HKFRS 15 Revenue from Contracts with Customers (Part 2) 29 November 2016

HKFRS 15 Revenue from Contracts with Customers (Part 2) 29 November 2016 LAM Chi Yuen Nelson 林智遠 FCPA(Practising), CFA Charter Holder MBA MSc BBA ACIS ACS CGMA CPA(U.S.) CTA FCA FCCA FCPA(Aust.) FHKIoD FSCA FTIHK MHKSI 2013 2016 Nelson Consulting Limited 1 Contents in HKFRS 15 Issued in 2014 A. Objective Topics of Part 1 (16 Nov. 2016) B. Scope More complicated in Part 2 (Today) C. Recognition Identifying the contract (Step 1) Identifying performance obligations (Step 2) Satisfaction of performance obligations (Step 5) D. Measurement Determining the (Step 4) Allocating the to performance obligations (Step 5) E. Contract costs F. Presentation G. Disclosure Full set of presentation (with colour) can be found in: www.facebook.com/nelsoncfa 2013 2016 Nelson Consulting Limited 2 1

Contents in HKFRS 15 Issued in 2014 A. Objective B. Scope C. Recognition Topics of Part 2 (Today) Identifying the contract (Step 1) with s, Figures and Cases Identifying performance obligations (Step 2) Satisfaction of performance obligations (Step 5) D. Measurement Determining the (Step 4) Allocating the to performance obligations (Step 5) E. Contract costs F. Presentation G. Disclosure Full set of presentation (with colour) can be found in: www.facebook.com/nelsoncfa 2013 2016 Nelson Consulting Limited 3 5 Step Model in HKFRS 15 Case Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Recognition Measurement Recognition Resolute Mining Ltd, an Australian mining co., stated in 2015 annual report that: An entity recognises revenue in accordance with that core principle by applying the following steps: (a) Step 1: contract(s) with a customer (b) Step 2: performance obligations in the contract (c) Step 3: Determine the (d) Step 4: Allocate the to the performance obligations in the contract (e) Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation 2013 2016 Nelson Consulting Limited Source: Intermediate Financial Reporting (Forthcoming 3 Ed.) by Nelson Lam and Peter Lau 4 2

C. Recognition and D. Measurement 2013 2016 Nelson Consulting Limited 5 Step 1: Contract(s) Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Contract criteria Combination of contract Contract modification Step 1: Identifying the Contract(s) A contract is an agreement between two or more parties that creates enforceable rights and obligations. The requirements of HKFRS 15 apply to each contract that has been agreed upon with a customer and meets specified criteria. In some cases, HKFRS 15 requires an entity to combine contracts and account for them as one contract. HKFRS 15 also provides requirements for the accounting for contract modifications. (HKFRS 15.IN7) 2013 2016 Nelson Consulting Limited 6 3

Step 1: Contract(s) When a contract with a customer does not meet the criteria in HKFRS 15.9 and an entity receives consideration from the customer, the entity shall recognise the consideration received as revenue only when either of the following events has occurred: a. the entity has no remaining obligations to transfer goods or services to the customer and all, or substantially all, of the consideration promised by the customer has been received by the entity and is non refundable; or b. the contract has been terminated and the consideration received from the customer is non refundable. (HKFRS 15.15) 2013 2016 Nelson Consulting Limited 7 Step 1: Contract(s) An entity shall recognise the consideration received from a customer as a liability until one of the events in HKFRS 15.15 occurs (as set out in last slide), or until the criteria in HKFRS 15.9 are subsequently met (see HKFRS 15.14, i.e. continue to assess the contract up subsequently met). Depending on the facts and circumstances relating to the contract, the liability recognised represents the entity s obligation to either transfer goods or services in the future or refund the consideration received. In either case, the liability shall be measured at the amount of consideration received from the customer. (HKFRS 15.16) 2013 2016 Nelson Consulting Limited 8 4

Step 1: Contract(s) Is it a contract with a customer? Yes Does the contract meet the contract criteria (i.e. HKFRS 15.9)? No Consideration received? No Yes Not within HKFRS 15 Yes Either of the following events has occurred? The entity has no remaining obligation and all or substantial all consideration received is non refundable; or The contract has been terminated and consideration received is non refundable No Consideration received recognised as liability Continue to assess whether the contract criteria are met subsequently Within HKFRS 15 continue the 5 step model of HKFRS 15 Yes Consideration received recognised as revenue 2013 2016 Nelson Consulting Limited Source: Intermediate Financial Reporting (Forthcoming 3 Ed.) by Nelson Lam and Peter Lau 9 Step 1: Contract(s) 1. Contract with a Customer Combination of Contracts Contract Modification An entity shall combine two or more contracts entered into at or near the same time with the same customer (or related parties of the customer) and account for the contracts as a single contract if one or more of the following criteria are met: a. the contracts are negotiated as a package with a single commercial objective; b. the amount of consideration to be paid in one contract depends on the or performance of the other contract; or c. the goods or services promised in the contracts (or some goods or services promised in each of the contracts) are a single performance obligation in accordance with HKFRS 15.22 30. (HKFRS 15.17) 2013 2016 Nelson Consulting Limited 10 5

Step 1: Contract(s) 1. Contract with a Customer Combination of Contracts Contract Modification An entity shall account for a contract modification as a separate contract if both of the following conditions are present: a. the scope of the contract increases because of the addition of promised goods or services that are distinct (in accordance with HKFRS 15.26 30); and b. the of the contract increases by Separate Contract an amount of consideration that reflects the entity s stand alone selling s of the additional promised goods or services and any appropriate adjustments to that to reflect the circumstances of the particular contract. (HKFRS 15.20) 2013 2016 Nelson Consulting Limited 11 Step 1: Contract(s) 1. Contract with a Customer Contract Modification If a contract modification is not accounted for as a separate contract in accordance with HKFRS 15.20 (as set out in last slide), an entity shall account for the promised goods or services not yet transferred at the date of the contract modification (i.e. the remaining promised goods or services) in whichever of the following ways is applicable: a. as if it were a termination of the existing contract and the creation of a new contract if b. as if it were a part of the existing contract if c. a combination of (a) and (b) Separate Contract New Contract Part of Existing Contract 2013 2016 Nelson Consulting Limited 12 6

Step 1: Contract(s) Does the scope of the contract increase? Yes Does the of the contract increase? Yes Contract modification is accounted for as a separate contract No No Contract modification is not accounted for as a separate contract Are the remaining goods or services distinct? Wholly distinct As if it were termination of the existing contract and creation of a new contract Wholly not distinct As if it were a part of the existing contract Partially distinct and partially not distinct Account for the effect in a manner consistent with the objectives as explained in (a) and (b) 2013 2016 Nelson Consulting Limited Source: Intermediate Financial Reporting (Forthcoming 3 Ed.) by Nelson Lam and Peter Lau 13 Comprehensive Step 1 Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 5 step by step 2013 2016 Nelson Consulting Limited 14 7

Comprehensive Step 1 Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Step 1: Contract or Contracts with a Customer In Step 1, Leon determines that, prima facie, the contract with Andy meets all the contract criteria and there is only one contract. 2013 2016 Nelson Consulting Limited 15 C. Recognition and D. Measurement 2013 2016 Nelson Consulting Limited 16 8

Step 2: Identify Performance Obligations Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Performance obligation Promises in a contract Distinct goods or services At contract inception, an entity shall assess the goods or services promised in a contract with a customer, and identify as a performance obligation each promise to transfer to the customer either: a. a good or service (or a bundle of goods or services) that is distinct; or b. a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (see HKFRS 15.23) (HKFRS 15.22) 2013 2016 Nelson Consulting Limited 17 Step 2: Identify Performance Obligations A good or service that is promised to a customer is distinct if both of the following criteria are met: a. the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (i.e. the good or service is capable of being distinct); and b. the entity s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (i.e. the good or service is distinct within the context of the contract). (HKFRS 15.27) Customer Benefit Separately Identifiable 2013 2016 Nelson Consulting Limited 18 9

Step 2: Identify Performance Obligations A customer can benefit from a good or service in accordance with HKFRS 15.27(a) if the good or service could be used, consumed, sold for an amount that is greater than scrap value or otherwise held in a way that generates economic benefits. For some goods or services, a customer may be able to benefit from a good or service on its own. For other goods or services, a customer may be able to benefit from the good or service only in conjunction with other readily available resources. (HKFRS 15.28) Customer Benefit 2013 2016 Nelson Consulting Limited 19 Step 2: Identify Performance Obligations In assessing whether an entity s promises to transfer goods or services to the customer are separately identifiable in accordance with HKFRS 15.27(b), the objective is to determine whether the nature of the promise, within the context of the contract, is to transfer each of those goods or services individually or, instead, to transfer a combined item or items to which the promised goods or services are inputs (HKFRS 15.29, as amended by Clarification Separately Identifiable to HKFRS 15 issued in June 2016) 2013 2016 Nelson Consulting Limited 20 10

Step 2: Identify Performance Obligations Factors that indicate that two or more promises to transfer goods or services to a customer are not separately identifiable include, but are not limited to, the following: a. the entity provides a significant service of integrating the goods or services with other goods or services promised in the contract into a bundle of goods or services that represent the combined output or outputs for which the customer has contracted. In other words, the entity is using the goods and services as inputs to produce or deliver the combined output or outputs specified by the customer. b. one or more of the goods or services significantly modifies or customises, or are significantly modified or customised by, one or more of the other goods or services promised in the contract. c. the goods or services are highly interdependent or highly interrelated. (HKFRS 15.29) 2013 2016 Nelson Consulting Limited 21 Step 2: Identify Performance Obligations Customer options for additional goods or services If, in a contract, an entity grants a customer the option to acquire additional goods or services, that option gives rise to a performance obligation in the contract Only if the option provides a material right to the customer that it would not receive without entering into that contract (e.g. a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer in that geographical area or market). If the option provides a material right to the customer, the customer in effect pays the entity in advance for future goods or services and the entity recognises revenue when those future goods or services are transferred or when the option expires. If a customer has the option to acquire an additional good or service at a that would reflect the stand alone selling for that good or service, that option does not provide the customer with a material right even if the option can be exercised only by entering into a previous contract. In those cases, the entity has made a marketing offer that it shall account for in accordance with HKFRS 15 only when the customer exercises the option to purchase the additional goods or services (HKFRS 15.B39 to 41) 2013 2016 Nelson Consulting Limited 22 11

Step 2: Identify Performance Obligations In some contracts, an entity charges a customer a nonrefundable upfront fee at or near contract inception. s include joining fees in health club membership contracts, activation fees in telecommunication contracts, setup fees in some services contracts, and initial fees in some supply contracts. (HKFRS 15.B48) Performance obligations 2013 2016 Nelson Consulting Limited 23 Step 2: Identify Performance Obligations To identify performance obligations in such contracts, an entity shall assess whether the fee relates to the transfer of a promised good or service. In many cases, even though a non refundable upfront fee relates to an activity that the entity is required to undertake at or near contract inception to fulfil the contract, that activity does not result in the transfer of a promised good or service to the customer (see HKFRS 15.25). Instead, the upfront fee is an advance payment for future goods or services and, therefore, would be recognised as revenue when Performance those obligations future goods or services are provided. The revenue recognition period would extend beyond the initial contractual period if the entity grants the customer the option to renew the contract and that option provides the customer with a material right as described in paragraph B40. (HKFRS 15.B49) 2013 2016 Nelson Consulting Limited 24 12

Step 2: Identify Performance Obligations If the non refundable upfront fee relates to a good or service, the entity shall evaluate whether to account for the good or service as a separate performance obligation in accordance with paragraphs 22 30. (HKFRS 15.B50) An entity may charge a non refundable fee in part as compensation for costs incurred in setting up a contract (or other administrative tasks as described in HKFRS 15.25). If those setup activities do not satisfy a performance obligation, the entity shall disregard those activities (and related costs) when measuring progress Performance in obligations accordance with HKFRS 15.B19. That is because the costs of setup activities do not depict the transfer of services to the customer. The entity shall assess whether costs incurred in setting up a contract have resulted in an asset that shall be recognised in accordance with HKFRS 15.95 (HKFRS 15.B51) 2013 2016 Nelson Consulting Limited 25 Comprehensive Step 2 Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 5 step by step 2013 2016 Nelson Consulting Limited 26 13

Comprehensive Step 2 Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Step 2: Performance Obligations in the Contract In Step 2, Leon observes that Leon, as a franchisor, has developed a customary business practice to undertake activities such as analysing the consumers changing preferences and implementing product improvements, pricing strategies, marketing campaigns and operational efficiencies to support the franchise name. However, Leon concludes that these activities do not directly transfer goods or services to Andy because they are part of Leon s promise to grant a licence. Leon determines that it has two promises to transfer goods or services: (a) a promise to transfer equipment and (b) a promise to grant a licence. 2013 2016 Nelson Consulting Limited 27 C. Recognition and D. Measurement 2013 2016 Nelson Consulting Limited 28 14

Step 3: Determine Transaction Price Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Step 3: Determining the Transaction Prices Transaction is the amount of consideration in a contract to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer Fixed consideration Variable consideration Consideration in other format Variable Consideration Constraining Estimates of Variable Con. Significant Financing Component Non cash Consideration Consideration Payable to Customer 2013 2016 Nelson Consulting Limited 29 Step 3: Determine Transaction Price Is there any variable consideration? Yes Choose one of the two methods to estimate the variable consideration (depending on which can better predict the consideration entitled) Variable Consideration The expected value method (may be appropriate for large number of contracts with similar characteristics) The most likely amount method (may be appropriate for the contract with only two possible outcomes) 2013 2016 Nelson Consulting Limited Source: Intermediate Financial Reporting (Forthcoming 3 Ed.) by Nelson Lam and Peter Lau 30 15

Step 3: Determine Transaction Price Refund Liability Based on Volume based Rebate Frank entered into a contract with a Customer, Renee, on 1 Jan. 2016 to transfer products to Renee for $150 per unit of products. If Renee buys over 1 million units in a year, the contract indicates that the per unit is retrospectively reduced to $125 per unit. Consideration is due when control of the units transfers to Renee. Thus, Frank has an unconditional right to consideration Variable (i.e. a receivable) Consideration for $150 per unit until the retrospective reduction applies. Constraining Estimates Frank concludes at contract inception that Renee will meet the 1 million units of Variable Con. threshold and estimates that the is $125 per unit. Consequently, upon the first shipment to Renee of 100 products Frank recognises the following: Dr Receivable ($150 per unit 100 units) $15,000 Cr Revenue ($125 per unit 100 units) $12,500 Refund liability (contract liability) 2,500 2013 2016 Nelson Consulting Limited 31 Step 3: Determine Transaction Price Right of Return Amy enters into 100 contracts with customers and each contract includes the sale of one chair for $100 (i.e. total consideration of $10,000). Cash is received when control of a chair transfers but Amy s practice is to allow a customer to return any unused chair within 30 days and receive a full refund. Amy s cost of purchase of each chair is $60. Amy applies the practical expedient in IFRS 15 (see Section 11.1.3) to the Variable Consideration portfolio of 100 contracts because it reasonably expects that the effects on the financial statements would not differ materially. Constraining Estimates As Amy allows a return of chairs, the consideration received from of Variable the Con. customer is variable. To estimate the variable consideration, Amy decides to use the expected value method because it is the method that Amy expects to better predict the amount of consideration to which it will be entitled. Using the method, Amy estimates that 97 chairs will not be returned. 2013 2016 Nelson Consulting Limited 32 16

Step 3: Determine Transaction Price Right of Return Amy also considers the requirements on constraining estimates of variable consideration to determine whether the estimated amount of variable consideration of $9,700 ($100 97 chairs not expected to be returned) can be included in the. Amy concludes that it is highly probable that a significant reversal in the cumulative amount of revenue recognised (i.e. $9,700) will not occur as the uncertainty is resolved (i.e. over the return period). Variable Consideration Upon transfer of control of the 100 chairs, Amy does not recognise Constraining revenue Estimates for the three chairs that it expects to be returned. Consequently, of Variable Amy Con. recognises the following: a. revenue of $9,700 ($100 97 chairs not expected to be returned); b. a refund liability of $300 ($100 3 chairs expected to be returned); and c. an asset of $180 ($60 3 chairs for its right to recover chairs from customers on settling the refund liability). 2013 2016 Nelson Consulting Limited 33 Step 3: Determine Transaction Price Right of Return The journal entries for the revenue recognition s should be as follows: Dr Cash $10,000 Cr Revenue $9,700 Refund liability 300 To recognise the revenue and refund liability. Variable Consideration Constraining Estimates Dr Cost of goods sold $5,820 of Variable Con. Inventories 180 Cr Liability ($60 100 chairs) $6,000 To recognise the purchase liability and expected return of chairs. 2013 2016 Nelson Consulting Limited 34 17

Step 3: Determine Transaction Price The objective when adjusting the promised amount of consideration for a significant financing component is for an entity to recognise revenue at an amount that reflects the that a customer would have paid for the promised goods or services if the customer had paid cash for those goods or services when (or as) they transfer to the customer (ie the cash selling ). (HKFRS 15.61) Significant Financing Component 2013 2016 Nelson Consulting Limited 35 Step 3: Determine Transaction Price A contract with a customer would not have a significant financing component if any of the following factors exist: a. 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. 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 the control of the customer or the entity. c. the difference between the promised consideration and the cash selling of the good or service (as Significant Financing Component described in HKFRS 15.61) 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. (HKFRS 15.62) 2013 2016 Nelson Consulting Limited 36 18

Step 3: Determine Transaction Price As a practical expedient, an entity need not adjust the promised amount of consideration for the effects of a significant financing component if the entity expects, at contract inception, that the period between when the entity transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less. (HKFRS 15.63) Significant Financing Component 2013 2016 Nelson Consulting Limited 37 Step 3: Determine Transaction Price Entitlement to Non Cash Consideration Billy contracted with a customer to provide a weekly service for one year on 1 Jan. 2016 and then work began. It is judged to be a single performance obligation. In exchange, the customer promised to pay 100 shares of its shares per week of service (a total of 5,200 shares) upon the completion of each week of service. In consequence, Billy would then Measure its progress towards complete satisfaction of the performance obligation as each week of service was complete. Determine the, Billy measures the fair value of 100 shares that are received upon completion of each weekly service. Not reflect any subsequent changes in the fair value of the shares received (or receivable) in revenue. Non cash Consideration Fair Value 2013 2016 Nelson Consulting Limited 38 19

Step 3: Determine Transaction Price An entity shall account for consideration payable to a customer as a reduction of the and, therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service (as described in HKFRS 15.26 30) that the customer transfers to the entity. Consideration payable to a customer Consideration payable to a customer includes cash amounts that an entity pays, or expects to pay, to the customer (or to other parties that purchase the entity s goods or services from the customer) credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity (or to other parties that purchase the entity s goods or services from the customer) Consideration Payable to Customer 2013 2016 Nelson Consulting Limited 39 Comprehensive Step 3 Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 5 step by step 2013 2016 Nelson Consulting Limited 40 20

Comprehensive Step 3 Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Step 3: Determine the Transaction Price In Step 3, Leon is required to determine the of the contract. Based on the contract terms, Leon determines that the of Leon s contract includes a fixed consideration of $150,000 for the equipment, and a variable consideration, i.e. a sales based royalty of 5% of Andy s monthly sales 2013 2016 Nelson Consulting Limited 41 Comprehensive Step 3 Step 3: Determine the Transaction Price Step 5: Step 3: Step 1: Step 2: Step 4: Recognise Sales based or usage based royalty Determine may result in variable consideration in Allocate the revenue when or the contract an with entity s a contract performance with a customer. as performance customer To account for obligations consideration in the form of a sales based or usage based obligation is royalty that is promised in exchange for a licence of intellectual property, satisfied Leon is specifically required to recognise revenue only when or as the later of the following events occurs: a. the subsequent sale or usage occurs; and b. the performance obligation to which some or all of the sales based or usage based royalty has been allocated has been satisfied (or partially satisfied). 2013 2016 Nelson Consulting Limited 42 21

C. Recognition and D. Measurement 2013 2016 Nelson Consulting Limited 43 Step 4: Allocate Transaction Price to PO Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Step 4: Allocating the Transaction Price An entity typically allocates the to each performance obligation on the basis of the relative stand alone selling s of each distinct good or service promised in the contract. If a stand alone selling is not observable, an entity estimates it (HKFRS 15.IN7) Allocation based on stand alone selling Allocation of a discount Allocation of variable consideration 2013 2016 Nelson Consulting Limited Source: Intermediate Financial Reporting (Forthcoming 3 Ed.) by Nelson Lam and Peter Lau 44 22

Step 4: Allocate Transaction Price to PO Case Orange S.A., originally known as France Telecom, explained the impact of IFRS 15 on allocating in its annual report of 2015 that: For the Group, this standard would mainly impact the accounting for bundled offers which include a handset component with a discounted and a communication service component: the cumulative revenue will not change but its allocation between the handset sold and the communication service will change (more equipment revenue and less service revenue). The resulting acceleration of the revenue recognition would lead to the recognition of a contract asset in the statement of financial position which would be settled against an asset receivable as the communication service is provided (receivable and contract asset are further explained later). 2013 2016 Nelson Consulting Limited 45 Step 4: Allocate Transaction Price to PO Customer Loyalty Programme Mary has a customer loyalty programme that rewards a customer with one loyalty point for every $10 of purchases. Each point is redeemable for a $1 Based discount on Stand alone on any future purchases of Mary s products. Selling During Price a reporting (SASP) period, customers purchase products for $100,000 and earn Allocation 10,000 of points a that are redeemable for future purchases. The consideration Discount is fixed and the stand alone selling of the purchased Allocation products of is Variable $100,000. Mary Consideration expects 9,500 points to be redeemed and estimates a stand alone selling of $0.95 per point (totalling $9,500) on the basis of the likelihood of redemption in accordance with IFRS 15. The points provide a material right to customers that they would not receive without entering into a contract. Consequently, Mary concludes that the promise to provide points to the customer is a performance obligation. 2013 2016 Nelson Consulting Limited 46 23

Step 4: Allocate Transaction Price to PO Customer Loyalty Programme Mary allocates the ($100,000) to the product and the points on a relative stand alone selling basis as follows: Based Product: on Stand alone $91,324 [$100,000 ($100,000 SASP $109,500)] Selling Points: Price (SASP) $8,676 [$100,000 ($9,500 SASP $109,500)] At Allocation the end of of a the first reporting period, 4,500 points have been redeemed Discount and Mary continues to expect 9,500 points to be redeemed in total. Allocation of Variable Mary Consideration recognises revenue for the loyalty points of $4,110 [(4,500 points 9,500 points) $8,676] and recognises a contract liability of $4,566 ($8,676 $4,110) for the unredeemed points at the end of the first reporting period. The journal entry would be: Dr Cash $100,000 Cr Revenue ( allocated to products sold) $91,324 Revenue (tran. allocated to redeemed points) 4,110 Contract liability (tran. allocated to unredeemed points) 4,566 2013 2016 Nelson Consulting Limited 47 Step 4: Allocate Transaction Price to PO Customer Loyalty Programme At the end of the second reporting period, 8,500 points have been redeemed cumulatively. Based Mary on updates Stand alone its estimate of the points that will be redeemed and now Selling expects Price that (SASP) 9,700 points will be redeemed. Mary Allocation recognises of a revenue for the loyalty points of $3,493 {[(8,500 total points redeemed Discount 9,700 total points expected to be redeemed) $8,676 initial Allocation allocation] of Variable $4,110 recognised in the first reporting period}. The contract liability Consideration balance is $1,073 ($8,676 initial allocation $7,603 of cumulative revenue recognised). The journal entry would be: Dr Contract liability $3,493 Cr Revenue (tran. allocated to the redeemed points) $3,493 2013 2016 Nelson Consulting Limited 48 24

Step 4: Allocate Transaction Price to PO Allocation of a Discount A customer receives a discount for purchasing a bundle of goods or services if the sum of the stand alone selling s of those promised goods or services in the contract exceeds the promised consideration in a contract. Except when an entity has observable evidence in accordance with HKFRS 15.82 that the entire discount relates to only one or more, but not all, performance obligations in a contract, the entity shall allocate a discount proportionately to all performance obligations in the contract. (HKFRS 15.81) 2013 2016 Nelson Consulting Limited 49 Step 4: Allocate Transaction Price to PO Allocation of a Discount An entity shall allocate a discount entirely to one or more, but not all, performance obligations in the contract if all of the following criteria are met: a. the entity regularly sells each distinct good or service (or each bundle of distinct goods or services) in the contract on a stand alone basis; b. the entity also regularly sells on a stand alone basis a bundle (or bundles) of some of those distinct goods or services at a discount to the SASP of the goods or services in each bundle; and c. the discount attributable to each bundle of goods or services described in HKFRS 15.82(b) is substantially the same as the discount in the contract and an analysis of the goods or services in each bundle provides observable evidence of the performance obligation(s) to which the entire discount in the contract belongs. (HKFRS 15.82) 2013 2016 Nelson Consulting Limited 50 25

Step 4: Allocate Transaction Price to PO An entity shall allocate a variable amount (and subsequent changes to that amount) entirely to a performance obligation or to a distinct good or service that forms part of a single performance obligation in accordance with HKFRS 15.22(b) if both of the following criteria are met: Allocation of Variable Consideration a. the terms of a variable payment relate specifically to the entity s efforts to satisfy the performance obligation or transfer the distinct good or service (or to a specific outcome from satisfying the performance obligation or transferring the distinct good or service); and b. allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective in HKFRS 15.73 when considering all of the performance obligations and payment terms in the contract. (HKFRS 15.85) 2013 2016 Nelson Consulting Limited 51 Comprehensive Step 4 Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 5 step by step 2013 2016 Nelson Consulting Limited 52 26

Comprehensive Step 4 Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Step 4: Determine the Transaction Price In Step 4, Leon has to determine whether the should be allocated to the two performance obligations in the contract. Leon applies IFRS 15 to determine whether the variable consideration should be allocated entirely to the performance obligation to transfer the franchise licence. 2013 2016 Nelson Consulting Limited 53 Comprehensive Step 4 Step 4: Determine the Transaction Price Step 5: Step 3: Step 1: Step 2: Step 4: Recognise Leon concludes that the variable Determine consideration (i.e. the sales based royalty) Allocate the revenue when or should be allocated entirely to the the franchise licence because the variable contract with a performance as performance customer consideration obligations relates entirely to Leon s promise to grant the franchise obligation is licence. satisfied In addition, Leon observes that allocating $150,000 to the equipment and the sales based royalty to the franchise licence would be consistent with an allocation based on Leon s relative stand alone selling s in similar contracts. Since Leon s stand alone selling of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy s sales. Consequently, Leon concludes that the variable consideration (i.e. the salesbased royalty) should be allocated entirely to the performance obligation to grant the franchise licence. 2013 2016 Nelson Consulting Limited 54 27

C. Recognition and D. Measurement 2013 2016 Nelson Consulting Limited 55 Step 5: Satisfy Performance Obligations Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Step 5: Satisfaction of performance obligations A an entity recognises revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer which is when the customer obtains control of that good or service. The amount of revenue recognised is the amount allocated to the satisfied performance obligation. (HKFRS 15.IN7) Performance obligations satisfied over the time Performance obligations satisfied at a point in time Measuring progress 2013 2016 Nelson Consulting Limited Source: Intermediate Financial Reporting (Forthcoming 3 Ed.) by Nelson Lam and Peter Lau 56 28

Step 5: Satisfy Performance Obligations Determine at contract inception Yes Yes Yes Does the customer receive and consume the benefits provided by the entity as the entity performs? No Does the customer control the asset being created or enhanced by the entity? No Does the entity s performance create an asset with an alternative use to the entity? No Does the entity have an enforceable right to payment for performance completed to date? Yes No Performance obligation satisfied over time Performance obligations satisfied at a point in time Measuring progress towards complete satisfaction of that performance 2013 2016 Nelson Consulting Limited Source: Intermediate Financial Reporting (Forthcoming 3 Ed.) by Nelson Lam and Peter Lau 57 Step 5: Satisfy Performance Obligations Measuring Progress Towards Complete Satisfaction of a Performance Obligation For each performance obligation satisfied over time in accordance with HKFRS 15.35 37, an entity shall recognise revenue over time by measuring the progress towards complete satisfaction of that performance obligation. The objective when measuring progress is to depict an entity s performance in transferring control of goods or services promised to a customer (i.e. the satisfaction of an entity s performance obligation). (HKFRS 15.39) Performance obligation satisfied over time Measuring progress towards complete satisfaction of that performance 2013 2016 Nelson Consulting Limited 58 29

Step 5: Satisfy Performance Obligations Measuring Progress Towards Complete Satisfaction of a Performance Obligation An entity shall apply a single method of measuring progress for each performance obligation satisfied over time and the entity shall apply that method consistently to similar performance obligations and in similar circumstances. At the end of each reporting period, an entity shall remeasure its progress towards complete satisfaction of a performance obligation satisfied over time. (HKFRS 15.40) Performance obligation satisfied over time Measuring progress towards complete satisfaction of that performance 2013 2016 Nelson Consulting Limited 59 Step 5: Satisfy Performance Obligations Methods for Measuring Progress Appropriate methods of measuring progress include output methods, and input methods (HKFRS 15.B14 B19 provide guidance) In determining the appropriate method for measuring progress, an entity shall consider the nature of the good or service that the entity promised to transfer to the customer. (HKFRS 15.41) Measuring Progress Over Time 2013 2016 Nelson Consulting Limited 60 30

Step 5: Satisfy Performance Obligations Methods for Measuring Progress Output methods recognise revenue on the basis of direct measurements of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract. Output methods include methods such as surveys of performance completed to date, appraisals of results achieved, milestones reached, time elapsed and units produced or units delivered. Measuring Progress Over Time 2013 2016 Nelson Consulting Limited 61 Step 5: Satisfy Performance Obligations Methods for Measuring Progress When an entity evaluates whether to apply an output method to measure its progress, the entity shall consider whether the output selected would faithfully depict the entity s performance towards complete satisfaction of the performance obligation. (HKFRS 15.B15) The disadvantages of output methods are that the outputs used to measure progress may not be directly observable and the information required to apply them may not be available to an entity without undue cost. Therefore, an input method may be necessary. (HKFRS 15.B17) Measuring Progress Over Time 2013 2016 Nelson Consulting Limited 62 31

Step 5: Satisfy Performance Obligations Methods for Measuring Progress Input methods recognise revenue on the basis of the entity s efforts or inputs to the satisfaction of a performance obligation (for example, resources consumed, labour hours expended, costs incurred, time elapsed or machine hours used) relative to the total expected inputs to the satisfaction of that performance obligation. If the entity s efforts or inputs are expended evenly throughout the performance period, it may be appropriate for the entity to recognise revenue on a straight line basis. (HKFRS 15.B18) Measuring Progress Over Time 2013 2016 Nelson Consulting Limited 63 Step 5: Satisfy Performance Obligations Methods for Measuring Progress A shortcoming of input methods is that there may not be a direct relationship between an entity s inputs and the transfer of control of goods or services to a customer. Therefore, an entity shall exclude from an input method the effects of any inputs that, in accordance with the objective of measuring progress in HKFRS 15.39, do not depict the entity s performance in transferring control of goods or services to the customer. (HKFRS 15.B19) Measuring Progress Over Time 2013 2016 Nelson Consulting Limited 64 32

Step 5: Satisfy Performance Obligations Performance Obligations Satisfied at a Point in Time In its application guidance, HKFRS 15 explains that the repurchase agreements generally come in the following three forms and described the respective consideration and consequences: a. an entity s obligation to repurchase the asset (a forward); b. an entity s right to repurchase the asset (a call option); and c. an entity s obligation to repurchase the asset at the customer s request (a put option). Performance obligations satisfied at a point in time 2013 2016 Nelson Consulting Limited 65 Step 5: Satisfy Performance Obligations Forward or call to repurchase at amount less than the original selling of the asset? Yes No Repurchase at amount less than the original selling of the asset Repurchase at amount equal to or more than the original selling of the asset No Is it part of sale and leaseback? Account for the contract as a lease in accordance with HKFRS 16 Yes Continue to recognise the asset and recognise a financial liability As a financing arrangement continue to recognise the asset and recognise a financial liability Recognise interest and, if applicable, processing or holding costs When the option lapses unexercised, an entity is required to derecognise the liability and recognise revenue 2013 2016 Nelson Consulting Limited Source: Intermediate Financial Reporting (Forthcoming 3 Ed.) by Nelson Lam and Peter Lau 66 33

Step 5: Satisfy Performance Obligations Put option at an exercise being lower than the original selling of the asset? Yes No Is it part of sale and leaseback? No Yes Account for the contract as a lease in accordance with IFRS 16 The customer has a significant economic incentive to exercise the put option? Yes Yes No Continue to recognise the asset and recognise a financial liability Repurchase of the asset is less than or equal to the expected market value of the asset? Yes No The customer has a significant economic incentive to exercise the put option? No As if it were the sale of a product with a right of return When the option lapses unexercised, an entity is required to derecognise the liability and recognise revenue As a financing arrangement Continue to recognise the asset and recognise a financial liability Recognise interest and, if applicable, processing or holding costs 2013 2016 Nelson Consulting Limited Source: Intermediate Financial Reporting (Forthcoming 3 Ed.) by Nelson Lam and Peter Lau 67 Comprehensive Step 5 Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 5 step by step 2013 2016 Nelson Consulting Limited 68 34

Comprehensive Step 5 Step 1: contract with a customer Step 2: performance obligations Step 3: Determine the Step 4: Allocate the Step 5: Recognise revenue when or as performance obligation is satisfied Step 5: Recognise Revenue When the Entity Satisfies a Performance Obligation In Step 5, Leon is required to recognise revenue when or as it satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to the customer, Andy. An asset is transferred when or as the customer obtains control of that asset. The amount of revenue recognised is the amount allocated to the satisfied performance obligation. A performance obligation may be satisfied at a point in time or over time. 2013 2016 Nelson Consulting Limited 69 Comprehensive Step 5 Step 5: Recognise Revenue When the Entity Satisfies a Step 3: Step 1: Step 2: Step 4: Performance Obligation Determine Allocate the the contract Leon with identifies a performance two performance obligations: customer (a) a promise obligations to transfer equipment and Step 5: Recognise revenue when or as performance obligation is satisfied (b) a promise to grant a franchise licence. For a promise of transfer equipment, the performance obligation is satisfied at a point in time as the three criteria for performance obligation satisfied over time are not met. While the allocated to it is the fixed consideration of $150,000, Leon finally recognises the fixed consideration when that promise is satisfied by delivering the equipment to Andy (i.e. control transferred). 2013 2016 Nelson Consulting Limited 70 35

Comprehensive Step 5 Step 5: Recognise Revenue When the Entity Satisfies a Step 5: Step 3: Step 1: Step 2: Step 4: Recognise Performance Obligation Determine Allocate the revenue when or the contract For with a promise a performance of transfer a franchise licence, the variable consideration, as performance i.e. customer in the form of obligations the sales based royalty, is allocated entirely to the obligation franchise licence. satisfied Then, the final step in recognised the allocated is to determine whether the performance obligation in licence transfer is satisfied at a point in time or over time. HKFRS 15 has a specific application guidance for licensing, which also includes sales based or usage based royalty. 2013 2016 Nelson Consulting Limited 71 Application Guidance Licensing A licence establishes a customer s rights to the intellectual property of an entity. In addition to a promise to grant a licence to a customer, an entity may also promise to transfer other goods or services to the customer. In case the promise to grant a licence is not distinct from other promised goods or services in the contract, an entity is required to account for the promise to grant a licence and those other promised goods or services together as a single performance obligation; and apply the application guidance to determine whether the performance obligation (which includes the promised licence) is a performance obligation satisfied over time, or a performance obligation satisfied at a point in time. 2013 2016 Nelson Consulting Limited 72 36

Application Guidance Licensing In case the promise to grant the licence is distinct from the other promised goods or services in the contract, the promise to grant the licence is a separate performance obligation. Then, an entity will determine whether the licence transfers to a customer either at a point in time or over time by using the application guidance in HKFRS 15. In making this determination, an entity is required consider whether the nature of the entity s promise in granting the licence to a customer is to provide the customer with either: a. a right to access the entity s intellectual property as it exists throughout the licence period (satisfied over time); or b. a right to use the entity s intellectual property as it exists at the point in time at which the licence is granted (satisfied at a point in time). 2013 2016 Nelson Consulting Limited 73 Application Guidance Licensing Is the promise to grant a licence distinct? Yes Determining the nature of the entity s promise Meet all three criteria to provide a right to assess the intellectual property (i.e. HKFRS 15.B58)? Yes It is right to assess the intellectual property and the performance obligation is satisfied over time No No Promise to grant a licence and other promises as a single performance obligation Determine performance obligation satisfied over time or at a point in time It is right to use the intellectual property and the performance obligation is at a point in time 2013 2016 Nelson Consulting Limited Source: Intermediate Financial Reporting (Forthcoming 3 Ed.) by Nelson Lam and Peter Lau 74 37

Comprehensive Licensing Leon Group signs a new contract with a customer, Andy Inc., which has business with Leon for a while and has good credit history The terms of the new contract include: a promises to grant a franchise licence that provides Andy with the right to use Leon s trade name and sell Leon s products for 10 years a promises to provide the equipment necessary to operate a franchise store. a fixed consideration of $150,000 for the equipment, that is payable to Leon when the equipment is delivered a sales based royalty of 5% of Andy s monthly sales, payable to Leon Leon s stand alone selling of the equipment is $150,000 and Leon regularly licenses franchises in exchange for 5% of Andy sales In recognising the revenue with Andy, Leon applies the 5 step model in HKFRS 5 step by step 2013 2016 Nelson Consulting Limited 75 Comprehensive Licensing Leon 5 Step Model and Application Guidance on Licensing Leon s promise to transfer franchise licence is distinct from the promise to transfer equipment. The application guidance of HKFRS 15 requires that, if the promise to grant the licence is distinct from the other promised goods or services in the contract and, therefore, the promise to grant the licence is a separate performance obligation, Leon will determine whether the licence transfers to a customer either at a point in time, or over time. Leon assesses the nature of Leon s promise to grant the franchise licence. Leon concludes that the criteria are met and the nature of Leon s promise is to provide access to Leon s intellectual property in its current form throughout the licence period. 2013 2016 Nelson Consulting Limited 76 38

Comprehensive Licensing Leon 5 Step Model and Application Guidance on Licensing This is because (three criteria): a. Leon concludes that Andy would reasonably expect that Leon will undertake activities that will significantly affect the intellectual property to which Andy has rights. b. Leon also observes that the franchise licence requires Andy to implement any changes that result from those activities and thus exposing Andy to any positive or negative effects of those activities. c. Leon also observes that even though Andy may benefit from the activities through the rights granted by the licence, they do not transfer a good or service to Andy as those activities occur. Because the criteria are met, Leon concludes that the promise to transfer the licence is a performance obligation satisfied over the time. 2013 2016 Nelson Consulting Limited 77 Comprehensive Licensing Leon 5 Step Model and Application Guidance on Licensing Leon also concludes that because the consideration that is in the form of a sales based royalty relates specifically to the franchise licence, Leon applies the requirements of HKFRS 15 on sales based or usage based royalties (HKFRS 15.B63). After the transfer of the franchise licence, Leon recognises revenue as and when Andy s sales occur because Leon concludes that this reasonably depicts Leon s progress towards complete satisfaction of the franchise licence performance obligation. 2013 2016 Nelson Consulting Limited 78 39

Contract Costs, Presentation & Discl. 2013 2016 Nelson Consulting Limited 79 E. Contract Costs Incremental Costs of Obtaining a Contract An entity shall recognise as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs. (HKFRS 15.91) The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (e.g. a sales commission). (HKFRS 15.92) Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained shall be recognised as an expense when incurred, unless those costs are explicitly chargeable to the customer regardless of whether the contract is obtained. (HKFRS 15.93) As a practical expedient, an entity may recognise the incremental costs of obtaining a contract as an expense when incurred if the amortisation period of the asset that the entity otherwise would have recognised is one year or less. (HKFRS 15.94) 2013 2016 Nelson Consulting Limited 80 40