MODULE 3 – CONTRACTS REVENUE, PROVISIONS,

CONTINGENT ASSETS AND CONTINGENT LIABILITIES

OBJECTIVES:
1. Requirements of IFRS 15 – contracts with customers
2. 5 Step Model – revenue from contracts with customers
3. IAS 37 – provision, contingent assets and contingent liabilities and its recognition

STANDARDS:
1. IASB Conceptual Framework
2. IAS 37 – Provisions, Contingent Assets and Contingent Liabilities
3. IRS 15 – Revenue from Contracts with Customers

PART A REVENUE FROM CONTRACTS WITH CUSTOMERS

Scope of IFRS 15
IFRS applies to all contracts with customers except,
1. Lease contracts under IFRS 16
2. Insurance contracts under IFRS 17
3. Financial instruments and other contractual rights and obligations under IFRS 9
4. Non-monetary exchanges between entities in the same line of business

It also extends to the recognition and measurement of gains and losses on the sale of non-financial
assets that are not an output of an entity’s ordinary activities

Impact of IFRS 15
Timing and amount of revenue recognised from contracts with customers
Changes in the terms of contracts -> Separate contract or Modification to an existing contract

Recognition of Revenue:
IFRS 15 establishes a framework on determining “When to recognise revenue” and “How much
revenue to recognise”

5 Step Approach
1. Identify the contract with the customer (recognition)
2. Identify the Performance Obligations (recognition)
3. Determine the Transaction Price (measurement)
4. Allocate the transaction price to the performance obligation (measurement)
5. Recognise revenue as or when the PO is satisfied (recognition)

STEP-1 IDENTIFY A CONTRACT

Criteria for a contract:
1. Parties have approved the contract
2. Rights to goods/services transferred
3. Payment terms
4. Contract has commercial substance
5. Probable flow of consideration to the entity
Contract Modifications:
Change in the SCOPE or PRICE or BOTH of a contract

1. Separate Contract (2 conditions to be met)

 Scope of the contract increases

 Price of the contract increases

The revenue recognised to date under the existing contract is not adjusted
Future revenues related to the existing contract will be accounted for under the existing contract
Future revenues related to modified contract will be accounted separately

2. Not a Separate Contract (3 scenarios – depends on goods/services transferred)

 If they are distinct

1) contract modification is accounted as a replacement of the existing contract
2) recognised to date under the existing contract is not adjusted

 If they are not distinct

1)contract modification is accounted as a part of the existing contract
2) past and future revenue is recognised retrospectively

 If they are a combination of distinct and not distinct

1) contract modification is accounted as partly the creation of a new contract and partly the
modification of existing contract
2) Combines both the recognition

STEP-2 IDENTIFY THE PERFORMANCE OBLIGATIONS

A good or service is distinct if:

The customer can derive benefit from the goods/services on its own
Separately identifiable promise to transfer a good/service

Series of distinct goods/services that are substantially the same and have the same pattern of
transfer

STEP-3 DETERMINE THE TRANSACTION PRICE

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 3rd parties

Effects to be considered while determining the transaction price:

1. Variable Consideration
2. Existence of a significant financing component
3. Non-cash consideration
4. Consideration that is payable to a customer

1) Variable Consideration – If consideration promised includes variable amount, an entity shall

“Estimate the amount” (discounts, rebates, refunds, credits, bonuses, penalties)

Entity may use the “Expected Value Method” or the “Most Likely Amount Method”
Expected-Value Method (predicts better if entity has large number of contracts)
1) Possible outcomes of a contract
2) Probability of each outcome occurring
3) Consideration amount entitled to under each outcome

Most Likely Amount Method (most suitable if entity has only 2 possible outcomes)

NOTE: Refund Liability – Not included in the transaction price

Entity recognise a refund liability if entity receives consideration from a customer and expects to
refund some or all of that consideration back to the customer.

Highly Probable
Variable consideration is included in the transaction price only to the extent that it is highly probable
that revenue recognised will be significantly reversed

2) Significant Financing Component

If consideration is paid in advance -> entity benefits of financing the transfer of goods/services
If consideration is paid in arrears -> customers benefits of financing the transfer of goods/services

1. Entity must first assess whether a contract contains a financing component

2. If it does, whether the component is significant or not to the contract

If the financing component is not significant -> no adjustment is made to the transaction price
If the financing component is significant
-> entity adjusts the consideration amount to the time value of money
-> two transactions in the contract [Entity must account for these two transactions separately]
1) exchange of a good or service
2) financing of that good or service

Entity recognises the difference between the nominal amount and cash selling price as
Interest revenue (if entity benefits from financing)
Interest expense (if customer benefits from financing)

Revenue recognised and interest revenue/expenses must be presented separately in the statements
of P/L and OCI

3) Non-cash Consideration

When a customer promises consideration in a form other than cash, the non-cash consideration
must be measured at IFRS 13 Fair Value Measurement and included in the transaction price.

When FV cannot be estimated, the non-cash consideration is measured at stand-alone selling price

4) Consideration payable to a Customer

When consideration payable > fair value of distinct goods/services -> entity accounts for the excess
as “reduction of the transaction price owed to the entity”

Consideration payable to encourage the customer to purchase a good or service is accounted for as
“Reduction in the transaction price owed to the entity” -> which reduces the revenue recognised by
the entity from its contract with customer
STEP-4 ALLCOATE THE TRANSACTION PRICE TO EACH PERFORMANCE OBLIGATION

Suitable methods in estimating stand-alone selling price

1. Adjusted Market Approach

- Entity evaluates the market
- Entity estimates the price customers would pay
2. Expected cost plus a margin Approach
- Entity forecasts its expected costs of satisfying a performance obligation
- Adds an appropriate margin
3. Residual Approach (applies only to goods/services with a highly-variable selling price)
- Entity estimates the stand-alone selling price
- Calculate total transaction price less the sum of observable stand-alone selling prices

Factors that influence the stand-alone selling price under each method

1. Adjusted Market Approach – Market conditions, supply and demand, competitor pricing
2. Expected cost plus margin Approach – Entity specific factors like internal cost structure and pricing
3. Residual Approach – High variable selling price

Allocation of a Discount

Entity must allocate a discount to all performance obligations. However, if an observable evidence
exists that the entire discount relates to one or more, but not all performance obligations, it will only
allocate the discount to those specific performance obligations

STEP-5 RECOGNISE REVENUE

When transferring control to the customer -> it can be done over time or point in time

Performance obligations satisfied over time

- customer simultaneously receives and consumes the benefits (applies only to services, not goods)
- entity’s performance creates or enhances an asset that the customer controls
- entity’s performance does not create an asset with an alternative use and entity has a right to
payment for performance completed

Measuring progress on PO satisfied over time (Two methods)

Output Methods – recognise revenue based on direct measurements of the value of goods/services
transferred to date
Input Methods – recognise revenue based on entity’s efforts or inputs towards satisfying a PO

Change in the measure of progress -> recognised as revenue in the current period
-> disclosed as a change in estimate under IAS 8

Performance obligations satisfied at a Point in time

Entity must recognise revenue at a point in time when it transfers control of the asset to the
customer (PO is satisfied when control is transferred)

CONTRACT COSTS:
1. Incremental Costs
2. Costs to fulfil a contract with a customer
Incremental Costs
Recognise as an “Asset” – if entity expects to recover these costs
Recovery can be Direct – reimbursement by the customer
Indirect – incorporated into the profit margin

Recognise as an “Expense” – Incremental costs when incurred

Costs to Fulfil a contract

If the costs incurred are within the scope of another standard, entity shall account for these costs in
accordance with that standard

If the costs incurred are not within the scope of another standard, entity recognises an asset from
the incurred costs only if all the below criteria are met:
1) Costs relate directly to a contract
2) Costs enhance resources that will be used to satisfy PO
3) Costs are expected to be recovered

Amortisation and Impairment

The recognised asset is subject to amortisation and impairment
Amortisation – consistent with the transfer of goods/services to customer
Impairment – entity recognises an impairment loss when CA > RA

DISCLOSURE:
IFRS 15 requires an entity to disclose all the qualitative and quantitative information about:
- contracts with customers
- significant judgements and changes in judgements

PART B PROVISIONS
Provision is a “liability of uncertain timing or amount”
Significant level of certainty -> amount is recognised as liability
Level of certainty cannot be measured -> recognised as contingent liability

Recognition of Provisions

Present Obligation (legal or constructive) of a past event

Probable that an outflow of benefits will be required
Reliable Estimate made on the amount of obligation

Legal Obligation -> legally enforceable by a binding contract or statutory requirement

Constructive Obligation -> valid expectation that the entity will discharge the obligation
(pattern of past practice, published policies)

Measurement of Provisions

Estimates of the provisions are required to be made – “Best Estimate”

Large number of items -> Expected value method to estimate

Single obligation is being measured -> Most likely outcome method to estimate