Do IFRS 15 require more information than IAS 18? Would its accounting be a troublesome for Accountants?

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:

• • You’ll need to apply IFRS for reporting periods beginning on or after1 January (early application permitted);
  • IFRS will replace the following standards and interpretations:
    • IAS Revenue,
    • IAS Construction Contracts
    • SIC Revenue – Barter Transaction Involving Advertising Services
    • IFRIC Customer Loyalty Programs
    • IFRIC Agreements for the Construction of Real Estate and
    • IFRIC Transfer of Assets from Customers
  • The core principle of IFRS is that an entity will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration (payment) to which the entity expects to be entitled in exchange for those goods or services.   To apply this principle, you need to follow a five-step model framework described below.

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• IFRS contains guidance for transactions not previously addressed (service revenue, contract modifications);
• IFRS improves guidance for multiple-element arrangements;
• IFRS requires enhanced disclosures about revenue.

 

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:

• Step1: Identify the contract(s) with a customer.   IFRS defines a contract as an agreement between two or more parties that creates enforceable rights and obligations and sets out the criteria for every contract that must be met.
• Step2: Identify the performance obligations in the contract.   A performance obligationis a promise in a contract with a customer to transfer a good or service to the customer.
• Step3: Determine the transaction price.  The transaction price is the amount of consideration (for example, payment) to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties.
• Step4: Allocate the transaction price to the performance obligations in the contract.

  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.

• Step5: Recognize revenue when (or as) the entity satisfies a 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:

• Johnny’s monthly fixed fee is CU.
• Johnny receives a free handset at the inception of the plan.

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.    

Revenue under IAS

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.

Revenue under IFRS

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):

1. Obligation to deliver a handset
2. Obligation to deliver network services over1 year

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:

• When ABC gives a handset to Johnny, it needs to recognize the revenue of CU.;
• When ABC provides network services to Johnny, it needs to recognize the total revenue of CU.. It’s practical to do it once per month as the billing happens.

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 revenue

So as you can see, Johnny effectively pays not only for network services, but also for his handset.