IFRS 15 – Revenue from Contracts with Customers (Video notes)
Step 1: Identify the contract with the customer
A contract is an agreement between two or more parties that creates enforceable rights and obligations. A contract can be written, oral, or implied by an entity’s customary business practices.
A contract creates present enforceable rights and obligations.
5 criteria must be met before an entity accounts for a contract with a customer under IFRS 15:
$1)$ Contract has commercial substance
$2)$ Contract has been approved and parties are committed to perform
$3)$ Rights and obligations are identified
$4)$ Payment terms identified
$5)$ Collectability of the transaction price is probable
A customer is the party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.
Understanding the entire contract is important to the accounting conclusion.
A company may enter into multiple contracts with the same customer and the contracts could also be affected by subsequent amendments, amendments or side agreements.
Contract characteristics may include amendments or side agreements that change or add rights/obligations; modifications affect revenue recognition.
A contract can be written (e.g., framework agreement, purchase order), oral, or implied by customary business practices.
A contract can be simple (single off-the-shelf product) or highly complex (industrial site).
Step 2: Performance obligations in the contract
Core concept: Identify the performance obligations (POs) in the contract. Under current practice, contracts in construction are often treated at the contract level; many arrangements are highly integrated and may contain a single PO.
Distinctness concepts:
Capable of being distinct: a good or service can be used on its own or with readily available goods/services.
Distinct in the context of the contract: not being used as an input to create an output that is substantially the same as the final product the customer expects.
A series of distinct goods or services is a single PO if both criteria are met:
Each good or service in the series is a PO satisfied over time.
Same method would be used to measure progress for each good or service in the series.
Immaterial/Materiality considerations:
Consider materiality concepts when identifying POs.
POs may include a significant service of integrating goods or services promised in the contract into a bundle.
A good significantly modifies or customizes, or is significantly modified or customized by, one or more of the other goods/services.
Highly interdependent or highly interrelated relationships may affect identification of POs.
Construction industry insight: Contracts with different customers may not be combined if they are economically linked; judgment is often required to determine whether multiple promises form a single PO.
Step 3: Determine the transaction price
Transaction price equals the amount of consideration to which the entity expects to be entitled in exchange for transferring goods or services.
Components of the transaction price:
Variable consideration
Significant financing component
Non-cash consideration
Consideration payable to customers
Other uncertain aspects of the price
Variable consideration: estimate the amount of consideration the entity expects to be entitled to; use either:
Expected value: sum of probability-weighted amounts in a range of possible consideration amounts:
ext{Expected value} =
ext{(sum over outcomes)} \ pi imes viMost likely amount: the single most likely amount in a range of possible outcomes.
Recognition of variable consideration depends on the degree of certainty that a significant revenue reversal will not occur in the future.
The variable consideration should be included in the transaction price if it is highly probable that it will not reverse later (the constraint).
Claims and overruns: included in transaction price only if probable the customer will accept the claim and the amount can be reliably measured.
Unpriced change orders: if not accounted for as separate contract, treat as variable consideration; estimate upon scope approval and adjust transaction price cumulatively if the goods/services are not distinct and are part of a single PO.
Awards, incentive payments, and liquidated damages can be variable consideration; include based on performance criteria and whether they are probable and reliably measureable.
Significant financing component:
Some long-term contracts have a financing component because payments occur significantly before/after transfer.
If a significant financing component exists, reflect its effects in the transaction price.
Retainage (retention) usually does not imply a significant financing component.
Practical note: determine whether any of these factors apply; the judgement often depends on contract structure and timing of payment.
Step 4: Allocate the transaction price
Allocation basis: allocate the transaction price to each PO based on the relative standalone selling price (SSP) of each PO.
Allocation methods:
Best evidence is the observable price.
If SSP is not observable, estimate using: cost plus a reasonable margin, market prices for similar goods/services, or a residual approach when SSP is highly variable.
Allocation formula:
ext{Allocated TP}{i} = ext{TP} imes rac{SSPi}{igl( ext{SSP}1 + ext{SSP}2 + igr) + ext{SSP}_n}Discounts:
A discount may be allocated entirely to one or more but not all POs if specific criteria are met.
Variable consideration allocation: allocate variable consideration entirely to a single PO if the payment relates specifically to that PO and is consistent with the overall allocation objective.
Illustrative allocation example (road and bridge):
Standalone selling prices: Road $SSP{ ext{road}} = 140$, Bridge $SSP{ ext{bridge}} = 30$; TP = $151$ million; variable component = $11$ million (assessed as part of total).
Allocation (relative SSP):
ext{Road share} = 151 imes rac{140}{140+30} = 151 imes rac{140}{170} = 124.4 ext{ million}The remaining amount would be allocated to the bridge based on its SSP proportion.
Note: For a single contract with a single performance obligation, allocation is straightforward; for multiple obligations, use the relative SSP approach to divide the TP across obligations.
Step 5: Recognise revenue when (or as) a performance obligation is satisfied
Revenue is recognised to reflect the transfer of promised goods or services to the customer.
Over time vs at a point in time:
Over time if the customer simultaneously receives and consumes benefits or controls the asset as it is created/enhanced, or if the entity’s work creates an asset with no alternative use and a right to payment for work completed to date.
Point in time if control transfers at a specific moment (e.g., transfer of goods).
Indicators of transfer of control (5-point framework):
$1)$ The company has a right to payment for the asset.
$2)$ The customer has title to the asset.
$3)$ The customer has physical possession of the asset.
$4)$ The customer has the significant risks and rewards of ownership.
$5)$ The customer has accepted the asset.
Measurement of progress for over-time recognition:
Input method (e.g., cost-to-cost or labor hours expended) – best when effort reflects transfer of goods/services.
Output method (e.g., milestones reached, units delivered) – when the transfer of goods/services can be measured directly.
Apply a single method to measure progress for each PO within a contract.
Uninstalled materials concept: exclude uninstalled materials from progress when the entity’s primary purpose is to procure materials to satisfy a PO; until installation occurs, they may not depict the transfer of goods/services.
Principal versus agent
In some arrangements, a company may act as a principal or as an agent in the transfer to the end customer.
Management should identify the specific good or service provided to the end customer and determine whether the entity controls that good or service before transfer.
Indicators to assess principal-versus-agent status include:
Pricing latitude
Primary obligation or performance of the core good/service
Inventory risk
Interaction with other controls and the ability to direct the use of the good/service
The revenue standard provides indicators to help determine whether the entity is the principal or an agent in an arrangement such as service offerings, extended warranties, product protection plans, installation services, and third-party gift card sales.
Licensing
Types of licenses:
Brand or trade name
Franchise rights
Trademark/copyright
Software
Media content
Drug formula
Is the license distinct?
Determine the nature of the license (right to use vs right to access).
Point in time recognition generally for a right-to-use license.
If the license is a right to access IP over the license period, revenue is recognised over time.
Right to use vs right to access:
Right to use: revenue recognized at a point in time; license does not require ongoing involvement.
Right to access: revenue recognised over the period of access.
Royalties constraint: for licenses of IP with a sales or usage-based royalty, revenue is recognised only when sales or usage occurs.
Additional considerations: Licensor activities that significantly affect the IP (and which are not a separate good/service) may influence when revenue is recognised.
Contract costs
Fulfillment costs: costs to fulfill a contract are first assessed to determine if they fall within other standards (e.g., inventory, intangibles, fixed assets). If so, apply those standards (capitalize or expense).
Costs to fulfill a contract that are not within another standard are evaluated under the revenue standard.
Decision flow for fulfillment costs:
Are costs related directly to a contract or to anticipated contract? If yes, proceed.
Do the costs generate or enhance resources that will be used in satisfying future performance obligations? If yes, proceed.
Are the costs expected to be recovered? If yes, recognize as an asset; otherwise expense as incurred.
Costs to obtain a contract (incremental costs):
Incremental costs of obtaining a contract are costs that would not have been incurred if the contract had not been obtained (e.g., sales commissions).
They can be recognized as an asset if they are expected to be recovered.
A practical expedient allows expensing contract acquisition costs as incurred for contracts with a duration of one year or less.
Non-incremental costs are expensed as incurred.
Illustrative examples and practical insights
Slotting fees (illustrative example):
Slotting fees paid to retailers for product placement are highly dependent on purchase and do not represent distinct goods/services.
They should be accounted for as a reduction of revenue (i.e., a reduction to the transaction price).
Buy three, get coupon for one free (illustrative example):
The free box represents a material right (a separate performance obligation).
Allocate part of the transaction price to this material right using the relative stand-alone selling price, accounting for expected redemption and breakage.
Example approach (summary): SSP of the option is €24 (300% of the base price multiplied by expected redemption), breakage is considered in the allocation, and revenue is allocated to the obligations accordingly once the customer takes delivery; amounts recognised at the relevant transfer points.
Price protection for retailers (illustrative example):
Revenue should be reduced by the estimated price-protection compensation when recognizing revenue on shipment of the original collection.
If protection is promised but not yet paid, a corresponding reduction in transaction price is recognized when revenue is recognized.
Waste disposal payments (illustrative example):
The disposal of packaging is a separate performance obligation (a service) distinct from the sale of goods.
If the amount paid for the disposal service does not reflect its fair value, the excess is a reduction of revenue from sales to retailers.
Unpriced change orders (illustrative example):
An unpriced change order is accounted for as variable consideration when scope changes are approved.
The estimated change in transaction price is updated via a cumulative catch-up adjustment, since the remaining goods/services are not distinct and form part of a single PO.
Award fees (illustrative example):
Award fees are variable consideration; estimate using the most likely amount method when outcomes are binary (e.g., $65M or $70M).
The most likely amount may be included in the transaction price and regularly reassessed; updates occur if expected outcomes change.
Significant financing component (illustrative example):
The presence of a financing component affects the transaction price; the long-term arrangement requires consideration of the time value of money.
Over time recognition (illustrative concepts):
If control transfers over time, revenue is recognized over time using a method that depicts transfer of goods/services (input or output method).
Additional practical notes:
Management should apply a single progress-measure method per PO.
Retainage typically does not create a significant financing component in long-term contracts.
Five-step summary and practical takeaways
Step 1: Identify the contract with the customer using the five contract criteria.
Step 2: Identify the performance obligations, considering distinct goods/services and series guidance; assess materiality and interdependence.
Step 3: Determine the transaction price, including variable consideration, financing, non-cash consideration, and consideration payable to customers; apply the constraint on variable consideration.
Step 4: Allocate the transaction price to the identified POs using SSP (relative SSP, observable prices, or estimation methods); allocate discounts and variable consideration appropriately.
Step 5: Recognise revenue when (or as) each PO is satisfied, using over-time or point-in-time criteria and the five indicators of control; choose the appropriate progress-measure method (input or output) for over-time recognition; consider uninstalled materials.
Additional topics to review: principal vs agent indicators, licensing (right to use vs right to access; royalties constraint), contract costs (fulfillment vs obtaining contract; one-year practical expedient), and illustrative construction industry specifics.
ext{Transaction price} = ext{Expected consideration in exchange for transferring goods or services}
ext{Road allocation to TP} = 151 imes rac{140}{140+30} = 124.4 ext{ million}
ext{Allocated TP}{i} = ext{TP} imes rac{SSPi}{ ext{SSP}1 + ext{SSP}2 + ext{SSP}3 + ext{SSP}n}
Quick glossary of key terms
IFRS 15: Revenue from Contracts with Customers
Transaction price: amount of consideration expected by the entity in exchange for transferring goods/services
Performance obligation (PO): promise in a contract to transfer a good or service
Stand-alone selling price (SSP): price at which the good/service would be sold separately
Variable consideration: portion of the transaction price that depends on outcomes like incentives or penalties
Significant financing component: financing effect due to timing differences between payment and transfer
Rights to use vs rights to access licenses: difference in timing of revenue recognition
Principal vs agent: who controls the good/service before transfer to the customer
Uninstalled materials: materials not yet integrated into the customer outcome and used for measuring progress
Breakage: expected non-redemption of options with a material right
Practical expedients: simplified accounting options for short-term contracts or other expedients
Step 1: Identify the contract with the customer
A contract is an agreement creating enforceable rights and obligations. Five criteria must be met before applying IFRS 15: the contract has commercial substance, is approved with committed parties, identifies rights and obligations, defines payment terms, and ensures probable collectability of the transaction price. Contracts can be written, oral, or implied and may include amendments or side agreements.
Step 2: Performance obligations in the contract
Identify distinct performance obligations (POs). A good or service is distinct if it can be used on its own or with readily available resources, and is not used as an input to create a substantially same final product. A series of distinct goods or services can be a single PO if satisfied over time using the same progress measurement method. Materiality considerations apply when identifying POs, especially for integrated or interdependent components.
Step 3: Determine the transaction price
The transaction price is the amount of consideration an entity expects to be entitled to. Components include:
Variable consideration: Estimated using either the expected value (probability-weighted amounts) or the most likely amount. It is included only if it is highly probable that a significant revenue reversal will not occur.
Significant financing component: Reflects the time value of money if payments occur significantly before or after the transfer of goods/services.
Non-cash consideration
Consideration payable to customers
Claims, unpriced change orders, awards, incentive payments, and liquidated damages can all be forms of variable consideration.
Step 4: Allocate the transaction price
Allocate the transaction price to each PO based on its relative standalone selling price (SSP). The best evidence for SSP is an observable price. If unobservable, estimate using methods like cost plus a reasonable margin, market prices, or a residual approach. Discounts and variable consideration may be allocated to specific POs if certain criteria are met.
Allocation formula: ext{Allocated TP}{i} = ext{TP} imes\frac{SSPi}{( ext{SSP}1 + ext{SSP}2 + ext{SSP}}3 + ext{SSP}n)}
Step 5: Recognise revenue when (or as) a performance obligation is satisfied
Revenue is recognized to reflect the transfer of promised goods or services to the customer. This occurs:
Over time: If the customer simultaneously receives and consumes benefits, controls the asset as it's created/enhanced, or if the entity's work creates an asset with no alternative use and a right to payment for work completed. Progress is measured using input (e.g., cost-to-cost) or output (e.g., milestones) methods.
At a point in time: When control transfers at a specific moment. Indicators of control include the right to payment, title, physical possession, significant risks and rewards of ownership, and customer acceptance. Uninstalled materials are typically excluded from progress measurement until installed.
Principal versus agent
Determine if the entity controls the good or service before transferring it to the customer (principal) or merely arranges for another party to provide it (agent). Indicators for this assessment include pricing latitude, primary obligation, and inventory risk.
Licensing
Licenses are categorized as either a "right to use" (revenue recognized at a point in time) or a "right to access" (revenue recognized over the license period). Sales- or usage-based royalties from licenses of intellectual property are recognized only when the underlying sales or usage occurs.
Contract costs
Fulfillment costs: Costs incurred to fulfill a contract are capitalized if they relate directly to a contract, enhance future resources satisfying POs, and are expected to be recovered. Otherwise, they are expensed.
Costs to obtain a contract (incremental costs): Costs that would not have been incurred if the contract had not been obtained (e.g., sales commissions) are recognized as an asset if recoverable. A practical expedient allows expensing these costs as incurred for contracts with a duration of one year or less.
Illustrative examples and practical insights
The note includes various illustrative examples demonstrating the application of these principles, such as slotting fees, material rights (e.g., "buy three, get one free"), price protection, waste disposal payments, unpriced change orders, and award fees, which help clarify complex accounting judgments.