Revenue from Contracts

IFRS 15 with Customers 12

CORE PRINCIPLE AND THE FIVE STEP MODEL |1

The core principle of IFRS 15 is that an entity recognises revenue:

(a) to depict the transfer of promised goods or services to customers
(b) at an amount that reflects the consideration to which the entity expects to be entitled in
exchange for those goods or services.
An entity recognises revenue in accordance with above core principle by applying the
following steps:
1 Identify the contract(s) with a customer
2 Identify the performance obligations (PO) in the contract
3 Determine the transaction price (TP)
4 Allocate the TP to the PO in the contract
5 Recognise revenue when (or as) the entity satisfies a PO

DEFINITIONS
Revenue Income arising in the course of an entity’s ordinary activities.
Customer 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.

STEP 1: IDENTIFY THE CONTRACT(S) WITH A CUSTOMER

Contract An agreement between two or more parties that creates enforceable rights
and obligations.
An entity shall account for a contract with a customer under IFRS 15 only
when all of the following criteria are met:
(a) the parties to the contract have approved the (binding) contract;
(b) the entity can identify each party’s rights regarding the goods or
services to be transferred;
Criteria (c) the entity can identify the payment terms for the goods or services to
be transferred;
(d) the contract has commercial substance; and
(e) it is probable that the entity will collect the consideration considering
only the customer’s ability and intention to pay that amount of
consideration when it is due.

QUESTION 01
Mr. Owais agreed on March 1, 2017 to sell 5 cutting machines to Axiom Enterprises. Due to
some deficiency in drafting the agreement each party’s rights cannot be identified. On March
31, 2017 Mr. Owais delivered the goods and these were accepted by Axiom Enterprises.
After 10 days of delivery i.e. April 10, 2017 Axiom Enterprises made the full payment and the
payment is non-refundable.

When should Owais record the revenue?

 ICMAP M4 Financial Accounting

An entity shall combine two or more contracts entered into at or near the
same time with the same customer (or related parties of the customer) and
account for the contracts as a single contract if one or more of the
following criteria are met:
Combination (a) the contracts are negotiated as a package with a single
of contracts commercial objective;
2| (b) the amount of consideration to be paid in one contract depends on
the price or performance of the other contract; or
(c) the goods or services promised in the contracts (or some goods or
services promised in each of the contracts) are a single PO.

QUESTION 02
Adil Ltd. enters into 2 separate agreements with customer X.
1. Agreement 1: Deliver 10,000 bricks for Rs. 100,000
2. Agreement 2: Build a boundary wall for Rs. 20,000

Should the above agreements be combined?

STEP 2: IDENTIFY PERFORMANCE OBLIGATIONS (PO)
A promise in a contract with a customer to transfer to the customer either:
Performance
(a) good or service (or a bundle of goods or services) that is distinct; or
Obligation
(b) a series of distinct goods or services that are substantially the same
(PO)
and that have the same pattern of transfer to the customer.

QUESTION 03
Case A: An entity, a software developer, enters into a contract with a customer to transfer a
software licence, perform an installation service and provide unspecified software updates
and technical support (online and telephone) for a two-year period. The entity sells the
licence, installation service and technical support separately. The installation service
includes changing the web screen for each type of user (for example, marketing, inventory
management and information technology). The installation service is routinely performed by
other entities and does not significantly modify the software. The software remains functional
without the updates and the technical support.

Case B: The promised goods and services are the same as in Case A, except that the
contract specifies that, as part of the installation service, the software is to be substantially
customised to add significant new functionality to enable the software to interface with other
customised software applications used by the customer. The customised installation service
can be provided by other entities.

Required:
Identify performance obligations.
STEP 3: DETERMINING THE TRANSACTION PRICE (TP)
The amount of consideration to which an entity expects to be entitled in
Transaction
exchange for transferring promised goods or services to a customer,
Price (TP)
excluding amounts collected on behalf of third parties.
When determining the TP, an entity shall consider the effects of all of the
following:
(a) variable consideration;
Factors to be (b) constraining estimates of variable consideration;
considered (c) the existence of a significant financing component in the contract;
(d) non-cash consideration (measured at fair value); and
(e) consideration payable to a customer (reduction in TP due to coupon
or vouchers).

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 Class Notes

QUESTION 04
An entity enters into a contract with a customer to build an asset for Rs.1 million. In addition,
the terms of the contract include a penalty of Rs. 100,000 if the construction is not completed
within three months of a date specified in the contract.
Required:
Using the expected value approach, determine the transaction price if there is 40% |3
probability of completing the contract on time, 30% that there would be delay of 3 days and
30% that there would be delay of 5 days.

STEP 4: ALLOCATING THE TRANSACTION PRICE (TP)

The objective when allocating the TP is for an entity to allocate the TP to each PO (or
distinct good or service) in an amount that depicts the amount of consideration to which the
entity expects to be entitled in exchange for transferring the promised goods or services to
the customer.
Stand-alone The price at which an entity would sell a promised good or service
selling price separately to a customer.
Suitable methods for estimating the stand-alone selling price of a good or
service include, but are not limited to, the following:
Allocation (a) Adjusted market assessment approach
based on (b) Expected cost plus a margin approach
stand-alone (c) Residual approach
selling prices
A combination of methods may need to be used to estimate the stand-
alone selling prices of the goods or services promised in the contract

QUESTION 05
An entity enters into a contract with a customer to sell Products A, B and C in exchange for
Rs. 100. The entity will satisfy the performance obligations for each of the products at
different points in time. The entity regularly sells Product A separately and therefore the
stand-alone selling price is directly observable. To estimate the stand-alone selling prices,
the entity uses the adjusted market assessment approach for Product B and the expected
cost plus a margin approach for Product C.
Stand-alone
Product Method
selling price
Product A 50 Directly observable
Product B 25 Adjusted market assessment approach
Product C 75 Expected cost (Rs. 60) plus a margin (Rs. 15) approach
Total 150
Required:
Allocate the transaction price of Rs. 100 to Product A, B and C in accordance with IFRS 15

QUESTION 06
An entity regularly sells Products A, B and C individually, thereby establishing the following
stand-alone selling prices:
Stand-alone
Product
selling price Rs.
Product A 40
Product B 55
Product C 45
In addition, the entity regularly sells Products B and C together for Rs. 60. The entity enters
into a contract with a customer to sell Products A, B and C in exchange for Rs. 100.
Required
Allocate the transaction price of Rs. 100 to Product A, B and C in accordance with IFRS 15

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 ICMAP M4 Financial Accounting

STEP 5: SATISFACTION OF PERFORMANCE OBLIGATIONS (PO)

An entity shall recognise revenue when (or as) the entity satisfies a PO by transferring a
promised good or service (ie an asset) to a customer. An asset is transferred when (or as)
the customer obtains control of that asset.
SATISFACTION AT A POINT OF TIME
4| To determine the point in time at which a customer obtains control of a promised goods or
services and the entity satisfies a PO, the entity shall consider the requirements for control.

In addition, an entity shall consider indicators of the transfer of control, which include, but are
not limited to, the following:
(a) The entity has a present right to payment for the asset.
(b) The customer has legal title to the asset.
(c) The entity has transferred physical possession of the asset.
(d) The customer has the significant risks and rewards of ownership of the asset.
(e) The customer has accepted the asset.
SATISFACTION OVER TIME
When goods or services are transferred continuously, a revenue recognition method that
best depicts the entity’s performance should be applied (and updated as circumstances
change).

Acceptable methods include:

Output methods: units produced, units delivered, contract milestones, survey of work
performed.
Input methods: costs incurred, labour hours expended, machine hours worked.

PRESENTATION
An unconditional right to consideration is presented as a receivable. The
accounting treatment to record the transfer of goods for cash or for an
Receivable unconditional promise to be paid consideration is straightforward.
Dr. Bank/Receivable
Cr. Revenue
A supplier might transfer goods or services to a customer before the customer
pays consideration or before payment is due. In this case the contract is
presented as a contract asset (excluding any amounts presented as a
receivable).
Contract
asset
A contract asset is a supplier’s right to consideration in exchange for goods or
services that it has transferred to a customer. A contract asset is reclassified
as a receivable when the supplier’s right to consideration becomes
unconditional.
A contract might require payment in advance or allow the supplier a right to an
amount of consideration that is unconditional (i.e. a receivable), before it
transfers a good or service to the customer.

Contract In these cases, the supplier presents the contract as a contract liability when
liabilities the payment is made or the payment is due (whichever is earlier).

The contract liability is a supplier’s obligation to transfer goods or services to a

customer for which it has received consideration (an amount of consideration
is due) from the customer.

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 Class Notes

QUESTION 07
On 1 January 20X8, X Limited enters into a contract to transfer Products A and B to Y
Limited in exchange for Rs. 1,000. Product A is to be delivered on 28 February. Product B is
to be delivered on 31 March. The promises to transfer Products A and B are identified as
separate performance obligations. Rs.400 is allocated to Product A and Rs.600 to Product
B. X Limited recognises revenue and recognises its unconditional right to the consideration
when control of each product transfers to Y Limited. |5

Required:
Journal entries to record revenue.

QUESTION 08
On 1 January 20X8, X Limited enters into a contract to transfer Products A and B to Y
Limited in exchange for Rs. 1,000. Product A is to be delivered on 28 February. Product B is
to be delivered on 31 March. The promises to transfer Products A and B are identified as
separate performance obligations. Rs.400 is allocated to Product A and Rs.600 to Product
B.

Revenue is recognised when control of each product transfers to Y Plc. Payment for the
delivery of Product A is conditional on the delivery of Product B. (i.e. the consideration of Rs.
1,000 is due only after X Limited has transferred both Products A and B to Y Limited). This
means that X Limited does not have a right to consideration that is unconditional (a
receivable) until both Products A and B are transferred to Y Limited.

Required:
Journal entries to record revenue.

QUESTION 09
On 1 January 20X8, X Limited enters into a contract to transfer Products A and B to Y
Limited in exchange for Rs. 1,000. X Limited can invoice this full amount on 31 January.
Product A is to be delivered on 28 February. Product B is to be delivered on 31 March. The
promises to transfer Products A and B are identified as separate performance obligations.
Rs.400 is allocated to Product A and Rs.600 to Product B.

Revenue is recognised when control of each product transfers to Y Limited.

Required:
Journal entries to record revenue.

QUESTION 10
An entity is developing a multi-unit residential complex. A customer enters into a binding
sales contract with the entity for a specified unit that is under construction. Each unit has a
similar floor plan and is of a similar size, but other attributes of the units are different (for
example, the location of the unit within the complex).

The contract inception is 1 January 2018. The price of one unit is Rs. 3,000,000. The
expected date of completion and possession transfer is 31 December 2019. The entity year
end is December 31. The construction is 40% complete by December 31, 2018.

The customer pays a 10% deposit upon entering into the contract and the deposit is
refundable only if the entity fails to complete construction of the unit in accordance with the
contract. The remainder of the contract price is payable on completion of the contract when
the customer obtains physical possession of the unit. If the customer defaults on the contract
before completion of the unit, the entity only has the right to retain the deposit.

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 ICMAP M4 Financial Accounting

Note: Ignore financing component

Note: Ignore accounting for contract costs

Required
Journal entries:
(a) The unit is completed and possession is transferred on due date
6| (b) The entity allocated the unit to another customer on 1 March 2018
(c) The entity completes the unit but customer defaults (the entity plans to sell unit to
another customer)

QUESTION 11
An entity enters into 100 contracts on 31 December 2017 with customers. Each contract
includes the sale of one product for Rs.100 (100 total products × Rs. 100 = Rs. 10,000 total
consideration). Cash is received when control of a product transfers. The entity’s customary
business practice is to allow a customer to return any unused product within 30 days and
receive a full refund. The entity’s cost of each product is Rs. 60.

Using the expected value method, the entity estimates that 97 products will not be returned.
The entity estimates that the costs of recovering the products will be immaterial and expects
that the returned products can be resold at a profit.

Required:
Journal entries:
(a) 3 products are returned on January 30, 2018
(b) 2 products are returned on January 30, 2018
(c) 4 products are returned on January 30,2018

QUESTION 12
An entity enters into a contract with a customer on 1 January 2018 to sell Product A for Rs.
100 per unit. If the customer purchases more than 1,000 units of Product A in a calendar
year, the contract specifies that the price per unit is retrospectively reduced to Rs. 90 per
unit.

For the first quarter ended 31 March 2018, the entity sells 75 units of Product A to the
customer. The entity estimates that the customer’s purchases will not exceed the 1,000- unit
threshold required for the volume discount in the calendar year.

In May 2018, the entity’s customer purchases an additional 500 units of Product A from the
entity. In the light of the new fact, the entity estimates that the customer’s purchases will
exceed the 1,000-unit threshold.

The payment from customer will be received on 31 December 2018 for all units sold during
the year.

Required:
Journal entries from 1 January 2018 to 30 June 2018 relating to above

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