IFRS-15 Revenue from

Contracts with the Customer

Core principle and the five step model

• IFRS 15 is based on a core principle that requires an entity to recognise

revenue:
a) in a manner that depicts the transfer of goods or services to customers
b) at an amount that reflects the consideration the entity expects to be
entitled to in exchange for those goods or services.
Definitions
c) Revenue is income arising in the course of an entity’s ordinary
activities.
d) A customer is a party that has contracted with an entity to obtain goods
or services that are an output of the entity’s ordinary activities.
• Applying this core principle involves following a five step model as
follows:
• Step 1: Identify the contract(s) with the customer
• Step 2: Identify the separate performance obligations
• Step 3: Determine the transaction price
• Step 4: Allocate the transaction price
• Step 5: Recognise revenue when or as an entity satisfies performance
obligations
IFRS 15: THE FIVE STEP MODEL
• Step 1: Identify the contract(s) with a customer
• The first step in IFRS 15 is to identify the contract. This may be
written, oral, or implied by an entity’s customary business practices.
• Definition
• A contract is an agreement between two or more parties that creates
enforceable rights and obligations.
• The general IFRS 15 model applies only when or if:
a) the parties have approved the contract;
b) the entity can identify each party’s rights;
c) the entity can identify the payment terms for the goods and services
to be transferred; and
d) it is probable the entity will collect the consideration.
• If a customer contract does not meet these criteria, revenue is
recognised only when either:
• the entity’s performance is complete and substantially all of the
consideration in the arrangement has been collected and is non-
refundable; or
• the contract has been terminated and the consideration received is
nonrefundable.
 A contract does not exist if each party has an enforceable right to
terminate a wholly unperformed contract without compensating the
other party.
Combination of contracts
• An entity must combine two or more contracts entered into at or near the
same time with the same customer (or related parties of the customer) and
treat them as a single contract if one or more of the following conditions
are present:
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 the contracts) are a single performance obligation
Contract modifications
• A contract modification is any change in the scope and/or price of a contract
approved by both parties for example changes in design, quantity, timing or
method of performance).
• If a scope change is approved but the corresponding price change is not yet
determined, these requirements are applied when the entity has an expectation
that the price modification will be approved.
• A contract modification must be accounted for as a separate contract when:
• the scope of the contract increases because of the addition of promised goods or
services that are distinct; and
• the price of the contract increases by an amount of consideration that reflects the
entity’s stand-alone selling prices of the additional promised goods or services
Step 2: Identify the separate performance
obligations in the contract
• Performance obligations are normally specified in the contract but
could also include promises implied by an entity’s customary business
practices, published policies or specific statements that create a valid
customer expectation that goods or services will be transferred under
the contract.
• A performance obligation is a promise in a contract with a customer to
transfer to the customer either:
a) a good or service (or a bundle of goods or services) that is distinct; or
b) a series of distinct goods or services that are substantially the same
and that have the same pattern of transfer to the customer.
• A good or service is distinct if both of the following criteria are met:
a) the customer can benefit from the good or service either on its own
or together with other resources that are readily available to the
customer; and
b) the entity’s promise to transfer the good or service is separately
identifiable from other promises in the contract.
Example: Promised goods and services
• Goods produced by an entity for sale
• Resale of goods purchased by an entity
• Performing a contractually agreed-upon task for a customer
• Constructing, manufacturing or developing an asset on behalf of a
customer
• Providing a service of arranging for another party to transfer goods or
services to the customer
• Granting licences
• When (or as) a performance obligation is satisfied, an entity will
recognise as revenue the amount of the transaction price allocated to
that performance obligation (step5)
• There are two issues to address:
• The amount of the transaction price, including any constraints (step 3))
• The allocation of that price to POs (step 4))
Step 3: Determine the transaction price
• The transaction price is the amount of consideration an entity expects to be entitled to
in exchange for the goods or services promised under a contract, excluding any
amounts collected on behalf of third parties (for example, sales taxes).
• The transaction price assumes transfers to the customer as promised in accordance
with the existing contract and that the contract will not be cancelled, renewed or
modified.
• An entity must consider the effects of all the following factors when determining the
transaction price:
• variable consideration;
• the constraint on variable consideration;
• time value of money;
• non-cash consideration;
Step 4: Allocate the transaction price to the
performance obligations
• The entity allocates a contract’s transaction price to each separate
performance obligation within that contract on a relative stand-alone
selling price basis at contract inception.
• A stand-alone selling price is the price at which an entity would sell a
promised good or service separately to a customer.
Step 5: Recognise revenue when or as an
entity satisfies performance obligations
• Revenue is recognised when or as the promised goods or services are transferred to
a customer.
a) A transfer occurs when the customer obtains control of the good or service.
b) A customer obtains control of an asset (good or service) when it can direct the
use of and obtain substantially all the remaining benefits from it. Indicators of
control include:
• The entity has a present right to payment for the asset
• The customer has legal title
• The customer has physical possession
• The customer has the significant risks and rewards of ownership of the asset
• The customer has accepted the asset
OTHER ASPECTS OF IFRS 15
• Contract costs
• Costs might be incurred in obtaining a contract and in fulfilling that contract.
• Incremental costs of obtaining a contract
• The incremental costs of obtaining a contract with a customer are recognised as an
asset if the entity expects to recover those costs.
• Costs that relate directly to a contract might include:
a) direct labour and direct materials;
b) allocations of costs that relate directly to the contract
c) costs that are explicitly chargeable to the customer under the contract;
d) other costs that are incurred only because an entity entered into the contract (e.g.
payments to subcontractors)
Example: Incremental costs of obtaining a
contract
• X Limited wins a competitive bid to provide consulting services to a
new customer.
• X Limited incurred the following costs to obtain the contract:
• Rs.
• Commissions to sales employees for winning the contract 10,000
• External legal fees for due diligence 15,000
• Travel costs to deliver proposal 25,000
• Total costs incurred 50,000
Analysis
• the commission to sales employees is incremental to obtaining the
contract and should be capitalised as a contract asset.
• The external legal fees and the travelling cost are not incremental to
obtaining the contract because they have been incurred regardless of
whether X Plc obtained the contract or not.
Example: Amortisation of contract costs
• X Limited wins a 5 year contract to provide a service to a customer.
• The contract contains a single performance obligation satisfied over time.
• X Limited recognises revenue on a time basis
• Costs incurred by the end of year 1 and forecast future costs are as
follows:
• Rs.
• Costs to date 10,000
• Estimate of future costs 18,000
• Total expected costs 28,000
Analysis
• Costs must be recognised in the P&L on the same basis as that used to
recognize revenue.
• X Limited recognises revenue on a time basis, therefore 1/5 of the
total expected cost should be recognised = Rs. 5,600 per annum.
Example: Amortisation of contract costs
• X Limited wins a contract to build an asset for a customer. It is anticipated
that the asset will take 2 years to complete
• The contract contains a single performance obligation. Progress to
completion is measured on an output basis.
• At the end of year 1 the assets is 60% complete.
• Costs incurred by the end of year 1 and forecast future costs are as follows:
• Rs.
• Costs to date 10,000
• Estimate of future costs 18,000
• Total expected costs 28,000
Analysis
• Costs must be recognised in the P&L on the same basis as that used to
recognize revenue.
• Therefore 60% of the total expected cost should be recognised (Rs.
16,800) at the end of year 1.
Presentation
• This section explains how contracts are presented in the statement of financial
position. In order to do this it explains the double entries that might result from the
recognition of revenue
• An unconditional right to consideration is presented as a receivable
• The accounting treatment to record the transfer of goods for cash or for an
unconditional promise to be paid consideration is straightforward.
• Illustration: Possible double entries on recognition of revenue
• Debit Credit
• Cash X
• Receivable X
• Revenue X
Example: Double entry – Unconditional right
to consideration
• 1 January 20X8
• X Limited enters into a contract to transfer Products A and B to Y
Limited in exchange for Rs. 1,000.
• Product A is to be delivered on 28 February.
• Product B is to be delivered on 31 March.
• The promises to transfer Products A and B are identified as separate
performance obligations. Rs.400 is allocated to Product A and Rs.600 to
Product B.
• X Limited recognises revenue and recognises its unconditional right to
the consideration when control of each product transfers to Y Limited.
• The following entries would be required to reflect the progress of the
contract)
• Contract progress
• 28 February: X Limited transfers Product A to Y Limited.
• At 28 February Dr (Rs.) Cr(Rs.)
• Receivables 400
• Revenue 400
• In other cases, a contract is presented as a contract asset or a contract
liability depending on the relationship between the entity’s
performance and the customer’s payment.
• Contract assets
• A supplier might transfer goods or services to a customer before the
customer pays consideration or before payment is due. In this case the
contract is presented as a contract asset
• A contract asset is a supplier’s right to consideration in exchange for
goods or services that it has transferred to a customer.
Contract liabilities
• A contract might require payment in advance or allow the supplier a
right to an amount of consideration that is unconditional (i.e. a
receivable), before it transfers a good or service to the customer.
• In these cases, the supplier presents the contract as a contract liability
when the payment is made or the payment is due (whichever is
earlier).