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.

Canada: Disclosure collage

The following article was originally published by Wiley.

The detail required for revenue under contracts with customers that have not yet been recognised poses a practical issue in that for many entities this information is likely to be outside of the accounting system. There is therefore a need to assemble the required disclosure which for many entities is likely to add to the Excel collage supporting the financial reporting, with all the inherent risks over completeness and manual errors.”

  1. Which types of transactions will the new standard have the greatest impact on and which industry sectors will be most affected?

The previous revenue standard used a risk and reward model for recognition, such that revenue was recorded if the significant risks and rewards of ownership had transferred to the customer. The new standard applies a control based model, such that revenue is recognised when control over the good or service passes to the customer. While the actual effect on reported revenues may not be substantial for many sales transactions because risks and rewards pass at the same time as control there will be a need for many entities to rigorously apply the new model to their revenue streams to ensure proper reporting.

Under IFRIC 15 the percentage of completion method was allowed for construction projects where the criteria in IAS 18.14 (the first of which is the transfer of the significant risks and rewards of ownership) were continuously met as construction progressed. With the change from a risk and rewards model to a control model, there may be changes required in the timing of recognising revenues from construction contracts.

IAS 18 included very limited guidance for recognising revenues where a contract comprises separately identifiable components. The guidance in IFRS 15 is significantly more detailed, and includes guidance for identifying the performance obligations in a contract and for allocating the transaction price between them. The circumstances in which the residual approach can be used to allocate the transaction price have been narrowly defined.

Any industry in which entities typically enter into contracts with multiple deliverables will be affected. Such arrangements are common in the telecommunications and software industries but also arise, for example, where any tangible product is sold along with either installation services or a maintenance contract.

  1. Do you anticipate that preparers will have difficulty identifying individual performance obligations and allocating the transaction price across them? If so, are there particular types of transactions where you believe this will be particularly problematic?

A performance obligation is a promise in a contract with a customer to transfer to the customer either: a good or service (or a bundle of goods and services) that is distinct, or a series of distinct goods or services that are substantially the same and have the same pattern of transfer.

Determining whether identified goods and services are distinct will often require a degree of judgement given the criteria that must be met: the customer must be able to benefit from the good or service either on its own or together with the customer’s existing resources and the good or service must be distinct within the context of the contract.

Software entities are again a good example of such transactions because a licence to software is often sold along with services to integrate the software with the customer’s existing systems. Determining whether a licence to software is distinct from the integration services may be a fine line, which is ultimately determined from the customer’s perspective despite the additional guidance provided in paragraph 28.

The transaction price is allocated to each performance obligation on a relative stand-alone selling price basis. The best evidence of a stand-alone selling price is an observable price when the entity sells the good or service in similar circumstances and to similar customers. When a stand-alone selling price is not available the amount that the entity expects to receive in exchange for each performance obligation must be estimated considering all information that is reasonably available.

The difficulty in such estimation will be exercising judgements consistently across contracts and across group entities.

  1. Do you anticipate that preparers will have difficulty determining whether a promised good or service is a performance obligation satisfied over time if it is unclear that the customer obtains control of the good or service over time? If so, are there particular types of transactions where you expect this may arise?

A good or service is a performance obligation satisfied over time if one of the following criteria is met:

(a)  The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs;

(b)  The entity’s performance creates or enhances an asset that the customer controls; or

(c)  The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.

This may arise in the software industry where a customer contracts to purchase both a license for the entity’s own software and also integration services. If the software licensed to the customer can be used on a stand-alone basis prior to it being integrated with the customer’s other hardware and software systems then a conflict exists as to when the customer takes control of the license: either on signing and delivery for the stand-alone use (because the customer obtains control of the asset), or as a bundle with the integration services (which could satisfy either b or c above, depending on the circumstances).

  1. Do you anticipate that an entity will encounter practical difficulties in preparing some of the required additional disclosures? If so, which disclosures and why?

The level of detail required to be disclosed is significantly increased from the prior revenue standards. There are two areas that may be problematic: first, revenue under contracts with customers that have not yet been recognised because the performance obligation has not been discharged (paragraphs120-122), and second the level of qualitative disclosure required.

The detail required for revenue under contracts with customers that have not yet been recognised poses a practical issue in that for many entities this information is likely to be outside of the accounting system. There is therefore a need to assemble the required disclosure which for many entities is likely to add to the Excel collage supporting the financial reporting, with all the inherent risks over completeness and manual errors.

Qualitative explanations and descriptions are required throughout the disclosure section of the standard. Examples include: an explanation of the timing of satisfying performance obligations and the timing of payments; detailed descriptive information about performance obligations; and a description of when future revenue will be recognised.

In applying the standard, the qualitative disclosures required are not defined. Therefore entities will have to rely on the general principle regarding the objective of disclosures: to disclose sufficient information to allow users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

The standard includes concessions for disclosures during the transition period: for example entities need not present qualitative information required by paragraph 28 of IAS 8 for the prior period.

  1. What are some of the key issues an entity should consider when planning to transition to the new standard?

Issues to be considered in the run up to adoption of the new standard include:

  • As with any new accounting standard that has an effect on financial performance, entities must consider the effect on the timing of revenue recognition and whether loan covenants will still be satisfied. If the changes in recognising revenue will mean covenants are breached the terms of loan agreements should be raised early with lenders.
  • Similarly, early communication with investors would be desirable once the effect on operating results is determined to set expectations and avoid surprises.
  • The transition method to be adopted is a decision that should be considered and concluded early.
  • Entities should consider desirable system and process changes in order to generate the required information for both accounting and disclosures.
  • For consolidated groups the consistency of exercising judgements and making estimates should be determined by the parent and disseminated to group entities.
  • In Canada the measure of income used for income tax purposes starts with income determined under GAAP unless the tax legislation requires some other measure or adjustment. Since the effect of the new standard on accounting income may be substantial for some entities, the tax consequences should be considered early in the process.
  1. A joint International Accounting Standards Board (the Board) & FASB resource group has been set up to discuss implementation issues. What type of implementation issues do you see this group addressing in the future?

With the new standard the additional guidance will be more useful in accounting for complex transactions. While it is difficult to speculate about the issues that will be considered by the resource group, the one issue likely to be addressed is the consistency of accounting for similar transactions.