In this month’s newsletter, we provide a high level overview of the new revenue recognition standard AASB 15 Revenue from Contracts with Customers. We provide a number of useful decision trees to assist readers with the application of the new 5-step model to recognise revenue.
1. Core Principle of AASB 15
The core principle of AASB 15 is to recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. As the title of AASB 15 suggests, an entity shall only apply AASB 15 to a contract if the counterparty to the contract is a customer. A customer is 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. This is in-line with the Framework for the Preparation and Presentation of Financial Statements which states in paragraph 74 that revenue arises in the course of the ordinary activities of an entity.
2. 5-Step Model to Apply the Core Principle
An entity recognises revenue in accordance with the core principle by applying the following steps:
3. Step 1: Identify the Contract(s) with a Customer
Step 1 consists of 2 parts, namely:
- Identifying the contract; and
- Considering the potential combination of contracts.
Identifying the Contract
An entity shall account for a contract with a customer that is within the scope of AASB 15 only when all of the following criteria are met:
(a) the parties to the contract have approved the contract (in writing, orally or in accordance with other customary business practices) and are committed to perform their respective obligations;
(b) the entity can identify each party’s rights regarding the goods or services to be transferred;
(c) the entity can identify the payment terms for the goods or services to be transferred;
(d) the contract has commercial substance (that is, the risk, timing or amount of the entity’s future cash flows is expected to change as a result of the contract); and
(e) it is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.
In evaluating whether collectability of an amount of consideration is probable, an entity shall consider only the customer’s ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession.
Considering the Potential Combination of Contracts
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:
(a) the contracts are negotiated as a package with a single commercial objective;
(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 performance obligation.
The following decision tree could be used to assess whether to combine two or more contracts:
4. Step 2: Identify the Separate Performance Obligations
At contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either:
(a) a good or service (or a bundle of goods or services) that is distinct; or
(b) a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.
The following decision tree could be used to identify separate performance obligations:
5. Step 3: Determine the Transaction Price
An entity shall consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is 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 (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.
The nature, timing and amount of consideration promised by a customer affect the estimate of the transaction price. When determining the transaction price, an entity shall consider the effects of all of the following:
(a) variable consideration;
(b) constraining estimates of variable consideration;
(c) the existence of a significant financing component in the contract;
(d) non-cash consideration; and
(e) consideration payable to a customer.
The following decision tree could be used to consider the implications of variable consideration:
6. Step 4: Allocate the Transaction Price
Entities will generally allocate the transaction price to each performance obligation in proportion to its stand-alone selling price. The best evidence of the stand-alone selling price is an observable price from stand-alone sales of that good or service to similarly situated customers. If the stand-alone selling price is not directly observable, entities should estimate it by either:
• Adjusted market assessment approach;
• Expected cost plus a margin approach; or
• In limited circumstances, residual approach.
7. Step 5: Recognise Revenue When a Performance Obligation is Satisfied
An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (that is, an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset. Control of an asset may be transferred at a point in time or over time. The following are indicators that the control has passed to a customer:
• The customer has a present obligation to pay;
• The customer has taken physical possession of the asset;
• Legal title has passed to the customer;
• The customer has accepted the risks and rewards of ownership; and
• The customer has accepted the asset.
The following decision tree could be used to determine when to recognise revenue:
8. Application Date
Currently, AASB 15 applies to annual reporting periods beginning on or after 1 January 2017. However, in July 2015, the International Accounting Standards Board (IASB) deferred the application date of IFRS 15 Revenue from Contracts with Customers by one year and therefore it is expected that the AASB will also defer the application date of AASB 15 by one year to annual reporting periods beginning on or after 1 January 2018.