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= At a Glance = International Accounting Standards Board (IASB), issued IFRS 15 Revenue from Contracts with Customers in May 2014. IFRS 15 sets out the requirements for recognizing revenue that apply to all contracts with customers (except for contracts that are within the scope of the Standards). The issuance of IFRS 15 signifies the culmination of a joint project with the US national standard-setter, the Financial Accounting Standards Board (FASB), to develop a high-quality global accounting standard for revenue recognition.

IFRS 15, establishes a single, comprehensive framework for revenue recognition. The framework will be applied consistently across transactions, industries and capital markets, and will improve comparability in the ‘top line’ of the financial statements of companies globally.

= Background = U.S. GAAP comprised wide-ranging revenue recognition concepts and requirements for particular industries or transactions that could result in different accounting for economically similar transactions. While IFRS had less guidance, preparers found the standards sometimes difficult to apply as there was limited guidance on certain important and challenging topics. The disclosures required by U.S. GAAP and IFRS often did not provide the level of detail investors and other users needed to understand an entity’s revenue-generating activities. Revenue recognition guidance under both frameworks needed improvement.

In October 2002, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) initiated a joint project to develop a single revenue standard containing comprehensive principles for recognizing revenue to achieve the following:

§ Remove inconsistencies and weaknesses in existing revenue recognition frameworks

§ Provide a more robust framework for addressing revenue issues

§ Improve comparability across entities, industries, jurisdictions, and capital markets

§ Provide more useful information to financial statement users through enhanced disclosures

§ Simplify financial statement preparation by streamlining and reducing the volume of guidance

The new revenue recognition standard eliminates the transaction and industry-specific revenue recognition guidance under current GAAP and replaces it with a principle based approach for determining revenue recognition. The new standard will significantly affect the current revenue recognition practices of many companies, particularly those that follow industry-specific guidance under US GAAP.

= Effective date = The revenue Standard was issued jointly by the IASB and the FASB in May 2014 with an effective date of 1 January 2017. Both Boards have now confirmed a one-year deferral of the effective date. Companies applying IFRS continue to have the option to apply the Standard earlier if they wish to do so.

= IFRS 15 will replace = IFRS 15 will replace the following standards and interpretations:

§ IAS 18 Revenue,

§ IAS 11 Construction Contracts

§ SIC 31 Revenue – Barter Transaction Involving Advertising Services

§ IFRIC 13 Customer Loyalty Programs

§ IFRIC 15 Agreements for the Construction of Real Estate and

§ IFRIC 18 Transfer of Assets from Customers

= Core principle of the new standard = The core principle is to recognize 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.

A company would apply the following five stops to achieve the core principles:

Step 1: Identify the contract(s) with a customer.

IFRS 15 defines a contract as an agreement between two or more parties that creates enforceable rights and obligations and sets out the criteria for every contract that must be met.

Step 2: Identify the performance obligations in the contract.

A contract includes promises to transfer goods or services to a customer. If those goods or services are distinct, the promises are performance obligations and are accounted for separately.

Step 3: Determine the transaction price.

The transaction price is the amount of consideration (for example, payment) to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. The transaction price can be a fixed amount of customer consideration, but it may sometimes include variable consideration or consideration in a form other than cash. The transaction price is also adjusted for the effects of the time value of money if the contract includes a significant financing component and for any consideration payable to the customer.

Step 4: Allocate the transaction price to the performance obligations in the contract.

For a contract that has more than one performance obligation, an entity should allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each performance obligation.

Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation. A performance obligation may be satisfied at a point in time or over time. For performance obligations satisfied over time, an entity recognizes revenue over time by selecting an appropriate method for measuring the entity’s progress towards complete satisfaction of that performance obligation.

= Changes on revenue recognition horizon =

= Who will have the Biggest Impact? = It is expected that Aerospace & Defense, Automotive, Communications, Engineering & Construction, Entertainment & Media, Pharmaceuticals & Life Sciences, and Technology industries to be impacted the most.

= What will change from existing practice? = Before IFRS 15 was issued, inconsistencies and weaknesses in revenue standards often resulted in companies accounting for similar transactions differently, which led to diversity in revenue recognition practices. By replacing those requirements with a comprehensive framework, contracts with customers that are economically similar will be accounted for on a consistent basis. However, the previous diversity in revenue recognition practices will mean that the nature and extent of the changes will vary between companies, industries and capital markets. Consequently, the requirements in IFRS 15 will result in changes in the accounting for only some revenue transactions for some companies. However, those changes are necessary to achieve consistent accounting for economically similar transactions in contracts with customers. (Note that below revenue transactions are not exhaustive list of changes under IFRS 15).

Performance obligations satisfied over time
IFRS 15 introduces a new approach to determine whether revenue should be recognized over time or at a point in time. Three scenarios are specified in which revenue will be recognized over time – broadly they are

§ The customer receives and consumes the benefits of the seller’s performance as the seller performs.

§ The seller is creating a ‘work in progress’ asset which is controlled by the customer.

§ The seller is creating a ‘work in progress’ asset which could not be directed to a different customer and customer has obligation to pay for the entity’s work to date.

If revenue is to be recognized over time, a method should be used which best reflects the pattern of transfer of goods or services to the customer. If a transaction does not fit into any of the three scenarios described above, revenue will instead be recognized at a point in time, when control passes to the customer.

Aerospace and Defence
In the aerospace and defence sector, if an entity is manufacturing items for a specific customer, this may require a careful analysis in light of the new requirements. Quite small differences between otherwise similar contracts could have a fundamental impact on the timing of revenue recognition. For instance, government will have control over the goods being manufactured under a contract, would result in revenue being recognized over time.

Automotive Sector
Automobile part manufacturers may be significantly impacted by the new requirements if the parts they manufacture cannot be directed to another customer and if they are entitled to payment for work to date, this require entities to recognize revenue over time when previously they have been recognizing it at a point in time.

Consumer Products
Where an ‘own brand’ product is manufactured for a particular supermarket such that the product could not be readily redirected to a different customer and the manufacturer is entitled to payment for work to date, the timing of revenue recognition may be significantly impacted by these new requirements.

Technology
In the technology sector, if an entity is manufacturing items for a specific customer this require entities to recognize revenue over time when previously they have been recognizing it at a point in time.

Warranties
The new Standard distinguishes between

§ A warranty providing assurance that a product meets agreed-upon specifications (they are not separate performing obligations and accounted for as a cost provision under IAS 37) and

§ A warranty providing an additional service (for which revenue will be deferred, based on relative stand-alone selling price allocation).

Consideration of factors such as whether the warranty is required by law, the length of the warranty coverage period, and the nature of the tasks the entity promises to perform will be necessary to determine which type of warranty exists. If a customer can choose whether or not to purchase a warranty as an ‘optional extra’, that warranty will always be treated as a separate service. Where a warranty is determined to include both elements (assurance and service), the transaction price is allocated to the product and the service in a reasonable manner (if this is not possible, the whole warranty is treated as a service).

Automotive Sector
A warranty may both assure the quality of the vehicle (assurance element) and provide a free maintenance (Service element) plan for two years. Where a warranty contains both elements, judgment will be needed in order to determine how to allocate the transaction price in a reasonable manner, and this may result in warranties being accounted for differently than at present.

Consumer Products
Where a warranty contains both elements such as assurance and service elements, judgment will be needed in order to determine how to allocate the transaction price in a reasonable manner, and this may result in warranties being accounted for differently than at present.

Technology
In technology sector, it is common to provide warranty on products (e.g., computer hardware, networking equipment). If an entity provides both assurance-type and service-type warranties within an arrangement, it is required to accrue for the expected costs associated with the assurance-type warranty and account for the service-type warranty as a performance obligation.

Variable or Uncertain revenues
There are new specific requirements in respect of variable consideration such that it is only included in the transaction price if it is highly probable that the amount of revenue recognized would not be subject to significant future reversals as a result of subsequent re-estimation.

Current IFRS permits recognition of contingent consideration, but only if it is probable that the economic benefits associated with the transaction will flow to the entity and the amount of revenue can be reliably measured. Some entities, therefore, defer recognition until the contingency is resolved. In contrast, the constraint on variable consideration in IFRS 15 is an entirely new way of evaluating variable consideration and is applicable to all types of variable consideration in all transactions. As a result, depending on the accounting treatment that entities currently apply, some entities may recognize revenue sooner under the new standard, while others may recognize revenue later. Greater judgment will also be required to measure revenue.

Aerospace and Defence
Contracts in the aerospace and defence sector can be of a long-term nature and will often include significant variable elements, such as performance bonuses or penalties, discounts, as well as the potential for subsequent downwards price renegotiations.

Automotive Sector
Contracts in the automotive sector can include significant variable elements, such as rebates, credits and incentives. Contracts that include residual value guarantees and make whole provisions may qualify for sale accounting under the revenue standard and also may include a component of variable consideration. These assessments will require considerable judgment.

Consumer Products
Retail and consumer products entities often provide a right of return to customers. Under IFRS 15, a right of return creates variable consideration. Hence, IFRS 15 requires the potential for customer returns to be considered when an entity estimates the transaction price and include amounts for which it is highly probable that a significant revenue reversal will not occur (i.e., they apply a constraint on variable consideration). An entity must recognize the amount of expected returns as a refund liability, representing its obligation to return the customer’s consideration. The entity must also recognize a return asset (and adjust the cost of sales) for its right to recover the goods returned by the customer. Today, the carrying value associated with any product expected to be returned typically remains in inventory. IFRS 15 requires entities to record the asset separately from inventory, which provides greater transparency, and to present the refund liability separately from the return asset.

Technology
The transaction price would be considered variable if it depended on the price at which a product is resold by a reseller or distributor or on achieving certain milestones.

Telecom
For many common telecom arrangements, estimating variable consideration could be a challenge. IAS 18 currently permits recognition of variable consideration, but only if it is probable that the economic benefits associated with the transaction will flow to the entity and the amount of revenue can be reliably measured. As a result, practice varies today in how telecom entities reflect terms such as tiered pricing/volume discounts, minimum contractual commitments and billing credits, depending on a telecom entity’s ability to make a reliable estimate. Some entities have concluded there is sufficient uncertainty in their estimates that no revenue can be recognized until the amounts become known. IFRS 15 will require a telecom entity to make estimates for these amounts and apply the constraint to those estimate.

Life Sciences
In life sciences arrangements, a portion of the transaction price can often vary in amount and timing due to rebates, incentives, rights of return, performance bonuses, milestones, other contingencies (e.g., future royalties) or concessions. A right of return in Life Sciences industry creates variable consideration that an entity will have to estimate and include in the transaction price.

Customer options for additional goods or services at a discount
An option that provides a customer with free or discounted goods or services in the future might be a material right. A material right is a promise embedded in a current contract that should be accounted for as a separate performance obligation. An entity must allocate a portion of the transaction price to the option and recognize revenue when control of the goods or services underlying the option is transferred to the customer, or when the option expires.

Current IFRS does not require entities to distinguish between an option and a marketing offer. Nor does it address the accounting for options that provide a material right to customers.

Automotive Sector
Some contracts in the automotive sector include a right for the customer to purchase additional goods or services at a discount, for example roadside assistance.

Consumer Products
Retail and consumer products entities frequently give customers the option to purchase additional goods or services. These options come in many forms, including sales incentives (e.g., coupons with a limited distribution) and customer award credits (e.g., loyalty or reward programs, gift cards issued by a retailer as a promotion). An option to acquire additional goods or services is a separate performance obligation.

Technology
Technology arrangements often include options to purchase additional goods or services that may be priced at a discount, such as sales incentives, contract renewal options (e.g., waiver of certain fees, reduced future rates) or other discounts on future goods or services. Current IFRS does not provide application guidance on how to distinguish between an option and a marketing offer. Nor does it address how to account for options that provide a material right. As a result, some entities may effectively account for such options as marketing offers, even if the options are substantive (i.e., the customer makes a separate buying decision and has the ability to exercise or not exercise its right). Careful assessment of the contractual terms will be important to distinguish between options that are accounted for as separate performance obligations under IFRS 15 and marketing offers.

Telecom
Many telecom contracts give customers the option to purchase additional goods or services such as premium TV channels or international voice and data plans, the option to change wireless plans at any time or the option to access video on demand. These additional goods and services may be priced at their stand-alone selling price, at a discount or may be provided free of charge.

Contract modifications
In the past, IFRSs included only limited guidance on how to account for modifications to a contract. IFRS 15 includes detailed guidance on whether a contract modification should be accounted for prospectively or retrospectively. An entity must determine whether the modification creates a new contract or whether it will be accounted for as part of the existing contract.

If the modification results in the addition of distinct goods or services and they are priced at their stand-alone selling prices, those contracts is treated as separate contracts. If these criteria are met, the accounting for the original contract is not affected by the modification and revenue recognition for the original contract is not adjusted.

If the goods and services to be provided after the contract modification are distinct from the goods and services provided on, or before, the modification, the entity accounts for the contract modification as a termination of the old contract and creation of a new contract. For these modifications, the revenue recognized to date on the original contract (i.e., the amount associated with the completed performance obligations) is not adjusted. Instead, the remaining portion of the original contract and the modification are accounted for together on a prospective basis, by allocating the remaining consideration to the remaining performance obligations.

If a modification involves goods or services that are not distinct from the goods and services already provided, the entity will account for the contract modification as part of the original contract. The entity will adjust the revenue previously recognized to reflect the effect that the contract modification has on the transaction price and measure of progress (i.e., the revenue adjustment is made on a cumulative catch-up basis).

Aerospace and Defence
Parties to A&D arrangements frequently agree to contract modifications (e.g., change orders) that modify the scope or price (or both) of a contract. . An entity must determine whether the modification creates a new contract or whether it will be accounted for as part of the existing contract, which would be different from entity’s existing practice of revenue recognition.

Technology
Tech companies enters into arrangements to provide subscription based services or supply of hardware parts to customers, frequently undergo contract modifications. An entity must determine whether the modification creates a new contract or whether it will be accounted for as part of the existing contract.

Illustration: A semi-conductor entity promises to provide 1,000 micro-processors to the customer for $100,000 ($100 per unit).The goods are transferred to the customer over a six-month period. The entity transfers control of each product upon delivery. After the entity has transferred 300 micro-processors, the contract is modified to require the delivery of an additional 500 micro-processors to the customer (i.e., total of 1,500 micro-processors). The price for the additional 500 micro-processors is $25,000 ($50 per unit). The price for the additional micro-processors does not reflect the stand-alone selling price at the time the contract is modified and, therefore, does not meet the criteria to be accounted for as a separate contract. Since the remaining products are determined to be distinct from those already transferred, the semi-conductor entity accounts for the modification as a termination of the original contract and creation of a new contract. The amount of revenue recognized for the remaining products under the new contract is a blended price of $79.17 {[(700 micro-processors not yet transferred x $100) + (500 micro-processors to be transferred under the contract modification x $50)] ÷ 1,200 remaining micro-processors}.

Telecom
Accounting for contract modifications has the potential to be a very complex issue for telecom entities. This is because customers frequently modify their contracts and can choose from a wide variety of offerings. Most modifications to telecom agreements will be accounted for prospectively, as either a new contract or a termination of the old and creation of a new contract. However, telecom entities should carefully analyze contract modifications to appropriately account for them. Entities that implement the standard on either a contract-by-contract basis or the portfolio approach will likely need to make changes to their accounting and IT systems to account for the effect of the modifications. For example, entities that implement the standard on a portfolio basis will need to determine how the modifications will affect the established portfolios. Accounting for modifications of contracts with millions of customers will likely be complex, regardless of the approach taken.

Licenses
Under current IAS, the revenue recognition guidance on accounting for licenses of intellectual property is broad. Different interpretations of that guidance has led to significant diversity in the accounting for licenses. IFRS 15 provides application guidance on how to apply the revenue framework to different types of licenses of intellectual property.

Consumer Products
Retail and consumer products entities frequently enter into brand licensing and franchising arrangements. Entities will have to consider whether such contracts include distinct licenses of intellectual property (IP) in order to apply the application guidance appropriately

Illustration: License that provides a right to access IP

CartoonCo is the creator of a new animated television show. It grants a three-year license to Retailer for use of the characters on consumer products. Retailer is required to use the latest image of the characters from the television show. There are no other goods or services provided to Retailer in the arrangement.

The license provides access to CartoonCo’s IP and CartoonCo will therefore recognize revenue over time.

Retailer is directly exposed to any positive or negative effects of CartoonCo’s activities, as Retailer must use the latest images that could be more or less positively received by the public as a result of CartoonCo’s activities.

Technology
Tech companies frequently enter into brand licensing and franchising arrangements.

Illustration: License that provides a right to use IP

SoftwareCo provides a fixed-term software license to TechCo. The terms of the arrangement allow TechCo to download the software by using a unique digital key provided by SoftwareCo. TechCo can use the software on its own server. TechCo also purchases post-contract customer support (PCS) with the software license. There is no expectation for SoftwareCo to undertake any activities other than the PCS.

SoftwareCo will recognize revenue at a point in time when TechCo is able to use and benefit from the license. SoftwareCo is not expected to perform any other activities that affect the IP; therefore, the three criteria required for a right to access IP over time are not met.

Life Sciences
Life sciences entities’ arrangements frequently include licenses of intellectual property (IP) for other goods and services, such as research and development or manufacturing services. Entities need to determine if contracts involving IP are contracts with customers or are, instead, financing arrangements. For those that are contracts with customers, entities will need to consider whether such contracts include distinct licenses of IP in order to apply the new standard appropriately.

Illustration: License that is not distinct

Biotech licenses IP to an early-stage drug compound to Pharma. Biotech also provides research and development (“R&D”) services as part of the arrangement. Biotech is the only vendor able to provide the R&D services based on its specialized knowledge of the technology.

The license is not distinct because Pharma cannot benefit from the license on its own or with resources readily available to Pharma. This is because Pharma cannot perform the R&D services on its own or obtain them from another vendor. The license and the R&D services should be combined and accounted for as a single performance obligation.

Financing Component
Under current IAS, if a customer pays for goods or services in advance or in arrears, some companies may not consider the effects of any financing components in the contract when determining the amount of revenue to be recognized. Under IFRS 15, a company is required to consider the effects of any significant financing components in the determination of the transaction price (and thus the amount of revenue recognized). This may affect long-term contracts in which payment by the customer and performance by the company occur at significantly different times. This applies to payments in advance as well as in arrears, but subject to an exemption where the period between payment and transfer of goods or services will be less than one year. This new guidance may change current accounting practices in some cases.

Aerospace and Defence
Many A&D contracts include payment terms (e.g., retainage, milestone or progress payments, award/incentive fees, advance payments) that A&D entities will need to evaluate to determine whether any differences in the timing of customer payments and the transfer of goods and services to the customer represent a significant financing component in the contract.

Automotive Sector
Sales by automotive companies may include financing arrangements in that the timing of cash inflows from the customer may not correspond with the timing of recognition of revenue. Under the new Standard, the financing component, if it is significant, is accounted for separately from revenue.

Technology
The treatment of the time value of money may have a significant effect on long-term contracts, such as multi-year maintenance arrangements with upfront payments. Even entities that do not believe a financing component is significant will need to make a formal assessment. Under IFRS 15, when a contract provides the customer with extended payment terms, an entity will need to consider whether those extended payment terms create variability in the transaction price (i.e., are a form of variable consideration) and whether a significant financing component exists.

Telecom
Telecom entities will not have to consider whether their long-term contracts have a significant financing component when the services are provided and payments for those services are made on a monthly basis. However, when they offer arrangements in which a good or service is provided upfront, but paid for over time, telecom entities will need to consider whether there is a significant financing component in the arrangement. For example, wireless entities will need to evaluate whether there is a significant financing component to the arrangement when an entity offers subsidized handsets in conjunction with a two-year wireless services contract or when an entity offers the customer an instalment plan for the handset.

Capitalization of Contract costs
Under the new standard, there are two types of contract costs for which an asset must be recognized:

§ Incremental costs of obtaining a contract with a customer if the entity expects to recover those cost

§ Costs incurred in fulfilling a contract with a customer that are not within the scope of another IFRS (e.g., IAS 2 Inventories, IAS 16 Property, Plant and Equipment or IAS 38 Intangible Assets), provided these costs relate directly to a contract (or to an anticipated contract that the entity can specifically identify), generate or enhance resources of the entity that will be used in satisfying (or in continuing to satisfy) performance obligations in the future and are recoverable.

IFRS 15 requires these costs to be recognized as an asset and amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates. Impairment assessments are also required for such assets.

Consumer Products
In the consumer products sector, contract cost becomes an issue because significant costs may be incurred that are directly attributable to obtaining contracts with customers, for example sales commissions that are only payable if a contract is obtained. At present, different entities might treat these costs differently. The new Standard will require entities to capitalize success fees, which will have an impact on operating profits.

Technology
The requirements to capitalize incremental costs of obtaining a contract and direct costs of fulfilling a contract may represent a significant change for technology entities that currently expense such costs as incurred. Although the standard requires incremental costs of obtaining a contract to be capitalized (unless the practical expedient is applied), it is unclear whether certain costs will be considered incremental such as bonuses paid for total bookings or meeting individual sales targets (e.g., costs associated with obtaining a group of contracts).

Telecom
The requirement to capitalize incremental costs of obtaining a contract that telecom entities expect to recover may represent a significant change for entities that currently expense such costs.

Identifying costs to fulfil a specific contract will likely be a significant change in practice for telecom entities and may be difficult for them to do. For enterprise customers, telecom entities may spend up to a year performing set-up, activation and installation services before beginning to provide services. Telecom entities will first need to determine whether the installation meets the definition of a separate performance obligation. If so, under IFRS 15, the costs associated with the installation performance obligation would be expensed when the related performance obligation (i.e., the installation) is satisfied. Telecom entities may need to make updates to their accounting systems in order to track these costs at the contract level.

Illustration: Telecom Industry

Telecom sells wireless mobile phone and other telecom service plans from a retail store. Sales agents employed at the store signed 120 customers to two-year service contracts in a particular month. Telecom pays its sales agents’ commissions for the sale of service contracts in addition to their salaries. Here, the only costs that qualify as incremental costs of obtaining contract are commissions paid, which telecom would not have incurred if it had not obtained the contracts. Telecom should record an asset for the costs, assuming they are recoverable.

Disclosure Requirements
Under current IAS, disclosure of information about revenue is inadequate and lacks cohesion with the disclosure of other items in the financial statements. For example, many investors have said that some companies present revenue in isolation, which means that investors cannot relate revenue to the company’s financial position.

IFRS 15 includes a comprehensive set of disclosure requirements that require a company to disclose qualitative and quantitative information about its contracts with customers to help investors understand the nature, amount, timing and uncertainty of revenue.

= References =