IFRS 15, Revenue from contracts with customers – Boutique treats on performance obligations and revenue recognition, Part III

Athens, June 2018
Chris Ragkavas, BA, MA, FCCA, CGMA

IFRS technical expert, financial consultant.

Determining 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.

Consideration may be variable due to price concessions, volume discounts, rebates, early settlement discounts, performance bonuses or other similar items.  The standard compels entities to recognize revenue even when it is variable, i.e. even if there is a degree of uncertainty with regards to the final amount that will be recognized, once the uncertainty associated with the variable consideration is subsequently resolved.

Reporting entities are to recognize variable consideration as revenue to the extent that is highly probable that a significant reversal of that revenue will not occur. Given the loose meaning given of the word probable in the IFRS context, i.e. more likely than not, highly probable denotes a very high degree of expectation of non-reversal.

Estimating the amount of variable consideration
Entities are to apply any of the two methods:

  • Expected values.

  • The most likely amount.

Example 1 – Expected values method
Impitech sold 23,000 units of mice to Global Merchant bank, for $10 each. They offer 10% discount if the bank pays within 30 days and 5% if it pays within 60 days. Impitech estimates that there is a 15% the bank will take advantage of the 30-day discount and 6% of the 60-day discount. Revenue is recognized as follows:

23,000 x 15% x $ 9 =  $  31,050
23,000 x 6% x $ 9.5 = $ 13,110
23,000 x 79% x $ 10 = $ 181,700
Total $ 225,860

Assuming Impitech invoice the bank for the total amount of 23,000 x $ 10 = $ 230,000, the original entry will be:

Trade receivables 230,000
Revenue                                   225,860
Refund liability                                        4,140

A refund liability is measured at the amount of consideration received (or receivable) for which the entity does not expect to be entitled, i.e. amounts not included in the transaction price.

Example 2 – The most likely amount
Impitech enters into a contract to develop software for Global Merchant bank between August 2018 and December 2019. This is a PO satisfied over time, as the software is custom made, has no alternative use for Impitech and Impitech has an enforceable right to payment for performance completed to date (see Part II for more details).

Consideration agreed is $ 2.5 million. Upon completion, Global Merchant bank’s Chief Information Officer will inspect the software, and provided it is deemed to be fit for purpose without any further customization,  Impitech will be entitled to a bonus of $ 0.7 million.

At each reporting period, Impitech will measure its progress towards completing the development, and will apply this to the expected consideration to be entitled to.

Let’s assume at the end of the first reporting period in September 2018, Impitech has completed 23% of the development.  This will be multiplied by the amount Impitech expect to earn at the end of December 2019. There are two possible outcomes, i.e. either $ 2.5 million, or $ 3.2 million. Impitech will apply professional judgment in order to select the most likely revenue expected to be entitled to, and multiply it by 23%. Assuming this is $ 2.5 million, revenue to be recognized as per 30/09/2018 will be $ 2.5 million x 23% = $ 0.575 million.

In both methods, revenue is subject to re-assessment at each reporting period and any difference to the originally recognized amount results in increase or decrease of the original amount.

Dealing with uncertainty of collectability

Before original revenue recognition

In order to consider recognizing any amount as revenue, Impitech will need to consider the bank’s ability and intention to pay that amount when due. So either the $ 2.5 or the $ 3.2 million are  deemed to be collectable by Impitech from the bank as and when they will be due, in order for Impitech to consider recognizing them in the first place.  Only then will Impitech consider which of the two is the most likely to be the final revenue and apply the corresponding %, reflecting stage of completion, at each reporting period. The same goes of course, for revenue recognized at a point in time.

Subsequent treatment of collectability 

Once revenue is recognized, entities need to assess the extent to which revenue will be collected. In fact, trade receivables, as well as contract assets, a new form of receivable introduced by IFRS 15, are subject to IFRS 9 Financial Instruments, assessment of expected credit losses.  Any amount expected not to be recoverable due to credit losses, is recognized as an expense and not as a reduction in revenue.

PO: performance obligation.
TP: transaction price.
SSP: stand-alone selling price.

Queries, comments, are welcome at [email protected]

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