Confusion Over Accounting Policies and Accounting Estimates?

This confusion has implications when an entity applies the requirements of IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, to a change in a policy or an estimate.

Changes proposed by the International Accounting Standards Board (the Board) are aimed at removing this confusion by clarifying the definition of accounting policies and their relationship with accounting estimates and by adding a definition of accounting estimates.

While the changes go a long way in improving the clarity of the standard, they may create further and different confusion. My suggestions are that:

  • the distinction between judgements made at different stages of the financial statement preparation process be explained explicitly in the standard itself; and
  • the definition of accounting estimates be amended.

My comment letter can be found here.


Statement of Financial Position, Controversy?

The Question

An entity is required to disclose a summary of what constitutes capital, based on internal reporting to key management. For example, capital may not simply be total equity because some entities consider subordinated debt to be capital. Others consider the equity components of cash flow hedges to be excluded from capital. To date this quantitative disclosure has been provided in a note to the financial statements.

With the amendments to IAS 1, Presentation of Financial Statements, the question arises: Can a subtotal of “capital under management” be presented in the statement of financial position?

Prior to the Amendment

For annual periods ending on December 31, 2015 and before, the minimum line items to be included in the statement of financial position were listed. Guidance was also provided on when to include line items, namely: when the “size, nature or function of an item” is relevant to understanding the financial position.

The standard explicitly stated that the “order or format” of line items is not prescribed and that the terminology and the ordering and aggregation of similar items can be determined by the entity to suit the nature of the business and the balances reported. However, different measurement bases used for different balances would suggest that their nature or function differs therefore warranting presentation on separate lines.

Preparers were allowed to include headings and subtotals where relevant to an understanding of financial position. However, the requirements were typically interpreted as prescribing the minimum line items to be presented and subtotals were therefore used sparingly.

The Amended Standard

IAS 1 was amended in December 2014, effective for annual periods beginning on or after January 1, 2016, to address these application issues (with similar changes related to the income statement) by:

i. explicitly stating that the minimum line items should be disaggregated; and

ii. that when additional subtotals are presented, they “shall:

(a) be comprised of line items made up of amounts recognized and measured in accordance with IFRS® Standards;

(b) be presented and labelled in a manner that makes the line items that constitute the subtotal clear and understandable;

(c) be consistent from period to period…; and

(d) not be displayed with more prominence than the subtotals and totals required in IFRS Standards for the statement of financial position.”

Such subtotals are explicitly required when they are relevant to an understanding of an entity’s financial position. They are therefore referred to as “additional GAAP measures.”

As examples of line items that could be disaggregated, the standard refers to the classifications that are often provided in note disclosures. For example, property, plant and equipment into the classes used by IAS 16 and receivables between trade receivables, balances due from related parties, prepayments and so on. Clearly any disaggregation that is applied by an entity will depend on the circumstances.


Consider an entity that has convertible debt and considers that instrument plus equity to constitute the capital it manages. In such a case, ordering the statement of financial position line items in a way that a subtotal of capital under management can be presented appears to be supported by these amendments. Similarly, using some other descriptive term (Permanent capital, perhaps) would also be permitted with appropriate explanation provided in a note.

Including such a subtotal on the balance sheet would assist users in assessing the entity’s financial strength.

In arriving at this conclusion, we make the following observations:

• All the items included in the subtotal are recognized and measured in accordance with the relevant IFRS Standards.

• Users of financial statements are already familiar with the concept of capital under management as a measure of the risk of an entity and its ability to weather economic adversity. Various regulatory requirements have existed for eons and the disclosure requirements for capital under management in IAS 1 became effective for annual periods commencing on or after January 1, 2007.

• There is no requirement in IAS 1 to present on the statement of financial position a subtotal of liabilities. This is even the case where an entity presents current and non-current liabilities.

• An entity is able to order the line items to suit the business or nature of the entity.

• Furthermore, information that is required to be disclosed can be included in either the statements themselves or in the notes unless ‘specified to the contrary’ by an IFRS. The fact that the capital disclosures are listed, amongst other required disclosures, under a section labelled “Notes” appears to be a drafting convenience given the qualitative nature of most of the required information. I do not read this as being “specified to the contrary.”

• For a public company, management’s discussion and analysis (MDA) should complement and supplement the financial statements. Therefore, the regulator would be satisfied if management discusses and refers to the subtotal presented.

Some Caveats

As with most financial reporting, consistency would be needed from period to period, and the subtotal cannot be displayed with more prominence than required subtotals.

Given the different nature of equity and convertible debt these amounts would still have to be presented separately with a subtotal and could not be combined on one line.

Some entities have more than one class or type of convertible debt instrument issued. IAS 1 comments that “some entities consider some forms of subordinated debt” to be capital. Therefore, how each convertible debt instrument is presented would have to be given some thought.

The High Cost of Low Corporate Taxes

This investigative project – by Marco Oved of Toronto Star and Toby Heaps of Corporate Knights – is the first comprehensive attempt to combine Canadian corporations’ audited financial statements with government data to quantify the extent of corporate tax avoidance.  Paul Rhodes contributed financial reporting expertise.

The full article is available here:

Ten Common Mistakes in Preparing Financial Statements

The following is a list of ten common errors & omissions in financial statements prepared under the International Financial Reporting Standards (IFRS® Standards) framework.

Several represent differences between Canadian Accounting Standards for Private Enterprises (ASPE) and IFRS Standards. Others relate to questions that are omitted from the accounting and financial reporting process.

These items should be on your To-Do list for 2018, as we come into the new reporting season.

  1. Concept of “conditions that existed at the end of the reporting period” not applied

For those events occurring after the reporting period, IFRS Standards differentiate between events that are recognized (that is, adjusted in the financial statements) and events that are not recognized but may require disclosure. The basis for making the determination is whether the event reflected conditions at the balance sheet date – if it did not, it is considered for disclosed only.

A commonly overlooked example is long term debt where there has been a breach of financial covenants making the debt repayable on demand. Such a breach is often fixed after the reporting period by either amendment to the agreement or by an injection of cash by a shareholder or other related party. On this basis it is still presented as long-term debt on the balance sheet when financial statements are prepared under ASPE.

Under IFRS Standards, however, the “conditions at the balance sheet date” concept is strictly applied, so, since the debt was due on demand at the date of the financial statements it should be presented as a current liability.  The fact that the breach was cured after the reporting period would be disclosed.

A similar presentation difference arises between private and international frameworks where there is demand debt owed to the shareholder or to another related party. Under ASPE, a representation is often obtained by the auditor to justify presenting the debt as long term on the balance sheet.

  1. Classification of financial instruments as debt or as equity ignored

Plain vanilla loans and plain vanilla common shares are presented as debt and equity respectively on the statement of financial position. However, all of the characteristics of a financial instrument should be analysed in detail to ensure the correct presentation. Those that have characteristics of both debt and equity are often required to be split with the respective components accounted for and presented as debt and as equity.

Similarly, some features of an instrument mean it is automatically treated as either debt or as equity, regardless of its other characteristics. For example, an instrument that is automatically repaid in cash on the occurrence of some future event (a so-called, puttable instrument) is presented as a liability on the statement of financial position. This can arise, for example, where the terms of a unanimous shareholders’ agreement require shares held by a member of management to be automatically redeemed by the company in the event of his/her death.

Note that this is the case even though the future event has not yet occurred, because the feature of the instrument existed at the reporting date.

Distributions made on shares presented as debt are expensed through the income statement as a financing cost. Therefore, incorrectly presenting these instruments can have a significant impact on financial covenants and on operating results.

  1. “Income before the undernoted” or similar subtotals used in the income statement

The phrase extraordinary item has long since been disallowed in financial reporting.  Recently, however, the heading “Income before the undernoted” is used to achieve a similar objective. When this subtotal is used, whether items of expense are placed above it or below it is often arbitrary and usually inconsistent.

Undernoted items can be one off costs (such as impairment losses), non-cash expenses (stock option expense) or be related to acquisitions (acquisition costs and depreciation of intangible assets).  Companies would like the reader to exclude such items from the analysis of performance.

An income statement prepared in accordance with IFRS Standards needs to comply with certain minimum disclosures. Additional subtotals can be included, provided they are necessary to understand the performance of the entity.  The most common additional subtotal is Income before tax, which is often included (but is not required as a minimum disclosure) on the grounds that the income tax expense is to some extent outside the control of the company. In this case, income before tax is considered a more appropriate measure of performance.

Meaningless subtotals and the arbitrary presentation of expenses should be avoided.

  1. Incorrectly accounting for related party transactions

This often arises due to a misunderstanding of the standard on related party transactions: it defines the disclosures required with respect to related party transactions only. It does not prescribe their accounting treatment. Any transactions with related parties are accounted for in accordance with the appropriate standard for such transactions.

For example, a term loan with a non-market interest rate between the entity and a related party would be accounted for in accordance with the financial instrument standard. That standard requires that the loan be recognized at its fair value on the date it is advanced with interest recognized over the term.

  1. Accounting for certain debits

An entity applying ASPE has accounting policy choices available to it, for example: choosing to capitalize borrowing costs to a qualifying asset or expense them as incurred; and to capitalize the costs of developing internally created intangible assets or to expense them as incurred.

Conversely, IFRS Standards require an entity to capitalize:

  • borrowing costs where the construction or development of an asset takes a substantial period of time. The requirement would also apply to inventory where the ‘substantial period of time’ criterion is met.


  • the costs of developing an intangible asset where defined conditions are met.

For entities considering adopting IFRS Standards, these considerations need to be identified at an early stage of the decision-making process because the accounting consequences can be time consuming to resolve.

  1. Failing to ask if an acquisition represents a business combination

A business is defined as a combination of inputs and processes applied to those inputs that are able to generate outputs, even though outputs are not necessary to meet the definition.

There are no practical differences between the two frameworks in this respect: the ASPE standard was copied from the international standard prior to Canada’s adoption of IFRS  Standards to avoid creating unnecessary accounting differences on transition to IFRS Standards.

A business combination can arise where an entity purchases assets and some processes, so addressing this question should not be overlooked.

  1. Going concern issues

An entity is no longer a going concern where management intends to cease operations or has no realistic alternative but to do so. In this case some other basis of accounting needs to be applied which will require consideration of many other issues, such as: the write down of assets to recoverable amounts; recognition of provisions for staff terminations and onerous leases; and so on.

The fact that management’s intention to cease operations means the entity is no longer a going concern can often go unnoticed.

More frequently an entity’s continued operation will depend on one or more factors, typically ramping up revenues and/or sourcing refinancing or additional financing rounds. Where that is the case, the financial statements need to include disclosures sufficient to paint an accurate picture for users.  Including a clear reference to that disclosure on the statement of financial position is required under IFRS Standards.

  1. Boilerplate language used in disclosures

The IFRS Standards and ASPE frameworks have the same roots and therefore have many similarities. However, many differences exist and these are often ignored when an entity reporting under ASPE changes to reporting under IFRS Standards. For professional accounting firms that are preparing financial statements on behalf of their clients, problems can arise when an ASPE financial statement template is used for a client reporting under IFRS Standards.

Some can be very subtle and depend on a detailed understanding of the standards. For example, under ASPE, where operating losses are available for carry forward for tax purposes but are unlikely to be used by the entity they are recognized for accounting purposes but with an allowance of equal value against them. Under IFRS Standards such a deferred tax asset is recognized only ‘to the extent’ that it is likely to be used.

Similarly, accounting policies and other disclosures are often based on boilerplate language which is frequently borrowed from the continuous disclosures of public companies.

A financial statement prepared under IFRS Standards should be convincing: it should look and feel like an IFRS Standards compliant financial statement. In addition, standard disclosures should be avoided. Instead they should be specific to the company and its business.

  1. Accounting for financial instruments

The current rules on accounting for financial instruments require an impairment loss on a financial instrument asset accounted for at amortized cost to be calculated as the difference between the present value of the cash expected to be collected and the carrying amount of the asset. The corollary of which is that interest revenue on the instrument is still earned after the impairment loss has been recognized.

Furthermore, that impairment loss can only be recognized where there is objective evidence that a loss has arisen at the date of the reporting period.  Any event occurring after that date that gives rise to a loss is not an adjusting event.

These accounting requirements are often misapplied.

  1. Failing to consider the question of functional versus reporting currency

The reporting currency can be any currency selected at the option of the entity.  The functional currency, however, must be identified based on the facts and circumstances.

A company is required to determine the functional currency by applying a list of criteria to the company’s operations and environment. In some cases that application and the resulting decision of functional currency is readily apparent.  In other cases, for example where the company earns significant revenues and is financed in other currencies, the decision can come down to a judgement call based on the weighting of the various criteria.

A Question Not to be Underestimated: Asset or Business Acquisition?

A transaction is either accounted for as a business acquisition under IFRS 3, Business Combinations, or, if it is not a business combination, in accordance with the appropriate standard for an asset purchase (for example: IAS 16 Property, Plant and Equipment; IAS 38 Intangible Assets; or IAS 40 Investment Property).

The question is important (and there are significant consequences to getting the answer wrong or not considering the question at all!), because in a business combination:

  • Goodwill or a gain on bargain purchase is accounted for;
  • Assets acquired and liabilities assumed are accounted for at their fair values rather than being recognized at their relative fair values in an asset purchase;
  • Directly attributable acquisition costs are expensed versus capitalized as part of the asset purchased;
  • Deferred tax assets and liabilities are recognized in a business combination;
  • IFRS® Standards provides guidance on recognizing contingent consideration but there is no guidance in the standards applicable to asset purchases;
  • The disclosure requirements are considerable in the financial statements for a period in which a business combination is completed, and the same disclosure applies in any year where an acquisition is made subsequent to the report date but before the financial statements are issued; and
  • Also note that some of these differences continue in future periods, such as impairment and depreciation/amortization.

An entity first needs to determine whether the assets acquired and liabilities assumed constitute a business (IFRS 3.3). If they do not meet the definition of a business, then the default is to account for the transaction an asset purchase.

Appendix A to IFRS 3 defines a business as, ‘an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return…to investors or other owners, members or participants.’  A business therefore consists of inputs and processes applied to those inputs that have the ability to generate outputs. Therefore, outputs themselves are not required.

Input: are economic resources, such as intellectual property, access to necessary materials, employees and non-current assets such as intangible assets or the rights to use non-current assets.

Process: is any system, standard, protocol, convention or rule, such as strategic management processes, operational or resource management processes. Administrative processes are specifically excluded.

Output: is a return in the form of dividends, lower costs or other economic benefits

You should note the following in applying the definition:

  • If the transaction does not include both inputs and processes then it is not a business combination.
  • Some processes must be included in the transaction, but all processes used by the vendor need not be included. Some necessary processes may be provided by the acquirer on integrating the business with their own operations.
  • A business need not have liabilities.
  • The set of assets and activities must be capable of being conducted and managed as a business by a market participant. Whether the seller operated the set as a business and whether the acquirer intends to operate it as a business is not relevant.
  • There is a rebuttable presumption that an asset that includes goodwill is a business.
  • The elements of a business vary by both industry and structure of an entity.
  • New businesses often have few inputs and processes and only one (or no) outputs. In this situation, other factors must be considered, including whether the set:
    • Has begun planned principal activities;
    • Is pursuing a plan to produce outputs; and
    • Is expected to obtain access to customers to purchase those outputs.

The determination of whether a transaction is a business acquisition or an asset purchase is a judgement call that must be disclosed.

The Application Guidance provides more detail that is useful in applying IFRS 3, including the following.

The definition of a business includes inputs and processes and may also result in outputs, although outputs are not necessary for a business to exist. A process is defined as, ‘any system, standard, protocol, convention or rule’ (IFRS 3.B7) that when applied to inputs creates, or has the ability to create, outputs. Examples of processes include strategic management, operational and resource management. Inputs are economic resources that create, or have the ability to create, outputs when one or more processes are applied, and include intangible assets or the rights to use non-current assets.

‘To be capable of being conducted and managed for the purposes defined, an integrated set of activities and assets requires two essential elements – inputs and processes’. Therefore both assets and processes must be included in the acquisition, even though all necessary processes need not be acquired (some processes may be contributed by the acquirer) (IFRS 3.B8). If no processes are included, then the transaction is an asset purchase; if this was not the case, then any asset purchased for use in an existing business would meet the definition of a business, which would be non-sense.

Furthermore, processes are described as ‘activities’ in IFRS 3.B8, which is consistent with the English language definitions of the word: (i) as a noun, ‘a series of actions or steps taken’ and (ii) as a verb, ‘perform a series of mechanical or chemical operations on something in order to change or preserve it.’ The purchase of in-place leases, for example, represents economic inputs and not a process; the leases represent a right to benefit from non-current assets. There are no activities inherent in a rent-roll, instead leasing and other management processes are applied to it.

Where the acquisition includes both inputs and some level of process (over and above administrative functions, which are specifically excluded by the definition) the determination can involve significant judgement. The IFRS® Interpretations Committee White Paper of May 2013 addressed the application of this principle in practice by different sectors, including the real estate sector, and in different jurisdictions.

One view in practice is that the processes acquired must have a level of sophistication that involves a degree of knowledge unique to the assets being acquired for a business to exist. Common themes in the responses received include:

(a)    Examples of significant management processes that management views as being integral for a business to exist, include marketing, tenancy management, financing, development operations and other functions that are typically undertaken by the parent company or external management.

(b)    The acquisition of an investment property together with the employment of key management personnel of the vendor is a strong indicator of a business.

(c)     Other processes such as cleaning, security and maintenance are generally not considered to be significant processes. Therefore, a transaction that only includes those or similar processes is generally treated as an asset purchase.

Note that these necessary processes meet both the definition in IFRS 3 and the English language definition, while in-place leases acquired do not.

The view that a level of sophistication is required is predominant in Europe and Australia and is consistent with the requirement that processes be at a more supervisory or management level (as per the definition: strategic management, operational and resource management).

The view from respondents using US GAAP (which is nearly identical to the guidance in IFRS Standards) is that ‘any process that, when applied to an input or inputs, create or have the ability to create outputs, gives rise to a business.’  Therefore, transactions are more likely to result in business acquisitions than asset purchases in the US GAAP world.

Under Canadian Accounting Standards for Private Enterprises (ASPE) the relevant standard is 1582 Business Combinations, which is a copy of IFRS 3 Business Combinations. Therefore, the guidance surrounding IFRS Standards can also be applied to the same asset or business combination question under ASPE. In applying the GAAP hierarchy in ASPE (standard 1100 Generally Accepted Accounting Principles), the first consideration would be IFRS Standards and not US GAAP. This is logical given the fact that 1582 and IFRS 3 are identical.

The International Accounting Standards Board (the Board) carried out a Post Implementation Review (PIR) of IFRS 3 in 2014/2015. The review found that stakeholders find it difficult to apply the definition of a business in practice. The Board issued an exposure draft in June 2016 which proposes: amending the language used in the standard, adding illustrative examples and simplifying the application of the standard in some situations. The comment period closed on October 31, 2016. Watch this space for a piece on the final amendments to the standard.

Implementing Hurdles with the New Revenue Recognition Standard (IFRS 15)

The following article was originally published by Wiley.

Canada: Crossing the Rubicon – High threshold of evidence required

It seems to me that alternative uses that remain theoretical would be a sufficient “practical limitation” to any ability to direct an asset to an alternative use and to cross that Rubicon would require a very high threshold of evidence. For example, subsequent events that show alternative uses have crystalised for the very same asset.

Paul Rhodes 

  1. Determining if a contract exists

Some practitioners have questioned the effect of contract termination provisions where only one party can cancel the contract. This would occur for instance when a service provider is committed to providing services for a specified period but the customer can terminate the contract any time without penalty.


Do you believe that:

  • the contractual period only includes the period for which the entity has an enforceable right to obligate the customer to purchase the goods or services? or
  • the contractual period is the specific duration for which the entity is obligated to continue to perform?

Whether an agreement with a customer meets the criteria in paragraph 9 is determined at contract inception, which includes that the entities are committed to perform their obligations under the agreement. The explanatory paragraphs that follow the criteria go on to state that a contract “creates enforceable rights and obligations” and that “enforceability…is a matter of law.” Therefore, a legal contract is not necessarily the same as a contract for financial reporting.

The standard is clear only in scenarios where the arrangement: can be unilaterally cancelled by either party; the entity has not yet transferred any promised goods or services; and has not yet become entitled to receive any consideration. In this case the arrangement would not be considered to be a contract.

Outside of this narrow example, such as when only the customer can cancel the contract at any time, an entity has to consider the practices and processes for establishing a contract with customers, and they may vary by legal jurisdiction, industry or type of entity. While judgement will be required, note that the commitment required of both parties – which is assessed at contract inception – is a lower bar than the legal criteria of enforceability.

The contractual period would not be limited to the period that can be enforced by the entity. It is likely that the contractual period would be the same as the initial contract term to which the parties committed.

2.  Onerous contracts

While IAS 11 Construction Contracts has been superseded by IFRS 15, the onerous contracts guidance in IAS 37 Provisions, Contingencies and Contingent Assets remains the sole piece of literature addressing loss-making contract situations. Concern has been expressed by some practitioners that the basis for measuring onerous contract provisions under IAS 37 is dissimilar to that of loss-making contracts under IAS 11. This is because IAS 37 has an unavoidable costs approach when IAS 11 considers all costs directly attributable to the contract.


Do you think that the approach to measuring loss-making contracts has changed with IFRS 15? Are you aware of practitioners changing the measurement basis for their loss-making contracts?

It is conceivable that there will be differences in accounting for loss making contracts in the following scenarios:

First, IAS 11 Construction Contracts measured total contract costs against total contract revenue. Included in contract costs are those costs that are attributable to the contract, such as insurance, design and other overheads. Under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, the unavoidable cost of an onerous contract is the lower of the cost of fulfilling the contract obligations and the costs and penalties of failure to perform the work. Except for extraneous circumstances, there is likely to be a constructive obligation for the contractor to perform the work. For a fixed fee construction contract, the unavoidable costs will still be included in the measure of the loss under IAS 37. However, the directly attributable cost under IAS 11 is a more comprehensive measure of project cost and may therefore result in smaller losses being recognised under the new revenue framework.

Secondly, IAS 11 included criteria – all three parts of which needed to be met – for an entity to group apparently separate contracts, or components, into a single contract for financial reporting purposes. That same grouping was also used when determining whether the contract for financial reporting was loss making. IFRS 15 also lists three conditions for grouping contracts for financial reporting purposes, however, only one of the three need to be met for individual contracts to be grouped. This may give rise to different financial reporting contracts under the new revenue regime, which could have a significant effect on whether a loss exists.

3.  Transaction price – minimum commitment

In some industries, for instance telecommunications, the customer signs up for a certain service level for a fixed term (for instance a 24 month 5GB data plan). The customer also commits to maintain a minimum level of service (for instance a 1GB data plan) throughout the contract term that is possibly lower than the service level subscribed at inception. Upon entering the contract, the customer receives a free or discounted good or service as an incentive for entering the contract. The contract has two performance obligations (the core service and the incentive) to which transaction price needs to be allocated. The question has arisen as to what is the transaction price?


Do you believe that the transaction should reflect the minimum service commitment or the initially contracted service level?

The total transaction price is relevant in allocating the price between the deliverables of the discounted good and the service commitment over the term. In measuring the consideration, paragraph 49 requires the entity to assume the deliverables are transferred to the customer, “in accordance with the existing contract and that the contract will not be cancelled, renewed or modified.” In a contract for telecommunication services, the customer is usually able to vary the service level (number of minutes of air time and data level) within the original contract terms.

Typically, if the customer’s use of minutes or data exceeds their plan the excess is charged at premium rates. The customer is also able to vary the service level at any time during the contract term by giving the defined period of notice to the entity. There is no guarantee that the service level will not be reduced to the minimum level that was promised in the contract.

The question is also whether this variability is to be accounted for as variability in the transaction price under IFRS 15. The examples listed in paragraph 51 are all changes in the consideration only with no commensurate change in the promises made by the entity or the customer. Since in our example, the change in the transaction price varies along with the level of service to be delivered by the entity (bandwidth, for example) it should not be treated as variable consideration in measuring the transaction price.

The transaction price to be measured is explained in paragraph 47 as:

“…the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer”

The only promises made in the contract are the minimum service levels. If the contracted service level is in excess of that, it should not be considered to be a promise because there is no commitment over the duration of the contract term. The ability of the customer to increase the level of service during the term is an option only and no promise exists that they will do so.

4.  No alternative use assessment

In the aerospace and defence industries, companies may conclude that a good has no alternative use (therefore meeting one of the criteria to be recognised over time) under current market conditions, because no other customer exists. However, the company may expect market conditions to change over the contract period so that the good could have alternative use as the market develops. The question has arisen as to whether the no alternative use criteria would be met in such circumstances.


Do you believe that expected change in market conditions should be taken into account when assessing no alternative use?

If the entity’s performance creates an asset with no alternative use then revenue for performance should be recognised over time. If there are alternative uses and none of the other criteria for satisfying a performance obligation over time are met, then the revenue is recognised at a point in time.

An absence of alternative uses can arise through either substantive restrictions included in the contract terms or through practical limitations. In the aerospace and defence industries, the application issue raised is one of practical limitations and not of contractual restrictions.

The standard requires alternative uses, or the lack thereof, to be determined at contract inception and describes this process as an “assessment” which implies that judgement is required. The basis of conclusions refers to “practical limitations on the entity’s ability to readily direct that asset for another use” and provides the example of selling the asset to another customer. Selling the asset to another customer may not be practical where there is a degree of customisation that would require rework, the cost of which would result in a loss. This is the case for the satellite in illustrative example 15.

Clearly several moving parts would come into play to make this judgement, not least of all the term of the contract. It seems to me that alternative uses that remain theoretical would be a sufficient “practical limitation” to any ability to direct an asset to an alternative use and to cross that Rubicon would require a very high threshold of evidence. For example, subsequent events that show alternative uses have crystalised for the very same asset would seem to be required.

5.  Movie rights – determining the point in time when control transfers

Uncertainty exists at what point in time movie production companies should recognize revenue when licensing out all broadcasting rights for a movie to a distributor. These rights may include all distribution channels like theatres, home video and television. However these rights may come with restrictions, for example, home video rights will not be available until 12 months after a theatre release.


Do you believe that in the above situation it would be appropriate to recognize all fixed transaction prices on day 1?

The license represents a single performance obligation, being a right to use the entity’s intellectual property (the rights to the movie production) as it exists at the time the license is granted.

Example 59, paragraph IE305, states that the point in time to recognize revenue is “when the customer can direct the use of, and obtain substantially all of the remaining benefits from, the licensed intellectual property.”

The remaining question is: what that point in time is for the home video rights: whether it is day 1 or 12 months after the theatre release date. In deciding this question we would apply the principle of control that underlies the recognition of revenue. Even though the licensee cannot exploit the intangible asset for a period of time in one of its applications, the fact that the licensor is prevented from licensing the intangible for home video use to another party, from otherwise using it and from using the intangible as security (which we assume are terms of the license agreement that would be negotiated by the licensee) would suggest that the entity no longer has control over the asset. In effect the licensee is able to enforce the legal terms of the license to “prevent other entities from directing the use of, and obtaining the benefits from, an asset,” which is an example of control passing in paragraph 33. The corollary of the licensee obtaining control is that the entity must no longer have control, which would be the case here.

The concept of revenue not being recognised before the licensee is able to obtain economic benefits in paragraph B61 appears to be superseded by the broader concept of control described above and in paragraph 38. In addition the example of revenue only being recognised once a code is delivered to the customer is not the same. Note that paragraph B62 explicitly excludes restrictions of time from the consideration of determining the nature of the rights being transferred.

Therefore the point in time for recognising the fixed revenue would be day 1.

This conclusion is consistent with the indicators of the transfer of control at a point in time in paragraph 39. For example, physical possession has likely transferred to the licensee and the licensee has assumed the risks and rewards of holding that title.

If any of the fixed consideration for the license, including for the home video release, is not due on signing the license then it should be discounted and the finance revenue recognised over the payment term, if material.

If the terms of the license are such that the entity is required to perform other obligations prior to the licensee being able to exploit the home video market, then the conclusion may need to be reconsidered. This is because the license itself may not be distinct and/or the license may represent a right to use intellectual property that changes over the term. For example, perhaps the point in time is not reached until the movie production has been significantly remastered or reengineered for the home market. This concept is discussed in paragraph B57.

6.  Indirect sales with subsequent repurchase and lease transactions

In some industries, such as automotive or telecommunications, companies offer their end customers to either lease or buy their product (car or mobile device). When such transactions are contracted through indirect channels, the company first sells the product to the dealer. Subsequently, if the end customer opts for the lease, the company buys back the product and leases it to the end customer. Some practitioners have questioned whether it is appropriate to recognize the sale of the product to the dealer in the first place, knowing that the company is implicitly committed to buying back the product and may have a history of demonstrating such a practice.


  • Are you aware of diversity in practice in such transactions under current GAAP?
  • Do you believe the accounting would change under IFRS 15?

We have no experience of such diversity in practice. For entities that recognise the initial transaction as a sale, a change on adopting the new revenue standard may be necessary depending on the specific terms of the arrangement.

For example, under IFRS 15, the entity would have to be satisfied that the initial sale contract has commercial substance and that it is probable that the consideration will be received. Commercial substance requires that there is some effect on the “risk, timing or amount of future cash flows.”

In addition, which entity (the automotive manufacturer or the dealer) controls the product may provide some insight as to whether the arrangement is one of inventory held on consignment by the dealer. For example, the dealer may be required to transfer vehicles to other dealers at the direction of the manufacturer. Similarly, the dealer may be acting as the manufacturer’s agent in making sales to the end customer.

Renewable Terms, Licences, Variable Consideration and other Contract Terms in the New IFRS 15 Revenue World

This article was originally published by Wiley.

  1. How will the new revenue standard apply to contracts with renewable terms?

Any contract that is renewed at the time of complete satisfaction of the contractual performance obligations would be treated as an entirely new contract for revenue recognition purposes. If a contract is renewed prior to that point then an entity needs to consider the effect of the renewal and any changes in terms in relation to the remaining deliverables under the contract.

A contract that includes renewable terms, such as a modification of either the price or quantities deliverable under the contract, may be treated as part of the existing contract if the remaining goods and services are not distinct and form part of a single performance obligation that is partially satisfied at the date the modification took place. Any adjustment to the total transaction price or the performance obligations under the modified contract is accounted for as a cumulative adjustment to revenue (IFRS 15.21(b)).

If the circumstances do not meet paragraph 21(b) then the modified contract is either an entirely new stand-alone contract to which IFRS 15 is applied (paragraph 20) or it represents the termination of the existing contract and the creation of a new contract (paragraph 21(a)).

  1. Under existing IFRS® Standards there has been debate about the appropriate revenue recognition for the sale of residential units in multi-storey apartment developments. Will IFRS 15 change the way in which those transactions are accounted for in your jurisdiction? If so, how and why?

Revenue recognition under IFRS 15 is based on control of the asset. In accordance with paragraph 35, revenue could be recognized for the sale of residential units in an apartment development when the entity does not have an alternative use for the asset created by performance of the contract and the entity has an enforceable right to payment for performance completed to date.

As described by illustrative example 17 Case B, the two criteria could be satisfied by, respectively, a contractual restriction preventing the entity from transferring the unit under construction to another buyer and when the entity’s right to payment of all the consideration for performance can be legally enforced against the customer.

Applying the same facts in this example to international financial reporting pre-IFRS 15 requires application of IFRIC 15: the contract is for the sale of goods because the buyer is not able to specify the major structural elements of the real estate and because the supply of materials is required. Therefore all the conditions in IAS 18 paragraph 14 must be met for revenue to be recognized. For certain real estate contracts the conditions can be met continuously allowing revenue to be based on the stage of completion. However, for the sale of a residential unit it seems likely that the entity will retain the risks and rewards of ownership until ownership passes to the buyer so revenue is only recognized at closing.

It seems likely that IFRS 15 will result in revenues being recognized over time, although the application of the new standard to contracts for the sale of units will depend on the exact terms of those contracts.

  1. How does the revenue standard allocate the transaction price when a bundle of goods or services is sold at a discount?

When a bundle of goods and services is sold under a contract the transaction price is allocated based on the relative stand-alone selling prices of the goods and services to be transferred, with the objective that the amount allocated depicts the amount that the entity expects to be entitled to in exchange for transferring the promised goods or services.

When the sum of the stand-alone selling prices for a bundle of goods and services exceeds the promised consideration the default method for allocating the discount is proportionately to all performance obligations in the contract, which is consistent with the method of allocating the transaction price.

As an exception to the default method, if there is observable evidence that the entire discount relates to only one or more, but not all, performance obligations then the discount is allocated appropriately. This allocation exception can be applied only when the criteria described in paragraph 82 are met, the objective of which is that the entity needs to have sufficient information to be able to allocate the discount to specific goods or services (or bundles of goods and services) within the contract.

While the criteria in themselves may not be immediately intuitive, taken together with illustrative example 34, they are more readily understandable.

  1. There are many different types of licences of intellectual property. Under IFRS 15, for some licences, an entity recognises revenue at the time the licence transfers to a customer. For other licences, an entity recognises revenue over a period of time. What factors determine whether an entity should recognise licence revenue at a point in time or over time? Do you believe the guidance provided in IFRS 15 will be operational in practice? If not, why not?

For simplicity, consider a contract under which the promise to grant a license is distinct from other deliverable goods and services. The point in time or period over which the entity satisfies a performance obligation for a deliverable item is dealt with in paragraphs 31 to 38 of IFRS 15; this guidance is applied to a distinct license in paragraphs B56 to B62.

The revenue recognition for a license between recognition at a point in time or over time is determined by whether a customer can direct the use of, and obtain substantially all of the remaining benefits from, a license at the point in time at which it is granted. The distinction is applied by considering whether the license conveys a right to access the intellectual property as it exists throughout the licence period, or a right to use the entity’s intellectual property as it exists at the point in time at which the licence is granted.

Therefore if the intellectual property over which the customer obtains rights changes over the license term then the customer cannot obtain substantially all of the remaining benefits from the license at the grant date. This is the distinction between a right to access (changing) intellectual property and a right to use (fixed) intellectual property.

The principle described is defined by the criteria in paragraph B58, all of which must be met if the license is considered a right to access the entity’s intellectual property.

The complexity of accounting for revenues arising under licenses is perhaps indicated by the fact that the standard includes so many illustrative examples on the subject.

Despite the number of illustrative examples, the application of these rules may pose problems in practice. For example, for a license of software which includes any updates for a period of time, an entity must consider whether it will ‘undertake activities that significantly affect the intellectual property.’ The phrase ‘significantly affect’ could be read in relation to the criteria in paragraph 33, in terms of ‘the potential cash flows (inflows or savings in out flows) that can be obtained.’

It is conceivable that rolling out later versions of the software could represent enhancements to the intellectual property from the customer’s perspective which should therefore be accounted for as a right to access that property as it exists throughout the license term. It is also likely that the nature of updates to be rolled out during the term, if indeed any will be, cannot be determined. Illustrative example 54 suggests that ‘because the software is functional when it transfers to the customer, the customer does not reasonably expect the entity to undertake activities that significantly affect the intellectual property.’ This seems too simplistic a statement for this industry.

  1. Do you anticipate any difficulties in applying the new standard’s requirements relating to the estimation of variable consideration? If so, in which circumstances and why?

Where variability exists in the amount of consideration receivable under a contract, the entity is required to make an estimate. The standard allows two methods of estimation: either the expected value, being the ‘sum of the probability-weighted amounts in a range of possible consideration amounts,’ or the most likely amount, being the ‘single most likely amount in a range of possible consideration amounts.’

Practical difficulties are likely to arise in a number of circumstances. For example, in determining the probability weighted amounts for the expected value method where the entity has individually unique contracts. The standard states that the expected value method may be appropriate where the entity has a large number of contracts with similar characteristics. However, the standard apparently only allows two methods of consideration estimation. If an entity has a number of contracts with dissimilar characteristics, each with a range of possible consideration amounts, the expected value approach would still have to be applied to each contract because the other method would not be appropriate.

In addition, an entity is required to consider a “reasonable number of possible consideration amounts” but a reasonable number is not defined. If there is a continuous range of possible consideration amounts under each dissimilar contract how many possible amounts should be considered in the estimation exercise?

As is often the case, the estimation of any amount can be based on accumulated historical experience. There is considerable scope where the lack of such knowledge would mean estimation is inhibited. For example, where an entity is required to refund to a customer some or all of the consideration received a refund liability is measured as the amount of consideration recognized for which the entity does not expect to be entitled. Similarly, the transaction price includes variable consideration only up to the constraint.

A lack of historical experience is likely to occur where an entity establishes a new business or product or sells existing products or services to a new customer segment which may have different characteristics rendering past experience irrelevant.