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IFRS 15 – revenue from contracts with customers (part 4). Determine the transaction price (continued)

Agnieszka NOSOWSKA
Junior Audit Manager at RSM Poland

Recently, when discussing the five-step model framework and determining the transaction price according to IFRS 15 we mentioned the methods of estimating the transaction price; we have decided to elaborate on these methods in today’s post.

THE EXPECTED VALUE METHOD

This method can well be used if:

  • there is a large number of contracts with similar characteristics;
  • more than two possible outcomes are expected;
  • the probability of these outcomes can be estimated.

In a nutshell: calculating the transaction price can be compared to summing up the products of probability-weighted possible consideration amounts.

Example[1]

An entity offering the sale of consultancy services has concluded a consultancy contract for implementing an integrated management system. Under the contract, the price for service performance and implementation is PLN 50,000, and the term is 6 months. The contract provides for penalties for late service delivery in the amount of PLN 6,000 for each month of delay and a bonus for service delivery within 5 months in the amount of PLN 10,000. The contract also provides for penalties for any necessary corrections and additional works resulting from improper system operation in the amount of PLN 500 per month.

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From the entity’s experience and judgement it can be estimated that for projects of this size and for the available resources and means:

  • probability of timely service delivery is 80%;
  • probability of early service delivery is 5%;
  • probability of late service delivery is 15% for a maximum of 1 month.

The expected value (transaction price) is: PLN 49,600, i.e. the total of the products:

80%*50,000 = 40,000,

5%*(50,000+10,000) = 3,000,

15%*(50,000-6,000) = 6,600

The estimated transaction price reflects a reasonable estimate of the expected consideration for the contract on the basis of earlier experiences and capacities of the entity in performing these types of services. The reliable transaction price estimate shall be revaluated for each balance sheet date. Assuming that the contract is being performed at the turn of the year, the entity should evaluate the estimate taking the current work progress and the expectations concerning the consideration for the contract into account. If it turns out that the probability of timely service delivery drops from 80% to 70%, and thus the probability of late contract performance grows to 20%, the entity should determine a new transaction price and adjust the revenue.

THE MOST LIKELY AMOUNT METHOD

This could be applied to contracts that may have two possible outcomes, e.g. if a bonus or a rebate may apply or not. The most likely value of the transaction price is determined from a range of possible amounts.

Example[2]

An entity signed a contract for the sale of a large volume of goods to a retail network. The price defined in the contract is PLN 900,000. At the same time, under the contract the customer shall receive a bonus in the amount of 5% of the sales value, provided that the customer places another order of a predefined volume and at a price lower by 0.5% than the price under the current contract.

The possible range of values of the transaction price is:

  • PLN 900,000 – if the next contract is not signed (the bonus will not apply),
  • PLN 855,000 – if the next contract is signed (the bonus will apply).

Based on the collaboration with other retailers and talks with the customer, it can be concluded that the probability of signing a contract for another delivery at a reduced price is very high and the next transaction is almost certain to be concluded. The entity shall recognise the revenue for the contract in the amount of PLN 855,000 as a consideration the entity expects to be entitled to for this sales contract.

Applying the five-step model framework for revenue recognition according to IFRS 15, the entity selects the method of estimating the transaction price on the basis of the characteristics of the concluded contract, and applies this method consistently throughout the entire contract term. When assessing the probability used in the case of the expected value method and the possible consideration amounts in the case of the most likely amount method, the entity relies on historical data and information as well as current forecasts and plans.

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[1] Compiled on the basis of training materials of the Education Centre of the Polish Chamber of Statutory Auditors – New model framework for revenue recognition according to IFRS 15 “Revenue from Contracts with Customers”.

[2] Compiled on the basis of training materials of the Education Centre of the Polish Chamber of Statutory Auditors – New model framework for revenue recognition according to IFRS 15 “Revenue from Contracts with Customers”.

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