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Summary

Summary of LU2...

Description

Luthando Zulu: 17599770 Accounting 2B – ACBP6212 LU2: IFRS15 – Revenue from contracts with customers Objective

The objective of IFRS15 is to lay down the principles an entity should apply when preparing and reporting useful information about nature, timing, amount and uncertainties surrounding revenue and cash flows generated from contracts with customers. This implies that an entity will recognize an amount (the ‘consideration’) that represents an amount it is entitled to in exchange for the transfer of goods/services to the customer.

Scope

In applying IFRS15, the entity should:  Consider the terms of and all relevant facts; and  Apply the principles of IFRS15 consistently to contracts with similar characteristics or circumstances IFRS15 applies to all contracts with customers except for:  Lease agreements (IFRS16)  Insurance contracts (IFRS4 to be superseded by IFRS17)  Financial instruments and other contractual rights or obligations within the scope of IFRS9, IFRS10, IFRS11, IAS27 and IAS28  Non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers Non-examinable An entity should only apply IFRS15 to a contract if the counterparty to the contract is a customer

Key terms: Contract Customer Contract asset

Contract liability

Income

Performance obligation

Revenue

An agreement between two or more parties hat creates enforceable rights and obligations A party that has contracted with an entity to obtain goods/services that are an output of the entity’s ordinary activities in exchange for consideration An entity’s right to consideration in exchange for goods/services that the entity has transferred to a customer when that right is conditional to something other than the passage of time e.g. the entity’s future performance An entity’s obligation to transfer goods/transfer goods/services to a customer for which the entity has received consideration (or the amount is due) from the customer 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 that relate to contributions from equity participants A promise in a contract with a customer to transfer to the customer either: a) A good/service (or a bundle of goods/services) that is distinct; or b) A series of distinct goods/services that are substantially the same and that have the same pattern of transfer to the customer Income arising in the course of an entity’s ordinary activities. These activities could include:  Sales of goods (merchandise)  Sales of services  Interest  Royalties

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 Dividends Revenue excludes trade discounts and VAT The price at which an entity would sell a promised good or service separately to a customer The amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods/services to a customer, excluding amounts collected on behalf of third parties.

Stand-alone selling price Transaction price (for a contract with a customer)

Revenue recognition requirements – the five-step approach: 1. Identifying the contract: An entity shall account for a contract with a customer in accordance with IFRS15 only when all of the criteria are met: i. The contract has been approved by both parties and both parties are committed to performing their respective obligations. This approval may be written, oral or in accordance with other customary business practices ii. The entity can identify each party’s rights regarding the goods/services to be transferred iii. The entity can identify the payment terms for the goods/services to be transferred iv. The contract has commercial substance i.e. the risk, timing or amount of the entity’s future cash flows are expected to change as a result of the contract v. It is probable that the consideration will be received. This involves assessing the customer’s creditworthiness by considering the customer’s ability and interaction to pay the expected consideration Modification to contract terms or conditions: A contract modification occurs when both parties agree to modify the scope and/or price of a contract. The modification creates new or changes existing enforceable rights and obligations of the parties to the contracts. Contract modifications can be approved in writing, by oral agreement or implied by customary business practices. Where a contract modification is awaiting approval, IFRS15 the existing contract. Once approved, the modification will stand-alone contract (creation of a new contract) or will contract. The modification will be treated as a stand-alone conditions are met: o o

should continue to be applied to either be treated as a separate be combined with the original contract if both of the following

The scope of the contract increases because of the addition of promised goods/services that are distinct The contract price increases by a consideration that reflects the entity’s stand-alone selling price of the additional goods/services plus any appropriate price adjustments

2. Identifying performance obligations: At the inception of the contract, the goods/services promised in a contract with the customer should be assessed. The performance obligation is the promise to transfer to the customer either:  A good/service or a bundle of goods or services that are distinct; or  A series of goods/services that are substantially the same and have the same and pattern of transfer to the customer

Distinct goods/services:

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A good/service is distinct if the customer can benefit from the good/service on its own or together with other readily available resources and is separately identifiable from other elements of the contract Promised goods and services may include, but are not limited to, the following: Indicator Sale of goods produced by an entity Resale of purchased goods by an entity

Resale of rights to purchased by an entity

goods/services

Performing a contractually agreed-upon task or tasks for a customer Constructing, manufacturing or developing an asset on behalf of a customer Granting licenses

Example Furniture manufacturer selling its furniture to customers A supermarket selling various household items and produce, purchased from its suppliers An estate agent marketing and selling houses on behalf of the owner of the property Gardening service providing fortnightly garden services to a customer A construction company building a block of flats for a property management company TV licensing authority issuing TV licenses (the right to use broadcasting services) to customers on an annual basis

3. Determining the transaction price: The transaction price is the expected consideration the entity is entitled to in exchange for transferring he promised goods/services to a customer, excluding amounts collected on behalf of third parties e.g. VAT. The transaction price could be affected by the nature, timing and amount of consideration. This includes any significant financing components (e.g. where the customer is offered deferred repayment terms that extend beyond the entity’s normal operating cycle), variable components (e.g. discounts, rebates, price concessions) and non-cash amounts (e.g. the customer exchanges their own goods and services) Variable components: The promised consideration may vary due to discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties or other similar items. The promised consideration could also vary due to the occurrence or non-occurrence of a future event. Variability may be explicitly stated in the contract, implied through customary business practices, published policies, or through other facts and circumstances that indicate the entity’s intention when entering the contract with the customer, is to offer a price concession. The variable components of promised consideration should be estimated at the inception of the contract by one of two methods: 1. Expected value: the sum of probability-weighted amounts in a range of possible consideration amounts. This method is appropriate where the entity has many contracts with similar characteristics 2. Most likely amount: the single most likely amount in a range of possible consideration amounts. This method is appropriate if the contract only has two possible outcomes

Significant financing component:

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A contract contains a significant financing component, if the effects of the time value of money on the timing of the repayments agreed to, provides the customer or the entity with a significant benefit of financing. When the receipt of the promised consideration is deferred such that the impact of the time value of money (the difference between the promised the consideration and the present value of the promised consideration) is material, the contract is considered to contain a significant financing component. The financing component may be explicitly stated in the contract or implied by the payment terms agreed by the parties to the contract. Under these circumstances, the amount of revenue recognized reflects the price that the customer would have paid for the transferred goods/services had the customer paid cash for these goods/services on the date they transferred to the customer i.e. the cash selling price. The following factors should be considered in assessing whether a significant component exists: 1. The difference between the promised consideration and the cash selling price of the promised goods/service 2. The length of time between the transfer of the goods/services to the customer and the receipt of the promised consideration 3. The impact of the prevailing interest rates on (2) above The financing component is presented separately from the revenue recognized as either interest income (if the customer pays in arrears) or interest expense (if the customer pays in advance). The interest income/expense is recognized over the period of finance using the effective interest rate method Non-cash consideration: Where a customer promises consideration that is non-cash in nature, an entity shall measure the non-cash consideration at fair value. If fair value cannot be reliably estimated, consideration is measure as the stand-alone selling price of the goods/services promised to the customer If the fair value of the non-cash consideration is variable, the entity should apply the requirements of IFRS15: para 50 to 59. If the customer contributes goods/services to facilitate the entity’s fulfilment of the contract, the entity shall assess if it obtains control of those contributed goods/services. If so, the contributed goods/services should be treated as non-cash consideration received from the customer. 4. Allocate the transaction price to the performance obligations: The transaction price is allocated at contract inception to each performance obligation based on the stand-alone selling price of each performance obligation. Allocation based on stand-alone selling prices: The best evidence of a stand-alone price is the observable price of a good/service when it is sold separately by the entity under similar circumstances and to similar customers (e.g. a list price for the goods/services). If the stand-alone price cannot be determined, an estimate is made using an approach that maximizes the use of observable inputs. Methods that may be used to estimate the stand-alone selling price of a good/service include:

Approach

Description

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Adjusted market assessmen t

Expected cost plus margin

Residual

Evaluate the market in which the goods/services sold and estimate the price that a customer in that market would be willing to pay for the good/service. This approach focusses on how much the entity believes the market is wiling to pay for the good/service and is primarily based on external factors as it considers market conditions. Best approach if the entity has a history of selling the good or service (there exists customer demand) or a competitor offers competing goods/services that can be used as a basis for analysis. Forecasting the expected costs of satisfying the performance obligation and then adding an appropriate margin for that good/service. This approach is primarily based on the internal factors. However, the margin should represent the margin rate the market is wiling to pay rather than just the entity’s target margin. The total transaction price less the aggregate of the observable stand-alone selling prices of other goods/services promised in the contract. This method may only be applied to multiple-element transactions when the selling price of a single good or service is unknown.

5. Recognize revenue when (or as) the entity satisfies a performance obligation: Satisfaction of performance obligations

Revenue is recognized when or as the entity satisfies the performance obligation by transferring the promised good/service (an asset) to the customer. This usually occurs when or as the customer obtains control of the asset. A performance obligation may be satisfied at a point in time (e.g. the sale of milk by a supermarket) or over time (e.g. construction of an apartment block). Obtaining control of the asset means that the customer obtains the direct use of, or substantially all the remaining benefits from the asset. This includes the ability to prevent others from directing the use of and obtaining benefits from an asset. The benefits of the asset include the direct or indirect potential cash flows that can be obtained from, for example, using the asset, selling the asset, pledging the asset as security for a loan and holding the asset.

Performanc e obligations satisfied over time

Indicators of transfer of control include:  The entity has a present right to payment for the asset – i.e. the customer is obliged to pay for the asset  The customer has legal title to the asset – i.e. the customer legal owns the asset  The entity has transferred physical possession of the asset to the customer  The customer has the significant risks and rewards of ownership of the asset Performance obligations are satisfied over time and revenue is recognized over time if one of the following criteria are met:  The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs  The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced. The asset being created or enhanced can be a tangible or intangible

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

asset. The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date. An asset with no alternative use to the entity is most likely an asset that is highly specialized/customized for a customer. Hence, it is unlikely that the entity would be able to use or sell the asset for any other purpose.

Measuring progress

To asses whether an entity has an enforceable right to payment for performance completed to date, IFRS15 requires an entity to consider the terms of the contract and any laws/regulations that relate to it. The right to payment needs to be a fixed amount, but the payment should at least compensate the entity for performance completed to date. A single revenue recognition method should be used that best depicts the entity’s performance in transferring goods/services to the customer. At the end of each reporting period, an entity shall remeasure its progress towards completion of a performance obligation satisfied over time. An entity can use output or input methods to measure progress.

Output methods

Input methods

Revenue recognized based on direct measurements of the value of goods/services transferred to the customer to date relative to remaining goods/services promised under the contract

Revenue recognized based on the entity's effort/inputs to the satisfaction of performance obligation

Examples: surveys of performance to date time lapsed units produced units delivered

Examples: resources consumed labor hours used costs incurred time lapsed

Shortcomings: Outputs used to measure performance may not be directly observable and the information needeed to apply them might not be available

Shortcomings: No direct relationship between the entity's inputs and the transfer of control of goods/services to the customer

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Contract cost: IFRS15 indicates the accounting treatment for the costs incurred by the entity obtaining and fulfilling a contract with customers Incrementa The incremental costs associated with obtaining a contract with a customer should be recognized as an asset provided the entity expects to recover these costs. l cost of obtaining a contract Incremental costs are the costs that the entity would have avoided had the contract with customer not been entered (e.g. sales commission). Costs incurred regardless of whether the contract with customer is obtained (i.e. non-incremental costs) should be recognized as expenses when incurred.

Costs to fulfil the contract

Recovery may be direct (in the form of reimbursement under the contract) or indirect (through a margin inherit in the contract). Where the recovery of costs is expected to occur within one year, the entity may expense the costs as incurred. Costs incurred to fulfill a contract are split into the following categories:  Costs that give rise to an asset: Where the costs incurred in fulfilling a contract with a customer give rise to an asset (e.g. in accordance with IAS2 Inventories, IAS16 Property, plant and equipment or IAS38 Intangibles), these costs should be capitalized as an asset if all of the criteria are met: 1. The costs directly relate to a contract or an anticipated contracted that can be specifically identified 2. The costs generate or enhance the resources of the entity that will be sed in satisfying future performance obligations 3. The costs are expected to be recovered Examples of costs that directly relate to a contract include: direct labor costs, direct materials, costs of contract management, insurance, depreciation of equipment used in fulfilling the contract, costs explicitly chargeable to the consumer under the contract 

Costs that should be expensed as incurred:

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The following costs cannot be recognized as an asset and should be expensed when incurred: o General and administrative costs o Costs of wasted materials, labor and other resources o Costs that relate to already satisfied performance obligations o Costs which cannot be allocated between unsatisfied and satisfied performance obligations Presentation in financial statements: Contracts with customers are presented in the statement of financial position as a contract liability or contract asset, depending on the relationship between the entity’s performance and the customer’s payment respectively. Any unconditional rights the entity has to consideration from a customer is presented separately as a receivable. Presentation of a contract liability occurs where a customer has paid consideration to the entity in advance of the entity performing by transferring a good/service to the customer. If the entity has performed by transferring a good or service to the customer and the customer has not yet paid the related consideration, a contract/receivable is presented in the statement of financial position. Recognition as a contact asset/receivable is dependent on the nature of the entity’s right to consideration. A contract asset is recognized if the entity’s right to consideration is conditional on something other than the passage of time (e.g. the future performance of the entity). A separate receivable is recognized if the ent...