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contract within the scope of the model exists. Once an entity determines that an IFRS 15
contract exists, it is required to identify the promises in the contract. Therefore, if the
entity has transferred goods or services prior to the existence of an IFRS 15 contract, we
believe that the free goods or services provided during the trial period would generally
be accounted for as marketing incentives.
Consider an example in which an entity has a marketing programme to provide a three
month free trial period of its services to prospective customers. The entity’s customers
are not required to pay for the services provided during the free trial period and the
entity is under no obligation to provide the services under the marketing programme. If
a customer enters into a contract with the entity at the end of the free trial period that
obligates the entity to provide services in the future (e.g. signing up for a subsequent 12-
month period) and obligates the customer to pay for the services, the services provided
as part of the marketing programme may not be promises that are part of an enforceable
contract with the customer.
However, if an entity, as part of a negotiation with a prospective customer, agrees to
provide three free months of services if the customer agrees to pay for 12 months of
services (effectively providing the customer a discount on 15 months), the entity would
identify the free months as promises in the contract because the contract requires it to
provide them.
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The above interpretation applies if the customer is not required to pay any
consideration for the additional goods or services during the trial period (i.e. they are
free). If the customer is required to pay consideration in exchange for the goods or
services received during the trial period (even if it is only a nominal amount), a different
accounting conclusion could be reached. Entities need to apply judgement to evaluate
whether a contract exists that falls within the scope of the standard.
4.1.1.C Consideration
of side agreements
All terms and conditions that create or negate enforceable rights and obligations must
be considered when determining whether a contract exists under the standard.
Understanding the entire contract, including any side agreements or other amendments,
is critical to this determination.
Side agreements are amendments to a contract that can be either undocumented or
documented separately from the main contract. The potential for side agreements is
greater for complex or material transactions or when complex arrangements or
relationships exist between an entity and its customers. Side agreements may be
communicated in many forms (e.g. oral agreements, email, letters or contract
amendments) and may be entered into for a variety of reasons.
Side agreements may provide an incentive for a customer to enter into a contract near the
end of a financial reporting period or to enter into a contract that it would not enter into
in the normal course of business. Side agreements may entice a customer to accept
delivery of goods or services earlier than required or may provide the customer with rights
in excess of those customarily provided by the entity. For example, a side agreement may
extend contractual payment terms; expand contractually stated rights; provide a right of
return; or commit the entity to provide future products or functionality not contained in
the contract or to assist resellers in selling a product. Therefore, if the provisions in a side
agreement differ from those in the main contract, an entity should assess whether the side
agreement creates new rights and obligations or changes existing rights and obligations.
See 4.3 and 4.4 below, respectively, for further discussion of the standard’s requirements
on combining contracts and contract modifications.
4.1.2
Parties have approved the contract and are committed to perform
their respective obligations
Before applying the model in IFRS 15, the parties must have approved the contract. As
indicated in the Basis for Conclusions, the Board included this criterion because a
contract might not be legally enforceable without the approval of both parties.
[IFRS 15.BC35]. Furthermore, the Board decided that the form of the contract (i.e. oral,
written or implied) is not determinative, in assessing whether the parties have approved
the contract. Instead, an entity must consider all relevant facts and circumstances when
assessing whether the parties intend to be bound by the terms and conditions of the
contract. In some cases, the parties to an oral or implied contract may have the intent
to fulfil their respective obligations. However, in other cases, a written contract may be
required before an entity can conclude that the parties have approved the arrangement.
[IFRS 15.10].
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In addition to approving the contract, the entity must also be able to conclude that
both parties are committed to perform their respective obligations. That is, the entity
must be committed to providing the promised goods or services. In addition, the
customer must be committed to purchasing those promised goods or services. In the
Basis for Conclusions, the Board clarified that an entity and a customer do not always
have to be committed to fulfilling all of their respective rights and obligations for a
contract to meet this requirement. [IFRS 15.BC36]. The Board cited, as an example, a
supply agreement between two parties that includes stated minimums. The customer
does not always buy the required minimum quantity and the entity does not always
enforce its right to require the customer to purchase the minimum quantity. In this
situation, the Board stated that it may still be possible for the entity to determine that
there is sufficient evidence to demonstrate that the parties are substantially
committed to the contract. This criterion does not address a customer’s intent and
ability to pay the consideration (i.e. collectability). Collectability is a separate
criterion and is discussed at 4.1.6 below.
Termination clauses are also an important consideration when determining whether
both parties are committed to perform under a contract and, consequently, whether a
contract exists. See 4.2 below for further discussion of termination clauses and how they
affect contract duration.
Legacy IFRS did not provide specific application guidance on oral contracts. However,
entities were required to consider the underlying substance and economic reality of an
arrangement and not merely its legal form. The 2010 – Conceptual Framework for
Financial Reporting – states that representing a legal form that differs from the
economic substance of the underlying economic phenomenon may not result in a
faithful representation. [CF(2010) BC3.26, CF 2.12].
Despite the focus on substance over form in IFRS, treating oral or implied agreements
as contracts is likely to be a significant change in practice for some entities. It may have
led to earlier accounting for oral agreements, i.e. not waiting until such agreements are
formally documented.
4.1.3
Each party’s rights regarding the goods or
services to be transferred
can be identified
This criterion is relatively straightforward. If the goods or services to be provided in the
arrangement cannot be identified, it is not possible to conclude that an entity has a
contract within the scope of the model in IFRS 15. The Board indicated that if the
promised goods or services cannot be identified, the entity cannot assess whether those
goods or services have been transferred because the entity would be unable to assess
each party’s rights with respect to those goods or services. [IFRS 15.BC37].
4.1.4
Payment terms can be identified
Identifying the payment terms does not require that the transaction price be fixed or
stated in the contract with the customer. As long as there is an enforceable right to
payment (i.e. enforceability as a matter of law) and the contract contains sufficient
information to enable the entity to estimate the transaction price (see further discussion
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at 6 below), the contract would qualify for accounting under the standard (assuming the
remaining criteria set out in paragraph 9 of IFRS 15 have been met – see 4.1 above).
4.1.5 Commercial
substance
The Board included a criterion that requires arrangements to have commercial
substance (i.e. the risk, timing or amount of the entity’s future cash flows is expected to
change as a result of the contract) to prevent entities from artificially inflating revenue.
[IFRS 15.BC40]. The model in IFRS 15 does not apply if an arrangement does not have
commercial substance. Historically, some entities in high-growth industries allegedly
engaged in transactions in which goods or services were transferred back and forth
between the same entities in an attempt to show higher transaction volume and gross
revenue (sometimes known as ‘round-tripping’). This is also a risk in arrangements that
involve non-cash consideration.
Determining whether a contract has commercial substance for the purposes of IFRS 15
may require significant judgement. In all situations, the entity must be able to
demonstrate a substantive business purpose exists, considering the nature and structure
of its transactions.
In a change from the legacy requirements in SIC-31, IFRS 15 does not contain
requirements specific to advertising barter transactions. We anticipate entities will need
to carefully consider the commercial substance criterion when evaluating these types
of transactions.
4.1.6 Collectability
Under IFRS 15, collectability refers to the customer’s ability and intent to pay the
amount of consideration to which the entity will be entitled in exchange for the goods
or services that will be transferred to the customer. An entity should assess a customer’s
ability to pay based on the customer’s financial capacity and its intention to pay
considering all relevant facts and circumstances, including past experiences with that
customer or customer class. [IFRS 15.BC45].
In the Basis for Conclusions, the Board noted that the purpose of the criteria in
paragraph 9 of IFRS 15 is to require an entity to assess whether a contract is valid and
represents a genuine transaction. The collectability criterion (i.e. determining whether
the customer has the ability and the intention to pay the promised consideration) is a
key part of that assessment. In addition, the Board noted that, in general, entities only
enter into contracts in which it is probable that the entity will collect the amount to
which it will be entitled. [IFRS 15.BC43]. That is, in most instances, an entity would not
enter into a contract with a customer if there was significant credit risk associated with
that customer without also having adequate economic protection to ensure that it would
collect the consideration. The IASB expects that only a small number of arrangements
may fail to meet the collectability criterion. [IFRS 15.BC46E].
The standard requires an entity to evaluate at contract inception (and when significant
facts and circumstances change) whether it is probable that it will collect the
consideration to which it will be entitled in exchange for the goods or services that will
be transferred to a customer. This is consistent with legacy IFRS, where revenue
recognition was permitted only when it was probable that the economic benefits
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associated with the transaction would flow to the entity (assuming other basic revenue
recognition criteria had been met).
For purposes of this analysis, the meaning of the term ‘probable’ is consistent with the
existing definition in IFRS, i.e. ‘more likely than not’. [IFRS 15 Appendix A]. If it is not
probable that the entity will collect amounts to which it is entitled, the model in IFRS 15
is not applied to the contract until the concerns about collectability have been resolved.
However, other requirements in IFRS 15 apply to such arrangements (see 4.5 below for
further discussion).
Paragraph 9(e) of IFRS 15 specifies that an entity should only assess only the
consideration to which it will be entitled in exchange for the goods or services that will
be transferred to the customer (rather than the total amount promised for all goods or
services in the contract). [IFRS 15.9(e)]. In the Basis for Conclusions, the Board noted that,
if the customer were to fail to perform as promised and the entity were able to stop
transferring additional goods or services to the customer in response, the entity would
not consider the likelihood of payment for those goods or services that would not be
transferred in its assessment of collectability. [IFRS 15.BC46].
In the Basis for Conclusions, the Board also noted that the assessment of collectability
criteria requires an entity to consider how the entity’s contractual rights to the
consideration relate to its performance obligations. That assessment considers the
business practices available to the entity to manage its exposure to credit risk
throughout the contract (e.g. through advance payments or the right to stop transferring
additional goods or services). [IFRS 15.BC46C].
The amount of consideration that is assessed for collectability is the amount to which
the entity will be entitled, which under the standard is the transaction price for the
goods or services that will be transferred to the customer, rather than the stated
contract price for those items. Entities need to determine the transaction price in
Step 3 of the model (as discussed in 6 below) before assessing the collectability of
that amount. The contract price and transaction price most often will differ because
of variable consideration (e.g. rebates, discounts or explicit or implicit price
concessions) that reduces the amount of consideration stated in the contract. For
example, the transaction price for the items expected to be transferred may be less
than the stated contract price for those items if an entity concludes that it has offered,
or is willing to accept, a price concession on products sold to a customer as a means
to assist the customer in selling those items through to end-consumers. As discussed
at 6.2.1.A below, an entity deducts from the contract price any variable consideration
that
would reduce the amount of consideration to which it expects to be entitled
(e.g. the estimated price concession) at contract inception in order to derive the
transaction price for those items.
The standard provides the following example of how an entity would assess the
collectability criterion. [IFRS 15.IE3-IE6].
Example 28.9: Collectability of the consideration
An entity, a real estate developer, enters into a contract with a customer for the sale of a building for CU1 million.
The customer intends to open a restaurant in the building. The building is located in an area where new
restaurants face high levels of competition and the customer has little experience in the restaurant industry.
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The customer pays a non-refundable deposit of CU50,000 at inception of the contract and enters into a long-
term financing agreement with the entity for the remaining 95 per cent of the promised consideration. The
financing arrangement is provided on a non-recourse basis, which means that if the customer defaults, the
entity can repossess the building, but cannot seek further compensation from the customer, even if the
collateral does not cover the full value of the amount owed. The entity’s cost of the building is CU600,000.
The customer obtains control of the building at contract inception.
In assessing whether the contract meets the criteria in paragraph 9 of IFRS 15, the entity concludes that
the criterion in paragraph 9(e) of IFRS 15 is not met because it is not probable that the entity will collect
the consideration to which it is entitled in exchange for the transfer of the building. In reaching this
conclusion, the entity observes that the customer’s ability and intention to pay may be in doubt because of
the following factors:
• the customer intends to repay the loan (which has a significant balance) primarily from income derived
from its restaurant business (which is a business facing significant risks because of high competition in
the industry and the customer’s limited experience);
• the customer lacks other income or assets that could be used to repay the loan; and
• the customer’s liability under the loan is limited because the loan is non-recourse.
Because the criteria in paragraph 9 of IFRS 15 are not met, the entity applies paragraphs 15-16 of IFRS 15
to determine the accounting for the non-refundable deposit of CU50,000. The entity observes that none of