IFRS 15, Revenue from contracts with customers ICAJ Workshop 2018 February 3, 2018
Introduction Overview of IFRS 15 The five steps to revenue recognition and changes to existing revenue guidance. Types of transactions that are likely to be significantly affected. Closing 2
Overview - IFRS 15, Revenue from Contracts with Customers The goal of the FASB and IASB joint revenue recognition project was to develop a common standard that: Removes inconsistencies and weaknesses in existing revenue recognition standards and practices Provides a more robust framework for addressing revenue recognition issues Improves comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets Provides more useful information to users of financial statements through improved disclosure requirements Simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer 3
Overview - IFRS 15 Scope (1) IFRS 15 was issued in May 2014 and supersedes IAS 11, IAS 18, IFRIC 13, IFRIC 15, IFRIC 18, SIC-31. The new guidance applies to all contracts to deliver goods or services to a customer, except: Lease contracts within the scope of IAS 17 Insurance contracts within the scope of IFRS 4 financial instruments and other contractual rights or obligations within the scope of IFRS 9, 10, 11 and IAS 27 and 28 Certain nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers Certain contracts may be partially within the scope of IFRS 15 as well as other Standards. 4
Overview - IFRS 15 Scope (2) A single global standard contract-based five-step analysis of transactions, focusing on transfer of control. Two approaches to recognise revenue: at a point in time or over time. Significant judgement required. Extensive new disclosure requirements for all companies. Effective date January 1, 2018 (early adoption permitted) 5
Overview - Some Key Sectors Impacted Contract Manufacturers Real estate and Construction Aerospace and Defense Software Financial institutions Licensors: Film, media and Entertainment, Franchisors Telecommunication and Cable 6
Revenue Recognition: 5-Step Approach Step 1: Identify the contract(s) with a customer Step 2: Step 3: Identify the performance obligations in the contract Determine the transaction price Step 4: Step 5: Allocate the transaction price to the performance obligations in the contract Recognize revenue when (or as) the entity satisfies a performance obligation 7
Step 1 Identify the Contract(s) With a Customer Contracts could be written, oral or implied A contract exists only if: The parties to the contract have approved the contract and are committed to perform their obligations The entity can identify each party s enforceable rights regarding the goods or services to be transferred The entity can identify the payment terms for those goods and services to be transferred The contract has commercial substance AND It is probable that the entity will collect the consideration to which it will be entitled under the contract in exchange for satisfaction of its performance obligations 8
Step 1 Identify the Contract(s) With a Customer Contracts may be combined and accounted for as a single contract. IFRS 15 CONTRACT 1 CONTRACT 2 Contracts are combined if entered into at or near the same time with the same customer and one or more of the following criteria are met. Negotiated as a package with a single commercial objective Consideration in one contract depends on the other contract. Goods and services are a single performance obligation. 9
Step 2 Identify the Performance Obligations in the Contract A performance obligation (PO) is a promise in a contract to deliver a good or service that meets both the following criteria Criterion 1: Can the customer benefit from the good or service either on its own or together with other resources that are readily available to the customer? Distinct performance obligation + Criterion 2: Is the promise to transfer the good or service separately identifiable from other promises in the contract? Not distinct combine with other goods and services Exception: A series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer may be a single performance obligation. 10
Step 2 - Single Performance Obligation? An entity enters into a contract to build a house for a customer. Potential Performance Obligations Blocks Windows Fittings Construction service Q: Do the goods and services individually meet the criteria? Criterion 1 Benefit on its own Each material could be used with another readily available item. Criterion 2 Good or service separately identifiable Entity is providing a significant integration service. 11
Step 2 Multiple Performance Obligations? Customer contract for a sale of a machine and standard installation. Installation services are also offered by third party providers. Can the customer benefit from Potential Performance Obligations Machine Installation Q: Does the machine meet the performance obligation criteria? Criterion 1 Benefit on its own Machine can be used with other available inputs. i.e. third party installation. Criterion 2 Good or service separately identifiable No significant integration service, because installation is a standard service.
Step 2 Goods or Services Provided to a Customer s Customer As an incentive for car dealers to purchase car X, a car manufacturer offers to provide the dealer the right to offer two free services to their customers. Can the customer benefit from Potential Performance Obligations Car Servicing Q: Is the offer of two free services a performance obligation of the car manufacturer? Yes, because: car meets the definition of a performance obligation; and right to offer free services can be used with an asset that the dealer has already obtained i.e. the car.
Step 2 Some Considerations
Step 3 Determine the Transaction Price Transaction price = The amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. expects to be entitled in exchange for Consider the effects of: Variable consideration Revenue Constraint Time value of money Non-cash consideration should be measured at fair value Consideration paid to a customer may be a reduction of transaction price, a payment for distinct goods or services, or a combination of the two ng promised goods or services to a customer.
Step 3 Variable Consideration Variable consideration can be Variable consideration is estimated using most appropriate method of either:
Step 3 Estimating Variable Consideration Contract to build a jet for a customer. The transaction price includes: Fixed amount: US$100m. Completion bonus: US$100m if completed two months prior to a specified date. Performance bonus: US$0 US$100 depending on the number of flights in its first 12 months of service. Q: How would the entity estimate variable consideration? Fixed Amount Completion Bonus Performance Bonus Not Variable Most likely amount Expected value
Step 3 Revenue Constraint The amount of revenue recognized to date cannot exceed the amount to which the entity is reasonably assured to be entitled. Factors that may increase the likelihood of revenue reversal include: The amount of consideration is highly susceptible to factors outside of the entity s influence, such as volatility in the market, judgment of third parties or risk of obsolescence of the promised good or service; Uncertainty about the amount of consideration is not expected to be resolved for a long time; The entity s experience (or other evidence) with similar types of contracts is limited; The entity has a practice of offering price concessions or changes to payment terms; and The contract has a large number of possible consideration amounts
Step 3 - Constraint on Variable Consideration Application Transaction price include the amount that is highly probable will not result in significant revenue reversal. Qualitative Assessment The risk of a reversal arising from an uncertain future event. The magnitude of the reversal if the uncertain event occurs.
Step 3 - Applying the Constraint Indicators Continuing from the jet example, the entity has estimated the variable consideration amounts to be: US$100m for the completion bonus; and US$80m for the performance bonus. This will be the first model of this type of jet constructed and put into service and it is expected to take five years from inception until the first jet is delivered. Q: At the commencement of the contract how much variable consideration should be included in the transaction price? Likely nil because No experience with similar contracts. Use of jet is outside entity s control. Large range of possible amounts.
Step 3 Time Value of Money Considerations Transaction prices are adjusted for the time value of money if vendor or customer receives a significant benefit of financing the transfer of goods or services Do NOT consider situations in which: The customer paid for the goods or services in advance, and the timing of the transfer of those goods or services is at the discretion of the customer Contract consideration is variable based on the occurrence (or nonoccurrence) of a future event that is not within the customer s or entity s control Differences between promised consideration and the cash selling price of the good or service arises for reasons other than financing and the difference approximates the value of such reason Financing component is presented separately
Step 3 - Significant Financing Component Significant financing component Transaction price compared to cash selling price. Period between payment and delivery. Other reasons for payment terms. Discount rate Rate that would be used in separate financing transaction between the entity and customer. Practical Expedient No adjustment required if the period between performance and payment is 12 months or less.
Step 3 - Significant Financing Component Contract with a customer to construct and deliver a piece of equipment. Agreed transaction price of US$80m is paid on signing the contract. Expected delivery date: Two years from signing the contract. The same piece of equipment can be purchased for US$100m when payment is made on delivery. Q: Does the transaction price include a significant financing component? Yes because Significant period between delivery and payment. Cash price is different from transaction price. No indicators advance is for another reason.
Step 4 Allocate the Transaction Price to the Performance Obligations Relative standalone selling price method Utilize standalone selling price if sold separately If not, estimate: Adjusted market assessment approach Expected cost plus margin approach Residual approach (in certain instances) Maximize observable inputs
Step 4 Allocate the Transaction Price to the Performance Obligations Allocate based on relative stand-alone selling prices Performance obligation 1 Performance obligation 2 Performance obligation 3 Determine stand-alone selling prices Best evidence Observable price If not available Estimate price Fair value measurement Adjusted market assessment approach Expected cost plus a margin approach Residual approach only if selling price is highly variable or uncertain
Step 4 Estimating the Selling Price A two year mobile phone contract where two performance obligations are identified; 1) phone and 2) data, calls and texts. Total transaction price = US$650. Price of the phone on the maker s website = US$350. The entity sells a twelve month plan without a phone that includes the same level of data, calls and texts for US$15 per month = US$360 (24 x US$15). Q: What methods could the entity use to allocate the transaction price? Observable price Adjusted market Cost plus Residual Phone allocation US$650 x (US$350/US$710) = US$320 Data, calls and texts US$650 x (US$360/US$710) = US$330
Step 5 Recognize Revenue as each Performance Obligation is Satisfied (1) Revenue is recognized when (or as) an entity satisfies a performance obligation by transferring a promised good or service to the customer. An asset is transferred when (or as) the customer obtains control of that asset. Either Satisfies performance obligation over time Satisfies performance obligation at a point in time
Step 5 Recognize Revenue as Each Performance Obligation is Satisfied (2) Performance obligation satisfied over time if at least one of the following criteria is met: 1 2 Customer simultaneously receives and consumes the benefits as the entity performs. Routine or recurring services. The customers controls the asset as the entity creates or enhances it. Asset built on customer s site. 3 The entity s performance does not create an asset for which the entity has an alternate use and there is a right to payment for performance to date. Asset built to order.
Step 5 Over Time Criteria Entity agrees to build a specialised equipment to integrate with the customer s existing plant. Customer can cancel contract on 30 days notice. If the contract is cancelled the entity has a right to payment that covers costs incurred. Customer has agreed to make quarterly payments. Q: Do the terms meet the no alternate use and right to payment criteria? No alternate use Right to payment Payment needs to approximate selling price of goods and services transferred to date i.e. payment amount should include a profit margin.
Step 5 Measuring Performance Over Time For each performance obligation an entity chooses the method that best depicts performance. Output method Surveys Milestones reached Units delivered Input method Costs incurred Labour hours Machine hours Units delivered and similar methods not appropriate if work in progress is material. Adjustments required for wastage and uninstalled materials when cost method used.
Step 5 Recognize Revenue as Each Performance Obligation is Satisfied (3) For performance obligations satisfied at a point in time, entities should consider the following factors to determine when a customer obtains control of the promised asset: Entity has present right to payment for the asset Customer has legal title to the asset Entity has transferred physical possession of the asset Customer has significant risks and rewards of ownership of the asset Customer has accepted the asset
Contract Modifications Modification A contract modification is a change in the scope or price (or both) of a contract that is approved by the parties to the contract. Accounted for as separate performance obligations if certain conditions are met If not treated as a separate performance obligation, the modification may represent: Termination of existing contract and creation of new contract (prospective method) Adjustment to existing contract (retrospective method) Combination of the two above methods
Disclosures Entities are required to provide quantitative and qualitative disclosures to help users understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers, including information regarding: Disaggregation of revenue Significant changes in contract assets, liabilities and costs Performance obligations Determination and allocation of transaction prices Amounts allocated to remaining performance obligations and when these amounts would be recognized as revenue Significant judgments and changes in judgments Costs capitalized in obtaining or fulfilling contracts
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