DE LA SALLE UNIVERSITY MANILA

RVR – COB DEPARTMENT OF ACCOUNTANCY

REVDEVT K31/K32/K323 2nd Term AY 15-16

Integrated Accounting Review - TOA

TOA Lecture 5 Prof. F. H. Villamin
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REVENUE FROM CONTRACTS WITH CUSTOMERS (IFRS 15)

INTRODUCTION
On May 28, 2014, the FASB and IASB jointly issued IFRS 15 Revenue from Contracts with Customers, IFRS
15 supersedes IAS 18 revenue and IAS 11 construction contracts to provide a simplified and consolidated
standard on revenue recognition for contracts with customers.

The focus of this chapter is accounting for and recognizing revenue in contracts with customers in
accordance with IFRS 15. First, methods of adoption are discussed for this new revenue recognition
standard. Next, improvements resulting from the new standard are briefly discussed. Finally, this chapter
lays out requirements to implement and adhere to this new standard.

The new revenue recognition policies are written to be in harmony with qualitative characteristics of the
Conceptual Framework, which states that the objective of general purpose financial statements is to provide
users with financial information about the reporting entity that is useful in making business and economic
decisions. For financial information to be useful, it must be relevant and faithfully represent what it purports
to represent. Thus, properly recognizing and measuring revenue fulfills the objective that the financial
statements faithfully represent the amount reported in revenue that is useful to external users in assessing an
entity’s performance and future cash flows. Additionally, such information enhances comparability of financial
information among periods and across industries and capital markets.

Revenue is a crucial part of an entity’s operating statement. Investors and creditors use an entity’s revenue
when analyzing the entity’s financial position and performance as a basis for making capital allocation
decisions. Revenue is also important to financial statement preparers, auditors and regulators. Identifying
when to recognize revenue in contracts with customers is the focus of this chapter. Significant judgment may
need to be made in applying the provisions of IFRS 15.

Issues in Accounting for Revenue

The primary issue in accounting for revenue is determining when to recognize revenue. Recognizing revenue
means incorporating revenue in the statement of comprehensive income that meets the definition of an
element and satisfies the criteria for recognition. Generally, revenue is recognized when it is probable that an
entity will receive the economic benefits associated with the revenue and the amount of revenue can be
reliably measured. Determining when to recognize revenue can be one of the most complex tasks entities
have. Historically, revenue recognition has been the most prevalent source of accounting fraud and the area
of most concern for auditors and regulators.

In today’s highly competitive economy, entities provide a countless array of products and services in order to
meet customers’ needs. More often than not, those products and services are delivered or performed over
various periods. Also, entities must often accrue before cash is received or defer revenue until the earning
process is virtually complete or recognize revenue over time during the earning process. Therefore, the
timing of revenue recognition is essential, i.e., the objective is to recognize revenue in the period or periods
that the revenue generating activities of the entity are performed. There are different levels of uncertainty
associated with different types of revenue. Also, judgments as to the collectibility of the cash from the sale of
a product or service may impact revenue recognition.

Revenue recognition can be a way for entities to manage earnings, primarily recognizing them prematurely.
Premature recognition of revenues reduces the quality of earnings, especially if those revenues never
materialize. Furthermore, the laws in different jurisdictions may affect the timing of revenue recognition. For
example, entities may need to follow the law establishing the point in time when the entity transfers the
significant risks and rewards of ownership.
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Companies operating in the telecoms or software industry often sell multiple deliverables in a bundle for a
lump-sum contract price. For example, telecoms entities provide arrangements such as bundled products,
free handsets, broadband connectivity, and television and installation fees. Judgment may be needed to
apply the recognition criteria to each to the separately identifiable component of a single transaction or
arrangement to reflect the substance of the transaction.

Key Terms Defined

Customer. 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.

Performance obligation. 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.

Revenue. The gross amount of economic benefit flowing to an entity from its ordinary business activities that
results in increases in equity other than from contributions made by equity holders.

Standalone selling price. The price at which an entity would sell a promised good or service separately to
a customer.

Transaction price. 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.

IFRS 15, REVENUE FROM CONTRACTS WITH CUSTOMERS

Objective and Scope

The objective of IFRS 15 is to set out standards for recognition and measurement of revenues in contracts
with customers and to simplify and consolidate the revenue recognition guidance found in IAS 18 and IAS 11,
which are both superseded by IFRS 15. According to IFRS 15, the standard applies to all contracts with
customers except:
 Lease contracts within the scope of IAS 17 Leases;
 Insurance contracts within the scope of IFRS 4;
 Financial instruments and other contractual rights or obligations within the scope of IFRS 9 Financial
Instruments, IAS 27 Separate Financial Statements and IAS 28 Investments in Associates and Joint
Ventures; and
 Non-monetary exchanges between entities in the same line of business to facilitate sales to
customers or potential customers. For example, this Standard would not apply to a contract between
two oil companies that agree to an exchange of oil to fulfill demand from their customers in different
specified locations on a timely basis.

Executive Summary
 An entity should recognize revenue in contracts with others that reflects the consideration expected to be
received from the transfer of goods or services.
 A contract does not exist if any of the parties to the contract have the unilateral enforceable right to
cancel a wholly unperformed contract without compensating the other parties to the contract.
 Entities are required to use either the full retrospective approach or the modified retrospective approach
when transitioning to IFRS 15.
 IFRS 15 specifies a five-step model when determining how and when to recognize revenue.
1. Identify the contract(s) with the customer;
2. Identify the separate performance obligations in the contract;
3. Determine the transaction price;
4. Allocate the transaction price to the separate performance obligations; and
5. Recognize revenue when (or as) each performance obligation is satisfied.

 IFRS requires both qualitative and quantitative information in three broad areas;
1. Contracts with customers;
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2. Significant judgments and changes in judgments made when applying guidance in the standard to
contract with customers; and
3. All assets recognized from the costs to obtain or fulfill a contract.

 Entities are required to adopt IFRS 15 on January 1, 2017 with early adoption allowed.

Overview of IFRS 15
The new Standard is a single revenue standard to be applied consistently across industries, regions and
transactions. The main principle in the model is that an entity should recognize revenue in contracts with
others that reflects the consideration expected to be received from the transfer of goods and services.
Contracts with customers that meet the following criteria fall within the scope of IFRS 15:

a. Contract-based revenue recognition. The parties to a contract have both approved the contract using
practices that are customary such as in writing or orally.
b. Commitment and intent to satisfy the contract. The parties to a contract have committed and intend to
fulfill the contract obligations.
c. Revenue is recognized when and as contractual performance obligations contract are fulfilled. The
entity recognizing the revenue is able to identify each party’s rights related to the goods or services to be
transferred.
d. The amount of revenue is measured based on an allocation of the customer’s aggregate consideration.
Payment terms for the goods or services to be transferred are identifiable. Therefore, an entity
transferring goods or services at separate time will need to allocate total consideration received to each
performance obligation. At inception, the transaction price is allocated between the performance
obligation on the basis of the relative stand-alone selling price of the associated goods or services.
e. The entity expects future cash flows to change because of the contract. The contract has commercial
substance.
f. Collection of the entitled consideration from an exchange is considered to be probable. The carrying
amount of an onerous performance obligation is increased based on the entity’s expected costs of
satisfying that performance obligation, and a corresponding contract loss is recognized.

The Standard specifies that a contract does not exist if any of the parties to the contract have the unilateral
enforceable right to cancel a wholly unperformed contract without compensating the other parties to the
contract. A contract is wholly unperformed when both of the following are met:
1. A party to the contract has not transferred any agreed on goods or services to another party of the
contract; and
2. A party has not received, and is not entitled to receive, any consideration in for the contracted goods
or services (IFRS 15.12).

Transitioning to IFRS 15
IFRS 15 requires all entities reporting using IFRS to adopt the new guidelines for annual periods beginning on
January 1, 2017. Entities can also elect to adopt the provisions of IFRS 15 earlier. When an entity
transitions to IFRS 15, it will be able to decide on one of two adoption methods:
1. The Full Retrospective Approach
2. The Modified Retrospective Approach

The Full Retrospective Approach

As its name suggests, the full retrospective approach requires that an entity apply the new revenue
recognition standard to all periods presented in the financial statements. This approach requires the entity to
apply the new guidance to all contracts that existed in the periods presented on the financial statements as if
the standard had been applied from the inception of the contracts. As a result of changing the revenue
recognition of the contracts in each of the years presented, the amount of revenue reported is expected to be
different from revenue reported under superseded IFRS. To account for this difference, the cumulative
effects of these changes to prior periods are included in the beginning balance of retained earnings. This
cumulative adjustment requires the entity to disclose the reason for the change and the method of applying
the change.

The Modified Retrospective Approach

The modified retrospective approach requires that the entity account for the cumulative effect of the changes
in the opening balance of retained earnings for the most current period presented. Any contracts existing
(does not apply to completed contracts) as the effective date are treated as if the standard was applied since
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the contract’s inception, and naturally, any future contracts would be accounted for under the new standard.
These changes are reflected in the beginning retained earnings balance only in the year that the standard is
adopted. If an entity elects to use the modified retrospective approach, it shall disclose a) the amount to
which item in the current period’s financial statements impacted by the standard compared to IAS 11 and 18,
and b) and explanation providing the reasons for the change. This requirement allows the financial statement
users to see the before and after effects of the application of the new Standard. Under the full retrospective
approach, each of the years presented are easily compared to each other; however, under the modified
retrospective approach, comparability is negatively impacted because the year during which the standard was
implemented is reported differently than the other years presented. This situation would cause reporting to
be inconsistent with the concepts of the Conceptual Framework creating difficulties when financial statement
users want to analyze trends and compare years of financial data. The additional disclosures require entities
to be transparent by providing information to users of the financial position of the before and after the new
standards were enacted.

Applying IFRS 15
IFRS 15’s core principle is that “an entity shall 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” (IFRS 15.2). To adhere to the core principle, an entity applies five
steps to determine when to recognize revenue:
1. Identify the contract(s) with the customer;
2. Identify the separate performance obligation in the contract;
3. Determine the transaction price;
4. Allocate the transaction price to the separate performance obligations; and
5. Recognize revenue when (or as) each performance obligation is satisfied.

The five steps are meant to help entities to determine when to recognize revenue and how much revenue
must be recognized.

Step 1: Identify the Contract with the Customer

“A contract is an agreement between two or more parties that create enforceable rights and obligations”
(IFRS 15.10). Legally enforceable contracts can be written, oral, or implied by the entity’s customary
business practices. However, contracts need to meet the following requirements for the purpose of applying
the new standard:
 The contract has commercial substance;
 The parties have approved the contract and are committed (the contract is likely to be executed) to
perform the respective obligations;
 The entity can identify each party’s rights regarding the goods or services to be transferred; and
 The entity can identify the payment terms for the goods or services to be transferred.

The standard is applicable to express contracts whether they are written or oral as well as “implied-in-fact”
contracts. An implied-in-fact contract is a contract that is constructively formed by the actions of the parties
involved – in other words, a tacit agreement.

For the purpose of applying the standard, a contract does not exist if (a) the contract is wholly unperformed
and (b) each party can unilaterally terminate the contract without compensating the other party(s). A contract
is wholly unperformed if the entity has not yet (a) transferred any promised goods or services to the
customer, and (b) received, and is not entitled to receive, any consideration in exchange for promised goods
or services (IFRS 15.12).
If the standard is applicable to a contract, and that contract is amended, the parties involved will need to
consider whether the contract modification requires prospective or retrospective adjustments. The standard
indicates that an entity should account for a contract modification prospectively if the goods or services under
the revised contract are not the same goods and services transferred before the modification.

A contract modification is accounted for as a cumulative catch-up adjustment if the goods or services are not
distinct and are part of single performance obligation.

An entity can combine two or more contracts entered into at approximately the same time and with the same
party and account for the different contract as a single contract provided the:
a. the contracts are negotiated as a package with a single commercial objective;
b. the amount of consideration to be paid in one contract depends on the price or performance of the
other contract; or
c. the goods or services promised in the contracts (or some goods or services promised in each of the
contracts) are a single performance obligation” (IFRS 15.17).
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Step 2: Identify the Separate Performance Obligations

A performance obligation is a contractual; promise with a customer to deliver a good or perform a service.
Performance obligations can come as separate obligation or a bundle of obligations that are not distinct from
each other. There are two criterial that must be met in order for an entity to determine that promised goods
and services are distinct from other goods and services in the contract.

Each good or service (or bundle of goods and services) is a separate performance obligation that is
accounted for separately if that good or service (or bundle) is both:
 Capable of being distinct, i.e. the customer can benefit from the good or service either on its own or
together with the other resources that are readily available to the customer; and
 Distinct in the context of the contract, i.e., the good or service is not highly dependent on or highly
interrelated with other goods or services promised in the contract (IFRS 15.27).

Identifying separate performance obligations is essential since these are the units of account to which the
transaction price is allocated. Determining how a performance obligation will be satisfied is necessary to
know when to record revenue.
Indicators that goods and/or services are not distinct include: 1) highly interrelated goods and services that
require the entity to provide significant services to integrate the goods or services into a combined product for
the customer, and 2) goods or services that are appreciably customized or modified in order to satisfy the
contract.

Step 3: Determine the Transaction Price

The transaction price is the amount of consideration an entity expects to receive under the contract in
exchange for transferring goods or services (excluding amounts received on behalf of third parties).
Transaction prices are normally easily determinable but complexities may arise if the consideration is
contingent on other factors or involves significant financing arrangements. The reason for this step is to
require entities to only recognize revenue for performance obligations that are not subject to significant future
reversals caused by uncertainties. This is an area that will require significant judgment and necessitate a
review of an entity’s experience with similar types of performance obligations. When determining the
transaction price, an entity must consider both the variable consideration and the time value of money.

Variable Consideration
The existence of discounts, refunds, rebates, contingencies and other contractual instruments may cause the
contract consideration to change. If the consideration in the contract is variable, and it is probable that
revenue reversal will not occur, an estimate of the variable consideration should be made so that the
consideration can be allocated to each performance obligation. For each contract that has variable
consideration for which an estimate must be generated, an entity may use only one of two methods:
1. The Expected Value Method. In order to implement this method, the entity must determine possible
variations in consideration and weigh them individually based on the probability of each occurring.
The sum of these weighted amounts is the expected value.
2. The Most Likely Value Method. Instead of weighting each possible variation in consideration, the
entity must choose the most likely variation.
Time Value of Money
When a contract extends more than one year, the transaction price must be adjusted for the time value of
money. In determining the effect of the time value of money on a transaction prices, management must
consider: (a) the length of time between when the good or service is transferred and when the payment is
received, (b) if the transaction price would be substantially different if the customer paid cash when the goods
or services were transferred, and (c) the prevailing interest rate in the market and in the contract.

Collectibility
The customer’s ability and intention to pay may not always match the price of the contract due to price
concession such as early payment discounts. In this case, the entity should only recognize what it expects to
receive from the customer. In order to recognize revenue on the contract, collectibility of the expected
amount must be probable or reasonably assured. When collectibility ceases to be probable, the entity must
expense the recorded receivable as bad debt.

Noncash Consideration
Occasionally, an entity may decide that, instead of cash, it wants to trade goods or service for other goods or
service. When this type of consideration is given, the transaction price is measured at the fair value of the
noncash consideration that the entity receives. In some cases, the fair value of the noncash consideration
may not be able to be (or cannot be reliably) determined. At this point, the transaction price becomes the
standalone selling price of the noncash consideration that the entity is to receive.
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Consideration Payable to a Customer

If the entity expects to give the customer coupons, rebates, cash or any other consideration that offsets the
consideration that the customer owes the entity and is not for a distinct good or service from the customer,
the transaction price of the contract should be reduced.

Step 4: Allocate the Transaction Price to the Separate Performance Obligations

After determining the multiple performance obligations of the contract, the transaction price will need to be
allocated across the different elements of contract. If there is only one performance obligation, this step is
unnecessary, but if there is more than one, the transaction price should be allocated to the separate
performance obligations.

There are several acceptable methods of valuation that an entity may use in the absence of directly
observable market prices.
1. The Adjusted Market Assessment Method. This method frames the issue in the economic
perspective of the customer. Implementing this method would cause an entity to ask itself “What is a
customer in this market willing to pay for this good or service?”
2. The Cost-Plus Method. This approach utilizes the readily available reference point of product or
service costs. An entity determines the cost of producing a good or rendering a service and adds a
margin on top of that.
3. The Residual Method. The entity determines the standalone selling prices for all of the underlying
goods and services except the one for which there is no directly observable prices. The remaining
consideration after subtracting the standalone selling prices of the other underlying goods and
services from the transaction price, is attributed to the good or service for which there is no directly
observable price.

Step 5: Recognize Revenue as Each Performance Obligation is Satisfied

After identifying a contract, determining separate performance obligations, determining the transaction price,
and allocating the transaction price across the contract, the benefits of the contract can be realized. Revenue
recognition is tightly linked to the completion of individual performance obligations. Revenue resulting from
the contract can only be recognized as each performance obligation is completed and in the amount of the
transaction price that was allocated to each performance obligation. However, understanding the timing of
each performance obligations is important because the way in which performance obligations are completed
affects revenue recognition. Performance obligations can be completed in one of two ways – they can be
completed at a single point in time or over time.

At a single point in time. If a performance obligation is completed at a single point in time, revenue for that
performance obligation may be recognized immediately upon completion. This happens most often when
goods are being delivered to the customer. For example, if a good is being shipped to a customer with terms
of FOB shipping point, the good is considered to be delivered to the customer at the moment that the truck
leaves the company’s docks.
In order for revenue to be recognized, control of the good – including the risks and rewards of ownership –
must be transferred to the customer. This means that even if an asset is sitting in the seller’s warehouse and
the customer has legal title to that asset (meaning that the customer has paid and is entitled to the asset),
control of the good has been transferred.

Over time. A performance obligation is considered to be completed over time if the performance obligation
meets one of the following criteria:
 The customer is receiving and consuming the benefits of the seller’s performance as the seller
performs.
 The seller creates or enhances an asset that the customer controls as it is created or enhanced.
 The asset created by the seller does not have an alternative use and the seller has a right to payment
for performance completed to date.

If the performance obligation satisfies one of these criteria, then revenue must be recognized over time as
progress is made in completing the performance obligation. There are two methods that an entity can use to
gauge progress made toward completion and guide revenue recognition.

1. The input method. Progress is measured by what inputs or efforts the company has made toward
completion of the performance obligation.
2. The output method. Progress is measured by what outputs or results that the company has delivered
to the customer so far.
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This process of revenue recognition is repeated until all performance obligations have been completed,
revenue has been fully recognized, and the contract is completed.

Disclosures
IFRS 15 requires enhanced disclosures to assist the users of financial statements to understand the amount,
timing and uncertainty of revenue and cash flows. The Standard requires both qualitative and quantitative
information in three broad areas:

1. Contracts with customers;

2. Significant judgments and changes in judgments made when applying guidance in the standard to
contract with customers; and
3. All assets recognized from the costs to obtain or fulfill a contract.

One of the main guiding principles articulated in the standard is that entities “shall consider the level of detail
necessary to satisfy the disclosure objective and how much emphasis to place on each of the various
requirements” (IFRS 15.111). This principle requires an entity to aggregate or disaggregate disclosures so
that information is clear to financial statement users without obscuring it with either large amounts of
insignificant details or the aggregation of items that are fundamentally different from each other.

Contracts with Customers

An entity is required to disclose revenue resulting from contracts with customers separately from its other
sources of revenue. This should be done with appropriate detail to clarify for the user the nature, amount,
timing and uncertainty of revenue cash flows from the contracts. This information should be tied into revenue
information available about the entity’s reportable segments so that a financial statement user can
understand the relationship between the two.

In addition to revenue disclosures, entities must disclose the beginning and ending balances of accounts
receivable, other assets related to the contract, and liabilities to the customer. Significant changes in the
assets and liabilities related to the contract should be disclosed with an explanation as to the nature of
changes. For example, if the customer declared bankruptcy, a large change in contract assets and liabilities
would result. This change should be explained both quantitatively and qualitatively.

Finally, an entity must disclose significant terms and performance obligations in the contract, including
consideration and goods and services promised in the contract, and how the terms of the contract are to be
carried out. What remains of the performance obligations to be completed must also be disclosed with an
explanation of how this remaining revenue is to be collected.

Significant Judgments
Entities should disclose any judgments or changes in judgments that were made during execution of the five
steps of revenue recognition for contracts with customers. Meriting special attention are disclosures for
judgments, regarding the timing of performance obligation satisfaction (when and how the obligation was
satisfied), transaction price, and allocations to separate performance obligations.

Assets Recognized from Costs to Obtain or Fulfill a Contract with a Customer

In obtaining a contract, costs are often incurred. When these costs are expected to be recovered and are
incremental, meaning that the costs are only incurred as a direct result of the contract, an entity should
capitalize (recognize as an asset) those costs. Costs incurred in fulfilling a contract should be recognized as
an asset if all of the following criteria are met:
1. The costs are not related to inventories, property, plant and equipment, or intangible assets (IAS 2,
IAS 16 and IAS 38 respectively).
2. The costs are expected to be recovered.
3. The costs generate or enhance resources of an entity that will be used in satisfying performance or
obligations in the future.
4. The costs relate directly to a specific contract or specific future contract.

Accounting firms often bill a specific customer for hours of work performed. This would qualify as a cost that
can be capitalized under IFRS 15. Costs that are capitalized as part of a contract with a customer must be
disclosed along with the judgments that led to the capitalization and the method of amortizing these
capitalized costs for each reporting period.

Information and Judgments

The Standard requires considerable judgments to identify separate performance obligations as well as the
timing and amount of revenue to be recognized. The overarching principle is that an entity needs to apply the
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criteria consistently to contracts with similar circumstances and characteristics. Examples of significant
judgments that may be required to apply IFRS 15 include:
 Selecting the method of transition to IFRS 15
 Identifying whether a contract exists and falls under IFRS 15
 Distinguishing between separate performance obligations
 Determining a transaction price and considering the factors that could affect it
 Allocating the transaction price to separate performance obligations
 Determining when a performance obligations is complete
 Determining how much work has been done on a performance obligation
 Recognizing revenue to reflect the completeness of a performance obligation
 Determining how to disclose the appropriate material in order to enhance the understandability,
relevance and reliability of the financial statements.

Key Differences between IFRS and U.S. GAAP

The IASB and the FASB issued a converged standard on revenue from contracts with customers (IFRS 15
and ASC 606, respectively). Any differences that do exist are minor and include differences in:
 Interim disclosure requirements. ASC 606 requires more interim disclosures regarding contracts with
customers than does IFRS 15. IFRS 15 requires mostly annual disclosures.
 Application of the standard. ASC 606 provides relief to nonpublic companies from certain disclosures
while IFRS 15 does not.
 Collectibility. Because the IASB and the FASB have different definitions of the word “probable”,
collectibility thresholds between the two are different. The threshold for determining collectibility is
lower under IFRS 15 because the IASB has defined “probable” as more likely than not,” while the
FASB has defined probable as “likely to occur”.
 Implementation. The date of required implementation differs between IFRS 15 and ASC 606. IFRS
15 mandates implementation for all companies on January 1, 2017 and allows early adoption while
ASC 606 requires implementation for public companies only for periods on or after December 15,
2016 (no early adoption). ASC 606 provides leeway for nonpublic companies while IFRS 15 does
not. The effective date for US nonpublic entities is for annual periods beginning after December 15,
2017 with early adoption allowed after December 15, 2016.

Reference:

International Financial Reporting Standards

A Framework-based Perspective
F. Greg Burton & Eva K. Jermakowicz
2015