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Publication date: 04 Apr 2019

Expand the sections below to access the latest standards, PwC interpretations, tools and practice aids for this topic.

Latest developments

In May 2014, the IASB and FASB jointly issued the converged standard on the recognition of revenue from contracts with customers. Both boards subsequently issued amendments to defer the effective date of the standard by one year. The standard will improve the financial reporting of revenue and improve comparability of the top line in financial statements globally. Companies using IFRS are required to apply the revenue standard for reporting periods beginning on or after 1 January 2018. Public companies using US GAAP will be required to apply it for annual reporting periods beginning after 15 December 2017 (including interim reporting periods therein).

In April 2016, the IASB issued amendments to IFRS 15 that comprise clarifications of the guidance on identifying performance obligations, accounting for licences of intellectual property (IP) and the principal versus agent assessment (gross versus net revenue presentation). New and amended illustrative examples have been added for each of those areas of guidance. The IASB has also included additional practical expedients related to transition to the new revenue standard. The amendments are effective for annual reporting periods beginning on or after 1 January 2018, with early application permitted.

The IASB and FASB also established a joint working group, the Transition Resource Group for Revenue Recognition (TRG), to assist preparers and users of financial statements in implementing IFRS 15 / ASC 606. TRG discussions are non-authoritative, but they may provide helpful insight on the requirements of the standard and implementation issues. In January 2016, the IASB announced that it does no plan to schedule additional TRG meetings. The IASB observed meetings of the US TRG in April and November 2016. In November 2016, the FASB announced that there are no further US TRG meetings schedule, but that they will continue to assess the need for future meetings. For further details, see FAQ 11.4.1 to Chapter 11 of Manual of accounting and In transition.

Overview

In May 2014, the IASB and FASB issued their converged standard on revenue recognition - IFRS 15 and ASC 606, Revenue from Contracts with Customers. The standard contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognised. The underlying principle is that an entity will recognise revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The standard could significantly change how many entities recognise revenue. The standard will also result in a significant increase in the volume of disclosures related to revenue recognition.

Under IFRS 15, revenue is recognised based on the satisfaction of performance obligations. In applying IFRS 15, entities would follow this five-step process:

  1. Identify the contract with a customer.
  2. Identify the separate performance obligations in the contract.
  3. Determine the transaction price.
  4. Allocate the transaction price to the separate performance obligations.
  5. Recognise revenue when (or as) each performance obligation is satisfied.

1. Identify the contract with a customer

The model starts with identifying the contract with the customer and whether an entity should combine, for accounting purposes, two or more contracts, to properly reflect the economics of the underlying transaction. An entity will need to conclude that it is 'probable’, at the inception of the contract, that the entity will collect the consideration to which it will ultimately be entitled in exchange for the goods or services that are transferred to the customer in order for a contract to be in the scope of the revenue standard. The term 'probable' has a different meaning under IFRS (where it means more likely than not - that is, greater than 50% likelihood) and US GAAP (where it is generally interpreted as 75-80% likelihood). This could result in a difference in the accounting for a contract if there is a likelihood of non-payment at inception. However, the boards decided that there would not be a significant practical effect of the different meaning of the same term because the population of transactions that would fail to meet the criterion in paragraph 9(e) of IFRS 15 would be small.

Two or more contracts (including contracts with related parties of the customers) should be combined if the contracts are entered into at or near the same time and the contracts are negotiated with a single commercial objective, the amount of consideration in one contract depends on the other contract, or the goods or services in the contracts are interrelated. A contract modification is treated as a separate contract only if it results in the addition of a separate performance obligation and the price reflects the stand-alone selling price (that is, the price the good or service would be sold for if sold on a stand-alone basis) of the additional performance obligation. The modification is otherwise accounted for as an adjustment to the original contract either through a cumulative catch-up adjustment to revenue or a prospective adjustment to revenue when future performance obligations are satisfied, depending on whether the remaining goods and services are distinct.

2. Identify the separate performance obligations in the contract

An entity will be required to identify all performance obligations in a contract. Performance obligations are promises to transfer goods or services to a customer and are similar to what we know today as 'elements' or 'deliverables’. Performance obligations might be explicitly stated in the contract but might also arise in other ways. Legal or statutory requirements to deliver a good or perform a service might create performance obligations even though such obligations are not explicit in the contract. A performance obligation may also be created through customary business practices, such as an entity’s practice of providing customer support, or by published policies or specific company statements. This could result in an increased number of performance obligations within an arrangement, possibly changing the timing of revenue recognition.

An entity accounts for each promised good or service as a separate performance obligation if the good or service is distinct. Such a good or service is distinct if both of the following criteria are met:

  1. the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (that is, the good or service is capable of being distinct); and
  2. the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (that is, the promise to transfer the good or service is distinct within the context of the contract).

Sales-type incentives such as free products or customer loyalty programmes, for example, are currently recognised as marketing expense under US GAAP in some circumstances. These incentives might be performance obligations under IFRS 15; if so, revenue will be deferred until such obligations are satisfied, such as when a customer redeems loyalty points. Other potential changes in this area include accounting for return rights, licences, and options.

3. Determine the transaction price

Once an entity identifies the performance obligations in a contract, the obligations will be measured by reference to the transaction price. The transaction price reflects the amount of consideration that an entity expects to be entitled to in exchange for goods or services transferred. The amount of expected consideration captures: (1) variable consideration if it is 'highly probable' (IFRS) or 'probable' (US GAAP) that the amount will not result in a significant revenue reversal if estimates change, (2) an assessment of time value of money (as a practical expedient, an entity need not make this assessment when the period between payment and the transfer of goods or services is less than one year), (3) non-cash consideration, generally at fair value, and (4) less any consideration paid to customers.

Variable consideration is measured using either a probability weighted or most likely amount approach; whichever is most predictive of the final outcome. Inclusion of variable consideration in the initial measurement of the transaction price might result in a significant change in the timing of revenue recognition. Such consideration is recognised as the entity satisfies its related performance obligations, provided (1) the entity has relevant experience with similar performance obligations (or other valid evidence) that allows it to estimate the cumulative amount of revenue for a satisfied performance obligation, and (2) based on that experience, the entity does not expect a significant reversal in future periods in the cumulative amount of revenue recognised for that performance obligation. Judgement will be needed to assess whether the entity has predictive experience about the outcome of a contract. The following indicators might suggest the entity’s experience is not predictive of the outcome of a contract: (1) the amount of consideration is highly susceptible to factors outside the influence of the entity, (2) the uncertainty about the amount of consideration is not expected to be resolved for a long period of time, (3) the entity’s experience with similar types of contracts is limited, and (4) the contract has a large number and broad range of possible consideration amounts.

4. Allocate the transaction price to the separate performance obligations

For contracts with multiple performance obligations (deliverables), the performance obligations should be separately accounted for to the extent that the pattern of transfer of goods and services is different. Once an entity identifies and determines whether to separately account for all the performance obligations in a contract, the transaction price is allocated to these separate performance obligations based on relative stand-alone selling prices.

The best evidence of stand-alone selling price is the observable price of a good or service when the entity sells that good or service separately. The selling price is estimated if a stand-alone selling price is not available. Some possible estimation methods include

(1) cost plus a reasonable margin or (2) evaluation of stand-alone sales prices of the same or similar products, if available. If the stand-alone selling price is highly variable or uncertain, entities may use a residual approach to aid in estimating the stand-alone selling price (that is, total transaction price less the standalone selling prices of other goods or services in the contract). An entity may also allocate discounts and variable amounts entirely to one (or more) performance obligations if certain conditions are met.

5. Recognise revenue when each performance obligation is satisfied

Revenue should be recognised when a promised good or service is transferred to the customer. This occurs when the customer obtains control of that good or service. Control can transfer at a point in time or continuously over time. Determining when control transfers will require significant judgement. An entity satisfies a performance obligation over time if: (1) the customer is receiving and consuming the benefits of the entity’s performance as the entity performs (that is, another entity would not need to substantially re-perform the work completed to date); (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 does not create an asset with an alternative use to the entity, the entity has a right to payment for performance completed to date that includes compensation for a reasonable profit margin, and it expects to fulfil the contract. A good or service not satisfied over time is satisfied at a point in time. Indicators to consider in determining when the customer obtains control of a promised asset include: (1) the customer has an unconditional obligation to pay, (2) the customer has legal title, (3) the customer has physical possession, (4) the customer has the risks and rewards of ownership of the good, and (5) the customer has accepted the asset. These indicators are not a checklist, nor are they all-inclusive. All relevant factors should be considered to determine whether the customer has obtained control of a good.

If control is transferred continuously over time, an entity may use output methods (for example, units delivered) or input methods (for example, costs incurred or passage of time) to measure the amount of revenue to be recognised. The method that best depicts the transfer of goods or services to the customer should be applied consistently throughout the contract and to similar contracts with customers.

Contract cost guidance

IFRS 15 also includes guidance related to contract costs. Costs relating to satisfied performance obligations and costs related to inefficiencies should be expensed as incurred. Incremental costs of obtaining a contract (for example, a sales commission) should be recognised as an asset if they are expected to be recovered. An entity can expense the cost of obtaining a contract if the amortisation period would be less than one year. Entities should evaluate whether direct costs incurred in fulfilling a contract are in the scope of other standards (for example, inventory, intangibles, or property, plant and equipment). If so, the entity should account for such costs in accordance with those standards. If not, the entity should capitalise those costs only if the costs relate directly to a contract, relate to future performance, and are expected to be recovered under a contract. An example of such costs may be certain mobilisation, design, or testing costs. These costs would then be amortised as control of the goods or services to which the asset relates is transferred to the customer. The amortisation period may extend beyond the length of the contract when the economic benefit will be received over a longer period. An example might include set-up costs related to contracts likely to be renewed.

Licensing

IFRS 15 includes specific implementation guidance on accounting for licences of IP. The first step is to determine whether the licence is distinct or combined with other goods or services. The revenue recognition pattern for distinct licences is based on whether the licence is a right to access IP (revenue recognised over time) or a right to use IP (revenue recognised at a point in time). For licences that are bundled with other goods or services, management will apply judgement to assess the nature of the combined item and determine whether the combined performance obligation is satisfied at a point in time or over time. In addition, the revenue standard includes an exception to variable consideration guidance for the recognition of sales- or usage-based royalties promised in exchange for a licence of IP.

Principal versus agent considerations

When an arrangement involves two or more unrelated parties that contribute to providing a specified good or service to a customer, management will need to determine whether the entity has promised to provide the specified good or service itself (as a principal) or to arrange for those specified goods or services to be provided by another party (as an agent). Determining whether an entity is the principal or an agent is not a policy choice. IFRS 15 includes indicators that an entity controls a specified good or service before it is transferred to the customer to help entities apply the concept of control to the principal versus agent assessment. The assessment should be made separately for each specified good or service. An entity could be the principal for some goods or services and an agent for others in contracts with multiple distinct goods or services.

Summary observations and anticipated timing

The above commentary is not all-inclusive. The effect of IFRS 15 is extensive, and all industries could be affected. Some will see pervasive changes, because the new model will replace all existing IFRS and US GAAP revenue recognition guidance, including industry-specific guidance with limited exceptions (for example, certain guidance on rate-regulated activities in US GAAP). Under IFRS, the final standard is effective for the first interim period within annual reporting periods beginning on or after 1 January 2018.

Entities should continue to evaluate how the model might affect current business activities, including contract negotiations, key metrics (including debt covenants and compensation arrangements), budgeting, controls and processes, information technology requirements, and accounting. IFRS 15 will permit an entity to either apply it retrospectively in accordance with IAS 8 or modified retrospectively (that is, including the cumulative effect at initial application date in opening retained earnings (or other equity components, as appropriate)).IFRS 15 also provide certain practical expedients that an entity could elect to apply to simplify transition.

 
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