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IFRS Revenue from Contracts with Customers
New revenue recognition standard was issued: IFRS Revenue from Contracts with Customers and it should fill the gap between IFRS and US GAAP.
FASB (the US GAAP standard setting body) issued the new revenue recognition standard, too: Topic, which is almost a mirror of IFRS (full text of Topic is here).
Although I’ll cover this standard in one of my videos in the following months, here are the basic points for your information:
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Five-Step Model Framework
Every company must follow the five-step model in order to comply with IFRS. We’ll not go into details, just let me brief you a bit:
For a contract that has more than one performance obligation, an entity should allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each performance obligation.
Example: IAS vs. IFRS
Johnny enters into a-month telecom plan with the local mobile operator ABC. The terms of plan are as follows:
ABC sells the same handsets for CU and the same monthly prepayment plans without handset for CU/month.
How should ABC recognize the revenues from this plan in line with IAS and IFRS?
OK, let’s ignore a couple of things here, like a price of a SIM kit, or the situations when Johnny hangs on the phone for hours and spends some minutes in excess of his plan. Let’s focus just on these2 things.
Current rules of IAS say that ABC should apply the recognition criteria to the separately identifiable components of a single transaction (here: handset + monthly plan).
However, IAS does not give any guidance on how to identify these components and how to allocate selling price and as a result, there were different practices applied.
For example, telecom companies recognized revenue from the sale of monthly plans in full as the service was provided, and no revenue for handset – they treated the cost of handset as the cost of acquiring the customer.
Some companies identified these components, but then limited the revenue allocated to the sale of handset to the amount received from customer (zero in this case). This is a certain form of a residual method (based on US GAAP’s cash cap method).
For the simplicity, let’s assume that ABC recognizes no revenue from the sale of handset, because ABC gives it away for free. The cost of handset is recognized to profit or loss and effectively, ABC treats that as a cost of acquiring new customer.
Revenue from monthly plan is recognized on a monthly basis. The journal entry is to debit receivables or cash and credit revenues with CU.
Under new rules in IFRS, ABC needs to identify the contract first (step1), which is obvious here as there’s a clear-month plan with Johnny.
Then, ABC needs to identify all performance obligations from the contract with Johnny (step2 in a5-step model):
The transaction price (step3) is CU, calculated as monthly fee of CU times months.
Now, ABC needs to allocate that transaction price of CU to individual performance obligations under the contract based on their relative stand-alone selling prices (or their estimates) – this is step4.
I made it really simple for you here, so let’s do it in the following table:
Performance obligation Stand-alone selling price % on total Revenue (=relative selling price =*%) Handset . .8% . Network services . (=*) .2% . Total . .0% .The step5 is to recognize the revenue when ABC satisfies the performance obligations. Therefore:
The journal entries are summarized in the following table:
Description Amount Debit Credit When Sale of handset . FP – Unbilled revenue P/L – Revenue from sale of goods When handset is given to Johnny Network services . (= monthly billing to Johnny) FP – Receivable to Johnny When network services are provided; on a monthly basis according to contract with Johnny . (=./) P/L – Revenue from network services . (=./) FP – Unbilled revenueSo as you can see, Johnny effectively pays not only for network services, but also for his handset.