CHAPTER 38: PFRS 15 - REVENUE FROM CONTRACTS WITH CUSTOMERS

Introduction

PFRS 15 is the new global framework for revenue recognition.

Entities that sell products and services in a bundle or multiple deliverables or those engaged in major projects could see
significant change in the timing of revenue recognition.

Entities likely to be affected by this new revenue standard include those engaged in telecom, software, engineering,
construction and real estate.

For other industries, it will be business as usual, as in the case of sale of merchandise in the ordinary course of business.

Revenue is income in the ordinary course of business activities.

Income is increase in economic benefit during the accounting period in the form of an inflow or enhancement of asset or
decrease in liability that results in an increase in equity, other than contribution from equity, other than contribution
from equity participants.

PFRS 15 applies to all contracts with customers, except:

a. Leases under PFRS 16

b. Insurance contracts under PFRS 17
c. Financial instruments under PFRS 9

Core principle

The core principle of the new revenue standard can be divided into two:

1. An entity should recognize revenue in a manner that depicts the pattern of transfer of good or service to a
customer.

2. The amount recognized as revenue should reflect the consideration to which the entity expects to be entitled in
exchange for good or service. Depending on whether certain criteria are met, revenue is recognized:

a. At a point in time or at particular date when control of the good or service is transferred to the customer.
b. Over time or over a certain period in a manner that depicts the entity's performance.

Five-step model
CHAPTER 38: PFRS 15 - REVENUE FROM CONTRACTS WITH CUSTOMERS

An entity that recognizes revenue in accordance with the core principle should apply the following five-step model:

Step 1: Identify the contract with the customer

Step 2: Identify the performance obligation in the contract

Step 3: Determine the transaction price

Step 4: Allocate the transaction price to the performance obligations in the contract

Step 5: Recognize revenue when or as the entity satisfies a performance obligation

Step 1 - Identifying a contract

A contract is an agreement between two or more parties that creates enforceable rights and obligations in a contract.

Enforceability of the rights and obligations in a contract is a matter of law.

Contract can be written, oral or implied by an entity’s customary business practice.

Contract criteria
A contract with a customer must meet all of the following criteria:

a. The parties to the contract have approved the contract in writing, orally or in accordance with customary
business practice.
b. The rights and obligations of the parties in the contract can be identified.
c. The payment terms in the contract can be identified.
d. The contract has commercial substance, meaning the entity’s cashflow is expected to change significantly as a
result of the contract.
e. The collection of the consideration is probable.

Generally, contracts should be accounted for separately.

In some cases, contracts should be combined as one if any of the following is satisfied

a. The contracts are treated as a single person.

b. The consideration in one contract depends on the good or service of another contract.
c. The goods or services in the contracts relate to a single performance obligation.

Step 2 – Identify the performance obligation

A performance obligation is a promise to deliver a good or service in a contract with customer.

A promise constitutes a performance obligation if the promised good or service is distinct.

CHAPTER 38: PFRS 15 - REVENUE FROM CONTRACTS WITH CUSTOMERS

A promised good or service is. distinct if it meets both of the following criteria:

a. The customer can benefit from the good or service

b. The entity's promise to transfer the good or service to the customer is separately identifiable from other
promises in the contract.

Distinct good or service

1. Sale of finished goods produced by a manufacturer

2. Sale of merchandise inventory by a retailer
3. Constructing, manufacturing or developing asset on behalf of customer, as in long-term construction contract
4. Granting license or franchise
5. Performing a contractually agreed-upon task for a customer, as in bookkeeping service or payroll processing
service

Step 3 - Determine the transaction price

The transaction price is the amount of consideration in a contract to which an entity expects to be entitled in exchange
for transferring good or service to a customer.

Factors that may affect the transaction price are:

a. Variable consideration
b. Time value of money
c. Noncash consideration
d. Consideration payable to a customer

Variable consideration

Variable consideration is included in the transaction price when it is highly probable that a significant reversal of revenue
or decrease in revenue will not occur.

For example, an entity has a contract to sell through a distributor. The distributor has a right to return if it cannot sell the
product and the entity recognizes revenue when the distributor resells the product to ultimate customers.

Under PFRS 15, the entity can recognize revenue when goods are sold to the distributor based on the number of units
sold less the units expected to be returned.

Time value of money

If the contract has a significant financing component, the consideration should be adjusted for time value of money,
Revenue is measured based on the cash selling price.

The difference between the total consideration and cash selling price is accounted for as interest income.

However, if the contract period is less than one year, the entity can disregard time value of money.

Noncash consideration

Noncash consideration is measured at fair value.

CHAPTER 38: PFRS 15 - REVENUE FROM CONTRACTS WITH CUSTOMERS

If the fair value cannot be reasonably estimated, the stand-alone selling of the promised good or service is used.

Consideration payable to the customer

The entity needs to determine if consideration payable to the customer may result in a reduction of the transaction
price.

Examples include vouchers, coupons and volume rebate.

Step 4 Allocation of the transaction price

The transaction price is allocated to each performance obligation on the basis of relative stand-alone selling price of
each good or service.

Stand-alone selling price is the price that the entity would sell a promised good or service separately to a customer.

Determining stand-alone selling price

The best evidence of the stand-alone selling price is an observable price of a good or service when sold on a stand-alone
basis or when sold separately,

If the stand-alone selling price is not directly observable, the entity must estimate such price by using the following
methods:

a. Adjusted market assessment approach

b. Expected coat plus margin approach
c. Residual approach

The adjusted market assessment approach means the entity may refer to prices from competitors for similar good or
service adjusted for specific cost and margin.

The expected cost plus margin approach means the entity may forecast expected cost to satisfy the performance
obligation adjusted for an appropriate margin or profit.

The residual approach may be used only when either the selling price of the good or service is highly variable or is
uncertain.

Under the residual approach, the stand-alone selling price is the difference between the total transaction price and the
sum of the observable stand-alone selling prices of other goods or services in the contract.

Step 5 Recognition of revenue

As entity shall recognize revenue when or as it satisfies a performance obligation by transferring control of a good or
service to a customer.

Simply stated, revenue should be recognized when an entity transfers control of the good or service to a customer.

The amount of revenue is the amount allocated to the performance obligation.

Control of an asset refers to the ability to direct the use of the asset and obtain substantially all of the benefits from the
asset.

Revenue can be recognized either at point in time or over time.

Revenue recognition at a point in time

CHAPTER 38: PFRS 15 - REVENUE FROM CONTRACTS WITH CUSTOMERS

The following factors would indicate revenue recognition at a point in time:

a. The entity has the right to receive payment for the asset and for which the customer is obliged to pay.
b. The customer has legal title to the asset.
c. The entity has transferred physical possession of the asset to the customer.
d. The customer has the significant risks and rewards of ownership of the asset.
e. The customer has accepted the asset.

Revenue recognition over time

Revenue is recognized over time when any of the following is satisfied:

a. The customer simultaneously receives and consumes the benefits provided by the entity's performance as the
entity performs.

For example, routine or recurring payroll processing services.

b. The entity's performance creates or enhances an asset that the customer controls as the asset is created or
enhanced.

For example, constructing an asset on a customer site.

c. The entity's performance does not create an asset with an alternative use to the entity and the entity has an
enforceable right to receive payment for performance completed to date.

For example, constructing a specialized asset that only the customer can use or constructing an asset in
accordance with customer order.

Sale of goods

When goods are sold in the ordinary course of business, revenue is recognized unquestionably at the point of sale.

The reason is that it is at the point of sale that the entity has transferred to the customer the significant risk and reward
of ownership of the asset. Stated differently, legal title passes to the customer at the point of sale.

Incidentally, the point of sale is usually the point of delivery which may be actual or constructive.

Legally, it is delivery that transfers title or ownership from the seller to buyer.

Sale with a right return

PFRS 15, paragraph B21, provides that an entity shall recognize the following with respect to a sale with a right of return:

a. Revenue equal to the total sale price less the sale price of the expected return.
b. Refund liability equal to the sale price. of the expected return.
c. A recover asset and the corresponding reduction of cost of goods sold equal to the cost of the expected return.

Illustration

On December 1, 2020, an entity sold 10,000 units at P200 per unit or P2,000,000. The cost for each unit is P140. The
entity granted the customers a right to return within 30 days if not satisfied and will receive either a full refund if cash
was already paid or full credit for the amount owed to the entity.
CHAPTER 38: PFRS 15 - REVENUE FROM CONTRACTS WITH CUSTOMERS

It estimated that 5% of the units sold or 500 units will be returned within the 30-day period. The entity used the
perpetual method

Computations

Revenue (9,500 units x 200) 1,900,000

Refund Liability (500 units x 200) 100,000
Costs of goods sold before expected return (10,000units x 140) 1,400,000
Cost of recover asset (500 x 140) 70,000

Journal entries on December 1, 2020

1. To record the sales and refund liability:

Accounts receivable 2,000,000

Sales 1,900,000
Refund liability 100,000

2. To record the cost of goods sold:

Cost of goods sold 1,400,000

Inventory 1,400,000

3. To record the recovered asset:

Recover asset 70,000

Cost of goods sold 70,000

Actual returns more than expected

Assume 800 units were actually returned on December 31, 2020:

1. To cancel the refund liability and decrease the sales for the excess actual returns:

Refund liability (500x200) 100,000

Sales (300x200) 60,000
Accounts Receivable 160,000

2. To revert to inventory the expected returns actually returned:

Inventory (500x140) 70,000

Recover asset 70,000

3. To revert to inventory actual returns in excess of the expected:

CHAPTER 38: PFRS 15 - REVENUE FROM CONTRACTS WITH CUSTOMERS

Inventory (300x140) 42,000

Costs of goods sold 42,000

No actual returns

Assume no actual returns were made on December 31, 2020 and the 30-day period has lapsed.

1. To increase the sales revenue:

Refund Liability 100,000

Sales 100,000

2. To recognize the corresponding cost of goods sold:

Cost of goods sold 70,000

Recover asset 70,000

Consignment arrangement

Consignment is a method of marketing goods in which the entity called the consignor transfers physical possession of
certain goods to a dealer or distributor called the consignee that sells the goods on behalf of the consignor.

The consignor shall not recognize revenue upon delivery of the goods to the consignee until the goods are sold by the
consignee.

The reason is that the product is controlled by the consignor and the consignee does not have an unconditional
obligation to pay for the product.

When consigned goods are sold by the consignee, a report called account sales is given to the consignor together with a
cash remittance for the amount of sales minus commission and other expenses chargeable against the consignor.

Bill and hold arrangement

Bill and hold arrangement is a contract under which an entity bills a customer for a product but the entity retains
possession of the product.

For example, a customer may request an entity to enter into such contract because of lack of space for the product or
because of delays in the customer's production schedule.

Depending on the terms of the contract, revenue shall be recognized when the customer obtains control or takes title of
the product even though the product remains in an entity’ s physical possession.

All of the following criteria must be met for the recognition of revenue in a bill and hold arrangement:

a. The customer has requested for the arrangement.

b. The product must be identified separately as belonging to the customer.
c. The product must be ready for physical transfer to the customer anytime.
d. The entity cannot have the ability to use the product or to direct it to another customer.

Customer loyalty program

CHAPTER 38: PFRS 15 - REVENUE FROM CONTRACTS WITH CUSTOMERS

Many entities use a customer loyalty program to build brand loyalty, retain their valuable customers and of course,
increase sales volume.

The customer loyalty program is generally designed to reward customers for past purchases and to provide them with
incentives to make further purchases.

If a customer buys goods or services, the entity grants the customer award credits often described as "points".

The entity can redeem the "points" by distributing to the customer free or discounted goods or services.

A customer loyalty program operates in a variety of ways.

Customers may be required to accumulate a specified minimum number of award credits or "points" before they can be
redeemed.

Measurement

An entity shall account for the award credits as a "separately component of the initial sale transaction".

In other words, the granting of award credits is effectively accounted for as a "future delivery of goods or services".

PFRS 15, paragraph 74, provides that an entity shall allocate the transaction price to each performance obligation
identified in a contract on a relative stand-alone selling price basis.

In other words, the fair value of the consideration received with respect to the initial sale shall be allocated between the
award credits and the sale based on relative stand-alone selling price.

The stand-alone selling price is the price at which an entity would sell a promised good or service separately to a
customer.

Recognition

The consideration allocated to the award credits ia initially recognized as deferred revenue and subsequently recognized
as revenue when the award credits are redeemed.

The amount of revenue recognized shall be based on the number of award credits that have been redeemed relative to
the total number expected to be redeemed.

The estimated redemption rate is assessed each period. Changes in the total number expected to be redeemed do not
affect the total consideration for the award credits.

Instead, the changes in the total number of award credits expected to be redeemed shall be reflected in the amount of
revenue recognized in the current and future periods.

In other words, the calculation of the revenue to be recognized in any one period is made on a "cumulative basis" in
order to reflect the changes in estimate.

Illustration

An entity, a grocery retailer, operates a customer loyalty program.

The entity grants program members loyalty points when they spend a specified amount on groceries.

Program members can redeem the points for further groceries. The points have no expiry date.
CHAPTER 38: PFRS 15 - REVENUE FROM CONTRACTS WITH CUSTOMERS

The sales during 2020 amounted to P9,000,000 based on stand-alone selling price.

During 2020, the customers earned 10,000 points.

But management expects that 80% or 8,000 Of these points will be redeemed.

The stand-alone selling price of loyalty point is estimated at P100.

On December 31, 2020, 4,000 points have been redeemed in exchange for groceries.

In 2021, the management revised expectations and now expects that 90% or 9,000 points will be redeemed altogether.

During 2021, the entity redeemed 4,100 points

In 2022, a further 900 points are redeemed

Management continues to expect that only 9,000 points will ever be redeemed, meaning, no more points will be
redeemed after 2022.

Allocation of transaction price

Product sales 9,000,000

Points-stand-alone selling price (10,000 x 100) 1,000,000
Total 10,000,000

Product sales (9,000,000/10,000,000x 9,000,000) 8,100,000

Points (1,000,000/10,000,000x 9,000,000) 900,000
Total 9,000,000

Journal entries

To record the initial sale in 2020:

Cash 9,000,000
Sales 8,100,000
Unearned revenue – points 900,000

Redemption of 4,000 points in 2020

Unearned revenue – points 450,000

Sales 450,000

Revenue to be recognized in 2020 (4,000/8,000 x 900,000) 450,000

Redemption of 4,100 points in 2021

CHAPTER 38: PFRS 15 - REVENUE FROM CONTRACTS WITH CUSTOMERS

Unearned revenue – points 360,000

Sales 360,000

Points redeemed in 2020 4,000

Points redeemed in 2021 4,100
Total points redeemed to December 31,2021 8,100

Cumulative revenue on December 31, 2021 (8,100/9,000 x 900,000) 810,000

Revenue recognized in 2020 (450,000)
Revenue to be recognized in 2021 360,000

Redemption of 900 points in 2022

Unearned revenue – points 90,000

Sales 90,000

Points redeemed in 2020 4,000

Points redeemed in 2021 4,100
Points redeemed in 2022 900
Total points redeemed to December 31,2022 9,000

Cumulative revenue on December 31, 2022 (9,000/9,000 x 900,000) 900,000

Cumulative revenue – December 31,2021 (810,000)
Revenue to be recognized in 2022 90,000