Revenue from contracts with customers

Revenue is income arising in the course of an entity's ordinary activities.

• ‘Ordinary activities’ means normal trading or operating activities.
• ‘Revenue’ presented in the statement of profit or loss should not include items such as
proceeds from the sale of non-current assets or sales tax.
Revenue recognition
A five step process
IFRS 15 Revenue from Contracts with Customers (para IN7) says that an entity recognises
revenue by applying the following five steps:
(1) 'Identify the contract
(2) Identify the separate performance obligations within a contract
(3) Determine the transaction price
(4) Allocate the transaction price to the performance obligations in the contract
(5) Recognise revenue when (or as) a performance obligation is satisfied.'

Revenue recognition
On 1 December 20X1, Wade receives an order from a customer for a computer as well as 12
months' of technical support. Wade delivers the computer (and transfers its legal title) to the
customer on the same day.
The customer paid $420 upfront. If sold individually, the selling price of the computer is $300
and the selling price of the technical support is $120.
Required:
Apply the 5 stages of revenue recognition, per IFRS 15, to determine how much revenue Wade
should recognise in the year ended 31 December 20X1.

Step 1 – Identify the contract

There is an agreement between Wade and its customer for the provision of goods and services.
Step 2 – Identify the separate performance obligations within a contract
There are two performance obligations (promises) within the contract:
• The supply of a computer
• The supply of technical support
Step 3 – Determine the transaction price
The total transaction price is $420.
Step 4 – Allocate the transaction price to the performance obligations in the contract
Based on standalone selling prices, $300 should be allocated to the sale of the computer and
$120 should be allocated to the technical support.
Step 5 – Recognise revenue when (or as) a performance obligation is satisfied Control over the
computer has been passed to the customer so the full revenue of $300 allocated to the supply
of the computer should be recognised on 1 December 20X1.
The technical support is provided over time, so the revenue allocated to this should be
recognised over time. In the year ended 31 December 20X1, revenue of $10 (1/12 × $120)
should be recognised from the provision of technical support.
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should be recognised from the provision of technical support.
The five steps of revenue recognition will now be considered in more detail.
Step 1: Identify the contract
IFRS 15 says that a contract is an agreement between two parties that creates rights and
obligations. A contract does not need to be written. An entity can only account for revenue
from a contract if it meets the following criteria:
• the parties have approved the contract and each party’s rights can be identified
• payment terms can be identified
• the contract has commercial substance
• it is probable that the entity will be paid

Step 2: Identifying the separate performance obligations within a contract

Performance obligations are promises to transfer distinct goods or services to a customer.
Some contracts contain more than one performance obligation. For example:
• An entity may enter into a contract with a customer to sell a car, which includes one year’s
free servicing and maintenance.
• An entity might enter into a contract with a customer to provide 5 lectures, as well as to
provide a textbook on the first day of the course.

The distinct performance obligations within a contract must be identified. If goods or services
are regularly sold separately then the supply of each is likely to form a distinct performance
obligation if included within the same contract.
Principals and agents
An entity must decide the nature of each performance obligation. IFRS 15 (para B34) says this
might be:
• 'to provide the specified goods or service itself (i.e. it is the principal), or
• to arrange for another party to provide the goods or service (i.e. it is an agent)'.
If an entity is an agent, then revenue will be recognised based on the fee it is entitled to.
Warranties
Most of the time, a warranty is assurance that a product will function as intended. If this is the
case, then the warranty will be accounted for in accordance with lAS 37 Provisions, Contingent
Liabilities and Contingent Assets.
If the customer has the option to purchase the warranty separately, then it should be treated
as a distinct performance obligation. This means that a portion of the transaction price must be
allocated to it see step 4).
Step 3: Determining the transaction price
IFRS 15 defines the transaction price as the amount of consideration the entity expects in
exchange for satisfying a performance obligation. Sales tax is excluded.
When determining the transaction price, the following must be considered:
• variable consideration
• significant financing components
• non-cash consideration
• consideration payable to a customer.
Variable consideration
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• consideration payable to a customer.
Variable consideration
If a contract includes variable consideration then an entity must estimate the amount it will be
entitled to. IFRS 15 says that this estimate 'can only be included in the transaction
price if it is highly probable that a significant reversal in the amount of cumulative revenue
recognised will not occur when the uncertainty is resolved' (IFRS 15, para 56).
Note that if a product is sold with a right to return it then the consideration is
variable. The entity must estimate the variable consideration and decide
whether or not to include it in the transaction price.
The refund liability should equal the consideration received (or receivable) that the entity does
not expect to be entitled to.
Financing
In determining the transaction price, an entity must consider if the timing of payments
provides the customer or the entity with a financing benefit. IFRS 15 provides the following
indications of a significant financing component:
• the difference between the amount of promised consideration and the cash selling price of
the promised goods or services
• the length of time between the transfer of the promised goods or services to the customer
and the payment date
If there is a financing component, then the consideration receivable needs to be discounted to
present value using the rate at which the customer borrows money
Non-cash consideration
Any non-cash consideration is measured at fair value.
If the fair value of non-cash consideration cannot be estimated reliably then the transaction is
measured using the stand-alone selling price of the good or services promised to the customer
Consideration payable to a customer
If consideration is paid to a customer in exchange for a distinct good or service, then it should
be accounted for as a purchase transaction.
Assuming that the consideration paid to a customer is not in exchange for a distinct good or
service, an entity should account for it as a reduction of the transaction price
Step 4: Allocate the transaction price
The total transaction price should be allocated to each performance obligation in proportion to
stand-alone selling prices. The best evidence of a stand-alone selling price is the observable
price when the good or service is sold separately.
If a stand-alone selling price is not directly observable then it must be estimated. Observable
inputs should be maximised whenever possible.
If a customer is offered a discount for purchasing a bundle of goods and services, then the
discount should be allocated across all performance obligations within the contract in
proportion to their stand-alone selling prices (unless observable evidence suggests that this
would be inaccurate).
Step 5: Recognise revenue
Revenue is recognised when (or as) the entity satisfies a performance obligation by transferring
a promised good or service to a customer.
An entity must determine at contract inception whether it satisfies the performance obligation

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An entity must determine at contract inception whether it satisfies the performance obligation
over time or satisfies the performance obligation at a point in time.
IFRS 15 (para 35) states that an entity satisfies a performance obligation over time if one of the
following criteria is met:
(a) 'the customer simultaneously receives and consumes the benefits provided by the entity’s
performance as the entity performs
(b) the entity’s performance creates or enhances an asset (for example, work in progress) that
the customer controls as the asset is created or enhanced, or (c) the entity’s performance does
not create an asset with an alternative use to the entity and the entity has an enforceable right
to payment for performance completed to date'

If a performance obligation is satisfied over time, then revenue is recognised over time based
on progress towards the satisfaction of that performance obligation
Methods of measuring progress towards satisfaction of a performance obligation include:
• output methods (such as surveys of performance, or time elapsed)
• input methods (such as costs incurred as a proportion of total expected costs).
If progress cannot be reliably measured then revenue can only be recognised up to the
recoverable costs incurred.
If a performance obligation is not satisfied over time then it is satisfied at a point in time. The
entity must determine the point in time at which a customer obtains control of a promised
asset.
An entity controls an asset if it can direct its use and obtain most of its remaining benefits.
Control also includes the ability to prevent other entities from obtaining benefits from an asset
IFRS 15 (para 38) provides the following indicators of the transfer of control:
• 'The entity has a present right to payment for the asset
• The customer has legal title to the asset
• The entity has transferred physical possession of the asset
• The customer has the significant risks and rewards of ownership of the asset
• The customer has accepted the asset'.
Contract costs
IFRS 15 says that the following costs must be capitalised:
• The costs of obtaining a contract. This must exclude costs that would have been incurred
regardless of whether the contract was obtained or not (such as some legal fees, or the costs of
travelling to a tender).
• The costs of fulfilling a contract if they do not fall within the scope of another standard (such
as IAS 2 Inventories) and the entity expects them to be recovered
The capitalised costs of obtaining and fulfilling a contract will be amortised to the statement of
profit or loss as revenue is recognised.
Disclosures
IFRS 15 requires an entity to disclose:
• revenue recognised from contracts with customers
• contract balances and assets recognised from costs incurred obtaining or fulfilling contracts
• significant judgements used, and any changes in judgements.
Judgement
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• significant judgements used, and any changes in judgements.
Judgement
Management judgement is required throughout all five steps of revenue
recognition. For example:
• Contracts with customers do not need to be in writing but may arise through customary
business practice. An entity must therefore ascertain whether it has a constructive obligation
to deliver a good or service to a customer.
• A contract can only be accounted for if it is probable that the entity will collect the
consideration that it is entitled to. Whether benefits are probable is, ultimately, a judgement.
• The identification of distinct performance obligations thus relies on management judgement
about both contract terms, and the
impact of the entity’s past behaviour on customer expectations.
• Variable consideration should be included in the transaction price if it is highly probable that
a significant reversal in the amount of cumulative revenue recognised to date will not occur.
This may involve making judgements about whether performance related targets will be met.
• The transaction price must be allocated to distinct performance obligations, based on
observable, standalone selling prices. However, estimation techniques must be used if
observable prices are not available.
• If a performance obligation is satisfied over time, revenue is ecognised based on progress
towards the completion of the performance obligation. There are various ways to measure
completion, using either input or output methods, and the entity must determine which one
most faithfully represents the transaction.
These judgements increase the risk that the management of an entity could manipulate its
profits. Adherence to the ACCA ethical code is, therefore,
vital.

Step 1: Identify the contract

Aluna has a year end of 31 December 20X1.
On 30 September 20X1, Aluna signed a contract with a customer to provide them with an asset
on 31 December 20X1. Control over the asset passed to the customer on 31 December 20X1.
The customer will pay $1 million on 30 June 20X2.
By 31 December 20X1, as a result of changes in the economic climate, Aluna did not believe it
was probable that it would collect the consideration that it was entitled to. Therefore, the
contract cannot be accounted for and no revenue should be recognised.
Step 2: Identifying the separate performance obligations within a contract
Variable consideration
On 1 December 20X1, Bristow provides a service to a customer for the next 12 months. The
consideration is $12 million. Bristow is entitled to an extra $3 million if, after twelve months,
the number of mistakes made falls below a certain threshold.
Required:
Discuss the accounting treatment of the above in Bristow’s financial statements for the year
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Discuss the accounting treatment of the above in Bristow’s financial statements for the year
ended 31 December 20X1 if:
(a) Bristow has experience of providing identical services in the past and it is highly probable
that the number of mistakes made will fall below the acceptable threshold.
(b) Bristow has no experience of providing this service and is unsure if the number of mistakes
made will fall below the threshold.

The $12 million consideration is fixed. The $3 million consideration that is dependent on the
number of mistakes made is variable. Bristow must estimate the variable consideration. It
could use an expected value or a most likely amount. Since there are only two outcomes, $0 or
$3 million, then a most likely amount would better predict the entitled consideration
(a) Bristow expects to hit the target. Using a most likely amount, the variable consideration
would be valued at $3 million Bristow must then decide whether to include the estimate of
variable
consideration in the transaction price.
Based on past experience, it seems highly probable that a significant reversal in revenue
recognised would not occur. This means that the transaction price is $15 million ($12m + $3m).
As a service, it is likely that the performance obligation would be satisfied over time. The
revenue recognised in the year ended 31 December 20X1 would therefore be $1.25 million
($15m × 1/12).
(b) Depending on the estimated likelihood of hitting the target, the variable consideration
would either be estimated to be $0 or $3 million
Whatever the amount, the estimated variable consideration cannot be included in the
transaction price because it is not highly probable that a significant reversal in revenue would
not occur. This is because Bristow has no experience of providing this service. Therefore, the
transaction price is $12 million.
As a service, it is likely that the performance obligation would be satisfied over time. The
revenue recognised in the year ended 31 December 20X1 would be $1 million ($12m × 1/12).

Step 2: Identifying the separate performance obligations within a contract

Nardone enters into 50 contracts with customers. Each contract includes the sale of one
product for $1,000. The cost to Nardone of each product is $400. Cash is received upfront and
control of the product transfers on delivery. Customers can return the product within 30 days
to receive a full refund. Nardone can sell the returned products at a profit.
Nardone has significant experience in estimating returns for this product. It estimates that 48
products will not be returned.

The fact that the customer can return the product means that the consideration is variable.
Using an expected value method, the estimated variable consideration is $48,000 (48 products
× $1,000). The variable consideration should be included in the transaction price because,
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× $1,000). The variable consideration should be included in the transaction price because,
based on Nardone’s experience, it is highly probable that a significant reversal in the
cumulative amount of revenue recognised ($48,000) will not occur.
Therefore, revenue of $48,000 and a refund liability of $2,000 ($1,000 × 2 products expected to
be returned) should be recognised.
Nardone will derecognise the inventory transferred to its customers. However, it should
recognise an asset of $800 (2 products × $400), as well as a corresponding credit to cost of
sales, for its right to recover products from customers on settling the refund liability.
Financing
Rudd enters into a contract with a customer to sell equipment on 31 December 20X1. Control
of the equipment transfers to the customer on that date. The price stated in the contract is $1
million and is due on 31 December 20X3.
Market rates of interest available to this particular customer are 10%.
Required:
Explain how this transaction should be accounted for in the financial statements of Rudd for
the year ended 31 December 20X1.

Due to the length of time between the transfer of control of the asset and the payment date,
this contract includes a significant financing component.
The consideration must be adjusted for the impact of the financing transaction. A discount rate
should be used that reflects the characteristics of the customer i.e. 10%.
Revenue should be recognised when the performance obligation satisfied. As such revenue,
and a corresponding receivable, should be recognised at $826,446 ($1m × 1/1.102) on 31
December 20X1.
The receivable is subsequently accounted for in accordance with IFRS 9 Financial Instruments.

Non-cash consideration
Dan sells a good to Stan. Control over the good is transferred on 1 January 20X1. The
consideration received by Dan is 1,000 shares in Stan with a fair value of $4 each. By 31
December 20X1, the shares in Stan have a fair value of $5 each.
Required:
How much revenue should be recognised from this transaction in the financial statements of
Dan for the year ended 31 December 20X1?
The contract contains a single performance obligation. Consideration for the transaction is non-
cash. Non-cash consideration is measured at fair value.
Revenue should be recognised at $4,000 (1,000 shares × $4) on 1 January 20X1.
Any subsequent change in the fair value of the shares received is not recognised within
revenue but instead accounted for in accordance with IFRS 9 Financial Instruments
Consideration payable to a customer
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Consideration payable to a customer
Golden Gate enters into a contract with a major chain of retail stores. The customer commits
to buy at least $20 million of products over the next 12 months. The terms of the contract
require Golden Gate to make a payment of $1 million to compensate the customer for changes
that it will need to make to its retail stores to accommodate the products. By the 31 December
20X1, Golden Gate has transferred products with a sales value of $4 million to the customer.
Required
How much revenue should be recognised by Golden Gate in the year ended 31 December 20X1

The payment made to the customer is not in exchange for a distinct good or service. Therefore,
the $1 million paid to the customer must be treated as a reduction in the transaction price.
The total transaction price is essentially being reduced by 5% ($1m/$20m). Therefore, Golden
Gate reduces the price allocated to each good by 5% as it is transferred.
By 31 December 20X1, Golden Gate should have recognised revenue of $3.8 million ($4m ×
95%).
Step 4: Allocate the transaction price
Shred sells a machine and one year’s free technical support for $100,000. The sale of the
machine and the provision of technical support have been identified as separate performance
obligations. Shred usually sells the machine for $95,000 but it has not yet started selling
technical support for this machine as a stand-alone product. Other support services
offered by Shred attract a mark-up of 50%. It is expected that the technical support will cost
Shred $20,000.
Required:
How much of the transaction price should be allocated to the machine and how much should
be allocated to the technical support?

The selling price of the machine is $95,000 based on observable evidence. There is no
observable selling price for the technical support. Therefore, the stand-alone selling price
needs to be estimated. A residual approach would attribute $5,000 ($100,000 – $95,000) to the
technical support. However, this does not approximate the stand-alone selling price of similar
services (which normally make a profit).
A better approach for estimating the selling price of the support would an expected cost plus a
margin (or mark-up) approach. Based on this, the selling price of the service would be $30,000
($20,000 × 150%).
The total of standalone selling prices of the machine and support is $125,000 ($95,000 +
$30,000). However, total consideration receivable is only $100,000. This means that the
customer is receiving a discount for purchasing a bundle of goods and services of 20%
($25,000/$125,000).
IFRS 15 assumes that discounts relate to all performance obligations within a contract, unless
evidence exists to the contrary. The transaction price allocated to the machine is $76,000
($95,000 × 80%).
The transaction price allocated to the technical support is $24,000 ($30,000 × 80%).
The revenue will be recognised when (or as) the performance obligations are satisfied.

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The revenue will be recognised when (or as) the performance obligations are satisfied.

Recognise revenue
On 1 January 20X1, Evans enters into a contract with a customer to provide monthly payroll
services. Evans charges $120,000 per year.
Required:
What is the accounting treatment of the above in the financial statements of Evans for the year
ended 30 June 20X1?

The payroll services are a single performance obligation. This performance obligation is
satisfied over time because the customer simultaneously receives and consumes the benefits
of the payroll processing. This is evidenced by the fact that the payroll services would
not need to be re-performed if the customer changed its payroll service provider.
Evans must therefore recognise revenue from the service over time. In the year ended 30 June
20X1, they would recognise revenue of $60,000 (6/12 × $120,000).
Recognise revenue
On 1 January 20X1, Baker enters into a contract with a customer to construct a specialised
building for consideration of $2 million plus a bonus of $0.4 million if the building is completed
within 18 months.
Estimated costs to construct the building are $1.5 million. If the contract is terminated by the
customer, Baker can demand payment for the costs incurred to date plus a mark-up of 30%. On
1 January 20X1, as a result of factors outside of its control, such as the weather and regulatory
approval, Baker is not sure whether the bonus will be achieved.
At 31 December 20X1, Baker is still unsure whether the bonus target will be met. Baker decides
to measure progress towards completion based on costs incurred. Costs incurred on the
contract to date are $1.0 million.
Required:
How should Baker account for this transaction in the year ended 31 December 20X1?

Constructing the building is a single performance obligation. The bonus is variable

consideration. Whatever its estimated value, it must be excluded from the transaction price
because it is not highly probable that a significant reversal in the amount of cumulative
revenue recognised will not occur.
The construction of the building should be accounted for as an obligation settled over time.
This is because the building has no alternative uses for Baker, and because payment can be
enforced for the work completed to date.
Baker should recognise revenue based on progress towards satisfaction of the construction of
the building. Using costs incurred, the performance obligation is 2/3 ($1.0m/$1.5m) complete.
Accordingly, the revenue and costs recognised at the end of the year are as follows:
$m
Revenue ($2m × 2/3) 1.3
Costs ($1.5m × 2/3) (1.0)
––––

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––––
Gross profit 0.3
––––

Recognise revenue
On 31 December 20X1, Clarence delivered the January edition of a magazine (with a total sales
value of $100,000) to a supermarket chain. Legal title remains with Clarence until the
supermarket sells a magazine to the end consumer. The supermarket will start selling the
magazines to its customers on 1 January 20X2. Any magazines that remain unsold by the
supermarket on 31 January 20X2 are returned to Clarence. The supermarket will be invoiced by
Clarence in February 20X2 based on the difference between the number of issues they
received and the number of issues that they return.
Required:
Should Clarence recognise revenue from the above transaction in the year ended 31 December
20X1

The performance obligation is not satisfied over time because the supermarket does not
simultaneously receive and benefit from the asset. Clarence therefore satisfies the
performance obligation at a point in time and will recognise revenue when it transfers control
over the assets to the supermarket.
The fact that the supermarket has physical possession of the magazines at 31 December 20X1
is an indicator that control has passed. Also, Clarence will invoice the supermarket for any
issues that are stolen and so the supermarket does bear some of the risks of ownership.
However, as at 31 December 20X1, legal title of the magazines has not passed to the
supermarket. Moreover, Clarence has no right to receive payment until the supermarket sells
the magazines to the end consumer.
Finally, Clarence will be sent any unsold issues and so bears significant risks of ownership (such
as the risk of obsolescence).
All things considered, it would seem that control of the magazines has not passed from
Clarence to the supermarket chain. Therefore, Clarence should not recognise revenue from this
contract in its financial statements .

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