A CONCISE INTRODUCTION

TO IFRS 15
REVENUE FROM CONTRACTS WITH CUSTOMERS

INTRODUCTION The first step is to identify the contract(s) with the

customer. Whatever the form, a contract creates
The International Accounting Standards Board published
enforceable rights and obligations between a vendor and
IFRS 15 in 2014, revised the effective date in 2015 and
its customer.
issued clarifications in 2016. IFRS 15 contains
comprehensive guidance for accounting for revenue and After identifying the contract(s) with the customer, a
will replace existing requirements which are currently vendor identifies the ‘performance obligations’. A
set out in a number of different standards and performance obligation is a promise by the vendor to
interpretations. transfer goods or services to a customer. Each
performance obligation is ‘distinct’, being either a good
IFRS 15 contains significantly more prescriptive and precise
or service from which the customer can benefit on its own
requirements in comparison with existing IFRS. This means
(or in combination with other readily available goods and
that for many entities, the timing and profile of revenue
services); two or more distinct goods and services (such as
recognition will change. In some areas the changes will be
the supply of construction material and labour) are
very significant and will require careful planning, including
combined if, in reality, they represent one overall
for commercial effects.
obligation.
THE CORE PRINCIPLE
In the third and fourth steps, a vendor determines the
The core principle is that a vendor should recognise transaction price of the entire contract and then allocates
revenue to depict the transfer of promised goods or the transaction price among the different performance
services to customers in an amount that reflects the obligations that have been identified.
consideration to which the vendor expects to be entitled in
In the fifth step, a vendor assesses when it satisfies each
exchange for those goods or services.
performance obligation (which may be at a point in time,
Revenue will now be recognised by a vendor when or as or over time) and recognises revenue. The principle is
control over the goods or services is transferred to the based around the point at which the customer obtains
customer. In contrast, IAS 18 based revenue recognition control of the good or service.
around an analysis of the transfer of risks and rewards; this
now forms one of a number of criteria that are assessed in
determining whether control has been transferred.
The application of the core principle in IFRS 15 is carried
out in five steps:

STEP ONE STEP TWO STEP THREE STEP FOUR STEP FIVE

Identify the Identify Determine the Allocate Recognise

contract separate transaction transaction revenue as or
performance price price to when each
obligations performance performance
obligations obligation is
satisfied
 A CONCISE INTRODUCTION TO IFRS 15| PAGE 2

SIGNIFICANT ISSUES THE CLARIFICATIONS

Our analysis of IFRS 15 indicates that the following areas The clarifications made in 2016 relate to
may be of particular significance:
• Identifying the performance obligations in a contract
• Is revenue recognised at a single point in time, or over
• Determining whether a party involved in a transaction
a period of time?
is the principal or the agent
• If revenue is recognised over time, how should
• Determining whether a licence provides the customer
progress towards completion be measured and
with a right to access or a right to use the entity’s
recognised?
intellectual property
• Will a contract need to be ‘unbundled’ into two or
They also introduced additional transitional provisions
more components? Alternatively, will two or more
relating to completed contracts and modified contracts.
contracts need to be ‘bundled’ into a single overall
obligation? COMMERCIAL EFFECT
• How should contracts which include variable amounts The adoption of IFRS 15 may lead to significant changes in
of consideration (including rights of return) be dealt the pattern of revenue and profit recognition. Careful
with? consideration and planning will be needed for a wide
range of issues, including the effect on:
• How should modifications to contracts be dealt with?
• Compliance with bank covenants
• Should costs associated with obtaining a contract be
capitalised, or expensed immediately? • Performance based compensation
(including share-based payments)
• What adjustments are required for the effects of the
time value of money (a ‘financing component’)? • Internal budgeting processes
IFRS 15 also introduces significantly more disclosures about • Corporate tax obligations
revenue recognition. It is possible that new and/or
modified internal processes will be needed in order to • Market and investor communications, including
obtain the necessary information. compliance with regulatory requirements (which might
arise from significant expected future changes to an
These are considered in more detail below. entity’s reported financial position or performance).
TIMING A review of the terms and conditions of existing contracts
will be needed (in particular long term contracts which
IFRS 15 is applicable for annual periods beginning on or
extend into periods covered by financial statements
after 1 January 2018. Earlier application is permitted.
affected by the adoption of IFRS 15) as well as those
which are to be entered into in future. In some cases,
entities may wish to consider whether changes should be
made to contracts.
It is also likely that sales departments will need to liaise
more closely with the accounting department in future, in
ACCOUNTING IMPACT order that the effects of any proposed contractual terms
on the related financial statements can be understood
Wide and potentially very significant effects on the in advance.
timing and profile of revenue and profit recognition
in comparison with current guidance. Significant A CLOSER LOOK AT THE SIGNIFICANT ISSUES
enhancements to disclosure requirements.
Is revenue recognised at a point in time, or over a
period of time?
ACTION REQUIRED IFRS 15 contains specific, and more precise, guidance to
be applied in determining whether revenue is recognised
The potentially serious commercial implications of over time (often referred to as ‘percentage of
this standard, and the fact that it may affect completion’ under existing standards) or at a point in
current contracts and their revenue reporting, time.
require most businesses to assess the impacts at an
early stage. There are three criteria, each of which would result in
recognition over time. These are:
At BDO, we can carry out an independent impact
assessment on the likely effects on your business. • The customer simultaneously receives and consumes
This could take the form of an initial short survey of the benefits provided by the vendor’s performance as
your revenue generating activities, followed, if the vendor performs the service
necessary, by a more detailed analysis.
• The vendor’s performance creates or enhances an
asset (for example, work in progress) that is controlled
by the customer as work progresses
• The vendor’s performance creates an asset which does
not have an alternative use to the vendor, and the
vendor has an enforceable right to be paid for work
completed to date.
A CONCISE INTRODUCTION TO IFRS 15| PAGE 3

The first two criteria are relatively straightforward. For Will a contract need to be ‘unbundled’ into two or
the third criterion, the first question which needs to be more components? Alternatively, will two or more
addressed is whether the asset being created has what is contracts need to be ‘bundled’ into a single overall
termed ‘an alternative use to the vendor’. The vendor obligation?
may not have an alternative use for the asset if
Previously, IFRS had little guidance for ‘unbundling’
contractually restricted from using the asset for any
contracts into components. In contrast, IFRS 15 contains
purpose other than selling it to the specific customer.
detailed guidance and it is likely that many entities will
This might be the case if the asset is being manufactured
need to amend their current accounting policies and
to the customer’s specification and could not readily be
approaches. This may have a significant effect on the
sold to any other customer without significant
pattern of revenue and profit recognition. Items that may
modifications being made and significant additional costs
need to be accounted for separately include incentives
incurred. Alternatively, if creation takes a substantial
offered at the time of sale (such as free periodic servicing
period of time (even if the asset is to a relatively
and maintenance for a specified period, or a warranty
standard specification) the contract with the customer
that goes beyond providing assurance that the item being
may have specified timing. This could have the effect that
supplied conforms with its agreed upon specification).
the asset to be transferred to that customer is specifically
identified from the point at which creation commences. IFRS 15 also requires two or more contracts to be
combined and accounted for as a single contract if one or
If the first (no alternative use to the vendor) part of the
more of the following conditions are met:
third criterion is met, there will then be significant focus
on whether the vendor has, at all stages of the contract, an • The contracts are negotiated as a package with a
enforceable right to be paid for the work which has been single commercial objective
completed to date. This will require careful analysis of the
precise terms of each contract, including in particular the • The amount of consideration to be paid in one
effect of any terms that permit the customer to cancel, contract depends on the price or performance of the
curtail or significantly modify the existing contract. This other contract
analysis may also require consideration of the general (or • The goods or services promised in the contracts (or
common) law in each jurisdiction. The focus is on whether some of them) are a single performance obligation.
in all circumstances, other than the vendor’s failure to
fulfil its obligations under the contract, the customer will
be required to pay for performance to date. This needs to The purpose of this guidance is to ensure that, for a
be an amount that approximates the selling price of the particular good or service, regardless of the legal form of
goods or services that have been provided; compensation a contract (or contracts) with a customer, the accounting
for loss of profit does not satisfy this condition. will be the same. Consequently, careful consideration will
Alternatively, the vendor may have the legal right and be required of the commercial objectives of, and item(s)
practical ability to require completion of the contract and covered by, one or more contract(s) with the same
payment by its customer. customer.
If revenue is recognised over time, how should progress How should contracts which include variable amounts
towards completion be measured and recognised? of consideration be dealt with?
If revenue is recognised over time, the overall principle is Contracts for sale often contain clauses which can give rise
that revenue is recognised to the extent that each of the to variations in the amount of consideration receivable by
vendor’s performance obligations has been satisfied. the vendor. For example, a customer might be granted a
IFRS 15 permits either output or input methods to be used retrospective rebate if a specified quantity of a particular
to calculate the amount of revenue to be recognised. An good is purchased during a specified period. Alternatively,
output method results in revenue being recognised on the for a more complex contract item which takes some time
basis of direct measurement of the value of goods or to complete, a bonus payment might be receivable if the
services transferred to date, while input methods result in item has been completed before a specified date, with
revenue being recognised based on measures such as penalties being deducted from the sales price if completion
resources consumed, costs incurred, time records or is late. A customer may be able to return goods and receive
machine hours. a refund, credit or another product in exchange.

It is noted explicitly that when input methods are used, These clauses give rise to what IFRS 15 calls ‘variable
there may not be a direct relationship between the inputs consideration’. This is significant, because when
being used, and the transfer of goods or services to a consideration is variable IFRS 15 places a limit on the
customer. Consequently, any inputs that do not relate amount that can be recognised. This limit means that
directly to the vendor’s performance in transferring those revenue is only recognised when it is highly probable that
goods and services are excluded when measuring progress there will not be a significant reversal in the cumulative
to date. amount of revenue recognised to date (for example,
because the criteria that were expected to be met for a
Certain contracts require administrative or other set-up bonus payment are not, in fact, satisfied). This may result
activities to be carried out in order that an entity is in a in later recognition of revenue and profit in comparison
position to carry out the services specified in a contract. with current accounting.
Under IFRS 15, these activities do not give rise to
revenue. Instead, consideration is given to whether the
costs incurred in setting up a contract meet the criteria
to be capitalised as a contract asset.
A CONCISE INTRODUCTION TO IFRS 15| PAGE 4

In assessing the amount of variable consideration which Once incremental costs have been identified, these are
should be recognised, IFRS 15 permits two approaches. recognised as an asset if there is an expectation that they
One, which applies to circumstances in which a large will be recovered, typically through profits to be
number of similar contracts exist, is to look at the generated from the related contract. This asset is then
expected value over the portfolio. The other, which amortised on a basis that is consistent with the transfer of
would generally be applied when there are only two the goods or services specified in the contract. It will be
possible outcomes (for example, a bonus payment will or necessary for judgement to be applied in determining an
will not be received), is the most likely outcome – subject appropriate amortisation period and profile.
to the constraint over recognition.
What adjustments are required for the effects of the
To the extent that the vendor expects customers to time value of money (a ‘financing component’)?
exercise the right of return, revenue is not recognised for
Contracts can involve cash receipts from customers which
the related goods even though these may already have
do not correspond with the timing of the recognition of
been transferred to the customer. Instead, a refund
revenue. If a financing component is significant, IFRS 15
liability is recognised together with an asset (and
requires an adjustment to be made for the effect of
corresponding adjustment to cost of sales) for the right to
implicit financing.
recover the original asset (depending on whether the item
recovered would have any value). As a practical expedient, adjustments for a financing
component are not required when there is a period of less
How should modifications to contracts be dealt with?
than one year between the transfer of goods or services
It is common for the scope and/or price of contracts to be and the receipt of payment from a customer.
modified, due to changes in the number of items to be
In a major change from existing practice, adjustments for
supplied, or the addition of new items to an order. For
a financing component are required for circumstances in
larger contracts, changes might be made to the
which customers pay in advance, as well as in arrears.
specifications of the goods or service to be supplied under
Payments in arrears will result in finance income and a
an existing contract and to similar goods or services to be
reduction in revenue (because the vendor is providing
supplied in future.
finance to its customer), while payments in advance will
IFRS 15 has detailed guidance to be applied in result in a finance expense and an increase in (deferred)
determining whether, from an accounting perspective, revenue (because the vendor is, in effect, borrowing funds
contract modifications result in changes to the existing from its customer).
contract or a new contract, and whether there is either
The purpose of this approach is to reflect the ‘cash selling
an adjustment to the amount of revenue recognised to
price’ of the underlying good or service at the point at
date (resulting in a ‘true up’ in the income statement) or
which it is transferred to the customer. It also results in
to revenue to be recognised in future. These new
transactions which involve a significant financing
requirements may result in significant changes to the
component being split into two parts; one for the sale of
pattern of revenue recognition.
the good or service and the other for the financing
Should costs associated with obtaining a contract be arrangement. However, the implications for the internal
capitalised, or expensed immediately? processes and systems that are needed in order to identify
when a financing component is to be recognised, and to
In addition to the substantially more detailed guidance for
account for this, may be significant.
revenue recognition, IFRS 15 contains prescriptive criteria
to be applied when determining whether costs associated
with the acquisition of a contract should be recognised as
an asset, or expensed as incurred. This extends to cover
all contract acquisition costs, such as bid costs incurred
prior to the award of a contract, as well as sales
commissions.
IFRS 15 is restrictive, in that it permits only incremental
costs of obtaining a contract to be considered.
Consequently, only those costs which would not have been
incurred if the contract had not been obtained are
eligible to be considered. An example is a sales
commission which is only payable in the event that a
contract is awarded. In contrast, ongoing costs of running
the business, such as a legal department, are not eligible
to be considered because these costs would have been
incurred regardless of whether a specific contract had
been obtained. Although it might be argued that the legal
department would not be needed unless an entity was
involved in obtaining sales contracts, IFRS 15 does not
permit those contracts to be analysed on a portfolio basis.
Instead, the focus is on whether costs attributable to each
individual contract are incremental.
A CONCISE INTRODUCTION TO IFRS 15| PAGE 5

Disclosure requirements For further information about how BDO can assist you and
your organisation, please get in touch with your usual
Comprehensive disclosure requirements have been
contact or one of the following:
included in IFRS 15. Even if an entity concludes that the
effect of the new standard on revenue recognition is not Birmingham
significant, changes to internal systems and processes may Tom Lawton
be required to enable the necessary information to be
collected for disclosures. These disclosures include +44(0)121 352 6372 [email protected]
quantitative and qualitative information about a vendors: Bristol
• Contracts with customers Neil Dimes
• Significant judgements, and changes in the +44(0)117 930 1501 [email protected]
judgements, made in applying IFRS 15 to those
East Anglia
contracts
Nick Buxton
• Assets recognised in respect of costs of obtaining
contracts, and in fulfilling contracts. +44(0)160 375 6916 [email protected]

In addition to the detailed guidance, an overall disclosure East Midlands

objective has been specified together with an explicit Gareth Singleton
statement that immaterial information does not need to
+44(0)115 962 9280 [email protected]
be disclosed and the disclosure requirements should not
be used as a checklist. This is because some disclosures Gatwick
may be very relevant for certain entities or industries, but
David Eagle
irrelevant for others. It is also intended to encourage
entities to give careful consideration to the information +44(0)1293 848950 [email protected]
that they will include in their financial statements in Guildford
order to meet the disclosure objective. However, this
again brings the need for careful planning, well in Nick Poulter
advance of adoption of the new requirements. +44(0)148 340 8086 [email protected]
Other Potential Issues to Consider London & Cambridge
Different businesses will be affected by various elements Tony Perkins
of the standard depending on their individual
+44(0)020 7893 2347 [email protected]
circumstances including how they operate. Much of this
may be driven by specific industry sector dynamics and North West
methods of operation. Julien Rye
BDO has developed a series of leaflets highlighting how +44(0)161 817 7505 [email protected]
businesses in specific industry sectors will be affected.
Reading
• Construction & Real Estate
Chris Pooles
• Manufacturing
+44(0)118 925 4412 [email protected]
• Media Scotland
• Professional Services Alastair Rae
• Retail +44(0)131 347 0349 [email protected]
• Software Southampton

• Telecommunications Malcolm Thixton

Contact us to receive a copy of any of these leaflets. +44(0)238 088 1895 [email protected]
Yorkshire
Paul Davies
+44(0)113 290 6144 [email protected]

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