Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.1

Part A – General aspects of IFRS 15

a) Revenue is defined as:

• income
• arising in the course of
• an entity's ordinary activities. IFRS 15 App A

Revenue thus differs from income in that it is simply a type of income – one that arises
from ordinary activities. Thus, income can arise from a variety of other sources, including
an entity's activities that are not considered to be 'ordinary'. Thus, income from an entity’s
activities that are not considered to be ‘ordinary’ would not meet the definition of revenue.

b) False.

IFRS 15 does not apply to all contracts. It is only applicable if the contract:
• meets the definition of a contract and
• involves a customer/s that meet the definition of a customer; and
• is not covered by another accounting standard (IFRS) (e.g. lease contracts &
insurance contracts); and
• does not involve:
− the exchange of non-monetary items
− between entities in the same line of business
− to facilitate sales to customers or potential customers. See IFRS 15.5-6

c) Revenue recognition and measurement involves a 5-step process.

These 5 steps are as follows:

Step 1: Identify whether we have a contract with a customer.
Step 2: Identify the performance obligations contained in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the identified performance obligations.
Step 5: Recognise revenue when the performance obligations are satisfied.

d) Step 5 in the 5-step process helps us identify the moment when revenue should be
recognised. In this regard, step 5 requires us to recognise the revenue when (or as) the
performance obligations are satisfied, which happens when the customer obtains control
over the promised good or service (ie an asset). See IFRS15.31

e) The term ‘contract asset’ refers to the entity’s right to receive payment from the customer
where that right is still conditional on something other than the passage of time.

The term ‘receivable’ refers to the right to receive payment from the customer, where that
right is no longer conditional on anything, other than perhaps the passage of time.

Part B continues on the next page

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.1 continued…

Part B – Identifying the contract

f) False. 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
• in exchange for consideration. IFRS 15 App A

The statement given did not clarify that the goods or services must be the output from the
entity’s ordinary activities.

g) A contract is defined as:

• an agreement between two or more parties
• that creates enforceable rights and obligations. IFRS 15 App A

h) If the contract does not meet the definition of a contract as provided in IFRS 15, we would
process the following journal:
Debit: Cash
Credit: Refund liability

Explanation:
• We would not be able to recognise the receipt from the customer as ‘revenue’ and
would thus have to recognise it as a refund liability instead; and
We would then continually reassess whether the criteria necessary to meet the contract
definition are subsequently met, at which point the refund liability would then be
reversed and recognised as revenue. See IFRS 15.14-16

i) Before we can conclude that we have a contract that falls within the scope of IFRS 15, all
the following 5 criteria must be met:
• It must be approved by all parties who are also committed to fulfilling their obligations.
• Each party’s rights to the goods and/or services must be identifiable.
• The payment terms must be identifiable.
• The contract must have commercial substance.
• It must be probable that the entity will collect the consideration to which it expects to
be entitled. See IFRS 15.9

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.1 continued…

Part C – Determining the transaction price

j) False. The transaction price is defined as:

• The amount of consideration
• To which an entity expects to be entitled
• In exchange for transferring goods or services to a customer
• Excluding amounts collected on behalf of third parties. See IFRS 15 App A

The statement given was incorrect because the transaction price has nothing to do with the
amount the entity expects to receive, but rather the amount to which it expects to be entitled.

k) The transaction price is C80 000, irrespective of how much is considered to be probable
of being recovered (i.e. collected).

Collectability of the consideration is not considered when measuring the transaction price.
Collectability is only considered when determining whether a valid contract existed (see
the fifth criteria listed in the solution to part (i) above).
• If the consideration to which the entity expects to be entitled is probable of being
collected, we would have a contract, the transaction price of which would be C80 000.
• If the consideration to which the entity expects to be entitled is not probable of being
collected, we would not have a contract and thus IFRS 15 would not apply.

l) The process of ‘constraining an estimate’ arises when a contract price includes variable
consideration. When this happens, we would need to estimate how much of the variable
consideration should be included in the transaction price. When we estimate this amount,
we need to ‘constrain the estimate’.

Constraining estimates simply means limiting the amount of variable consideration to be

included in the transaction price:

The amount that we include in the transaction price is limited in a way that ensures that it
is 'highly probable that a significant reversal' of revenue will not be required when the
uncertainty around this consideration is eventually resolved. See IFRS 15.56

m) The variable consideration to be included in the transaction price is calculated as follows:

Step 1: Estimate the amount of variable consideration, using either the ‘most likely
amount’ or an ‘expected value’; and then
Step 2: Limit this estimate to an amount that is ‘highly likely of not resulting in a
significant reversal of revenue in the future’.

n) A contract is said to contain an element of financing (i.e. a ‘financing component’) if the

following dates differ:
• the date of transfer of goods or services, and
• the date of settlement agreed to in the contract (explicitly or implicitly). See IFRS 15.60

This financing component could provide the benefit to either the customer or the entity.

Continued …

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.1 continued…

Part C continued …

o) The existence of a financing component in a contract with a customer would only affect the
calculation of the transaction price:
• if the period between these dates is greater than a year and the effect of the financing
is considered to be significant, then the contract is said to contain a significant financing
component: in this case, the transaction price must be adjusted to exclude the effects of
the financing.
For your interest, the transaction price would not be effected by the existence of a financing
component in the following two situations:
• If the period between these dates is equal to or less than a year, the effect of financing
may be ignored (the practical expedient).
• If the period between these dates is greater than a year, but the effect of the financing
is considered to be insignificant, then the effect of financing may be ignored.

p) The effect of financing (if it is considered to be significant) is calculated by:

• First measuring the transaction price at the cash price:
The cash price is calculated at the present value of the expected consideration to which
the entity expects to be entitled.
• Then, calculate the effect of financing:
The effect of financing is the difference between this cash price and the expected
consideration.

The interest (expense or income) is then recognised over the period of the financing using
the effective interest method described in IFRS 9 Financial instruments.

q) When calculating the present value of consideration to which the entity expects to be
entitled, we must use an appropriate discount rate.

A discount rate is appropriate if it:

• is determined at contract inception, and
• is the rate:
- that the entity and the customer would have agreed upon had they entered into a
separate financing contract, and
- takes into account the specific circumstances at contract inception regarding:
o the credit risk of the borrower and
o any security that the borrower may have offered. See IFRS 15.64

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.1 continued…

Part D – Allocating the transaction price

r) The allocation of a transaction price means apportioning the transaction price to each of
the performance obligations contained in the contract.

s) The allocation of a transaction price to the various performance obligations is normally

done based on their relative stand-alone selling prices. If there is only one performance
obligation, the entire transaction price is allocated to that one performance obligation.
See IFRS 15.74

t) For an item that has been sold on an individual basis before and is now sold as part of a
bundle, the transaction price is allocated on a ‘proportionate basis’. This means that if there
are two items in a bundle costing C120 000, and product A was previously sold for C70 000
and product B was sold for C100 000 on a standalone basis, then the C120 000 is allocated
to each product proportionately. Thus, C49 412 will be allocated to product A and C70 588
to product B.

u) If an item, which is sold as part of a bundle, has never been sold on its own before, an entity
will have to estimate a stand-alone selling price for it.

IFRS 15 does not stipulate how the stand-alone selling price should be estimated, but it
suggests three possible approaches that may be helpful. An entity may use a combination
of these approaches, or may use any other reasonable approach.
• Adjusted market assessment approach: this approach assesses the market and estimates
what the customer would be prepared to pay for the stand-alone good/service in this market.
• Expected cost plus margin approach: this approach requires that the entity first
estimates the cost incurred in satisfying the performance obligation, and then adding
its required mark up to get a suitable selling price.
• Residual approach: this approach is suitable when the entity knows the selling price of
the other performance obligations in the contract, in which case, the stand-alone selling
price for the unknown PO is the residual value after deducting the observable stand-
alone selling prices from the transaction price.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.1 continued…

Part E – Satisfying the performance obligations

v) A performance obligation is defined as:

• A promise contained in a contract
• To transfer to a customer either:
− A distinct good or service or bundle of goods or services; or
− A series of distinct goods or services that are:
− substantially the same; and
− have the same pattern of transfer to the customer. See IFRS 15.22 (reworded)

w) Performance obligations are classified as either:

• satisfied over time or
• satisfied at a point in time.

x) We must measure an entity’s ‘progress towards complete satisfaction of a performance

obligation’ when this performance obligation is classified as ‘satisfied over time’.

y) Progress may be measured using either:

• an input method (e.g. costs incurred to date as a percentage of total costs expected to
be incurred); or
• an output method (e.g. work certified to date as a percentage of total work to be
certified).

z) The essential difference between the input method and output method of measuring
progress towards complete satisfaction of the performance obligation is that:
• The input method is a measure of the entity’s efforts to date towards completion of the
performance obligation.
• The output method is a measure of the value that the customer has received to date.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.2

a) Customer A: Early settlement discounts

Calculation:

Transaction price:
= Contract price: C350 000 – Expected early settlement discount: (C350 000 x 10%)
= C315 000

Journal:
Debit Credit
1 January 20X1
Receivable (A) 100% x C350 000 350 000
Receivable: settlement discount allowance (-A) 10% x C350 000 35 000
Revenue from customer contract 315 000
Revenue from customer contract satisfied at a point in time, net of
expected settlement discount

Explanation:

The transaction price is the amount of consideration to which the entity expects to be entitled. Thus,
if the entity expects that the customer will qualify for the discount of C35 000, the entity expects to
be entitled to only C315 000 (C350 000 – C35 000). Thus the revenue, measured at the transaction
price, must be presented as C315 000.

For your interest:

Note 1. The customer will be billed at C350 000, but the customer will be reflected as a debtor at
the net amount of C315 000 (receivable account: 350 000 – receivable allowance account:
35 000).

Note 2. If the customer fails to pay in time and forfeits his settlement discount, this settlement
discount allowance will be transferred to revenue.

b) Customer B: Rebates

Calculation:

Transaction price:
= Contract price: C350 000 – Expected rebate: C140 000
= C210 000

Journal:
Debit Credit
1 January 20X1
Receivable (A) 100% x C350 000 350 000
Refund liability (L) Given 140 000
Revenue from customer contract 210 000
Revenue from customer contract satisfied at a point in time, net of
expected rebate

Explanation:

The transaction price is the amount of consideration to which the entity expects to be entitled. Thus,
if the entity expects that the customer will qualify for the rebate of C140 000, the entity the entity
expects to be entitled to only C210 000 (C350 000 – C140 000). Thus, the revenue, measured at the
transaction price, must be presented as C210 000.

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Solution 4.2 continued …

c) Customer C: Financing component (less than a year)

i) Financing is insignificant

Calculation:

Transaction price
= Contract price: C350 000 – significant financing component: C0
= C350 000

Journal:
Debit Credit
1 January 20X1
Receivable (A) 100% x C350 000 350 000
Revenue from customer contract 350 000
Revenue from customer contract satisfied at a point in time,
financing component exists but it is insignificant and results from
financing over a period less than one year

Explanation:

The transaction price was not adjusted for the financing component because the effect thereof was
considered to be insignificant. In addition, whether or not the effects of the financing are considered
to be significant, the period between the date of transfer of the goods or services and the date of
settlement is only 6 months: the effects of financing are only accounted for if the period is greater
than a year.

ii) Financing is significant

Calculation:

Transaction price
= Contract price: C350 000 – significant financing component: C0 (ignored because less than a year
of financing)
= C350 000

Journal:
Debit Credit
1 January 20X1
Receivable (A) 100% x C350 000 350 000
Revenue from customer contract 350 000
Revenue from customer contract satisfied at a point in time,
financing component exists but it was ignored because, although
the effects thereof were significant, it resulted from financing
over a period less than one year

Explanation:

The transaction price was not adjusted for the financing component because, although the effects
thereof were considered to be significant, the period between the date of transfer of the goods or
services and the date of settlement is only 6 months: the effects of financing are only accounted for
if the period is greater than a year.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.2 continued …

d) Customer D: Financing component (more than a year)

i) Financing is insignificant

Calculation:

Transaction price
= Contract price: C350 000 – significant financing component: C0
= C350 000

Journal:
Debit Credit
1 January 20X1
Receivable (A) 100% x C350 000 350 000
Revenue from customer contract 350 000
Revenue from customer contract satisfied at a point in time,
financing component exists but it is insignificant

Explanation:

The transaction price is only adjusted for the financing component:

• if the period between transfer of goods/services and date of settlement is greater than a year and
• if the effects of the financing are considered to be significant.

Although the period of financing was greater than a year (2 years financing was provided to
customer D), the effects of the financing were considered to be insignificant and thus the transaction
price was not adjusted

ii) Financing is significant

Calculation:

Transaction price
= Present value of the contract price, discounted at 10%: C289 256

The PV can be calculated using a financial calculator or as follows:

= C350 000 ÷ 1.1 ÷ 1.1 = 289 256

Journal:
Debit Credit
1 January 20X1
Receivable (A) 289 256
Revenue from customer contract Cash price: PV of consideration 289 256
Revenue from customer contract satisfied at a point in time
30 June 20X1
Receivable (A) 14 463
Revenue from interest (I) 289 256 x 10% x 6/12 14 463
Interest income recognised on the significant financing
component using the effective interest method

Explanation:
The transaction price is only adjusted for the financing component if the period between transfer of
the goods or services and the date of settlement is greater than a year and the effects of the financing
are considered to be significant. Thus since Orchard provided customer D with financing for a period
of 2 years and the effects thereof were considered significant, the transaction price must be adjusted
for the effects of the financing component.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.3

a) Journals:
Debit Credit
5 April 20X3
Receivable (A) Contract price 330 000
Receivable: settlement discount allowance (-A) 330 000 x 10% 33 000
Revenue from customer contract Transaction price 297 000
Revenue from customer contract satisfied at a point in time
4 May 20X3
Receivable: settlement discount allowance (-A) 33 000
Revenue from customer contract 33 000
Settlement discount forfeited by the customer is reversed and
recognised as revenue (the TP has increased since the entity now
expects to be entitled to a higher amount)
31 May 20X3
Bank (A) Contract price 330 000
Receivable (A) 330 000
Receipt from customer is recorded
Transaction price at contract inception: (Contract price: 330 000 – Expected discount: 33 000)
b) Explanation:
The transaction price is the amount of consideration to which the entity expects to be entitled. Thus,
if the entity expects that the customer will qualify for the discount, the entity expects to be entitled
to C297 000 (C330 000 – C33 000) and thus this amount is said to be its transaction price.
The contract involves a single performance obligation and thus the entire transaction price of
C297 000 (C330 000 – C33 000) is allocated to the single performance obligation.
Journal on 5 April 20X3:
Revenue is recognised as and when the performance obligations are satisfied. Since there is a single
performance obligation that is satisfied at a point in time, we recognise the full revenue when this
performance obligation is satisfied. The performance obligation is satisfied when the customer
obtains control over the goods or services. In this case, we assume that the customer obtains control
over the goods (light fittings) on the date that the customer receives physical delivery thereof, being
5 April 20X3 (the transaction date).
The receivable account is debited with the full price of C330 000 (this receivable asset records how
much the customer has agreed to pay) and the expected settlement discount of C33 000 is credited
to an allowance account (a measurement account that effectively reduces the carrying amount of the
receivable asset). The related revenue is thus recognised (credited) at the transaction price of C297
000, being the amount to which the entity expects to be entitled.
Journal on 4 May 20X3 (or close of business on 3 May 20X3):
The customer had not yet paid as at 3 May 20X3 and thus the customer forfeits the settlement
discount that had been offered to him. The settlement discount allowance must thus be reversed
(thus we debit the settlement allowance account).
Since the discount has been forfeited, it means that the amount to which the entity expects to be
entitled is now C330 000 (i.e. the transaction price is now C330 000 – it is no longer C297 000).
Thus the total revenue to be recognised from this performance obligation, once completed, is
C330 000 (not C297 000).
Since the performance obligation had already been satisfied by the time the discount was forfeited,
the revenue from this performance obligation had already been recognised. Thus the adjustment to
the transaction price is recognised as an immediate adjustment to revenue (credit revenue).
Journal on 31 May20X3:
The customer settles his account (debit the bank account) and thus the receivable account is reversed
(credit the receivable account).

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.4

a) Definitions

A contract asset is defined as:

• an entity’s right to consideration
• in exchange for goods or services that the entity has transferred to a customer
• when that right is conditioned on something other than the passage of time (e.g. the
entity’s future performance). IFRS 15 App A

A receivable is defined as:

• an entity’s right to consideration
• that is unconditional. IFRS 15.108 (extract)

A right to consideration is unconditional if:

• all we have to do is wait for time to pass
• before payment thereof falls due. See IFRS 15.108 (reworded)

A contract liability is defined as:

• an entity’s obligation to transfer goods or services to a customer
• for which:
- the entity has received consideration from the customer; or
- the amount of consideration is due. IFRS 15 App A (slightly reworded)

A comparison of the above terms:

A contract asset and receivable both represent the entity's rights.
• a contract asset is an entity’s right that is still conditional; whereas
• a receivable is an entity’s right that is unconditional.

A contract liability represents the entity's obligation

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Solution 4.4 continued …

b) The 5-step process to revenue recognition

Revenue from a customer contract may only be recognised once steps 1-5 are complete:

Step 1: Identify if there is a contract with a customer

A single customer has been identified. It will be assumed that this customer meets the
requirements of a customer as prescribed in IFRS 15.

Step 2: Identify the performance obligations

There is a single performance obligation, being to deliver baskets to the customer. There
is no information to suggest that the delivery itself is a separate performance obligation.

Step 3: Determine the transaction price

The transaction price is C300 per basket. This is the amount Grey Dog expects to be
entitled to for each basket delivered (there appears to be no portion thereof that is payable
to third parties – if there had been, then this would have had to be deducted from the C300).

Step 4: Allocate the transaction price to each performance obligation

As there is only one performance obligation (PO), the full transaction price will be
allocated to it.

Step 5: Recognise the transaction price as revenue when/as the performance obligations
are met
(i.e. the allocated transaction price is recognized as revenue in its entirety at a
single point in time, if the performance obligation is satisfied at a point in time;
or the transaction price is recognized as revenue gradually over time, if the
performance obligation is satisfied over time).

This contract involves a single performance obligation that is satisfied at a point in time.
We are told that the performance obligation was satisfied on 31 March 20X2 and thus the
transaction price is recognized on this date.

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Solution 4.4 continued ...

c) Explanation regarding the recognition of revenue:

cancellable versus non-cancellable contracts

Introduction:

There are three dates that we need to consider:

• 10 January 20X2: the date the contract is agreed to;
• 10 February 20X2: the date the consideration becomes payable; and
• 31 March 20X2: the date the performance obligation is satisfied.

Normally, revenue would be recognised when the performance obligation is satisfied.

However, in this situation, the consideration becomes payable before the performance
obligation is satisfied and, thus, we must consider whether the contract is:
• cancellable; or
• non-cancellable.

i) If the contract is cancellable

The contract is signed on 10 January 20X2 and the customer is expected to make payment
on 10 February 20X2, however, if the contract is cancellable, both these dates are ignored:
• revenue may not be recognised on either the 10 January 20X2 or 10 February 20X2
because the entity has not yet satisfied its performance obligations – whether the
contract is cancellable or non-cancellable has no bearing on this;
• a receivable may not be recognised on either the 10 January 20X2 or 10 February 20X2
because the entity does not yet have an unconditional right to consideration: the contract
is cancellable which means that the entity must first perform its obligations before it
will be entitled to receive the consideration; and
• a contract asset may not be recognised because the entity has not yet satisfied any part
of its performance obligation.

Thus, in this example, the revenue and receivable will only be able to be recognised once
the performance obligations are satisfied.

Grey Dog performed its obligations on 31 March 20X2, at which point the entity must
recognise the related revenue. At the same time, the entity obtains an unconditional right
to receive consideration and must thus recognise a receivable.

The following journal is thus processed:

Debit Credit
31 March 20X2
Receivable (A) 300 000
Revenue from customer contract Transaction price 300 000
Revenue from customer contract satisfied at a point in time

Continued on the next page

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Solution 4.4 continued ...

c) continued…

ii) If the contract is non-cancellable

The contract is signed on 10 January 20X2, but this date is ignored because:
• the entity is unable to recognise the related revenue because it has not yet satisfied its
performance obligations; and furthermore
• the entity is unable to recognise either a contract asset or a receivable:
- a contract asset may not be recognised because the entity has not yet satisfied any
part of its performance obligation; and
- a receivable may not be recognised because the entity does not yet have an
unconditional right to consideration:
although the contract is non-cancellable, the contract states that the customer is
only required to make payment on 10 February 20X2. See IFRS 15.IE199

The contract states that the customer must make payment on 10 February 20X2.
• Assuming the contract is non-cancellable, Grey Dog will obtain an unconditional right
to receive consideration on this date – even though it has not yet have satisfied any of
its performance obligations.
Thus, on 10 February 20X2, Grey Dog must recognise a receivable.
• However, Grey Dog may not recognise the revenue because it has not yet satisfied any
of its performance obligations. This means that, since it must recognise a receivable
(i.e. a debit entry must be processed) but it may not recognise revenue yet, the entity
must recognise a contract liability instead (i.e. the credit entry will have to be to the
contract liability account and not the revenue account).

The following journal is thus processed:

Debit Credit
10 February 20X2
Receivable (A) 300 000
Contract liability Transaction price 300 000
A receivable is recognised due to the payment terms of the non-
cancellable contract and a contract liability is recognised to
reflect the entity’s obligation to satisfy its performance obligations

The entity performed its obligations on 31 March 20X2, at which point the entity must
recognise the related revenue. At this point, the contract liability no longer exists because
there is no longer an obligation to transfer goods or services to the customer.

Thus, the contract liability is reversed (debit) and the revenue is recognised (credit).

The following journal is thus processed:

Debit Credit
31 March 20X2
Contract liability 300 000
Revenue from customer contract Transaction price 300 000
Revenue is recognised from the customer contract because the
PO is satisfied (satisfied at a point in time) and the contract
liability is derecognised because the entity has no further POs to
satisfy

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.5

Part A: the contract is cancellable

General comment relating to both (a) and (b):

• In both (a) and (b), we must assess the transaction price (TP) at contract inception
(1 May 20X1) based on the consideration that the entity expects to be entitled to.
• The entity expects it will grant the C3 200 discount (32 000 widgets x C1 x 10%) and thus
the transaction price is C28 800 (contract price: C32 000 – expected discount: C3 200).
• A receivable reflects the entity’s unconditional right to consideration. Since this contract is
cancellable, the date on which the customer is expected to pay is ignored. Thus, if a contract
is cancellable, the unconditional right to consideration (recognised as a receivable) only arises
once the entity has satisfied its PO, which will also be the date on which we recognise the
related revenue. Since the entity satisfies its performance obligation on 31 May 20X1, we
must recognise the receivable and the revenue on this date.
• The receivable balance of C28 800 is created by debiting ‘receivable’ (A) with C32 000 and
crediting ‘receivable: discount allowance’ (-A) with C3 200. This is because the receivable
account is used to send the statement of account to the customer and since the discount had
not yet been granted, we would still want to reflect that the customer owes C32 000.

a) A decision was made to grant the discount:

31 May 20X1 Debit Credit

Receivable (A) 32 000
Receivable: discount allowance (-A) 3 200
Revenue from customer contract (I) 28 800
Recognising the receivable and the revenue on the date that the
PO is satisfied

4 July 20X1: Debit Credit

Receivable: discount allowance (-A) 3 200
Receivable (A) 3 200
Discount is granted: reversing the discount allowance account
and thus reducing the receivable account
Bank (A) 28 800
Receivable (A) 28 800
Recognising the receipt and reversing the receivable

b) A decision was made to not grant the discount

31 May 20X1 Debit Credit

Receivable (A) 32 000
Receivable: discount allowance (-A) 3 200
Revenue from customer contract (I) 28 800
Recognising the receivable and revenue on the date that the PO
is satisfied

4 July 20X1: Debit Credit

Receivable: discount allowance (-A) 3 200
Revenue from customer contract (I) 3 200
Discount is not granted: reversing the discount allowance
account and recognising it as revenue
Bank 32 000
Receivable (A) 32 000
Recognising the receipt and reversing the receivable

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Solution 4.5 continued ...

Part B: The contract is non-cancellable

General comment relating to both (a) and (b):

• In both (a) and (b), we must assess the transaction price (TP) at contract inception
(1 May 20X1) based on the consideration that the entity expects to be entitled to. The entity
expects it will grant the C3 200 discount (32 000 widgets x C1 x 10%) and thus the
transaction price is C28 800 (contract price: C32 000 – expected discount: C3 200).

• A receivable reflects the entity’s unconditional right to consideration. Since this contract
is non-cancellable, the date on which the customer is expected to pay (18 May 20X1) leads
to an unconditional right to receive consideration and will thus require the entity to
recognise a receivable, even if it has not performed its POs.

• In this scenario, the unconditional right to consideration arises on 15 May 20X1, which is
indeed before the entity has satisfied its performance obligation (PO), which means that,
although the receivable must be recognised, revenue may not yet be recognised. Thus,
when recognising this receivable on 15 May 20X1, we will need to recognise a contract
liability (instead of revenue) to reflect the fact that the entity still has an obligation to
perform its obligations.

• When the entity satisfies its performance obligation on 31 May 20X1, it must then recognise
the revenue and, at the same time, extinguish the contract liability.

• The receivable balance of C28 800 would be created by debiting ‘receivable’ (A) with C32
000 and crediting ‘receivable: discount allowance’ (-A) with C3 200. The receivable
account would be used to send the statement of account to the customer and since the
discount had not yet been granted, we would still want the debtors statement to reflect that
the customer owes C32 000.

a) A decision was made to grant the discount:

18 May 20X1 Debit Credit

Receivable (A) 32 000
Receivable: discount allowance (-A) 3 200
Contract liability (L) 28 800
Recognising the receivable on due date for payment (contract is
non-cancellable) and recognising a contract liability because
we are not yet able to recognise the revenue
31 May 20X1
Contract liability (L) 28 800
Revenue from customer contract (I) 28 800
Recognising the revenue and reversing the contract liability on
the date that the POs are satisfied
4 July 20X1
Receivable: discount allowance (-A) 3 200
Receivable (A) 3 200
Discount is granted: reversing the discount allowance account
and thus reducing the receivable account
Bank 28 800
Receivable (A) 28 800
Recognising the receipt and reversing the receivable

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Solution 4.5 continued ...

Part B continued …

b) A decision was made to not grant the discount

15 May 20X1 Debit Credit

Receivable (A) 32 000
Receivable: discount allowance (-A) 3 200
Contract liability (L) 28 800
Recognising the receivable on due date for payment (contract is
non-cancellable) and recognising a contract liability because
we are not yet able to recognise the revenue
31 May 20X1
Contract liability (L) 28 800
Revenue from customer contract (I) 28 800
Recognising the revenue and reversing the contract liability on
the date that the POs are satisfied

4 July 20X1
Receivable: discount allowance (-A) 3 200
Revenue from customer contract (I) 3 200
Discount is not granted: reversing the discount allowance
account and recognising it as revenue
Bank 32 000
Receivable (A) 32 000
Recognising the receipt and reversing the receivable

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.6
Part A: Animania Properties contract

Determining the transaction price

The transaction price in a contract with a customer is the consideration that the entity expects
to be entitled to in exchange for the transfer of the promised goods and services, excluding any
amounts collected on behalf of third parties.

The determination of the transaction price involves the assessment of whether the contract price
includes:
• fixed consideration and/ or variable consideration;
• a significant financing component;
• non-cash consideration; and /or
• consideration payable to the customer.

The contract price does not involve amounts collected on behalf of third parties, a financing
component, non-cash consideration or consideration payable to the customer but it does involve
a mixture of fixed and variable consideration. This is explained below.

The contract price has been determined at C24 000 000 together with a further performance
bonus of C2 400 000 if the construction is completed within a 24-month period. The possibility
of a bonus means that the contract includes not only fixed consideration (C24 000 000) but also
variable consideration (C2 400 000).

Variable consideration should be included in the determination of the transaction price at the:
• estimated amount that the entity expects to be entitled to, which has been
• suitably constrained to an amount that has a high probability of not causing a significant
reversal in the future.

When estimating the amount to which the entity expects to be entitled, we may use:
• the ‘expected value’ method; or
• the ‘most likely amount’ method. See IFRS 15.53

The expected value method is most suitable for situations where there are many possible
outcomes whereas the ‘most likely amount’ method is generally most suitable for situations
where there are only a few possible outcomes (and ideal for situations where there are only two
possible outcomes). See IFRS 15.53

There are only two possible outcomes in this situation:

• Bob Construction completes it within 24 months, in which case it will earn the bonus (bonus
= C2 400 000); or
• Bob Construction does not complete it within 24 months, in which case it will not earn the
bonus (bonus = C0).

Since there are only two possible outcomes, we use the ‘most likely amount’ method.

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Solution 4.6 continued …

Part A continued …

Since Bob Construction has estimated that there is a 95% chance that the bonus criteria will be
met and thus a 5% chance that the bonus criteria will not be met, we estimate the variable
consideration to be C2 400 000 (on the basis that it has the higher likelihood of occurring). The
transaction price is therefore C26 400 000 (fixed consideration: C24 000 000 + variable
consideration: C2 400 000).

This estimate must then be constrained to an amount that has a high probability of not causing
a significant reversal in the future. Since this is a simple situation involving only 2 possible
outcomes, we simply conclude that, based on the high probability (95%) of this outcome
occurring, there is a high probability of there being no significant revenue reversal in future.

Comment:
The fact that the customer is required to make progress payments during the course of
construction would be relevant information when assessing whether or not the performance
obligation is satisfied at a point in time or over time.

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Solution 4.6 continued ...

Part B: Goofy Property Holdings

a) Discussion

Determining the transaction price

The transaction price in a contract with a customer is the consideration to which the entity
expects to be entitled in exchange for the transfer of the promised goods and services, excluding
any amounts collected on behalf of third parties.

The determination of the transaction price involves the assessment of whether the contract price
includes:
• fixed consideration and/ or variable consideration
• a significant financing component
• non-cash consideration; and/ or
• consideration payable to the customer.

The contract price has been determined at C2 880 000, being fixed consideration: it does not
involve variable consideration. It also does not include amounts collected on behalf of third
parties, non-cash consideration and nor does it include consideration payable to the customer.
However, it does involve financing since the timing of the transfer of goods to the customer
(machinery) differs from the timing of the receipt of the consideration from the customer.

In this case, the goods are transferred to the customer before the customer makes the necessary
payments. This means that Bob Construction (BBC) is providing finance to the customer,
Goofy Property Holdings (GPH) (i.e. GPH is receiving the financing benefit).

The effect of providing the customer with a financing benefit should be separated from the
transaction price and recognised as income from interest (i.e. instead of as revenue from the
customer contract) if the effect thereof is significant.

As a practical expedient, IFRS 15 allows Bob Construction to ignore the effects of financing if
the period between the date on which the goods are transferred and the date on which the
consideration is payable is a year or less.

However, since the period between the transfer of the machine and the final payment is more
than a year (in this case, the period is three years), this practical expedient is not available to
BBC. Thus, BBC must decide if the effect of the financing is considered to be significant.

If BBC concludes that the effect of the financing is considered to be insignificant, then the
transaction price would be determined to be C2 880 000.

However, if BBC concludes that the effect of the financing is considered to be significant, then
the transaction price would be determined by excluding the financing component. In other
words, the transaction price would thus be measured at the cash selling price of C2 250 000
(given). The difference between the contract price of C2 880 000 and the transaction price of
C2 250 000 will be recognised as interest income using the effective interest rate method (in
accordance with IFRS 9 Financial instruments).

In order to satisfy this requirement, the implicit interest rate needs to be calculated for the
transaction. The implicit interest rate is calculated overleaf.

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Solution 4.6 continued ...

Part B: continued …

a) continued …

The implicit interest rate is calculated (using a financial calculator) as follows:

N=3
PV = C2 250 000
PMT = -C960 000 (C2 880 000 / 3 annual payments)
Comp I = 13.4368%

The revenue from interest would then be measured using the effective interest rate method,
shown in the following effective interest rate table:

Opening Interest at Closing

Year balance 13,4368% Instalment balance
(1) (2) (3)
Year 1 (20X6) 2 250 000 302 328 (960 000) 1 592 328
(2)
Year 2 (20X7) 1 592 328 213 958 (960 000) 846 286
(2)
Year 3 (20X8) 846 286 113 714 (960 000) 0
(1) The C2 250 000 is recognised as revenue from the customer contract in January 20X6 (IFRS 15).
(2) The interest of C302 328, C213 958 and C113 714 is recognised as income from interest in each of
the three years, using the above effective interest rate method (IFRS 9).
(3) The annual instalment = C2 880 000 / 3 instalments = C960 000.

Allocating the transaction price

Since there is only one performance obligation (the transfer of machinery), the entire
transaction price of C2 250 000 is allocated to this single performance obligation.

b) Journals

01 January 20X6 Debit Credit

Accounts receivable (A) Transaction price 2 250 000
Revenue from customer contract (I) 2 250 000
Recording the sale of the machinery on deferred payment terms

31 December 20X6
Accounts receivable (A) C2 250 000 x 13.4368% 302 328
Revenue from interest (I) 302 328
Recording interest income using the effective interest rate

31 December 20X6
Bank (A) 960 000
Accounts receivable (A) 960 000
First instalment paid by customer – C2 880 000/3

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Solution 4.7
The contract price is C550 000 (550 000 widgets x C1 per widget). However, the transaction price
(TP) is determined, at contract inception (1 February 20X3), based on the consideration that the
entity expects to be entitled to. In this example, the contract price equals the transaction price
(the contract does not involve variable consideration, a significant financing component, non-cash
consideration or consideration to be paid to a customer).

28 February 20X3: Debit Credit

Receivable (A) TP: 550 000 widgets x C1 x 100% 550 000

Revenue (I) 550 000
Recognising revenue and a receivable when PO satisfied (i.e. when
the customer obtains control)

Impairment – credit loss (E) TP: 550 000 x 50% (lifetime 137 500
Receivable: loss allowance (-A) expected credit loss) x 50%(POD) 137 500
Recognising a separate loss allowance based on expected credit losses

15 March 20X3:

Impairment – credit loss (E) TP: 550 000 x 60% – 137 500 192 500
Receivable: loss allowance (-A) 192 500
Remeasuring the loss allowance to reflect information received regarding
the customer’s liquidity problems

5 August 20X3:

Bank Given 165 000

Receivable (A) 165 000
Recognising the receipt from the customer

Impairment – credit loss (E) Receivable balance: (550 000 – 55 000

Receivable: loss allowance (-A) received: 165 000) – Loss allowance 55 000
balance (137 500 + 192 500)
Remeasuring the loss allowance on date of the receipt from the customer
based on the fact that the entity does not expect to receive the remaining
balance still owed by the customer (385 000): the loss allowance balance
thus needs to be increased from 330 000 to 385 000

Receivable: loss allowance (-A) 137 500 + 192 500 + 55 000 385 000
Receivable (A) 550 000 – 165 000 385 000
Derecognising the receivable and its related allowance account

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Solution 4.7 continued…

Explanation of each journal (for your interest)

28 February 20X3:
• The entity satisfies its PO on 28 February 20X3, thus obtaining an unconditional right to
consideration and thus necessitating the recognition of a receivable.
• Because the PO has been satisfied, the entity must also recognise revenue.
• In terms of IFRS 9 Financial instruments, a loss allowance must be recognised on initial recognition.
As this is a trade receivable, the simplified method must be used in terms of IFRS [Link]. Thus,
the loss allowance is equal to the lifetime expected credit losses (transaction price x lifetime expected
credit losses x probability of default).

15 March 20X3:
• The entity is apprised by the customer’s lawyers of the customer’s liquidity problems and the entity
must thus impair the receivable balance in terms of IFRS 9 Financial instruments to reflect the
concern over collectability of this balance. However, since the receivable account is used to send
statements of account to the customer, the entity would still want the statement of account to reflect
that the customer owes C550 000. Thus, the impairment loss is indirectly credited to the receivable
account by crediting a ‘receivable loss allowance’ account.

5 August 20X3:
• The entity recognises the receipt from the customer.
• This receipt was less than the full amount due and, given the cash flow problems, the entity predicts
that the rest of the balance owing will never be recovered (i.e. receipt of the full amount is doubtful).
Thus, the entity recognises a further impairment loss relating to its receivable account: the previous
impaired balance (prior to the receipt of C165 000) was reflected at a net amount of C220 000
(receivable: 550 000 – loss allowance: 330 000 = 220 000) but only C165 000 has been received and
no further receipts are expected. Thus, the entity must process a further impairment loss of C55 000
(C220 000 – C165 000) in terms of IFRS 9 Financial instruments.
• Then, if the entity accepts that the remaining balance owed will never be received and thus does not
intend to pursue this customer for further payments, the entity derecognises the customer’s
receivable account and the related receivable loss allowance account (effectively reversing the loss
allowance account against the related receivable account).

P.S. If Macrobyte had not considered the payment from the customer to be the final settlement and,
instead, intended to pursue the customer for further payments, then the third journal on 5 August 20X3
(derecognizing the receivable) would not have been processed. In other words, the journals on 5 August
20X3 would simply have been as follows:

5 August 20X3: Debit Credit

Bank Given 165 000

Receivable (A) 165 000
Recognising the receipt from the customer

Impairment – credit loss (E) Receivable balance: (550 000 – 55 000

Receivable: loss allowance (-A) received: 165 000) – Loss allowance 55 000
balance (137 500 + 192 500)
Remeasuring the loss allowance on date of the receipt from the customer
based on the fact that the entity does not expect to receive the remaining
balance still owed by the customer (385 000): the loss allowance balance
thus needs to be increased from 330 000 to 385 000

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.8

a) Discussion: identification of the performance obligations

Answer: The design and construction of the plumbing system comprises a single performance
obligation.

Discussion:

Introduction

The contract involves the design and construction of a plumbing system. Whether the design
and the construction of the plumbing system constitute two separate performance obligations
or one single performance obligation depends on whether the design and construction are
considered to be individually distinct.

When deciding whether the goods or services promised in a contract are individually distinct,
we need to consider whether each is:
• individually capable of being distinct (able to generate economic benefits for the customer);
and
• individually distinct in the context of the contract.

Application to the scenario provided

The design is probably able to generate economic benefits for the customer (through the sale or
use thereof etc): the completed design work could no doubt be sold by the customer or the
customer could give the completed design to another company to perform the construction of
the plumbing system, where the final constructed plumbing system would then generate
economic benefits for the customer. Thus, we conclude that the design is ‘capable of being
distinct’.

However, the design would not be considered to ‘be distinct in the context of the contract’.
• For a good or service to ‘be distinct in the context of the contract’ means it must be
separately identifiable from the other goods or services promised within the contract.
• Professional judgement is required in assessing all facts and circumstances in this regard.
• In this situation, the construction of the plumbing system is highly dependent on the design
work. In other words, the customer could not have purchased the manufactured plumbing
system from Matthew without the design work having been completed first. Thus, the
design and the construction are considered so interdependent that they cannot be considered
separately identifiable from one another.

Conclusion

Although the design and the construction of the plumbing system are each ‘capable of being
distinct’, they are not ‘distinct in the context of the contract’ and thus the design of the plumbing
system and the construction of the plumbing system are not considered to be individually
distinct goods or services. Thus, we conclude that the design and construction of the plumbing
system constitutes a single performance obligation.

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Solution 4.8 continued ...

b) Discussion of 5 step process (bill and hold sale – storage incidental)

Revenue recognition and measurement involves a 5-step process.

These 5 steps are as follows:

Step 1: Identify whether we have a contract with a customer.
Matthew and Luke entered into a contract on 15 October 20X0. We are told that
the contract meets the requirements set out in IFRS 15 to be considered a ‘contract
with a customer’.
Step 2: Identify the performance obligations contained in the contract.
This contract has one performance obligation: to design and construct a plumbing
system (see part a)
Step 3: Determine the transaction price.
The transaction price is C1 540 000 (given).
Step 4: Allocate the transaction price to the identified performance obligations.
As there is only one performance obligation, the full transaction price is allocated
to the performance obligation.
Step 5: Recognise revenue when the performance obligations are satisfied.
See discussion that follows:

Introduction

Before revenue may be recognised from the sale of the plumbing system (step 5), we must first
prove that the performance obligations are satisfied. In this regard, we must prove that control
has passed to Luke.

Passing of control in a normal transaction: assessment of IFRS 15’s example indicators

(IFRS 15.38)

We prove that control has passed to a customer by considering whether there are any indications
of the transfer of control, using the five example indicators provided in IFRS 15.38 (see
Gripping GAAP section [Link], diagram 6).

An assessment of the facts and circumstances suggests that a number of these indicators were
met by 8 January 20X1, thus suggesting that control had passed to Luke:
• Luke had become obliged to pay for the plumbing system;
• Luke had obtained legal title over the plumbing system;
• Luke had inspected the plumbing system and accepted that it met all required specifications.

Passing of control in a bill-and-hold sale transaction: 4 extra criteria (IFRS 15.B81)

However, the sale of the plumbing system is a bill-and-hold sale since Matthew Limited:
• had invoiced Luke on 8 January 20X1; and yet
• had retained physical possession of the plumbing system.

Continued on the next page…

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Solution 4.8 continued ...

b) continued …

Since the sale is a bill-and-hold sale, we need to consider whether all four additional criteria
relevant to a bill-and-hold sale (provided in IFRS 15.B81) have been met:
• the reason for the bill-and-hold arrangement must be substantive (e.g. the customer must
have requested it);
• the product must be identified separately as belonging to the customer;
• the product must be ready for physical transfer to the customer; and
• the entity must not have the ability to use the product or to direct it to another customer.

In this regard, we conclude that all these criteria have also been met:
• the bill-and-hold arrangement is substantive because Luke requested that Matthew Limited
retain possession;
• the plumbing system is separately identified as having been sold to Luke (the sale
agreement has been signed thus providing legal proof that this particular plumbing system
has been sold to Luke and furthermore, the plumbing system is stored in the separate storage
area for items sold but not yet collected);
• the plumbing system was ready for delivery on 8 January 20X1;
• the plumbing system is specialised and thus it is practically not possible for it to be
redirected to another customer and unlikely to be able to be used by Matthew Limited.

Conclusion:

We conclude that control passed to Luke on 8 January because there are a number of indications
that control had passed on this date (per the example indicators listed in IFRS 15.38) and
because all further criteria were met relevant to a bill-and-hold arrangement (listed in
IFRS 15.B81). Thus, Matthew Limited must recognise the revenue from the sale of the
plumbing system on 8 January 20X1 (i.e. it does not wait until the customer obtains physical
possession of the plumbing system).

Since the storage is for a minimal period of time, the agreement to store the plumbing system
for a few days is considered incidental to the design and construction of the plumbing system
and thus is not considered to be a separate performance obligation.

Since the transfer of the plumbing system is a performance obligation that is satisfied at a point
in time, the revenue from this PO is recognised on 8 January 20X1. Since the consideration
was paid by the customer on this same day, no receivable was recognised.

Thus, the journal for the year ended 28 February 20X1 is as follows:

8 January 20X1 Debit Credit

Bank (A) Given 1 540 000
Revenue from customer contract (I) Working above 1 540 000
Recording the receipt from the customer and the related revenue from
the bill-and-hold sale of plumbing system – the only PO identified

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Solution 4.8 continued ...

c) Discussion bill and hold sale (storage significant)

Luke’s subsequent request for storage constitutes a distinct service but since the storage has
been requested over a 6-month period, which the wording of the question suggests is a fairly
significant period of time, we would have to conclude that we now have two performance
obligations:
• the transfer of a plumbing system; and
• the provision of storage over 6-months.

However, this request for storage occurred after the contract was agreed to and is thus
effectively a contract modification. Modifications to contracts that have been approved by all
parties are accounted for in one of the following ways:
• option 1: as an additional separate contract;
• option 2: as a termination of the old contract plus the creation of a new contract; or
• option 3: as part of the existing contract.

Option 1 and 2 apply in the event that the modification involves a distinct good or service
whereas option 3 applies in the event that it involves a good or service that is not distinct. Since
the storage is clearly distinct from the supply of a plumbing system, option 3 will not be
discussed further. Options 1 and 2 will now be considered:

Option 1:

We would account for the modification as a separate contract if:

• the scope increases due to extra goods or services that are distinct from the original goods
or services promised; and
• the price increases by an amount that reflects the stand-alone selling prices of these extra
goods or services.

In this case, the scope has increased to the extent of the extra distinct service (storage).
However, Matthew Limited agreed to waive the costs of the extra storage and thus the contract
price did not increase. Since both criteria for recognition of the modification as a separate
contract are not met, we do not account for the modification as a separate contract.

Option 2:

We would account for the modification as a termination of the old contract plus a creation of
a new contract if:
• the modification does not meet the criteria to be accounted for as a separate contract; and
• the remaining goods or services still to be transferred are distinct from the goods or services
already transferred.

Since the modification did not meet the criteria to be accounted for as a separate contract (see
discussion of option 1 above) and the remaining service to still be transferred (the storage) is
clearly distinct from the good already transferred (the plumbing system), the modification must
be accounted for as a termination of the old contract plus a creation of a new contract.

We thus reassess the contract and the subsequent request for storage as a single contract and
conclude the following:
• the contract price remains C1 540 000; and
• the contract now includes two performance obligations:
- transfer of a good: a plumbing system (PO#1): satisfied at a point in time; and
- transfer of a service: storage (PO#2): satisfied over time.

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Solution 4.8 continued ...

c) continued ...

In light of the conclusion that we have a contract modification, we must reassess the 5 steps of
revenue recognition.
Step 1 involved identifying the contract. No new information arose in this regard and thus we
continue to conclude (as we did in part b) that there appears to be a contract and we assume that
all criteria to prove the existence of the contract were met.
Step 2 involves identifying the performance obligations in the contract, step 3 involves
identifying the transaction price, step 4 involves allocating the transaction price to the
performance obligations and step 5 involves recognising revenue when the performance
obligation/s is/are satisfied. Steps 2 – 5 are reconsidered below.

Due to the contract modification, we now have 2 performance obligations (i.e. step 2 changes
as there was previously only 1 PO). This also means that we will now need to allocate the
transaction price to each of these 2 POs (i.e. step 4 changes because there was previously only
1 PO and thus the entire transaction price was simply allocated to the 1 PO).

Since there was no extra charge for the storage, the contract price does not change. However,
before assuming that the contract price is the transaction price and thus that step 3 remains
unchanged, we now need to consider the effects of the financing, since the terms of the modified
contract now include a financing component (thus step 3 changes).

A financing component arises since there is a difference between the date on which the
consideration is paid (8 January 20X1) and the date on which one of the performance
obligations is to be satisfied (the transfer of the storage services is to be provided over the 6-
month period ending 30 June 20X1).

However, since the period between these dates is not more than one year (the period is just
under 6 months), the effects of the financing are not taken into account when determining the
transaction price, even if they were considered to be significant. See comment at end

Thus, the transaction price is taken to be C1 540 000 (i.e. the contract price of C1 540 000 is
not adjusted for the financing component and thus the contract price = the transaction price).

Allocating the transaction price of C1 540 000 to the 2 performance obligations (step 4) must
be done based on the stand-alone selling prices (SASPs) of each performance obligation:
• we have the stand-alone selling price of the storage (C10 000 x 6 months = C60 000) but
• there is no stand-alone selling price available for the plumbing system (no doubt due to the
fact that it is highly specialised).

Where stand-alone selling prices are not available, they must be estimated. They may be
estimated on any basis, but IFRS 15 suggests the use of an ‘adjusted market price method’, a
‘cost plus method’ or a ‘residual method’. Insufficient information is available to estimate the
SASP of the plumbing system using either an ‘adjusted market price method’ or a ‘cost plus
method’ and thus we will use the ‘residual method’.

Performance obligations: Stand-alone

selling prices
1. Plumbing system C1 480 000 Estimated using the residual method:
Balancing: C1 540 000 – C60 000
2. Storage C60 000 Given: C10 000 x 6 months
C1 540 000

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Solution 4.8 continued ...

c) continued ...

Step 5 previously involved the transaction price being recognised as revenue when the one and
only performance obligation was satisfied, (i.e. the transfer of the plumbing system). However,
the contract modification changes step 5 as follows: the transaction price will be recognised as
revenue as and when each of the 2 performance obligations (POs) are satisfied.
• The transfer of the plumbing system is a performance obligation (PO) that is satisfied at a
point in time. This means that the portion of the transaction price allocated to this PO
(C1 480 000) will be recognised as revenue on 8 January 20X1.
• The provision of storage is a performance obligation (PO) that is satisfied over time. This
means that the portion of the transaction price allocated to this PO (C60 000) must be
recognised as revenue over the 6 months that the storage is provided.
Since we receive the full transaction price of C1 540 000 on 8 January 20X1, but yet on this
date we have only satisfied one of the performance obligations (i.e. the transfer of the plumbing
system), we may not recognise the entire receipt as revenue. Instead, the portion of the
transaction price that relates to the transfer of the plumbing system (C1 480 000) is recognised
as revenue, since it is the PO that has been satisfied, but the portion that relates to the provision
of future storage (C60 000) is initially recognised as a contract liability, thus reflecting the
entity’s obligation to either satisfy this PO or to refund this amount. The contract liability will
gradually be recognised as revenue as and when this latter PO is satisfied (i.e. at C10 000 per
month over the 6-month period that storage is provided).

Thus, if Matthew Limited’s financial year end was 28 February 20X1, the journal entries would
be as follows (not required, but provided for informative purposes):

8 January 20X1 Debit Credit

Bank (A) Given 1 540 000
Revenue from customer contract (I) Working above 1 480 000
Contract liability (L) Working above 60 000
Receipt from the customer and the related revenue from the bill-and-hold
sale of plumbing system (PO#1) and a contract liability for the balance
31 January 20X1
Contract liability (L) See calculation in narration 10 000
Revenue from customer contract (I) 10 000
Recognising revenue from the transfer of storage services – a time-basis
(an input method) would be considered a suitable measure of progress:
progress to date = 1 month completed / 6 months in total = 16.67%.
Thus, revenue recognised to date: 16.67% x C60 000 – revenue already
recognised: C0 = 10 000
28 February 20X1
Contract liability (L) See calculation in narration 10 000
Revenue from customer contract (I) 10 000
Recognising revenue from the transfer of storage services – a time-basis
(an input method) would be considered a suitable measure of progress:
progress to date = 2 months completed / 6 months in total = 33,33%.
Thus, revenue recognised to date: 33,3% x C60 000 – revenue already
recognised: C10 000 = 10 000

Comment for your interest: If Matthew had received financing from the customer for a period of more
than a year and the effects thereof were significant, the transaction price allocated to the provision of
these services will be determined at an amount net of the interest expense. E.g. if the effects of the
financing were quantified at C2 000, then revenue of C62 000 would be recognised (the transaction
price) over the period of the storage and an interest expense of C2 000 would be recognised over the
period of the financing using the effective interest method.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.9

Part A:

Journals:

1 January 20X8 Debit Credit

Bank (A) Given 48 000
Contract liability (L) 48 000
Recognising the receipt from the customer and the related contract
liability for the future services

31 December 20X8
Contract liability (L) W2 10 105
Revenue from customer contract (I) 10 105
Recognising the revenue from the first of the three services

31 December 20X9
Contract liability (L) 15 158
Revenue from customer contracts 15 158
Recognising the revenue from the second of the three services

Workings:

W1 Transaction price

= Contract price: C48 000 – Effect of significant financing component: N/A = C48 000

W2 Allocation of transaction price

The transaction price of C48 000 is allocated to the 3 separate POs (i.e. the 3 annual services), each of
which was a PO satisfied at a point in time, based on their relative standalone selling prices. The relative
stand-alone selling prices were not given and thus had to first be estimated. This solution estimated the
stand-alone selling prices using the ‘expected cost-plus margin’ approach (i.e. cost plus the required
margin, calculated as a mark-up on cost of 20%).

Estimated Allocation of
Mark up %
Cost standalone transaction price
(20% x cost)
selling price
First service C12 000 C2 400 C14 400 14 400 / 68 400 x 48 000 C10 105
Second service C18 000 C3 600 C21 600 21 600 / 68 400 x 48 000 C15 158
Third service C27 000 C5 400 C32 400 32 400 / 68 400 x 48 000 C22 737
C68 400 C48 000 W1

Notice that, although the TP must technically be allocated to each of the 3 POs based on their
relative stand-alone selling prices (SASPs), this solution estimated the SASPs using the
‘expected cost-plus appropriate margin’ approach, where the profit margin was a standard 20%
for each of the 3 POs (i.e. for each of the 3 services). This means that the same allocation of the
transaction price could have been achieved by allocating the transaction price based on the costs
of each PO as follows (IMPORTANT: the following table is for your information only - you
should not set out your answer in this way since it may suggest that you do not understand that
the TP should be allocated to multiple POs using their relative SASPs!):

Costs Workings Revenue allocation

First service C12 000 C12 000/57 000 x C48 000 C10 105
Second service C18 000 C18 000/57 000 x C48 000 C15 158
Third service C27 000 C27 000/57 000 x C48 000 C22 737
C57 000 C48 000 (W1)

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.9 continued ...

Part A continued …

Explanation (not required, included for informative purposes):

The journals provided above were based on the conclusion that the three annual services are
three separate performance obligations. This conclusion would have been drawn after
analysing the facts and concluding that:
• the services are capable of being distinct; and
• the services are distinct in the context of the contract.

Where a contract involves more than one performance obligation (PO), the contract’s
transaction price must be allocated to each of the performance obligations based on the stand-
alone selling prices (SASPs) of each PO.

The transaction price is the amount to which the entity expects to be entitled in exchange for
transferring the goods or services. The transaction price would need to exclude the effects of
any significant financing component. In this solution, the effect of financing was considered
to be insignificant and thus the transaction price was not adjusted. In other words, we conclude
that the contract price of C48 000 equals the transaction price.

The contract price is C48 000, which, when compared to the sum of the individual stand-alone
selling prices of the services over the three-year period of C68 400, effectively provides the
customer with an overall net discount of C20 400 (C68 400 – C48 000).

Since there is no evidence to suggest that the discount applies to one specific performance
obligation (e.g. to the first service), the discount of C20 400 inherent in the contract price is
allocated proportionately to each of the individual services. This is automatically achieved
when we allocate the transaction price to the performance obligations based on their individual
stand-alone selling prices as shown in the journals above.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.9 continued ...

Part B:

a) In order to determine how many performance obligations are evidenced in this contract, the
entity will have to draw conclusions after analysing the facts and circumstances. In this
regard, the entity ought to consider whether:
• the services are considered capable of being distinct; and
• the services are distinct in the context of the contract.

The services are designed to address different aspects of the engine as it ages and we are
thus told that each service is dependent on the previous service/s having been performed
timeously and in the correct sequence. As such each year of service is not capable of being
distinct and each year of service is not distinct in the context of the contract.

The three annual services are thus a single performance obligation.

b) Journals

01 January 20X8 Debit Credit

Bank (A) Given 48 000
Contract liability (L) 48 000
Recognising the receipt from the customer and the related contract
liability for the future services

31 December 20X8
Contract liability (L) W1 10 105
Revenue from customer contract (I) 10 105
Recognising the revenue from the first of the three services

31 December 20X9 (for illustrative purposes only)

Contract liability (L) 15 158
Revenue from customer contracts 15 158
Recognising the revenue from the second of the three services

WORKINGS:

W1 Transaction price

= Contract price: C48 000 – Effect of significant financing component: N/A = C48 000

W2 Allocation of transaction price

The transaction price of C48 000 is allocated to the 3 services based on the expected cost of each.
Costs Workings Revenue allocation
Year 1 C12 000 C12 000/57 000 x C48 000 C10 105
Year 2 C18 000 C18 000/57 000 x C48 000 C15 158
Year 3 C27 000 C27 000/57 000 x C48 000 C22 737
C57 000 C48 000 (W1)

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.9 continued ...

Part B continued…

b) Continued …

Explanation (not required, include for informative purposes):

The transaction price is the amount to which the entity expects to be entitled in exchange
for transferring the goods or services. The transaction price would need to exclude the
effects of any significant financing component. In this solution, the effect of financing was
considered to be insignificant and thus the transaction price was not adjusted. In other
words, the contract price of C48 000 was accepted as being the transaction price.

Since there is only one performance obligation, the entire transaction price is simply
allocated to this performance obligation. Since the performance obligation is satisfied over
time, the transaction price is recognised as revenue using a suitable measure of progress. It
is suggested that a suitable measure of progress would be costs incurred to date as a
percentage of total expected costs although a variety of methods are possible.

Comment:

Let’s compare Part A and Part B:

• In Part A, we have 3 POs and thus the TP must be allocated to each PO based on its relative
SASP. Each of these POs was a PO satisfied at a point in time and thus the portion of the TP
allocated to that PO would simply be recognised as revenue when that PO was satisfied.
• In Part B, we have 1 PO and thus the entire TP is allocated to that PO. This PO is a PO satisfied
over time and thus the TP is recognised as revenue based on the PO’s stage of completion. In
this solution, we chose to calculate the stage of completion based on the expected costs.

Please note that, since the SASPs in Part A were estimated based on a standard 20% mark-up on
costs, the allocation of the TP looks identical in both part A and part B, but this will not always be
the case, (e.g. had Part A stated that the entity worked on a 20% mark-up for service 1 and 30%
mark-up for service 2 and 40% mark-up for service 3, then the answer would have differed).

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Solution 4.10

Part A: Journals involving a warranty (assurance-type)

01 January 20X1 Debit Credit

Bank (A) 75 000
Revenue from customer contract (I) 75 000
Recognising the receipt from the customer as revenue
Cost of sales (E) Given 21 750
Inventory (A) 21 750
Recognising the cost of the goods sold
31 December 20X1 (cumulative journal)
Bank (A) 75 000 x 3,5% x 12/12 2 625
Interest income (A) 2 625
Recognising interest as income (not revenue in terms of IFRS 15!)

Explanation (for your interest only):

A warranty is generally understood to be ‘an undertaking as to the quality of a thing sold etc,
often accepting responsibility for defects or repairs over a specified period’. (Oxford
Dictionary, 1996)
However, IFRS 15 clarifies that the nature of warranties can vary widely across the world.
IFRS 15 separates warranties into two types:
• assurance-type warranties (assurance that the product complies with agreed-upon
specifications); and
• service-type warranties (where the customer is provided with a service in addition to the
assurance that the product complies with agreed-upon specifications).

Assurance-type warranties are not accounted for in terms of IFRS 15 but instead are accounted
for as liabilities (provisions) in terms of IAS 37 Provisions, Contingent Liabilities and
Contingent Assets.
Service-type warranties, on the other hand, are accounted for in terms of IFRS 15 as a separate
performance obligation and thus a portion of the transaction price would be allocated to this
warranty obligation.
If a warranty contained in a contract could have been purchased separately by a customer, then
that warranty is automatically accounted for as a service-type warranty.
In the scenario provided, the warranty appears to be a simple assurance-type warranty:
• If the goods are found to be defective within 9-months of purchase, they may be returned
for a refund (together with a nominal amount of interest), suggesting it is an assurance-type
warranty; and
• There is no evidence to suggest that this warranty is sold separately and thus it is not
automatically accounted for as a service-type warranty.
Thus, in this case, the sale must be recognised as revenue in terms of IFRS 15 and the warranty,
being an assurance-type warranty, must be accounted for in terms of IAS 37.
In terms of IAS 37, a warranty provision (a liability) would be recognised if the warranty met
the definition of a liability (present obligation as a result of a past event that is expected to result
in an outflow of future economic benefits) and if a reliable estimate thereof was possible. In
this case, the entity has no past experience on which to assess the probability of return and thus
the definition of a liability is not met and a reliable estimate of the possible outflow resulting
from the warranty policy is not possible. In such cases, a contingent liability is disclosed in the
notes instead.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.10 continued...

Part B: Journals involving a right of return

01 January 20X1 Debit Credit

Bank (A) Given 75 000

Refund liability (I) 75 000
Recognising the receipt from the customer as a refund liability due to
the right of return

Right of return asset (A) Given 21 750

Inventory (A) 21 750
Recognising the cost of the inventory sold as a right of return asset

1 October 20X1

Refund liability (L) 75 000

Revenue from customer contract (I) 75 000
Cost of sales (E) 21 750
Right of return asset (A) 21 750
Recognising the revenue from the customer contract and the cost of sale
expense on the date that the right of return expired without the customer
having returned any of the goods

31 December 20X1 (cumulative journal)

Bank (A) 75 000 x 3,5% x 12/12 2 625

Interest income (A) 2 625
Recognising interest as income (not revenue in terms of IFRS 15!)

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.10 continued ...

Part B continued ...

Explanation (for your interest only)

When dealing with a right of return, one is dealing with variable consideration. This is because
one is unsure of how much will be returned and thus how much of the transaction price we will
be able to keep.

Variable consideration is included in the transaction price only to the extent that it is highly
probable that there will be no need for a significant reversal of revenue in the future. This is
referred to as constraining the estimated variable consideration.

In assessing whether there would be a high probability of a significant reversal of cumulative

revenue in the future, IFRS 15 requires us to consider the likelihood and the magnitude of the
reversal. In this regard, it provides, by way of example, a number of factors that may suggest
a high likelihood of a significant reversal (see IFRS 15.57 for the full list).

In this case, Boutique has no past experience on which to predict the possibility of the goods
being returned. Consequently, assuming that the sale amount of C75 000 is considered to be
material, the inability to predict means that Boutique cannot conclude that there is a high
probability that a significant reversal of cumulative revenue will not occur in the future.

Thus, Boutique must initially recognise the entire receipt as a refund liability and only recognise
the receipt as revenue when the right of return period expires without the goods having been
returned.

In addition to the recognition of the entire receipt as a refund liability, we will need to recognise
the entire cost of the goods sold as a refund asset, reflecting the right to recover the asset (i.e.
right of return asset).

This refund asset should be measured at the cost of the item sold and adjusted for any costs
expected to be incurred in recovering these goods. No evidence was given of extra costs of
recovery, so we assume these to be nil.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.10 continued ...

Part C: Journals involving a warranty (service-type warranty)

01 January 20X1 Debit Credit

Bank (A) Given 75 000

Revenue from customer contract (I) Revenue from sale of product: 64 286
75 000/ (product 75 000 + warranty
12 500) x 75 000
Warranty provision (L) Revenue from sale of warranty: 10 714
12 500/ (product 75 000 + warranty
12 500) x 75 000
Recognising the receipt from the customer: only the portion of the total
transaction price that relates to the sale of the item is recognised as
revenue. The portion that relates to the warranty becomes a
performance obligation forming part of the bundle and must initially be
recognised as a liability

Cost of sales (E) Given 21 750

Inventory (A) 21 750
Recognising the cost of the inventory sold as an expense.

31 December 20X1

Warranty provision (L) 10 714

Revenue from customer contract (I) 10 714
Recognising the revenue from the sale of the warranty provision when
the warranty expired without the need to replace the item

31 December 20X1 (cumulative journal)

Bank (A) 75 000 x 3,5% x 12/12 2 625

Interest income (A) 2 625
Recognising interest as income (not revenue in terms of IFRS 15!)

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.11
Journals

Mykonos Hotel

30 June 20X4 Debit Credit

Receivable (A) 92 000 x C3.00 276 000

Refund liability (L) 92 000 x (C3.00 – C2.70) 27 600
Revenue from customer contract (I) 92 000 x C2.70 248 400
Transaction with Mykonos Hotel:
Recognising the receivable (they were granted 30 days credit), and both the
related revenue and refund liability, reflecting the potential volume rebate

Trekker’s Hideaway

30 June 20X4 Debit Credit

Bank (A) 49 500 x C3.00 148 500

Refund liability (L) 49 500 x (C3.00 – C2.88) 5 940
Revenue from customer contract (I) 49 500 x C2.88 142 560
Transaction with Trekker’s Hideaway:
Recognising the cash received (The Red Radish operates on a cash on
delivery basis), and both the related revenue and refund liability,
reflecting the potential volume rebate

Spring Apartments

30 June 20X4 Debit Credit

Bank (A) C800 000 800 000

Refund liability (L) C800 000 – C51 750 748 250
Revenue from customer contract (I) 17 250 x C3.00 51 750
Transaction with Spring Apartment:
Recording the receipt from the customer and the related revenue (based
on the normal unit price since there is currently no rebate expected) and
refund liability (the difference between the cash received and the revenue
is recognised as a refund liability because the customer has currently
overpaid – there is no potential rebate currently expected and thus the
refund liability purely reflects the overpayment)

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Solution 4.11 continued ...

Discussion and explanation – for your interest only

General comment:

Revenue recognised is measured based on the transaction price, which in a nutshell, is the
amount to which the entity expects to be entitled in exchange for the goods or services. The
transaction price is thus not always equal to the contract price / invoice price.

There are various factors that we need to consider when determining the transaction price, for
example:
• we would exclude any significant financing components (financing is an issue that requires
discussion in the case of Spring Apartments); and
• we would need to carefully measure any consideration that is considered to be variable (The
Red Radish’s pricing structure explicitly states how the prices would vary depending on
annual volumes purchased, and thus, since The Red Radish is unable to be certain of the
annual volume that each of its customers will purchase, the invoiced price to all three
customers will not necessarily equal the transaction price, since each transaction is affected
by what is referred to as variable consideration).

Variable consideration must be included in the transaction price at the estimated amount to
which the entity expects to be entitled, where this estimate must be constrained to an amount
that has a high probability of not causing a significant reversal of revenue in the future.

Mykonos Hotel

Mykonos purchased 92 000 units from The Red Radish in June 20X4 and is thus, based on the
pricing model, charged C3,00 per unit.

However, Mykonos is expected to purchase 1 112 500 units during the calendar year and thus,
according to the pricing model, which is based on cumulative purchases over the year, the price that
the Sunflower Company expects to charge Mykonos per unit is only C2,70 (in other words, The Red
Radish expects to have to provide Mykonos with a rebate some time before year end).

This means that if we recognised revenue based on C3,00 per unit, there would be a high
probability of a significant reversal of revenue by year-end. Thus, although we invoice the
customer at C3,00, we must constrain the invoice price of C3,00 to C2,70 when measuring the
revenue to be recognised from this sale, being the estimated consideration that we expect to be
entitled to and which is not expected to result in a highly probable significant reversal of
revenue in the future.

Thus, the revenue recognised from the sale of the first 92 000 units will be based on a
transaction price of C2,70 per unit even though the actual price charged on the invoice is C3,00
per unit. This C3,00 per unit is used to recognise the receivable. The difference of C0.30 per
unit (C3,00 – C2,70) between the invoice price (i.e. the contract price) and the transaction price
is recognised as a refund liability, representing the expected rebate.

Thus, the journals are as follows:

30 June 20X4 Debit Credit

Receivable (A) 92 000 x C3.00 276 000
Refund liability (L) 92 000 x (C3.00 – C2.70) 27 600
Revenue from customer contract (I) 92 000 x C2.70 248 400
Recognising the Mykonos receivable and the related revenue and refund
liability, subject to a potential volume rebate

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.11 continued ...

Trekker’s Hideaway

Trekker’s Hideaway purchased 49 500 units from The Red Radish in June 20X4 and is thus,
based on the pricing model, charged C3,00 per unit.

However, Trekker’s Hideaway is expected to purchase 490 000 units during the calendar year
and thus, according to the pricing model, which is based on cumulative purchases over the year,
the price that The Red Radish expects to charge Trekker’s Hideaway per unit is only C2,88 (in
other words, The Red Radish expects to have to provide Trekker’s Hideaway with a rebate of
C0,12 per unit some time before year end).

This means that if we recognised revenue based on C3,00 per unit, there would be a high
probability of a significant reversal of revenue by year-end. Thus, although we invoice the
customer at C3,00, we must constrain the invoice price of C3,00 to C2,88 when measuring the
revenue to be recognised from this sale, being the estimated consideration that we expect to be
entitled to and which is not expected to result in a highly probable significant reversal of
revenue in the future.

Thus, the revenue recognised from the sale of the first 49 500 units will be based on a
transaction price of C2,88 per unit even though the actual price charged on the invoice is C3,00
per unit. This C3,00 per unit is used to recognise the receivable. The difference of C0,12 per
unit (C3,00 – C2,88) between the invoice price (i.e. the contract price) and the transaction price
is recognised as a refund liability, representing the expected rebate.

Thus, the journals are as follows:

30 June 20X4 Debit Credit

Bank (A) 49 500 x C3.00 148 500
Refund liability (L) 49 500 x (C3.00 – C2.88) 5 940
Revenue from customer contract (I) 49 500 x C2.88 142 560
Recognising the Trekker’s Hideaway receivable and the related
revenue and refund liability, subject to a potential volume rebate

Spring Apartments

Spring Apartments purchased 17 250 units from The Red Radish in June 20X4 and is thus,
based on the pricing model, charged C3,00 per unit.

Spring Apartments is expected to purchase 237 900 units during the calendar year.
Consequently, the price expected to be charged to Spring Apartments is C3,00 per unit. The
transaction price to be allocated to the sale therefore matches the invoice price (i.e. the contract
price). There is thus no rebate expected and the entire invoiced price may be recognised as
revenue.

However, Spring Apartments has paid for further units in advance. The amount paid in advance
is allocated to a refund liability account because The Red Radish is not yet unconditionally
entitled to the amount.

If the timing of the receipt of consideration differs from the timing of the exchange of goods or
services, either the entity or its customer is said to receive a financing benefit. Where this
occurs, the contract is said to include a financing component. However, we only adjust the
transaction price if the financing component is considered to be a significant financing
component and if the period between the date of the receipt of consideration and the date of
exchange of the goods or services is more than one year.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.11 continued ...

In the case of Spring Apartments, however, the financing benefit enjoyed by The Red Radish
is ignored when determining the transaction price because the period between the date of receipt
of the consideration and the date of transfer of control over the flower arrangements is not more
than one year. the receipt of the C800 000 relates to both:
• the sale of flower arrangements in June (i.e. the period between the date of receipt of
consideration and the date of delivery of the flower arrangements is less than a month); and
• future expected sale of flower arrangements during the remainder of the same year (i.e. the
period between the date of receipt of consideration, being June 20X4, and the date of
expected delivery of the flower arrangements is less than a year).

Thus, the journals are as follows:

30 June 20X4 Debit Credit

Bank (A) C800 000 800 000
Refund liability (L) C800 000 – C51 750 748 250
Revenue from customer contract (I) 17 250 x C3.00 51 750
Recognising the receipt from Spring Apartments and the related revenue
and refund liability (no potential volume rebate expected)

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.12

Part A

a) Allocation of transaction price to items within a bundle (calculations)

Allocation of transaction prices of each bundle

Braai bundle Standalone selling price Allocation of TP

Sports Books C50 (50/86 x C78) C45,35
Entertainment books C36 (36/86 x C78) C32,65
C86 C78,00

Winter bundle Standalone selling price Allocation of TP

Cooking book C24 (24/52 x C42) C19,38
History book C28 (28/52 x C42) C22,62
C52 C42,00

NY Resolution bundle Standalone selling price Allocation of TP

Sports book C50,00 (50/144.96 x C126) C43,46
Entertainment book C36,00 (36/144.96 x C126) C31,29
Cooking book C24,00 (24/144.96 x C126) C20,86
History book C28,00 (28/144.96 x C126) C24,34
E-books C 6,96 (6.96/144.96 x C126) C 6,05
C144,96 C126,00

The stand-alone selling price for the E-books was estimated using the entity’s cost plus its required 16%
profit mark-up: Cost: C6 + Profit: (C6 x 16%) = C6.96

b) Allocation of transaction price to items within a bundle (brief explanation)

The allocation of the transaction price within each bundle is performed based on the observable
stand-alone selling prices for each item within the bundle.

However, an observable stand-alone selling price for the E-books was not available (since it is
not sold separately) and thus had to be estimated before we could allocate the transaction price
of the NY resolutions bundle. The stand-alone selling price for the E-books could be estimated
in any number of ways, but IFRS 15 suggests the use of the ‘adjusted market assessment
approach’, the ‘expected cost-plus margin approach’ and the ‘residual approach’. In this
situation, we were given the cost and the required mark-up and thus we are able to use the
‘expected cost-plus margin approach’.

The fact that the sum of the stand-alone selling prices of the items within each bundle exceeded
the contract price per bundle, meant that the contract price was discounted in each of the three
bundles. Since we are not told that the discount applies to any specific item/s in these bundles,
these discounts were automatically allocated to each item in the bundle when allocating the
transaction price per bundle to each item in the bundle.

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Solution 4.12 continued …

Part A continued …
b) Continued…a more detailed discussion (not required, included for interest only)

Note from the author: The question asked you to ‘briefly explain how each of the three
bundle prices are allocated’ and thus the above explanation should suffice. However, the
extent of your answer in a test situation should always be dictated by the mark allocation. A
slightly more detailed explanation is thus provided for your interest:

IFRS 15 Revenue from Contracts with Customers prescribes how an entity should account for
revenue from contracts with customers. The core principle of IFRS 15 is that an entity should
recognise revenue to depict the transfer of goods/services to customers at an amount that reflects
the consideration to which the entity expects to be entitled in exchange for those goods and
services. In other words, we are talking about how much of the transaction price should be
allocated to each of the goods or services (which would be recognised as revenue when the
relevant performance obligation is satisfied), because the transaction price is defined as the
consideration to which the entity expects to be entitled in exchange for transferring goods and
services to a customer, excluding amounts collected on behalf of third parties.

Marleybone normally sells two types of bundled products (the Braai bundle and the Winter
bundle), but at New Year season, it sells a third type of bundle (the New Year’s resolution
bundle). The Braai bundle has a retail price of C78, the Winter bundle has a retail price of C42
and the New Year’s resolution bundle has a retail price of C126. The retail price of each bundle
is referred to as each bundle’s contract price.

When determining how much of the contract price represents the transaction price, we must
exclude amounts collected on behalf of third parties but must also consider:
• Variable consideration
• Significant financing components
• Non-cash consideration
• Consideration paid to the customer.

In this case, there is no talk of amounts collected on behalf of third parties. Similarly, there is no
significant financing component, non-cash consideration or consideration paid to the customer.
Variable consideration includes items such as possible discounts, which may need to be estimated
and then constrained. In this case, there are discounts involved but these are not variable. Thus,
in this case, each bundle’s contract price also represents its transaction price.

A discount is offered on the sale of each of the three bundles. This is evident since the sum of the
relevant standalone selling prices was lower than the retail price of the bundle.

This discount does not relate to any specific item in the bundle and must thus be allocated to each
of the items within the bundle based on each item’s relative stand-alone selling price. The
allocation of this discount is not done as a separate calculation since it is automatically allocated
to each of the items in the bundle when allocating the transaction price (which is already net of
the discount) of that bundle based on the relative standalone selling prices of the individual items
that make up that bundle.

Since there is no observable stand-alone selling price for the E-books (i.e. it had not previously
been sold separately), this stand-alone selling price must be estimated. The stand-alone selling
price for the E-books could be estimated in any number of ways, but IFRS 15 suggests the use of
the ‘adjusted market assessment approach’, the ‘expected cost plus margin approach’ and the
‘residual approach’. In this situation, we were given the cost and the required mark-up on cost
and thus we are able to use the ‘expected cost plus margin approach’ (Cost: C6 + Profit: (C6 x
16%) = C6.96).

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.12 continued …

Part B

Journals in 20X9
Debit Credit
31 January 20X9

Bank (A) 200 x C126 25 200

Revenue – Entertainment book sales 200 x C31,29 (see Part A) 6 258
Revenue – Cooking book sales 200 x C20,86 (see Part A) 4 172
Revenue – History book sales 200 x C24,34 (see Part A) 4 868
Revenue – E-books sales 200 x C6,05 (see Part A) x 60% 726
Contract liability – E-books 200 x C6,05 (see Part A) x 40% 484
Contract liability – Sports books 200 x C43,46 (see Part A) 8 692
Recognising the receipt from customers for 200 New Year’s resolution
bundles, recognising part as revenue and part as a contract liability
depending on the extent to which the performance obligation had been
satisfied

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.13
a) Recognition of the receipt of joining fees and membership fees:

Joining fees

The joining fees charged to members (i.e. customers) are, in effect, related to the administrative
costs of setting up the members on the gym’s systems. The process of setting up the member
on the gym’s system, whilst necessary for the entity to do, does not ‘transfer a good or service
to the customer’. Thus, the joining fee is accounted for as an advance part payment in exchange
for access to the gym facilities. In other words, it means that the joining fee should be
recognised as and when this performance obligation (i.e. access to gym facilities) is satisfied.
See IFRS 15.B49

Since the contract involves providing a member with access to the gym facilities for a 12-month
period (i.e. not just a day-access), this performance obligation will be satisfied over time and
thus any related revenue would be recognised over this same time-period.

It was therefore incorrect to recognise the C30 000 received in joining fees as revenue upon
date of receipt (i.e. it should be recognised over 12 months).

Membership fees

The annual membership fees charged to members (i.e. customers) entitle the members to access
the Fitness gym facilities for a 12-month period. Thus, Fitness has a performance obligation
that will be satisfied over time.

Since the performance obligation is satisfied over time, the revenue relating to this performance
obligation must also be recognised over this same time-period.

It was therefore incorrect to recognise the C450 000 received in membership fees as revenue
upon date of receipt (i.e. it should be recognised over 12 months).

Conclusion:

Until the performance obligation was satisfied, the receipt should be recognised as a contract
liability, thus reflecting the entity's obligation to provide services to the customers. This contract
liability should then have been gradually reversed and recognised as revenue as the related
performance obligations were satisfied.

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Solution 4.13 continued ...

b) Determining the transaction price

Introduction

First, we determine the contract price and then ascertain whether this needs to be adjusted for
issues such as significant financing components, non-cash consideration, consideration payable
to the customer and variable consideration. In this case, there is no non-cash consideration, no
consideration payable to the customer and no variable consideration. However, we need to
consider whether the financing benefit is a significant financing component.

The contract price

As referred to above, membership of the gym effectively involves two fees:

• a joining fee of C100 (as explained above, this does not provide the customer with a
separate transfer of goods or services in addition to the service of access to the gym facilities
and thus the joining fee is added to the membership fee when determining the transaction
price relating to the contract providing access to the gym facilities); and
• a membership fee of C1 500 (providing access to the gym facilities for 12-months).

The total contract price to secure gym membership is therefore C1 600 (C100 + C1 500).

The existence of a financing benefit

The fact that the fees (i.e. the joining fees and membership fees) are paid by the customer in
advance means that the entity obtains a financing benefit. The effects of financing are taken
into account when determining the transaction price if they are considered to represent a
significant financing component.

However, due to the practical expedient given in IFRS 15, we do not account for the effects of
this financing benefit, whether significant or not, because the period between the date of receipt
and the timing of the transfer of services is not greater than one year. See IFRS 15.63

Furthermore, if the primary purpose of the advance payment was not to obtain financing from
the customer, (e.g. if the advance payment was to simplify the otherwise burdensome
administration of receiving monthly payments and the difference between the promised
consideration and the total cash price if paid on a monthly basis ‘is proportional to the reason
for the difference’), then any benefit received from the financing would not be considered to be
a significant financing component and thus the transaction price would not require adjustment.
See IFRS 15.62

We thus conclude that the transaction price is simply the unadjusted contract price of C1 600.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.13 continued ...

c) Identifying the performance obligations

The contract provides the customer with access to the gym for a period of time. This is clearly
a performance obligation (which will be satisfied over time). However, the existence of a
renewal option must also be considered when identifying the performance obligations and also
when allocating the transaction price.

The membership contract (for which the total contract price is effectively C1 600) enables the
customer to renew his/her contract and is thus said to include an ‘option of renewal’.

Since the optional renewal is offered at a 20% discount off the normal stand-alone selling price,
and assuming this discount is significant, this option is considered to be a material right granted
to the customer.

On the assumption that this right would be considered to be material, and since this material
right is only available to customers that had entered into the original membership contract, this
material right must be accounted for as a separate performance obligation within the original
membership contract. See IFRS 15.B40

This means that the contract effectively contains two performance obligations:
• PO#1: Access: to provide access to the gym facilities for 12-months
• PO#2: Option: to provide discount of 20% if the contract is renewed.

Note:
The revenue from the second performance obligation would be recognised when the services
are transferred or when the option expires. See IFRS 15.B40

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Solution 4.13 continued ...

d) Allocation of the transaction price

Introduction

Having two performance obligations within the contract (providing gym access and the option
of renewal) means that the transaction price will need to be allocated between these two
performance obligations. This is normally done based on their relative stand-alone selling
prices. See IFRS 15.B42

However, since the renewal entitles a customer to services that are similar to the services offered
in the original contract and on the same terms as the original contract, IFRS 15 provides an
alternative method of accounting for the transaction price (i.e. instead of the normal method of
allocating the transaction price to the performance obligations based on their relative stand-
alone selling prices). See IFRS 15.B43

Each of these two methods is explained below.

Normal method (IFRS 15.B42)

Each of the two stand-alone selling prices (SASP) would need to be determined:
• The SASP for PO # 1 (access for 12 months) is C1 600; but
• The SASP for PO #2 (the option to renew) would need to be estimated.
This estimate would reflect the discount that the customer would enjoy if he/she exercised
the option, adjusted for the likelihood that it would be exercised:
C1 500 x 20% x 55% = C165. See IFRS 15.B42

We would then need to allocate the transaction price of C1 600 to each of these performance
obligations based on these stand-alone selling prices.

The allocation would be as follows:

Stand-alone Transaction price Allocation of TP based on SASP:

selling prices (300 members)
PO#1 C1 600 Calculation (a) C435 127 C480 000 x (1 600 ÷ 1 765)
PO#2 165 Calculation (b) 44 873 C480 000 x (165 ÷ 1 765)
C1 765 C480 000 C1 600 x 300 members

a) Joining fee: C100 + Membership fee: C1 500 = C1 600

b) Discount on renewal of membership: C1 500 x 20% discount x 55% likelihood = C165

Alternative method (IFRS 15.B43)

Since the renewal entitles a customer to services that are similar to the services offered in the
original contract and on the same terms as the original contract, we may, as a matter of practical
expediency, not bother determining the two stand-alone selling prices (i.e. the SASP for the
provision of access to gym facilities for 12 months and the SASP for the option to renew) and
then allocating the transaction price to each.

Instead, we are allowed to simply calculate the total expected consideration and the total
expected services to be provided and then allocate this total expected consideration to these
total expected services in a way that reflects the progress towards complete satisfaction of the
total expected services.

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Solution 4.13 continued ...

d) continued …

In this case, we would estimate the total expected transaction price by adding to the initial
C480 000 received (i.e. joining fees: C30 000 + membership fees: C450 000), the expected
extra consideration from the anticipated renewals of C198 000 (membership fees: C450 000 x
55% x 80% - or see alternative calculations below).

Total expected
consideration
Year 1 C480 000 Calculation (a)
Year 2 C198 000 Calculation (b)
C678 000
a) Consideration from the original contract:
(300 members x Joining fee: C100) + (300 members x Membership fee: C1 500) = C480 000
b) Consideration from the expected renewals:
(300 members x 55% x Membership fee: C1 500 x 80%) = C198 000

We would then recognise this total expected consideration as revenue over the two years using an
appropriate measure of progress. In this case there is no evidence to suggest that the cost of
providing access to the gym facilities in the second year would differ from the first year and thus a
simple time-based measure of progress is considered acceptable (i.e. straight-lining over 2 years).

Allocation of Allocation based on measure of progress:

total expected Total revenue x measure of progress to date – revenue recognised previously
consideration
Year 1 C339 000 C678 000 x 12/24 months – Recognised in a prior year: C0
Year 2 C339 000 C678 000 x 24/24 months – Recognised in a prior year: C339 000
C678 000

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.13 continued ...

e) Journals

Overview

Since the renewal option provided the customer with goods / services similar to the goods/
services in the original contract and on the same terms as the terms in the original contract,
IFRS 15 allows for two different methods of allocation of the transaction price: the normal
method and the alternative method. The journals that are processed will be affected by which
method was chosen. Thus, the journals for each of these two methods are presented separately
below.

The journals based on the normal method of allocation (see part d)

The accountant was incorrect to recognise the total receipts of C480 000 as revenue on date of
receipt. Instead, these receipts should have initially been recognised as a contract liability, thus
reflecting Fitness’s obligation to either satisfy the performance obligations or to refund the
money. Then, assuming that we used the normal method of allocating the transaction price,
revenue of C435 127 should have been recognised during the course of 20X8, leaving a balance
of C44 873 (C480 000 – C435 127) in the contract liability account (see part (d) for workings).
This balance of C44 873 reflected the obligation to provide a discount on any renewals.

This remaining contract liability would then be recognised as revenue as the options were
exercised or expired (i.e. on 31 January 20X9).

The journals should thus have been as follows (for practical reasons, these journals are
presented as cumulative journals for the year):
Debit Credit
On receipt during 20X8
Bank (A) 30 000 + 450 000 480 000
Contract liability (L) 480 000
Receipt from customers: membership fees of C450 000 plus joining
fees of C30 000

By the end of 20X8

Contract liability (L) Working in part (d) 435 127
Revenue from customer contracts (I) 435 127
Recognition of revenue: allocating TP to POs using SASPs

By the end of 20X9 (assuming renewals were as expected)

Bank 300 x 55% x C1 500 x 80% 198 000
Contract liability (L) CL bal: 480 000 – 435 127 44 873
Revenue from customer contracts (I) 198 000 + 44 873 242 873
Recognition of revenue: allocating TP to POs using SASPs

Note: The cumulative revenue recognised is C678 000

The journals based on the alternative method of allocation (see part d), are presented on the
next page….

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.13 continued ...

e) Journals continued …

The journals based on the alternative method of allocation (see part d)

The accountant was incorrect in recognising the total receipts of C480 000 as revenue on date
of receipt. Instead, these receipts should have initially been recognised as a contract liability,
thus reflecting Fitness’s obligation to either satisfy the performance obligations or refund the
money. Then, assuming that we used the alternative method of recognising the transaction
price as revenue based on a measure of progress, revenue of C339 000 should have been
recognised during the course of 20X8, leaving a balance of C141 000 in the contract liability
(C480 000 – C339 000) (see part (d) for workings).

This contract liability would then be recognised as revenue over the remaining year (20X9) as
the second year of gym access was provided to those original members who decided to renew
their contracts.

The journals should thus have been as follows (for practical reasons, these journals are
presented as cumulative journals for the year):
Debit Credit
On receipt during 20X8
Bank (A) 30 000 + 450 000 480 000
Contract liability (L) 480 000
Receipt from customers: membership fees of C450 000 plus joining
fees of C30 000

By the end of 20X8

Contract liability (L) Working in part (d) 339 000
Revenue from customer contracts (I) 339 000
Recognition of revenue: allocating the total expected consideration
to the total expected services to be provided, recognising the
revenue using a time-based measure of progress

By the end of 20X9 (assuming renewals were as expected)

Bank C1 500 x 80% x 300 x 55% 198 000
Contract liability (L) CL bal: 480 000 – 339 000 141 000
Revenue from customer contracts (I) 198 000 + 141 000 339 000
Recognition of revenue: allocating the total expected consideration
to the total expected services to be provided, recognising the
revenue using a time-based measure of progress

Income from non-members (for your interest only as the question only asked about the joining
fees and membership fees)

The income from the non-members represents consideration that would have been received in
exchange for immediate access to the gym. As such, the performance obligations related to the
non-members would be classified as ‘satisfied at a point in time’ and thus revenue from these
performance obligations (being the service of providing access to the facilities) would be
recognised at the same time that the access was provided.

Since the access would have been provided at the same time as the consideration would have
been received, the immediate recognition of the receipt as revenue is acceptable.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.14

Customer A:

Journals
Debit Credit
31 January 20X6

Receivable (A) Contract price: 200 000 x 50% - 100 000

receivable already recognised: 0
Receivable: rebate allowance (-A) Rebate: 80 000 x 50% - rebate 40 000
allowance already recognised: 0
Revenue from customer contract Transaction price: 120 000 x 50% - 60 000
revenue already recognised: 0
Revenue from customer contract satisfied over time: the contract was
signed on 1 January 20X6 for a 2-month period and thus progress at
31 January 20X6 is 50% (one out of 2 months), thus 50% of the TP is
recognised as a receivable, but a rebate of C40 000 (50% of the total
rebate of C80 000) is taken into account when measuring the revenue

5 February 20X6
Bank (A) Given 140 000
Receivable (A) Contract price: 200 000 x 50% 100 000
Refund liability (L) Balancing 40 000
Receipt from the customer reduces the receivable but the excess is an
advance payment that must be recognised as a refund liability (i.e. it may
not yet be recognised as revenue)

28 February 20X6
Receivable (A) Contract price: 200 000 x 100% - 100 000
receivable already recognised: 100 000
Receivable: rebate allowance (-A) Rebate: 80 000 x 100% - rebate 40 000
allowance already recognised: 40 000
Revenue from customer contract Transaction price: 120 000 x 100% - 60 000
revenue already recognised: 60 000
Revenue from customer contract satisfied over time: the contract was
signed on 1 January 20X6 for a 2-month period and thus progress at
28 February 20X6 is thus measured at 100%

Receivable: rebate allowance (-A) 80 000

Revenue from customer contract 80 000
Reversing the rebate allowance since it is forfeited and recognising it as an
adjustment to revenue (since the POs had already been satisfied)
Refund liability (L) 40 000
Receivable (A) 40 000
Reversing the refund liability and recognising it as a reduction in the
receivable balance now that the related POs have been satisfied

Calculations:
(a) TP: transaction price = (contract price: 200 000 – expected rebate: 80 000)
(b) Measure of progress:
• At 31 January 20X6: 1 month completed ÷ 2 months in total = 50%
• At 28 February 20X6: 2 months completed ÷ 2 months in total = 100%

Notice:
Did you notice that the receivable balance is actually measured based on 50% of the transaction price?
For example, the net receivable balance at 31 January 20X6 is C60 000 (receivable account: C100 000 –
rebate allowance account: C40 000), which equals: Transaction price of C120 000 x Measure of progress
of 50% = C60 000.

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Solution 4.14 continued ...

Customer A continued ….

Explanation

The transaction price is the amount of consideration to which the entity expects to be entitled.
Since the entity expects the customer will provide the necessary documentation timeously and
will thus qualify for the rebate, it means that, at contract inception, the entity expects to be
entitled to C120 000 (C200 000 – C80 000).

The contract involves a single performance obligation and thus the entire transaction price of
C120 000 (C200 000 – C80 000) is allocated to the single performance obligation.

The revenue is then recognised when this performance obligation is satisfied. Since this
performance obligation is a performance obligation satisfied over time, the related revenue will
be recognised gradually over time, based on the measure of the entity’s progress towards
complete satisfaction of the performance obligation.

The chosen measure of progress is not given, but since the performance obligations will be
satisfied evenly over a two-month period, a time-based method (an input method) would be
considered acceptable.

Journal on 31 January 20X6:

Assuming that a time-based method was used to measure progress, we would conclude that the
entity had satisfied 50% of its performance obligations at 31 January 20X6 (1 month completed
/ 2 months in total) and thus 50% of the revenue must be recognised on 31 January 20X6.

Journal on 5 February 20X6:

The customer has paid an amount of C140 000 and thus we debit the bank. However, the
customer has only been invoiced C100 000 to date and thus this receipt exceeds the (gross)
receivable balance by C40 000. This extra C40 000 may not be recognised as revenue since the
revenue must reflect the portion of the transaction price that reflects the measure of progress
(i.e. C60 000). Thus, the excess received is recognised as a refund liability (reflecting the fact
that we must either perform our obligation or refund the customer this amount).

Journal on 28 February 20X6:

Two issues need to be accounted for on 28 February 20X6:

• Revenue must be recognised when the second (and final month’s) month of services are
provided.
• When the documentation fails to be presented, the rebate is forfeited and is recognised as
an adjustment to revenue.

Since the performance obligations are completely satisfied, the amount received that was
initially recognised as a refund liability, must now be recognised as a reduction in the receivable
balance instead (i.e. the refund liability is derecognised, debited, and the contra entry being a
credit to the receivable account).

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Solution 4.14 continued ...

Customer B:

Journals
Debit Credit
31 January 20X6

Receivable (A) Contract price: 600 000 x 33,3% – 200 000

Receivable already recognised: 0
Receivable: rebate allowance (-A) Rebate: 240 000 x 33,3% – Rebate 80 000
allowance already recognised: 0
Revenue from customer contract (I) Transaction price: 360 000 (a) x 33,3% 120 000
– Revenue already recognised: 0
Revenue from customer contract satisfied over time:
Measure of progress = 1 / 3 months = 33,3%

15 February 20X6 (Date on which the required BEE certificate was

presented)

Receivable: rebate allowance (-A) Rebate: (240 000 – 180 000) x 33,3% 20 000
Revenue from customer contract 20 000
Decrease in rebate allowance account and an increase in revenue due to
change in expected variable consideration (increasing the TP)

Receivable: rebate allowance (-A) Balance was: 80 000 – Adjustment: 60 000

Receivable (A) 20 000 60 000
Rebate allowance set-off against the receivable to reflect the fact that it
has now been confirmed that the rebate will be granted.
Notice that the receivable account now reflects a balance of C140 000:
(contract price C600 000 – confirmed rebate: C180 000) x 33,3%

28 February 20X6

Receivable (A) Transaction price: 420 000 x 66,6% – 140 000

Receivable already recognised:
(C200 000 – C60 000)
Revenue from customer contract (I) Transaction price: 420 000 (b) x 66,6% 140 000
– Revenue already recognised:
(C120 000 + C20 000)
Revenue from customer contract satisfied over time
Measure of progress = 2 / 3 months = 66,6%
Calculations:
(a) Transaction price (contract inception) = Contract price: 600 000 – Expected rebate: 240 000 = 360 000
(b) Transaction price (adjusted) = Contract price: 600 000 – Confirmed rebate: 180 000 = 420 000
Notice:
Did you notice that, at 28 February 20X6, the adjustment to the receivable account of C140 000 was
calculated based on the transaction price whereas at 31 January 20X6, the adjustment to the receivable
account of C140 000 was based on the contract price.
The use of the contract price to calculate the receivable balance at 31 January 20X6 was necessary
because, at that stage, we did not know the exact rebate that would be granted. In other words, we
measured the receivable account (from which the statement that would be mailed to the debtor) based on
the contract price and recognised a separate receivable rebate allowance account, measured based on the
expected rebate. However, the net effect of the receivable account and the receivable rebate allowance
account (commonly referred to as a negative asset, or an asset measurement account, similar in effect to
accumulated depreciation) is that the receivable balance presented in the SOFP at 31 January 20X6 would
still be measured based on the estimated transaction price.

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Solution 4.14 continued ...

Customer B continued …

Explanation

The transaction price is the amount of consideration to which the entity expects to be entitled.
Since the entity expects the customer will be entitled to a rebate of C240 000, it means that, at
contract inception, the entity expects to be entitled to C360 000 (C600 000 – C240 000). This
amount is considered to be the transaction price. Incidentally, since we are unsure of the extent
of the rebate, it means that the transaction price involves variable consideration. If our estimate
of the variable consideration changes at a subsequent date, we must adjust our original estimate
of the transaction price.

The contract involves a single performance obligation and thus the entire transaction price of
C360 000 is to be allocated to the single performance obligation.

The revenue is then recognised when this performance obligation is satisfied. Since this
performance obligation is a performance obligation satisfied over time, the related revenue will
be recognised gradually over time, based on the measure of the entity’s progress towards
complete satisfaction of the performance obligation.

The chosen measure of progress is not given, but since the performance obligations will be
satisfied evenly over a three-month period, a time-based method (an input method) would be
appropriate.

Journal on 31 January 20X6:

Assuming that a time-based method (an input method) is used to measure progress, we would
conclude that the entity has satisfied 33,3% of its POs at 31 January 20X6 (1 month completed
/ 3 months in total) and thus 33,3% of the revenue would be recognised on 31 January 20X6.

Journals upon receipt of BEE certificate:

The entity obtains information that clarifies that the rebate will now only be C180 000 (not
C240 000). This means that the transaction price must be adjusted (i.e. because the estimated
variable consideration has changed). The transaction price must be adjusted from C360 000
(C600 000 – C240 000) to C420 000 (C600 000 – C180 000).

Since 33,3% of the POs have been satisfied, it means that 33,3% of the originally estimated
transaction price of C360 000 has already been recognised as revenue. Since the transaction
price is now estimated at C420 000 (not C360 000), it means that the revenue recognised to
date has been understated and that the related rebate allowance has been overstated. Thus, the
adjustment to the transaction price will result in an adjustment (i.e. an increase) to the revenue
account and an adjustment (i.e. a decrease) to the rebate allowance account.

Furthermore, since the rebate is now confirmed, the adjusted balance in the rebate allowance is
now set-off against the receivable account. After setting off the rebate allowance account
against the receivable account, the receivable account will then reflect that the customer
currently owes the entity C140 000, being one month of the three months’ services, based on
the adjusted contract price: [(contract price: 600 000 – confirmed rebate: 180 000) x 33,3%].

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Solution 4.14 continued ...

Customer B continued …

Explanation continued …

Journal on 28 February 20X6:

The customer completes a further month of performance obligations and thus, the measure of
progress is 66,6% (2 months completed/ 3 months in total).

Thus, revenue to the extent of 66,6% of the transaction price must be recognised to date.

The transaction price was adjusted to C420 000 (600 000 – 180 000) due to the fact that the
estimated variable consideration changed and thus the revenue to recognise in February is
calculated as:
[Revenue to be recognised to date: (Adjusted TP: C420 000 x Measure of progress: 66,6%)] –
[Revenue already recognised: (120 000 + 20 000)] = Revenue still to be recognised: C140 000

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.15

a) Journals – sale of goods with a right of return

01 March 20X9 Debit Credit

Accounts receivable (A) Full invoice amount 307 800

Current tax payable: VAT VAT: 307 800 / 1.14 x 0.14 37 800
Accounts receivable: unearned interest (-A) TP excl VAT – PV of TP excl VAT 38 519
Revenue from customer contract (I) PV of TP excl VAT x 95% 219 907
Refund liability (L) PV of TP excl VAT x 5% 11 574
Recognising the sale of the goods on deferred payment terms and with
a right of return

Cost of sales (E) Balancing: 135 000 – 6 345 128 655

Right of return asset (A) 135 000 x 5% x 94% 6 345
Inventory Given 135 000
De-recognition of inventory and recognition of right of return asset and
cost of sales

Explanation of journals
1. Accounts receivable: C307 800
The receivable account is debited with the full amount payable.
2. VAT: C37 800
The invoice price of C307 800 includes VAT at 14%, which is an amount collected on behalf
of third parties. The transaction price is defined as excluding amounts collected on behalf of
third parties and thus the VAT is excluded when determining the transaction price. This VAT
is thus not recognised as revenue but instead, is recognised as a current liability, payable to the
third party (tax authorities).
The VAT portion is calculated as: C307 800 / 1.14 x 0.14 = C37 800
3. Financing component: C38 519
Then we need to consider the contract duration of 24 months (measured from delivery date to
payment date). The practical expedient of ignoring the financing component is only available
if the financing period is 12 months or less. Since the financing period is 24 months in this
example, the practical expedient relating to the financing component is not available and hence
the cash flows need to be discounted at an appropriate discount rate (given as 8% pa).
The transaction price (excl VAT) of C270 000 (C307 800 x 100% / 114%) is thus reduced to
the present value of C231 481 discounted at 8% for 2 years.
N = 2; FV = C270 000; I = 8%; Comp PV = C231 481
Of this present value of C231 481, 95% will be immediately recognised as ‘revenue from
customer contracts’ and 5% will be recognised as a ‘refund liability’ – see below. The 5%
refund liability will subsequently be recognised as ‘revenue from customer contracts’ if the
goods are not returned after 3 months. The difference between the transaction price of C270 000
and the PV of C231 481 will be recognised as ‘revenue from interest’ using the effective interest
rate method.

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Solution 4.15 continued …

a) continued …

4. Right of return – effect on revenue and refund liability

The goods sold can be returned for a full refund. This means that the transaction price
effectively includes variable consideration. The 5% expected return reduces the transaction
price at which revenue is initially recognised and will be accounted for as a refund liability
(IFRS 15.55 & IFRS 15.B21-23). In other words, the 5% expected return is excluded from the
transaction price and is recognised as a refund liability instead of as revenue. Thus the effect of
the right of return means that we recognise:
• Revenue: PV of ex VAT TP: 231 481 x Not expected to be returned: 95% = 219 907
• Refund liability: PV of ex VAT TP: 231 481 x Portion expected to be returned: 5% = 11 574
5. Right of return – effect on cost of sales and right of return asset
In addition to recognising the refund liability, we need to recognise a refund asset to reflect the
inventory that we expect to receive back into stock. This is explained as follows:
We expect that 5% of the inventory could be returned and thus the possible return of inventory
is initially recognised as a ‘right of recovery asset’ (also called a ‘right of return asset’) instead
of as a ‘cost of sales expense’.
The cost of the inventory expected to be returned is: 5% x cost of inventory: C135 000 = C6 750
However, we are told that the returned goods will have suffered a 6% loss of value as a
consequence of the returns, (e.g. possibly due to the need to re-package/clean-up/re-paint the
inventory etc).
The expected loss of value is calculated as: 6% x C6 750 = C405
The net value of the inventory expected to be returned is thus calculated as: C6 750 – C405 = C6 345
The net value of the asset is the amount at which the right of recovery asset (or right of return
asset) must be measured (C6 345) and the residual cost of inventory is then expensed to cost of
sales (total cost of inventory: 135 000 – right of return asset: 6 345 = C128 655)
Another way of calculating the cost of sales of C128 655, is that it is the sum of:
• Cost of inventory sold and not expected to be returned: 95% x C135 000 = C128 250; plus
• Cost of fixing the returned inventory: C405.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.15 continued …

b) Journals relating to the return of goods

i) No goods are returned within the 90-day period

31 May 20X9 Debit Credit

Refund liability (L) 11 574

Revenue from customer contract (I) 11 574
Derecognising the entire refund liability and recognising it as revenue
on expiry of the right to return when goods had still not been returned

Cost of sales (E) 6 345

Right of return asset (A) 135 000 x 5% x 94% 6 345
Derecognising the entire right of return asset and recognising it as cost
of sales on expiry of the right to return when goods had still not been
returned

ii) 5% of the goods are returned within the 90-day period

31 May 20X9 Debit Credit

Refund liability (L) 11 574

Accounts receivable (A) 11 574
Derecognising the entire refund liability and recognising it as a
reduction in the receivable when goods are returned

Inventory (A) 6 345

Right of return asset (A) 135 000 x 5% x 94% 6 345
Derecognising the right of return asset and recapitalising as inventory
when goods are returned

iii) 3% of the goods are returned within the 90-day period

31 May 20X9 Debit Credit

Refund liability (L) 11 574

Revenue from sale of goods 11 574 / 0.05 x 0.02; or 4 630
Balancing: 11 574 – 6 944
Accounts receivable (A) 11 574 / 0.05 x 0.03; or 6 944
PV 231 481 x 3%
Derecognising a portion of the refund liability (6 944) and reducing the
receivable by this amount when goods are returned and derecognising
the remaining refund liability (4 630) and recognising this as revenue
when right to return period expires without the return of goods

Cost of sales (A) 6 345 / 0.05 x 0.02 2 538

Inventory (A) 6 345 / 0.05 x 0.03 3 807
Right of return asset (A) 135 000 x 5% x 94% 6 345
Derecognising the right of return asset (6 345) and recognising part of
this as cost of sales (2 538) to the extent that goods were not returned
and part as a recapitalisation as inventory (3 807) to the extent that
goods were returned

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Solution 4.15 continued …

b) Continued …

iv) 7% of the goods are returned within the 90-day period

31 May 20X9 Debit Credit

Refund liability (L) 11 574

Accounts receivable (A) 11 574
Revenue from sale of goods PV 231 481 x (7% - 5%) 4 630
Accounts receivable (A) 4 630
De-recognition of the refund liability when goods are returned and
reducing the receivable (in respect of the 5% expected return) and
reducing the previously recognised revenue and reducing the receivable
(in respect of the unexpected further return of 2%)

Inventory (A) 135 000 x 5% x 94% 6 345

Right of return asset (A) 6 345
Inventory (A) 135 000 x 7% x 94% - 6 345 2 538
Cost of sales 2 538
De-recognition of right of return asset and recapitalisation as inventory
(in respect of the 5% expected return) and reducing the previously
recognised cost of sales and recapitalisation as inventory (in respect of
the extra unexpected 2% returns)

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.16

a) Definitions

Definition: Performance obligation:

IFRS 15 defines a performance obligation as:

‘A promise in a contract with a customer to transfer to the customer either:
• a good or service (or a bundle of goods or services) that is distinct; or
• a series of distinct goods or services that are substantially the same and that have the same
pattern of transfer to the customer.’ IFRS 15 Appendix A

Definition: Distinct

Goods/services are considered distinct if they meet both the following criteria:
• The good or service must be capable of being distinct:
‘the customer can benefit from the good or service on its own or together with other
resources that are readily available to the customer’ IFRS 15.27(a)

A good or service is considered to be capable of being distinct if it is able to generate

economic benefits for the customer by the customer using it, consuming it or selling it at a
price greater than scrap. See IFRS 15.28

• The good or service must be distinct is the context of the contract:

The entity’s promise to transfer the good/service must be ‘separately identifiable from other
promises within the contract’. IFRS 15.27(b)

As a guideline, IFRS 15 mentions certain factors to be considered, in deciding whether or

not a specific promise to transfer goods or services is separately identifiable from other
promises in the context of the contract.
The following are the examples given of goods or services promised in terms of a contract
which would not be considered separately identifiable and would thus not be distinct in the
context of a contract. Goods or services that are:
- used as an input to create an output within the same contract: if the entity is using the
goods or services as an input to create some other promised item for the customer within
the same contract, then that good or service being used is considered to be part of this
other promised item (i.e. it is merely an input to create an output);
- used as an input to modify an output within the same contract: if the entity is using the
goods or services to significantly customise another good or service promised within
the same contract, then that good or service is considered to be part of the customised
good or service (i.e. it is merely an input to modify an output);
- highly dependent on another good or service promised within the same contract: for
example, if it is not possible for the customer to buy the one without the other, then
these goods or services are so interdependent that they cannot be considered separately
identifiable from one another. See IFRS 15.29

Comment:

The extent of your answer in a test situation always depends on the mark allocation.
Depending on the marks awarded to the answer to this question.

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Solution 4.16 continued …

b) Steps 2 – 4 of the revenue recognition process

Step 2: Identifying the performance obligations

The contract between TerraDrive and SolidState offers three performance obligations:
• The supply of hard drives,
• The installation of hard drives; and
• The system maintenance.

Explanation:

The above three goods and services are considered to be separate performance obligations since
each is capable of being distinct and each is distinct in the context of the contract:

• The hard drives, installation and maintenance are each capable of being distinct for the
following reasons:

− SolidState could use the hard drives or, since there is a market for hard drives, it could
no doubt sell it for an amount greater than scrap;

− The installation of the hard drives will enable SolidState to use the hard drives thus
improving business processes; and

− The maintenance of the hard drives will enable the hard drives to continue to be used
over the period of the maintenance (lack of maintenance may reduce its ability to be
used).

− Furthermore, according to IFRS 15, the mere fact that TerraDrive sells each of these
three goods or services separately (there are separate stand-alone prices for each),
allows us to assume that each of these is capable of generating economic benefits for
the customer.

• The hard drives, installation of the hard drives and maintenance are each distinct in the
context of the contract for the following reasons:

− The fact that one can purchase the hard drives from TerraDrive without being forced to
also have it installed by TerraDrive means that that the hard drives and the installation
of the hard drives are not that interdependent that we cannot identify them separately.

− Similarly, the maintenance of the hard drives is merely ‘popular’ with TerraDrive’s
customers and is thus not a requirement. Thus, the maintenance is not considered to be
highly dependent on either the installation of the hard drives or the supply of the hard
drives.

− None of these 3 goods or services was used as an input to create or modify a single
output promised in the same contract.

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Solution 4.16 continued …

b) continued …

Step 3: Determining the transaction price

The transaction price is C2 000 000.

Explanation:

TerraDrive has specified a contract price of C2 000 000. However, the transaction price does
not always equal the contract price.

The transaction price in a contract with a customer is defined as:

• ‘the amount of consideration 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’. IFRS 15. Appendix A

The determination of the transaction price involves, not only excluding amounts collected on
behalf of third parties, but also the assessment of whether the contract price includes:
• fixed consideration and/ or variable consideration
• a significant financing component
• non-cash consideration; and/ or
• consideration payable to the customer.

The contract price is given as C2 000 000 and there is no reference to amounts collected on
behalf of third parties (e.g. VAT collected on behalf of the tax authorities).

This contract price of C2 000 000 is fixed and contains no variable consideration (which would
have involved including in the transaction price a ‘constrained estimate of variable
consideration’).

An element of financing does exist since the date of the receipt of the consideration is not the
same as the dates on which the goods or services are transferred. However, we would only
adjust the transaction price if the effect of this financing is considered to constitute a significant
financing component. In this regard, we are told that the effects of the financing do not
constitute a significant financing component.

The contract refers only to C2 000 000 and does not refer to the existence of non-cash
consideration.

Similarly, there is no evidence to suggest that TerraDrive is required to transfer consideration

to SolidState, its customer.

Thus, the transaction price is equal to the contract price of C2 000 000.

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Solution 4.16 continued …

b) continued …

Step 4: Allocating the transaction price to the performance obligations

The contract has 3 separate performance obligations. This means that the transaction price will
need to be allocated to each of these performance obligations. This allocation is done based on
the relative stand-alone selling prices of each performance obligation.

The sum of the relative stand-alone prices for the 3 performance obligations is C2 480 000
(C320 000 + C840 000 + C1 320 000), whereas the transaction price is only C2 000 000. This
indicates that the customer has been given a discount of C480 000 (C2 480 000 – C2 000 000)
for purchasing a bundle of goods and services (See IFRS 15.81).

There is no evidence to suggest that the discount relates to any specific good or service within
the bundle and thus the discount is allocated proportionately to all the goods or services in the
contract (i.e. to all three performance obligations) (See IFRS 15.81).

Stand-alone Allocation of TP
selling price
Hard-drive C320 000 C320 000/C2 480 000 x C2 000 000 C258 065
Installation C840 000 C840 000/C2 480 000 x C2 000 000 C677 419
Maintenance C1 320 000 C1 320 000/C2 480 000 x C2 000 000 C1 064 516
C2 480 000 C2 000 000

Notice that, by allocating the discounted transaction price, the discount of C480 000 is allocated
automatically to each of the three performance obligations in the same ratio as their relative
stand-alone selling prices.

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Solution 4.16 continued ...

c) Journals

Journals in 20X7
Debit Credit
28 December 20X7

Bank (A) Given 1 000 000

Contract liability (L) 1 000 000
Recognising the receipt of 50% from the customer together with the
contract liability representing the 3 performance obligations

Contract liability (L) 258 065

Revenue from customer contracts (I) See working in part (b) 258 065
Recognising the revenue from the transfer of the hard drives (one of the
three POs)

Comment (for your informative purposes only):

• A contract liability is defined as:
• an entity’s obligation to transfer goods or services to a customer
• for which:
- the entity has received consideration from the customer; or
- the amount of consideration is due.
• Thus, the contract liability of C741 935 (1 000 000 – 258 065) reflects TeraDrive’s two remaining
performance obligations for which consideration has already been received.

Journals in 20X8
Debit Credit
9 January 20X8

Contract liability (L) 677 419

Revenue from customer contracts (I) See working in part (b) 677 419
Recognising the revenue from the completion of the installation (one of
the three POs), reversing part of the contract liability account (P.S. the
CL now has a balance of C64 516 (1 000 000 – 258 065 – 677 419)

31 December 20X8

Contract liability (L) Balance in this account: 64 516

1 000 000 – 258 065 – 677 419
Receivable (A) Balancing: 354 838 – 64 516 290 322
Revenue from customer contracts (I) 1 064 516 (See working in part 354 838
(a)) / 3 years x 1 year
Recognising revenue from the completion of the first yr of the 3-year
maintenance service: revenue recognised was measured based on the
measure of progress, which was based on time – first reversing the
remaining balance in the contract liability account and then recognising
a receivable for the remaining revenue

Bank (A) (Contract price: 2 000 000 – 500 000

Deposit: 1 000 000) x 50%
Receivable (A) Balance in this account 290 322
Contract liability (L) Balancing: 500 000 – 290 322 209 678
Recognising the receipt of the first of the two instalments (the balance
owed by SolidState, calculated after deducting the 50% deposit of
C1 000 000 that was received in advance, was receivable in 2 further
equal instalments)
The excess over the receivable is recognised as a contract liability

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.17

a) Identifying performance obligations

A performance obligation is a promise to transfer:

• a distinct good/service (or bundle thereof); or
• a series of distinct goods or services that are substantially the same and that have the same
pattern of transfer to the customer.

The process of creating the customised call-centre software involves the transfer of six different
modules (services).

The question is thus whether these various modules are distinct services that should thus be
accounted for as separate performance obligations or whether the completed software package
is a single performance obligation.

Goods/services are considered to be distinct if they meet both the following criteria –
• The good or service is capable of being distinct; and
• The good or service is distinct is the context of the contract.

Criterion #1: are the 6 modules capable of being distinct?

A good or service is considered capable of being distinct if it is able to generate economic

benefits for the customer, either on its own or in combination with readily available resources.
• These resources do not need to be currently owned by the customer but must simply be
resources that the customer could obtain if desired (resources are considered to be readily
available if they are sold separately by the entity or any other entity).
• Goods or services are considered capable of generating economic benefits for the customer
if the customer is able to use or consume them or is able to sell them for a price greater than
scrap value.

In this case, we are told that Mango, the customer, is unable to make use of the software until
the sixth and final module is complete and thus the various modules are only able to generate
economic benefits for Mango when they are used as part of the completed call centre software
package. It is unlikely that the individual modules could be sold as they have been customised
specifically for Mango (logos, user interface etc).

Thus, we conclude that the modules are not individually capable of being distinct.

Criterion #2: are the 6 modules distinct in the context of the contract?

A good or service is distinct in the context of the contract if the promise to transfer it is
separately identifiable in the contract. There are no sub-criteria to be met in order to prove this
criterion but IFRS 15 gives examples of when a good or service would or would not be
considered distinct in context of the contract. Based on these examples, goods or services are
not distinct in the context of the contract if the good or service:
• is used as an input to create an output promised in the same contract; or
• is used as an input to modify an output promised in the same contract; or
• is highly dependent on another good or service promised in the same contract (e.g. if it is
not possible to buy the one without the other).

In this case, the services (the six modules to be delivered) are not distinct in the context of the
contract because the most significant and core promise in the contract is to create a complete
software package, rather than to promise to supply individual modules.

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Solution 4.17 continued…

a) continued …

In other words, all six modules are used as an input to create the output (the software package)
that was promised in the same contract.

Thus, we conclude that the six modules are not distinct in the context of the contract.

Conclusion:

Thus, since the six modules are neither capable of being distinct nor are they distinct in the
context of the contract, they are bundled together into a single performance obligation, being
the creation of the complete call centre software package. In other words, there is one
performance obligation: the supply of customised call-centre software.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.17 continued…

b) Determining the transaction price

The contract price is given as C1 800 000. However, the transaction price does not always equal
the contract price.

The transaction price in a contract with a customer is defined as:

• ‘the amount of consideration 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’. IFRS 15. Appendix A

The determination of the transaction price involves, not only excluding amounts collected on
behalf of third parties, but also the assessment of whether the contract price includes:
• fixed consideration and/ or variable consideration
• a significant financing component
• non-cash consideration; and/ or
• consideration payable to the customer.

The contract price quoted by TP does not involve any amounts collected on behalf of third
parties, non-cash consideration nor does it include consideration payable to the customer but it
does involve a mixture of fixed and variable consideration and a financing component. This is
explained below.

Variable consideration

The contract price is C1 800 000 but we are told that there is a possible discount of C120 000.

The possibility of a discount means that the contract involves variable consideration. Variable
consideration should be included in the determination of the transaction price at the:
• estimated amount that the entity expects to be entitled to, which has been
• suitably constrained to an amount that has a high probability of not causing a significant
reversal in the future. See IFRS 15.56

When estimating the amount to which the entity expects to be entitled, we may use:
• the ‘expected value’ method; or
• the ‘most likely amount’ method. See IFRS 15.53

The expected value method is most suitable for situations where there are many possible
outcomes whereas the ‘most likely amount’ method is generally most suitable for situations
where there are only a few possible outcomes (and ideal for situations where there are only two
possible outcomes). See IFRS 15.53

There are only two possible outcomes in this situation:

• TP will grant the discount of C120 000 and thus will expect consideration of C1 680 000
(Contract price: C1 800 000 – expected discount: C120 000); or
• TP will not grant the discount of C120 000 and thus will expect consideration of
C1 800 000 (Contract price: C1 800 000 – expected discount: C0).

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Solution 4.17 continued…

b) continued …

Since there are only two possible outcomes, we use the ‘most likely amount’ method. Since
TP has indicated that it expects to grant the discount of C120 000, we estimate the transaction
price at the most likely amount of C1 680 000. This estimate has a high likelihood of not
resulting in a significant reversal of cumulative revenue in future (in fact, if the discount is not
granted, the revenue will be increased rather than reversed). Thus, the transaction price is
C1 680 000, representing the amount that TP expects to be entitled to.

Financing component

The terms of the contract require Mango to pay a deposit of 35% at the inception of the contract.
This advance payment indicates that the customer has provided a financing benefit to TP. TP
will need to account for the interest expense if:
• the main purpose of requiring an advance payment from the customer was to obtain
financing; and
• if this financing benefit is regarded as significant; and
• if the period between the timing of the payments and the transfer of the services is more
than a year. See IFRS 15.61 and IFRS 15.63

Since the transfer of the services is expected to be complete within 560 hours of signing the
contract, the period between the advance receipt of 35% of the contract price and the transfer
of the services is well under one year. Thus, irrespective of both the primary purpose of the
advance payment and whether the financing benefit was considered to be significant or not, the
financing benefit received by TP is ignored in determining the transaction price.

Conclusion:

The transaction price is C1 680 000, (being the contract price of C1 800 000 less the expected
discount of C120 000).

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Solution 4.17 continued…

c) Journals

1 September 20X6 Debit Credit

Bank (A) C1 800 000 x 35% 630 000
Contract liability (L) 630 000
Recognising the receipt of the deposit of 35% of the contract price as a
contract liability

31 March 20X7 (a cumulative journal)

Contract liability (L) Per journal above 630 000
Receivable (A) Revenue 1 176 000 – CL 630 000 546 000
Revenue from customer contracts (I) Calculation (a) 1 176 000
Recognising the revenue based on measure of progress

Calculations:

Calculation (a): Transaction price allocated to POs satisfied by year-end =

Transaction price: C1 680 000 ÷ 560 hours x [3 modules x 84 hrs each Calc (c) + module 4:
140 hrs Calc (b)] = C1 176 000.

Calculation (b): # hours that Module 4 is expected to take = 140 hours

Calculation (c): # hours that each module other than module 4 are expected to take = 84 hours each

Comments:

• TP recognises the revenue on the assumption that the PO (creating the software) is a PO
that is satisfied over time. This is based on criterion 3 (see IFRS 15.35 (c)):
− There is no alternative use for the asset (it is software that is customised specifically
for the customer, Mango); and
− TP has an enforceable right to receive payment for performance completed to date (we
are told that the contract provides that TP be paid costs plus a 20% profit if the contract
is cancelled at any stage and that TP believes that a 20% profit is reasonable).

• The measure of progress has been based on the number of hours per module since no
evidence has been given to suggest that the cost per hour is significantly different depending
upon the module being worked on – thus it is assumed that the cost per hour is relatively
stable around the C1 800 per hour average given in the question.

• The deposit of C630 000 (35% x contract price: C1 800 000) would initially have been
recognised as a contract liability to reflect TP’s obligation to perform or refund the money.

• As the modules were completed and accepted by Mango, the related revenue would have
been recognised. This gradual recognition of revenue to the year ended 31 March 20X7
(of C1 176 000) will have caused the contract liability of C630 000 to be gradually reversed
and a receivable of C546 000 (Revenue: C1 176 000 – contract liability: C630 000) to be
gradually recognised.

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.18

Part A

When a contract with a customer to provide goods or services also provides the customer with
an option to acquire additional goods or services, this must be accounted for as a separate
performance obligation if this option amounts to a ‘material right that it would not receive
without entering into that contract’. See IFRS 15.B40

In this case, the contract provides the customer with points, based on existing purchases, that
equate to a discount of C3 per point on future purchases of a specific product (if, for example,
the customer purchased further goods of the same amount, it would effectively work out to a
10% discount off the selling price of these purchases). The points thus amount to a material
right that the customer would not have received had that customer not entered into the first
contract. Thus, the offer of points must be accounted for as a separate performance obligation.

This means that the total transaction price (C450 000) must be allocated between two
performance obligations: the sale of goods and the sale of points.

The sale of goods to the value of C450 000 automatically results in the sale of 15 000 points
since every sale of C30 results in the sale of one point (C450 000 / C30 = 15 000 points).

The allocation of the transaction price must be done based on the relative stand-alone selling
prices. Where a stand-alone selling price is not available, it must be estimated.

The total stand-alone selling price of the goods sold is C450 000 (i.e. the price of the goods sold
does not change based on whether the customer is a member of the loyalty programme) and the
points that are effectively ‘sold’ are valued at C3 per point. When allocating the transaction
price, however, we must also build into the estimate of the stand-alone price ‘the likelihood that
the option will be exercised’. In this regard, the entity estimates that only 95% of the points will
be redeemed (15 000 x 95% = 14 250 points), thus the stand-alone selling price of the points is
estimated at C42 750 (14 250 points x C3 = C42 750).

The transaction price of C450 000 is thus allocated as follows:

Stand-alone Allocation of TP
selling price
Goods sold C450 000 C450 000/C492 750 x C450 000 C410 959
Points sold C42 750 C42 750/C492 750 x C450 000 C39 041
C492 750 C450 000

The sale of goods is recognised as revenue at the point of sale (because the sale of goods is a
PO satisfied at a point in time). The sale of points is recognised as a contract liability until either
the points are redeemed or expire, whichever occurs first.

On date of sale of goods – January Debit Credit

Bank/ Receivable (A) Given 450 000
Revenue from customer contract (I) Working above 410 959
Contract liability (L) Working above 39 041
Recognising the receipt from the customer (or receivable), partly
recognised as revenue from the sale of goods and partly recognised as a
contract liability for the sale of customer loyalty points

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Solution 4.18 continued …

Part B

On date of redemption of points – February Debit Credit

Contract liability (L) C39 041 x 3 000 / 14 700; Or 7 968
Revenue from customer contract (I) C39 041 x C9 000 / C44 100 7 968
Recognising the revenue when the customer loyalty points are redeemed
P.S. the C39 041 is the total contract liability, calculated in Part A

Explanation (for your interest):

On the date of the redemption of the 3 000 points, a portion of the contract liability is
derecognised and recognised as revenue instead. The portion is measured based on the
proportion of the points redeemed (3 000 points) relative to the latest estimate of the points that
will be redeemed. We can calculate this proportion in terms of number of points or in terms of
their value:
• The number of points that are expected to be redeemed has increased from 14 250 points
(95% x 15 000 points) to 14 700 points (98% x 15 000 points), and thus the proportion of
the contract liability that must be recognised as revenue can be expressed as: 3 000/ 14 700
• The total value of the points expected to be redeemed has increased from C42 750 (95% x
15 000 points x C3) to C44 100 (98% x 15 000 points x C3), where the value of the current
points redeemed is C9 000 (3 000 points x C3). Thus the proportion of the contract liability
that must be recognised as revenue can be expressed as: C9 000/C44 100

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Solution 4.19
a) Discussion

Determining the transaction price

The sale of the 80 air-conditioning units for C15 000 per unit, suggests that the contract price
is C1 200 000 (C15 000 x 80 units).
The contract price is not always equal to the transaction price. This is because the transaction
price in a contract with a customer is defined as:
• ‘the amount of consideration 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’. IFRS 15. Appendix A

The determination of the transaction price involves, not only excluding amounts collected on
behalf of third parties, but also the assessment of whether the contract price includes:
• fixed consideration and/ or variable consideration
• a significant financing component
• non-cash consideration; and/ or
• consideration payable to the customer.
There is no evidence that the contracted price of C15 000 per unit contains an amount collected
on behalf of a third party, nor is there evidence of variable consideration, non-cash
consideration or consideration payable to the customer. However, the payment terms have been
deferred and consequently the contract involves a financing arrangement.
If financing is included in the contract, then depending on whether the entity or the customer
obtains the financing benefit, interest expense or interest income must be accounted for.
However, the effect of the financing is only accounted for in the event that it is considered to
be a significant financing component. Furthermore, as a practical expedient, we need only
account for the financing component if the time delay between satisfying the PO and the receipt
of payment is more than a year.
In this case, although the period of financing of the sale of the unit is less than a year (from
30 December 20X4 to 30 June 20X5), the financing of the 2-year maintenance exceeds one
year (from 30 June 20X5 to the final date of maintenance, 31 December 20X6). This means
that the practical expedient is not available to us and we would have to account for the effects
of the financing component. However, we are told that the financing component is insignificant
and thus the effect of the financing component is ignored.

The transaction price is thus C1 200 000 (i.e. the transaction price equalled the contract price).
Identifying the performance obligations
Before we can allocate the transaction price, we must identify the performance obligations
(POs). The contract with the government has 3 distinct performance obligations:
• Sale of the air-conditioning unit
• Installation/ fitment of the unit
• Maintenance services over a period of 2 years

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.19 continued …

a) continued …

Allocating the transaction price

As the contract contains multiple performance obligations, the transaction price needs to be
allocated to each performance obligation. The allocation of the transaction price is based on the
relative stand-alone selling prices of each PO that existed at contract inception.

The stand-alone selling prices are ideally based on directly observable market prices. However,
they may be estimated based, for example, on the cost plus an appropriate margin, an adjusted
market assessment approach or using the residual approach. See IFRS 15.78-79

We are given the costs for each of the services (the fitment and the maintenance) and we are
given the cost of each of the air-conditioning units. We are also given the normal market-related
mark-up on the cost of each of these services as being 18%. However, we are not told what the
normal mark-up on cost would be for the supply of the air-conditioning units and nor are we
given the normal market price of the unit. However, since we have been given sufficient
information to estimate the stand-alone selling prices for 2 of the 3 POs (based on the cost plus
an appropriate mark-up), we can use the residual approach to then estimate the stand-alone
selling price for the third PO (i.e. the supply of the unit).

Stand-alone Allocation of TP
selling price (x 80 units)
(per unit)
Fitment C1 062 C900 x 1.18 C84 960
2-year maintenance C7 195 C2 916 x 1,03 x 1.18 + C2 916 x 1.03 x 1.03 x 1.18 C575 600
Air-conditioning units C6 743 C15 000 – 1 062 –7 195 C539 440
C15 000 C1 200 000

Comment on the allocation of the TP to the 2-year maintenance:

The information provided states that the maintenance costs are ‘currently C2 916 pa’ and that
they increase by 3% at the end of the year. We know that this cost of C2 916 relates to
maintenance performed in 20X4 (we know this due to the use of the future tense in the
information provided to us: the government will place an order on 1 October 20X4 and
BlackRock will deliver the units on 30 December 20X4). However, the contract under
discussion involves the provision of maintenance services in 20X5 and 20X6. This means that
an increase of 3% will be applied on 31 December 20X4 which would be effective in 20X5 –
and a further increase of 3% would then be applied on 31 December 20X5, which would be
effective in 20X6. Thus, the costs and related stand-alone selling price for maintenance services
(using an 18% mark-up on costs) in the 20X5 and 20X6 is calculated as follows:

Maintenance Calc of costs pa Costs Calc of selling price Stand-alone

selling price
(per unit)
20X5 2 916 x 1.03 C3 003 3 003 x 1.18 C3 544
20X6 2 916 x 1.03 x 1.03 C3 094 3 094 x 1.18 C3 651
C7 195

Comment on the timing of the recognition of the related revenue (for informative purposes)
• The revenue from the sale of the air-conditioning unit will be recognized at a point in time
(when control passes to the customer, which normally coincides with delivery)
• The revenue from the fitment will be recognized at a point in time (fitment date)
• The revenue from the maintenance will be recognized over time (2 years)

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.19 continued …

a) continued …

Comment:

The extent of your answer in a test situation always depends on the mark allocation. This
question specifically required a discussion regarding how to determine the TP and how to
allocate the TP. It did not specifically require a full discussion on how to identify the POs.
However, depending on the marks awarded to the answer to this question, a discussion thereof
could have been implicitly required. In that case, the following additional discussion regarding
how we go about identifying the POs could also have been provided:

POs are the distinct promises in the contract. Promises in the contract are considered to be
distinct if they meet both the following criteria:
• The good or service must be capable of being distinct:
• The good or service must be distinct is the context of the contract. See IFRS 15.27

A good or service is considered to be capable of being distinct if ‘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’. IFRS 15 goes on to explain that this situation arises if the good or service is
able to generate economic benefits for the customer by the customer using it, consuming it or
selling it at a price greater than scrap. However, IFRS 15 states that ‘various factors may provide
evidence that the customer can benefit from a good or service either on its own or in conjunction
with other readily available resources’ and gives, as an example: ‘the fact that the entity
regularly sells a good or service separately’. See IFRS 15.27 (a) and IFRS 15.28

The question clarifies that ‘the accepted industry practice to apply an 18% profit margin on
similar services’ suggests that ‘the initial fitment…and the maintenance services’ are services
that are regularly sold separately. Thus, we conclude that the supply of the air-conditioning unit,
the installation thereof and the ensuing maintenance are all capable of being distinct.

A good or service is considered to be distinct is the context of the contract if the entity’s promise
to transfer the good/service is ‘separately identifiable from other promises within the contract’.
There are no sub-criteria to prove whether a good or service is distinct in the context of the
contract, but IFRS 15 provides examples to assist with this criterion. In this regard, a good or
service is not distinct in the context of the contract if it is:
• used as an input to create an output that is promised in the same contract (i.e. ‘the entity
does not provide a significant service of integrating the good or service with other goods or
services promised in the contract into a bundle of goods or services ….’)
• used as an input to modify an output that is promised in the same contract
• highly dependent on another good/ service promised in the same contract. See IFRS 15.27 & 29

Black Rock does not promise a significant service of integrating the air-conditioning unit with
the installation and the maintenance. Nor is there evidence to suggest that the installation and/
or the maintenance involves modifying the unit in any way. Similarly, there is nothing to suggest
that any of the inputs are ‘highly dependent’ on other inputs in the same contract. For example,
Black Rock could have installed a unit that the government had purchased from another entity
and similarly, Black Rock could have supplied the government with a unit that was then
installed by another entity. In other words, there is not a high degree of inter-dependence
between the inputs to create a single output. Thus, we conclude that supply of the unit, the
installation and maintenance are all distinct in the context of the contract.

Thus, the supply of the unit, the installation and maintenance are three distinct POs (they are
capable of being distinct and are distinct in the context of the contract).

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.19 continued …

b) Journals

30 December 20X4 Debit Credit

Receivable (A) Alloc of TP – see part (a) – supply of 539 440

Revenue from customer contract (I) air-conditioning units 539 440
Recognising the receivable and revenue from the supply of the air-
conditioning units in terms of the contract with the government

Cost of sales (E) C6 600 (given) x 80 units 528 000

Inventory (A) 528 000
Recognising the cost of the sales

3 January 20X5 Debit Credit

Receivable (A) Alloc of TP – see part (a) – fitment of 84 960

Revenue from customer contract (I) air-conditioning units 84 960
Recognising the receivable and revenue from the fitment of the air-
conditioning units in terms of the contract with the government

Cost of service - fitment (E) C900 (given) x 80 units 72 000

Revenue from customer contract (I) 72 000
Recognising the cost of the fitment

30 June 20X5

Bank (A) Given 1 200 000

Receivable (A) 539 440 + 84 960 624 400
Contract liability (L) Balancing: 1 200 000 – 624 400 575 600
Recognising the receivable and revenue from the supply of the air-
conditioning units in terms of the contract with the government

31 December 20X5

Contract liability (L) Alloc of TP: part (a): maintenance of 287 800
Revenue from customer contract (I) air-conditioning units: 287 800
C575 600 / 24 months x 12 months
Recognising the receivable and revenue from the first year’s
maintenance of the air-conditioning units in terms of the contract

Cost of service - maintenance (E) C2 916 x 1.03 p.a. (given) x 80 units 240 278
Revenue from customer contract (I) 240 278
Recognising the cost of the first year’s maintenance

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Solutions to GAAP: Graded Questions Revenue from contracts with customers

Solution 4.20

Debit Credit
Financial year-end: 31 December 20X5
1 March 20X5
Accounts receivable (A) C87 500 x 10 875 000
Revenue from customer contract – caravans 875 000
Cost of sales C102 375 / 1,3 x 10 787 500
Inventory 787 500
Recognising the revenue from the sale of the caravans and the related
cost of sales
1 March 20X5
Bank (A) Given 175 000
Accounts receivable 175 000
Recognising the first payment received
31 December 20X5
Accounts receivable (A) 105 000 (W1) x 10/12 87 500
Interest income (I) 87 500
Recognising the interest earned for the year (10 months to date)

Financial year-end: 31 December 20X6

28 February 20X6
Accounts receivable (A) 105 000 (W1) x 2/12 17 500
Interest income (I) 17 500
Recognising interest earned for the year until receipt of the second
instalment (2 months)
28 February 20X6
Bank (A) Given 350 000
Accounts receivable (A) 350 000
Recognising the receipt of the 2nd instalment of C350 000
31 December 20X6
Accounts receivable (A) 68 250 (W1) x 10/12 56 875
Interest income (I) 56 875
Recognising of the interest earned for the year (10 months between last
instalment and financial year-end)

W1: Effective interest rate table relating to the interest on the sale of the caravans

Opening Interest at
Year balance 15 % Instalment Closing balance
1 March 20X5 875 000 (175 000) 700 000
To 28 February 20X6 700 000 105 000 (350 000) 455 000
To 28 February 20X7 455 000 68 250 (523 250) 0

Comment:

The contract involved the supply of caravans upfront followed by payment in instalments over a period
of 2 years. The delay between the supply and the payment in full is more than one year and thus the
practical expedient offered by IFRS 15 to ignore the effect of financing is not available. Since no
evidence was given to the contrary, we assumed further that:
• the effect of the financing was considered to be a significant financing component; and
• the 15% p.a. was an appropriate interest rate.

The transaction price is thus the present value of the payments expected to be received, discounted at
this effective interest rate of 15% (you can use a calculator or divide each instalment by the present
value factor:
C175 000/ 1 + C350 000 / PVF: 1.15 + C523 250/ PVF: (1.15/1.15) = C1 200 000.

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