IFRS 15 – Revenue from Contracts with Customers (part 3)

Aleksandra SYSIAK
Audit Senior at RSM Poland

In the previous article we presented the first step in the model framework of revenue recognition, namely contract identification. Under IFRS 15, revenue should be recognised when contractual obligations are satisfied. Therefore, the entity must first indicate performance obligations in the contract, which makes the second step in the new model of revenue recognition. We are going to discuss it further in this article.  ​

 The key term in the discussion of the second step in the model framework  is performance obligation. 

When concluding a contract, the entity should assess goods and services, and identify any promise to transfer either a good or service (or a bundle of goods or services) to a customer that is distinct or a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer as a performance obligation . It should be mentioned here that performance obligations do not include activities the entity must undertake in order to perform the contract unless these activities consist in the transfer of a good or service to the customer. In other words, there is no performance obligation, e.g. as regards any administrative proceedings, contract preparation, etc., if a good or service has not been transferred.

Distinct goods or services

For the proper identification of a performance obligation, it is necessary to properly identify distinct goods or services. Below you will find a chart presenting the approach helping to identify whether goods or services are distinct according to IFRS 15:

The customer can benefit from a good or service if these goods or services can be used, consumed, sold for an amount higher than the liquidation value, or stored in a way that offers economic benefits.

Factors indicating that a promise to transfer goods or services to the customer can be identified as distinct include, but are not limited to, the following circumstances: 

• the entity does not provide a significant service of integrating a good or service with other goods or services promised in the contract into bundles being the subject of the contract concluded by the customer,
• goods or services do not significantly modify and do not customize other goods or services promised in the contract,
• goods or services are not highly interrelated with other goods or services promised in the contract, and are not highly interdependent.

EXAMPLE 1

The entity is a company providing a wide range of office space construction and arrangement services. They include preparing designs and plans on paper, obtaining necessary permits, purchase of land on behalf of the client, end-to-end or partial construction project delivery together with interior finishing, and construction advisory. Every contract is concluded individually to to for the client’s needs. 

The entity is currently working on a contract for an office project for one of their clients. Under the contract, the entity is supposed to acquire real estate for refurbishment, obtain all permits, prepare the interior design and deliver a complete office refurbishment and interior finishing project.

Should goods and services included in the contract be considered distinct?

Given the fact that the first criterion is met (there are many goods or services in the contract), there are indications that individual goods or services are distinct, because the customer could benefit from goods or services as they are being transferred to them (e.g. purchased real estate prior to refurbishment, construction materials or delivery of arrangement elements). What is more, the aforementioned works are listed as separate goods and services in the entity’s portfolio.

We should note, however, that all these goods and services are not distinct under this specific contract. The entity’s task is to deliver a complete office, being the final product comprising all those goods and services. Thus, we are dealing with a situation in which the entity provides a significant service of integrating the goods or services with other goods or services promised in the contract into a bundle, being the subject of the contract; goods or services significantly modify or customize other goods or services promised in the contract; in addition, goods or services are highly interrelated with other goods or services promised in the contract or highly interdependent.

In the light of the above analysis, all the provided services and transferred goods should be treated as a single performance obligation. 

And when the sale should actually be recognised?

According to the standard, the entity recognises revenue when (or as) a performance obligation is satisfied through the transfer of the promised good or service to the customer. The transfer of these goods or services takes place the moment the customer takes control over them.

At the inception of the contract, the entity must define, for each performance obligation, whether a given performance obligation will be satisfied over time or at a point in time. Both aspects will be presented when discussing step five. Now it is worth bearing in mind that if a performance obligation is satisfied over time, it is assumed that it is being satisfied at a certain point it time. When it comes to the control of an asset, it is about the ability to prevent other entities from both controlling the asset and obtaining benefits from it. Under the standard, benefits are potential cash flows that may be obtained by way of:

• using the asset to produce goods or provide services,
• using the asset to enhance the value of other assets,
• using the asset to settle liabilities or reduce expenses,
• selling or exchanging the asset,
• pledging the asset to secure a loan,
• holding the asset.

Once (or as) performance obligations are satisfied, the entity shall recognise the amount equal to the transaction price as revenue. Determining the transaction price is step three in the model framework, to be discussed soon.