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IFRS 15 – Revenue from contracts with customers (part 6). Recognise revenue

Leszek WOZIŃSKI
Audit Manager at RSM Poland

In our previous posts we have presented four steps of the model framework for revenue recognition. The last step of the five-step model framework described in IFRS 15 is to recognise revenue once conditions related to different contract elements are met.

The entity recognises revenue when (or as) a performance obligation is satisfied by way of transferring the promised good or service (i.e. an asset) to the customer. The transfer of an asset takes place once the customer takes control over this asset.

In this case, the control is understood as the ability to direct the use of and obtain substantially all of the benefits from the asset (or to prevent others from doing so). The revenue may be recognised at a point in time or it may be recognised over time.

REVENUE RECOGNISED OVER TIME

The entity transfers the control over the good or service over time and thus satisfies the performance obligation and recognises revenue over time if one of the following conditions is met:

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When making an assessment whether a given asset has an ‘alternative use’, the vendor must analyse whether they can use the assets for purposes other than those defined in the contract with the customer at the contract’s inception (both in contractual and practical terms).

If any of the above criteria is met, the entity is obliged to recognise the revenue over time in a way that best reflects the method of transferring the goods or services to the customer.

Example[1]

Company ABC asked consultancy company XYZ to prepare an opinion concerning the accounting and tax treatment of the planned transaction of an in-kind contribution of an organised part of an enterprise to a new subsidiary. Under the contract, the consideration for delivering the opinion is PLN 20,000. However, the contract provides that the customer shall be obliged to cooperate and hand over any and all documents and information necessary to prepare the opinion to consultancy company XYZ.

XYZ is not under any formal obligation to provide the customer with any partial findings or results of their work.

Should the customer decide to terminate the contract prematurely (before the opinion is delivered) for reasons other than a breach of performance obligations by XYZ, the customer shall be obliged to cover the costs incurred to date by XYZ plus a margin, let us say in the amount of 15%.

Question

How are performance obligations satisfied in the described example: over time or at a point in time?

Answer     

Each of the three conditions presented below must be considered:

1. Does company ABC simultaneously receive and consume the benefits provided by consultancy company XYZ as it performs?

If XYZ was not able to perform, and ABC hired another company to prepare the opinion, the new company would have to repeat the work performed to date by XYZ to a large extent.

What is more, an inherent feature of the service of preparing a professional opinion is that the customer will benefit from it only once it is delivered. The benefits obtained in the process of preparing the opinion (certain partial findings, discussions and consultations with the company preparing the opinion) may occur, but this is not a must. Thus, this condition is not met.

2. Does the performance of the consultancy company create or enhance an asset that company ABC controls as the asset is created or enhanced?

Even if we assumed that the ready-made opinion has certain characteristics of an asset, company ABS does not control it when it is being prepared. Thus, this condition is not met.

3. Does the performance of XYZ create an asset with an alternative use to XYZ? Does the consultancy company have an enforceable right to payment for performance completed to date? 

Given the fact that the opinion prepared by XYZ pertains to specific circumstances of the operation of company ABC and a specific transaction that it is planning to perform, it is very likely that XYZ will not have an option of any alternative use of this opinion. Furthermore, XYZ is entitled to adequate consideration for any work completed to date if the customer terminates the contract prematurely (for reasons other than a breach of contract terms and conditions by XYZ). Thus, this condition is met.

Since the third condition is met for this contract, the performance obligation is being satisfied over time.

REVENUE RECOGNISED AT A POINT IN TIME

If a performance obligation is not satisfied over time, the entity satisfies the performance obligation at a point in time.

Factors that must be considered in this step in order to recognise revenue properly and at the right time include a present right to payment, a legal title to the asset, a transfer of the physical possession of the asset, a transfer of significant risks and rewards related to the ownership and an acceptance of the asset by the customer.

This is why every step of revenue recognition according to IFRS 15 requires an analysis of the micro- and macroeconomic environment (customers, suppliers, competition, legal and fiscal regulations), and not just a thorough analysis of contracts. As a result, it is a complex process that involves not only accounting professionals, but most of all the entity’s key personnel who are knowledgeable when it comes to the industry and customer relations. And how do you recognise revenue in different industries? We are soon going to discuss it in our blog along with other aspects of IFRS 15.

[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”.

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