IFRS 15 Revenue Recognition

Revenue from Contracts with Customers (IFRS 15)

• Lecture slides should be used as a guide when reading the chapter
• Key texts include:
  • Chapter 13 from Melville, A. (2022). International Financial Reporting (8th ed.). Pearson Education
  • Chapter 4 from Connolly, C. (2018). International Financial Accounting and Reporting (6th ed.). Chartered Accountants Ireland
  • Chapter 18 from Alexander, D., Jorissen, A., Hoogendoorn, M., Van Mourik, C., & Kirwan, C. (2020). International Financial Reporting and Analysis (8th ed.). Cengage Learning

Objectives

• Grasp fundamental concepts of revenue recognition and measurement
• Learn to apply the five-step revenue recognition process
• Be able to illustrate the revenue recognition process with examples
• Understand and discuss contract costs with relevant examples
• Explore various revenue recognition scenarios
• Discuss the presentation and disclosure requirements of IFRS 15

Definition of Revenue

• Revenue is defined as "income arising in the course of an entity’s ordinary activities"
• Generally, it stems from the sale of goods or services to customers
• Revenue excludes items such as:
  • Borrowings
  • Contributions from shareholders
  • Gains from the disposal of non-current assets

Key Concepts of Revenue Recognition

• Key objective is to recognize revenue to depict the transfer of promised goods or services
• Must reflect the consideration expected in return for those goods or services
• Revenue recognition principle revolves around recognizing revenue in the relevant accounting period
• This should occur when the performance obligation is satisfied

Double Entry

• A simple double entry can be:
  • Dr Receivables/Cash
  • Cr Revenue (Income)
• Other scenarios are more complex

Process for Revenue Recognition - The Five-Step Model

• Step 1: Identify the contract with a 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 as each performance obligation is satisfied

Step 1: Identify the Contract

• A contract is an agreement between two or more parties that creates rights and responsibilities
• A contract should only be accounted for if:
  • All parties are committed to the contract
  • Each parties rights can be identified
  • Payment terms are established
  • It carries substance
  • The entity is likely to collect the consideration
• Payments received from a customer before these conditions are satisfied are recorded as a liability
• A contract can be:
  • Written
  • Oral
  • Implied from the company's practices

Step 2: Identify Performance Obligations

• A performance obligation entails a promise in a contract to transfer a good or service to a customer
• This promise must be distinct
• A good or service is distinct if:
  • The customer can benefit on its own
  • The promise to transfer is separately identifiable within the contract
• Distinct goods/services are:
  • Individually Distinct, where the customer can use, consume, or sell the item separately
  • Distinct within the context of the contract, such as a bundle of goods or service
• If a promised good or service is not distinct, it must be combined with other promised goods or services
• This forms a distinct bundle
• All promised goods/services in a contract can be treated as a single performance obligation

Step 3: Determine the Transaction Price

• An entity will consider the terms of the contract and business practices
• The transaction price is the expected consideration for transferring promised goods or services
• This excludes amounts collected on behalf of third parties, or sales tax
• The amount to consider is that which the company expects to receive
• Variable consideration and/or constrained estimates must be assessed
• The transaction price can vary because of factors like discounts and penalties, so estimate the variable rate using one of:
  • The "expected value" method
  • The "most likely amount" method
• The chosen method should best predict the ultimate amount being considered
• It is only possible to include variable consideration in the transaction price if a significant revenue reversal is highly unlikely
• Factors to consider in this calculation are:
  • Uncertainty over a long period of time
  • Broad range of outcomes
  • Limited experience with similar contracts
  • Skepticism to factors out of control
• If a customer or entity receives a significant benefit of financing, adjust accordingly
• No adjustment is necessary if:
  • The period between performance and payment is less than a year
  • The variance depends on factors outside of the control of the customer or entity
  • The advance payment is at the customer's discretion
  • The difference between the consideration and the selling price arises for other reasons than financing

Step 4: Allocate the Transaction Price

• The transaction price is allocated to the performance obligations according to the stand-alone price of each obligation

• If a stand-alone price is unavailable, the entity will estimate a standalone price by:

  • Adjusting market assessment approach, or expected cost plus margin approach
  • Residual approach, when a selling price is highly variable or uncertain

• For bundle sales, the discount should be allocated across each component

• A discount should only be allocated to a specific component if that component is regularly sold separately at a discount

Step 5: Recognise Revenue When Or As A Performance Obligation Is Satisfied

• This is achieved by transferring a good or service to the customer
• The amount recognized is the amount allocated to that obligation
• Transfer only occurs when the customer obtains control of the good or service
• If an obligation is satisfied "over time,” revenue is recognized according to progress made towards complete satisfaction
• If an obligation is satisfied "at a point in time", revenue is recognized when the obligation has been satisfied
• Performance obligations can be satisfied over time with fulfilment of the following criteria:
  • The customer simultaneously receives and consumes the benefits as the performance takes place.
  • The entity's performance creates or enhances an asset that the customer controls
  • Entity performance with no alternative use, and enforceable right to payment for performance

Performance Obligations Satisfied Over Time

• Progress can be measured using "output methods" or "input methods"
  • Output methods include a direct measure of the transferred goods and services up to date
  • Input methods measure an entity's inputs to date relative to the overall inputs required to fulfill performance
• The correct method should faithfully depict the entity's progress

Contract Costs

• Costs incurred in fulfilling a performance obligation that falls within the scope of another standard (e.g., IAS 2), are accounted for in accordance with that standard
• Contract costs are recognized as “contract assets", subject to certain conditions
• When a performance obligation is subsequently satisfied, the related costs will be transferred to the statement of comprehensive income as an expense
• They will be matched against the revenue allocated to that performance obligation

Presentation

• If an entity has performed an obligation but has not yet been paid, they should present a "contract asset" (excluding amounts presented as a receivable)
• A payment before goods/services are transferred will result in recognizing a "contract liability"

Contracts Where Performance Obligations Satisfied over time – P&L

• For a contract with a customer where revenue is recognised over time, there are three important rules:
  • If profit is expected, revenue/costs should be recognised according to contract progress
  • if losses are expected, the whole loss must be immediately recognised
  • if the expected outcome is unknown, recognise revenue in the income statement only to the extent of the recoverable costs

Contracts Where Performance Obligations Satisfied over time – Steps to follow:

• Step 1: Calculate overall profit or loss
• Step 2: Determining the progress of a contract
  • Input methods – based on the inputs used e.g. (Costs to date/Total costs) x 100% = % complete
  • Output methods - based on performance e.g. (Work certified/Contract price) x 100% = % complete
  • If progress cannot be accurately measured, revenue should be recognised only to the extent that contract costs are likely to be recoverable
• Step 3: The statement of profit or loss if profitable calculates:
  • Revenue (Total price x progress (%))
  • "Less" revenue recognized in previous years
  • Cost of sales (Total costs × progress (%))
  • "Less" costs of sales recognized in previous years to give the remaining annual Profit only if there is overall profit
• Step 4: The statement of financial position calculates “current assets” for contract asset which are presented as assets separately
  • Cost in to date
  • "Plus" recognized profits
• "Less" any recognized losses
• "Less" receivable (i.e., amounts invoiced to the customer to date)

Special Revenue Recognition - Consignment Arrangement

• When delivering product under consignment, the customer (dealer) doesn't have control
• No revenue is recognized upon delivery here
• Consignment indicators:
  • the product is controlled by the entity until a specified event occurs
  • the entity is able to require the return
• the dealer does not have an unconditional obligation to pay for the product

Special Revenue Recognition - Sales and Repurchase Agreements

• "Repurchase agreements" allow a company to transfer assets while retaining an obligation/right to repurchase them
• If the obligation/right to repurchase is for greater than/equal to the selling price, the transaction is simply financing

Special Revenue Recognition - Principal Agent Relationships

• If acting as an "Agent", revenue is recognised based on the fee/commission
• Here principal’s give “goods” perform “services” directly
• The agent facilitates for the principal and is paid to do So with commission

Main Disclosure Requirements

• IFRS15 disclosure standards include:
  • revenue recognised in the period
  • impairment losses recognised in the period on contract assets or receivables
  • opening and closing balances of accounts receivables”
  • contract liabilities”
  • contract assets”
  • significant judgements made by the entity in applying the requirements of IFRS15
  • revenue allocation