International Financial Reporting Standards (IFRS) 15 specifies how and when an entity will recognize revenue as well as requiring such entities to provide users of financial statements with more informative, relevant disclosures. The standard provides a single, principles based five-step model to be applied to all contracts with customers.
IFRS 15 was issued in May 2014 and applies to an annual reporting period beginning on or after 1 January 2017.
Philippine Financial Reporting Standards (PFRS) in the Philippines are adopted from the IFRS. IFRS, when used in this article, also pertains to PFRS as used in the Philippine setting. IFRS 15 replaces the following standards and interpretations:
- IAS 11 Construction Contracts
- IAS 18 Revenue
- IFRIC 13 Customer Loyalty Programmes
- IFRIC 15 Agreements for the Construction of Real Estate
- IFRIC 18 Transfers of Assets from Customers
- SIC-31 Revenue – Barter Transactions Involving Advertising Services
In the Philippines, it is to be noted that the effectivity of the IFRIC 15 was deferred until the issuance of the final revenue standards by the IASB. Now that PFRS 15 was already issued, the requirements in IFRIC 15 were already covered and such interpretation is superseded even before it becomes effective.
Convergence with the US GAAP
Revenue is a vital metric for users of financial statements and is used to assess a company’s financial performance and prospects. However, the previous requirements of both IFRS and US GAAP were different and often resulted in different accounting for transactions that were economically similar. Furthermore, while revenue recognition requirements of IFRS lacked sufficient detail, the accounting requirements of US GAAP were considered to be overly prescriptive and conflicting in certain areas.
Responding to these challenges, the boards have developed new, fully converged requirements for the recognition of revenue in both IFRS and US GAAP—providing substantial enhancements to the quality and consistency of how revenue is reported while also improving comparability in the financial statements of companies reporting using IFRS and US GAAP.
The core principle of the new Standard is for companies to recognise revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration (that is, payment) to which the company expects to be entitled in exchange for those goods or services. The new Standard will also result in enhanced disclosures about revenue, provide guidance for transactions that were not previously addressed comprehensively (for example, service revenue and contract modifications) and improve guidance for multiple-element arrangements.
Accounting Requirements For Revenue
The five-step model framework
The core principle of IFRS 15 is that an entity will 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. This core principle is delivered in a five-step model framework:
- Identify the contract(s) with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognise revenue when (or as) the entity satisfies a performance obligation.
Application of this guidance will depend on the facts and circumstances present in a contract with a customer and will require the exercise of judgment.
Step 1: Identify the contract with the customer
A contract with a customer will be within the scope of IFRS 15 if all the following conditions are met:
- the contract has been approved by the parties to the contract;
- each party’s rights in relation to the goods or services to be transferred can be identified;
- the payment terms for the goods or services to be transferred can be identified;
- the contract has commercial substance; and
- it is probable that the consideration to which the entity is entitled to in exchange for the goods or services will be collected.
If a contract with a customer does not yet meet all of the above criteria, the entity will continue to re-assess the contract going forward to determine whether it subsequently meets the above criteria. From that point, the entity will apply IFRS 15 to the contract.
The standard provides detailed guidance on how to account for approved contract modifications. If certain conditions are met, a contract modification will be accounted for as a separate contract with the customer. If not, it will be accounted for by modifying the accounting for the current contract with the customer. Whether the latter type of modification is accounted for prospectively or retrospectively depends on whether the remaining goods or services to be delivered after the modification are distinct from those delivered prior to the modification. Further details on accounting for contract modifications can be found in the Standard.
Step 2: Identify the performance obligations in the contract
At the inception of the contract, the entity should assess the goods or services that have been promised to the customer, and identify as a performance obligation:
- a good or service (or bundle of goods or services) that is distinct; or
- a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.
A series of distinct goods or services is transferred to the customer in the same pattern if both of the following criteria are met:
- each distinct good or service in the series that the entity promises to transfer consecutively to the customer would be a performance obligation that is satisfied over time (see below); and
- a single method of measuring progress would be used to measure the entity’s progress towards complete satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.
A good or service is distinct if both of the following criteria are met:
- the customer can benefit from the good or services on its own or in conjunction with other readily available resources; and
- the entity’s promise to transfer the good or service to the customer is separately idenitifable from other promises in the contract.
Factors for consideration as to whether a promise to transfer the good or service to the customer is separately identifiable include, but are not limited to:
- the entity does not provide a significant service of integrating the good or service with other goods or services promised in the contract.
- the good or service does not significantly modify or customise another good or service promised in the contract.
- the good or service is not highly interrelated with or highly dependent on other goods or services promised in the contract.
Step 3: Determine the transaction price
The transaction price is the amount to which an entity expects to be entitled in exchange for the transfer of goods and services. When making this determination, an entity will consider past customary business practices.
Where a contract contains elements of variable consideration, the entity will estimate the amount of variable consideration to which it will be entitled under the contract. Variable consideration can arise, for example, as a result of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties or other similar items. Variable consideration is also present if an entity’s right to consideration is contingent on the occurrence of a future event.
The standard deals with the uncertainty relating to variable consideration by limiting the amount of variable consideration that can be recognised. Specifically, variable consideration is only included in the transaction price if, and to the extent that, it is highly probable that its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved.
However, a different, more restrictive approach is applied in respect of sales or usage-based royalty revenue arising from licences of intellectual property. Such revenue is recognised only when the underlying sales or usage occur.
Step 4: Allocate the transaction price to the performance obligations in the contracts
Where a contract has multiple performance obligations, an entity will allocate the transaction price to the performance obligations in the contract by reference to their relative standalone selling prices. If a standalone selling price is not directly observable, the entity will need to estimate it. IFRS 15 suggests various methods that might be used, including:
- Adjusted market assessment approach
- Expected cost plus a margin approach
- Residual approach (only permissible in limited circumstances).
Any overall discount compared to the aggregate of standalone selling prices is allocated between performance obligations on a relative standalone selling price basis. In certain circumstances, it may be appropriate to allocate such a discount to some but not all of the performance obligations.
Where consideration is paid in advance or in arrears, the entity will need to consider whether the contract includes a significant financing arrangement and, if so, adjust for the time value of money. A practical expedient is available where the interval between transfer of the promised goods or services and payment by the customer is expected to be less than 12 months.
Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation
Revenue is recognised as control is passed, either over time or at a point in time.
Control of an asset is defined as the ability to direct the use of and obtain substantially all of the remaining benefits from the asset. This includes the ability to prevent others from directing the use of and obtaining the benefits from the asset. The benefits related to the asset are the potential cash flows that may be obtained directly or indirectly. These include, but are not limited to:
- using the asset to produce goods or provide services;
- using the asset to enhance the value of other assets;
- using the asset to settle liabilities or to reduce expenses;
- selling or exchanging the asset;
- pledging the asset to secure a loan; and
- holding the asset.
An entity recognises revenue over time if one of the following criteria is met:
- the customer simultaneously receives and consumes all of the benefits provided by the entity as the entity performs;
- the entity’s performance creates or enhances an asset that the customer controls as the asset is created; or
- 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.
If an entity does not satisfy its performance obligation over time, it satisfies it at a point in time. Revenue will therefore be recognised when control is passed at a certain point in time. Factors that may indicate the point in time at which control passes include, but are not limited to:
- the entity has a present right to payment for the asset;
- the customer has legal title to the asset;
- the entity has transferred physical possession of the asset;
- the customer has the significant risks and rewards related to the ownership of the asset; and
- the customer has accepted the asset.
The incremental costs of obtaining a contract must be recognised as an asset if the entity expects to recover those costs. However, those incremental costs are limited to the costs that the entity would not have incurred if the contract had not been successfully obtained (e.g. ‘success fees’ paid to agents). A practical expedient is available, allowing the incremental costs of obtaining a contract to be expensed if the associated amortisation period would be 12 months or less.
Costs incurred to fulfil a contract are recognised as an asset if and only if all of the following criteria are met:
- the costs relate directly to a contract (or a specific anticipated contract);
- the costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the future; and
- the costs are expected to be recovered.
These include costs such as direct labour, direct materials, and the allocation of overheads that relate directly to the contract.
The asset recognised in respect of the costs to obtain or fulfil a contract is amortised on a systematic basis that is consistent with the pattern of transfer of the goods or services to which the asset relates.
The disclosure objective stated in IFRS 15 is for an entity to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Therefore, an entity should disclose qualitative and quantitative information about all of the following:
- its contracts with customers;
- the significant judgments, and changes in the judgments, made in applying the guidance to those contracts; and
- any assets recognised from the costs to obtain or fulfil a contract with a customer.
Entities will need to consider the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the requirements. An entity should aggregate or disaggregate disclosures to ensure that useful information is not obscured.
In order to achieve the disclosure objective stated above, the Standard introduces a number of new disclosure requirements. Further detail about these specific requirements can be found at IFRS 15.
Discussions on IFRS 15
There has been a lot of on-going discussions tackling IFRS 15. Various firms are promoting awareness and educating clients and other practitioners regarding the provisions of IFRS 15.
I recently attended in a 90-minute webcast sponsored by EY entitled “The new revenue recognition standard – A webcast for US GAAP reporters and practitioners”. This was aired last June 2, 2014 but is still accessible from the archive. To launch the archive and watch the presentation, click this link.
There will be another discussion on June 10, 2014, entitled “The new revenue recognition standard – A webcast for IFRS reporters and practitioners“. This will be a live webcast and will be aired June 10, 2014 at 8:00 AM of the Philippine time. Everyone is free to register and participate. Click here.
There will also be a reply of the webcast on June 11, 2014, 12:00 AM of the Philippine time. Click here to participate in the replay.
- IASB’s Article on IASB and FASB issue converged Standard on revenue recognition
- Delloite Article on IFRS 15 – Revenue fro Contracts with Customers
- EY’s article on IASB and FASB issue new revenue recognition standard — IFRS 15
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