IFRS 15 Revenue from Contracts with Customers

https://www.ifrsbox.com/ifrs-15-revenue-contracts-customers/

Overview of IFRS 15

• Issued: in 2014; followed by clarifications

• Effective date: 1 January 2018

• What it does:

o It sets the principles for reporting the information about the

revenues about:
▪ Nature
▪ Amount
▪ Timing
▪ Uncertainties

o It describes the five-step model for revenue recognition and provides

guidance about each step:

1. Identify the contract with the customer

2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations in the
contracts
5. Recognize revenue when (or as) the entity satisfies a performance
obligation

o It provides the guidance on contract costs.

o It contains further clarifications related to specific transactions such as

sale of licenses, warranties, repurchase agreements and other topics.

o It sets the requirements for presentation and disclosures in the financial

statements.
KEY POINTS

New revenue recognition standard was issued: IFRS 15 Revenue from Contracts with
Customers and it should fill the gap between IFRS and US GAAP.

o You’ll need to apply IFRS 15 for reporting periods beginning on or after 1

January 2018 (early application permitted)

o IFRS 15 will replace the following standards and interpretations:

▪ IAS 18 Revenue
▪ IAS 11 Construction Contracts
▪ SIC 31 Revenue – Barter Transaction Involving Advertising Services
▪ IFRIC 13 Customer Loyalty Programs
▪ IFRIC 15 Agreements for the Construction of Real Estate and
▪ IFRIC 18 Transfer of Assets from Customers

o 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 (payment) to which the entity
expects to be entitled in exchange for those goods or services.

To apply this principle, you need to follow a five-step model framework described
below.

Five-Step Model Framework

Every company must follow the five-step model in order to comply with IFRS 15.

• Step 1: Identify the contract(s) with a customer.

IFRS 15 defines a contract as an agreement between two or more parties that

creates enforceable rights and obligations and sets out the criteria for every
contract that must be met.

• Step 2: Identify the performance obligations in the contract.

A performance obligation is a promise in a contract with a customer to transfer

a good or service to the customer.

• Step 3: Determine the transaction price.

The transaction price is the amount of consideration (for example, payment) 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.
 • Step 4: Allocate the transaction price to the performance obligations in the
contract. For a contract that has more than one performance obligation, an
entity should allocate the transaction price to each performance obligation in
an amount that depicts the amount of consideration to which the entity expects
to be entitled in exchange for satisfying each performance obligation.

• Step 5: Recognize revenue when (or as) the entity satisfies a performance
obligation.

Who Will Feel the Biggest Impact of IFRS 15?

The experts say that the most impacted industries are telecom, software
development, real estate and other industries with long-term contracts.

If you work in an industry where bundled contracts of “product + service” are quite
common, then you should pay attention.

I’m referring mainly to software development or telecommunications, where customers

usually buy a prepayment plans with a handset or software development comes with
implementation and post-delivery service in 1 package, or any similar arrangements.

Under the new model, companies in telecom and software will probably recognize
revenue earlier than under older rules.

Why is that?

Well, because under new IFRS 15, the transaction price must be allocated to the
individual performance obligations in the contract and recognized when these
obligations are delivered or fulfilled.

It means that under new IFRS 15, telecom operator must allocate a part of the revenue
from prepayment plan with free handset to the sale of handset, too.

Under IAS 18, the revenue is defined as a gross inflow of economic benefits arising from
ordinary operating activities of an entity.

It means that if the operator gives a handset for free with the prepayment plan, then
the revenue from handset is 0.
Example: IAS 18 vs. IFRS 15

Johnny enters into a 12-month telecom plan with the local mobile operator ABC. The
terms of plan are as follows:

• Johnny’s monthly fixed fee is Php 100.

• Johnny receives a free handset at the inception of the plan.

ABC sells the same handsets for Php 300 and the same monthly prepayment plans
without handset for Php 80/month.

How should ABC recognize the revenues from this plan in line with IAS 18 and IFRS 15?

Revenue under IAS 18

Current rules of IAS 18 say that ABC should apply the recognition criteria to the
separately identifiable components of a single transaction (here: handset + monthly
plan).

However, IAS 18 does not give any guidance on how to identify these components and
how to allocate selling price and as a result, there were different practices applied.

For example, telecom companies recognized revenue from the sale of monthly plans in
full as the service was provided, and no revenue for handset – they treated the cost of
handset as the cost of acquiring the customer.

Some companies identified these components, but then limited the revenue allocated to
the sale of handset to the amount received from customer (zero in this case). This is a
certain form of a residual method.

For the simplicity, let’s assume that ABC recognizes no revenue from the sale of
handset, because ABC gives it away for free. The cost of handset is recognized to profit
or loss and effectively, ABC treats that as a cost of acquiring new customer.

Revenue from monthly plan is recognized on a monthly basis. The journal entry is to
debit receivables or cash and credit revenues with Php 100.
Revenue under IFRS 15

Under new rules in IFRS 15, ABC needs to identify the contract first (step 1), which is
obvious here as there’s a clear 12-month plan with Johnny.

Then, ABC needs to identify all performance obligations from the contract with
Johnny (step 2 in a 5-step model):

1. Obligation to deliver a handset

2. Obligation to deliver network services over 1 year

The transaction price (step 3) is Php 1 200, calculated as monthly fee of Php 100 times
12 months.

Now, ABC needs to allocate that transaction price of Php 1 200 to individual
performance obligations under the contract based on their relative stand-alone selling
prices (or their estimates) – this is step 4.

I made it really simple for you here, so let’s do it in the following table:

Stand-alone Revenue (=relative

Performance obligation % on total
selling price selling price = 1 200*%)
Handset 300.00 23.8% 285.60
Network services 960.00 (=80*12) 76.2% 914.40
Total 1 260.00 100.0% 1 200.00

The step 5 is to recognize the revenue when ABC satisfies the performance
obligations. Therefore:

▪ When ABC gives a handset to Johnny, it needs to recognize the

revenue of Php 285.60
▪ When ABC provides network services to Johnny, it needs to
recognize the total revenue of Php 914.40. It’s practical to do it
once per month as the billing happens.

The journal entries are summarized in the following table:

Description Amount Debit Credit When

285.60 FP – Unbilled P/L – Revenue from When handset is
revenue sale of goods given to Johnny
100.00 (= monthly FP – Receivable to When network
billing to Johnny) Johnny services are
Network 76.20 (=914.40/12) P/L – Revenue from provided; on a
services network services monthly basis
23.80 (=285.60/12) FP – Unbilled according to
revenue contract with Johnny

So as you can see, Johnny effectively pays not only for network services, but also for his
handset.
What’s the Impact of the IFRS 15?
The biggest impact of the new standard is that the companies will report profits in a
different way and profit reporting patterns will change.

In our telecom example, ABC reported loss in the beginning of the contract and then
steady profits under IAS 18, because they recognized the revenue in line with the
invoicing to customers.

Under IFRS 15, ABC’s reported profits are the same in total, but their pattern over time
is different.

Why does it matter?

Well, because some contracts surpass one accounting period. They are long-term and
reporting revenues in incorrect accounting periods might cause wrong taxation,
different reporting to stock exchange and other things, too.

Just look at ABC. Let’s say that contract started on 1 July 20X1 and ABC’s financial year-
end is 31 December 20X1. Just look how much profits ABC reports from the same
contract with Johnny under IAS 18 and IFRS 15 in the year 20X1:

Performance obligation Under IAS 18 Under IFRS 15

Handset 0.00 285.60
Network services 600.00 (=100*6) 457.20 (=76.2*6)
Total 600.00 742.80