pwc.com/ifrs Practical guide to IFRS · 2015-06-03 · Practical guide to IFRS – Revenue from...

pwc.com/ifrs

Practical guide to IFRS Revenue from contracts with customers

At a glance Overview The FASB and IASB (the ‘boards’)

released an updated exposure draft, ‘Revenue from contract with customers’, on 14 November 2011 and are requesting comments by 13 March 2012.

The boards have asked whether the proposed guidance is clear, and requested feedback specifically on: performance obligations satisfied over time; presentation of the effects of credit risk; recognition of variable consideration; the scope of the onerous performance obligation test; interim disclosures; and transfer of non-financial assets that are outside an entity's ordinary activities (for example, sale of PP&E).

The proposed model requires a five-step approach. Management will first identify the contract(s) with the customer and separate performance obligations within the contract(s). Management will then estimate and allocate the transaction price to each separate performance obligation. Revenue is recognised when an entity satisfies its obligations by transferring control of a good or service to a customer.

It is unclear when a final standard will be issued; however, the boards have indicated that the final standard will have an effective date no earlier than 2015. Full retrospective application will be required with the option to apply limited transition reliefs.

Background 1. The boards initiated this joint project in 2002 to develop a common revenue standard for IFRS and US GAAP. The original exposure draft was issued in June 2010 (the ‘2010 exposure draft’).

2. The boards received nearly 1,000 comment letters on the 2010 exposure draft, which highlighted a number of recurring themes that were discussed during re-deliberations. They addressed several areas including the identification of separate performance obligations, determining the transaction price, accounting for variable consideration, transfer of control, warranties, contract costs, and accounting for licences to use intellectual property, among others. 3. The boards decided to re-expose the proposed revenue guidance to avoid unintended consequences from the final standard and to increase transparency. The updated exposure draft was issued in November 2011. References within this practical guide to the ‘exposure draft’ or ‘proposed standard’ refer to the exposure draft issued in November 2011, unless otherwise indicated. 4. The exposure draft proposes a new revenue recognition model that could significantly change the way entities recognise revenue. The objective is to remove inconsistencies in existing revenue requirements and improve the comparability of revenue recognition across industries and capital markets. 5. The proposed standard employs an asset and liability approach − the cornerstone of the IASB’s and FASB’s conceptual frameworks. Current revenue guidance under both frameworks focuses on an ‘earnings process,’ but difficulties often arise in determining when revenue is ‘earned’ and when the earnings process is complete. The boards believe a single, contract-based model that reflects changes in contract assets and liabilities will lead to greater consistency in the recognition and presentation of revenue.

November 2011

Practical guide to IFRS – Revenue from contracts with customers – November 2011 2

PwC observation: The proposed standard will be a significant shift in how revenue is recognised in many circumstances. The effect could be considerable, requiring management to perform a comprehensive review of existing contracts, business models, company practices, and accounting policies. The proposed standard could also have broad implications for an entity's processes and controls. Management might need to change existing IT systems and internal controls in order to capture different information than in the past. The effect could extend to other functions such as treasury, tax, and human resources. For example, changes in the timing or amount of revenue recognised may affect long-term compensation arrangements, debt covenants, and key financial ratios.

6. This practical guide explores key aspects of the proposed standard. The boards’ conclusions are tentative and subject to change until they issue the final standard. We have summarised the key changes to the 2010 exposure draft in an appendix to this practical guide. Scope 7. The proposed standard defines a contract as an agreement between two or more parties that creates enforceable rights and obligations. A contract can be written, oral, or implied by an entity's customary business practice. A customer is defined as a party that has contracted with an entity to obtain goods or services that are an output of the entity's ordinary activities.

8. The proposed standard applies to an entity's contracts with customers, except for: Lease contracts; Insurance contracts; Certain contractual rights or

obligations within the scope of other standards including financial instruments and extinguishments of liabilities;

Certain guarantees within the scope of other standards (other than product warranties); and

Non-monetary exchanges between entities in the same line of business to facilitate sales to customers.

9. Some contracts might include components that are in the scope of the proposed standard and other components that are in the scope of other standards (for example, a contract that includes both a lease and maintenance services). In this situation, an entity will apply the other standard to separate and measure that component of the contract if that standard has separation and measurement guidance. Otherwise, the principles of this proposed standard are applied.

PwC observation: The proposed standard addresses contracts with customers across all industries and eliminates industry-specific guidance. Most transactions accounted for under existing revenue standards in IFRS and US GAAP will be within the scope of the proposed standard. Certain transactions in industries that recognise revenue from a counterparty that is a collaborator or partner that shares risk in developing a product might not be in the scope of the proposed standard. For example, some collaborative arrangements in the biotechnological industry or entitlement-based arrangements in the oil and gas industry might not be within the scope of the proposed standard.

The proposed model 10. Entities will perform the following five steps in applying the proposed model: Identify the contract with the

customer; Identify the separate performance

obligations in the contract; Determine the transaction price and

amounts not expected to be collected; Allocate the transaction price to

separate performance obligations; and Recognise revenue when (or as) each

performance obligation is satisfied.


PwC observation: The steps in the proposed standard may appear simple, but significant judgment will be needed to apply the principles. For example, determining whether a good or service is a separate performance obligation, and thus should be accounted for separately, will require judgment. Management will also need to consider a number of factors to estimate the transaction price, including the effects of variable consideration and time value of money.

Identify the contract with the customer 11. A contract exists if all the following criteria are met: The contract has commercial

substance; The parties to the contract have

approved the contract and are committed to perform their respective obligations;

Management can identify each party's rights and obligations regarding the goods or services to be transferred; and

Management can identify the terms and manner of payment for the goods or services to be transferred.

12. Two or more contracts entered into at or near the same time with the same customer (or parties related to the customer) may need to be combined if one or more of the following criteria are met: The contracts are negotiated with a

single commercial objective; The consideration paid in one

contract depends on the price or performance under the other contract; or

The goods or services promised under the contracts are a single performance obligation.

PwC observation: Identifying the contract with the customer will be straightforward in many cases. The approval of a contract might not be as strict as some existing guidance under US GAAP. For example, the software guidance under US GAAP today has strict rules to establish whether or not a contract with the customer meets the ‘evidence of an arrangement’ requirement. The underlying concepts are otherwise consistent with existing guidance under US GAAP and IFRS. It may be more challenging to identify the contract with the customer in situations where an arrangement involves three or more parties, particularly if there are separate contracts with each of the parties. These types of arrangements might occur in the asset management industry, for example, or when credit card holders buy goods from a retailer but receive reward points from the credit card issuer. The exposure draft does not include specific guidance on how to account for these types of arrangements.

13. A contract modification is treated as a separate contract only if it results in the addition of a separate performance obligation and the price reflects the stand-alone selling price (that is, the price the good or service would be sold for if sold on a stand-alone basis) of the additional performance obligation. The modification is otherwise accounted for as an adjustment to the original contract either through a cumulative catch-up adjustment to revenue or a prospective adjustment to revenue when future performance obligations are satisfied, depending on the facts and circumstances.


Example 1.1

Contract modifications A manufacturing entity enters into a contract with a customer to deliver 1,000 products over a one year period for C50 per product. The products are distinct performance obligations because the entity regularly sells each product separately (see paragraphs 14-19). The contract is modified six months after inception to include an additional 500 products for C45 per product. The new price reflects the stand-alone selling price of the product at the time of the contract modification. The contract modification is a separate contract that should be accounted for prospectively. The additional products are distinct performance obligations and the price reflects the stand-alone selling price of each product at the time of the contract modification.

Example 1.2

Contract modifications A construction entity enters into a contract with a customer to build a customised house. The contract is a single performance obligation given the deliverable promised to the customer (see paragraphs 14-19). Costs incurred to date in relation to total estimated costs to be incurred is the best measure of the pattern of transfer to the customer (see paragraphs 39-40). The original transaction price in the contract was C500,000 with estimated costs of C400,000. The customer requests changes to the design midway through construction (C200,000 of costs have been incurred). The modification increases the transaction price and estimated costs by C100,000 and C50,000, respectively. The entity should account for the contract modification as if it were part of the original contract because the modification does not result in a separate performance obligation. Management should update its measurement of progress on the original contract to reflect the contract modification because the remaining goods and services are part of a single performance obligation that is partially satisfied at the modification date.

Original Modification Revised

Transaction price C500,000 C100,000 C600,000

Estimated costs C400,000 C50,000 C450,000

Percent complete 50% 44%

Revenue to date C250,000 C264,000

Incremental revenue C14,000

Identify the separate performance obligations 14. A performance obligation is a promise (whether explicit, implicit or implied) in a contract with a customer to transfer a good or service to the customer. A contract might explicitly state performance obligations, but they could also arise in other ways. Legal or statutory requirements can create performance obligations even though such obligations are not explicit in the contract. Customary business practices, such as an entity’s practice of providing

customer support, might also create performance obligations.

15. An entity accounts for each promised good or service as a separate performance obligation if the good or service is distinct. A good or service is distinct if either of the following criteria is met: The entity regularly sells the good or

service separately; or The customer can benefit from the

good or service either on its own or together with other resources that are readily available to the customer.


16. An entity should combine a bundle of distinct goods or services into a single performance obligation if both of the following criteria are met: The goods or services are highly

interrelated and require the entity to provide a significant service of integrating the goods or services into a combined item that the customer has contracted for; and

The entity significantly modifies or customises the goods or services to fulfil the contract.

17. Readily available resources are goods or services that are sold separately by the entity or another entity, or resources that the customer already has obtained from the entity or from other transactions or events.

18. An entity may account for separate performance obligations satisfied at the same time or over the same period as one

performance obligation as a practical expedient.

19. An entity should combine goods or services that are not distinct with other goods or services until there are bundles of goods or services that are distinct.

PwC observation: The exposure draft provides criteria for assessing whether a bundle of goods or services should be combined into a single performance obligation, but does not provide detailed guidance on how to assess whether integration services are ‘significant’ or when an entity is ‘significantly’ modifying or customising a good. We believe management should carefully evaluate the criteria provided to ensure that combining goods and services results in accounting that reflects the underlying economics of the transaction.

Example 2.1

Integration services A construction entity enters into a contract with a customer to build a bridge. The entity is responsible for the overall management of the project including excavation, engineering, procurement, and construction. The entity would account for the bundle of goods and services as a single performance obligation since the goods and services to be delivered under the contract are highly interrelated. There is also a significant integration service to customise and modify the goods and services necessary to construct the bridge.

Example 2.2

Separate performance obligations and consideration of timing: A manufacturing entity enters into a contract with a customer to sell a unique tool and replacement parts. The entity always sells the unique tool and replacement parts together, and no other entity sells either product. The customer can use the unique tool without the replacement parts, but the replacement parts have no use without the unique tool. There would be two distinct performance obligations if the manufacturing entity transfers the tool first, because the customer can benefit from the tool on its own and the customer can benefit from the replacement parts using a resource that is readily available (that is, the tool that was transferred first). There would only be one performance obligation if the manufacturing entity transfers the replacement parts first, because the customer does not have a readily available resource to benefit from the replacement parts. The entity would account for both products as a single performance obligation in this scenario.


Determine the transaction price and amounts not expected to be collected 20. The transaction price in a contract reflects the amount of consideration that an entity expects to be entitled to in exchange for goods or services delivered. The transaction price is readily determinable in some contracts because the customer promises to pay a fixed amount of consideration in return for the transfer of a fixed number of goods or services in a reasonably short timeframe. In other contracts, management needs to consider the effects of: Variable consideration; Time value of money; Noncash consideration; and Consideration paid to a customer.

Variable consideration 21. The transaction price might include an element of consideration that is variable or contingent on the outcome of future events, including (but not limited to) discounts, rebates, refunds, credits, incentives, performance bonuses, and royalties. Management estimates the total amount of consideration the entity is entitled to as part of the transaction price when a contract includes variable consideration. Management should use one of the following approaches to estimate variable consideration depending on which is the most predictive, and that estimate should be updated at each reporting period: The expected value, being the sum of

probability-weighted amounts; or The most likely outcome, being the

most likely amount in a range of possible amounts.

22. The amount of variable consideration included in the transaction price and allocated to a satisfied performance obligation should be recognised as revenue only when the entity is reasonably assured to be entitled to that amount. See paragraphs 41-43 for further discussion of this constraint on the recognition of revenue.

PwC observation: The proposed guidance requires management to determine the total transaction price, including an estimate of variable consideration, at the outset of the contract and on an ongoing basis. Variable consideration is also referred to as contingent consideration and can come in a variety of forms. Some contingencies may relate to future performance by the seller that is substantially within the seller's control, while other contingencies may depend heavily on the actions of a customer or a third party. Revenue will not be recognised for variable consideration if the entity is not reasonably assured to be entitled to that consideration, as discussed further below. However, management may still be required to estimate all forms of variable consideration to measure and allocate the transaction price to each separate performance obligation. In some cases, such as when there is only a single performance obligation that is delivered at a point in time, it may not be necessary to estimate variable consideration until management is reasonably assured to be entitled to the consideration.

Example 3.1

Estimating variable consideration A construction entity enters into a contract with a customer to build an asset for C100,000 with a performance bonus of C50,000 that will be paid based on the timing of completion. The amount of the performance bonus decreases by 10 percent per week for every week beyond the agreed-upon completion date. The contract requirements are similar to contracts the entity 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 one week late, and only a 10% possibility that it will be completed two weeks late. The transaction price should include management’s estimate of the amount of consideration to which the entity will be entitled. Management has concluded that the probability-weighted method is the most predictive approach for estimating the variable consideration in this situation:


60% chance of C150,000=C90,000

30% chance of C145,000=C43,500

10% chance of C140,000=C14,000 The total transaction price would be C147,500 based on the probability-weighted estimate. Management should update its estimate each reporting date. Using a most likely outcome approach may be more predictive if a performance bonus is binary such that the entity earns either C50,000 for completion on the agreed-upon date, or nothing for completion after the agreed-upon date. In this scenario, if management believes that the entity will meet the deadline and estimates the consideration using the most likely outcome, the total transaction price would be C150,000.

Time value of money 23. The transaction price should reflect the time value of money when the contract contains a significant financing component. When a significant financing component exists, management should use a discount rate that reflects a financing transaction between the entity and its customer that does not involve the provision of other goods or services. The entity presents the effects of financing as interest expense or income. 24. Management should consider the following factors to determine if there is a significant financing component in a contract: The length of time between when the

entity transfers the promised goods or services to the customer and when the customer pays for those goods or services;

Whether the amount of consideration would substantially differ if the customer paid in cash at the time of transfer of the goods or services; and

The interest rate in the contract and prevailing interest rates in the relevant market.

25. An entity is not required to reflect the time value of money in the measurement of the transaction price when the time from transfer of the goods or services to payment is less than one year, as a practical expedient.

PwC observation: Determining whether a significant financing component exists in a contract could be particularly challenging in long-term or multiple-element arrangements where goods or services are delivered and cash payments are made throughout the arrangement. Management will need to assess the timing of delivery of goods and services in relation to cash payments to determine if the length of time is in excess of one year, which could indicate that a significant financing component exists. Accounting for the effects of the time value of money could result in a considerable change in practice for certain entities, particularly when consideration is paid significantly in advance or in arrears. This could result in the recognition of revenue in an amount that is different from the amount of cash received from the customer. If payments are made in arrears, revenue recognised will be less than cash received. If payments are made in advance, revenue recognised will exceed the cash received. An example of how to apply the guidance for the time value of money in a basic transaction is included in the implementation guidance within the proposed standard. The calculations could be significantly more challenging in complex situations or when estimates change throughout the life of an arrangement.


Non-cash consideration 26. An entity measures non-cash consideration received for satisfying a performance obligation at its fair value. When management cannot estimate fair value reliably, the entity measures the non-cash consideration received indirectly by reference to the stand-alone selling price of the goods or services transferred. Consideration paid to a customer 27. Consideration paid by an entity to its customer might include rebates or upfront payments (for example, slotting fees), and could take the form of cash or credit. Consideration paid to a customer is assessed to determine if the amount should be reflected as a reduction of the transaction price, because it represents a discount on the goods or services delivered or to be delivered. If the consideration represents payment for distinct goods or services received from the customer, it is treated like any other purchase from a vendor.

28. An entity reduces revenue when it pays consideration to a customer that represents a discount at the later of when the entity: (a) transfers the promised goods or services to the customer or (b) promises to pay the consideration (even if the payment is conditional on a future event). That promise may be implied by customary business practice.

PwC observation: The underlying concepts for both non-cash consideration and consideration paid to a customer are consistent with current revenue guidance under both US GAAP and IFRS. We do not anticipate a significant change in practice in these areas on adoption of the proposed standard. The proposed guidance is not as explicit about whether payments paid to customers to enter into a customer-vendor relationship should be capitalised. We believe that in certain situations these amounts should be capitalised and the subsequent amortisation of such amounts would reduce revenue.

Collectibility 29. Collectibility refers to the risk that the customer will not pay the promised consideration. An entity recognises an allowance for any expected impairment loss (determined in accordance with ASC 310, Receivables, or IFRS 9, Financial Instruments) and presents that allowance in a separate line item adjacent to revenue. Both the initial assessment and any subsequent changes in the estimate are recorded in this line item (if the contract does not have a significant financing component).

PwC observation: Current guidance requires that revenue cannot be recognised unless collectibility is reasonably assured (under US GAAP) or is probable (under IFRS). Collectibility will no longer be a recognition threshold, so revenue might be recognised earlier under the proposed guidance. Presenting credit risk in this manner will align revenue recognised with cash ultimately received from the customer if the contract does not have a significant financing component. This will help financial statement users who are interested in reconciling revenue with cash ultimately received from the customer. It is not clear where impairment will be classified if the arrangement contains a significant financing component. The proposed guidance requires management to look to ASC 310 or IFRS 9 to measure expected impairment loss. We believe there is a potential conflict with the impairment model in ASC 310 and IFRS 9 in the classification of subsequent changes to the initial assessment. Subsequent impairment of a financial instrument is recognised as other income and expense, while subsequent changes for receivables would be recognised in the line item adjacent to revenue. The boards have acknowledged that this decision could create consequences for the impairment model being developed for financial instruments and it will therefore need to be discussed further at a future date.


Example 4.1

Presentation of credit risk A consumer products entity enters into a contract with a customer to provide goods for C1,000. Payment is due one month after the goods are transferred to the customer. Management assesses that the customer will not pay 10% of the consideration based on its current knowledge of the customer and its financial position. The entity should recognise revenue, which reflects the total transaction price under the contract, when the goods are transferred to the customer. The entity would also recognise the estimated amount of consideration that is uncollectible as a separate line item adjacent to the revenue line item. The below table summarises the presentation under the current and proposed guidance.

Current Proposed

Revenue

C1,000 Revenue C1,000

Impairment loss (100)

Subtotal 900

COGS (400) COGS (400)

GM C 600 GM C 500

GM % 60% GM % 56%

Allocate the transaction price to distinct performance obligations 30. The transaction price should be allocated to separate performance obligations in a contract based on the relative stand-alone selling prices of the goods or services. The best evidence of stand-alone selling price is the observable price of a good or service when the entity sells that good or service separately. Management needs to estimate the selling price if a stand-alone selling price is not available, and should maximise the use of observable inputs. Possible estimation methods include (but are not limited to): Expected cost plus reasonable margin; Assessment of market prices for

similar goods or services; and Residual approach, in certain

circumstances. 31. A residual approach may be used to calculate the stand-alone selling price when there is significant variability or uncertainty in one or more performance obligations, regardless of whether that performance obligation is delivered at the beginning or end of the contract. A residual approach involves estimating the stand-alone selling price of a good or

service by reference to the total transaction price less the sum of the stand-alone selling prices of other goods or services promised in the contract.

32. A selling price is highly variable when an entity sells the same good or service to different customers (at or near the same time) for a broad range of amounts. A selling price is uncertain when an entity has not yet established a price for a good or service or the good or service has not previously been sold. 33. An entity should allocate a discount entirely to one separate performance obligation in the contract if the price of a good or service is largely independent of the price of other goods or services in the arrangement based on the following criteria: The entity regularly sells each good or

service in the contract separately; and The observable selling prices from

those sales provide evidence of the performance obligation to which the entire discount in the contract belongs.

34. Changes to the transaction price, including changes in the estimate of variable consideration, might only affect one performance obligation. Such changes would be allocated to that


performance obligation rather than all performance obligations in the arrangement if the following criteria are met: The contingent payment terms relate

to a specific performance obligation or outcome from satisfying that performance obligation; and

Allocating the contingent amount of consideration entirely to the separate performance obligation is consistent with the amount of consideration that the entity expects to be entitled for that performance obligation.

PwC observation: The residual approach in the proposed guidance should not be confused with the residual method that has historically been used to allocate the transaction price by software entities applying US GAAP and, in some circumstances, by entities applying IFRS. First, the proposed guidance states that the residual approach should only be used when the standalone selling price of a good or service is highly variable or uncertain. Second, the residual approach would be used solely to develop an estimate of the stand-alone selling price of the separate good or service and not to determine the allocation of consideration to a specific performance obligation.

Example 5.1

Use of residual approach An entity enters into a contract with a customer to provide a package of products for C1,000. The arrangement includes three separate performance obligations: products A, B, and C. The entity sells products A and B both individually and bundled together in a package. Product C is unique and has never been sold before. Its estimated selling price is therefore unknown. Products A and B sell for C200 and C300, respectively, when sold on a stand-alone basis. However, as a package, products A and B sell for a discounted amount of C400. Management might conclude the estimated stand-alone selling price of product C is C600 (C1,000 less C400). The C1,000 transaction price would be allocated as follows: Product A = (C200/C500) x (C400/C1,000) or 16% Product B = (C300/C500) x (C400/C1,000) or 24% Product C = C600/C1,000 or 60%

We believe this is one way that a residual approach might be used to estimate the stand-alone selling price. However, this concept is not illustrated in the proposed guidance and it is possible that this topic may be subject to further clarification by the boards.

Recognise revenue when (or as) each performance obligation is satisfied Transfer of control 35. Revenue is recognised when (or as) a promised good or service is transferred to the customer. An entity transfers a promised good or service and satisfies a performance obligation when the customer obtains control of that good or service. A customer obtains control of a good or service if it has the ability to direct the use of and receive the benefit from the good and service. Indicators that the customer has obtained control of the good or service include:

The entity has a right to payment for the asset;

The entity transferred legal title to the asset;

The entity transferred physical possession of the asset;

The customer has the significant risk and rewards of ownership; and

The customer has accepted the asset.

PwC observation: The proposed guidance provides indicators to determine the point of time at which a performance obligation is satisfied. The indicators are not a checklist, and no one indicator is determinative. The indicators are factors that are often present when control has transferred to a customer. There may be situations where some


indicators are not met, but management’s judgment is that control has been transferred. Management will still need to consider all of the facts and circumstances to understand if the customer has the ability to direct the use of and benefit from the goods or services.

Satisfaction of performance obligations over time 36. Performance obligations can be satisfied either at a point in time or over time. An entity transfers control of a good or service over time if at least one of the following two criteria is met: The entity's performance creates or

enhances an asset that the customer controls; or

The entity's performance does not create an asset with alternative use to the entity and at least one of the following criteria is met: − The customer simultaneously

receives and consumes the benefits of the entity’s performance as it performs;

− Another entity would not need to substantially re-perform the work the entity has completed to date if that other entity were required to fulfil the remaining obligation to the customer; or

− The entity has a right to payment for performance completed to date and it expects to fulfil the contract.

37. An asset with alternative use is an asset that an entity could readily direct to another customer. For example, a

standard inventory item might have an alternative use because it can be used as a substitute across multiple contracts with customers. An asset that is highly customised would be less likely to have an alternative use to the entity because the entity would likely incur significant costs to direct the asset to another customer. 38. Management should consider the effects of contractual limitations when assessing whether an asset has an alternative use. A contract that precludes an entity from redirecting an asset to another customer results in the asset not having an alternative use because the entity is legally obligated to direct the asset to a specific customer.

PwC observation: Management will need to apply judgment to assess the criteria for when a performance obligation is satisfied over time to ensure the timing of revenue recognition reflects the transfer of control to the customer based on the economic substance of the arrangement. We understand the objective of the ‘right to payment’ criterion is that the consideration would be intended to compensate the entity for performance to date and not, for example, a stipulated penalty to cover lost profits in the arrangement.

Example 6.1

Assessing whether an asset has alternative use An industrial products entity enters into a contract with a customer to deliver the next piece of specialised equipment produced. The customer paid a deposit that is only refundable if the entity fails to perform. The deposit also requires the entity to procure materials to produce the specialised equipment. The contract precludes the industrial products entity from redirecting the piece of specialised equipment to another customer. The specialised equipment does not have alternative use to the industrial products entity because the contract has substantive terms that preclude the entity from redirecting the specialised equipment to another customer. The industrial products entity would need to assess the rest of the criteria to determine if production of the specialised equipment represents a performance obligation satisfied over time. The performance obligation would be satisfied at a point in time if the criteria are not met. It is likely in this example that the performance to date would have to be re-performed by another entity and the customer doesn’t immediately receive the benefits of the entity’s performance. Management would therefore have to assess whether the deposit is a right to payment that is commensurate with work performed. If not, and assuming the other criteria are not met, the performance obligation would be satisfied at a point in time, not over time.


Measurement of progress 39. An entity recognises revenue for a performance obligation satisfied over time by measuring the progress toward complete satisfaction of the performance obligation. The objective when measuring progress is to depict the transfer of control of the promised goods or services to the customer. Methods for measuring progress include: Output methods that recognise

revenue on the basis of units produced, units delivered, contract milestones, or surveys of work performed; and

Input methods that recognise revenue on the basis of costs incurred, labour hours expended, time lapsed, or machine hours used.

40. When applying an input method to a separate performance obligation that includes goods that a customer controls at a point in time significantly prior to the performance of the services related to those goods, revenue may be recognised in an amount equal to the cost for those goods if both conditions are present:

The cost of the transferred goods is significant relative to the total expected costs to completely satisfy the performance obligation; and

The entity procures the goods from another entity and is not significantly involved in designing and manufacturing the goods.

PwC observation: The exposure draft allows both input and output methods for measuring progress, but management should select the method that best depicts the transfer of control of goods and services. Output methods directly measure the value of the goods or services transferred to the customer. The use of an input method measures progress toward satisfying a performance obligation indirectly. Management should take care when using an input model that the inputs represent the transfer of control of the asset to the customer and exclude any inputs that do not depict the transfer of control (for example, upfront purchases of significant materials that have not yet been utilised or transferred to the customer, or wasted effort or materials).

Example 7.1

Use of an input method to measure progress A manufacturing entity enters into a contract with a customer to provide specialised equipment and install the equipment into a data centre facility. The entity will need to procure the specialised equipment from an independent source. The entity will account for the bundle of goods and services as a single performance obligation since the goods and services provided under the contract are highly interrelated. There is also a significant integration service to customise and modify the specialised equipment for the data centre facility. The entity expects to incur the following cost in connection with the project:

Transaction price C500,000

Cost of specialised equipment 150,000

Other costs to fulfil 100,000

Total estimated costs to complete C250,000

The manufacturing entity concludes that an input method (costs incurred to date in relation to total estimated costs to be incurred) best depicts the pattern of transfer of control to the customer. Since the costs incurred by the entity to procure the specialised equipment are significant to the overall costs of the project and the entity is not involved in the manufacturing of the equipment, the entity excludes the costs of the equipment from its measurement of progress toward satisfaction of the performance obligation. The entity incurs the following costs and estimates progress for revenue recognition excluding the costs to procure the specialised equipment:


Incurred costs to date

Cost of specialised equipment

150,000

Other costs to fulfil

50,000

Percent complete excluding specialised

equipment

(C50,000 / (C250,000 - C150,000)) 50%

Revenue recognised to date

(50% x (C500,000 - C250,000)) C125,000

The manufacturing entity estimates that the performance on the project is 50% complete and recognises revenue of C125,000. The entity will recognise revenue in an amount equal to the costs of C150,000 upon transfer of control of the specialised equipment to the customer.

Constraint on revenue recognition 41. Variable consideration included in the transaction price that is allocated to a satisfied performance obligation is recognised as revenue only when the entity is reasonably assured to be entitled to that amount. An entity is reasonably assured when the entity has experience with similar types of contracts and that experience is predictive of the outcome of the contract.

42. Management needs to apply judgment to assess whether it has predictive experience about the outcome of a contract. The following indicators might suggest the entity's experience is not predictive of the outcome of a contract: The amount of consideration is highly

susceptible to factors outside the influence of the entity;

The uncertainty about the amount of consideration is not expected to be resolved for a long period of time;

The entity's experience with similar types of contracts is limited; and

The contract has a large number and broad range of possible consideration amounts.

43. The proposed guidance includes an exception for intellectual property licensed in exchange for royalties based on the customer's subsequent sales of a good or service. The entity can only become reasonably assured to be entitled to the related variable consideration (the royalty payment) once those future sales occur.

PwC observation: The boards included the ‘reasonably assured’ constraint in response to feedback that revenue could be recognised prematurely for variable consideration. The constraint is not meant to be a specific quantitative threshold but rather a qualitative assessment based on the level of predictive experience held by a particular entity. We expect that some entities will recognise revenue earlier under the proposed guidance because they will be able to recognise amounts before all contingencies are resolved. The constraint on revenue recognition is generally limited to situations where management has no predictive experience. Revenue will be recognised in these circumstances only when the amounts become reasonably assured, which may be closer to the timing of recognition under existing practice. The ‘bright line’ exception included in the proposed guidance for royalties received from licences to use intellectual property seems to result in divergent outcomes for economically similar transactions in some cases. For example, the exposure draft includes an example (Example 14) that addresses trailing commissions received by an agent of an insurance company. The example concludes that the entity can recognise commissions related to future policy renewals at the outset of the arrangement because management determines such amounts are reasonably assured of being received.


It is worth noting that like the royalties, the trailing commissions are also dependent on the customer's future sales. Therefore, the exposure draft appears to require that the exception for licences to use intellectual property should not be applied by analogy to other types of transactions.

Example 8.1

Estimating variable consideration based on predictive experience: An entity sells maintenance contracts to customers on behalf of a manufacturer for an upfront commission of C100 and C10 per year for each contract based on how long the customer renews the maintenance contract. Once the initial maintenance contracts have been sold, the entity has no remaining performance obligations. Management has determined that past experience is predictive (for example, experience with similar types of contracts and customers) and that experience indicates that customers typically renew for 2 years. The total transaction price is therefore estimated to be C120 and the entity will recognise that amount of revenue when the maintenance contract is sold to the customer. As renewal experience changes, management will update the transaction price and recognise revenue or a reduction of revenue to reflect the updated renewal experience.

Other considerations Identify the separate performance obligations 44. The proposed standard includes guidance on the following areas when considering the impact of identifying separate performance obligations in the contract: Principal versus agent; Options to acquire additional goods or

services; Licences; Rights of return; Warranties; and Non-refundable upfront fees.

Principal versus agent 45. Entities often involve third parties when providing goods and services to their customers. In these situations, management needs to assess whether the entity is acting as the principal or as an agent. An entity recognises revenue gross if it is the principal, and net (that is, equal to the commission received) if it is an agent. An entity is the principal if it obtains control of the goods or services of another party in advance of transferring control of those goods or services to the customer. The entity is an agent if its performance obligation is to arrange for another party to provide the goods or services.

46. Indicators that the entity is an agent include: The other party has primary

responsibility for fulfilment of the contract (that is, the other party is the primary obligor);

The entity does not have inventory risk;

The entity does not have latitude in establishing prices;

The entity does not have customer credit risk; and

The entity's consideration is in the form of a commission.

PwC observation: The proposed guidance and list of indicators are similar to the current guidance under US GAAP and IFRS. The proposed guidance does not weigh any of the indicators more heavily than others. The growth in business models that involve the use of the internet to conduct transactions has continued to increase the focus in this area under existing standards. We expect similar issues to arise under the new guidance, but do not expect a significant change in practice in this area.

Options to acquire additional goods or services 47. An entity may grant a customer the option to acquire additional goods or services free of charge or at a discount. These options may include customer award credits or other sales incentives


and discounts. That promise gives rise to a separate performance obligation if the option provides a material right to the customer that the customer would not receive without entering into the contract. The entity should recognise revenue allocated to the option when the option expires or when the additional goods or services are transferred to the customer. 48. An example of a material right would be a discount that is incremental to the range of discounts typically given to similar customers in the same market. The customer is effectively paying in advance for future goods or services and therefore, revenue is recognised when those future goods or services are transferred or when the option expires. 49. An option to acquire an additional good or service at a price that is within the range of prices typically charged for those goods or services does not provide a material right to the customer and is a marketing offer. This is the case even if the option can be exercised only because of entering into the previous contract.

50. The estimate of a stand-alone selling price for a customer's option to acquire additional goods or services is the discount the customer will obtain when exercising the option. This estimate is adjusted for any discount the customer would receive without exercising the option and the likelihood that the customer will exercise the option (that is, breakage or forfeiture).

PwC observation: The amount allocated to the loyalty rewards under the proposed standard is deferred and revenue is recognised when the rewards expire or are redeemed. An existing IFRS interpretation requires entities to account for loyalty programs using a model that is largely consistent with the guidance in the proposed standard. However, there is divergent practice in the accounting for loyalty programs under US GAAP with many entities following the incremental cost accrual model under which revenue is not allocated to the loyalty awards and the cost of fulfilling the awards is accrued. The proposed standard will therefore result in later revenue recognition for these entities.

Example 9.1

Loyalty points An entity grants its customers one point per C10 spent on purchases. Each point earned has a value of C1, which customers may redeem against future purchases. A customer purchases goods for C1,000 and earns 100 points redeemable against future purchases. The entity estimates that the stand-alone selling price of one point is C0.95 based on the redemption value of the points adjusted for the history of redemptions (that is, 5% breakage). The stand-alone selling price of the goods is C1,000. The option (loyalty points) provides a material right to the customer and is a separate performance obligation. The entity will allocate the total transaction price between goods and loyalty points based on their relative stand-alone selling prices. The transaction price allocated to the points will be recognised as revenue when the points are redeemed (and the related goods or services are transferred to the customer), or when they expire unused. Product C913 (1,000 x 1,000/1,095) Points C87 (95 x 1,000/1,095) The C913 of revenue allocated to the goods is recognised upon transfer of control of the goods and the C87 allocated to the points is recognised upon the earlier of the redemption or expiration of the points.


Licences 51. A licence is the right to use an entity's intellectual property. Intellectual property includes among others: software and technology; media and entertainment rights (for example, motion pictures and music); franchises; patents; trademarks; and copyrights.

52. An entity should recognise revenue from granting the right to use intellectual property when the customer obtains control of the rights. This occurs when control of the right to use the intellectual property transfers, but is no earlier than the beginning of the licence period.

53. If there is more than one performance obligation in the arrangement, management will have to first assess whether the promised right to use intellectual property is a separate

performance obligation, or if it should be combined with other performance obligations.

PwC observation: The guidance in the proposed standard for licences to use intellectual property could result in earlier revenue recognition than current practice under US GAAP and IFRS. However, revenue might not be recognised immediately upon transfer of the right if the licence is not distinct from other performance obligations in the contract. Additionally, there is often variable consideration in a licence arrangement, in which case revenue recognition is constrained until the entity is reasonably assured to be entitled to the consideration. Revenue recognition is constrained until the customer’s future sales occur for sales-based royalty payments.

Example 10.1

Licence to use intellectual property A technology entity enters into a contract with Customer A to license its intellectual property for one year. The technology entity also enters into a contract with Customer B to provide a perpetual licence to its intellectual property. Management will need to assess when the customer obtains control of the promised rights, which will determine when revenue should be recognised. Control of the rights to use intellectual property cannot be transferred before the beginning of the period during which the customer can use and benefit from those rights. In this example, the right to use the intellectual property for both Customer A and Customer B would transfer at the same point in time. The customer obtains control of the promised rights when the software licence is transferred. If the contract includes other performance obligations in addition to the licence, management will need to evaluate whether the right to use the intellectual property is distinct from those other performance obligations. If it is, revenue is recognised when control of the licence is transferred (assuming the entity is reasonably assured to be entitled to the consideration). If it is not distinct, the right to use the intellectual property should be combined with other performance obligations until management identifies a bundle of goods or services that is distinct. Revenue is recognised when (or as) the combined performance obligation is satisfied.

Rights of return 54. An entity accounts for the sale of goods with a right of return as follows: Revenue is recognised for the

consideration to which the entity is reasonably assured to be entitled (considering the products expected to be returned) and a liability is recognised for the refund expected to be paid to customers. The refund liability is updated for changes in expected refunds at each reporting period.

An asset and corresponding

adjustment to cost of sales is recognised for the right to recover goods from customers. The asset is initially measured at the original cost of the goods less any expected costs to recover those goods. Impairment is assessed at each reporting date.

55. A contract that provides the customer with the right to exchange one product for another product of the same type, quality, condition, and price (for example, a red shirt for a blue shirt) does


not provide a return right accounted for under the proposed standard.

PwC observation: Entities will be precluded from recognising revenue prior to the lapse of the return right when management is unable to estimate returns, similar to current guidance. However, the proposed standard requires an entity to recognise an asset for the right to recover a product and an offsetting liability for the refund, which may be different from current practice. The asset recognised for the right to recover a product is assessed for impairment in accordance with existing standards.

Warranties 56. An entity accounts for a warranty as a separate performance obligation if the customer has the option to the purchase the warranty separately. An entity accounts for a warranty as a cost accrual if it is not sold separately. However, if a warranty provides a customer with a service in addition to the assurance that the product complies with agreed specifications, that service is a separate performance obligation.

57. An entity that promises both a quality assurance and service-based warranty, but cannot reasonably separate the obligations and account for them separately, accounts for both warranties together as a separate performance obligation.

PwC observation: The exposure draft provides a practical expedient to accounting for warranties and is generally consistent with current guidance under US GAAP and IFRS. However, it might sometimes be difficult to separate a single warranty that provides both a standard warranty and a service. Determining the estimated stand-alone selling price for warranty-related services when such services are not sold separately could also be challenging.

Non-refundable upfront fees 58. Some entities charge a customer a non-refundable fee at the beginning of an arrangement. Examples may include setup fees, activation fees, or membership fees. Management needs to determine whether a non-refundable upfront fee relates to the transfer of a promised good or service to a customer. 59. A non-refundable upfront fee may relate to an activity undertaken at or near contract inception (for example, customer setup activities), but it does not indicate satisfaction of a separate performance obligation if the activity does not result in the transfer of a promised good or service to the customer. The upfront fee is recognised as revenue when goods or services are provided to the customer in the future.

.60 If the non-refundable upfront fee relates to a performance obligation, management needs to assess whether that performance obligation is distinct from the other performance obligations in the contract.

Recognise revenue when each performance obligation is satisfied 61. The proposed standard includes guidance on the following areas when considering when each performance obligation is satisfied: Bill-and-hold arrangements Consignment arrangements Sale and repurchase of a product

Bill-and-hold arrangements 62. Under a bill-and-hold arrangement, an entity bills a customer for a product but does not ship the product until a later date. Revenue is recognised on transfer of control of the goods to the customer. All of the following requirements must be met to conclude that the customer has obtained control in a bill-and-hold arrangement: The reason for the bill-and-hold

arrangement must be substantive; The product must be identified

separately as the customer's; The product must be ready for

delivery at the time and location specified by the customer; and


The entity cannot have the ability to sell the product to another customer.

63. Management also needs to consider whether the custodial services of storing the goods are a material separate performance obligation to which some of the transaction price should be allocated.

PwC observation: The proposed guidance and list of indicators for bill-and-hold transactions are generally consistent with the current guidance under IFRS. There may be situations where revenue is recognised earlier compared to current US GAAP for bill-and-hold arrangements because there is no longer a requirement for the vendor to have a fixed delivery schedule from the customer in order to recognise revenue.

Consignment arrangements 64. Certain industries transfer goods to dealers or distributors on a consignment basis. The transferor typically owns the inventory on consignment until a specified event occurs, such as the sale of the product to a customer of the distributor, or until a specified period expires. 65. Management needs to consider the following factors to determine whether revenue should be recognised on transfer to the distributor or on ultimate sale to the customer: Whether the distributor has an

unconditional obligation to pay for the goods; and

Whether the entity can require return of the product or transfer to another

distributor (which indicates that control has not transferred to the distributor).

PwC observation: The proposed standard requires management to determine when control of the product has transferred to the customer. If the customer (including a distributor) has control of the product, including a right of return at its discretion, revenue is recognised when the product is delivered to the customer/distributor. Any amounts related to expected sales returns or price concessions affect the amount of revenue (that is, the estimate of the transaction price), but not when revenue is recognised. An entity that is unable to estimate returns, however, would not recognise revenue until the return right lapses, similar to today’s model. The timing of revenue recognition could change for some entities compared to current guidance, which is more focused on the transfer of risks and rewards than the transfer of control. The transfer of risks and rewards is an indicator to assess in determining whether control has transferred under the proposed standard, but additional indicators will also need to be considered to determine whether control has transferred. If the entity is able to require the customer/distributor to return the product (that is, it has a call right), control has not transferred to the customer/distributor; therefore, revenue is only recognised when the products are sold to a third party.

Example 11.1

Sale of products on consignment: A consumer products entity provides household goods to a retailer on a consignment basis. The retailer does not take title to the products until they are scanned at the register. Any unsold products are returned to the consumer products entity. Once the retailer sells the products to the consumer, the consumer products entity has no further obligations with respect to the products, and the retailer has no further return rights. Management will need to assess whether the retailer has obtained control of the products, including whether the retailer has an unconditional obligation to pay the entity, absent a sale to the consumer. Revenue recognition prior to the sale to the consumer might not be appropriate. If the consumer products entity retains the right to call back unsold product, control has not transferred and revenue is recognised only when the product is sold to the consumer.


Sale and repurchase of a product 66. When an entity has an unconditional obligation or unconditional right to repurchase an asset (a forward or a call option), the buyer does not obtain control of the asset because the buyer does not have the ability to direct the use of and obtain substantially all of the remaining benefits from the asset. In this situation, an entity accounts for the transaction as follows: A lease, if the entity has the right or

obligation to repurchase the asset for less than the original sales price of the asset; and

A financing arrangement, if the entity has the right or obligation to repurchase the asset for an amount that is equal to or more than the original sales price of the asset.

67. The entity continues to recognise the asset in a financing arrangement and recognises a financial liability for any consideration received from the buyer. The difference between the amount of consideration received from the customer and the amount of consideration paid is interest expense.

68. When a customer has the right to require the entity to repurchase an asset (a put option), the arrangement should be accounted for as an operating lease (that is, the income is recorded over time) if the arrangement provides the customer a significant economic incentive to exercise that right, as the customer effectively pays for the right to use the asset over time. An arrangement is a financing if the repurchase price of the asset exceeds the original selling price and is more than the expected market value of the asset.

PwC observation: Management needs to assess the nature of a sale and repurchase arrangement to determine whether the arrangement should be accounted for as a lease, as this determination is critical to applying the appropriate accounting model. The boards decided that if an entity enters into a contract with a repurchase agreement at a price less than the original sales price and the customer does not obtain control of the asset, the contract is accounted for as a lease in accordance with IAS 17, ‘Leases’.

Contract costs 69. An entity recognises an asset for the incremental costs to obtain a contract that management expects to recover. Incremental costs of obtaining a contract are costs the entity would not have incurred if the contract had not been obtained (for example, sales commission). An entity is permitted to recognise the incremental cost of obtaining a contract as an expense when incurred if the amortisation period would be less than one year, as a practical expedient.

70. An entity recognises an asset for costs to fulfil a contract when specific criteria are met. Management will first need to evaluate whether the costs incurred to fulfil a contract are in the scope of other standards (for example, inventory, fixed assets, intangibles). Costs that are in the scope of other standards should be either expensed or capitalised as required by the relevant guidance.

71. If fulfilment costs are not in the scope of another standard, an entity recognises an asset only if the costs relate directly to a contract, will generate or enhance a resource that the entity will use to satisfy future performance obligations, and are expected to be recovered.

72. An asset recognised for the costs to obtain or costs to fulfil a contract should be amortised on a systematic basis as the goods or services to which the assets relate are transferred to the customer. An entity recognises an impairment loss to the extent that the carrying amounts of an asset recognised exceeds (a) the amount of consideration the entity expects to receive for the goods or services less (b) the remaining costs that relate directly to providing those goods or services.

PwC observation: Entities that currently expense all contract fulfilment costs as incurred might be affected by the proposed guidance since costs are required to be capitalised when the criteria are met. Fulfilment costs that are likely to be in the scope of this guidance include, among others, set-up costs for service providers and costs incurred in the design phase of construction projects.


The proposed standard requires entities to capitalise incremental costs to obtain a contract that management expects to recover. This may be different from current practice where entities have the option to expense contract acquisition costs as incurred, allowing for diversity in practice.

Onerous performance obligations 73. An entity recognises a liability and a corresponding expense if a performance obligation that is satisfied over a period of time greater than one year is onerous. A performance obligation is onerous if the lowest cost of settling the performance obligation exceeds the amount of the transaction price allocated to that performance obligation. The lowest cost of settling a performance obligation is the lower of (a) the amount the entity would pay to exit the performance obligation and (b) the costs that relate directly to satisfying the performance obligation by transferring the goods or services.

74. Performance obligations that are satisfied over a period of time less than a year are excluded from the onerous performance obligation assessment.

PwC observation: Limiting the need to assess onerous performance obligations to only those obligations satisfied over a period of time greater than one year is narrower in scope than what had been proposed in the 2010 exposure draft. However, some additional complexity may have been introduced, for example, in determining whether (a) a contract requires satisfaction of a series of distinct performance obligations or a single performance obligation over time and (b) management expects the contract to exceed one year. There may also be a number of challenges in determining the appropriate costs to consider in the assessment. Processes and controls will need to be updated to closely monitor performance obligations satisfied over time and associated costs remaining to satisfy those obligations. Management will need to pay particular attention to contracts with decreasing revenue streams and flat or increasing costs as performance obligations are satisfied over time. These performance obligations could become onerous even if the contract is profitable overall. The proposed guidance will also accelerate the recognition of losses for ‘loss leader’ contracts if such contracts include performance obligations satisfied over time.

Example 12.1

Onerous performance obligations A transportation entity signs a contract to provide ferry service for a local government. The contract requires the transportation entity to provide daily service for a three-year period at a fixed price per trip. Assume that there has been an unforeseen spike in fuel costs midway through the first year of the contract. Based on the current fuel costs, the contract is no longer profitable and the entity would have to pay a substantial penalty to terminate the contract early. The transportation entity will need to first assess whether the ferry service represents a series of individual distinct performance obligations per trip which are satisfied at a point in time, or whether the contract is one performance obligation that is satisfied over the three-year contract term. If management concludes that the ferry service is one performance obligation satisfied over a period of time beyond a year, it will be required to assess whether the performance obligation is onerous.


Disclosures 75. The exposure draft includes a number of proposed disclosure requirements intended to enable users of financial statements to understand the amount, timing and judgment around revenue recognition and corresponding cash flows arising from contracts with customers.

76. The required disclosures include qualitative and quantitative information about contracts with customers, such as significant judgments and changes in judgments made in accounting for those contracts, and assets recognised from the costs to obtain or fulfil those contracts. The following are some of the key disclosures from the proposed standard: The disaggregation of revenue into

primary categories that depict the nature, amount, timing and uncertainty of revenue and cash flows;

A tabular reconciliation of the movements of the assets recognised from the costs to obtain or fulfil a contract with a customer;

An analysis of the entity's remaining performance obligations including the nature of the goods and services to be provided, timing of satisfaction, and significant payment terms;

Information on onerous performance obligations and a tabular reconciliation of the movements in the corresponding liability for the current reporting period; and

Significant judgments and changes in judgments that affect the determination of the amount and timing of revenue from contracts with customers.

Interim disclosures 77. The boards propose to amend existing interim disclosure guidance to specify the disclosures about revenue from contracts with customers that an entity should provide in interim financial statements. If material, the disclosures that would be required include most of the disclosures required in the annual financial statements.

Non-public entity disclosures (US GAAP only) 78. A non-public entity may elect not to provide any of the following disclosures: A reconciliation of contract balances; The amount of the transaction price

allocated to remaining performance obligations and when the entity expects to recognise revenue on that amount;

A reconciliation of liability balances recognised from onerous performance obligations;

A reconciliation of asset balances recognised from the costs to obtain or fulfil a contract with a customer; and

An explanation of the judgments, and changes in judgments, used in determining the timing of satisfaction of performance obligations, determining the transaction price and allocating it to separate performance obligations.

Transition 79. The boards have not yet decided on the effective date of the proposed standard, except that it will be no sooner than annual periods beginning on or after January 1, 2015. Earlier adoption is not permitted under US GAAP, although it will be permitted under IFRS.

80. The proposed guidance will be applied retrospectively. However, an entity may use one or more of the following practical expedients: An entity can elect not to restate

contracts that begin and end within the same annual reporting period;

An entity may use the transaction price at the date the contract was completed rather than estimating variable consideration for contracts completed on or before the effective date;

An entity does not have to apply the onerous performance obligation test to performance obligations in comparative periods unless an onerous contract liability was recognised previously; and

An entity is not required to disclose the amount of the transaction price allocated to remaining performance obligations with an explanation on the timing of revenue recognition (the so-called ‘maturity analysis’).


Next steps 81. The comment period for the exposure draft ends on 13 March 2012. The boards continue to perform targeted consultation with key industries and other interested parties regarding some of the more significant changes. It is unclear when a final standard will be issued; however, the boards have indicated that the final standard will have an effective date no earlier than 2015.


Appendix Key differences between the 2010 and 2011 exposure drafts

Topic 2010 exposure draft1 2011 exposure draft

2

Combining

contracts

An entity should combine two or more

contracts if the prices of those contracts are

interdependent.

An entity may need to combine two or more contracts entered into at or near the same time with the same customer if one or more of the following criteria are met:

The contract is negotiated with a single commercial objective

The amount of consideration paid in one contract depends on the other contract

The goods or services promised between the contracts are a single performance obligation

Segmenting contracts

A single contract should be segmented into two or more contracts if some goods or services within the contract are independently priced from other goods or services in that contract.

The contract segmentation guidance has been removed from the proposed standard. An entity should identify separate performance obligations in a contract.

Contract modifications

A contract modification is combined with the original contract if the prices of the original contract and the modification are interdependent (that is, treat the modification and original contract as one contract).

A contract modification is treated as a separate contract only if it results in the addition of a separate performance obligation and the price is reflective of the stand-alone selling price of that additional performance obligation.

1 Refers to the exposure draft issued on 24 June 2010

2 Refers to the exposure draft issued on 14 November 2011

(1) Identify the contract(s) with

the customer

(2) Identify and separate

performance obligations

(3) Determine the transaction price

(4) Allocate the transaction price

(5) Recognize revenue when a

performance obligation is

satisfied


Topic 2010 exposure draft 2011 exposure draft

Performance

obligations

Performance obligations are enforceable promises (whether explicit or implicit) in a contract with a customer to transfer a good or service to the customer.

Performance obligations are promises in a contract to transfer goods or services to a customer. The term enforceable was removed from the definition in the proposed standard.

Identification of

separate

performance

obligations

An entity recognises revenue from performance obligations separately if the goods or services are distinct. A good or service is distinct if an entity sells an identical or similar good or service separately. A good or service that has a distinct function and a distinct profit margin from the other goods or services in the contract is also distinct, even if not sold separately.

A separate performance obligation exists if the goods or services are ‘distinct.’ Goods or services are ‘distinct’ if:

The entity regularly sells the good or service separately

The customer can use the good or service on its own or together with resources readily available to the customer.

A bundle of goods or services is accounted for together as one performance obligation if both of the following criteria are met:

The goods and services are highly interrelated and the entity provides a significant service of integrating goods and services into the combined item that the customer has contracted for

The entity is contracted by the customer to significantly modify or customise the goods or services

Warranties Revenue is deferred for warranties that require replacement or repair of components of an item, but only for the portion of revenue attributable to the components that must be repaired or replaced.

Warranties that provide the customer with coverage for faults that arise after the entity transfers control to the customer give rise to a separate performance obligation.

Warranties that the customer has the option to purchase separately are accounted for as a separate performance obligation.

An entity should account for a warranty as a cost accrual if it is not sold separately and the warranty does not provide a service in addition to a standard warranty.

An entity that promises both a quality assurance and service-based warranty but cannot reasonably separate them, should account for both as separate performance obligations.


the customer







satisfied



Variable

consideration

The transaction price is the consideration that the entity expects to receive from the customer. The transaction price includes the probability-weighted estimate of variable consideration when management can make a reasonable estimate of the amount to be received. An estimate is reasonable only if an entity:

has experience with similar types of contracts, and

does not expect circumstances surrounding those types of contracts to change significantly.

The transaction price is the consideration that the entity is entitled to under the contract, including variable or uncertain consideration. It is based on the probability-weighted estimate or most likely amount of cash flows entitled from the transaction, depending on which is most predictive of the amount to which the entity is entitled. Revenue on variable consideration is only recognised when the entity is ‘reasonably assured’ to be entitled to it.

Collectibility Collectibility is not a hurdle to recognition of revenue. The transaction price is adjusted to reflect the customer's credit risk by recognising the consideration expected to be received using a probability-weighted approach. Changes in the assessment of consideration to be received due to changes in credit risk are recognised as income or expense, separately from revenue.

Collectibility of the transaction price is not a hurdle to revenue recognition. The transaction price is presented without adjustment for credit risk. An allowance for the expected impairment loss on receivables is presented in a separate line item adjacent to revenue. Both the initial impairment assessment and any subsequent changes in the estimate of collectibility are recorded in this line (if the contract does not have a significant financing component).

Time value of money

The transaction price reflects the time value of money whenever the contract includes a material financing component.

The transaction price should reflect the time value of money when the contract includes a significant financing component. As a practical expedient, an entity is not required to reflect the effects of the time value of money in the measurement of the transaction price when the period between payment by the customer and the transfer of the goods or services is less than one year.


the customer







satisfied



Allocation method The transaction price is allocated to separate performance obligations based on the relative stand-alone selling price of the performance obligations in the contract.

An entity may not use the residual method to allocate the transaction price.

The transaction price is allocated to separate performance obligations based on the relative stand-alone selling price of the performance obligations in the contract. A residual value approach may be used as a method to estimate the stand-alone selling price when there is significant variability or uncertainty in the selling price of a good or service, regardless of whether that good or service is delivered at the beginning or end of the contract. Some elements of the transaction price, such as uncertain consideration, discounts or change orders, may be allocated to only one performance obligation rather than all performance obligations in the contract under certain circumstances.

Breakage An entity should consider the impact of breakage (forfeitures) in determining the transaction price allocated to the performance obligations in the contract.

The entity should recognise the effects of the expected breakage as revenue in proportion to the pattern of rights exercised by the customer if the amount of expected breakage is reasonably assured.

The entity should recognise the effects of the expected breakage when the likelihood of the customer exercising its remaining rights becomes remote, if the amount of breakage is not reasonably assured.


the customer







satisfied



Transfer of goods Revenue is recognised when a promised good or service is transferred to the customer. An entity transfers a promised good or service and satisfies a performance obligation when the customer obtains control of that good or service. A customer obtains control of a good or service if it has the ability to direct the use of and receive the benefit from the good or service. Performance obligations can be satisfied at a point in time or continuously over time. Indicators that the customer has obtained control of the good or service may include:

The customer has an unconditional obligation to pay

The customer has legal title

The customer has physical possession

The customer specifies the design or function of the good or service

An entity recognises revenue for the sale of a good when the customer obtains control of the good. Indicators that the customer has obtained control of the good include:

The customer has an unconditional obligation to pay

The customer has legal title

The customer has physical possession

The customer has risks and rewards of ownership

The customer provided evidence of acceptance

Continuous transfer of goods and services

The exposure draft had no specific guidance for services. The guidance was the same as the guidance for goods above.

An entity must determine if a performance obligation is satisfied continuously to determine when to recognise revenue for certain performance obligations. The entity should then select a method for measuring progress in satisfying that performance obligation. An entity should recognise revenue for performance obligations satisfied continuously only if the entity can reasonably measure its progress toward completion. A performance obligation is satisfied continuously if (a) the entity's performance creates or enhances an asset that the customer controls, or (b) the entity's performance does not create an asset with alternative use to the entity but one of the following criteria is met:


the customer







satisfied



The customer simultaneously receives and consumes the benefits of the entity’s performance as it performs

Another entity would not need to substantially re-perform the task(s) if that other entity were required to fulfil the remaining obligation to the customer

The entity has a right to payment for performance completed to date and it expects to fulfil the contract

Measuring progress of satisfying a performance obligation

Methods for recognising revenue when control transfers continuously include:

Output methods that recognise revenue on the basis of units produced, units delivered, contract milestones, or surveys of work performed

Input methods that recognise revenue on the basis of costs incurred, labour hours expended, or machine hours used

Methods based on the passage of time

The objective is to faithfully depict the pattern of transfer of the goods or services to the customer. Methods for recognising revenue when control transfers continuously include:

Output methods that recognise revenue on the basis of the value of the entity's performance to date (for example, surveys of goods or services transferred to date, appraisals of results achieved)

Input methods that recognise revenue on the basis of inputs to the satisfaction of a performance obligation (for example, time, units delivered, resources consumed, labor hours expended, costs incurred, and machine hours used)

An entity may select an appropriate input method if an output method is not directly observable or available to an entity without undue cost. The effects of any inputs that do not represent the transfer of goods or services to the customer, such as abnormal amounts of wasted materials, should be excluded from the measurement of progress. It may be appropriate to measure progress by recognising revenue equal to the costs of the transferred goods if the costs of goods are significant and transferred at a significantly different time from the related service (such as materials the customer controls before the entity installs the materials).



Constraint on recognising revenue

Amounts are only included in the transaction price allocated to performance obligations if they can be ‘reasonably estimated.’

Revenue is recognised when the performance obligation is satisfied and the entity is ‘reasonably assured’ to be entitled to the transaction price allocated to that performance obligation. An entity is reasonably assured to be entitled to variable consideration if both of the following criteria are met:

The entity has experience with similar types of performance obligations

The entity's experience is predictive of the amount of consideration to which the entity will be entitled in exchange for satisfying those performance obligations

There is an exception regarding licences to use intellectual property in exchange for royalties based on the customer's subsequent sales of a good or service. The related variable consideration only becomes reasonably assured once those future sales occur.

Licences and rights to use

The contract is a sale of intellectual property if the customer obtains control of the entire licensed intellectual property (for example, the exclusive right to use the licence for its economic life). The performance obligation is satisfied over the term of the licence if the customer licences intellectual property on an exclusive basis but does not obtain control for the entire economic life of the property. A contract that provides a nonexclusive licence to use intellectual property (for example, off-the-shelf software) is a single performance obligation. An entity recognises revenue when the customer is able to use the licence and benefit from it.

The promised rights are a performance

obligation that the entity satisfies when the

customer obtains control (that is, the use

and benefit) of those rights. An entity should consider whether the rights give rise to a separate performance obligation or whether the rights should be combined with other performance obligations in the contract.



Costs of obtaining a contract

An entity recognises costs to obtain a contract (for example, costs of selling, marketing, or advertising) as incurred.

Costs to obtain a contract should be recognised as an asset if they are incremental and expected to be recovered. Incremental costs of obtaining a contract are costs that the entity would not have incurred if the contract had not been obtained.

Costs of fulfilling a contract

An entity may capitalise the costs to fulfil a contract in certain circumstances. Management will need to evaluate whether the costs incurred in fulfilling a contract are in the scope of other standards (for example, inventory, fixed assets, intangibles) to determine which costs may be recognised as an asset. An entity should recognise an asset for costs that are not within the scope of another standard only if the costs relate directly to a contract, will generate or enhance a resource that the entity will use to satisfy future performance obligations in a contract, and are expected to be recovered under a contract.

Costs to fulfil a contract are in the scope of the proposed guidance only if those costs are not addressed by other standards. Costs required to be expensed by other standards cannot be capitalised under the proposed guidance. An entity should recognise an asset for costs that are not within the scope of another standard only if the costs relate directly to a contract, will generate or enhance a resource that the entity will use to satisfy future performance obligations in a contract, and are expected to be recovered under a contract. An entity amortises an asset recognised for fulfilment costs in accordance with the transfer of goods or services to which the asset relates, which might include goods or services to be provided in future anticipated contracts.

Onerous performance obligations

A performance obligation is onerous when the present value of the probability-weighted direct costs to satisfy the obligation exceed the consideration (that is, the amount of transaction price) allocated to it.

An entity should recognise a liability and corresponding expense if a performance obligation that is satisfied over a period of time is onerous. The performance obligation will not need to be assessed if it is satisfied over a period less than one year.

A performance obligation is onerous if the lowest cost of settling the performance obligation exceeds the amount of transaction price allocated.

The lowest cost of settling a performance obligation is the lower of the following:

The costs directly related to satisfying the performance obligation

The amount the entity would have to pay to exit the performance obligation

Other considerations



Sale and

repurchase

agreements (‘put

options’)

An entity should account for the transaction as a sale of a product with a right of return when it sells a product to a customer that includes an unconditional right to require the entity to repurchase that product in the future.

Arrangements where a customer has the right to require the entity to repurchase an asset (a put option) should be accounted for as a lease under the leasing standard if the arrangement represents a right to use the asset over time rather than a sale.

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. It does not take into account any

objectives, financial situation or needs of any recipient; any recipient should not act upon the information contained in this publication without obtaining independent

professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication,

and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of

care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

© 2011 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International

Limited, each of which is a separate and independent legal entity.

pwc.com/ifrs Practical guide to IFRS · 2015-06-03 · Practical guide to IFRS – Revenue from...

Documents

Transcript of pwc.com/ifrs Practical guide to IFRS · 2015-06-03 · Practical guide to IFRS – Revenue from...