Athens, January 2019
Chris Ragkavas, BA, MA, FCCA, CGMA
IFRS technical expert, financial consultant.
Though the main focus of the standard is indeed revenue, issues related to contract costs are also addressed, given their nature, i.e. provided they can be associated with a contract and which the entity has an interest to capitalize, i.e. to recognize them as a non-current asset, and expense them gradually instead of through an one-off transaction.
Costs to obtain a contract
These may concern a wide range of costs, as:
- Sales bonuses paid to personnel upon closing the deal.
- Travel expenses to / from the customer.
- Exhibition, presentation, marketing expenses, aiming at closing the deal.
In order to recognize any of these costs as assets, they must be:
- Incremental, i.e. they would not be incurred, unless the entity would enter into the contract with its customer.
- Recoverable, i.e. they will be earned back by the entity, either because they are rechargeable, or because the contract which they concern, is simply profit-making.
Sales bonuses that are paid as a result of closing the deal are clearly incremental. General bonuses given “for good performance”, are not incremental and not subject of our discussion. So there must be a link between incurrence and contract, or portfolio of contracts. Portfolio, is a group of contracts with similar characteristics.
Provided these bonuses are also recoverable, they should be capitalized, and amortized over the estimated contract duration, and not the strict contractual term, unless the estimated amortization period is 12 months or less, in which case, they may simply be expensed.
Categories 2 and 3 above, are not incremental. However, provided they are explicitly chargeable to the customer, they are also capitalized. So although in the strict sense they are not incremental and should be expensed, if the customer has accepted being recharged for them, they will be treated as if they were incremental.
Example 1 – Costs to obtain a contract
Momma enters on 1/1/2020, into a 2-year contract with Specter, an existing key account, to render printing, publishing and digital marketing services. Average duration of Momma-Specter contracts, is 4 years. Expected revenue to be earned both over time and at a point in time, is $ 2,340,000 and the contract will be profit-making.
Momma paid $ 132,000 to its sales personnel involved into closing the deal, based on their contractual terms.
Momma will recognize the $ 132,000 as an non-current asset, and amortize it over the estimated contract duration period. The asset will be treated as any other non-current asset, being subject to IAS 36 Impairment of Assets, and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
Costs to fulfil a contract
The standard requires entities, to seek first whether the costs to fulfil the contract are subject to another standard. I’d like to point out that the most relevant in this case, would be IAS 16 Property, Plant and Equipment. If that is the case, the costs will be subject to that other standard.
If that is not the case, then these costs will be capitalized, as long as [IFRS 15: 95]:
- They relate directly to a contract;
- They generate or enhance resources that will be used in satisfying POs;
- They are recoverable.
Example 2 – Costs to fulfill
Businesscom entered into a profit-making contract with Dream Hotel Resorts, a luxury hotel chain with average occupancy 90% in its 200 bedroom facility in Crete, to provide high-speed internet and landline services, for an estimated period of 6 years. They laid a fiber-optic line for that purpose, at a cost of $ 245,000. Businesscom do not expect to obtain any future benefits from this line, for a longer period than the estimated duration.
As the costs comply with all three requirements mentioned above (a, b, and c), they will be capitalized and amortized over the 6-year period. Again, they will be treated as any other non-current asset, being subject to IAS 36 Impairment of Assets, and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
Example 3 – Costs to fulfill
Businesscom entered into a profit-making contract with Dream Hotel Resorts, with average occupancy 90% in its 300 bedroom facility in Southwest London, to provide high-speed internet and landline services, for an estimated period of 6 years. They laid a fiber-optic line for that purpose, at a cost of $ 345,000.
Businesscom are reasonably certain that this will give them the opportunity to acquire more accounts, now that they have established their presence in Southwest London. Small inns, international hotel chains, are potential customers, to which Businesscom expect to render services, for an estimated period of 12 years. Laying the fiber-optic line is an investment that will generate economic benefits, for a much longer period than the duration of the DHR contract. Businesscom decide that the $ 345,000 are subject to IAS 16, and classify and present them as such.
They will be depreciated during the estimated 12-year period, and again, they will be treated as any other non-current asset, being subject to IAS 36 Impairment of Assets, and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
PO: performance obligation.
TP: transaction price.
SSP: stand-alone selling price.
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