QUESTION 1

(a) IFRS 15 Revenue from Contracts with Customers was issued in 2014 and replaces the previous international financial reporting
standard relating to revenue.
Required:
(i) Identify the five steps which need to be followed by entities when recognising revenue from contracts with a customer.
(ii) Explain how IFRS 15 is expected to improve the financial reporting of revenue. (5 marks)
(b) Kappa prepares financial statements to 30 September each year. During the year ended 30 September 2015, Kappa entered into
the following transactions:
(i) On 1 September 2015, Kappa sold a machine to a customer. Kappa also agreed to service the machine for a two-year
period from 1 September 2015 for no additional charge. The total amount payable by the customer for this arrangement
was agreed to be:
– N800,000, if the customer paid by 31 December 2015.
– N810,000, if the customer paid by 31 January 2016.
– N820,000, if the customer paid by 28 February 2016.
The directors of Kappa consider that it is highly probable the customer will pay for the products in January 2016. The
stand-alone selling price of the machine was N700,000 and Kappa would normally expect to receive N140,000 in
consideration for providing two years’ servicing of the machine. The alternative amounts receivable are to be treated
as variable consideration. (10 marks)
(ii) On 20 September 2015, Kappa sold 100 identical items to a customer for N2,000 each. The items cost Kappa N1,600
each to manufacture. The terms of sale are that the customer has the right to return the goods for a full refund within
three months. After the three-month period has expired the customer can no longer return the goods and payment
becomes immediately due. Kappa has entered into transactions of this type with this customer previously and can
reliably estimate that 4% of the products are likely to be returned within the three-month period. (5 marks)
Required:
Explain and show how both these transactions would be reported in the financial statements of Kappa for the year ended 30
September 2015.
QUESTION 2
Chelsea constructs retail vehicle outlets and enters into contracts with customers to construct buildings on their land. The
contracts have standard terms, which include penalties payable by Chelsea if the contract is delayed, or payable by the customer,
if Chelsea cannot gain access to the construction site.
Due to poor weather, one of the projects was delayed. As a result, Chelsea faced additional costs and contractual penalties. As
Chelsea could not gain access to the construction site, the directors decided to make a counter-claim against the customer for
the penalties and additional costs which Chelsea faced. Chelsea felt that because claims had been made against the customer,
the additional costs and penalties should not be included in contract costs but shown as a contingent liability. Chelsea has
assessed the legal basis of the claim and feels it has enforceable rights.
In the year ended 28 February 2017, Chelsea incurred general and administrative costs of N10 million, and costs relating to
wasted materials of N5 million.
Additionally, during the year, Chelsea agreed to construct a storage facility on the same customer’s land for N7 million at a
cost of N5 million. The parties agreed to modify the contract to include the construction of the storage facility, which was
completed during the current financial year. All of the additional costs relating to the above were capitalised as assets in the
financial statements.
The directors of Chelsea wish to know how to account for the penalties, counter claim and additional costs in accordance with
IFRS 15 Revenue from Contracts with Customers.
Required:
Advise Chelsea on how the above transactions should be dealt with in its financial statements with reference to relevant
International Financial Reporting Standards.
QUESTION 3
IFRS 15 Revenue from Contracts with Customers specifies how to account for costs incurred in fulfilling a contract which are not in the
scope of another standard. Costs to fulfil a contract which is accounted for under IFRS 15 are divided into those which give rise to an asset
and those which are expensed as incurred. Entities will recognise an asset when costs incurred to fulfil a contract meet certain criteria, one
of which is that the costs are expected to be recovered.
For costs to meet the ‘expected to be recovered’ criterion, they need to be either explicitly reimbursable under the contract or reflected through
the pricing of the contract and recoverable through the margin. The penalty and additional costs attributable to the contract should be
considered when they occur and Chelsea should have included them in the total costs of the contract in the period in which they had been
notified.
As regards the counter claim for compensation, Chelsea accounts for the claim as a contract modification in accordance with IFRS 15. The
modification does not result in any additional goods and services being provided to the customer. In addition, all of the remaining goods and
services after the modification are not distinct and form part of a single performance obligation.
Consequently, Chelsea should account for the modification by updating the transaction price and the measure of progress towards complete
satisfaction of the performance obligation.
A contract modification may exist even though the parties to the contract have a dispute about the scope or price (or both) of the modification
or the parties have approved a change in the scope of the contract but have not yet determined the corresponding change in price. In
determining whether the rights and obligations which are created or changed by a modification are enforceable, an entity should consider all
relevant facts and circumstances including the terms of the contract and other evidence. On the basis of information available, it is possible
to feel that the counter claim had not reached an advanced stage, so that claims submitted to the client could not be included in total revenues.
When the contract is modified for the construction of the storage facility, an additional N7 million is added to the consideration which Chelsea
will receive. The additional N7 million reflects the stand-alone selling price of the contract modification. The construction of the separate
storage facility is a distinct performance obligation; the contract modification for the additional storage facility would be, in effect, a new
contract which does not affect the accounting for the existing contract. Therefore the contract is a performance obligation which has been
satisfied as assets are only recognised in relation to satisfying future performance obligations. General and administrative costs cannot be
capitalised unless these costs are specifically chargeable to the customer under the contract. Similarly, wasted material costs are expensed
where they are not chargeable to the customer. Therefore a total expense of N15 million will be charged to profit or loss and not shown as
assets.