The implementation of IFRS 15 (Revenue from Contracts with Customers) has come into effect, while IFRS 16 (Leases) is around the corner. It is important that companies start evaluating what impact the introduction of these two accounting standards will have on the Annual Financial Statements as well as on the business as a whole.

The requirements set out in these two standards could have a significant impact on all preparers of financial statements compared to the current accounting polices being applied.

IFRS 15 applies to any business that has revenue .

Below is a brief summary of IFRS 15.

Why the need for a new standard? One of the main reasons for the new standard was to align revenue accounting between the users of IFRS and US GAAP. There have historically been major differences between the two frameworks. Another reason was that IAS 18 – Revenue, has been unchanged for more than a decade and as business has evolved the guidance and application in IAS 18 with regards to more and more complex transactions has really fallen behind.

The core principle of IFRS 15 is that an entity recognises 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.

An entity recognises revenue in accordance with that core principle by applying the five steps as per IFRS 15 and these will be discussed below.

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

There are five criteria that a contract needs to meet in order to meet the definition of a contract in terms of IFRS 15.

  • The contract needs to be an approved contract where both parties are committed to performing their respective obligations. The contract must create enforceable rights and obligations.

  • Each party’s rights regarding the good or services to be transferred can be identified.

  • Payment terms can be identified.

  • The contract has commercial substance.

  • It is probable that the entity will collect the consideration to which it is entitled in exchange for the goods and services transferred.

If all the above are met then step 1 has been complied with and there is a contact in place.

It is important to note that a contract can be either written, oral or implied by an entity’s customary business practices.

Step 2: Identify the performance obligations in the contract.

A performance obligation is a promise in the contract with the customer 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.

A good or service is distinct if the customer can benefit from the good or service on its own or together with other resources that are readily available to the customer and the entity and the obligation to transfer goods or services is separately identifiable from other promises.

Step 3: Determine the transaction price.

The transaction price is the amount of consideration in a contract to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer.

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. There is however a practical expedient available whereby time value of money need not be taken into account if the consideration is expected to be received within 12 months.

If the consideration is variable, an entity estimates the amount of consideration to which it will be entitled in exchange for the promised goods or services. Variable consideration includes discounts, rebates, credits or incentives, etc.

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

An entity typically allocates the transaction price to each performance obligation on the basis of the relative stand-alone selling prices of each distinct good or service promised in the contract. If a stand-alone selling price is not observable, an entity should estimate the stand-alone selling price. This could be done by using one of the following methods:

  • Adjusted market assessment

  • Expected cost plus an appropriate margin

  • Residual approach

Sometimes, the transaction price includes a discount or a variable amount of consideration that relates entirely to a part of the contract.

The requirements of IFRS 15 specify when an entity allocates the discount or variable consideration to one or more, but not all, performance obligations (or distinct goods or services) in the contract.

Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation.

An entity recognises revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer (which is when the customer obtains control of that good or service).

The amount of revenue recognised is the amount allocated to the satisfied performance obligation.

A performance obligation may be satisfied at a point in time (typically for promises to transfer goods to a customer) or over time (typically for promises to transfer services to a customer).

For performance obligations satisfied over time, an entity recognises revenue over time by selecting an appropriate method for measuring the entity’s progress towards complete satisfaction of that performance obligation.

With regards to control under IFRS 15:

  • Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset.

  • Control includes the ability to prevent other entities from directing the use of, and obtaining the benefits from, an asset.

  • In assessing whether a performance obligation is satisfied at a point in time, the entity must consider when the customer obtains control over the asset. Indicators include:

    • Obligation to pay
    • Transfer of legal title
    • Transfer of physical possession
    • Transfer of risks and rewards of ownership
    • Customer acceptance of the product

Revenue is recognised over time by measuring the progress towards complete satisfaction of each separate performance obligation. Recognise revenue as control of the asset is transferred to the customer.

An entity needs to meet one of the following to recognise revenue over time:

  • Customer simultaneously receives and consumes the benefits (cleaning service for example).

  • Entity creates or enhances an asset that the customer controls as it is created or enhanced.

  • Entity’s performance does not create an asset with an alternative use and the entity has an enforceable right to payment for performance to date.

Effective date

The effective date of IFRS 15 is for year ends beginning on or after 1 January 2018. An entity’s 31 December 2018 financial statements will need to prepared applying the requirements of IFRS 15.

Transition

There are two transition options available to an entity when applying IFRS 15 for the first time:

  • Option 1 - Fully retrospective application. There are practical expedients available for completed contracts, variable consideration estimates and disclosure exceptions.

  • Option 2 - Limited retrospective application. An entity would not restate comparative information and would recognise the cumulative effect of uncompleted contracts in the opening current year Statement of Financial Position.

It should be noted that both options would require similar effort in calculating the cumulative effect of applying IFRS 15.

Michael Steenkamp

Partner, Johannesburg

Also read: A Look at IFRS 16 - Leases