Chapter 3 Revenue from Contracts with Customers

Related standard: PFRS 15 Revenue from Contracts with Customers

LEARNING OBJECTIVES
• State the five steps in the recognition of revenue.
• Describe how performance obligations are identified in a contract.
• Describe how the transaction price is determined and how it is allocated to the
performance obligations.
• State the timing of revenue recognition and its measurement.
• State the presentation of contracts with customers in the statement of financial
position.

INCOME VS. REVENUE

The Conceptual Framework provides the following definitions:
• Income – increases in economic benefits during the accounting period in the
form of inflows or enhancements of assets or decreases of liabilities that result
in increases in equity, other than those relating to contributions from equity
participants. Income encompasses both revenue and gains.
• Revenue – income arising in the course of an entity’s ordinary activities.

PFRS 15 supersedes the following standards:

• PAS 18 Revenue;
• PAS 11 Construction Contracts;
• IFRIC 13 Customer Loyalty Programmes;
• IFRIC 15 Agreements for the Construction of Real Estate;
• IFRIC 18 Transfers of Assets from Customers; and
• SIC-31 Revenue - Barter Transactions Involving Advertising Services.

APPLICABILITY OF PFRS 15
PFRS 15 shall be applied to contracts wherein the counterparty is a customer.
• Contract – An agreement between two or more parties that creates enforceable
rights and obligations. A contract can be written, oral, or implied by an entity’s
customary business practice.
• 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.

PFRS 15 shall not be applied to the following:

• Lease contracts (PAS 17 Leases);
• Insurance contracts (PFRS 4 Insurance Contracts);
• Financial instruments; and
• Non-monetary exchanges between entities in the same line of business to
facilitate sales to customers. For example, PFRS 15 is not applicable to a
contract between two oil companies that agree to exchange oil to fulfil customer
demands in different locations on a timely basis.
CORE PRINCIPLE
• An entity recognizes 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.

STEPS IN THE RECOGNITION OF REVENUE

PFRS 15 requires the following steps in recognizing revenue:
• Step 1: Identify the contract with the customer
• Step 2: Identify the performance obligations 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: Identify the contract with the customer

Requirements before a contract with a customer is accounted for under PFRS 15:
a. The contract must be approved and the contracting parties are committed
to it;
b. rights and payment terms are identifiable;
c. The contract has commercial substance; and
d. The consideration is probable of collection.

No revenue is recognized if the contract does not meet the criteria above. Any
consideration received is recognized as liability.

Step 2: Identify the performance obligations in the contract

Each promise in a contract to transfer a distinct good or service is treated as a
separate performance obligation.

Identifying distinct goods or services

A good or service is distinct if:
(a) the customer can benefit from it, either on its own or together with
other resources that are readily available to the customer (e.g., the good
or service is regularly sold separately); and
(b) the good or service is separately identifiable (i.e., not an input to a
combined output, does not significantly modify the other promises, or not
highly interrelated with the other promises).

A good or service that is not distinct shall be combined with the other promises in
the contract. Combined promises are treated as a single performance obligation.

Step 3: Determine the transaction price

• The entity shall determine the transaction price because this is the
amount at which revenue will be measured.
• Transaction price is “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 (e.g., some sales taxes).” The consideration may include fixed
amounts, variable amounts, or both.
Step 4: Allocate the transaction price to the performance obligations
• The transaction price shall be allocated to each performance obligation
identified in a contract based on the relative stand-alone prices of the
distinct goods or services promised to be transferred.

• The stand-alone selling price is the price at which a promised good or

service can be sold separately to a customer.

Estimating the stand-alone selling price

If the stand-alone selling price is not directly observable, the entity shall estimate
it using one or a combination of the following methods:

• Adjusted market assessment approach – the entity evaluates the

market in which it sells goods or services and estimates the price that a
customer in that market would be willing to pay for those goods or
services.
• Expected cost plus a margin approach – the entity forecasts its
expected costs of satisfying a performance obligation and then add an
appropriate margin for that good or service.
• Residual approach – the entity estimates the stand-alone selling price
as the total transaction price less the sum of the observable stand-alone
selling prices of other goods or services promised in the contract.

Step 5: Recognize revenue when (or as) the entity satisfies a performance
obligation
• A performance obligation is satisfied when the control over a promised
good or service is transferred to the customer.
• Revenue is measured at the amount of the transaction price allocated to
the satisfied performance obligation.

Performance obligations are classified into the following:

1. Performance obligation that is satisfied over time
2. Performance obligation that is satisfied at a point in time

Performance obligations satisfied over time

For a performance obligation that is satisfied over time, revenue is
recognized over time AS the entity progresses towards the complete
satisfaction of the obligation.

A performance obligation is satisfied over time if one of the following

criteria is met:
a. The customer simultaneously receives and consumes the benefits
provided by the entity’s performance as the entity performs.
b. The entity’s performance creates or enhances an asset that the
customer controls as the asset is created or enhanced.
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 payment for performance completed to date.
 Measuring progress towards complete satisfaction of a
performance obligation
• For each performance obligation satisfied over time, an entity shall
recognize revenue over time by measuring the progress towards
complete satisfaction of that performance obligation.
• Examples of acceptable measurement methods:
1. Output methods (e.g., surveys of work performed)
2. Input methods (e.g., relationship between costs incurred to
date and total expected costs)

If efforts or inputs are expended evenly throughout the performance

period, revenue may be recognized on a straight-line basis.

Cost-recovery Approach
If the outcome of a performance obligation cannot be reasonably
measured, revenue shall be recognized only to the extent of costs
incurred that are expected to be recovered.

Performance obligations satisfied at a point in time

• A performance obligation that is not satisfied over time is presumed
to be satisfied at a point in time.
• For a performance obligation that is satisfied at a point in time,
revenue is recognized WHEN the performance obligation is satisfied.

Contract costs
Contract costs include the following:
(a) Incremental costs of obtaining a contract – recognized as asset if
they are recoverable and avoidable. As a practical expedient, the
costs are recognized as expense if their expected amortization
period is 1 year or less.
(b) Costs to fulfill a contract –if within the scope of PFRS 15, they are
recognized as asset if they are: (a) directly related to a contract, (b)
generate or enhance resources, and (c) recoverable.

Presentation
A contract where either party has performed is presented in the
statement of financial position as a contract liability, contract asset or
receivable.
• Contract liability – is an entity’s obligation to transfer goods or
services to a customer for which the entity has received
consideration (or the amount is due) from the customer.
• Contract asset – is an entity’s right to consideration in exchange
for goods or services that the entity has transferred to a customer
when that right is conditioned on something other than the
passage of time.
• Receivable – is an entity’s right to consideration that is
unconditional.
ADDITIONAL CONCEPTS
Concepts related to Step 2 (Identifying the performance obligations)
• A warranty that provides the customer service in addition to assurance that
the product complies with agreed-upon specifications is a performance
obligation. A warranty required by law is not a performance obligation.
• An option granted to a customer to acquire additional goods or services is a
performance obligation if it gives the customer a material right.
• Non-refundable upfront fee is a performance obligation only if it relates to the
transfer of goods or services. It is not a performance obligation if it relates to
administrative tasks to set up a contract. In the latter case, the non-refundable
upfront fee is treated as a prepayment and recognized as revenue only when the
related goods or services are transferred to the customer.

Concepts related to Step 3 (Determining the transaction price)

• Discounts are allocated to all of the performance obligations, unless it is clear
that the discount relates only to some, but not all, of those obligations.
• In a sale with right of return, the entity does not recognize revenue from
goods that are expected to be returned. An asset (and corresponding
adjustment to cost of sales) is recognized for the entity’s right to recover products
from the customer on settling the refund liability.
• If the timing of agreed payments provides the customer or the entity with a
significant benefit of financing, the revenue recognized shall reflect the cash
selling price of the goods or services. As a practical expedient, the effect of time
value of money may be disregarded if the consideration is expected to be
collected within 1 year from the date of transfer of the goods or services.
• A non-cash consideration is measured at:
a. fair value; or
b. if fair value is not available, at the selling price of the good or service
promised to be transferred to the customer.