A contract modification arises when there’s a change in either the scope or price (or both) of a contract, resulting in new or amended rights and obligations.
Modifications treated as separate contracts
A contract modification is considered a separate contract for accounting purposes when both of the following conditions are met (IFRS 15.20):
- The scope of the contract expands due to the inclusion of distinct promised goods or services.
- The contract’s price increases by an amount that reflects the entity’s stand-alone selling prices of the newly promised goods or services.
When these conditions are met, the modification is akin to entering a new contract. Hence, the performance obligations of the existing contract remain unchanged by the modification. It’s important to note that the stand-alone selling prices should be adjusted for specific circumstances related to the contract, such as discounts due to the absence of commission costs for acquiring a new customer or volume rebates.
Refer also to Example 5 (Case A) accompanying IFRS 15.
Modifications not treated as separate contracts
If a contract modification doesn’t qualify as a separate contract based on the above criteria, the entity must determine whether the promised goods or services yet to be provided under the original contract are distinct from those already delivered (IFRS 15.21).
If the remaining goods or services are distinct, the modification is accounted for prospectively. This means revenue from previously satisfied performance obligations remains unchanged (IFRS 15.21(a)). The transaction price that’s still outstanding gets allocated to the unsatisfied performance obligations. This encompasses both the price allocated to performance obligations under the contract before its modification and those added due to the modification. Refer also to Example 6 (products) and Example 7 (services) accompanying IFRS 15.
If the goods or services still to be provided aren’t distinct, the added goods or services post-modification are seen as part of a singular performance obligation that’s partially satisfied at the time of modification. This results in a one-time cumulative catch-up adjustment to revenue (IFRS 15.21(b)). Refer also to Examples 8 and 9 accompanying IFRS 15.
A blend of these methods can be used if it accurately captures the essence of the contract modification (IFRS 15.21(c)). This approach is usually employed when a modification isn’t tied to previously satisfied performance obligations but pertains to the remaining ones. Refer also to Example 5 (Case B) accompanying IFRS 15.
Occasionally, contract modifications essentially involve price adjustments tied to already satisfied performance obligations, such as discounts on new goods due to defects in previously supplied items. In such instances, the guidelines concerning changes in the transaction price should be applied, which might necessitate a one-time cumulative adjustment to revenue.--
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Changes in transaction price and unpriced change orders
If both parties have agreed to a scope change but haven’t settled on a new price (known as unpriced change orders), the contract is deemed modified. The yet-to-be-determined price change should be estimated based on the criteria associated with variable consideration (IFRS 15.19).
Approval of contract modifications
For a modification to be valid, all parties involved in the contract must approve it. If any party hasn’t consented to the modification, the original contract remains in effect for accounting purposes (IFRS 15.18).
More about IFRS 15
See other pages relating to IFRS 15:
Identifying 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