Transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties, e.g. VAT (IFRS 15.47). Transaction price is determined after taking into account the impact of the following (IFRS 15.48):
- variable consideration,
- the existence of a significant financing component in the contract,
- non-cash consideration,
- consideration payable to a customer.
When determining the transaction price, entities should assume that the goods or services will be transferred to the customer as promised in the existing contract and that the contract will not be cancelled, renewed or modified (IFRS 15.49).
Sources of variability
Sometimes the amount of consideration depends on various factors, such as discounts, rebates, performance bonuses, rights of return, penalties (e.g. for delays or cancellations), price protection, SLAs (service level agreements) and other items (IFRS 15.51). Variability of consideration may be explicitly written in the contract (also as a penalty reducing revenue), but may also result from other factors, such as customary business practices, published policies or specific statements (IFRS 15.52). Variable consideration is sometimes referred to as contingent consideration. See also Example 20 accompanying IFRS 15.
Variability of consideration may result also from implicit price concessions (see Example 2 accompanying IFRS 15). It may not always be obvious whether an entity has granted implicit price concession or incurred a subsequent impairment loss (IFRS 15.BC194). The significance of this distinction is that the price concession is recognised as a decrease in revenue, whereas impairment losses are recognised as an expense. Unfortunately, IFRS 15 does not contain any guidance on making this distinction.
Estimating variable consideration
When some variability of consideration exists, entities should estimate how much they will be entitled to receive after taking into account all the relevant factors (IFRS 15.50). The estimation of variable consideration should be based on:
- the most likely amount, or
- expected value approach.
depending on which method better predicts the amount of consideration which the entity will be entitled to (IFRS 15.53-54).
The expected value approach is best suited for large volume of similar contracts or contracts with a large number of possible outcomes. The most likely amount approach should be applied to contracts where only two or three outcomes are possible (IFRS 15.BC200). See Examples 3, 21, 23, 24 accompanying IFRS 15.
The estimated transaction price should be reassessed at the end of each reporting period. See Example 8 accompanying IFRS 15.
Estimated transaction price does not include estimates of consideration from the future exercise of options for additional goods or services or from future change orders (IFRS 15.BC186).
At the end of each reporting period, entities should update the estimated transaction price, including updating its assessment of whether an estimate of variable consideration is constrained (IFRS 15.59). Accounting for changes in the transaction price is covered in a separate section.
Constraining estimates of variable consideration
If an estimate of variable consideration is too uncertain, it can be recognised as revenue only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty is subsequently resolved (so-called ‘constraining estimates of variable consideration’) (IFRS 15.56). The ‘highly probable’ threshold is not defined in IFRS 15, but it is defined in IFRS 5 as ‘significantly more likely than probable’ – which is not that much helpful (remember that ‘probable’ means probability of >50% in IFRS).
As we can see from the definitions above, IFRS 15 is prudent here and does not want revenue to be recognised too early, or overstated at any point. However, the requirements on constraining estimates of variable consideration do not override the necessity to make estimates in determining the transaction price (IFRS 15.BC204). Paragraph IFRS 15.57 provides examples of factors that could increase the likelihood or the magnitude of a revenue reversal.
See also Examples 23 (Case B), 24 and 25 accompanying IFRS 15 and examples below.
Example: Constraining estimates of variable consideration
Entity A is a renovation company that provides renovation services for individual customers. It entered into a contract with a customer for renovation of an old house. The contract has a fixed fee of $50,000 plus the following performance bonuses: $20,000 if the work is completed in no more than 6 months or $10,000 if the work is completed in 6 to 8 months. There is no performance bonus if the work takes longer than 8 months. Entity A has considerable experience in similar contracts and concludes that the probabilities of achieving a performance bonus are as follows:
$20,000: probability 50%
$10,000: probability 30%
$0: probability 20%
Entity A decides do adopt an expected value approach and include $13,000 in transaction price as variable consideration ($20,000 x 50% + $10,000 x 30% + $0 x 20%). Entity A considered all the factors relating to constraining estimates of variable consideration listed in IFRS 15.57 and concluded that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty is resolved. Total transaction price, including estimated variable consideration, amounts to $63,000. If the entity completes the work in 6 to 8 months, the revenue reversal will amount to only $3,000 (5% of total transaction price), which is an insignificant percentage when applied to the total transaction price (see also IFRS 15.BC217).
It is worth noting that the expected value approach limits, to some extent, the likelihood of significant reversal in the amount of cumulative revenue recognised, because the probabilities are by definition taken into account when assessing the amount of variable consideration.
Right of return and other refund liabilities
Some entities grant their customer a right to return a product (e.g. if they change their mind). This right may be written in a contract or result from customary business practices, published policies or specific statements.
When a customer returns a product, they can receive the money back, a voucher to purchase another product or a different product right away. Strictly speaking, a contract with a right of return contains two performance obligations from IFRS 15 perspective: obligation to provide the good to the customer and a stand-ready obligation to accept the goods returned by the customer during the return period. For the sake of simplicity, IASB decided to provide a relief and a right of return is not accounted for as a separate performance obligation (e.g. there is no need to estimate a stand-alone selling price). Instead, the following approach should be applied for contracts with a right of return (IFRS 15.B21):
- Revenue is recognised excluding the amount attributable to products expected to be returned.
- Unrecognised revenue from point 1. is recognised as a refund liability.
- Cost of sales is decreased and a corresponding asset is recognised for the products expected to be returned. Value of this asset should take into account expected costs to recover returned products and decrease in value, if applicable.
All the relevant requirements relating to variable consideration apply also to accounting for rights of return (IFRS 15.B23). The assessment of 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, for large volume of sales, the expected value approach is the best way to account for rights of return. See Examples 22 and 26 accompanying IFRS 15.
Rights to return a defective product or to exchange one product for another of the same type, quality, condition and price are not considered to be rights of return under IFRS 15.B26-B27.
If the entity expects to refund 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).
Sales-based or usage-based royalties
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.
Significant financing component
Overview of the requirements relating to significant financing component
When a contract contains a significant financing component, the consideration receivable (or received) should be adjusted to reflect that, i.e. it should be recognised in a cash selling price or otherwise determined using discount rate that would be reflected in a separate financing transaction between the entity and its customer at contract inception (IFRS 15.60-61). The existence of a significant financing component need not be explicitly stated in the contract – it can be implied by the payment terms. Paragraph IFRS 15.61 lists examples of facts and circumstances that should be considered:
- the difference, if any, between the amount of promised consideration and the cash selling price of the promised goods or services
- the combined effect of both of the following:
- the expected length of time between when the entity transfers the promised goods or services to the customer and when the customer pays for those goods or services; and
- the prevailing interest rates in the relevant market.
See Examples 26, 27,29 and 30 accompanying IFRS 15.
Paragraph IFRS 15.BC234 explains that the entity should consider the significance of a financing component at a contract level only rather than considering whether the financing is material to the entity as a whole when taken all the contracts altogether.
The effects of financing should be presented as interest revenue/income separately from revenue from contracts with customers. In case of receiving advance payments constituting a significant financing component, the unwinding of discount is presented as interest expense.
Paragraph IFRS 15.63 offers a practical expedient to ignore the financing component if the transfer of goods or services and related payment are no more than 12 months apart.
Determination of discount rate is covered in paragraph IFRS 15.64. This paragraph explains that entities cannot use risk free rate, but risk-adjusted rate, which takes into account customer credit risk and collaterals, if applicable. If a cash-price of the goods/services can be identified, the discount rate applied can be the rate that discounts the nominal amount of the consideration to the ‘spot’ cash price. See Example 28 accompanying IFRS 15.
The discount rate is not updated after contract inception, even if market rates or customer credit risk change (IFRS 15.65).
No significant financing component despite existence of significant timing differences
Paragraph IFRS 15.62 provides some specific factors indicating that there is no significant financing component despite existence of significant differences between timing of payments and satisfaction of performance obligations:
- 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 (e.g. pre-paid gift cards),
- 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 (e.g. a sales-based royalty),
- the difference between the promised consideration and the cash selling price of the good or service 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 (e.g. payments as means of assurance that the party will perform as promised).
Overview of requirements relating to non-cash consideration
Non-cash consideration provided by a customer is measured at fair value of the assets received. Alternatively, if the fair value of consideration received cannot be measured reliably, it can be determined indirectly by reference to the stand-alone selling price of the goods or services delivered to the customer in exchange for this non-cash consideration (IFRS 15.66-68).
If a customer contributes goods or services (for example, materials, equipment or labour) to facilitate an entity’s fulfilment of the contract, it is treated as non-cash consideration only if the entity obtains control of those contributed goods or services (IFRS 15.69). See Example 31 accompanying IFRS 15.
Measurement of non-cash consideration
Unfortunately, IFRS 15 is silent on the measurement date, therefore an entity needs to develop its own policy. The most common approaches are: contract inception, satisfaction of performance obligation, receipt of consideration. US GAAP revenue recognition standards require non-cash consideration to be measured at the inception of the contract. Additionally, under US GAAP, any subsequent changes in fair value are accounted for in accordance with other applicable standards and they are excluded from revenue from contracts with customers. IASB decided not to add similar clarifications to IFRS 15 (see IFRS 15.BC254A-BC254H).
Consideration payable to a customer
Consideration payable to a customer is treated as a reduction in 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 (i.e. all the way down the distribution chain) (IFRS 15.70). Examples of common arrangements when consideration is payable to customer and should be deducted from transaction price include:
- fees payable by manufacturer or wholesaler for displaying their products prominently by the retailer,
- fees payable by manufacturer or wholesaler for receiving access to retailer’s distribution chain,
- reimbursements to retailer by manufacturer or wholesaler for poor sales of a product (including reimbursements due to discounted prices that had to be offered by 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 revenue reduction. When fair value of distinct goods or services purchased from a customer cannot be reliably measured, all consideration payable to a customer is recognised as a revenue reduction (IFRS 15.71-72).
Significant judgement is needed in 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 as such should be deducted from the transaction price and revenue.
Customer credit risk
As mentioned earlier, the transaction price is the amount of consideration to which an entity expects to be entitled. It therefore excludes the impact of customer credit risk. However, revenue cannot be artificially inflated as discussed in the section on probability of receiving 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 obvious whether certain amounts should be presented as revenue and expenses or offset without impact in P/L. In case of taxes, it very much depends on local law. In case of doubt, the principal vs. agent considerations may be helpful.
Expenses recharged to the customer
Some contracts include clauses allowing an entity to recharge incurred expenses to the customer (e.g. travel expenses). In such cases, it is generally not appropriate to offset these amounts in P/L as they are not collected on behalf of third parties, they 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
Transaction price should be allocated to each performance obligation promised in the contract (IFRS 15.73).
Allocation based on stand-alone selling prices
Stand-alone selling price
Transaction price should be allocated to each performance obligation on a relative stand-alone selling price (‘SSP’) basis (IFRS 15.74). SSP is the price at which an entity would sell a promised good or service separately to a customer. The best evidence of SSP is the observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers. A contractually stated price or a list price for a good or service may be (but cannot be presumed to be) the SSP of that good or service (IFRS 15.76-77).
If SSP is not directly observable, entities should estimate it making use of all available information and maximising observable inputs. Paragraph IFRS 15.79 lists the following examples of methods for estimating SSP:
Combination of different methods is also allowed if two or more of goods or services have highly variable or uncertain stand-alone selling prices (IFRS 15.80).
Example 33 accompanying IFRS 15 illustrates simple approach to allocation mechanics.
Adjusted market assessment approach
In this approach, the entity evaluates the market and estimates the price that a customer in that market would be willing to pay. This approach often treats prices charged by competitors as a significant input.
Expected cost plus a margin approach
In this approach, the stand-alone selling price is estimated based on expected costs of providing a good or service increased by an appropriate margin. IFRS 15 does not elaborate on what an appropriate margin is. For sure, entities should maximise observable inputs, such as market conditions.
Under the residual approach, the stand-alone selling price is determined as the difference between the total transaction price less the sum of the observable stand-alone selling prices of other goods or services promised in the contract. One of the two following criteria must be met in order to apply the residual approach:
- the 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
- the 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.
See Example 34 Cases B and C accompanying IFRS 15.
Allocation of a discount
As a rule, a discount given to a customer for purchasing a bundle of goods or services should be allocated proportionately to all performance obligations in the contract (IFRS 15.81). It is however possible that a discount relates to only one or more, but not all, performance obligations. This is especially true when low margin and high margin products are sold together in a bundle and allocating discount proportionately would result in the low margin product being sold at a loss. Therefore, the entity should allocate a discount to only selected performance obligations if the criteria specified in paragraph IFRS 15.82 are met (see also Example 34 accompanying IFRS 15):
- 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 regularly sells on a stand-alone basis a bundle (or bundles) of some of those distinct goods or services at a discount to the stand-alone selling prices of the goods or services in each bundle; and
- the discount attributable to each bundle of goods or services from point b. above is substantially the same as the discount in the contract in question and an analysis of the goods or services in each bundle provides observable evidence of the performance obligation (or performance obligations) to which the entire discount in the contract belongs.
Allocation of variable consideration
Depending on facts and circumstances, variable consideration may be allocated to all performance obligations or only to selected performance obligations. Paragraph IFRS 15.85 provides criteria for allocating a variable consideration only to a specific part of a contract:
- 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; and
- allocating the variable amount of consideration entirely to the performance obligation or the distinct good or service is consistent with the allocation objective when considering all of the performance obligations and payment terms in the contract.
See Example 35 accompanying IFRS 15.
Changes in transaction price
Changes in transaction price resulting from contract modification, including unpriced change orders, are covered on a separate page. Other changes in transaction price should be allocated to performance obligations on the same basis as at contract inception, even if stand-alone selling price has changed since then. Amounts allocated to an already satisfied performance obligation are therefore 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 allocated entirely to one or more, but not all, performance obligations if the same criteria as set out in IFRS 15.85 for allocating variable consideration to a single performance obligation are met (IFRS 15.89).
Changes in transaction price may result from contract modifications. If a change in transaction price takes place after the contract modification, paragraph IFRS 15.90 applies.
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