IFRS 15: Specific Application Points

Principal vs. agent considerations are otherwise known as gross vs. net presentation. The principal is the party that controls the goods or services before they are transferred to customers, whereas an agent arranges for the goods or services to be provided by other party without taking control over those goods or services. Paragraph IFRS 15.B34 requires entities to assess whether they act as a principal or an agent for each for each good and service provided to a customer. Paragraph IFRS 15.B34A provides an important two-step framework in making such an assessment, which starts with identifying the specified goods or services to be provided to the customer. This first step is especially important in relation to services and intangible assets.

As mentioned earlier, principal is a party that controls a good or service before it is transferred to customer and paragraph IFRS 15.B37 provides indicators helpful in assessing whether the entity controls a specified good or service before it is transferred to the customer. An entity that does not control a good or service before it is transferred to customer cannot consider itself as a principal in the transaction. It is worth noting that exposure to credit risk is not listed as a factor to be considered. It was concluded by the IASB that it is mostly irrelevant as agents are often exposed to credit risk as well as principals.

As said before, an agent arranges for the provision of goods or services by another party without taking control over those goods or services before they are transferred to a customer.

See Examples 45, 46, 46A, 47, 48 and 48A accompanying IFRS 15.

A principal recognises revenue and expenses in gross amounts, whereas an agent recognises only fees or commissions, even if gross cash flows go through the agent (IFRS 15.B35-B36).

Principal vs. agent considerations in relation to services

Particular difficulties in principal vs. agent considerations relate to services when the entity will not itself provide a final service. For example, when a travel agent sells an airline ticket to a tourist, will it always act as an agent in IFRS 15 meaning because the service (the flight) will be provided by an airline? The answer is no, paragraph IFRS 15.B34A clearly states that the good or service provided to the customer could be a right to a good or service to be provided in the future by another party. For example, when a travel agent buys airline tickets in advance and then sells them to tourist, it can consider itself a principal and recognise gross revenue.

Additionally, paragraph IFRS 15.B35A provides additional guidance to be applied in situations when another party is involved in providing goods or services to a customer.

Warranties are commonly provided in connection with the sale of a product. They can be written in a contract with customer, result from the entity’s customary business practices and/or simply be required by law.

A warranty can sometimes be a distinct service that needs to be treated as a separate performance obligation. It is the case when a warranty can be purchased separately or it provides more than just a regular assurance that the product is not defective and that it complies with required specifications. On the other hand, if the warranty does just that, i.e. it provides assurance that the product is not defective and complies with required specifications for a minimum period required by law, it is not treated as a separate performance obligation (IFRS 15.B28-B29). Paragraph IFRS 15.B31 provides criteria that assist entities in deciding whether a warranty should be considered to be a distinct service.

If a warranty is considered to be a distinct service (a service-type warranty), it is accounted for in accordance with IFRS 15 as a separate performance obligation. Otherwise, is it accounted for under IAS 37 as a provision and an expense (IFRS 15.B30).

If an entity promises both an assurance-type warranty and a service-type warranty but cannot reasonably account for them separately, the entity shall account for both of the warranties together as a single performance obligation (IFRS 15.B32).

When a contract grants a customer the option to acquire additional goods or services, such an option is treated as a separate performance obligation if it gives ‘a material right’ to the customer. It other words, when it is different from a regular marketing/promotional offer.  If this is the case, the customer has in substance prepaid for goods or services to be delivered in the future. A material right is a right that (IFRS 15.B39-B41):

  • the customer would not receive without entering into that contract and
  • gives the customer an option to acquire an additional good or service at a price that is lower than the stand-alone selling price (SSP).

It is necessary to estimate SSP of an option in order to allocate a part of transaction price to this option as it is treated as a separate performance obligation. Such an estimate takes into account the following factors (IFRS 15.B42):

  • the discount that this option gives
  • the discount that the customer could receive without the option under analysis and
  • the likelihood that the option will be exercised.

Revenue relating to the option is recognised when future goods or services are transferred or when the option expires (IFRS 15.B40).

See Examples 49,50,51 and 52 accompanying IFRS 15 and the examples below.

Example: an option for additional good

Entity A sells to its customer product X for $1,000 and grants and option to purchase product Y for $500.  Product Y is sold separately by Entity A for $700. Entity A determines that the option to purchase product Y for $500 is a material right to a customer. Entity A must therefore determine SSP of this option and estimates it to be $120 as follows:

(discount that this option gives ($200) – discount that is given to other returning customers ($50))x80% likelihood that the customer will exercise this option.

The transaction price in the contract of $1,000 is allocated between product X and an option for product Y as follows:

Note: you can scroll the table horizontally if it doesn’t fit your screen

 SSPRelative %Allocated price
Product X$1,00089%
($1,000/$1,120)
$890
($1,000x89%)
Option for product Y$12011%
($120/$1,120)
$110
($1,000x11%)

On delivery of Product X to the customer, Entity A recognises $890 of revenue (and cost of Product X as an expense). $110 is presented as contract liability.

When the customer exercises his option, it purchases Product Y for $500. Entity A recognises revenue of $610, consisting of the stated price of $500 and utilisation of contract liability of $110. Cost of product Y is of course recognised as an expense at the same time.


Example: customer loyalty programme (points redeemable by the entity itself)

Entity A operates a customer loyalty programme. For every $100 worth of purchases, a customer receives 5 loyalty points. These points can be spent on purchases from Entity A and each point can be spent on $1 worth of purchases. Entity A estimates that 90% of points will be redeemed by customers and remaining 10% will expire, therefore the stand-alone selling price of one point is $0.9 ($1 x 90% redemption likelihood). Points can be redeemed by the end of the year following the year of issuance of the points.

During year 20X1, Entity A sells products for $100 million. Therefore, 5 million points were awarded to customers. Total transaction price of $100 million is allocated between products sold and points awarded as follows:

Note: you can scroll the table horizontally if it doesn’t fit your screen

 SSPRelative %Allocated price
Products sold$100m96%
($100m/$104.5m)
$96m
($100m x 96%)
Loyalty points$4.5m4%
($4.5m/$104.5m)
$4m
($100m x 4%)

The entries made by Entity A are as follows:

 DRCR
Cash$100m
Revenue$96m
Contract liability$4m

During year 20X2, 3.5 million points are redeemed by customers for purchases of products. Entity A updates its assessment and now believes that 95% of points will be redeemed and only 5% will expire. As a result, $3 million of contract liability is released to revenue (3.5 million points / 4.75 million points expected to be redeemed x $4 million of the allocated transaction price) and $1 million remains recognised as contract liability and will be recognised in year 20X3 when the remaining points will be redeemed or expire. Obviously, the cost of products given to customers in exchange for loyalty points is recognised in P/L.


Example: loyalty programme operated by a third party

Entity A takes part in a customer loyalty programme operated by a large electronics retailer + Entity X.  For every $100 worth of purchases, a customer receives 5 loyalty points. These points can be spent on purchases from Entity X only and each point can be spent on $1 worth of purchases. Entity A estimates the stand-alone selling price of one point to be $0.9. For each point transferred to a customer, Entity A pays Entity X $0.7.

During year 20X1, Entity A sells products for $100 million. Therefore, 5 million points were awarded to customers. Total transaction price of $100 million is allocated between products sold and points awarded as follows:

 SSPRelative %Allocated price
Products sold$100m96%
($100m/$104.5m)
$96m
($100m x 96%)
Loyalty points$4.5m4%
($4.5m/$104.5m)
$4m
($100m x 4%)

Additionally, Entity A concludes that it acts as an agent of Entity X. Therefore, Entity A recognises revenue immediately when points are awarded to customers, as its performance obligation as an agent was to provide customers with the loyalty points of Entity X. Entity A recognises revenue relating to loyalty points on a net basis (a commission), which is the allocated price of $4 million less $3.5 million paid to Entity X.

The entries made by Entity A are as follows:

Step 1 – products are sold and points awarded

 DRCR
Cash$100m
Revenue$96m
Contract liability$4m

Step 2 – Revenue relating to loyalty points is recognised as a commission and payment to Entity X is made:

 DRCR
Cash$3.5m
Revenue$0.5m
Contract liability$4m

Paragraphs IFRS 15.B44-B47 require entities to estimate the so-called ‘breakage’, that is the amount/value of contractual rights that will never be exercised. This usually concerns gift cards and non-refundable tickets. Such an estimated breakage is recognised as revenue when the likelihood of the customer exercising its remaining rights becomes remote, even though the performance obligation has not been satisfied. See Example 52 accompanying IFRS 15.

Non-refundable upfront fees should be assessed against the criteria for identifying a performance obligation which will determine their accounting treatment. Usually, the upfront fee does not result in the transfer of a distinct good or service to the customer and therefore is not treated as a separate performance obligation. Instead, it is allocated to other performance obligations identified in the contract (IFRS 15.B48-B50).

When the up-front fees are deemed to be a compensation for set-up costs incurred by the entity, those costs can be recognised as costs to fulfil a contract (assets) (IFRS 15.B51).

See Example 53 accompanying IFRS 15.

Paragraphs IFRS 15.B52-B63 cover licensing of intellectual property such as (IFRS 15.B52):

  • software and technology;
  • motion pictures, music and other forms of media and entertainment;
  • franchises; and
  • patents, trademarks and copyrights.

The main challenges in this area relate to determination whether licensing of intellectual property constitutes a distinct good/service and if so, whether related performance obligation is satisfied over time or at a point in time.

Licence is usually capable of being distinct (the first step in a 2-step approach), but sometimes a customer benefits only from a combined entity’s output and therefore a license forms a part of wider performance obligation. Examples of licences that are not distinct are the following (IFRS 15.B54):

  • a licence that forms a component of a tangible good and that is integral to the functionality of the good (e.g. an operating system installed in a smartphone);
  • a licence that the customer can benefit from only in conjunction with a related service.

If a licence is distinct, it can provide a customer with either (IFRS 15.B56):

  • a right to access the entity’s intellectual property as it exists throughout the licence period; or
  • a right to use the entity’s intellectual property as it exists at the point in time at which the licence is granted.

A licence provides a right to access the entity’s intellectual property as it exists throughout the licence period, and therefore the related performance obligation is satisfied over time, if the customer will essentially be using the most recent form of the intellectual property during the licence period. This is the case when all the following criteria are met (IFRS 15.B58):

a/ the contract requires, or the customer reasonably expects, that the entity will undertake activities that significantly affect the intellectual property to which the customer has rights (see paragraphs IFRS 15.B59 -B59A for more discussion);

b/ the rights granted by the licence directly expose the customer to any positive or negative effects of the entity’s activities identified above; and

c/ those activities do not result in the transfer of a good or a service to the customer as those activities occur (e.g. software updates treated as distinct services).

Additionally, paragraph IFRS 15.BC410 explains that the assessment of the above criteria cannot be affected by other performance obligations in the contract. For example, when software updates are treated as a distinct service, they are not taken into consideration in determining when and how control of the software is transferred to the customer.

Examples 54, 55, 56, 58, 59 accompanying IFRS 15 cover licensing of intellectual property.

It is worth noting that payment terms are not listed in paragraph IFRS 15.B58. It is so, because the IASB considers payment terms as not indicative of whether the licence provides the customer with a right to access or right to use the intellectual property and therefore when the performance obligation is satisfied (IFRS 15.BC412d)).

If the criteria from IFRS 15.B58 listed above are not met, the performance obligation is satisfied at the point in time at which the licence is granted to the customer.

It may be also useful to familiarise yourself with the distinction between functional and symbolic intellectual property existing in US GAAP which is cited in paragraph IFRS 15.BC414M.

License that is not distinct

If a license is not distinct, entities should determine whether the license is a primary or dominant component in the performance obligation (IFRS 15.BC407). If so, the specific provision relating to licensing of intellectual property should be applied. If the license is not a primary or dominant component in the performance obligation, the general criteria for satisfaction of performance obligations apply. IFRS 15 does not contain any specific criteria for determining whether a license is a primary or dominant component in the performance obligation, there is however an example discussed in IFRS 15.BC414X.

Paragraphs IFRS 15.B63-B63B provide specific guidance on revenue from sales-based or usage-based royalties. Revenue is recognised only when (or as) the later of the following events occurs:

  • the subsequent sale or usage occurs; and
  • 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).

The specific recognition criteria for sales-based or usage-based royalties override the general requirements for recognition of variable consideration.

See Examples 57, 60, 61 accompanying IFRS 15.

The substance of some performance obligations is to stand-ready to serve the customer and not to deliver the underlying goods/services. Such performance obligations are usually treated as satisfied over time with straight line revenue recognition. For example, a gym membership is an obligation to stand-ready to provide the customer with access to the gym and its equipment. It would not provide meaningful results if the gym tried to assess the number of hours that the customer will use throughout the contract and recognise revenue based on actual/total ratio. Instead, revenue is recognised proportionately to time lapsed.

See other pages relating to IFRS 15:

Scope of IFRS 15

IFRS 15: Identify a Contract

IFRS 15: Performance Obligations and Timing of Revenue Recognition

IFRS 15: Transaction Price

IFRS 15: Contract Assets and Contract Liabilities

IFRS 15: Contract Costs

IFRS 15: Disclosure

 


© 2018-2019 Marek Muc

Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). The information provided on this website does not constitute professional advice and should not be used as a substitute for consultation with a certified accountant.