the events described in paragraph 15 have occurred – that is, the entity has not received substantially all
of the consideration and it has not terminated the contract. Consequently, in accordance with paragraph 16,
the entity accounts for the non-refundable CU50,000 payment as a deposit liability. The entity continues
to account for the initial deposit, as well as any future payments of principal and interest, as a deposit
liability, until such time that the entity concludes that the criteria in paragraph 9 are met (i.e. the entity is
able to conclude that it is probable that the entity will collect the consideration) or one of the events in
paragraph 15 has occurred. The entity continues to assess the contract in accordance with paragraph 14 to
determine whether the criteria in paragraph 9 are subsequently met or whether the events in paragraph 15
of IFRS 15 have occurred.
While this requirement is similar to the legacy requirements in IAS 18, applying the
concept to a portion of the contractual amount, instead of the total, is likely to be a
significant change. Before revenue could be recognised under IAS 18, it had to be
probable that the economic benefits associated with the transaction would flow to the
entity. [IAS 18.14(b), 18, 20(b)]. In practice, entities likely considered the entire contractually
agreed consideration under IAS 18. If so, the requirements in IFRS 15 could result in the
earlier recognition of revenue for a contract in which a portion of the contract price
(but not the entire amount) is considered to be at risk.
Significant judgement is required to determine when an expected partial payment
indicates that there is an implied price concession in the contract, there is an impairment
loss or the arrangement lacks sufficient substance to be considered a contract under the
standard. See 6.2.1.A below for further discussion on implicit price concessions.
ASC 606 also uses the term ‘probable’ for the collectability assessment. However,
‘probable’ under US GAAP is a higher threshold than under IFRS.19
The FASB’s standard includes additional guidance to clarify the intention of the
collectability assessment. However, the IASB stated in the Basis for Conclusions on
IFRS 15 that it does not expect differences in outcomes under IFRS and US GAAP in
relation to the evaluation of the collectability criterion. [IFRS 15.BC46E].
Revenue
2019
4.1.6.A
Assessing collectability for a portfolio of contracts
At the January 2015 TRG meeting, the TRG members considered how an entity would
assess collectability if it has a portfolio of contracts. The TRG members generally agreed
that if an entity has determined it is probable that a customer will pay amounts owed
under a contract, but the entity has historical experience that it will not collect
consideration from some of the customers within a portfolio of contracts (see 4.3.1
below), it would be appropriate for the entity to record revenue for the contract in full
and separately evaluate the corresponding contract asset or receivable for
impairment.20 That is, the entity would not conclude the arrangement contains an
implicit price concession and would not reduce revenue for the uncollectable amounts.
See 6.2.1.A below for a discussion of evaluating whether an entity has offered an implicit
price concession.
Consider the following example included in the TRG agenda paper: an entity has a
large volume of similar customer contracts for which it invoices its customers in
arrears, on a monthly basis. Before accepting a customer, the entity performs
procedures designed to determine if it is probable that the customer will pay the
amounts owed. It does not accept customers if it is not probable that the customer
will pay the amounts owed. Because these procedures are only designed to determine
whether collection is probable (and, thus, not a certainty), the entity anticipates that
it will have some customers that will not pay all of the amounts owed. While the
entity collects the entire amount due from the vast majority of its customers, on
average, the entity’s historical evidence (which is representative of its expectations
for the future) indicates that the entity will only collect 98% of the amounts invoiced.
In this case, the entity would recognise revenue for the full amount due and recognise
a bad debt expense for 2% of the amount due (i.e. the amount the entity does not
expect to collect).21
In this example, the entity concludes that collectability is probable for each customer
based on procedures it performed prior to accepting each customer and on its
historical experience with this customer class, while also accepting that there is some
credit risk inherent with this customer class. Furthermore, the entity concludes that
any amounts not collected do not represent implied price concessions. Instead, they
are due to general credit risk that was present in a limited number of customer
contracts. Some TRG members cautioned that the analysis to determine whether
to recognise a bad debt expense for a contract in the same period in which revenue
is recognised (instead of reducing revenue for an anticipated price concession) will
require judgement.
4.1.6.B
Determining when to reassess collectability
As discussed at 4.1 above, IFRS 15 requires an entity to reassess whether it is probable
that it will collect the consideration to which it will be entitled when significant facts
and circumstances change. Example 4 in IFRS 15 illustrates a situation in which a
customer’s financial condition declines and its current access to credit and available
cash on hand is limited. In this case, the entity does not reassess the collectability
criterion. However, in a subsequent year, the customer’s financial condition further
declines after losing access to credit and its major customers. Example 4 in IFRS 15
2020 Chapter 28
illustrates that this subsequent change in the customer’s financial condition is so
significant that a reassessment of the criteria for identifying a contract is required,
resulting in the collectability criterion not being met. As noted in the TRG agenda
paper, this example illustrates that it was not the Board’s intent to require an entity
to reassess collectability when changes occur that are relatively minor in nature
(i.e. those that do not call into question the validity of the contract). The TRG
members generally agreed that entities need to exercise judgement to determine
whether changes in the facts and circumstances are significant enough to indicate
that a contract no longer exists under the standard.22
4.2
Contract enforceability and termination clauses
An entity has to determine the duration of the contract (i.e. the stated contractual term
or a shorter period) before applying certain aspects of the revenue model
(e.g. identifying performance obligations, determining the transaction price). The
contract duration under IFRS 15 is the period in which parties to the contract have
present enforceable rights and obligations. An entity cannot assume that there are
present enforceable rights and obligations for the entire term stated in the contract and
it is likely that an entity will likely have
to consider enforceable rights and obligations
in individual contracts, as described in the standard.
The standard states that entities are required to apply IFRS 15 to the contractual period
in which the parties have present enforceable rights and obligations. [IFRS 15.11]. For the
purpose of applying IFRS 15, a contract does not exist if each party has the unilateral
enforceable right to terminate a wholly unperformed contract without compensating
each other or other parties. The standard defines a wholly unperformed contract as one
for which ‘both of the following criteria are met: (a) the entity has not yet transferred
any promised goods or services to the customer; and (b) the entity has not yet received,
and is not yet entitled to receive, any consideration in exchange for promised goods or
services.’ [IFRS 15.12].
The period in which enforceable rights and obligations exist may be affected by
termination provisions in the contract. Significant judgement will be required to
determine the effect of termination provisions on the contract duration.
Under the standard, this determination is critical because the contract duration to which
the standard is applied may affect the number of performance obligations identified and
the determination of the transaction price. It may also affect the amounts disclosed in
some of the required disclosures. See 4.2.1.A below for further discussion on how
termination provisions may affect the contract duration.
If each party has the unilateral right to terminate a ‘wholly unperformed’ contract (as
defined in paragraph 12 of IFRS 15) without compensating the counterparty, IFRS 15
states that, for purposes of the standard, a contract does not exist and its accounting and
disclosure requirements would not apply. This is because the contracts would not affect
an entity’s financial position or performance until either party performs. Any
arrangement in which the vendor has not provided any of the contracted goods or
services and has not received or is not entitled to receive any of the contracted
consideration is considered to be a ‘wholly unperformed’ contract.
Revenue
2021
The requirements for ‘wholly unperformed’ contracts do not apply if the parties to the
contract have to compensate the other party if they exercise their right to terminate the
contract and that termination payment is considered substantive. Significant judgement
will be required to determine whether a termination payment is substantive and all facts
and circumstances related to the contract should be considered.
Evaluating termination provisions is a change from legacy IFRS. Under IAS 18,
entities applied the revenue requirements for the stated term of the contract and
generally accounted for terminations when they occurred. Under IFRS 15, entities
would be required to account for contracts with stated terms as month-to-month
(or possibly a shorter duration) contracts if the parties can terminate the contract
without penalty.
4.2.1
Implementation questions on contract enforceability and termination
clauses
4.2.1.A
Evaluating termination clauses and termination payments in determining
the contract duration
Entities need to carefully evaluate termination clauses and any related termination
payments to determine how they affect contract duration (i.e. the period in which there
are enforceable rights and obligations). TRG members generally agreed that enforceable
rights and obligations exist throughout the term in which each party has the unilateral
enforceable right to terminate the contract by compensating the other party. For
example, if a contract includes a substantive termination payment, the duration of the
contract would equal the period through which a termination penalty would be due.
This could be the stated contractual term or a shorter duration if the termination penalty
did not extend to the end of the contract. However, the TRG members observed that
the determination of whether a termination penalty is substantive, and what constitutes
enforceable rights and obligations under a contract, will require judgement and
consideration of the facts and circumstances. The TRG agenda paper also noted that if
an entity concludes that the duration of the contract is less than the stated term because
of a termination clause, any termination penalty should be included in the transaction
price. If the termination penalty is variable, the requirements for variable consideration,
including the constraint (see 6.2.3 below), would be applied.
The TRG members also agreed that if a contract with a stated contractual term can be
terminated by either party at any time for no consideration, the contract duration ends
when control of the goods or services that have already been provided transfers to the
customer (e.g. a month-to-month service contract), regardless of the contract’s stated
contractual term. In this case, entities also need to consider whether a contract includes
a notification or cancellation period (e.g. the contract can be terminated with 90 days’
notice) that would cause the contract duration to extend beyond the date when control
of the goods or services that have already been provided were transferred to the
customer. If such a period exists, the contract duration would be shorter than the stated
contractual term, but would extend beyond the date when control of the goods or
services that have already been provided were transferred to the customer.23
2022 Chapter 28
Example 28.10: Duration of contract without a termination penalty
Entity A enters into a three-year contract with a customer to provide maintenance services. Entity A begins
providing the services immediately. Consideration is payable in equal monthly instalments, and each party has
the unilateral right to terminate the contract without compensating the other party if it provides 30 days’ notice.
While Entity A may have considered the contract term to be three years historically, its rights and obligations
are enforceable only for 30 days. Under IFRS 15, the contract would be accounted for as a one-month contract
with a renewal option for additional months of maintenance services. This is because the customer or Entity A
could cancel the agreement with 30 days’ notice without paying a substantive termination payment.
Entity A would also need to evaluate the accounting for the renewal option(s) to determine whether it is a
material right (see 5.6 below).
4.2.1.B
Evaluating the contract term when only the customer has the right to
cancel the contract without cause
Enforceable rights and obligations exist throughout the term in which each party has
the unilateral enforceable right to terminate the contract by compensating the other
party. The TRG members did not view a customer-only right to terminate sufficient to
warrant a different conclusion than one in which both parties have the right to
terminate, as discussed in 4.2.1.A above.
The TRG members generally agreed that a substantive termination penalty payable
by a customer to the entity is evidence of enforceable rights and obligations of both
parties throughout the period covered by the termination penalty. For example,
<
br /> consider a four-year service contract in which the customer has the right to cancel
without cause at the end of each year, but for which the customer would incur a
termination penalty that decreases each year and is determined to be substantive.
The TRG members generally agreed that the arrangement would be treated as a four-
year contract.
The TRG members also discussed situations in which a contractual penalty would result
in including optional goods or services in the accounting for the original contract
(see 5.6.1.D below).
The TRG members observed that the determination of whether a termination penalty
is substantive, and what constitutes enforceable rights and obligations under a contract,
will require judgement and consideration of the facts and circumstances. In addition, it
is possible that payments that effectively act as a termination penalty and create or
negate enforceable rights and obligations may not be labelled as such in a contract. For
example, the TRG agenda paper included an illustration in which an entity sells
equipment and consumables. The equipment is sold at a discount, but the customer is
required to repay some or all of the discount if it does not purchase a minimum number
of consumables. The TRG paper concludes that the penalty (i.e. forfeiting the upfront
discount) is substantive and would be evidence of enforceable rights and obligations up
to the minimum quantity. This example is discussed further at 5.6.1.D below. See 4.2.1.D
below for another example.
Revenue
2023
If enforceable rights and obligations do not exist throughout the entire term stated in
the contract the TRG members generally agreed that customer cancellation rights would
be treated as customer options. Examples include, when there are no (or non-
substantive) contractual penalties that compensate the entity upon cancellation and
when the customer has the unilateral right to terminate the contract for reasons other
than cause or contingent events outside the customer’s control. In the Basis for
Conclusions, the Board noted that a cancellation option or termination right can be
similar to a renewal option. [IFRS 15.BC391]. An entity would need to determine whether
a cancellation option indicates that the customer has a material right that would need to
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