IFRS 15 - ACCA SBR notes PDF

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ACCA SBR notes...

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IFRS 15: Revenue from Contract with Customer Objective: The objective of IFRS 15 is to establish the principles that an entity shall apply 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. IFRS 15 will have an impact on most suppliers of goods and services. Suppliers will need to reassess their revenue recognition policies and may need to revise them. The timing and amount of revenue recognised may not change for simple contracts but may well change for more complex arrangements (say involving several different types of goods and services or a combination of both).

Scope: IFRS 15 Revenue from Contracts with Customers applies to all contracts with customers except for: leases within the scope of IAS 17 Leases; 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; insurance contracts within the scope of IFRS 4 Insurance Contracts; and nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers. A contract with a customer may be partially within the scope of IFRS 15 and partially within the scope of another standard. In that scenario: • If other standards specify how to separate and/or initially measure one or more parts of the contract, then those separation and measurement requirements are applied first. The transaction price is then reduced by the amounts that are initially measured under other standards; • If no other standard provides guidance on how to separate and/or initially measure one or more parts of the contract, then IFRS 15 will be applied.

Key definitions Contract Customer Income

Transaction price

Revenue

An agreement between two or more parties that creates enforceable rights and obligations. 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. Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants. The amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. Income arising in the course of an entity’s ordinary activities. • 'Ordinary activities' means normal trading or operating activities. • 'Revenue' presented in the statement of profit or loss should not include items such as proceeds from the sale of non-current assets or sales tax.

2. Revenue recognition A five step process: A contract to supply goods and services places a performance obligation (or a number of performance obligations) on the seller to deliver goods and services in accordance with the contract. Goods and services being sold are often described as “deliverables”. The core principle of IFRS 15 is that an entity will recognise 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. This core principle is delivered in a five-step model framework: (1) 'Identify the contract(s) with the customer (2) Identify the separate performance obligations within a contract (3) Determine the transaction price (4) Allocate the transaction price to the performance obligations in the contract (5) Recognise revenue when (or as) a performance obligation is satisfied.' Application of this guidance will depend on the facts and circumstances present in a contract with a customer and will require the exercise of judgment. Example: Summary of guidance: X Plc is a software developer. X Plc enters into a contract with a customer to transfer a software licence, perform an installation service and provide unspecified software updates and technical support for a two-year period. IFRS 15 provides guidance in the following areas: Step 1: Whether the contract is within the scope of IFRS 15 and what to do if IFRS 15 does not apply. Step 2: If IFRS 15 applies, whether the contract contains a single performance obligation or separate performance obligations (say for the licence, installation and updates). Step 3: How to identify the transaction price and whether this should be adjusted for time value of money. What to do if the consideration might vary depending on circumstance. Step 4: How the transaction price should be allocated to the separate performance obligations. Step 5: Whether the performance obligation is satisfied (and thus revenue recognised) over time or at a point in time. The application of IFRS 15 is straightforward for many contracts. However, IFRS 15 provides guidance for complex contracts where there are several deliverables. Note that revenue recognition and invoicing are two separate processes. Revenue recognised and amounts invoiced might be the same in many cases but are not the same in many others. Illustration 1 – The five steps: On 1 December 20X1, Wade receives an order from a customer for a computer as well as 12 months' of technical support. Wade delivers the computer (and transfers its legal title) to the customer on the same day.

The customer paid $420 upfront. If sold individually, the selling price of the computer is $300 and the selling price of the technical support is $120. Required: Apply the 5 stages of revenue recognition, per IFRS 15, to determine how much revenue Wade should recognise in the year ended 31 December 20X1. Solution: Step 1 – Identify the contract: There is an agreement between Wade and its customer for the provision of goods and services. Step 2 – Identify the separate performance obligations within a contract: There are two performance obligations (promises) within the contract: • The supply of a computer • The supply of technical support. Step 3 – Determine the transaction price: The total transaction price is $420. Step 4 – Allocate the transaction price to the performance obligations in the contract: Based on standalone selling prices, $300 should be allocated to the sale of the computer and $120 should be allocated to the technical support. Step 5 – Recognise revenue when (or as) a performance obligation is satisfied: Control over the computer has been passed to the customer so the full revenue of $300 allocated to the supply of the computer should be recognised on 1 December 20X1. The technical support is provided over time, so the revenue allocated to this should be recognised over time. In the year ended 31 December 20X1, revenue of $10 (1/12 × $120) should be recognised from the provision of technical support.

Step 1: Identify the contract: The first step in IFRS 15 is to identify the contract. A contract might be written, oral, or implied by a supplier’s customary business practices. There is no contract if each party has an enforceable right to terminate a wholly unperformed contract without compensating the other party. Combination of contracts: Two or more contracts entered into at or near the same time with the same customer (or related parties) must be combined and treated as a single contract if one or more of the following conditions are present: • 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; or • The goods or services promised in the contracts (or some goods or services promised in the contracts) are a single performance obligation.

Application criteria: A contract with a customer will be within the scope of IFRS 15 if all the following conditions are met: • The contract has been approved by the parties to the contract are committed to perform their respective obligations • Each party’s rights in relation to the goods or services to be transferred can be identified; • The payment terms for the goods or services to be transferred can be identified; • The contract has commercial substance (i.e. it is expected to change the risk, timing or amount of a supplier’s future cash flows); and • It is probable that the consideration to which the entity is entitled to in exchange for the goods or services will be collected. If a contract with a customer does not yet meet all of the above criteria, the entity will continue to reassess the contract going forward to determine whether it subsequently meets the above criteria. From that point, the entity will apply IFRS 15 to the contract. The standard provides detailed guidance on how to account for approved contract modifications. If certain conditions are met, a contract modification will be accounted for as a separate contract with the customer. If not, it will be accounted for by modifying the accounting for the current contract with the customer. Whether the latter type of modification is accounted for prospectively or retrospectively depends on whether the remaining goods or services to be delivered after the modification are distinct from those delivered prior to the modification. Further details on accounting for contract modifications can be found in the Standard. A good or service is not separately identifiable if: • Goods or service is not integrated with other goods or service in the contract. • Does not modify or customize another good or service in the contract. • Does not depend on other goods or services promised in the contract The contract: Aluna has a year end of 31 December 20X1. On 30 September 20X1, Aluna signed a contract with a customer to provide them with an asset on 31 December 20X1. Control over the asset passed to the customer on 31 December 20X1. The customer will pay $1m on 30 June 20X2. By 31 December 20X1, as a result of changes in the economic climate, Aluna did not believe it was probable that it would collect the consideration that it was entitled to. Therefore, the contract cannot be accounted for and no revenue should be recognised. Example: Application criteria X Plc is a real estate developer. X Plc enters into a contract with Mr. A for the sale of a limousine for $100,000. Mr. A intends to use the limousine to operate an executive transport service. Mr. A has no experience of executive transport and faces high levels of competition.

Mr. A pays a non-refundable deposit of $25k, and entered into a financing agreement for the remaining 75%. This is to be paid out of the proceeds of the new business venture. X Plc can repossess the limousine if Mr. A defaults but cannot seek further compensation. Analysis Have the parties approved the contract and are committed to perform their respective obligations? Can X Plc identify each party’s rights? Can X Plc identify the payment terms for the goods and services to be transferred? Does the contract have commercial substance? Is it probable the supplier will collect the consideration? It is not probable that X Plc will collect the consideration because:

Yes Yes Yes Yes No (see below)

(a) Mr A intends to repay the loan from income derived from a business which faces significant risks (high competition and Mr A’s limited experience); (b) Mr A lacks other income or assets that could be used to repay the loan; and (c) Mr A’s liability under the loan is limited because the loan is nonrecourse. Conclusion: The contract does not meet the IFRS 15 applicability criteria. Any consideration received in respect of a contract that does not meet the criteria is recognised as a liability. X Plc must recognise the $25,000 received as a liability until either there it becomes probable that the consideration will be received or until the revenue recognition criteria are met. This is where X Plc’s performance is complete and substantially all of the consideration in the arrangement has been collected and is non-refundable or the contract has been terminated and the consideration received is non-refundable. In each case the $25,000 would be recognised as revenue.

Step 2: Identifying the separate performance obligations within a contract: At the inception of the contract, the entity should assess the goods or services that have been promised to the customer, and identify as a performance obligation or at the inception of a contract a supplier must determine whether the contract is for the sale of a single deliverable or several deliverables. This is important as revenue is recognised as these separate goods and services are delivered to the customer. 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. Distinct goods and services: At the inception of a contract the supplier must identify each promise to transfer distinct goods and services to the customer as performance obligations. 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; and • The supplier’s or entity’s promise to transfer the good or service is separately identifiable from other promises in the contract. A series of distinct goods or services is transferred to the customer in the same pattern if both of the following criteria are met: • Each distinct good or service in the series that the entity promises to transfer consecutively to the customer would be a performance obligation that is satisfied over time and • A single method of measuring progress would be used to measure the entity’s progress towards complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer. Separately identifiable: In order to be identified as “distinct” goods or services must be separately identifiable. Promised goods or services that are not distinct are combined until a distinct bundle can be identified. This could mean that all of the goods or services promised in a contract might be accounted for as a single performance obligation. Factors for consideration as to whether a promise to transfer goods or services to the customer is not separately identifiable include, but are not limited to: • The entity does provide a significant service of integrating the goods or services with other goods or services promised in the contract; • The goods or services significantly modify or customize other goods or services promised in the contract; • The goods or services are highly interrelated or highly interdependent. Benefit from a good or service: A customer can benefit from a good or service if it could be used in some way to generate economic benefits. A supplier might regularly sell a good or service separately. This implies that a customer can benefit from such goods and services purchased together. A customer may be able to benefit from a good or service on its own, whereas for others the customer may be able to benefit from the good or service only in conjunction with other readily available resources. A readily available resource is a good or service that is sold separately or a resource that the customer has already obtained from the supplier. Example: Distinct goods and services: X Plc is a contractor which enters into a contract to build a bridge for a customer. X Plc is responsible for the overall management of the project. The project involves the provision of various goods and services including design, site preparation and construction of the bridge.

Analysis Can the customer benefit from the goods and services either on their own or together with other readily available resources?

Yes X Plc or its competitors regularly sells many of these goods and services separately to other customers. Also, the customer could generate economic benefit from the individual goods and services by using, consuming, selling or holding those goods or services. Is X Plc’s promise to transfer individual goods and No services in the contract separately identifiable X Plc provides a significant service of integrating from other promises in the contract? the goods and services (the inputs) into the hospital (the combined output) for which the customer has contracted. (It is responsible for the overall management of the project). Conclusion: X Plc should account for all of the goods and services in the contract as a single performance obligation. If goods or services do not significantly modify other goods or service promised in the contract they would be separately identifiable. Example: Distinct goods and services: X Plc is a mobile phone company. X Plc sells mobile phone contracts under which a customer receives a handset and a contract under which the handset is connected to the network for a 24 month period. Monthly payments made by customers entitles them to send specified number of texts, a specified number of call minutes and a specified data download volume. Usage in excess of the specified amounts incurs an extra charge. X Plc sells the handset and network connection service separately and these are routinely available from other suppliers. Analysis Can the customer benefit from the goods and services either on their own or together with other readily available resources?

Is X Plc’s promise to transfer individual goods and services in the contract separately identifiable from other promises in the contract?

Yes The customer can benefit from each of the goods and services either on their own or together with the other goods and services that are readily available.

Yes The handset and the network uses are separate outputs instead of inputs used to produce a combined output. Conclusion: X Plc should account for three separate performance obligations (the handset, the network service and network use above the specified minimum). Goods or services that are highly dependent on, or highly interrelated with, other goods or services in the contract are not separately identifiable.

Example: Distinct goods and services: X Plc is a mobile phone company. X Plc sells mobile phone contracts under which a customer receives a handset and a contract under which the handset is connected to the network for a 24 month period. Monthly payments made by customers entitles them to send specified number of texts, a specified number of call minutes and a specified data download volume. Usage in excess of the specified amounts incurs an extra charge. X Plc does not sell the handsets and network connections separately. Analysis Can the customer benefit from the goods and services either on their own or together with other readily available resources?

Yes The customer can benefit from the handset and the network contract together but the ability to buy extra usage is a separate benefit. Is X Plc’s promise to transfer individual goods and No services in the contract separately identifiable The handset and the network uses are a single from other promises in the contract? input used to produce a combined output. The sale of extra minutes is a separate output. Conclusion: X Plc should account for two separate performance obligations (the handset and the network contract as a bundle and network use above the specified minimum). Step 3: Determining the transaction price: IFRS 15 defines the transaction price as the amount of consideration the entity expects to be entitled to in exchange for satisfying a performance obligation. The transaction price does not include the price collected for third parties for example sales tax or VAT. A supplier must consider the terms of the contract and its customary practices in determining the transaction price. The transaction price assumes transfers t...