Article: 

Does IFRS 15 change the pattern of revenue recognition?10 April 2018

The answer to this question is potentially, yes. One of the key changes introduced by IFRS 15 Revenue from Contracts with Customers is that revenue recognition
is now based on the transfer of control over goods or services to a customer, rather than just the transfer of risks and rewards. For many companies this is resulting
in changes to the pattern of revenue recognition from over time to a point in time, or vice versa (less common). Where point in time recognition remains
appropriate, changes to the timing of the “point in time” might arise.
All entities adopting IFRS 15 need to assess how the new requirements apply to them and update how their revenue recognition policies are described in the
financial statements.

 Over time or at a point in time

Under IFRS 15, an entity must determine for each performance obligation whether control is transferred over time or at a point in time. If control is not transferred
over time, the default position is that the performance obligation is satisfied at a point in time.
 Revenue recognised over time IFRS 15 provides three criteria, at least one of which must be met to qualify for revenue recognition over time.
Comments and additional
Criteria Examples
guidance
 Typically applies to
a. The customer contracts for services
simultaneously  The concept of control of an
receives and asset applies because
consumes the services are viewed as an
 Cleaning services
economic benefits asset (momentarily) when
 Transportation services
provided by the they are received and used
 Some professional services
vendor’s or consumed
performance  Consider whether another
vendor would need to
  substantially re-perform the
work completed to date

b. The vendor creates  A building constructed on

or enhances an  Typically applies when an land owned by the
asset controlled by asset (tangible or intangible) customer
the customer is being constructed on the  Customised software
customer’s premises written into a customer’s
  existing IT infrastructure

c. (1) The vendor’s  Construction and real

performance does estate (developers)
not create an asset  Typically applies to  Manufacturing/engineering
for which the construction/development of contracts for customised
vendor has an assets to customer products/assets
alternative use; and specifications  Some advertising and
(2) The vendor has  Consider the terms of the professional services
an enforceable contract and any relevant  Software development
right to payment laws or regulations projects hosted on the
for performance vendor’s servers while
completed to date  under development

 In practice, it is not always straightforward to determine which of the ‘over time’ criteria, if any, are relevant and whether they are satisfied. For example, in the
case of a professional services engagement:
  Does the customer receive a service or goods? Payroll processing services could be services that the customer receives and benefits from throughout the
contract and may qualify for over time revenue recognition under the criteria in (a).
 Is the objective of the engagement to produce a report? The customer is unlikely to benefit until the report is delivered. In such cases, the entity needs to
consider the criteria in (c) or revenue might need to be recognised at a point in time when the report is completed.

Where (c) applies, a careful review of the contract terms, and the legal frameworks that govern the transaction, is required.  There is often considerable judgement
involved in assessing:

 Whether the asset can be sold to another customer, and

 Whether there is a right to payment for both costs incurred to date and a reasonable profit margin at all times throughout the contract.

 Revenue recognised at a point in time

When recognising revenue at a point in time, entities need to consider when the customer obtains the ability to direct the use of, and obtain substantially all of the
remaining benefits from, the asset.  IFRS 15 provides a list of indicators that control has passed, including if the customer has:

 A present obligation to pay

 Physical possession of the asset(s)
 Legal title
 Risks and rewards of ownership
 Accepted the asset(s).

While risks and rewards continues to be an indicator, entities moving from IAS 18 to IFRS 15 should consider whether a different indicator or indicators could
more accurately depict the transfer of control for the asset in question, which could change the point in time when revenue is recognised. For example, some
consumer product manufacturers and retailers ship goods on “Free On Board (FOB) shipping point” terms, but retain a degree of risk during shipment and may
conclude that control is transferred (based on legal title, right to payment, the customer’s right to redirect the goods) earlier than risks and rewards and may
recognise revenue earlier under IFRS 15.
Article: 
Will advance billing hurt your balance sheet?
09 March 2018
As IFRS 15 is about revenue recognition, you would expect it to have most impact on the P&L. However, as the pattern of revenue recognition changes, it will
also affect companies’ balance sheets because they will need to reflect different performance obligations or contract assets. Companies that bill in advance for the
delivery of goods or services may see a marked impact on their first balance sheet after adopting IFRS 15.
Accounting for advance billing under IAS 18 often initially resulted in the recognition of a trade receivable and deferred revenue. Under IFRS 15, this ‘grossing
up’ of the balance sheet may not be appropriate – reducing gross assets and gross liabilities.
 
Practical example
A company has sold software maintenance services in a stand-alone transaction (ie not bundled with other goods or services) for a two-year ‘non-cancellable’
period. The company has decided to recognise the revenue evenly - £1,000 per month over the 24-month period. Payment for the service can be structured in one
of the following ways:

1. Invoiced in full at the start (say 1 January 2018) and payable in full on 31 March 2018
2. Invoiced in full at the start but payable in 24 equal instalments at the end of each calendar month, or
3. Invoiced and payable in 24 equal instalments at the end of each calendar month.

Under IAS 18, for options 1 and 2, companies would often have recognised a trade receivable of £24,000 and deferred revenue of £24,000 on 1 January 2018.
However, under IFRS 15, the contract liability and trade receivable should be shown net until the earlier of either:

a. The date the payment becomes due (ie when the ‘receivable’ is recognised), or
b. The date the goods or services are delivered (ie when a ‘contract asset’ is recognised).

Under IFRS 15, the fact that the contract is ‘non-cancellable’ affects the date at which payment becomes due: it is the date at which the cash payment should be
received under the contract, not the invoice date of the trade receivable.
 

Comparison of accounting entries

Receivables and contract assets must be presented separately either in the notes or on the face of the balance sheet.
   1 January 31 January 28 February 31 March
Dr Deferred Revenue   £1,000
Option 1 Dr Receivable £24,000 Dr Deferred Revenue   £1,000 Dr Deferred Revenue   £1,000
Cr Revenue   £1,000
IAS 18 Cr Deferred Revenue £24,000 Cr Revenue   £1,000 Cr Revenue   £1,000
 
Dr Receivable £24,000
Option 1 -  Dr Contract asset   £1,000 Dr Contract asset   £1,000 Cr Contract asset   £2,000
IFRS 15 -  Cr Revenue   £1,000 Cr Revenue   £1,000 Cr Revenue   £1,000
Cr Contract liability £21,000
Option 2 Dr Receivable £24,000 Dr Deferred Revenue   £1,000 Dr Deferred Revenue   £1,000 Dr Deferred Revenue   £1,000
IAS 18 Cr Deferred Revenue £24,000 Cr Revenue   £1,000 Cr Revenue   £1,000 Cr Revenue   £1,000
Option 2 - Dr Receivable   £1,000 Dr Receivable   £1,000 Dr Receivable   £1,000
IFRS 15 - Cr Revenue   £1,000 Cr Revenue   £1,000 Cr Revenue   £1,000
Option 3 Dr Receivable   £1,000 Dr Receivable   £1,000 Dr Receivable   £1,000
 
IAS 18 Cr Revenue   £1,000 Cr Revenue   £1,000 Cr Revenue   £1,000
Option 3 - Dr Receivable   £1,000 Dr Receivable   £1,000 Dr Receivable   £1,000
IFRS 15 - Cr Revenue   £1,000 Cr Revenue   £1,000 Cr Revenue   £1,000
 
The balance sheet effect
The new treatment under IFRS 15 will have no bearing on the pattern of revenue recognition or, of course, the cash position of the company. However, it may have
a significant effect on the appearance of the balance sheet.
As can be seen in the example under IAS 18 both gross assets and gross liabilities are increased by £24,000 at 1 January. Under IFRS 15 this grossing up may
occur at a later date (option 1) or not at all (option 2 and 3) 
If the changes to your balance sheet are going to be significant/material, you will want to explain them to the company’s stakeholders. This is done by making
disclosures in your last annual report prior to implementing IFRS 15 (as required under IAS 8.30 – disclosures for new standards not yet effective).
Article: IFRS 15 in the Spotlight: Variable consideration & the sales-based or usage-based royalty exception 12 January 2018
In our November IFRS 15 article we considered the impact of variable consideration on revenue recognition and the requirement to estimate this consideration,
subject to the variable consideration constraint. This article explains an exception to variable consideration treatment for certain licences of intellectual property
(IP).
Where the variable consideration in relation to the licence (but not sale) of IP is in the form of a sales-based or usage-based royalty, ie the amount of consideration
receivable is dependent upon the number of sales the customer makes using the IP, then that variable consideration is subject to different constraints.
This restriction only applies where the sales-based or usage-based royalty relates solely or predominantly to the IP licence such as may be the case with, for
example, a licence for a movie for six weeks of screenings, along with providing memorabilia at the start of the screening period. In instances where the royalty
relates solely or predominantly to the IP licence then the sales-based or usage-based royalty exception (the ‘royalty exception’) must be applied to the royalty in its
entirety.
In these instances, instead of the ‘general approach’ to estimating the variable consideration amount, IFRS 15 only permits the recognition of the revenue from
these sales-based or usage-based royalties when, or as, the later of the following occurs:
The subsequent sale or usage occurs, or
The performance obligation to which some or all of these royalties has been allocated has been satisfied (or partially satisfied).
The subsequent sale or usage occurs
This may require an element of estimation of sales/usage-based royalties where there is a timing difference between the sale or usage occurring, and when these
reports by the customer are received by the licensing entity.
Satisfaction of performance obligation
The purpose this test is to prevent the acceleration of revenue recognition before an entity has performed the obligation. This is because the royalty exception
applies to the restriction of variable consideration that can be recognised, but doesn’t over-ride the underlying requirements of IFRS 15 that where revenue is
recognised over time, the measurement depicts an entity’s performance in transferring control of the goods or services.
Example – recognition restricted to satisfaction of performance obligation
An entity licences IP to a customer for five years, and determines that revenue is to be recognised over time. The royalty exception applies because the payment
schedule sets out that the amount billed is at the following royalty rates on the customers’ sales: Year 1: 10%, Year 2: 8%, Year 3: 6%, Year 4: 4% Year 5: 2%.
The entity estimates that:
The customer sales on which the royalty is based will be approximately equal for each of the five years under licence, and
Any activities undertaken by the entity affecting its IP will be performed on an even and continuous basis throughout the licence period.
Should the entity recognise the royalty revenue based upon contractual terms?

Following the legal form of the royalty might not appropriately depict progress in satisfying its performance obligation for providing access to the entity’s IP as it
may exist from time to time throughout the licence period.
Although the royalty exception sets a limit on the maximum amount of revenue that might be recognised, this does not mean that this maximum amount should
always be recognised. The entity may therefore need to defer some of this revenue to satisfy the second test within the royalty exception recognition criteria. In
practice, in the scenario above, this might be done by applying an average expected royalty rate to calculate the revenue deferral.
When does this exception apply?
The term ‘royalty’ is not defined within the standards, and care must be taken when determining whether the royalty exception applies in certain payment
structures which may be ‘in-substance’ sales or usage-based royalties (for example, milestone payments).
An example of this would be where a company licences IP with a payment structure as follows:
£1.5m for the licence of IP for 2 years
Additional £0.5m if customer makes sales of more than £100m in the 2 years
Additional £1.0m if customer makes sale of more than £200m in the 2 years.
In the above example, the entity will recognise revenue of £1.5m when, or as, control of the licence passes, and the additional £0.5m/£1.0m in the period(s) that the
customers’ sales exceed the cumulative £100m / £200m targets.
What if the contract includes a minimum royalty guarantee?
Often, licence of IP contracts can include a fixed element and a royalty based element, such as a sales-based royalty payment plan with a minimum royalty
guarantee of £2m.
The minimum royalty guarantee element would not be subject to the royalty exception, as it does not form part of the variable consideration, and so would be
recognised when, or as, control of the licence is passed to the customer. Any additional sales-based or usage-based royalties in excess of this guaranteed minimum
would be subject to the royalty exception and recognised in the period that the sales/usage occurs.
Where the licence of the IP is recognised at a point in time, the guaranteed minimum amount is recognised at that point in time, with any excess royalties
recognised once the sales/usage that take the royalties above the guaranteed minimum occur.
Where the licence of the IP is recognised over time, more judgement is required by management as they will need to determine an appropriate measure of progress.
Regardless of the measure of progress selected, cumulative revenue at any point in time must not exceed the sum of minimum guaranteed royalties plus excess
royalties earned to date.

Article: 
IFRS 15 in the Spotlight: Variable consideration13 November 2017
Many businesses have contracts with their customers that set out the consideration receivable that is not just for a fixed amount. The consideration receivable can
often include amounts such as:
Awards for early or timely delivery and penalties for late delivery (common in industries such as construction – see example 1 below), or

Volume based rebates or stepped-pricing (common in industries such as retail or manufacturing – see example 2 below).
Under IFRS 15 these amounts are referred to as ‘variable consideration’. Variable consideration can also arise in other situations such as sales with a right of
return, or where there is a valid expectation (either based on customary business practice, or the seller’s intention when entering into the contract) that a price
concession will be offered later.
It is important to consider the treatment of these elements of revenue when looking at the accounting required under IFRS 15 as this can differ from the previous
accounting treatment.
At the start of the contract a seller must estimate the amount of consideration to which it expects to be entitled on the contract. This estimate is updated at each
reporting date until no further consideration is receivable. IFRS 15 requires that this estimate of variable consideration is determined using either:

 The expected value method – based on probability-weighted amounts, or

 The most likely outcome method – appropriate where there are few possible outcomes (for example, an entity either achieves a performance bonus or not).

The most appropriate method should be selected for each contract, and then must be applied consistently throughout the contract term.
Regardless of which method is used, the estimation of the variable consideration amount is constrained to the extent that it is highly probable that a significant
reversal in the amount of cumulative revenue recognised will not occur. This means that when estimating the variable consideration, IFRS 15 sets a higher hurdle
than the previous IFRS standards which may defer the recognition of some revenue.
An exception to the above approach is made in relation to consideration in the form of a sales-based or usage-based royalty for the licence of intellectual property
which we will consider in next month’s issue.
 

Example 1: variable consideration – over-time revenue recognition

A construction company enters into a contract to build a bridge for £10m with an expected completion date of July 2019. The company determines that the over-
time revenue recognition criteria of IFRS 15 have been met. The contract contains award / penalty clauses depending on the date of completion as follows:
Date of Completion Award Penalty
  £’000 £’000
June 2019 or earlier 200 -
July or August 2019 - -
September 2019 or later - (1,000)
Due to the presence of a £1m penalty clause, the fixed consideration is £9m with any additional revenue being variable consideration.
At the start of the contract, the construction company determines with a high degree of certainty that the bridge will be completed on time and therefore, using the
most likely outcome method and applying the constraint, no awards or penalty deductions are included when estimating contract consideration (£10m).
At their reporting date of 31 December 2018 they reassess their variable consideration estimate. At this point, it is most likely that the bridge will be completed in
August 2019 but there is a reasonable chance that it will not be completed until September 2019 so they determine that the date by which completion is highly
probably is September 2019.
Variable consideration to be recognised is therefore estimated to be constrained to £nil due to the penalty. Previously, the penalty deduction may only have been
accounted for when incurred.
If at 31 December 2018 the most likely date of completion is June 2019, with the date by which completion is highly probably being determined as July 2019, then
the variable consideration to be recognised would be estimated as £1m giving total consideration of £10m. Previously this may have been £10.2m, including
receipt of the award based on the most likely completion date.
 

Example 2: variable consideration – point in time recognition

A manufacturing company (the ‘supplier’) enters into a contract to sell the product ‘A Biscuit’ to a supermarket chain. The pricing in this contract is such that each
pack is sold for £10, with a rebate being offered at the end of the year based upon the total number of packs sold in 12 months. Revenue is recognised for each
pack upon delivery of that pack to the supermarket.
Number of packs sold in 12m Price per pack
  £
1 – 1,000 10
1,001 – 1,500 8
1,501 or more 7
Start of the contract
The variable consideration is the £3 per pack that reflects the difference between the £10 and £7 selling prices.
To determine how much of this variable consideration it can recognise on the sale of the packs to the supermarket chain throughout the year, the supplier must
estimate how many packs of A Biscuit it expects to sell. At the start of the contract, based upon normal sale volumes to businesses similar to the supermarket chain
it estimates that it will sell 1,200 packs (so consideration of £8 per pack) and it is highly probable that they will not sell more than 1,500 packs. The variable
consideration of £3 is therefore constrained to £1 – giving a transaction price per pack of £8.
During the year
Upon sale of each pack of A Biscuit to the supermarket chain during the year, the supplier recognises £8 revenue. The difference of £2 between the invoice amount
and revenue recognised is recorded as a contract liability.
At year end
At their reporting date of 31 December 2018 they reassess their variable consideration estimate. At this point, based upon volumes sold to date and the remaining
period of the contract, they estimate that they will now sell 2,000 packs to the supermarket chain in total. The variable consideration is now constrained to £nil –
giving a transaction price and revenue per pack of £7.
Stepped pricing
The above example shows a reduction in the price of each pack sold in the year. If the pricing were stepped rather than cumulative (ie first 1,000 at £10, the next
500 at £8, and all the rest at £7) the process of estimating variable consideration would still be the same:

 During the year: recognise revenue of £9.67 for each pack sold as they estimate sales of 1,200 packs and it is highly probable that they will not sell more
than 1,500 packs [(1,000 x £10 + 200 x £8)/1,200]
 At year end: recognise revenue of £8.75 for each pack sold as they estimate sales of 2,000 [(1,000 x £10 + 500 x £8 + 500 x £7)/2,000]. This will result in
a cumulative adjustment of (£0.92) reduction in revenue for each pack sold to date.

 Article: Contract Costs and IFRS 1517 October 2017

Although IFRS 15 is primarily a standard on revenue recognition, it also includes requirements relating to contract costs. As a result, companies may need to
change their accounting for those costs on adoption of IFRS 15 for annual reporting periods beginning on or after 1 January 2018. This could affect their profit and
financial position - especially for entities involved in construction and long-term service contracts. Taken together with changes in the pattern of revenue
recognition under IFRS 15, this may result in increased volatility in profit margins on a contract in different reporting periods.
For example, Capita, in its recent announcement notes that some of its contract costs will be expensed as currently, while certain other costs (previously expensed)
will now be capitalised as contract fulfilment assets and released over the contract life. Taken with changes in revenue timing, this may lead to potentially lower
profits or losses in the early years of contracts – but with overall contract profitability unchanged. 
 What is changing?
As there is no specific IFRS addressing the accounting for costs, entities currently refer to a number of different standards and principles in accounting for various
types of costs incurred. Existing standards IAS 18 Revenue and IAS 11 Construction Contracts contain only limited guidance, mainly on applying the percentage
of completion method (under which contract revenue and costs are recognised with reference to the stage of completion).
IFRS 15 introduces new guidance on accounting for all contract costs, distinguishing between:

 Incremental costs incurred in obtaining a contract, and

 Costs incurred to fulfil a contract.

Subject to certain criteria, these contract costs must be capitalised, amortised and assessed for impairment under guidance in IFRS 15 (eg not IFRS 9 or IAS 36),
while all other types of costs have to be expensed as incurred. Assets recognised for contract costs are a new asset category and are presented separately from
contract assets and contract liabilities arising on the recognition of revenue. This could bring about a change in practice for many entities.
 Incremental costs of obtaining a contract
Incremental costs are costs that would not have been incurred had that individual contract not been obtained, eg a sales commission. Currently, entities either
expense the costs of obtaining a contract as incurred, include them as part of contract costs under IAS 11 Construction Contracts, or capitalise them under IAS
38 Intangible Assets as ‘directly attributable’ costs.
However, under IFRS 15, these costs are recognised as an asset if they are expected to be recovered from the customer. As a practical expedient, incremental costs
of obtaining a contract can be expensed if the amortisation period would be one year or less. Any other costs of obtaining a contract are expensed when incurred,
unless they are explicitly chargeable to the customer regardless of whether the contract is obtained.
 

Example
A company wins a competitive tender to provide consulting services to a new customer and incurs the following costs to obtain the contract:
 Costs £ IFRS 15 accounting treatment
External legal fees for due Expensed as incurred as these would have been
35,000
diligence incurred whether or not the tender was won.
Expensed as incurred as these would have been
Travel costs to deliver proposal 5,000
incurred whether or not the tender was won.
Recognise as an asset as these are incremental costs
Commissions to sales employees 10,000 of obtaining the contract and the company expects to
recover them through future consultancy fees.
Total costs incurred 50,000  
 
Costs to fulfil a contract
In accounting for costs to fulfil a contract, an entity must first assess whether the costs fall within the scope of another IFRS (eg IAS 2 Inventories, IAS
16 Property, Plant and Equipment and IAS 38 Intangible Assets) and, if so, account for them in accordance with that standard.
Any other costs to fulfil a contract are recognised as an asset under IFRS 15 only if they:

 Relate directly to a contract, or to an anticipated contract that can be specifically identified

 Generate or enhance resources to be used to satisfy performance obligations in future, and
 Are expected to be recovered.

There is no practical expedient to expense costs to fulfil a contract.

Costs that relate directly to a contract could include direct labour and materials or allocations of costs such as depreciation or insurance, anything explicitly
chargeable to the customer under the contract and subcontractor costs. However, general and administrative costs that are not explicitly chargeable to the customer
and the costs of wasted materials, labour and other resources that were not reflected in the price of the contract do not qualify.
Costs relating to satisfied or partially satisfied performance obligations (past performance) must be expensed. 

Article: Contract modifications and IFRS 15 20 September 2017

In all businesses, sales contracts are extended, adapted or modified on a regular basis as client’s needs develop. Accounting for those changes so that revenues are
correctly recognised can be a challenging task.
Currently, when a construction contract is changed, companies must use the rules set out in IAS 11 to decide if the modified contract should be accounted for as a
separate contract. This will change for annual reporting periods beginning on or after 1 January 2018: IFRS 15 introduces three different approaches to recognising
revenue when any contracts are modified. However, let’s start with the basics.
 Has there been a modification?
A contract modification exists when the parties to a contract approve a change that either:

 Changes existing enforceable rights and obligations of the parties, or

 Creates new enforceable rights and obligations of the parties.

You have to consider all relevant facts and circumstances (eg external evidence as well as the terms of the contract) to determine enforceability. A contract
modification may exist even though the parties:

 Have a dispute about the scope and/or price (or both) of the modification or
  They have approved a change in the scope of the contract but have not yet determined the corresponding change in price.

If a change in price has not been agreed, for accounting purposes businesses must use the rules for estimating variable consideration (see – Sale with a right of
return).
 How do I account for it?
IFRS 15 sets out three different approaches to accounting for a contract modification. To determine which approach is required you have to ask:

 Are the additional goods or services distinct from those in the original contract?  and
 Does the modification reflect the standalone selling price of the additional goods or services?

Different combinations of answers to the question can result in the change being treated as either:

a. A separate contract in addition to the original contract,

b. The termination of the original contract and the creation of a new contract (which will include the unsatisfied performance obligations from the original
terminated contract) or
c. As part of the original contract.

IFRS 15 example – sale of a product

A company enters into a contract to sell 200 units of a product for £16,000 (£80 each) and will supply 50 units per month over a four month period (control over
each unit passes to the customer on delivery). After 150 units have been delivered, the contract is modified to require the delivery of an additional 50 units (ie 250
in total). At the modification date, the stand-alone selling price of one unit of the product has fallen to £75.
The additional units are distinct from those in the original contract under IFRS 15. Consequently, the subsequent accounting will depend on whether or not the
sales price for the additional units reflects the stand-alone selling price at the date of contract modification (£75). This is illustrated below.
Stand-alone
Modified Seller’s recognises
Unit Price of unit price at
contract Accounting treatment
extra units date contract revenue of
example
changes
£80 per unit for the original
1. contract (including the remaining
Treat extra units as 50 units to be delivered)
50 extra £75 £75 being sold under a new
units and separate contract  
£75 per unit for extra 50 units
2. £60* (ie £65 £75 Recognise discount on Recognise the £5 per unit discount
 first contract
(£250 in total) as an immediate
 
reduction in revenue of £250 for
  the first 50 units delivered that
were defective.
 
50 extra agreed unit  
 
units with price less £5 Revenue before change is a
discount per unit in Treat original contract proportion of total contracts value
because of respect of as terminated at date of (see below)
faults in faults on first change
units 50) *  
already  
 
delivered Treat all subsequent
deliveries as under a Use weighted average to determine
new contract ( ie deemed new contract revenue to be
remaining 50 plus extra recognised (see below)
50)
* This reflects an agreed price of £65 per unit less a credit of £250 for poor service as some of the first 50 units that had been delivered were faulty and the vendor
had been slow in rectifying the position.
 Revenue calculations in 2
Use a weighted average to establish the amount of revenue recognised for each of the units delivered after the contract change, calculate as:
((50 x £80) + (50 x£65)) = £7,250          (100 units weighted average £72.50 each)
Therefore, revenue to be recognised for deliveries before the contract change is calculated as:
Total revenue of £16,000 (200 x £80) + £3,000 (50 x £60) = £19,000 less £7,250 recognised after the contract change = £11,750# (150*£80-£250).
#
 including the £250 credit
 Article: IFRS15 in the spotlight - Significant financing components in contracts 11 July 2017
From 1 January 2018, the new revenue recognition standard will apply specific rules where the timing of cash payments specified in a contract is different from the
timing of the transfer of control of the related goods or services to the customer (ie different from the date the related revenue is recognised).
If the timing of payments agreed by the parties to the contract (either explicitly or implicitly) provides either the customer or the vendor with a significant
financing benefit (eg if £4m is paid in full up front but delivery takes place 24 months later or vice versa), then IFRS 15 requires that the transaction price is
adjusted to reflect this ‘financing component’.
This is a significant departure from previous requirements as, under IAS 18, similar financing arrangements will generally only have been considered where
payment terms were deferred; typically payments in advance would not have affected revenue. The objective of including such new adjustments for significant
financing components is for the vendor to recognise revenue at the cash selling price, even if the contract contains an element of financing.
 
Example - A significant financing component arising from a payment in advance
A company enters into a contract with a customer to construct a new building. An analysis of the contract has determined that the revenue for the building will be
recognised at a point in time, rather than over time, with control over the completed building passing to the customer in two years’ time. The contract contains two
payment options: Either the customer can pay £5 million in two years’ time when it obtains control of the building, or the customer can pay £4 million on the
signing of the contract. The customer decides on the latter option.
The company concludes that, because of the significant period of time between the date of payment by the customer and the transfer of the completed building to
the customer and the effect of prevailing market rates of interest, there is a significant financing component in the arrangement.
The interest rate implicit in the transaction is 11.8%. However, because the vendor is effectively borrowing from its customer, the vendor is also required to
consider its own incremental borrowing rate which it has determined to be 6%. The accounting entries required to reflect the significant financing component are
as follows:
 

Contract inception:

Cash  £4,000,000  

Contract liability     £4,000,000

Recognition of a contract liability for the payment in advance.

 
Over the two year construction period:

Interest expense       £494,000         

Contract liability   £494,000      

Accretion of the interest at 6% incremental borrowing rate.

 
At the date of transfer of the building to the customer:

Contract liability £4,494,000  

Revenue   £4,494,000

 
Ignoring costs of sales, over the two year duration of the project, cumulative profit before tax will not be affected (the increase in revenue being offset by the
increase in interest expense). However, other possible KPIs may change (eg EBITDA will increase from £4,000 to £4,494 over that period).
As a practical expedient, IFRS 15 allows the effects of a significant financing component to be ignored if the vendor expects, at contract inception, that the period
between the transfer of a promised good or service to the customer and the date of payment will be one year or less.
 

 
Practical issues
This may also lead to a change in current practice, particularly in environments where interest rates are high, as a financing component may have been recognised
under IAS 18 for periods less than one year.
IFRS 15 also identifies a number of situations where there may be a timing difference between the supply of the goods or services and payment that is not regarded
as giving rise to a significant financing component, for example where:
 A customer has paid in advance and the timing of transfer of those goods or services is at the discretion of the customer (such as prepaid phone cards and
customer loyalty points)
 A substantial amount of consideration payable by the customer is variable and the amount or timing of that consideration will be determined by future
events that are not substantially within the control of either the vendor or the customer (such as a sales-based royalty)
 The difference between the promised consideration and the cash selling price of the goods or services is for a reason other than financing to either the
customer or the vendor (such as to provide the customer with protection that the vendor will fail to adequately complete its obligations – like the
completion of post construction remedial work on a building).
Article: To bundle or not to bundle, that is the question 12 June 2017
It is common for a business to provide customers with several goods and services at the same time, such as a mobile phone company who sells a monthly phone
contract to a customer which includes a hand-set. These multiple deliverables may all be under a single contract or may each be under a separate contract. For
example, in the mobile contract above there is one fixed monthly fee which in the contract is for both the hand-set and the data/minutes allowance.
When applying IFRS 15, it is necessary to combine or separate (‘bundle’ or ‘unbundle’) these into individual performance obligations. When identifying
performance obligations within a contract (or a group of related contracts), IFRS 15 requires you to look at the overall substance of the arrangement, rather than
the legal form.
 

Distinct goods and services

Previously, IFRSs had little guidance for bundling and unbundling separate deliverables in a contract.  IFRS 15, however, contains detailed requirements and
examples.  For the purposes of the new standard it is key to look at the relationship between contract components to determine whether they are ‘distinct in the
context of the contract’. If individual components are not considered distinct, they are bundled together in order to form a single distinct performance obligation. 
In order to determine whether goods or services are, the vendor will need to consider a number of factors, including:
 Can the customer benefit from the good or service either on its own or together with other resources that are readily available to them.  In other words, can
someone else provide the other good(s) or perform the other service(s) required, or does the customer already have these? For a mobile phone contract, the
answer would be yes - the hand-set can be bought from one company and the data/minutes allowance from another
 Are these goods or services regularly sold separately? For example, mobile phone hand-sets are now regularly sold outside of contracts, and sim-only
contracts are available.
 Is the vendor providing a significant service to integrate two or more of the services or goods promised?
 Do any of the goods or services significantly affect any of the other promised goods or services? In other words, are they highly dependent on (or highly
interrelated with) one another? In context of the mobile phone contract the response would be no – the hand-set is not altered by the data/minutes
allowance package.
Given the number of different considerations that may factor into this determination, this is likely to be an area of significant judgement for management. In
consequence, it is expected to feature in the disclosure of key accounting judgements required within the financial statements for businesses where this is relevant.
For the example of a mobile phone contract sale which for a fixed monthly fee which includes the hand-set, these are distinct goods and services and so will need
to be ‘unbundled’ and treated as a) the sale of a hand-set and b) the provision of mobile service with data/minutes allowance. The portion of the total contract fee
which is allocated to the hand-set under IFRS 15 will need to be recognised on day one.
 
Do I need to bundle?
The exact commercial/operational nature of the services or goods provided are important when determining whether goods and services are distinct; there is no
‘one-size-fits-all’, even when it comes to companies operating in similar markets. Let’s consider a contract for a licence of software, along with product support
for three years:
Example A – to ‘bundle’
It has been determined that the level of support provided is considered essential for the software to function properly and that only the vendor is capable of
providing the support. In this example, the software and the support elements of the contract are considered to be highly interrelated and will be bundled together
as a single performance obligation.

Example B – not to ‘bundle’

It has been determined that, whilst the software licence is always sold with a three year support agreement, the software can function properly without that support.
What’s more, support can also be provided by other providers after the initial support period has elapsed. Here, the software and the support are each considered to
be distinct parts of the contract treated as two separate performance obligations.
 
Why does this matter?
Whether components are bundled together into one performance obligation or not is particularly important when it comes to the timing of revenue recognition as
each performance obligation is considered separately for ‘point in time’ versus ‘over time’ revenue recognition. For example:
A. In example A above, the software licence and support are not distinct and are treated as a single performance obligation that is fulfilled over the three year
contractual period. This would generally meet the criteria for ‘over time’ revenue recognition.
B. In example B above, the software licence and support are two separate performance obligations. The licence may meet the criteria for ‘point in time’
revenue recognition and will be earned on the delivery of the software to the customer. However, the support will still be delivered over the three year
contractual period and would generally meet the criteria for ‘over time’ revenue recognition.
The effect of these different revenue recognition patterns is shown below:
  Year 1 Year 2 Year 3 Total
Example A - Single performance obligation
  Total: 1,500 1,500 1,500 4,500
 
Example B - Separate performance obligations
  Software 3,000 - - 3,000
  Support 500 500 500 1,500
  Total: 3,500 500 500 4,500
           
Difference (2,000) 1,000 1,000 -

Article: Sale with a right of return 20 April 2017

Customers have a legal right to return goods that are faulty, not as described, or unfit for purpose. Even if goods are not faulty many retailers have a goodwill
policy allowing returns within a specified period. The level of these returns can be high, especially where sales are made online.
IFRS 15 has prescriptive guidance on how to account for these return rights which requires the estimation not only of the number of expected returns, but also the
nature of these returns. These estimates could be difficult to quantify and businesses may need to change their management reporting systems in order to ensure
that they have the information needed to implement this new standard.
IFRS 15 defines a right to return as a right that enables a customer to receive:
1. A full or partial refund of any consideration paid
2. A credit that can be applied against other amounts owed, or that will be owed, to the vendor by the customer
3. A different product in exchange, or
4. Any combination of the above.
It is important to note that, the third point notwithstanding, an exchange by customers of one product for another of the same type, quality, condition and price (for
example, exchanging the product for one of a different colour or size) is not considered a return for the purposes of applying IFRS 15. Where an exchange occurs,
revenue is recognised on the date of the original sale. This means that estimating expected returns under IFRS 15 could be complex, given the different accounting
treatments of exchanges for similar and different items.
How do I account for this under IFRS 15?
Where a right to return exists, IFRS 15 requires sales revenue to be reduced to reflect the expected value of returns using the rules relating to variable
consideration. Instead of recognising revenue for these expected returns, a refund liability is recognised. The inventory cost of items expected to be returned are
also excluded from cost of sales and instead remain within inventory, adjusted for any potential impairment or restocking costs.
In subsequent periods, the vendor updates its expected levels of returns, adjusting the measurement of the refund liability and the associated inventory asset.
How might this differ from previous practice?
This may be a major change from the approach taken previously, particularly if past practice was to record a refund provision for only the margin earned on the
original sale of the items expected to be returned. This is especially the case where recognition of this provision was taken against cost of sales rather than reducing
revenue. This change will also represent a ‘grossing-up’ of the balance sheet as the refund liability and inventory cost of expected returns are not off-set.

Example of the potential effect of the new requirements

A retailer sells 100 items for £10, with a cost per item of £8 resulting in a margin of £2 per item. It anticipates that 12 of those items will be returned for a cash
refund or exchanged for a different item.
  Possible previous accounting IFRS 15 accounting
Revenue 1,000 (100 x £10) 880 (100-12) x £10
Cost of Sales 824 (100 x £8) + (12 x £2) 704 (100-12) x £8
Gross Profit 176   176  
         
Inventories -   96 (12 x £8)
Refund liability 24 (12 x £2) 120 (12 x £10)
Although gross profit is unaffected, revenue, which is likely to be a key performance indicator, may be significantly reduced. Therefore, it is clear that estimating
expected levels of returns will be a critical estimate, especially for businesses selling to the public.
Article: 
IFRS 15 in the spotlight: Accounting for vouchers
13 March 2017
IFRS 15 ‘Revenue from contracts with customers’ is mandatory for periods beginning on or after 1 January 2018. In a series of articles before its effective date, we
are going to look at a different aspect of the standard’s requirements. In this first article, we look at the treatment of voucher schemes under IFRS 15.
Why do I need to worry about vouchers?
Although IFRS 15 has five overarching principles, it also contains a significant amount of more detailed and prescriptive Application Guidance on those principles
which, its name notwithstanding, constitutes binding requirements rather than non-binding guidance. Two areas are particularly relevant to voucher schemes:
 Customers’ unexercised rights (breakage)
 Customer options for additional goods or services (loyalty schemes).
In both cases, the effect of IFRS 15 is likely to be the deferral of revenue until additional goods or services are transferred to the customer in exchange for the
vouchers.
 

A customer’s unexercised rights (breakage)

When a customer buys a non-refundable gift voucher that can be exchanged for goods or services of the issuing retailer, the retailer will recognise a ‘contract
liability’ on its balance sheet. Ordinarily, that contract liability will be released to the income statement as and when the voucher is redeemed. What happens,
however, if there is an expectation that the voucher will never be redeemed (eg because it has been lost)?
When drafting IFRS 15, the IASB considered whether, in such circumstances, the retailer should recognise as revenue immediately on receipt of the customer
payment for vouchers that they did not think would be redeemed (estimated breakage). It rejected that approach however and, instead, required the retailer to
recognise the expected breakage amount as revenue in proportion to the pattern of rights exercised by the customer. In other words, the value of the expected
breakage is combined with the value of the vouchers that the retailer ultimately expects to be redeemed and recognised when those vouchers are redeemed.
In order to calculate the value of breakage revenues that should be combined in this calculation, the retailer must determine the value of vouchers that it can
demonstrate are ‘highly probable’ not to be redeemed. This must be an evidence-based estimate. If the retailer does not have sufficient evidence over the expected
breakage, it recognises the breakage amount as revenue when the likelihood of the customer exercising its remaining rights becomes remote.
 
Example
A retailer sells a gift card for £100.00. Based on historical experience, the retailer believes that £10 of the gift card will ultimately not be redeemed but can only
demonstrate that expectation to a high probability for £6. The retailer should recognise as revenue £1.064 (£100/£94) for each £1 redeemed, after £90 has been
redeemed that would leave £4.26 (£4*£1.064) to be recognised either as the remaining £4 is redeemed or when likelihood of the customer exercising its remaining
rights becomes remote (eg when the gift card reaches its expiry date).
 
Customer options for additional goods and services (loyalty schemes)
When a customer acquires goods from a retailer, they are sometimes awarded with points or vouchers that can be used to obtain other goods or services from that
retailer, or to receive a discount on the future purchase of goods or services. IFRS 15 requires such offers to be considered a separate performance obligation if
they constitute a ‘material right’ to the customer. A material right is a right that the customer would not have if they had not entered in to the original transaction.
For example, a “10% off your next purchase” voucher provided as a result of a sales transaction would only constitute a material right if the retailer did not
routinely offer a similar right for free in newspaper adverts.
Where a loyalty scheme does constitute a material right, revenue is apportioned to it in accordance with the relative stand-alone selling prices of the items sold.
Example
As part of a loyalty scheme, a retailer gives customers a ‘free’ loyalty point for every £10 that they spend, with each point giving a £1 discount on future purchases
(past experience suggests that it is highly probably that only 90% of the points will be redeemed). The retailer concludes that the points are a ‘material right’.
The retailer sells goods to a customer for £1,000 and also issues 100 loyalty points. The £1,000 is allocated to the original goods and the points based on their
relative fair values: £917.43 (1,000*[1,000/[1,000+90]]) would be allocated to the goods and £82.57 (1,000-917. 43) to the points. The retailer would recognise
£0.92 (£82.57/£90) for each £1 redeemed.