100 contract in terms of IRFS 15, whether the 12-month warranty offered on the iFoni SP should be identified as a separate performance obligation. Do not discuss the seven-day returns policy.

(9)

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Solution The first part of your discussion would be similar to Question 2 above. Over and above that discussion, the B paragraphs needs to considered.

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Solution (Theory) Furthermore, IFRS 15 gives specific guidance to identify if a warranty should be identified as a separate performance obligation in the contract. If a customer does not have the option to purchase the warranty separately, the entity shall account for the warranty in terms of IAS 37 Provisions, Contingent Liabilities and Contingent Assets, unless the promised warranty, or part of the promised warranty, provides the customer with a service in addition to the assurance that the product complies with the agreed-upon specifications (IFRS 15.B30). (1) (Application) Customers do not have the option to purchase the 12-month warranty separately. (1)

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(Theory) In assessing whether the warranty provides the customer with a service in addition to the assurance that the product complies with the agreed-upon specifications, the following facts should be considered (IFRS15.B31): (1) a) (Theory) Whether the warranty is required by law – indicate that the warranty is not a separate performance obligation. (½)  (Application) The 12-month warranty provided by Cellular is required by the Consumer Protection Act of South Africa. (½)

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b) (Theory) The length of the warranty coverage period – the longer the coverage, the more likely it is that the warranty is a separate performance obligation. (½)  (Application) The warranty provided by Cellular is for 12 months only, which is considered to be a short period when compared to actual warranties on electronics. (½)

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c) (Theory) The nature of the tasks that the entity promises to perform – if the entity has to perform specified tasks to provide assurance that the product complies with agreed-upon specifications, then those tasks likely do not give rise to a separate performance obligation. (½)  (Application) Cellular will replace a defective iFoni SP at its own cost within the first 12 months. This suggests that Cellular is only providing assurance that their product will function as intended for a period of at least 12 months. (½)

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To conclude, the warranty does not provide a service in addition to the assurance that the iFoni SP will function as intended for a period of at least 12 months and should not be identified as a separate performance obligation in the MyLife100 contract, but should rather be bundled with the sale of the iFoni SP. The warranty should be treated in accordance with IAS 37. (1) (9 marks from B paragraph and 7 marks from the performance obligation discussion)

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Principal vs agent considerations • If another party is involved in providing goods or services to a customer, entity shall determine whether the nature of its promise is a performance obligation to provide the specified goods or services itself1 (i.e. = principal) or to arrange for the other party to provide those goods or services2 (i.e. = agent).{B34} • An entity is a principal if it controls the specified good or service before that good or service is transferred to customer (legal title does not necessary equate control)

Principal vs agent considerations • Indicators that the entity controls goods or services before it is provided to the client include, but are not limited to the following {.B37}: a) The entity is primarily responsible for fulfilling the promise to prov...