Transaction Price (IFRS 15)

The transaction price is the sum an entity expects to receive in return for transferring promised goods or services to a customer, excluding any amounts collected on behalf of third parties, such as VAT (IFRS 15.47). The transaction price is determined after considering the effects of (IFRS 15.48):

In determining the transaction price, entities should presume that the goods or services will be transferred to the customer as promised in the contract, and that the contract will not be cancelled, renewed, or modified (IFRS 15.49).

Variable consideration

Sources of variability

The amount of consideration can sometimes vary due to factors such as discounts, rebates, performance bonuses, rights of return, penalties (for example, for delays or cancellations), price protection, SLAs (service level agreements), and other elements (IFRS 15.51). The variability of consideration may be explicitly stated in the contract (even as a penalty reducing revenue) but could also arise from other factors like customary business practices, public policies or specific statements (IFRS 15.52). Variable consideration is occasionally referred to as contingent consideration. For more context, see Example 20 accompanying IFRS 15.

Implicit price concessions can also cause variability in consideration (see Example 2 accompanying IFRS 15). It might not always be apparent whether an entity has granted an implicit price concession or has incurred a subsequent impairment loss (IFRS 15.BC194). The distinction is important because a price concession is recognised as a decrease in revenue, while impairment losses are recognised as an expense. Unfortunately, IFRS 15 does not provide any guidance on how to differentiate between the two.


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Estimating variable consideration

When there’s variability in consideration, entities should estimate the amount they will be entitled to receive after taking all relevant factors into account (IFRS 15.50). The estimation of variable consideration should be based on either:

  • Most likely amount, or
  • Expected value.

The choice depends on which method more accurately forecasts the consideration the entity will receive (IFRS 15.53-54). The estimated transaction price should not include considerations from the potential exercise of options for additional goods or services or from future change orders (IFRS 15.BC186).

The expected value approach is most appropriate for a large volume of similar contracts or contracts with a significant number of possible outcomes. The most likely amount approach should be used for contracts with only two or three potential outcomes (IFRS 15.BC200). Refer to Examples 3, 21, 23, 24 accompanying IFRS 15.

At the end of each reporting period, entities should update the estimated transaction price, including revising its assessment of whether an estimate of variable consideration is constrained (IFRS 15.59). For further guidance, see Changes in transaction price.

Constraining estimates of variable consideration

If an estimate of variable consideration is highly uncertain, it can only be recognised as revenue to the extent that it is highly probable that a significant reversal in the cumulative revenue recognised will not occur when the uncertainty is subsequently resolved (otherwise known as ‘constraining estimates of variable consideration’) (IFRS 15.56). The ‘highly probable’ threshold is not defined in IFRS 15, but it is described in IFRS 5 as ‘significantly more likely than probable’ – a definition that is not particularly illuminating (note that ‘probable’ denotes a probability of more than 50% according to IFRS).

When determining if a significant reversal in cumulative revenue recognised is unlikely to occur after resolving the uncertainty around variable consideration, entities must weigh both the probability and magnitude of such a reversal. Several factors might heighten this likelihood or magnitude, including consideration highly influenced by external factors like market volatility, third-party decisions, weather, or risk of obsolescence. Other factors include prolonged uncertainty, limited or non-predictive experience with similar contracts, or a tendency to offer extensive price concessions (IFRS 15.57).

From the above definitions, it is clear that IFRS 15 applies a conservative approach to prevent premature or overstated revenue recognition. However, the requirements on constraining estimates of variable consideration do not eliminate the necessity to make estimates when determining the transaction price (IFRS 15.BC204). Please refer to Examples 23 (Case B), 24 and 25 accompanying IFRS 15 and examples below for further guidance.

Example: Constraining estimates of variable consideration

Consider Entity A, a renovation company that provides services to individual customers. It has entered into a contract for the renovation of an old house for a fixed fee of $50,000, with additional performance bonuses: $20,000 if the work is completed within 6 months, or $10,000 if it is completed between 6 and 8 months. No bonus is given if the work takes longer than 8 months. Based on Entity A’s extensive experience with similar contracts, it estimates the probabilities of receiving a performance bonus as follows:

  • $20,000: 50%,
  • $10,000: 30%,
  • $0: 20%.

Entity A opts for the expected value approach and includes $13,000 in the transaction price as variable consideration ($20,000 x 50% + $10,000 x 30% + $0 x 20%). Having considered all the factors relating to constraining estimates of variable consideration outlined in IFRS 15.57, Entity A concluded that it is unlikely a significant reversal in the cumulative revenue recognised will occur when the uncertainty is resolved. The total transaction price, including the estimated variable consideration, comes to $63,000. If the work is completed between 6 to 8 months, the revenue reversal would only be $3,000 (5% of the total transaction price), an insignificant percentage when applied to the total transaction price (refer also to IFRS 15.BC217). The expected value approach, by definition, limits the likelihood of significant reversals in cumulative revenue recognised as it accounts for probabilities when assessing the amount of variable consideration.

Right of return and other refund liabilities

Certain entities grant their customers the right to return a product, for instance, if they change their mind. This right might be stipulated in a contract or derived from standard business practices, public policies or specific statements.

If a customer returns a product, they may receive a refund, a voucher for another product, or a different product immediately. Technically speaking, a contract with a right of return has two performance obligations under IFRS 15: the obligation to deliver the goods to the customer and a standing obligation to accept the returned goods during the return period. For simplicity’s sake, the IASB has decided that a right of return is not to be treated as a separate performance obligation, thus there’s no need to estimate its stand-alone selling price. Instead, accounting for contracts with a right of return (IFRS 15.B21) should be as follows:

  • Recognise revenue excluding the amount attributed to products expected to be returned.
  • Unrecognised revenue from above is recognised as a refund liability.
  • Decrease the cost of sales and recognise a corresponding asset for the products expected to be returned. The value of this asset should account for expected costs to recover returned products and any decrease in value, if applicable.

All the relevant requirements relating to variable consideration also apply to accounting for rights of return (IFRS 15.B23). The estimate of the volume of products to be returned should be updated at the end of each reporting period, with corresponding adjustments to revenue and cost of sales (IFRS 15.B23-B25). In practice, the expected value approach is the best method for large volume sales to account for rights of return. For further guidance, see Examples 22 and 26 accompanying IFRS 15.

Rights to return a defective product or exchange one product for another of the same type, quality, condition and price are not deemed to be rights of return under IFRS 15.B26-B27.

If the entity anticipates refunding some or all of the consideration to a customer for reasons other than a right to return a product, a refund liability should be recognised instead of revenue (IFRS 15.55).

Example: Right of return

An entity sold 1,000 products at £200 each, totalling sales of £200,000. The cost of procuring each product was £150. The entity’s standard practice allows customers to return any unused product within 30 days for a full refund. Given this return policy, the consideration from these sales is considered variable.

To estimate this variable consideration, the entity employed the expected value method. This approach was selected as it most accurately forecasts the revenue the entity will ultimately receive. Under this method, the entity anticipates that 20 of the 1,000 products sold will be returned, leaving 980 products with the customers. Therefore, the estimated revenue, excluding potential returns, is £196,000 (£200 x 980 products).

In assessing whether to include this estimated variable consideration of £196,000 in the transaction price, the entity considered guidelines on constraining estimates of variable consideration. Despite not having control over product returns, the entity has extensive experience in predicting return rates for this specific product and customer segment. Moreover, the uncertainty surrounding returns will be resolved within a short period, namely the 30-day return window. As a result, the entity is confident that there won’t be a significant reversal in the recognised revenue once the uncertainty about returns is resolved. The entity also expects that the costs associated with recovering any returned products will be negligible and that these products can be resold profitably.

At the point of transferring the products, the entity recognises revenue for only those 980 products it expects not to be returned. The accounting entries are as follows:

  • DR Cash: £200,000 (representing sales of 1,000 products)
  • CR Revenue: £196,000 (representing revenue from 980 products not expected to be returned)
  • CR Refund Liability: £4,000 (representing potential refunds for 20 products expected to be returned)
  • CR Inventory: £150,000 (reflecting the cost of 1,000 products)
  • DR Cost of Sales: £147,000 (representing the cost associated with the 980 products not expected to be returned)
  • DR Refund Asset: £3,000 (reflecting the right to recover 20 products from customers if a refund is processed).

Sales-based or usage-based royalties

Guidance on revenue from sales-based or usage-based royalties can be found in IFRS 15.B63-B63B. Revenue from these sources is only recognised when the later of these events occurs:

  • Subsequent sale or usage occurs, and
  • Performance obligation to which the royalty has been allocated is fully or partially satisfied.

These specific recognition criteria supersede the general requirements for recognition of variable consideration. For further guidance, see Examples 57, 60, and 61 accompanying IFRS 15.

See also Revenue from Licensing of Intellectual Property.

Significant financing component

A significant financing component exists when the timing of payments provides or requires financing to the customer or to the entity. If a contract contains a significant financing component, the consideration (to be) received should be adjusted accordingly to reflect this. In other words, revenue must be recognised at a cash selling price or otherwise determined using a discount rate that would be applicable in a separate financing transaction between the entity and its customer at the contract inception (IFRS 15.60-61).

Even if not explicitly mentioned in the contract, a significant financing component can be implied by the payment terms. Several factors (IFRS 15.61) must be considered:

  1. Any difference between the promised consideration and the cash selling price of the goods or services.
  2. The cumulative impact of the following:
  • The expected duration between when the entity transfers the promised goods or services to the customer and when the customer pays for them.
  • The prevailing interest rates in the relevant market.

For further guidance, see Examples 26, 27, 29 and 30 accompanying IFRS 15.

IFRS 15.BC234 clarifies that the significance of a financing component should only be assessed at the contract level, rather than considering its materiality to the entity as a whole.

Financing effects should be presented as separate interest income apart from revenue from contracts with customers. For advance payments comprising a significant financing component, the unwinding of discount is presented as an interest expense. As a practical expedient, IFRS 15.63 allows the financing component to be disregarded if the transfer of goods or services and the related payment occur within a 12-month period.

Discount rate

The determination of the discount rate is addressed in IFRS 15.64. Entities should use a risk-adjusted rate rather than a risk-free rate. This adjusted rate should take into account the customer’s credit risk and any collaterals, if applicable. If a cash price for the goods or services can be identified, the applicable discount rate can be the rate that discounts the nominal consideration to the ‘spot’ cash price (see Example 28 accompanying IFRS 15). Even if market rates or customer credit risk change, the discount rate is not updated after the contract’s inception (IFRS 15.65).

No significant financing component despite timing differences

IFRS 15.62 provides guidance for situations where significant timing differences exist, but there is no significant financing component. These situations may include:

  • The customer paid for the goods or services in advance, and the timing of their transfer is at the customer’s discretion (e.g., prepaid gift cards).
  • A substantial portion of the consideration promised by the customer is variable, and the amount or timing of that consideration depends on a future event that is beyond the customer or the entity’s control (e.g., a sales-based royalty).
  • The difference between the promised consideration and the cash selling price of the goods or services arises for reasons other than the provision of finance to either the customer or the entity, and this difference is proportional to its cause (e.g., payments as a form of assurance of performance).

Non-cash consideration

Non-cash consideration received from a customer is measured at the fair value of the received goods or services. Alternatively, if the fair value of the consideration received cannot be reliably measured, it can be determined indirectly by referring to the stand-alone selling price of the goods or services provided to the customer in exchange for this non-cash consideration (IFRS 15.66-68).

Should a customer contribute goods or services (such as materials, equipment, or labour) to facilitate an entity’s fulfilment of the contract, this is treated as non-cash consideration only if the entity obtains control of the contributed goods or services (IFRS 15.69). Please refer to Example 31 accompanying IFRS 15 for further details.

Regrettably, IFRS 15 does not provide guidance on the measurement date, necessitating an entity to develop its own policy. Common approaches include: contract inception, satisfaction of performance obligation, or receipt of consideration. US GAAP require non-cash consideration to be measured at the inception of the contract. Moreover, under US GAAP, any subsequent changes in fair value are accounted for in accordance with other applicable standards and excluded from revenue from contracts with customers. The IASB decided not to incorporate similar clarifications into IFRS 15 (refer to IFRS 15.BC254A-BC254H).

Consideration payable to a customer

Any consideration payable to a customer is treated as a reduction in the transaction price and revenue. Such consideration includes cash and similar items (coupons, vouchers) payable to the customer or to other parties that purchase the entity’s goods or services from the customer (down the distribution chain) (IFRS 15.70). Common arrangements where consideration payable to a customer should be deducted from the transaction price include:

  • Fees paid by a manufacturer or wholesaler for their products to be prominently displayed by a retailer, or for access to a retailer’s distribution chain, and
  • Reimbursements to a retailer due to poor sales of a product (including reimbursements due to discounts offered by the retailer to end customers).

See also Example 32 accompanying IFRS 15.

If the consideration payable to a customer is made in exchange for distinct goods or services, but it exceeds their fair value, the difference is still recognised as a reduction in revenue. If the fair value of distinct goods or services bought from a customer cannot be reliably measured, all consideration payable to a customer is recognised as a reduction in revenue (IFRS 15.71-72).

Significant judgement is needed when accounting for contracts where a customer receives a gift card which can be used for purchases with various retailers. Such vouchers are often in substance a substitute for cash payments and should therefore be deducted from the transaction price and revenue.

Customer credit risk

As mentioned earlier, the transaction price is the amount of consideration an entity expects to receive, excluding the impact of customer credit risk. However, it is worth noting that revenue should not be artificially inflated as highlighted in Probability of payment.

Amounts collected on behalf of third parties

Amounts collected on behalf of third parties are excluded from the transaction price (IFRS 15.47). Typical examples of such amounts include VAT and excise duties. It may not always be clear whether certain amounts should be presented gross as revenue and expenses or offset in the income statement. In the case of taxes, it largely depends on local law. If in doubt, the principal vs agent considerations may be helpful.

Expenses recharged to the customer

Some contracts include clauses that allow an entity to recharge expenses incurred to the customer (for example, travel expenses). In such cases, it is generally inappropriate to offset these amounts in the income statement as they are not collected on behalf of third parties. These are expenses incurred in fulfilling the contract and should be presented as expenses (and revenue from a customer).

Allocating the transaction price to performance obligations

The transaction price must be allocated to each performance obligation promised in the contract (IFRS 15.73).

Allocation based on stand-alone selling prices

Stand-alone selling price

The transaction price should be allocated to each performance obligation on a relative stand-alone selling price (‘SSP’) basis (IFRS 15.74). The SSP is the price an entity would charge to sell a promised good or service separately to a customer. The most reliable evidence of SSP is the observable price of a good or service when the entity sells it separately in similar circumstances and to similar customers. While a contractually stated price or a list price for a good or service may be the SSP of that good or service, this is not always the case (IFRS 15.76-77).

If the SSP is not directly observable, entities should estimate it using all available information and maximising observable inputs. IFRS 15.79 outlines several methods for estimating SSP, such as:

  • Adjusted market assessment approach.
  • Expected cost plus a margin approach.
  • Residual approach.

Different methods can also be combined if two or more goods or services have highly variable or uncertain stand-alone selling prices (IFRS 15.80). For a simple approach to allocation mechanics, please refer to Example 33 accompanying IFRS 15.

Adjusted market assessment approach

Under this approach, the entity evaluates the market and estimates the price that a customer in that market would be willing to pay. This method often utilises prices charged by competitors as a key input.

Expected cost plus a margin approach

In this method, the SSP is estimated based on the expected costs of providing a good or service, increased by an appropriate margin. However, IFRS 15 does not provide further guidance on what constitutes an appropriate margin. Entities should certainly seek to maximise observable inputs, such as market conditions.

Residual approach

Under the residual approach, the SSP is determined by subtracting the sum of the observable SSPs of other goods or services promised in the contract from the total transaction price. One of the following two criteria must be met to apply the residual approach:

  • Entity sells the same good or service to different customers (at or near the same time) for a broad range of prices (e.g. intellectual properties or intangible assets), or
  • Entity has not yet established a price for that good or service, and the good or service has not previously been sold on a stand-alone basis.

For further information, refer to Example 34 Cases B and C accompanying IFRS 15.

Allocating discount

As a general rule, a discount provided to a customer for purchasing a bundle of goods or services should be proportionately allocated to all performance obligations in the contract (IFRS 15.81). However, there may be circumstances where the discount is linked only to one or several, but not all, performance obligations. This is especially likely when low margin and high margin products are sold together in a bundle, and proportionately allocating the discount would lead to the low margin product being sold at a loss. Hence, an entity should allocate a discount to only selected performance obligations if all the criteria outlined in IFRS 15.82 are met:

  • The entity regularly sells each distinct good or service (or each bundle of distinct goods or services) on a stand-alone basis.
  • The entity also frequently sells a bundle (or bundles) of some of those distinct goods or services at a discount to the SSPs of the goods or services in each bundle.
  • The discount attributable to each bundle of goods or services from point 2 above aligns closely with the discount in the specific contract, and an analysis of the goods or services in each bundle provides observable evidence of the performance obligation (or obligations) to which the entire discount in the contract pertains.

Allocation of discount is illustrated in Example 34 accompanying IFRS 15.

Allocating variable consideration

Variable consideration may be allocated to all performance obligations, or only to selected ones, based on specific facts and circumstances. IFRS 15.85 outlines the criteria for allocating variable consideration solely to a specific part of a contract:

  • Terms of a variable payment are directly linked to the entity’s efforts to satisfy the performance obligation or transfer the distinct good or service, and
  • Allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service aligns with the allocation objective when taking into account all of the performance obligations and payment terms in the contract.

Please refer to Example 35 accompanying IFRS 15 for further discussion.

Changes in transaction price

Changes in transaction price that aren’t the result of contract modifications (for example, resolution of uncertain events) should be allocated to performance obligations on the same basis as at contract inception, regardless of any changes in the stand-alone selling price since then. Sums allocated to an already satisfied performance obligation are thus recognised as a one-off increase or decrease in revenue when the transaction price changes (IFRS 15.87-88).

However, changes in transaction price should be entirely allocated to one or more, but not all, performance obligations if the same criteria outlined in IFRS 15.85 for allocating variable consideration to a single performance obligation are met (IFRS 15.89).

Changes in transaction price due to contract modification, including unpriced change orders, are discussed in Allocating variable consideration.

More about IFRS 15

See other pages relating to IFRS 15:

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