A contract modification is a change in the scope or price (or both) of a contract that creates new, or changes existing, rights or obligations.
Contract modification that is an additional separate contract
A contract modification should be treated as a separate contract for accounting purposes when both of the criteria below are satisfied (IFRS 15.20):
- the scope of the contract increases because of the addition of promised goods or services that are distinct; and
- the price of the contract increases by an amount of consideration that reflects the entity’s stand-alone selling prices of the additional promised goods or services.
When the above criteria are satisfied, there is no substantial difference between entering into a new contract and modifying an existing one. For such modifications, performance obligations under an existing contract are unaffected by the contract modification.
The stand-alone selling prices mentioned in the second criterion above should be adjusted to take into account facts and circumstances specific to that contract, e.g. discounts reflecting the fact that an entity didn’t have to pay commission for acquisition of a new customer or volume rebates.
See also Example 5 (Case A) accompanying IFRS 15.
Contract modification that is not an additional separate contract
When a contract modification is not treated as an additional separate contract based on the above-mentioned criteria, entities need to assess whether the promised goods or services that are still to be transferred under the original contract are distinct from the goods or services already transferred on or before the date of the contract modification (IFRS 15.21).
If the remaining goods or services that are still to be transferred under the original contract are distinct, the contract modification is accounted for prospectively, i.e. the revenue recognised for previously satisfied performance obligations is not adjusted (IFRS 15.21a). Instead, the remaining transaction price is allocated to remaining performance obligations. These include transaction price of the performance obligation remaining under a contract before modification and added by the modification. See also Example 6 (for products) and Example 7 (for services) accompanying IFRS 15.
If the goods or services that remain undelivered at the modification date are not distinct, entities treat the additional goods or services after the contract modification as a part of a single performance obligation that is partially satisfied at the date of the contract modification with a one-off cumulative catch-up adjustment to revenue (IFRS 15.21b). See also Examples 8 and 9 accompanying IFRS 15.
A combination of these two approaches is also allowed if it best reflects the substance of the contract modification (IFRS 15.21c). Typically, this approach will be applied when a contract modification is unrelated to already satisfied performance obligations, but is related to remaining performance obligations. See also Example 5 (Case B) accompanying IFRS 15.
Some contract modifications may in substance include price modifications relating to already satisfied performance obligations (e.g. an entity gives a discount for additional goods because those already delivered were faulty). In such a case, requirements relating to changes in transaction price should be applied which may result in a one-off catch-up adjustment to revenue.
Changes in transaction price and unpriced change orders
If the parties to a contract have approved a change in the scope of the contract but have not yet determined the corresponding change in price (so-called unpriced change orders), the contract should be considered to be modified. The change in price should be estimated using criteria relating to variable consideration (IFRS 15.19).
See also accounting for changes in transaction price which do not result from a contract modification.
Approval of contract modifications by the parties
Contract modification must be approved by all the parties to the contract. When a modification has not been approved by all parties, the existing unmodified contract is still in force for accounting purposes (IFRS 15.18).
More about IFRS 15
See other pages relating to IFRS 15:
Identify a Contract
Performance Obligations and Timing of Revenue Recognition
Principal vs Agent, or Reporting Revenue Gross vs Net
Revenue from Licensing of Intellectual Property
Revenue from Customers’ Unexercised Rights (Breakage)
Customer Loyalty Programmes and Other Options for Additional Goods or Services
Contract Assets and Contract Liabilities