Ifrs 15 New Friday (2).ppt 42616f

IFRS 15

REVENUE FROM CONTRACTS WITH CUSTOMERS 1 This material is the property of Department of ing and Finance, CoBE, AAU. Permission must be obtained from

Learning Objectives At the completion of studying this chapter, you will be able to: • •

• • •

•

Understand revenue recognition issues Identify the five steps in the revenue recognition process Identify other revenue recognition issues Identify contract costs Describe presentation and disclosure regarding revenue. distinguish between the ing treatment of revenue recognition under US GAAP and

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LIST OF APPLICABLE IFRS Topic List Revenue From Contracts with Customers Fair Value Presentations of Financial Statements

Standards IFRS 15 IFRS 13 ISA 1

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THE OBJECTIVE OF IFRS 15 

The objective of IFRS 15:  to establish the principles that : ― an entity shall apply to report useful information to s of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from a contract with a customer. ― recognising, measuring and disclosing revenue arising from a contract with a customer that are not dealt with specifically in another IFRS. 4

THE SCOPE OF IFRS 15 

IFRS 15 Revenue from Contracts with Customers applies to all contracts with customers except for:  leases IFRS 16;  insurance contracts IFRS 4;  financial instruments and other contractual rights or obligations IFRS 9; interest and dividend income IFRS 9; IFRS 10 Consolidated Financial Statements; IFRS 11 t Arrangements; IAS 27 Separate Financial Statements; IAS 28 Investments in Associates and t Ventures;  Nonmonetary exchanges to facilitate sales to customers  Certain transactions may fall partially within the scope of IFRS 15 and partially within the scope of other standards 5

THE SCOPE OF IFRS 15 



IFRS 15 applies to various revenues generated by banks, such as fees, commissions and other income that may result from servicing loans, asset management, custody services, pension istration, insurance broking, but are not limited to those. Effective date  Annual reporting periods beginning on or after January 1, 2018, including interim reporting periods therein (FY 2018)  Early application is permitted 6

REVENUE MEASUREMENT 



Revenue is measured as the fair value of the consideration received or receivable. The nature, timing and amount of consideration promised by a customer affect the estimate of the transaction price. When determining the transaction price, an entity shall consider the effects of all of the following:  variable consideration;  constraining estimates of variable consideration;  the existence of a significant financing component in the contract;  non-cash consideration; and  consideration payable to a customer . 7

REVENUE MEASUREMENT 

Amounts received on behalf of other parties (e.g. valued added taxes, amounts collected on behalf of the principal in agency arrangements) are not economic benefits flowing to the entity and do not result in increases in equity. Therefore, they do not constitute revenue.

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REVENUE RECOGNITION 

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The primary issue in ing for revenue is determining when to recognize revenue. Revenue is recognized when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably. IFRS 15 identifies the core principle that:  an entity recognizes 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. 9

The Five-step Model Framework 

An entity recognizes revenue in accordance with that core principle by applying the following steps:

Identify the contract with a customer (Step 1)

Identify the performance obligations in the contract (Step 2)

Determine the transaction price (Step 3)

Allocate the transaction price to performance obligations (Step 4)

Recognize revenue when (or as) the entity satisfies a performance obligation (Step 5)

The Five-step Model Framework

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Identify Contract with Customers—Step 1 

Contract:

Agreement

between two or more parties that

creates enforceable rights or obligations. Can

be written, oral, or implied from customary

business practice. Company

applies the revenue guidance to a

contract according to the following criteria:

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Contract with Customers— Step 1 •

A contract with a customer will be within the scope of IFRS 15 if all the following conditions are met:  the contract has been approved by the parties to the contract;  each party’s rights in relation to the goods or services to be transferred can be identified;  the payment for the goods or services to be transferred can be identified;  the contract has commercial substance; and  it is probable that the consideration to which the entity is entitled to in exchange for the goods or services will 12 be collected.

Contract with Customers—Step 1 • Contract Modifications •Change in contract while it is ongoing. •Companies determine  whether a new contract (and performance

obligations) results or  whether it is a modification of the existing contract. • Prospective Modification Company should - for effect of change in period of change as well as future periods if change affects both. - not change previously reported results. 14

Contract with Customers— Basic ing Step 1 •Revenue

cannot be recognized until a contract

exists. •Company

obtains rights to receive consideration and assumes obligations to transfer goods or services. •Rights

and performance obligations gives rise to an (net) asset or (net) liability. •Company Contract

assetnot = Rights received > Performance does recognize contract assets or liabilities until one orobligation both parties to the contract Contract liability = Rights received < Performance perform. obligation 13

Example: Bank B sells to its customers, through its branches, insurance products on behalf of insurance company X. under the agreement between B and X, Bank B promises to provide three types of services, as follows: 





Acquisition of new clients in exchange for a fixed of Birr 100 fee to be paid by X on the g of a new insurance product  Bank B acquires 20 clients for the year 2016 of which 4 is waiting VISA to travel to Sweden. Collection of successive annual s, renewals, one-off payments etc in exchange for 5% fees per person that are paid by X over time, once the contract is renewed or s collected; and  Bank B expects 6 clients of year 2015 will renewed their policy in 2016 Consultancy and post-sale services to customers in exchange for fees that are paid up-front; however, based on the reimbursements that customers are entitled to claim due to contract or law provisions, B may have to



Under step 1 of the model, Bank B determines that its agreement with X creates enforceable rights and obligations based on the following:  Both parties have approved the contract, either in writing, orally or in accordance with other customer business practices;  The right s to goods and services and the payment are identified in the contract;  The contract has commercial substance; and  Collection of the consideration from X is probable.

Identify Performance Obligations—Step 2   

A performance obligation is a contract to provide a product or service to a customer. This promise may be explicit, implicit or possibly based on customary business practice. The entity should assess the goods or services that have been promised to the customer either:  



a good or service (or bundle of goods or services) 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.

A performance obligation to transfer goods and services is satisfied when the goods or services are delivered to the customer and the customer thereby obtains control over the promised goods or services. 17

Identify Performance Obligations— Step 2

Revenue Recognition Situations Type of Transactio n Descriptio n of Revenue Timing of Revenue Recognitio n

Sale Saleofofproduct product from inventory from inventory

Revenue Revenuefrom from sales sales

Date Dateofofsale sale(date (date ofofdelivery) delivery)

Performing Performing aaservice service

Permitting Permitting use useof ofan an asset asset

Sale Saleof ofasset asset other than other than inventory inventory

Revenue Revenue from fromfees feesor or services services

Revenue Revenue from from interest, interest, rents, rents,and and royalties royalties

Gain Gainor orloss loss on on disposition disposition

Services Services performed performed and andbillable billable

As Astime time es esor or assets assetsare are used used

Date Date of of sale sale or or trade-in trade-in 15

Identify Performance Obligations—Step 2 

Under step 2, assume that B concludes that there are two performance obligations. Service (a) is identified as a distinct performance obligationi.e. the acquisition of new clients. Services (b)and (c) represent a combined output for which X has contracted – i.e. the bank’s ability to provide ongoing services to customers – and therefore the combined bundle is a performance obligation.

Determining Transaction Price—Step 3 Transaction price Amount

of consideration that company expects to receive from a customer. In

a contract is often easily determined because customer agrees to pay a fixed amount. Other

-

contracts, companies must consider: Variable consideration Time value of money Non-cash consideration Consideration paid or payable to customers LO 5

Determining Transaction Price—Step 3 Variable Consideration Price dependent on future events. - May include discounts, rebates, credits, performance bonuses, or royalties. Companies estimate amount of revenue to recognize. - Expected value - Most likely amount Companies only recognize variable consideration if 1. they have experience with similar contracts and are able to estimate the cumulative amount of revenue, and 2. based on experience, they do not expect a significant reversal of revenue previously recognized. If

these criteria are not met, revenue recognition is constrained. 21

Variable Consideration ESTIMATING VARIABLE CONSIDERATION Facts: Peabody Construction Company enters into a contract with a customer to build a warehouse for Birr 100,000, with a performance bonus of Birr 50,000 that will be paid based on the timing of completion. The amount of the performance bonus decreases by 10% per week for every week beyond the agreed-upon completion date. The contract requirements are similar to contracts that Peabody has performed previously, and management believes that such experience is predictive for this contract. Management estimates that there is a 60% probability that the contract will be completed by the agreed-upon completion date, a 30% probability that it will be completed 1 week late, and only a 10% probability that it will be completed 2 weeks late. Question: How should Peabody for this revenue arrangement?

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Variable Consideration Question: How should Peabody for this revenue arrangement? Management has concluded that the probability-weighted method is the most predictive approach: 60% chance of Birr 150,000 = 30% chance of Birr 145,000 = 10% chance of Birr 140,000 =

Birr 90,000 43,500 14,000 Birr 147,500

Most likely outcome, if management believes they will meet the deadline and receive the Birr 50,000 bonus, the total transaction price would be? Birr 150,000 (the outcome with 60% probability)

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Determining Transaction Price—Step 3

Time Value of Money When contract involves a significant financing component. - Interest accrued on consideration to be paid over time. -

Fair value determined either by measuring the consideration received or by discounting the payment using an imputed interest rate. Company reports as interest expense or interest revenue.

Non-Cash Consideration Goods, services, or other non-cash consideration. -

-

Customers sometimes contribute goods or services, such as equipment or labor, Companies generally recognize revenue on the basis of the fair value of what is received.

Consideration Paid or Payable to Customers May include discounts, volume rebates, coupons, free products. In general, these elements reduce the consideration received and the revenue to be recognized.

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







In this example, step 3 is a critical one, especially if we look at service(C). The transaction price is the amount of consideration to which B expects to be entitled in exchange for transferring the service to X. when establishing the amount of consideration, B will have to consider the risk and magnitude of revenue reversal that the reimbursements climate may require a higher or lower degree of judgment and complexity ( e.g. forecasts of the amount of cancellations could also mean estimating customers’ behavior) and different estimation methods (i.e. the expected value or the most likely amount). Based on this estimate, the revenue will be recognized only up to the constrained amount and there will be a net contract asset or liability depending on the balance of performance under the contract.

Allocating Transaction Price to separate performance obligations —Step 4 •

•

Where a contract has multiple performance obligations, an entity will allocate the transaction price to the performance obligations in the contract by reference to their relative standalone selling prices. If a standalone selling price is not directly observable, the entity will need to estimate it by various methods including:

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Allocating Transaction Price to separate performance obligations —Step 4

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Recognize Revenue when (or as) the entity Satisfies a Performance Obligation—Step 5 

Under step 4, Once the transaction price is determined, it will be allocated to the performance obligations in the contract based on their stand – alone selling prices.  

Services c Service b and c

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Recognize Revenue when (or as) the entity Satisfies a Performance Obligation—Step 5 •

•

•

A company satisfies its performance obligation when the customer obtains control of the goods or services. Control of an asset is defined as the ability to direct the use of and obtain substantially all of the remaining benefits from the asset. Companies satisfy performance obligation either  at a point in time or  over a period of time.

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Recognize Revenue when (or as) the entity Satisfies a Performance Obligation—Step 5 

B will recognize revenue when or as it provides the services to X. in this example, service (a) is satisfied at a point in time because X benefits from the service only when a cline signs a new contract – i.e. X benefits from B’s performance only when the performance obligation is satisfied at a point in time because X benefits from the service only when the performance obligation is satisfied. However, services (b) and (c) are satisfied over time, because X simultaneously receives and consumes the benefits of the services that B provides to its existing customers. 30

OTHER REVENUE RECOGNITION ISSUES • Right of return •

Repurchase agreements

•

Warranties

•

Consignments

•

Etc

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RIGHT OF RETURN 

Example: Venden Company sells 100 products for Birr 100 each to Amaya Inc. for cash. Venden allows Amaya to return any unused product within 30 days and receive a full refund. The cost of each product is Birr 60. To determine the transaction price, Venden decides that the approach that is most predictive of the amount of consideration to which it will be entitled is the most likely amount. Using the most likely amount, Venden estimates that:

Three products will be returned. 2. The costs of recovering the products will be immaterial. Question: should Venden record this sale? 3. TheHow returned products are expected to be resold at a profit. 1.

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RIGHT OF RETURN Question: How should Venden record this sale? Venden records the sale as follows with the expectation that three products will be returned: Cash

10,000

Sales Revenue [Birr 9,700 x (Birr100 x 97)]

9,700

Refund Liability (Birr 100 x 3)

300

Venden records the cost of goods sold with the following entry. Cost of Goods Sold Estimated Inventory Returns (Birr 60 x 3) Inventory

5,820 180 6,000 33

RIGHT OF RETURN Question: How should Venden record this sale? When a return occurs, Venden records the following entries. Refund Liability (2 x Birr100)

200

s Payable Returned Inventory (2 x Birr 60) Estimated Inventory Returns

200 120 120

Companies record the returned asset in a separate from inventory to provide transparency.

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Repurchase Agreements 

Transfer control of (sell) an asset to a customer but have an obligation or right to repurchase.



If obligation or right to repurchase is for an amount greater than or equal to selling price, then transaction is a financing transaction.

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Repurchase Agreements REPURCHASE AGREEMENT Example: Morgan Inc., an equipment dealer, sells equipment on January 1, 2015, to Lane Company for Birr 100,000. It agrees to repurchase this equipment on December 31, 2016, for a price of Birr 121,000.

Question: How should Morgan Inc. record this transaction? Assuming an interest rate of 10 percent is imputed from the agreement, Morgan makes the following entry to record the financing on January 1, 2015. Cash Liability to Lane Company

100,000 100,000

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Repurchase Agreements Question: How should Morgan Inc. record this transaction? Morgan Inc. records interest on December 31, 2016, as follows. Interest Expense

10,000

Liability to Lane Company (Birr100,000 x 10%)

10,000

Morgan Inc. records interest and retirement of its liability to Lane Company on December 31, 2016, as follows. Interest Expense

11,000

Liability to Lane Company (Birr 110,000 x 10%) Liability to Lane Company

11,000

121,000

Cash (Birr 100,000 + Birr 10,000 + Birr 11,000)

121,000 37

Consignments

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Consignments

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Warranties WARRANTIES Facts: Maverick Company sold 1,000 Refrigerators during 2015 at a total price of Birr 6,000,000, with a warranty guarantee that the product was free of any defects. The cost of Refrigerators sold is Birr 4,000,000. The term of the assurance warranty is two years, with an estimated cost of Birr 30,000. In addition, Maverick sold extended warranties related to 400 Refrigerators for 3 years beyond the 2-year period for Birr 2,000.

Question: What are the journal entries that Maverick Company should make in 2015 related to the sale and the related warranties?

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Warranties Question: What are the journal entries that Maverick Company should make in 2015 related to the sale and the related warranties? To record the revenue and liabilities related to the warranties: Cash (Birr 6,000,000 + Birr12,000) Warranty Expense

6,012,000 30,000

Warranty Liability

30,000

Unearned Warranty Revenue

12,000

Sales Revenue

6,000,000

To reduce inventory and recognize cost of goods sold: Cost of Goods Sold Inventory

4,000,000 4,000,000 41

REVENUE RECOGNITION OVER TIME Under certain circumstances companies recognize revenue over time. The most notable context in which revenue may be recognized over time is long-term construction contract ing. Long-term contracts frequently provide that seller (builder) may bill purchaser at intervals. ►Examples: 

Development of military and commercial aircraft



Space exploration hardware

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REVENUE RECOGNITION OVER TIME A company recognizes revenue over time if it can reasonably estimate its progress toward satisfaction of the performance obligations.  Methods for measuring progress  Output methods  units-of- work-performed method (ratio of units of work performed to date to estimated total unit of work in project)  Input methods  efforts-expended method (ratio of labor hours, machine hours or material quantities used to the total units of that measure of work required to complete the contract),  cost-to-cost method (ratio of actual contract costs incurred during the reporting period to total estimated contract costs). 

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REVENUE RECOGNITION OVER TIME 

Company recognizes revenues and gross profits each period based upon the progress of the construction—referred to as the percentage-ofcompletion method.



Company recognizes revenues and gross profit when the contract is completed, referred to as the cost-recovery (zero-profit) method.

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REVENUE RECOGNITION OVER TIME Percentage-of-Completion Method Revenue to Recognized Cost-to-Cost Basis

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PERCENTAGE-OF-COMPLETION METHOD

Illustration: Hardhat Construction Company has a contract to construct a £4,500,000 bridge at an estimated cost of £4,000,000. The contract is to start in July 2015, and the bridge is to be completed in October 2017. The following data pertain to the construction period.

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PERCENTAGE-OF-COMPLETION METHOD

ILLUSTRATION 18A-4

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PERCENTAGE-OF-COMPLETION METHOD

ILLUSTRATION 18A-5

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PERCENTAGE-OF-COMPLETION METHOD

Illustration: Percentage-of-Completion Revenue, Costs, and Gross Profit by Year ILLUSTRATION 18A-6

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PERCENTAGE-OFCOMPLETION METHOD

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PERCENTAGE-OF-COMPLETION METHOD

Illustration: Content of Construction in Process — Percentage-of-Completion Method

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PERCENTAGE-OF-COMPLETION METHOD

Financial Statement Presentation—Percentage-ofCompletion Computation of Unbilled Contract Price at 12/31/15

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PERCENTAGE-OF-COMPLETION METHOD

Financial Statement Presentation—Percentage-ofCompletion Method (2015)

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PERCENTAGE-OF-COMPLETION METHOD

Financial Statement Presentation—Percentage-ofCompletion Method (2016)

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LONG-TERM CONSTRUCTION CONTRACTS

Cost-Recovery (Zero-Profit) Method This method recognizes revenue only to the extent of costs incurred that are expected to be recoverable. Only after all costs are incurred is gross profit recognized.

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COST-RECOVERY (ZERO-PROFIT) METHOD

Illustration: Hardhat Construction would report the following revenues and costs for 2015–2017.

COST-RECOVERY (ZERO-PROFIT) METHOD Cost-Recovery Method Revenue, Costs, and Gross Profit by Year

Journal Entries— Cost-Recovery Method

COST-RECOVERY (ZERO-PROFIT) METHOD Cost-Recovery Method Revenue, Costs, and Gross Profit by Year

Comparison of Gross Profit Recognized under Different Methods

COST-RECOVERY (ZERO-PROFIT) METHOD

LONG-TERM CONSTRUCTION CONTRACTS

Long-Term Contract Losses 1. Loss in Current Period on a Profitable Contract ►

Percentage-of-completion method only, the estimated cost increase requires a current-period adjustment of gross profit recognized in prior periods.

2. Loss on an Unprofitable Contract ►

Under both percentage-of-completion and costrecovery methods, the company must recognize in the current period the entire expected contract loss.

LONG-TERM CONTRACT LOSSES

Illustration: Loss in Current Period Casper Construction Co.

Prepare the journal entries to record revenue and expense for 2014, 2015, and 2016 assuming the estimated cost to complete at the end of 2015 was $215,436.

LONG-TERM CONTRACT LOSSES

Illustration: Loss in Current Period

LONG-TERM CONTRACT LOSSES

Illustration: Loss in Current Period

LONG-TERM CONTRACT LOSSES

Illustration: Loss on Unprofitable Contract Casper Construction Co.

Prepare the journal entries for 2014, 2015, and 2016 assuming the estimated cost to complete at the end of 2015 was $246,038 instead of $170,100.

LONG-TERM CONTRACT LOSSES

Illustration: Loss on Unprofitable Contract

$675,000 – 683,438 = (8,438) cumulative loss

LONG-TERM CONTRACT LOSSES

Illustration: Loss on Unprofitable Contract

LONG-TERM CONTRACT LOSSES

Illustration: Loss on Unprofitable Contract For the Cost-Recovery method, companies would recognize the following loss :

COSTS TO FULFILL THE CONTRACT •

•

•

•

The incremental costs of obtaining a contract must be recognized as an asset if the entity expects to recover those costs. Costs incurred to fulfill a contract are recognized as an asset if and only if all of the following criteria are met:  the costs relate directly to a contract (or a specific anticipated contract);  the costs generate or enhance resources of the entity that will be used in satisfying performance obligations in the future; and  the costs are expected to be recovered. These include costs such as direct labor, direct materials, and the allocation of overheads that relate directly to the contract. The asset recognized in respect of the costs to obtain or fulfill a contract is amortized on a systematic basis. 68

COSTS TO FULFILL THE CONTRACT 



Example: A media company owns and operates radio stations. The main revenue stream is advertising revenue. Contracts are signed with various businesses for the sale of airtime. The executives obtain these contracts and are compensated through a 5% commission on the total contract price for each new contract signed. Executive X has obtained a new twoyear advertising contract with Company ABC. Total contract costs related to this contract are as follows: 

  



Legal fees (contract drafting (incurred on a “no win, no fee” basis)) Birr10,000 Commission (paid to the executive) Birr7,500 Meals and entertainment (incurred during the sales process) Birr1,750 Creative Director’s time (salary allocation of Creative Director to develop on-air ad) Birr 1,500 Actors (amounts paid to external actors to record the on-air ad) Birr 750 69

COSTS TO FULFILL THE CONTRACT 

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

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The legal fees and commission will be considered an “incremental cost of obtaining a contract” because these costs were only incurred as a result of obtaining the contract. Had the contract not been obtained, these costs would not have been incurred. If the legal fees had been incurred prior to obtaining the contract, they would not be capitalized. The meals and entertainment costs are not eligible to be capitalized because they would have been incurred regardless of whether the contract had been obtained. The costs related to the Creative Director’s time and the costs associated with hiring actors are direct labor costs associated with providing the advertising services and are considered to be costs directly related to the contract and are not covered by any other standard. 70

PRESENTATION AND DISCLOSURE Presentation •

•

Contracts with customers will be presented in an entity’s statement of financial position as  a contract liability,  a contract asset, or a receivable, depending on the relationship between the entity’s performance and the customer’s payment. Any difference between the initial recognition of a receivable and the corresponding amount of revenue recognized should also be presented as an expense, for example, an impairment loss. 71

PRESENTATION AND DISCLOSURE Disclosures •

      

Companies disclose qualitative and quantitative information about the following: Contracts with customers. Significant judgments. Assets recognized from costs incurred to fulfill a contract. Reconciliation of contract balances. Remaining performance obligations. Cost to obtain or fulfill contracts. Other qualitative disclosures.

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COMPARISON OF IFRS 15 AND

US GAAP •

•

•

In May 2014, the IASB and FASB issued a converged standard on revenue recognition entitled Revenue from Contracts with Customers. The boards achieved their goal of reaching the same conclusions on all requirements for the ing for revenue from contracts with customers. However, there are some minor differences in the standards:  collectability threshold;  interim disclosure requirements;  early application and effective date;  impairment loss reversal; and  non-public entity requirements 73