IFRS 15 Revenue from contracts with customers 1 Overview This policy is based on IFRS 15 Revenue from contracts with customers effective from 1 January 2018. The core principle of the policy is that an entity recognizes revenue to represent the transfer of promised goods or services to customers, reflecting the amount of consideration to which an entity expects to be entitled in exchange for those goods or services. The policy focuses on the identification of performance obligations and distinguishes between performance obligations satisfied at a point in time and those satisfied over time, which is determined by the manner, control of goods or services, passes to the customer. The policy should be applied consistently to contracts with similar characteristics and in similar circumstances. The entity shall recognize revenue by applying the five step model in order to meet the standards core principles and ensure a consistent approach. All of the five steps in the model should be considered for every contract with a customer, unless the step is clearly not applicable. 1.1 Individual contract or a portfolio approach The standard allows a practical expedient, the five steps can be applied to a portfolio of contracts with similar characteristics provided that it is reasonably expected that the effects on the financial statements of applying a portfolio approach will not differ materially from applying IFRS 15 to the individual contracts within that portfolio. When accounting for a portfolio, estimates and assumptions that reflect the size and composition of portfolio should be used, applying the five step model as explained in the following chapters. An entity will need to exercise significant judgment in segregating its contracts into portfolios with similar characteristics at a level with sufficient granularity to ensure that the outcome of using a particular portfolio approach is not expected to differ materially from applying the requirements of the standard to each individual contract. 1
1.2 The five step model The first step in the five step model is to identify whether a contract exists and meets specified criteria. Entities are required to account for a contract with a customer that is within the scope of IFRS 15 only when five requirements as specified in step 1 are met. A contract is out of scope of the policy if one or more of the five requirements are not met, or if the contract is wholly unperformed and each party can unilaterally terminate the contract without compensation. The second step is to identify all performance obligations in the contract. The goods or services that will be transferred to the customer are usually explicitly stated in the contract. The performance obligations identified in a contract with a customer are not limited to the goods or services that are explicitly stated in the contract, this is referred to as implicit offers. Implicit offers are promises that are implied by the entity s customary business practices, published policies or specific statements that raise valid expectation of the customer that the entity will transfer such goods or services. The entity hence has to identify all the explicit, the explicit but offered for free (non-prized) and the implicit offers as performance obligations. The third step is to determine the transaction price, which is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. The estimate of transaction price will be affected by the nature, timing and amount of consideration promised by the customer. In determining the transaction price the following effects have to be considered using certain methods: a) Variable consideration b) Significant financing component in the contract c) Non-cash consideration d) Consideration payable to a customer The fourth step is to allocate the transaction price to each performance obligation identified in step 3. The amounts allocated should represent the consideration to whom which the entity expects to be entitled in exchange for transferring the performance obligations to the customer. The entity is required to allocate the transaction price to each identified performance obligation on a relative stand-alone selling price basis. This means that each performance obligation will be allocated its share of revenue based on its stand-alone selling price put in relation to the sum of all performance obligations stand-alone selling price. The fifth step is to recognize revenue when the entity satisfies a performance obligation by transferring a promised goods or service to the customer. An asset is transferred when the customer obtains control of the asset hence revenue can be recognized. Control of an asset refers to the ability to direct the use of, and obtain substantially all of the remaining benefits from the asset. 2
The starting point is to identify if revenue should be recognized over time or not. When any of the following criteria are met it demonstrates that an entity is transferring control of a good or service over time: 1. The customer simultaneously receives and consumes the benefit of the entity s performance as the entity performs; or 2. The entity s performance creates or enhances an asset controlled by the customer; or 3. The entity s performance creates an asset with no alternative use to the entity and the entity has an enforceable right to be paid for performance completed to date If a performance obligation is not satisfied over time it is satisfied point in time, transfer of control is indicated by any of the below criteria: 1. Present right to payment 2. Legal title of goods and services 3. Transferred physical possession 4. Significant risks and rewards of ownership 5. The customer has accepted the asset 1.3 Certain aspects to consider in five step model Contract modifications Contract can sometimes be modified due to additional quantity or added number of products. Revenue from modified contracts should be recognized in different manners depending on the modification, such as additional quantity but to a price below stand-alone selling price. Such modification causes the existing contract to be terminated. The new contract created should take into account the un-performed parts from the terminated contract and the additional ordered services or goods. Contract costs Contract costs refer to cost to obtain a contract and costs to fulfill a contract. These costs can under certain conditions be reported as a contract asset (non-fixed asset) and periodized over the contract period. Licensing Licenses provided to a customer can either be recognized over time or point in time due to the level of integration needed. In many cases other services than a license is often provided such as installation, support and updates. All these aspect of the license agreement needs to be considered when judging the timing of recognizing revenue. Repurchase clauses Customers are sometimes offered the option to sell back the bought equipment to predetermined price at a certain date in the future. Such clauses need extra attention since the 3
transfer of control might not have taken place. This is the case when a customer has a significant economic incentive to exercise that option (the repurchase price is considered being at market price level or higher at the contracted date of possible return). The revenue from that contract shall than be recognized as an operational lease according to IFRS16 Leases. Further details on revenue recognition according to Sandvik s policy are found in the chapters to follow. 2 Introduction This policy is based on IFRS 15 Revenue from contracts with customers effective from 1 January 2018. 3 Scope The policy should be applied to all contracts with customers excluding those who fall in the following categories: Lease contracts see IFRS 16 Leases applicable from 1 January 2019 Insurance contracts see IFRS 4 Insurance contracts Financial instruments - see IFRS 9 Financial Instruments applicable from 1 January 2018 Non-monetary exchanges between entities in the same line of business to facilitate sales to customers 4 Definitions Below follows definitions of terms in the policy. A contract Practical expedient Contract inception A performance obligation Implicit offers Consideration is defined as an agreement (either in writing, orally or in accordance with other customary business practices) between two or more parties that creates enforceable rights and obligations. is synonymous to a relief, an exception for practical reasons. the effective date of the contract. is defined as a promise in a contract with a customer to transfer to the customer a distinct goods or services. is defined as promises that are implied by the entity s customary business practices, published policies or specific statements that raise valid expectation of the customer that the entity will transfer such a good or service (even though it is not explicitly stated in contract). is synonymous to remuneration, in return for something, reward, anything given or promised by one in exchange for the promise of another. 4
Cost are expected to be recovered means that the contract costs are part of a break-even or profitable contract. The stand-alone selling price of a good or is defined as the price at which an entity service would sell a promised good or service separately to a customer. Probable means that a threshold of higher than 50 percent is reached. Highly probable means that a threshold of 80 percent or higher is reached. A contract asset is defined as an entity s right to consideration in exchange for goods or services that the entity has transferred to the customer when that right is conditioned on something other than the passage of time. A contract liability It is reported as a non-fixed asset in the short term, variable asset section of the balance sheet. is defined as an entity s obligation to transfer goods or services to the customer for which the entity has received consideration from the customer. It is reported as a non-loan asset in the short term, variable liability section of the balance sheet. 5 Matters of materiality The revenue policy includes several practical expedients that Sandvik have chosen to apply in order to avoid unnecessary administrative burden. The standard also includes several thresholds, probabilities and levels of significance to be considered, in order to only recognizing revenue adjustments that are expected not to be reversed. This will as well reduce the administrative burden. An entity has to make sure that those expedients, probabilities and levels of significance are properly applied to avoid administration of petty revenue adjustments. The expedients, probabilities and levels of significance are to be applied by all entities without exception. In other matters of materiality concerning revenue recognition the entity has to consider how an external party would view the effect of applying a level of materiality (on all concerned contracts). The entities financial performance shall be viewed as unaffected by the applied materiality threshold. 5
6 Recognition of revenue from contracts with customers The core principle of the policy is that an entity recognizes revenue to represent the transfer of promised goods or services to customers, reflecting the amount of consideration to which an entity expects to be entitled in exchange for those goods or services. The revenue standard focuses on the identification of performance obligations and distinguishes between performance obligations satisfied at a point in time and those satisfied over time, which is determined by the manner, control of goods or services passes to the customer. The policy should be applied consistently to contracts with similar characteristics and in similar circumstances. The entity shall recognize revenue by applying the five step model below in order to meet the standards core principles and ensure a consistent approach. All of the five steps in the model should be considered for every contract with a customer, unless the step is clearly not applicable. 6.1 Principal versus agent When another party is involved in providing the goods or services to a customer, the entity should determine whether the nature of its promise is a performance obligation to provide the specified goods or services itself (a principal) or to arrange for the other party to provide those goods or services (an agent). An entity is an agent if the performance obligation is to arrange for the provision of goods or services by another party. The entity acting as an agent recognizes either the commission or the net amount of consideration that the entity retains after paying the other party the consideration received in exchange for the goods or services transferred. Indication that an entity is an agent includes the following: a) Another party is primarily responsible for fulfilling the contract; b) The entity does not have any inventory risk at any point during the contract; c) The entity does not have discretion in establishing prices for the other party s goods or services; d) The entity s consideration is in the form of a commission; e) The entity is not exposed to any credit risk for the amount receivable from a customer in exchange for the other party s goods or services. 6
When an entity determines in accordance with the above that it provides goods or services as a principal, it should recognize revenue (gross amounts), according to the five-step model below. Example A Entity acting as an agent An entity, within the Mining industry, enters into a contract with a customer to supply three rock tool machines. The contract stipulates that the entity should on behalf of the customer organize the over-sea transportation with the customers transporter located in the region. It is agreed that the cost for the transportation should be included on the invoice to the customer with an agreed mark-up of 10 percent covering the entity s administration costs. The control of the equipment is agreed in the contract to have taken place FOB shipping point, control is transferred to the customer when equipment has been loaded on the sea carrier. The entity considers the criteria of being an agent in relation to the transportation and identifies the following as being applicable: The transporter is primarily responsible for fulfilling the performance obligation of taking the equipment over-seas. The entity does not have the discretion in establishing the price for the over-seas transportation since it is a given by the contract between the customer and the transporter. The entity s consideration is in the form of a commission (the net between the transportation cost and the agreed mark-up). The entity concludes that it should treat the recognition of revenue related to the transportation being an agent, hence recognize it as commission (the net of the invoiced amount and the transportation cost) when the transportation is organized. 6.2 Portfolio approach a practical expedient IFRS 15 specifies the accounting for an individual contract with a customer, the standard allows as a practical expedient that it can be applied to a portfolio of contracts with similar characteristics provided that it is reasonably expected that the effects on the financial statements of applying a portfolio approach will not differ materially from applying IFRS 15 to the individual contracts within that portfolio. When accounting for a portfolio, estimates and assumptions that reflect the size and composition of portfolio should be used, applying the five step model explained in the following chapters. An entity will need to exercise significant judgment in segregating its contracts into portfolios with similar characteristics at a level with sufficient granularity to ensure that the outcome of using a particular portfolio approach is not expected to differ materially from applying the requirements of IFRS 15 to each individual contract. 7
In segregating contracts into portfolios with similar characteristics, an entity should apply objective criteria associated with the particular contracts or performance obligations and their accounting consequences. Objective criteria that might be used (but not limited to): Contract deliverables Contract duration Terms and conditions of the contract Amount, form and timing of consideration Characteristics of the customer Characteristics of the entity Timing of transfer of goods or services different mix of products and services, options to acquire additional goods and services, warranties etc short-term, long-term rights of return, shipping terms, bill and hold arrangement, consignment stock, cancellation privileges fixed, time and material, variable, upfront fees, significant financing component Size, type, creditworthiness, geographical location, sales channel Volume of contracts that include different characteristics, historical information available over time or point in time Example A applying the portfolio approach An entity within Sandvik have analyzed its contracts and concluded that some revenue streams are built up on standardized contracts in big volume. The entity decides to see if they can segregate that/those revenue streams into portfolios. The first revenue stream concerns contracts containing inserts sold to local customers, price list is applied, point in time (ex works) and with a general volume discount of three percent, paid out annually. The entity has solid historical information on the volume rebates credited to the customers. The entity concludes that applying an estimate of potential volume rebates on the portfolio of contracts will not differ from reviewing each and every contract to achieve the same adjustment of recognized revenue. The timing of revenue will also be accurate since the control transfers to the customer in similar fashion for all contracts. The entity establishes a revenue recognition template for the identified portfolio of contracts applying the five step model. The template will then be applied to the portfolio of contracts. 6.3 Step 1 - Identify the contract The first step in the five step model is to identify whether a contract exists and meets specified criteria. Entities are required to account for a contract with a customer that is within the scope of IFRS 15 only when all the below criteria are met: 1. The contract has been approved by the parties, and the parties are committed to perform their respective obligations. An approved contract means either in writing, orally or in accordance with other customary business practices. If a written contract is being prepared and not yet being signed by the parties, this might itself be an indication that the contract not yet has been approved. 8
2. The entity can identify each party s rights regarding the goods or services to be transferred. 3. The entity can identify the payment terms for the goods or services to be transferred. 4. Commercial substance. 5. It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services to be transferred to the customer. A contract is out of scope of IFRS 15 if one or more of the above requirements are not met or if the contract is wholly unperformed and each party can unilaterally terminate the contract without compensation. The contract can then neither be recognized as order intake nor as revenue. 6.3.1 Reassessing the criteria for identifying a contract If the criteria set out above, in chapter 6.3 Step 1 Identify the contract, are met at contract inception, the entity should not reassess those unless there is an indication of a significant change in facts and circumstances. For example, if a customer s ability to pay the consideration deteriorates significantly, an entity would reassess whether it is probable that the entity will collect the consideration. If the customers fall below the threshold of 50 percent probability of collecting the consideration the entity should cease to recognize revenue and impair any contract assets in line with IFRS9 Financial Instruments. 6.3.2 Combining contracts Two or more contracts entered into at or near the same time with the same customer should be combined and accounted for 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 is dependent on the price or performance of the other contract; or c) The goods or services promised in the contracts (or some of the goods or services promised in each of the contracts) are a single performance obligation. 6.4 Step 2 - Identifying performance obligations At this stage the purpose is to identify all performance obligations in the contract. The goods or services that will be transferred to the customer are usually explicitly stated in the contract. However, the performance obligations identified in a contract with a customer are not limited to the goods or services that are explicitly stated in the contract, this is referred to as implicit offers. Implicit offers are promises that are implied by the entity s customary business practices, published policies or specific statements that raise valid expectation of the customer that the entity will transfer such a good or service. The entity hence has to identify all the explicit, the explicit but offered for free (non-prized) and the implicit offers as performance obligations. 9
Example A Explicit promise of service An entity sells inserts to a distributor, the entity promises to provide a performance review for no additional consideration (for free) to any party that purchased the product from the distributor. Because the promise of a performance review is a promise to transfer goods or services in the future and is part of the negotiated exchange between the entity and the distributor, the entity determines that the promise to provide performance reviews is a performance obligation. The entity allocates a portion of the transaction price to the promise to provide performance reviews. Example B Implicit promise of service An entity has historically provided performance reviews for no additional consideration (for free) to end customers that purchase the entity s inserts from the distributor. The entity does not explicitly promise performance reviews during negotiations with the distributor and the final contract does not specify such terms or conditions for those reviews. However, on basis of its customary business practice, the entity determines at contract inception that it has made an implicit promise to provide performance reviews as part of the negotiated exchange with the distributor. The entity identifies the promise of performance reviews as a performance obligation to which it allocates a portion of the transaction price. 6.4.1 Distinct goods or services In order to identify if a performance obligation should be recognized individually both the following criteria have to be met: a) The customer can benefit from the goods or services either on its own or together with other resources that are readily available to the customer, and b) The entity s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract. When considering the criteria b) above, factors that indicate that an entity s promise to transfer goods or services to a customer is separately identifiable include: a) The entity does not provide a significant service of integration of the good or service with other goods or services promised in the contract into a bundle of goods or services that represent the combined output for which the customer has contracted. b) The good or service does not significantly modify or customize another good or service promised in the contract c) The good or service is not highly dependent on or highly interrelated with other goods or services promised in the contract. If the top two criteria are met, the promise is distinct and a performance obligation exist, that shall be recognized individually. Example Distinct goods or services An entity, within the Mining industry, enters into a contract with a customer to supply a drill rig including commissioning. The entity sells the drill rig and the commissioning separately. The commissioning includes checking fuel, oil levels, tire pressure, mounting of inserts and a test drive to control that the drill rig is ready to be used. The commissioning is routinely performed by other entities and does not modify the drill rig in any aspect. The drill rig remains functional without the commissioning. 10
The entity assesses the goods and services promised to the customer to determine which goods and service are distinct in line with chapter 5.3.1 Distinct goods or services. The entity concludes that the customer can benefit from each of the goods and services either on their own or together with other readily available goods and services. The promise to transfer each good and service to the customer is separately identifiable from each other to the other promises in the contract. In particular, the entity observes that the commissioning does not significantly modify or customize the drill rig itself, and the drill rig and commissioning are separate outputs promised by the entity instead of inputs used to produce a combined output. The entity concludes that it has two distinct performance obligations, the drill rig and the commissioning respectively. 6.4.2 Goods or services that are not distinct If the above test indicates that the entity s promise to transfer good or service to a customer is not distinct, an entity combines that good or service with other promised goods or services until it identifies a bundle of goods or services that is distinct. Example Significant customization The promised goods and services are the same as in example Distinct goods or services above, except that the contract stipulates that, in addition, a critical software installation and customization in the drill rig should be performed which without the drill rig can t operate according to specifications. The installation and customization of the software can be provided by other entities. The entity observes that the terms of the contract result in a promise to provide a significant service of integration of the licensed software in order for the drill rig to perform according to promises. Although the installation and customization can be performed by other entities, the entity determines that within the context of the contract the promise of installation and customization of the software in the drill rig is not separately identifiable from delivering the drill rig itself, since without the installation and customization of software it will not work according to specifications. The entity concludes that it has two distinct performance obligations, the drill rig including the installation and customization of software and the commissioning respectively. 6.4.3 Special considerations in Step 2 - Identifying performance obligations Some promises in a customer contract need special attention in order to properly identify it as a performance obligation. 6.4.3.1 Warranties In the case of warranties, see below, the promise can fall under two standards, either IFRS 15 Revenue from contracts with customers or IAS 37 Provisions, Contingent Liabilities and Contingent Assets or in a combination of both. 11
Assurance type warranties Some warranties provide the customer with assurance that the related product will function as the parties intended because it complies with agreed upon specifications (an assurance type of warranty). Such a warranty should be accounted for in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets, see policy xxx. Service type warranties Other warranties provide the customer with a service in addition to the assurance that the product complies with agreed upon specifications (a service type warranty). When the customer can purchase such a warranty separately, the warranty is a distinct service because the entity has promised to provide that service in addition to the product that has the functionality described in the contract. Under such circumstances, the promised warranty is accounted for as a separate performance obligation. This will require a portion of the transaction price to be allocated to the warranty service provided. Identification of type of warranties The following criteria can be used to help identifying the type of warranty: a) If the entity is required by law to provide warranty, the existence of that law indicates that the warranty is an assurance type of warranty and is not a performance obligation. b) The longer the coverage period, the more likely it is that a service-type warranty exists and should be identified as a distinct service. In some cases the customer has purchased a warranty as a distinct service in addition to a warranty that cannot be purchased separately, and then both standards apply to its respective warranty. Example Warranties An entity, within the stainless steel industry, enters into a contract with a customer to supply a set of tubes, including a warranty that assures that the goods complies with agreed-upon specifications and will operate as promised for one year from the date of purchase. In addition, the customer is also provided with an extension of the existing warranty with a guarantee of having any specification related issue solved within 24 hours. The entity sells the tubes and the extended warranty separately. The entity assess the promise to provide warranties and observes that it offers two warranties, one of assurance type and one of service type. It concludes that the assurance type warranty does not provide the customer with a good or service in addition to that assurance and therefore does not account for it as a performance obligation. The service type warranty on the other hand provides the customer with a distinct service and is considered a performance obligation. The entity allocates the transaction price to the two performance obligations (the tubes and the service type warranty). The assurance type of warranty is accounted for in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. 12
6.4.3.2 Customer options for additional goods and services Customers can sometimes be offered an option of buying additional goods or services at a discount or for free. This option can be provided as sales incentives, customer award credits, contract renewal options or other discounts on future goods or services. This optional right should be considered a distinct performance obligation when it provides a material right to the customer. A material right is defined as a right that the customer would not have received without entering into that contract. If the option provides the customer with a material right, the customer is in effect paying the entity in advance for future goods and services. The entity should then defer the recognition of revenue allocated to that option until those goods or services are transferred or the option expires. 6.4.3.3 Stand-ready obligations A stand-ready obligation should also be considered a distinct performance obligation if such a commitment exist in the contract. A stand ready obligation can be allocation of production capacity, staff being on call or any other resource in control of the entity that is or will come available to the customer. 6.5 Step 3 - 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. The consideration might include fixed amounts, variable amounts or both. Both the terms of the contract and the entity s customary business practices (implicit offers) needs to be considered. The estimate of transaction price will be affected by the nature, timing and amount of consideration promised by the customer. In determining the transaction price the following effects have to be considered: e) Variable consideration f) Significant financing component in the contract g) Non-cash consideration h) Consideration payable to a customer 13
6.5.1 Variable consideration If the consideration includes a variable amount, the entity is required to estimate the amount of consideration to which it will be entitled in exchange for the promised goods or services. Examples of variable considerations are the following: a) Cash discounts b) Volume rebates c) Right of return d) Refunds e) Credits f) Price concessions g) Incentives h) Performance bonuses i) Penalties If any of the above aspects are present in the contract, explicitly or implicitly, either of two different methods shall be used to estimate the consideration the entity is entitled to. a) The Expected value method this method may be appropriate when the entity has a large number of contracts with similar characteristics. The outcome is calculated as the sum of probability weighted amounts in a range of possible considerations. b) The Most likely amount this maybe appropriate when a contract has only two possible outcomes. It is the single most likely amount in a range of possible consideration amounts. (The amount received is based on whether a performance bonus is achieved or not). Then the entity shall determine if it is highly probable that a significant revenue reversal will not occur in the future. An entity has to consider certain aspects when assessing the likelihood of a reversal, such as: a) The amount of consideration is highly susceptible to factors outside the entity s influence b) The uncertainty about the timing of consideration is not expected to be resolved in a long time. c) The experience with similar types of contracts is limited or has limited predictable value. d) The entity has a practice of offering a broad range of price concessions. e) There are a large number and broad range of possible consideration amounts within the contract. f) If it is highly probable that a significant revenue reversal will not occur in the future the variable consideration should be taken into account and reduce the consideration the entity is entitled to. Comment [JE1]: You need to apply i the following order: 1.Estimate the consideration to which the entity is entitled to (expected valu method or most likely amount metho 2.Determine that is it highly probable that a significant revenue reversal wil not occur on the estimated consideration 14
6.5.1.1 Reassessment of variable consideration The estimated transaction price is updated at the end of each reporting period to represent the circumstances present at the end of the reporting period and any changes in circumstances during the reporting period. The changes to the estimated transaction prices due to variable consideration should be adjusted in line with chapter 5.6.2.2 Allocation of variable consideration. Example Variable consideration An entity enters into a contract with a customer to build a customized asset. The promise to transfer the asset is a performance obligation that is satisfied over time. The promised consideration is CU 2 500 000, which will be invoiced when the delivery is approved by the customer. The consideration will be reduced or increased depending on the timing of the completion of the asset. For each day after 31 of March 20x7 that the asset is incomplete, the promised consideration is reduced by CU 10 000. For each day before 31 March 20x7 that the asset is completed, the promised consideration increases by CU 10 000. In addition, upon completion of the asset a rating of specific metrics of the asset will be performed. If the asset receives a specified rating, the entity will be entitled to an incentive bonus of CU 150 000. a) The entity decides to use the expected value method to estimate the variable consideration associated with the daily penalty or incentive. The entity decides to use the most likely amount to estimate the variable consideration associated with the incentive method.in the example of variable consideration in case a) they calculate as follows: 50 % on time, 30 % 2 days early and 20 % 3 days early (0,5*0+0,3*20 000+0,2*30 000 = 12 000). The entity foresee that it is highly probable that they will be on time or early since the entity have performed well in terms of delivery of this type of asset. In the example of variable consideration in case b) they calculate as follows: The entity can either be within specification and then entitled to zero or outside specification and then penalized with 150 000. The entity determine that they will have issues and be outside specification, causing a penalty of 150 000 The entity foresee with high level of probability that they will come across the issue with not meeting specifications. The consideration to be recognized over time amounting to in total at the end of the contract, just before invoicing, will be the following: 2 500 000 + 12 000 150 000 = 2 362 000 Revenue cr 2 362 000 revenue recognized over time Contract asset db 2 362 000 the day before invoiced to customer The rights and performance obligations in a contract should always be accounted for and presented on a net basis, as either a contract asset or a contract liability. In this example the contract end up with a net contract asset of 2 362 000. 15
6.5.1.2 Sale with a right of return To account for the transfer of products with a right of return, the entity should recognize all of the following: 1. An amount of revenue for the products transferred based on the consideration to which the entity expects to be entitled. (The entity should not recognize revenue for the products expected to be returned.) 2. A refund liability for the amounts expected to be refunded. 3. An asset with a corresponding adjustment of Cost of goods sold, for the entities right to recover products from the customer on settling the refund liability. In each reporting period the entity should reassess, separate from each other the refund liability respectively the asset. The refund liability should be reassessed based on the expectations of refunds and the asset also for the expected amounts to be refunded but also the changes in value of the returned assets. It is important to separate right of return transactions from warranty returns which has a different treatment. Example Right of return An entity enters into 100 contracts with customers. Each contract includes the sale of 1 000 products for CU 100 (100*1 000*100 = CU 10 000 000 in total consideration). In the contract the customer is allowed to return any unused product within 60 days and receive a full refund. The entity s cost for each product is CU 60. The entity applies the portfolio approach as stated in chapter 5.2 Portfolio approach - a practical expedient. Because the contract allows a customer to return the products, the consideration received from the customer is variable. The entity decides to use expected value method and estimates that 97 percent of the products will not be returned. The entity estimates that the cost of recovering the products will be immaterial and expects that the returned products can be resold at a profit. Upon transfer of control of the 1 000 products, the entity does not recognize revenue for the 30 products that it expects to be returned. The contract is recognized as follows: Revenue cr 97 000 (CU 100 * 1 000 * 0,97) COGS db 58 200 (CU 60 * 1 000 * 0,97) Asset, its right to recover db1 800 (CU 60 * 30) 30 products on settling the refund liability Refund liability cr 3 000 (CU 100 * 30) 16
6.5.1.3 Sale with a repurchase agreement A repurchase agreement is a contract in which the entity sells an asset and also promises or has the option to repurchase the asset. The agreement will be accounted for as a product with a right of return if either, see example in chapter 5.3.1.1 Sale with right of return: The customer doesn t have significant economic incentive to exercise the option at a price lower than the original selling price. The repurchase price of the asset is equal to or greater than the original selling price and is less than or equal to the expected market value of the asset, and the customer does not have a significant incentive to exercise its option. The customer can sometimes be offered an option of selling back the acquired goods at a pre-agreed price, a put option, or the entity might opt for a similar right to buy back the sold goods at a pre-agreed price, a call option. Repurchase agreements generally come in three forms: a) The entity has an obligation to repurchase the asset, a forward contract. b) The entity has the right to repurchase the asset, a call option. c) The entity has an obligation to repurchase the asset at the customer s request, a put option. In Sandvik s case the contracts agreed with the customer, the customer most often have a put option, the repurchase takes place at the request by the customer. If the entity has the obligation to repurchase the asset at a price lower than the original selling price of the asset, the entity should consider if the customer have a significant economic incentive to exercise that right. If the entity concludes that the customer has significant economic incentive to exercise the put option, the agreement is accounted for as a lease in accordance with IAS 17 Leases, see Sandvik policy in FRP chapter 2.2.4.01 Leases. In order to proper measure the incentive one has to consider the expected market price at the date of repurchase and the amount of time until the option expire. If the market price is expected to be above or in level with the repurchase price that indicates that the customer has a significant economic incentive to exercise the option. If any of the two other forms of repurchase agreements are applicable, a forward contract or a call option, a customer does not obtain full control of the asset. The contract should be accounted for as either: a) A lease in accordance with IAS 17 Leases, if the entity has an obligation or the right to repurchase the asset at an amount less than the original selling price. b) A financing arrangement if the entity has an obligation or a right to repurchase the asset for an amount that is equal to or more than its original selling price. If the repurchase agreement is a financing agreement the entity should continue to recognize the asset and it should recognize a liability for any consideration received from the customer. The difference between the amount of consideration received from the customer and the amount of consideration to be paid to the customer should be recognized as interest. 17
6.5.2 Significant financing component A promised amount of consideration is adjusted for the effects of the time value of money if the timing of payments agreed by the parties provides the entity with a significant benefit of financing the transfer of the goods or services to the customer. A practical expedient exists when there is a shorter period than one year or less between the entity transferring the goods or services and the customer paying for it. This expedient shall be applied by all Sandvik entities with advances received and unperformed for periods shorter than one year. A significant financing component is identified by assessing the following: a) The difference, if any, between the amount of promised consideration and the cash selling price of the promised goods or services, and b) The combined effect of: i. The expected length of time between when the entity transfers the promised goods or services to the customer and when the customer pays for those, and ii. The prevailing interest rates in the relevant market. The entity need to determine the discount rate to apply: The discount rate to be use should reflect that which would be used in a spate financing transaction between the entity and its customer at contract inception. The discount rate is not updated for interest changes or similar aspects after contract inception. An entity can also estimate the discount rate by using the implicit rate, which is calculated by establishing the cash selling price and put in it in relation to the contract consideration. This can only be done if it is seen as an appropriate estimation of the above method. The financing component is accounted for by debiting financial interest and crediting contract liabilities. At date of revenue recognition the contract consideration including the accrued interest is reported as revenue point in time or over time. A contract with a customer does not include a significant financing component if any of the following factors exists: a) The customer paid for the goods in advance and the timing of the transfer of those goods or services is at the discretion of the customer. b) A substantial amount of the consideration promised by the customer is variable and the amount or timing of that consideration varies on the basis of the occurrence or non-occurrence of a future event that is not substantially within control of the customer or the entity. c) The difference between the promised consideration and the cash selling price of the good or service arises for reasons other than the provision of finance to either the customer or the entity, and the difference between those amounts is proportional to the reason for the difference. For example, the payment terms might provide the entity or the customer with protection from the other party failing adequately to complete some or all of its obligations under the contract. 18
Example Significant financing component An entity enters into a contract with a customer to sell Tubes. Control of the Tubes will transfer to the customer in one and a half years time, over time (from 17 to 24 months). The contract stipulates that the customer has to pay an advance amount of 50 percent of the total contract value of CU 4 000 000. The interest rate is estimated to 5 per cent which is the market rate for borrowing / lending transactions in this type of business at contract inception. The entity concludes that the contract contains a significant financing component because of the length of time between when the customer pays the advance and when the entity transfers the asset to the customer and the interest rate is significant. The following entries illustrate how the entity would account for the significant financing component: Recognize a contract liability for the CU 2 000 000 received at contract inception: Cash db 2 000 000 Contract liability cr 2 000 000 During the first 16 months, until the start of the over-time transfer in month 17 of the asset to the customer, the entity adjusts the promised amount of consideration and increases the contract liability by recognizing interest on the CU 2 000 000 at five percent per year for 16 months: Interest expense db 150 000 Contract liability cr 150 000 (2 150 000 will now be the total balance) As the transfer of the asset commence, the entity will recognize the following revenue according to the input method, between months 17-24, in total in month 24: Revenue cr 4 150 000 (advance incl interest of 2 150 000 recognized as revenue, 1 000 000 recognized and invoiced plus revenue accrual of 1 000 000) Accounts receivable Contract asset db 1 000 000 (still due from latest invoicing occasion) db 1 000 000 (accrued revenue, not yet invoiced) 6.5.3 Non-cash considerations Not applicable to Sandvik. A customer promises considerations in another form than cash, for example an advert in the customer s newspaper in exchange for the goods or services. 19
6.5.4 Consideration payable to a customer An entity sometimes does business with their customer. The transactions between the parties should then be treated in a certain way. In Sandvik the situation with consideration payable to a customer is most common is when we accept a trade-in as part of the contract with the customer. 6.5.4.1 Trade-ins If consideration payable to a customer is a payment for a distinct good or service from the customer, then the entity should account for the purchase of the good or service in the same way that it accounts for other purchases from its suppliers. If the amount of consideration exceeds the fair value of the distinct good or service that the entity receives from the customer, then the excess is accounted for as a reduction of the transaction price. If the entity cannot reasonably estimate the fair value of the good or service received from the customer, it should account for all of the consideration payable to the customer as a reduction of the transaction price. 6.6 Step 4 - Allocate the Transaction price When allocating the transaction price to each performance obligation identified in step 3, the objective is to allocate the amounts that represents the consideration to whom which the entity expects to be entitled in exchange for transferring the performance obligations to the customer. The entity is required to allocate the transaction price to each identified performance obligation on a relative stand-alone selling price basis. This means that each performance obligation will be allocated its share of revenue based on its stand-alone selling price put in relation to the sum of all performance obligations stand-alone selling price. The allocation is subject to exceptions that might be applicable when allocating discounts and when allocating considerations that include variable amounts, see 6.6.2.1 Allocation of discounts and 6.6.2.2 Allocation of variable amounts. 6.6.1 To determine the stand alone selling price If a stand-alone selling price is not observable for one or more of the performance obligations, the entity can, but not limited to, apply one of three methods, listed below in order of preference. A combination of methods applied to a contract might be needed in order to be able to allocate the transaction price. The use of observable input should be maximized for this estimation, and the methods used should be applied consistently in similar circumstances. Adjusted market assessment approach by evaluating the market in which it sells goods or services the entity estimates the price that a customer on that market would be willing to pay for those goods or services. 20