IFRS 15 - Revenue from Contracts with Customers

IFRS 15 was issued in May 2014 and applies to an annual reporting period beginning on or after 1 January 2018. For the syllabus between September 2017 and August 2018, IFRS 15 will be examined and IAS 18 Revenue will no longer be examined.

This new standard considers there to be a five step approach when recognising revenue:

Step 1: Identify the contract with the customer

Step 2: Identify the performance obligations in the contract

Step 3: Determine the transaction price

Step 4: Allocate the transaction price to the performance obligations in the contract

Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation

The significant area in which the F3/FFA syllabus will be affected is the recognition of revenue for sales where a cash/settlement discount allowed is offered to the customer.

ACCOUNTING FOR DISCOUNTS

Prompt payment discounts (also known as settlement or cash discounts) are offered to credit customers to encourage prompt payment of their account. It is not guaranteed that customers will take advantage of prompt payment discounts at the point of sale as it is dependent upon whether or not credit customer pays within the settlement window.

Historically, and in accordance with IAS 18 Revenue, income from a credit sale in which a settlement discount has been offered has been recognised in full at the point of sale. Accounting for the settlement discount only takes place if the customer pays within the required settlement period (thus accepting the discount). The discount allowed would be recorded as an expense in the seller’s statement of profit or loss and revenue would remain at the full amount.

Example: Freezy Ltd sold goods with a list price of $2,000 on credit to a customer. A Ltd has a 30-day payment period and has offered the customer a 5% prompt payment discount if payment is made within 14 days.

Solution: In accordance with IAS 18 Revenue, the initial sale would have been recorded as debit Receivables $2,000 credit Revenue $2,000. If the customer pays within the 14-day settlement period, the accounting entry would be Debit Cash $1,900 Debit Discounts Allowed $100 Credit Receivables $2,000. If the customer pays out with the 14-day period, Freezy Ltd would record the receipt as Debit Cash $2,000 Credit Receivables $2,000.

IMPACT OF IFRS 15 ON ACCOUNTING FOR PROMPT PAYMENT DISCOUNTS

The five step approach to recognising revenue as outlined above will change the way in which prompt payment discounts are accounted for. In order to recognise revenue, an entity must determine the amount of consideration it expects to be entitled to in accordance with the criteria of IFRS 15.

Per IFRS 15, the third step of the five step approach requires an entity to 'Determine the transaction price', which is the amount to which an entity expects to be entitled in exchange for the transfer of goods and services. When making this determination, an entity will consider past customary business practices. [IFRS 15:47]

When prompt payments discounts are offered, it means that the expected consideration is variable (variable consideration) as the amount the entity will actually receive is dependent upon the customer choice as to whether it will take advantage of the discount.

Where a contract contains elements of variable consideration, the entity should estimate the amount of variable consideration to which it will be entitled under the contract. [IFRS 15:50]

The standard deals with the uncertainty relating to variable consideration by limiting the amount of variable consideration that can be recognised. Specifically, variable consideration is only included in the transaction price if, and to the extent that, it is highly probable that its inclusion will not result in a significant revenue reversal in the future when the uncertainty has been subsequently resolved. [IFRS 15:56]

When an entity enters into a sale with a customer and a prompt payment discount has been offered, the amount of revenue to be recognised initially will need to be estimated taking into account the probability of the discount being accepted. When the entity expects that the customer will accept the discount, revenue should be recorded net of the discount.

Example: J Ltd sold goods with a list Price of $2,000 on credit to a customer. J Ltd has a 30 day payment period and has offered the customer a 3% prompt payment discount if payment is made within 15 days. Based on past experience the customer is expected to take up the 3% discount.

Solution:

The initial sale will be recorded as

	$	$
Receivables	1,940
Revenue		1,940

If the customer pays within the 14-day settlement period, the accounting entry would be

	$	$
Cash	1,940
Receivables		1,940

If the customer does not pay within the 14-day period,

	$	$
Cash	2,000
Receivables		1,940
Revenue		60

Refer to same example if based on past experience the customer is not expected to take up the 3% discount.

Solution:

The initial sale will be recorded as

	$	$
Receivables	2,000
Revenue		2,000

If the customer pays within the 14-day settlement period, the accounting entry would be

	$	$
Cash	1,940
Revenue	60
Receivables		2,000

If the customer pays as expected date

	$	$
Cash	2,000
Receivables		2,000

As the above example highlights, the introduction of IFRS 15 will have a significant impact on the reported revenue. Offering prompt payment discounts will result in lower revenue being recognised (when the discount is accepted). This will have an impact on entities’ gross profit margins. However, the net impact on profit as a whole will be the same as, by recording revenue net of the prompt payment discount, there is no longer a requirement to record a discount allowed expense in the statement of profit or loss. Prompt payment discounts are examined in FA1, FA2 and FA and so an appreciation of this impact is important.

source;

https://www.accaglobal.com/my/en/student/exam-support-resources/fundamentals-exams-study-resources/f3/technical-articles/discounts.html

IFRS 15 is concerned with reporting the nature, amount, timing and uncertainty of revenue and cash flows resulting from contracts with customers.

revenue from contracts with customers arises from fairly common transactions:

• the sale of goods
• the rendering of services.

Generally revenue is recognised when the entity has transferred control over goods and services to the buyer. Control of an asset is  described in the standard as 'the ability to direct use of, and obtain substantially all the remaining benefits from, the asset' (IFRS 15)

Revenue is generally recognised as earned at the point of sale, because at that point four criteria will generally have been met

• the product or service has been provided to the buyer
• the buyer has recognised his liability to pay for the goods or services provided. The converse of this is that the seller has recognised that the ownership of goods has passed from himself to the buyer.
• the buyer has indicated his willingness to hand over cash or other assets in settlement of his liability
• The monetary value of the goods or services has been established

Key definitions [IFRS 15: Appendix A]

Contract	An agreement between two or more parties that creates enforceable rights and obligations.
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.
Income	Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants.
Performance obligation	A promise in a contract with a customer to transfer to the customer either: ·         a good or service (or a bundle of goods or services) that is distinct; or ·         a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.
Revenue	Income arising in the course of an entity’s ordinary activities.
Transaction price	The amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties.

source: bpp interative text

[IFRS 15: Appendix A]

An agreement between two or more parties that creates enforceable rights and obligations.

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.

Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants.

A promise in a contract with a customer to transfer to the customer either:

• a good or service (or a bundle of goods or services) that is distinct; or
 
• a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.

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

The amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties.