Module 3 - Revenue from Contracts with Customers PDF

MODULE 3 - REVENUE FROM CONTRACTS WITH CUSTOMERS; PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS Foreword This material has been prepared by Edoosmart’s trainer solely based on CPA Program, Financial Reporting (6th Edition), John Wiley & Sons Australia, Ltd, Ric...

MODULE 3 - REVENUE FROM CONTRACTS WITH CUSTOMERS; PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS Foreword This material has been prepared by Edoosmart’s trainer solely based on CPA Program, Financial Reporting (6th Edition), John Wiley & Sons Australia, Ltd, Richmond, Victoria 3121, on behalf of CPA Australia Ltd (2020) for the purpose of teaching and studying CPA Program Financial Reporting. PART A: REVENUE FROM CONTRACTS WITH CUSTOMERS (P.117) OVERVIEW OF IFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS (P.118) « IFRS 15 was introduced to improve the financial reporting of revenue by: - providing a more robust framework for addressing revenue recognition issues; - improving comparability of revenue recognition practices across entities, industries, jurisdictions and_capital markets; - simplifying the preparation of financial statements by reducing the amount of guidance to which entities must refer; and - requiring enhanced disclosures to help users of financial statements better understand the nature, amount, timing and uncertainty of revenue that is recognised (IFRS 15 Basis for Conclusions, para. BC3). * Toassist entities in applying IFRS 15, the new standard provides guidance on how to account for numerous contract types and their elements, including: - contracts with a right of return period - contracts providing goods or services with warranties - contracts in which a third party provides the goods or services to the customer (principal vs agent considerations) - contracts with options for customers to purchase additional goods or services at a discount or free of charge - customer prepayments and payment of non-fundable upfront fees - licensing and repurchase agreements - consignment and bill-and-hold arrangements SCOPE OF IFRS 15 (P.118) + IFRS 15 applies to all contracts with customers, except those contracts that are: - lease contracts within the scope of IFRS 16 Leases; - contracts within the scope of IFRS 17 Insurance Contracts. F - Financial instruments and other contractual rights or obligations within the scope of IFRS 9 Financial Instruments, IFRS 10 Consolidated Financial Statements, [FRS 11 Joint Arrangements, IAS 27 Separate Financial Statements and IAS 28 Investments in Associates and Joint Ventures; and - non-monetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers (IFRS 15, para. 5) * Acontract with a customer may be partially within the scope of IFRS 15 and partially within the scope of one of the above standards. In such cases, IFRS 15 applies as follows. - If the other standards specify how to separate or initially measure one or more parts of the contract, then an entity shall apply those separation or measurement requirements first. The transaction price of the contract is then reduced by the amounts initially measured under the other standards, with the remaining transaction price being accounted for under IFRS 15. - If the other standards do not specify how to separate or initially measure one or more parts of the contract, then an entity shall apply IFRS 15 to the contract (IFRS 15, para. 7) IMPACT OF IFRS 15 (P.119): * Entities in the technology sectors were particularly affected, making IFRS 15 a prime example of the IASB’s response to the various aspects of the recent technological advancements impact * Forinstance, telecommunications entities may provide customers with a ‘free’ handset that they can use in return for entering a monthly payment plan for a minimum period. * Asaresult, some telecommunication entities recognised revenue from the sale of the monthly plans when the service was provided and treated the cost of the handsets as a marketing expense whilst others treated the handset as a cost of acquiring the customer and amortised it over the minimum contract period = Under IFRS 15, telecommunication entities must allocate the total contract price between the sale of the handset and the monthly plan. + This changed the timing of the recognition of revenue, with revenue allocated to the handset now being recognised earlier (i.e. at the time of its sale).  Overall, the practical implications of IFRS 15 are that the timing and amount of revenue recognised from contracts with customers will change for some entities that have been applying previous revenue standards (i.e. IAS 18 and IAS 11 Construction Contracts). This is because entities will be required to alter their accounting treatment of items such as contracts for bundled goods and services, contract modifications and contracts that are satisfied over time. 3.1 RECOGNITION OF REVENUE (P.120) IFRS 15 establishes a framework for determining when to recognise revenue and how much revenue to recognise (E.g. Telstra —iPhone and Data Bundle — Phone and Data are accounted for separately) The core principle of IFRS 15 is that an entity should recognise ‘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’ (IFRS 15, para. 2). To meet this core principle, an entity needs to adopt a five-step recognition model for each customer, Step 1, step 2 and step 5 refer to recognition requirements, while step 3 and step4 cover measurement requirements. 1FRS 15 Aevere fom Cortracts wfth Gustomers Tvs-step mocel stepa obigarion's i he contract sTEPS Determine the transaction prioe o the contract STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER (P.121) IFRS 15 defines a customer as ‘a party that has contracted with an entity to obtain goods/services that are an output of the entity’s ordinary activities in exchange for consideration’ (IFRS 15, Appendix A) A contract is ‘an agreement between two or more parties that creates enforceable rights and obligations’ (IFRS 15, Appendix A) and this agreement can be written, oral or implied by an entity’s customary business practices (E.g. A person buying a home) An entity shall apply the requirements of IFRS 15 to each contract that has all these attributes: the parties have approved the contract and are committed to perform their obligations - the entity can identify each party’s rights regarding, and the payment terms for, the g00ds or servicesto be transferred - the contract has ‘commercial substance’ (i.e. should influence future cash flows of the entity) - itis probable that the entity will collect the consideration that it is entitled to in exchange for the goods or services that it transfers to the customer (IFRS 15, para. 9)  IFRS 15 Revenue from Contracts with Customers Finanial Reporting Module 3 (4" Edition - 2018) Contract approved by /el parties /| /e aoodsiseices to be /| transferred can be Hentified Criteria for contracts Payment terms for IFRS 15, para. 9 goads/services can be identified Contract has commercial substance \ [ probable flowor considerstion o the entiy for | goodssenices * If the contract does not have ALL of the above attributes, IFRS 15 does not apply and this must continually be reassessed to determine whether all attributes are subsequently present. Combining Multiple Contracts (p.122): * Paragraph 17 of IFRS 15 requires an entity to combine 2 or more contracts entered at the same time with the same customer and to account for them as 1 contract if there is the following: > ‘the contracts are negotiated as a package with a single commercial objective’ - the consideration ‘to be paid in one contract depends on the price or performance of the other contract’, or - ‘the goods or services promised in the contracts (or some goods or services promised in each of the contracts) are a single performance obligation’ * However, if the entity expects that the financial statement effects of accounting for multiple contracts as a single contract will be materially different from accounting for the contracts individually, the entity is not required to combine multiple contracts into one contract (IFRS 15, para. 4). C A contract modification is a change in the scope or price (or both) of a contract that is approved by both contracting parties and it exists when the contracting parties approve a modification that creates new, or changes existing, enforceable rights and obligations of the parties. * Like the contract itself, the modification can be written, oral or implied by customary business practices (IFRS 15, para. 18). arate contract oR NOT 2 separate L) 4 Bath scape. and price Modification Accounted for as a Separate Contract (p.122): + If the modification has been approved by both contracting parties, it shall be accounted for asa separate contract if BOTH of the following conditions are met: 1. ‘the scope of the contract increases because of the addition of promised goods or services that are distinct’ (IFRS 15, para. 20(a))  2. ‘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 and any appropriate adjustments to that price to reflect the circumstances of the particular contract’ (IFRS 15, para. 20(b)). An example of price adjustment is when discounts are given to customers. Additional good/services are distinct Contract price increases = adjusted stand alone prices - The existing contract is unaffected by the contract modification, as the revenue recognised to date and future revenue under the existing contract (being the amounts associated with those performance obligations already completed) is not adjusted. * Future revenues associated with the performance obligations remaining under the contract modification will be accounted for separately. Modification Not Accounted for as a Separate Contract (p.122): * If neither of the conditions for a separate contract is met, how the contract modification is accounted for depends on whether the remaining goods or services to be transferred under the existing contract are distinct from those goods or services that were already transferred before the contract modification. « The 3 accounting approaches are outlined: 1. If they are distinct, the contract modification is accounted for as a replacement of the existing contract with the creation of a new contract. 2. If they are not distinct, the contract modification is accounted for as part of the existing contract. 3. Ifit'sa combination of 1 and 2, the contract modification is accounted for as partly the creation of a new contract and partly modification of the existing contract (IFRS 15, para. 21) bistinet STEP 2: IDENTIFY THE PERFORMANCE OBLIGATIONS IN THE CONTRACT (P.123) * Apromise constitutes a performance obligation if it is for the transfer of either: a) agood or service (or a bundle of goods or services) that s 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 (IFRS 15, para. 22). - Provided it is considered distinct, any good or service promised (either explicit or implicit) toa customer as a result of a contract gives rise to a performance obligation. - Promised goods or services may give rise to a performance obligation even if the promise is incidental or part of an entity’s marketing campaign. (E.g. “Free” handsets as part of mobile plans) Determining what is Meant by “Distinct (p.124): * Agood or service is considered distinct when: 3) the customer can derive benefit from the good or service eitheron its own or together with other resources that are readily available to the customer (IFRS 15, para. 27(a)), and b) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (IFRS 15, para. 27(b)). Series of Distinct Goods and Services that are Substantially the Same and have the Same Pattern of Transfer 125): + IFRS 15 permits an entity to account for a series of distinct goods or services that are substantially the same and have the same pattern of transfer as a single performance obligation, provided: - eachdistinct good or service in the series that the entity promises to transfer to the customer represents a performance obligation to be satisfied over time - the entity uses the same method to measure its progress towards satisfaction of the performance obligation for each distinct good or service in the series (IFRS 15, para. 23). * Asstated, these requirements apply to goods or services that are delivered consecutively rather than concurrently (E.g. They would apply to repetitive service contracts such as cleaning contracts) STEP3: DETERMINE THE TRANSACTION PRICE OF THE CONTRACT (P.125) * The 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 3rd parties (E.g. GST)' (IFRS 15, para. 47). ™ * When determining the transaction price, an entity shall consider the effects of: 1. variable consideration, including any constraining estimates of that consideration 2. the ‘existence of a significant financing component in the contract’ 3. non-cash consideration 4. consideration that is payable to a customer (IFRS 15, para. 48) 1. Variable Consideration (p.126): * The consideration promised in a contract with a customer may include fixed amounts, variable amounts or both and the variable amount can be estimated by the entity * Paragraph 51 of IFRS 15 specifies examples of when consideration may vary including: - discounts, rebates, refunds, credits and price concessions (whether explicit in the contract or implied from an entity’s customary business practices, published policies or statements to the customer) offered to customers, or - incentives or performance bonuses offered to the entity on the occurrence of a future event, or penalties imposed on the entity on the occurrence of a future event Estimating Variable Consideration Expected Value Method * Anentity shall estimate variable consideration using either the ‘expected value’ or the ‘most likely amount’ method and this must be applied consistently throughout the contract * However, an entity is permitted to choose different methods for estimating different types of variable consideration within one contract. * Under the expected-value method, the expected value of variable consideration is the sum of probability- weighted amounts in a range of possible consideration amounts. + The expected-value method may better predict variable consideration if the entity has many contracts with similar characteristics. + This method requires an entity to identify: 1) the possible outcomes of a contract; 2) the probability of each outcome occurring; and 3) the consideration amount it is entitled to under each outcome. + The sum of each probability-weighted consideration amount the entity is entitled to under each outcome is the expected value of variable consideration  Expected value method Most Likely Amount Method: Under the most likely amount method, the expected value of variable consideration is the consideration amount the entity is entitled to under the ‘most likely’ possible outcome of a contract. This amount is not probability-weighted rather, an entity determines, from a range of possible outcomes, the outcome that is most likely to occur. This method may be a better predictor of variable consideration than the expected-value method if the contract has only 2 possible outcomes (e.g. an entity either achieves a performance bonus or not) Most likely method Constraining Estimates of Variable Consideration: On estimating the amount of variable consideration within the transaction price, an entity needs to consider the likelihood that this amount will be realised. Variable consideration is included in the transaction price ‘only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved’ (IFRS 15, para. 56) If the entity assesses that it is highly probable that including its variable consideration estimate will not result in a significant revenue reversal, the amount is included in the transaction price and this assessment must be done for each performance obligation that contains variable consideration. Further, the magnitude of a possible revenue reversal should be assessed relative to the total consideration for each performance obligation. At the end of each reporting period, an entity must update the transaction price to reflect the amount of consideration to which it expects to be entitled and this includes a reassessment of whether the variable consideration is constrained and, if so, by what amount. Significant Financing Component in the Contract (p.128): The payment of consideration by a customer may not occur at the same time the entity transfers the good or service to the customer as the consideration may be paid before or after the transfer occurs. When consideration is paid in advance, the entity receives (from the customer) the benefit of financing the transfer of the good or service. Alternatively, when consideration is paid in arrears, the customer receives (from the entity) the benefit of financing the transfer. When a contract contains a significant financing component, the entity adjusts the promised amount of consideration (and, therefore, the transaction price of the contract) for the effects of the time value of money. Under IFRS 15, an entity must assess, 1st, whether a contract contains a financing component and, 2nd, if it does, whether that component is significant to the contract. This assessment is not required when the period between the entity transferring a promised good or service to a customer and the customer paying for the good or service is 1 year or less. If the assessment is not required, the financing component (if any) is automatically considered to be not significant (IFRS 15, para. 63). For those contracts in which the period between the transfer of the good or service and the payment of consideration is greater than one year, the entity must consider all relevant facts and circumstances in assessing whether the contract contains a significant financing component.  These facts and circumstances include: - the difference, if any, between the amount of promised consideration and the price that a customer would have paid for the good or service if the customer had paid cash for the good or service at the time of transfer (i.e. the cash selling price) - the combined effect of: (1) the ‘expected length of time between when the entity transfers the promised good or service to the customer and when the customer pays for the good or service’; and (2) ‘the prevailing interest rates in the relevant market’ (IFRS 15, para. 61). If the financing component is not considered to be significant, no adjustment is made to the transaction price of the contract. If the financing component is significant, the entity adjusts the amount of the promised consideration for the effects of the time value of money by discounting the nominal amount of promised consideration to the cash selling price at the discount rate that would be used if the entity and customer entered into a separate financing transaction. In effect, if a contract contains a significant financing component, the contract conceptually consists of 2 transactions: one for the exchange of a good or service and another for the financing of that good or service and thus IFRS 15 requires each transaction to be accounted for separately. The entity recognises revenue from contracts with customers as the portion of promised consideration that equals the cash selling price. The entity recognises the difference between the nominal amount of promised consideration and the cash selling price as interest revenue (if the entity benefits from financing) or interest expense (if the customer benefits from financing) recognised in the statement of P/L and OCI Non-Cash Consideration (p.130): When a customer promises consideration in a form other than cash, the non-cash consideration should be measured at fair value according to IFRS 13 Fair Value Measurement and included in the transaction price. When fair value cannot be reasonably estimated, the non-cash consideration is measured as the stand-alone selling price of the goods or services promised to the customer in exchange for the consideration (IFRS 15, paras 66 and 67). Consideration Payable to a Customer (p.130): Consideration may be payable by entities to their customers: - inexchange for a distinct good or service that the customer transfers to the entity, or - asan incentive provided by the entity to the customer to encourage the customer to purchase a good or service from the entity (e.g. a credit, coupon, voucher, or free product or service that can be applied against amounts owed to the entity). Consideration payable to a customer in exchange for a distinct good or service is accounted for in the same way that the entity accounts for other purchases from suppliers. However, when the consideration payable exceeds the fair value of the distinct good or service, the entity accounts for the excess as a reduction of the transaction price owed to the entity. If the entity cannot reasonably estimate the fair value of the distinct good or service, all the consideration payable is accounted foras a reduction of the transaction price owed to the entity. The effect of a reduced transaction price is a reduction in the revenue recognised by the entity. Consideration is considered payable to the customer when the recipient of the consideration is another party that purchased the entity’s goods or services from the customer. E.g. A car manufacturer that offers consumers 12 months of free car servicing would account for this as a reduction of the transaction price with the car dealer that sold the car to the consumer. STEP 4: ALLOCATE THE TRANSACTION PRICE TO EACH PERFORMANCE OBLIGATION (P.131) -l tra Financial Reporting Module 3 (4" Edition-~ 2018) slingprices. Aused martt assesimentapprosch pars.76) 4 toan 79) i orce (cara 77) 4{ Stand-alone seling. e [ not observable entty| / fon Expected cost plus & margin approach Alccatiog Tanssction Prce ) Pl o prfermnce E——— S | other ‘ | v T| // st)y S [ g e | * For contracts with a single performance obligation, the allocation process is simple: the entire transaction price relates to the single performance obligation. * Anentity shall allocate the transaction price to each performance obligation based on the stand-alone selling price of the distinct good or service. * Todo this, an entity determines the stand-alone selling price of each distinct good or service underlying each performance obligation in the contract. * Onceall stand-alone selling prices have been determined, the entity allocates the transaction price in proportion to those stand-alone selling prices (IFRS 15, para. 76). * The stand-alone selling price is the (“observable”) price (at the time of entering into the contract) for which an entity would sell the distinct good or service separatelyto a customer and may be estimated Under paragraph 79 of IFRS 15, the 3 suitable estimation methods are: 1) Adjusted market assessment approach: An entity evaluates the market in which it sells goods or services and estimates the price customers would be willing to pay for those goads or services, whether provided by the entity or a competitor. Under this approach, an entity focuses on market conditions, including supply of and customer demand for, the good or service; competitor pricing for the same or similar good or service; and the entity’s share of the market. 2) Expected cost plus a margin approach: An entity forecasts its expected costs of satisfying a performance obligation and then adds an appropriate margin for that good or service. Under this approach, the entity primarily focuses on entity-specific factors, including its internal cost structure and pricing strategies and practices. 3) Residual approach: An 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. Under this approach, when all but one of the stand-alone selling prices of promised goods or services is directly observable, the stand-alone selling price of the good or service that is not observable is the difference between the total transaction price and the sum of directly observable stand-alone selling prices. An entity, however, may only use the residual approach for a good or service with a highly variable selling price. Otherwise, the selling price is uncertain because the good or service has not previously been sold on a stand-alone basis.  [ e o [ e ) Sullani metho orextmatng e str sk selig piceof 4 o3 cr servics A discount exists when the sum of the stand-alone selling prices of the distinct goods or services in the contract exceeds the promised consideration in a contract. * Anentity must allocate a discount proportionately to all performance obligations in the contract. * However, if the entity has observable evidence that the entire discount relates to not all performance obligations in a contract, it will allocate the discount to those specific performance obligations only + The entity has observable evidence when both of the following criteria are met: - The entity regularly sells each (or bundles of each) distinct good or service in the contract on a stand-alone basis and regularly at a discount to the stand-alone selling price. - Thediscount in the contract is substantially the same as the discount regularly given on a stand- alone basis Allocation of Variable Consideration (p.133): E.g. Consider an entity that enters into a contract with a customer to provide 2 distinct goods at different times where each distinct good constitutes a separate performance obligation. + Abonus is payable by the customer to the entity on timely delivery of the 2nd good and the bonus constitutes variable consideration, and it would be inappropriate to allocate it to both performance obligations given that it relates to the 2nd performance obligation only. STEP5: RECOGNISE REVENUE WHEN EACH PERFORMANCE OBLIGATION IS SATISFIED (P.133) Step 5 - Recognise revenue Financial Reporting Module 3 (4 Edition - 2018) Customer sty eceves ndcomsumes 31 e beratts oty pertormances. If 50 - revenue is ONE o the folloin 5 et ceates orenancesangset recognised aresdy convoled by the (a2 35) gradually Feerrancs dos WO eate sset wih i termatve us o the ey and ety bas argh 10 yment ? e el ’ { [— A et e ] > (para. 31) \ C— I oot ts ‘ 1;,4._:‘4 e | Cuntomerbes sgoicant Saksandrewards of ownersh \mm hasaccepted aset Under IFRS 15, a performance obligation is satisfied when a promised good or service is transferred to the customer when they ‘obtain control’ of that good or service (IFRS 15, para. 31) According to IFRS 15, a good or service is an asset to a customer: the standard states, ‘control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset’ (IFRS 15, para. 33). The benefits of an asset are the potential cash inflows or savings in cash outflows obtained directly or indirectly from the asset. At the time of entering into a contract, an entity must determine whether it will satisfy the performance obligation over time or at a point in time. If a performance obligation will not meet the criteria to be satisfied over time, it is satisfied at a point in time. Performance Obligations Satisfied Over Time (p.134): A performance obligation is satisfied over time if 1 of the following criteria is met: 1) the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs; 2) the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced; or 3) the entity’s performance doesn’t create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed (IFRS 15, para. 35). If any of these 3 criteria are met, the entity transfers control of the good or service over time while concurrently satisfying the performance obligation. The transaction price allocated to the performance obligation is recognised as revenue gradually as the performance obligation is increasingly completed over time Customer Simultaneously Receives and Consumes the Benefit of the Entity’s Performance (p.134): This criterion implies that the entity’s performance creates an asset only momentarily, as the asset is simultaneously created, received and consumed by the customer while the entity performs. As such, this criterion applies only to services and not goods, as a customer cannot simultaneously receive and consume a good while it is being produced. For some service-type performance obligations, the customer’s receipt and simultaneous consumption of the benefits of the entity’s performance can be readily identified. E.g. Performance obligations for routine services such as cleaning services (IFRS 15, para. B3)  * Ifitis unclear that the performance obligations have been satisfied, the entity will determine whether another entity would need to substantially re-perform the work it has completed to date if that other entity were to fulfil the remaining performance obligation to the customer. + If substantial re-performance isn't required, the performance obligation is satisfied over time (IFRS 15, para. B4). Customer Controls the Asset as it is Being Created or Enhanced (p.134): * Under this criterion, control of an asset is transferred over time if the entity’s performance creates or enhances an asset that a customer controls as the asset is created or enhanced * E.g. Anentity enters into a contract with a single performance obligation to construct a building on the customer’s land and the customer controls any work in progress as the building is constructed. - Because the customer controls the work in progress, it is obtaining benefits of the goods and services the entity is providing and thus the performance obligation is satisfied over time. Entity’s Performance does not Create an Asset with an Alternative Use, and the Entity has a Right to Payment for Performance Completed to Date (p.134) + This criterion has 2 components that BOTH need to be satisfied: 1) The entity’s performance does not create an asset with an alternative use to the entity; and 2) The entity has an enforceable right to payment for performance completed to date. * Alternative use - When the entity’s performance creates an asset with an alternative use to the entity, the entity could direct the asset to another customer. - The customer does not control the asset as it is being created because it cannot restrict the entity from directing that asset to another customer. - E.g The production of identical inventory items that the entity can substitute across different contracts with customers. - Theentity is less likely to have an alternative use for a highly customised asset that is created for a customer as it would incur significant costs to rework the asset for another customer or need to sell it at a significantly reduced price. - Asaresult, control of the asset could be transferred over time + Rightto payment: - Anentity has a right to payment if it is entitled to an amount that compensates it for its performance completed to date should the customer or another party terminate the contract for reasons other than the entity’s failure to perform as promised. Measuring Progress on Performance Obligations Satisfied Over Time (p.135}: * IFRS 15 specifies 2 types of methods of measuring progress on performance obligations that are satisfied over time: output methods and input methods 1. Output methods recognise revenue based on direct measurements of the value (to the customer) of the goods or services transferred to date relative to the remaining goods or services promised under the contract. E.g. Surveying performance completed to date, appraising results or milestones achieved, determining time elapsed under the contract and measuring units produced or delivered to date (IFRS 15, para. B15). 2. Input methods recognise revenue based on the entity’s efforts or inputs towards satisfying a performance obligation relative to the total expected inputs to satisfy the performance obligation. E.g. Measuring (to date) resources consumed, labour hours expended, costs incurred, time elapsed under the contract or machine hours used (IFRS 15, para. B18). * When an entity is closer to completely satisfying the performance obligation than the previous period, the change in the measure of progress is recognised as revenue in the current period. Performance Obligations Satisfied at a Point in Time (p.135): + If none of the 3 criteria for recognising revenue over time are met, an entity must recognise revenue at a point in time when the entity transfers control of the asset to the customer. * Atthe time control is transferred, the performance obligation is satisfied. 3.2 CONTRACT COSTS (P.136) IFRS 15 permits an entity to recognise the following as assets: 1) The incremental costs of obtaining a contract with a customer 2) The costs to fulfil a contract with a customer Contractcosts = Assetsor Expenses? Financial Reporting Module 3 (4 Edition - 2016) | Recogniseasanasset £ recoverable. 1 | incemenstcoss o thtcodte boen avoided if contract 1 | / | L wasunsuccessful | Expense f amortisation | period i less than 12 morths Costs reate directly to | the contract Conractcosts ‘ [ Recognise as an asset if It —1 ALLaf the ofollowing re e fufthe Cortsto oot | | ennanceresources et | (paras95 %96) \ \ be used to satisfy PO will - \ \ w [ET———— Amortise consistent with \ [ Teamoised " |- |the pattern of ransterf | Costsareexpected to b (para.99) oot andservces Tpars. 39) | coveren ) INCREMENTAL COSTS OF OBTAINING A CONTRACT (P.136) Under paragraph 91 of IFRS 15, the incremental costs of obtaining a contract shall be recognised as an asset if the entity expects to recover those costs. There are 2 aspects to this recognition requirement. 1) The costs of obtaining a contract are ‘incremental’, and 2) The entity expects to recover these costs. Costs of obtaining a contract are incremental if they would not have been incurred had the contract not been obtained (IFRS 15, para. 92), while recovery of these costs may be either direct (i.e. reimbursement by the customer under the terms of the contract) or indirect (i.e. incorporated into the profit margin of the contract). Costs of obtaining a contract that are not incremental (i.e. costs incurred regardless of whether the contract was obtained) are recognised as an expense when incurred, unless they are chargeable to the customer regardless of whether the contract is obtained up to 1 year (IFRS 15, para. 93/94). COSTS TO FULFIL A CONTRACT (P.137) If the costs incurred to fulfil a contract are within the scope of another standard, IFRS 15 states that an entity shall account for those costs in accordance with that standard (IFRS 15, para. 96). If the costs incurred are not within the scope of another standard, an entity recognises an asset from the incurred costs only if ALL of the following criteria are met: - the costs ‘relate directly to a contract or to an anticipated contract that the entity can specifically identify’ (e.g. direct labour, direct materials, allocation of overheads that relate directly to the contract, costs explicitly chargeable to the customer under the contract, and other costs that are incurred only because an entity entered into the contract) - the costs ‘generate or enhance resources of the entity that will be used in satisfying performance obligations in the future” the costs ‘are expected to be recovered’ (IFRS 15, para. 95). AMORTISATION AND IMPAIRMENT (P.137) Amortisation occurs ‘on a systematic basis consistent with the transfer to the customer of the goods or services to which the asset relates’ and the amortisation is for the contract life (IFRS 15, para. 99). When there is a significant change in the entity’s expected timing of transfer to the customer of the goods or services to which the asset relates, the entity updates the amortisation to reflect the change E.g. If the entity renews a contract for an extra period that wasn't anticipated at contract inception. An entity recognises an impairment loss to the extent that the carrying amount of the asset that is recognised exceeds ‘the remaining amount of consideration that the entity expects to receive in exchange for the goods or services to which the asset relates’, less the yet-to-be-incurred costs ‘that relate directly to providing those goods or services’ (IFRS 15, para. 101). 3.3 DISCLOSURE (P.138) CONTRACTS WITH CUSTOMERS (P.138) An entity must disclose disaggregated revenue from contracts with customers, contract balances, performance obligations and the transaction price allocated to remaining performance obligations. Disa regation of Revenue 38): Under IFRS 15, an entity must disclose revenue recognised from contracts with customers that has been disaggregated into categories ‘that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors’ (IFRS 15, para. 114). Examples of this disaggregation includes: a) type of good or service (for example, major product lines); b) geographical region (for example, country or region); c) market or type of customer (for example, government and non-government customers); d) type of contract (for example, fixed-price and time-and-materials contracts); e) contract duration (for example, short-term and long-term contracts); f) timing of transfer of goods or services (for example, revenue from goods or services transferred to customers at a point in time and revenue from goods or services transferred over time); and g) sales channels (for example, goods sold directly to consumers and goods sold through intermediaries) (IFRS 15, para. B89). Contract Balances 38 In relation to contract balances, an entity must disclose ALL of the following: - the opening and closing balances of receivables, contract assets and contract liabilities from contracts with customers - revenue recognised in the reporting period that was included in the contract liabilities opening balance - revenue recognised in the reporting period from performance obligations that were either completely or partially satisfied in previous periods (IFRS 15, para. 116). A contract liability arises when an entity has received consideration or has an unconditional right to receive consideration from the customer before the entity transfers a good/service to the customer. The unconditional right to receive compensation from a customer constitutes a receivable. This is distinct from a contract asset, which is “[a]n 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 (for example, the entity’s future performance) Disclosures about an entity’s contract balances help users understand the relationship between the revenue recognised and changes in the balances of an entity's contract assets and liabilities during a reporting period E.g. Disclosing the opening balances of contract liabilities will help users understand the amount of revenue that will be recognised during the current period, while disclosing the opening balances of contract assets will provide them with an understanding of the amounts that will be transferred to accounts receivable or collected as cash during the period Performance Obligations (p.139 In relation to performance obligations, an entity must disclose a description of ALL of the following: - ‘when the entity typically satisfies its performance obligations’ (e.g. on shipment, on delivery, as services are rendered or when they are completed) - ‘the significant payment terms’ (e.g. when payment is due, whether the contract includes a significant financing component, and whether the amount of consideration is variable, or its estimate is constrained) - ‘the nature of the goods or services that the entity has promised to transfer’ > ‘obligations for returns, refunds and other similar obligations’ - ‘types of warranties and related obligations’ (IFRS 15, para. 119). Transaction Price Allocated to Remaining Performance Obligations (p.139): The final disclosure requirement related to contracts with customers requires an entity to disclose the amount of the transaction price that is allocated to the unsatisfied performance obligations ina contract (whether partial or complete) at the end of the reporting period.  + Anentity must provide an explanation of when it expects to recognise as revenue the transaction price allocated to the unsatisfied performance obligations and can be either quantitative (e.g. amounts to be recognised as revenue according to specified times) or qualitative (IFRS 15, para. 120). + These disclosure requirements provide users with information about the amount and timing of revenue that an entity expects to recognise from the remaining performance obligations in its existing contracts with customers (IFRS 15 Basis for Conclusions, para. BC350). SIGNIFICANT JUDGMENTS IN THE APPLICATION OF IFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS (P.140) * Anentityis required to disclose and explain the judgments and changes in judgments used to determine the: - ‘timing of satisfaction of performance obligations’ - ‘transaction price and amounts allocated to performance obligations’ (IFRS 15, para. 123). ASSETS RECOGNISED FROM CONTRACT COSTS (P.140) * Forassets recognised from the costs to obtain or fulfil a contract with a customer, an entity must: - provide a description of the judgments made in determining the amount of the costs, and of the amortisation method used for each reporting period - disclose the closing balances of the assets recognised - disclose the amount of amortisation and any impairment losses recognised in the reporting period (IFRS 15, paras 127 and 128) PART B: PROVISIONS (P.142) SCOPE OF IAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS (P.142) + IAS 37 applies to all provisions, other than those that: - result from executory contracts, except for onerous contracts - are covered by another standard (IAS 37, para. 1) « Executory contracts are ‘contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent’ (IAS 37, para. 3) DEFINITION OF PROVISIONS (P.143) * Aprovision is defined in IAS 37 as a ‘liability of uncertain timing or amount’ (IAS 37, para. 10) and a key aspect of this is the requirement that uncertainty exists. * For a present obligation to exist, the entity must have no realistic alternative to settling the obligation created by the event (IAS 37, para. 17). * When there is a significant level of certainty, the amount is not recognised as a provision but as a liability (E.g. Liabilities are borrowings, trade creditors and accruals) = In cases where the degree of uncertainty in relation to the timing or amount of the liability cannot be measured with sufficient reliability, the amount is classified as a contingent liability « Provisions are ‘liabilities of uncertain timing or amount’ (IAS 37, para. 10) whereas contingent liabilities arise where the degree of uncertainty in relation to the timing or amount of the liability cannot be measured with sufficient reliability. (IAS 37 para. 12). 3.4 RECOGNITION OF PROVISIONS (P.143) * 1AS 37 requires the following conditions to be met for a provision to be recognised: a) an entity has a present obligation (legal or constructive) as a result of a past event; b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and c) areliable estimate can be made of the amount of the obligation (IAS 37, para. 14). + Criteria for a present obligation (IAS 37, para 17): 1. Legally enforceable 2. Aduty or responsibility 3. A3“partyis owed something Present Obligation and Past Event (p.143): * The standard setters believed that it will normally be clear whether a past event has given rise to a present obligation that should be recognised in the statement of financial position. * Anobligation ‘is a duty or responsibility that an entity has no practical ability to avoid’ (Conceptual  Framework, para. 4.29) and is legally enforceable due to a binding contract or statutory requirement « The most common form of present obligation is a legal obligation, in which an external party has a present legal right to force the entity to pay or perform. + However, it may also be a constructive obligation to the extent that there is a valid expectation in other parties that the entity will discharge the obligation. « Eg Amanufacturer provides warranties at the time of sale to purchasers of its product lines and under the warranty, the manufacturer undertakes to repair or replace items that fail to perform satisfactorily within 2 years from the date of sale * Assuch, the present obligation as a result of a past event occurs when on the date of sale which gives rise to a legal obligation from the sale date to honour the warranty in the event of fault. - Aconstructive obligation derives from an entity’s actions where: a) byan established pattern of past practice, published policies or a specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and b) asa result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities (IAS 37, para. 10). * The definition of a present obligation includes liabilities arising from normal business practice or custom, a desire to maintain good business relations or a desire to act in an equitable manner (E.g. habitually providing staff with bonuses), but not from a contractual agreement with another entity 1AS 37 para. 17 : Probable Outflow of Economic Benefits (p.144) * This occurs when the ‘the probability that the event will occur is greater than the probability that it will not’ (IAS 37, para. 23). * Where there are several similar obligations (E.g. Warranty obligations) the class of obligations is considered in determining whether an outflow of resources is probable (IAS 37, para. 24). Reliable Measurement (p.144 « Consequently, a provision is capzble of being reliably measured even if several possible outcomes exist. 3.5 MEASUREMENT OF PROVISIONS (P.145) The amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period (IAS 37, para. 36). The best estimate is the amount that an entity would rationally pay either to settle the obligation at that date or to transfer it to a 3rd party at that time. When measurement uncertainty exists, the provision amount should be estimated based on its circumstance but measurement uncertainty does not suggest that no provision is required. The estimation requirements differ depending on whether the provision involves a large population of items or a single obligation including: - “Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities. The name for this statistical method of estimation is “expected value” (IAS 37, para. 39). - “Where asingle obligation is being measured, the individual most likely outcome may be the best estimate of the liability’ (IAS 37, para. 40). The most appropriate estimate of the provision is determined is by using the judgement of the management of the entity, supplemented by experience of similar transactions and, reports from independent experts. The evidence considered includes any additional evidence provided by events after the reporting period (IAS 37, para. 38). Discounting (p.146): Consequently, provisions are discounted when the effect of this discounting is material. The discount rate should be a pre-tax rate that reflects ‘current market assessments of the time value of money and the risks specific to the liability and should NOT reflect risks already accounted for in cash flow estimates (IAS 37, para. 47) When the use of economic resources depends on technology (E.g. For cleaning up asite in the future), the estimated amount should be based on the current, not future technology (IAS 37, para. 49). In order to account for this changed risk, the firm may either adjust the future cash flow estimates OR adjust the discount rate to reflect this E.g. The journal entry to unwind a discount for an environmental provision is: Dr Environmental Provision Expense (Expense - P/L) Cr Environmental Provision (Liability- B/S) 3.6 IAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS: DISCLOSURE (P.147) PROVISIONS (P.147) * When there is a possible obligation whose existence will be confirmed only by the occurrence or nonoccurrence of 1 or more uncertain future events not wholly within the control of the entity, the possible liability must be disclosed in the financial statements as a contingent liability as the possibility of an outflow in settlement is more than remote. The key disclosures required by IAS 37 relating to provisions are: * For each class of provision, an entity shall disclose: a) the carrying amount at the beginning and end of the period b) additional provisions made in the period, including increases to existing provisions; ) amounts used (i.e. incurred and charged against the provision) during the period; d) unused amounts reversed during the period; and e) the increase during the period in the discounted amount arising from the passage of time and the effect of any change in the discount rate. = An entity shall disclose the following for each class of provision: a) brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits; b) an indication of the uncertainties about the amount or timing of those outflows and where necessary to provide adequate information, an entity shall disclose the major assumptions made concerning future events, and 4 Contingent Probable (hety [Pl el ] [[ contingent oisioseasset | ot Probabilty o Not probable | Woacion (remote) required TABLE 3.1 Application of probablllty criteria to contingent assets inflow of Accounting treatment In accordance wi et ontingent Assats Virtually cetan 1S approprate to recognise the asset where he fealsation of income s irtually certan as the asset Is not a contingent assel (AS37, para. 33). Probable but not I hereis possible asset for wiich fuure benefts ar= probable, but ot virtually vitually certan certah, po asset s recogrised (AS 37, para. 31, but a contngent asset s disciosed (AS 37, para.89). Not proadle It there is a possiole asset for which the prbabily that future benefita il eventuate is ot probable,no assa s resognisad (AS 37 para. 31) and o disclesuref roguired for the contingent asset (IAS 37, para. 89). 3.9 CONTINGENT LIABILITIES (P.152) * Contingent liabilities are a present obligation where the outflow of resources in the future is not probable (IAS 37 para. 10(b)(i)) a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or b) a present obligation that arises from past events but is not recognised because: i. itis not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or ii. the amount of the obligation cannot be measured with reliability (I1AS 37, para. 10) * A contingent liability must be disclosed when: a) The occurrence of an event has resulted in probable sacrifice of future economic benefits, but the amount can’t be reliably measured b) Asaconsequence of the event, a present obligation exists but the future sacrifice of economic benefits is unlikely - The ability to reliably estimate the amount of a present obligation can be the difference between recognising a provision and disclosing a contingent liability. + If aliability/asset satisfies 1 criterion of the recognition criteria in that it can be reliably measured but fails the other in that the inflow of economic benefits at year end is NOT probable, then no action should be taken by the entity TABLE 32 Application of probabllty criteria to provisions and contingent liabilities ACGOUNTING treatment I 8CCOrdancCe Wit 1AS 37 Provisions, Coniingent Lisbities and Contingent Asse Present abligatin that probably requres an A provison isecogrised (AS 37, para. 14) ouliow of resouces "Disciosurese required forthe provision(AS 37, para, 84-65) Possibie obligation or presant obigation that Noprovision & recognissd (1AS 37, para. 27) may. but probatiy wil not. require an ouffiow Diclosed as a contingent labilty (1AS 37. para.88) of resources Possitio or procant obigation whare No provision & recognised AS 37, para. 27) the likelihoodof outlow of resourcess remote: No disciosure s required (1AS 7. para. 88) Exremely rar case where there is a by, No provision i recognised IAS 37, pera. 27) but I carmot be mesured reflably Disciosed as a contiigent Habilty (1AS 37, pera. 86) « From paragraph10 of IAS 37, a contingent liability will exist in the event of: 1) A possible obligation to be confirmed by uncertain future events 2) Apresent obligation where the future sacrifice of economic benefits is not probable, or 3) A present obligation with a probable future sacrifice of economic benefits that is not reliably measurable. - Itis only when the probability of future sacrifice is higher than remote that the contingent liability will be disclosed in a note to the financial statements LIABILITIES VS CONTINGENT LIABILITIES (P.154) * When it is determined whether a liability or a contingent liability exists, it will normally be clear whether a past event has given rise to a present obligation. * Where the existence of a present obligation is still unclear — and this will only be confirmed by the occurrence or non-occurrence of some future event outside the control of the entity — a possible obligation is identified and treated as a contingent liability. 3.10 CONTINGENCIES AND PROFESSIONAL JUDGEMENT (P.154) * Anaccountant must exercise professional judgment in determining whether an item should be recognised as a financial statement element or whether it constitutes a contingency. * E.g. Anaccountant must assess whether, after all available evidence has been considered, if an asset exists. - Anaccountant must decide whether an obligation is a possible or present obligation and if itis a possible obligation, a contingent liability exists and must be disclosed. + Ifitisa present obligation, the accountant must determine whether an outflow of resources is probable and whether the amount of the obligation is reliably measurable. « When a contingency is required to be disclosed, an accountant must also exercise discretion in deciding the extent to which potentially sensitive information is made public. + Eg Anentity subject to a strong legal claim that has been brought against it, where the outcome is uncertain, has a contingent liability. References: « CPA Financial Reporting (FR) Study Guide 6th Edition, published by John Wiley & Sons Australia, Ltd e CPA Ethics and Governance (E&G), Knowledge Equity