IFRS 15 Revenue from Contracts with Customers to take effect from 1 January 2018
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Last week we wrote about the new standard for financial instruments
, but that’s not the only important development in 2018. With effect from 1 January, IFRS 15 Revenue from Contracts with Customers
is replacing IAS 18 Revenue
and IAS 11 Construction Contracts
as well as outlining a single approach to accounting for revenue. This article explores the new IFRS 15.
The new standard will be mandatory for Latvian entities that prepare their financial statements to IFRS or whose parents require that financial information be prepared to IFRS for group reporting purposes.
The standard will mostly affect entities that provide telecommunication or IT services, engage in construction, or offer more customer loyalty programmes. However, other entities should also carefully evaluate their goods or service offerings to find out whether the new standard will affect the way they recognise and account for revenue.
The standard sorts out the revenue recognition process by laying down five steps:
First of all the entity should identify the contract with the customer. A contract for the purposes of IFRS 15 can be written, oral, or established by practice, but it should be commercially sound and accepted by both parties, and the parties should be able to perform it. The standard offers examples where multiple interrelated contracts that are entered into separately should be accounted for as a single contract.
After identifying the contract, the performance obligations to sell goods or provide services should be identified. Each performance obligation in the contract should be accounted for separately as long as it is capable of separation (i.e. a performance obligation from which the customer can benefit separately and which is not highly dependent on or related to other goods or services in the contract). Accurate identification of the performance obligations is crucial because all revenue will be recognised for each obligation separately.
After identifying the contract and the performance obligations, the transaction price should be determined. With a fixed price this determination is relatively easy to make. Where a contract contains elements of variable consideration, the entity should estimate the amount of variable consideration and recognise it to the extent that no substantial reduction in that amount is expected in the future. Like the current rules, the new standard provides for considering any changes in monetary value over time, and so discounted values should be recognised for all payment periods exceeding one year. Credit risk (provision for impairment loss) as a cost should be recorded separately and measured according to IFRS 9.
Once the transaction price has been determined, it should be allocated to each performance obligation in the contract. The new standard recommends an allocation method that is based on the relative standalone selling price (taking the market price of goods or services and proportionally allocating the overall discount between performance obligations). Other allocation methods can be used only where market prices either cannot be identified or are highly volatile.
The actual recognition of revenue in the new standard is based on control – risks associated with ownership. Returns are ranked among other significant indicators of control. Recognition over time applies to any revenue where the customer has already received a benefit during performance of the service and no repeat performance is necessary (e.g. cleaning a room), where an asset is created or a customer’s asset improved (e.g. erecting a building on a customer’s land or installing technical equipment in a customer’s building), or where the seller does not create an asset with an alternative use and is entitled to the full payment for performance completed to date (e.g. specific consulting services or erecting a building according to the customer’s plans). Revenue performance over time can be measured under the revenue or cost method. Other revenue is mostly recognised at a point in time – when complete control over goods is transferred or a service completed.
The standard also offers explanations for contract cost capitalisation, licensing transactions, non-financial asset transfers outside the entity’s core activity (e.g. fixed-asset sales) and principles for determining an agent-principal relationship.
The standard can be applied either retrospectively, which involves filing the financial statements for 2018 with the figures for 2017 recalculated to IFRS 15, or retrospectively in a modified way, which involves filing the financial statements for 2018 with details of revenue for 2018 according to IAS 18 and IAS 11 as well as IFRS 15 in parallel.