IFRS 15 “Revenue from Contracts with Customers” contains fundamentally new rules on revenue recognition. The standard requires entities reporting under IFRS to provide useful information on the nature, amount, timing, and uncertainty of revenue and cash flows from a contract with a customer.
Under the requirement of IFRS 15, revenue is recognized when a performance obligation is satisfied by transferring a promised good or service to a customer (which is when the customer obtains control of that good or service).
Obligations can be performed at a point in time (usually for commitments to transfer goods to customers) or periodically (usually commitments to provide services to customers). For obligations performed over a period, the enterprise should choose a reasonable measure of the process to accurately determine the amount of revenue that should be recognized in proportion to the portion of the obligation that has been fulfilled. Businesses operating in the Telecommunications, Software Development and Real Estate industries will be greatly affected by this new accounting standard.
IFRS 15 introduces a five-step model of revenue recognition, for common to all types of transactions, to all companies and industries. This model will be applied in two versions, depending on how performance obligation is satisfied:
(1) Over time
(2) At a point in time
The moment of revenue recognition under the basic principle of IFRS 15 when the control over a product/service is being transferred to the client. Control is a broader term than the previously used criterion of risk and rewards, which determines when the revenue will be recognized.
IFRS 15: Revenue from Contracts with Customers - VAS 14: Revenue
Contract with a customer will be within the scope of IFRS 15 if all the following five (5) conditions are met:
a) The contract has been approved by the parties to the contract;
b) Each party's rights relating to the goods or services to be transferred can be identified;
c) The payment terms for the goods or services to be transferred can be identified;
d) The contract has commercial substance; and
e) The probability that the consideration to which the entity is entitled to in exchange for the goods or services will be collected.
Recognition is the process of incorporating an item that meets the definition of revenue in the statement of profit or loss when it meets the following criteria:
a) The economic benefits associated with the item of revenue will probably flow to the entity, and
b) The amount of revenue can be measured reliably.
The core principle of IFRS 15 is that an entity will 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.
The five-step model framework**
This core principle is delivered in a five-step model framework:
1. Identify the contract(s) with a customer.
2. Identify the performance obligations in the contract.
3. Determine the transaction price: using the most likely amount or expected value approach.
4. Allocate the transaction price to the performance
obligations in the contract.
5. Recognize revenue when (or as) the entity satisfies a performance obligation.
Revenue should be recognized as follows:
a) Sales of goods:
recognized when significant risks and rewards have been transferred to the buyer, the seller has lost effective control, and costs can be reliably measured.
b) Rendering of services:
recognized on percentage of completion method.
c) Interest recognition:
recognized on the allocation basis.
recognized on an accrual basis under the substance of the agreement.
recognized on when the shareholder's right to receive payment is established.
Specific implementation guidance
This standard includes the following detail implementation guidance:
(a) Performance obligations satisfied over time;
(b) Methods for measuring progress towards complete satisfaction of a performance obligation;
(c) Sale with a right of return;
(e) Principal versus agent considerations;
(f) Customer options for additional goods or services;
(g) Customer's unexercised rights;
(h) Non-refundable upfront fees;
(j) Repurchase arrangements;
(k) Consignment arrangements;
(l) Bill-and-hold arrangements;
(m) Customer acceptance;
(n) Disclosures of disaggregation of revenue.
**The five-step model framework:
Step 1: Identify the contract with a customer
A contract is defined as an agreement (including oral and implied), between two or more parties, that creates enforceable rights and obligations and sets out the criteria for each of those rights and obligations. The contract needs to have commercial substance and the enterprises can exchange and record the consideration to which it will be entitled.
Step 2: Identify the performance obligations in the contract
Performance obligation in a contract is a promise (including implicit) to transfer a good or service to the customer. Each performance obligation should be capable of being distinct and is separately identifiable in the contract.
Step 3: Determine the transaction price
Transaction price is the amount of consideration that the entity can be entitled to, in exchange for transferring the promised goods and services to a customer, excluding amounts collected on behalf of third parties.
Step 4: Allocate the transaction price to the performance obligations in the contract
For a contract that has more than one performance obligation, the entity will allocate the transaction price to each performance obligation separately, in exchange for satisfying each performance obligation. The acceptable methods of allocating the transaction price include:
- Adjusted market assessment approach,
- Expected costs plus a margin approach; and
- The residual approach in limited circumstances. discounts given should be allocated proportionately to all performance obligations, unless certain criteria are met, and no re-allocation of individual sales prices is allowed after the initial recognition period.
Step 5: Recognize revenue as and when the entity satisfies a performance obligation
The entity should recognize revenue at a point in time, except if it meets any of the three criterias below would require revenue recognition over time:
- The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced;
- The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs;
- 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.
What work needs to be done?
- IFRS 15 impact assessment should be performed along with other standards, review of existing customer contracts and related accounting treatments, contract renegotiation and amendments, to reflect appropriate economic terms of the transaction, together with the involvement of legal and accounting advisors to better explain contract terms and applicability of IFRS 15,
- Adjust the IT systems to comply with the requirements of the standard and other necessary changes to ensure readiness for IFRS 15.