IFRS 15 – Revenue from Contracts with Customers (part 2)

Aleksandra SYSIAK
Audit Junior Manager at RSM Poland

The five-step model framework: Identify the contract

When applying IFRS 15, the first step should be to determine whether the contract exists and has been concluded with the customer.

According to the definition provided in the standard, the contract is an agreement between two or more parties that creates enforceable rights and obligations. The customer is a party that has contracted with an entity in order to obtain goods or services, in exchange for consideration.

Even though the standard allows for a contract to be concluded either in written or oral form or implicitly based on the usual practice of a given entity, the contract is within the scope of IFRS 15 only if all the following conditions are met:

• parties to the contract have approved the contract and they have performance obligations;
• the entity is able to identify each party’s rights in relation to the goods or services to be transferred;
• the entity is able to identify payment terms for goods or services to be transferred;
• the contract has commercial substance;
• it is probable that the consideration due for the goods and services to be transferred will be collected (NOTE: when assessing the probability of receiving the consideration, the entity shall consider only the ability and the intention of paying the amount of consideration by the customer).

If a contract with a customer meets all the above conditions when it is being concluded, there is no obligation to re-assess these conditions unless there are indications of a material change of facts and circumstances (e.g. the customer’s ability to pay the consideration is reduced).

EXAMPLE 1

The entity has concluded a 6-month contract for services from 1 January to 30 June 201X. The consideration for services was defined to amount to 1,000 units. The contract failed to provide for its early termination or renewal after 6 months.

As both parties were interested in further cooperation, the entity continued to provide services and received consideration in July and August. However, the negotiation process was under way, and it ended on 1 September when a new contract was signed; it provided for an increase of the monthly consideration to 1,200 units. The contract will apply retroactively (as of 1 July). 

The fact that the entity has been providing services and received consideration for it indicates that a contract exists despite the fact that no contract was signed in July and August. This situation, however, requires the exercise of judgment in legal terms to determine whether the parties’ rights and obligations were enforceable in these circumstances. Should the entity find that enforceable rights and obligations exist, the recognition of revenue should not be postponed on the grounds of the absence of a signed contract only.

And if the contract fails to meet the IFRS 15 criteria?

In such case, the collected consideration shall be recognised as payables until one of the following events occurs:

• the entity does not have any other obligations to transfer goods or services to the customer and has already received the entire or basically entire consideration promised by the customer, and the consideration is not refundable; or
• the contract was terminated, and the consideration collected from the customer is not refundable.

Contract modifications

A contract is modified once the parties have approved the modification that introduces new or changes the existing enforceable rights and obligations. If the parties have agreed to change the scope of the contract, but have not yet agreed the corresponding price modification, the entity shall estimate the change of the transaction price resulting from the modified contract in accordance with the methods set forth in the standard.

Contract merging

If one of the below conditions is met, the entity is obliged to treat one or more contracts as one:

• contracts are negotiated as a package and pertain to the same commercial purpose;
• the amount of consideration due under one contract depends on the price or performance of another contract;
• goods or services promised in the contracts (or part of them) constitute a single performance obligation. 

What is a single performance obligation? We are going to explain this term in the next article.