2.1.1.A Master supply arrangements (MSA)

An entity may use an MSA to govern the overall terms and conditions of a business arrangement between itself and a customer (e.g. scope of services, pricing, payment terms, warranties and other rights and obligations). Typically, when an entity and a customer enter into an MSA, purchases are subsequently made by the customer by issuing a non-cancellable purchase order or an approved online authorisation that explicitly references the MSA and specifies the products, services and quantities to be delivered.

In such cases, the MSA is unlikely to create enforceable rights and obligations, which are needed to be considered a contract within the scope of the model in IFRS 15. This is because, while the MSA may specify the pricing or payment terms, it usually does not specify the specific goods or services, or quantities thereof, to be transferred. Therefore, each party’s rights and obligations regarding the goods or services to be transferred are not identifiable. It is likely that the MSA and the customer order, taken together, would constitute a contract under IFRS 15. As such, entities need to evaluate both the MSA and the subsequent customer order(s) together to determine whether and when the criteria in paragraph 9 of IFRS 15 are met. [IFRS 15.9].

If an MSA includes an enforceable clause requiring the customer to purchase a minimum quantity of goods or services, the MSA alone may constitute a contract under the standard because enforceable rights and obligations exist for this minimum amount of goods or services.

2.1.1.B Free trial period

Free trial periods are common in certain subscription arrangements (e.g. magazines, streaming services). A customer may receive a number of ‘free’ months of goods or services at the inception of an arrangement; before the paid subscription begins; or as a bonus period at the beginning or end of a paid subscription period.

Under IFRS 15, revenue is not recognised until an entity determines that a 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 obliges the entity to provide services in the future (e.g. signing up for a subsequent 12-month period) and obliges 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.

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.

2.1.1.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 2.3 and 2.4 below, respectively, for further discussion of the standard’s requirements on combining contracts and contract modifications.

(i) Variable consideration versus credit risk

In the Basis for Conclusions on IFRS 15, the IASB acknowledged that in some cases, it may be difficult to determine whether the entity has implicitly offered a price concession (i.e. variable consideration) or whether the entity has chosen to accept the risk of default by the customer of the contractually agreed-upon consideration (i.e. impairment losses under IFRS 9, see Chapter 51). [IFRS 15.BC194]. The Board did not develop detailed guidance for distinguishing between price concessions (recognised as variable consideration through revenue) and an expected credit loss to be accounted for as an impairment loss under IFRS 9 (i.e. outside of revenue). Therefore, entities need to consider all relevant facts and circumstances when analysing situations in which, at contract inception, an entity is willing to accept a lower price than the amount stated in the contract. In Chapter 29 at 2.2.1.A, we discuss certain factors that may suggest the entity has implicitly offered a price concession to the customer.

After the entity has determined the amount to assess for collectability under paragraph 9(e) of IFRS 15, it also has to apply the requirements in IFRS 9 to account for any expected credit loss for the receivable (or contract asset) that is recorded (i.e. after consideration of any variable consideration, such as an implicit price concession). Also, it should present any resulting impairment loss as an expense under IFRS 9 (i.e. not as a reduction of the transaction price).

Examples 2 (included as Example 29.2 in Chapter 29 at 2.2.1.A), 3 and 23 (included as Example 29.7 in Chapter 29 at 2.2.3) from the standard illustrate situations where the transaction price that is evaluated for collectability is not the amount stated in the contract. In contrast, the TRG discussed an example (included at 2.1.6.A below) in which an entity, at contract inception, believes it is probable that its customers will pay amounts owed and the transaction price (i.e. revenue recorded) equals the contract price, even though, on a portfolio basis, 2% is not expected to be collected.

(ii) Example of assessing the collectability criterion

The standard provides the following example of how an entity would assess the collectability criterion. [IFRS 15.IE3-IE6].

2.1.6.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 2.3.1 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.² That is, the entity would not conclude the arrangement contains an implicit price concession and would not reduce revenue for the uncollectable amounts. See Chapter 29 at 2.2.1.A for a discussion of evaluating whether an entity has offered an implicit price concession.

Consider the following example included in the TRG agenda paper:

Some TRG members cautioned that the analysis to determine whether to recognise an impairment loss for a contract in the same period in which revenue is recognised (instead of reducing revenue for an anticipated price concession) will require judgement.

2.1.6.B Determining when to reassess collectability

As discussed at 2.1 above, paragraph 13 of 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 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. [IFRS 15.IE14-IE17]. 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.⁴

Example 4 in the standard also notes that the entity accounts for any impairment of the existing receivable in accordance with IFRS 9 (see Chapter 51). [IFRS 15.IE17].

2.2.1.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 does 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, requires 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 needs to be included in the transaction price. If the termination penalty is variable, the requirements for variable consideration, including the constraint (see Chapter 29 at 2.2.3), apply.

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.⁵ Consider the following examples that illustrate how termination provisions affect the duration of a contract.

2.2.1.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 2.2.1.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, 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 (see Example 28.4, Scenario B at 2.2.1.A above).

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 3.6.1.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, requires 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. 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 is evidence of enforceable rights and obligations up to the minimum quantity. This example is discussed further at 3.6.1.D below. See 2.2.1.D below for another example.

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 be accounted for as a performance obligation (e.g. there is a discount for goods or services provided during the cancellable period that provides the customer with a material right) (see 3.6 below).⁶

2.2.1.C Evaluating the contract term when an entity has a past practice of not enforcing termination payments

A TRG agenda paper for the October 2014 TRG meeting noted that the evaluation of the termination payment in determining the duration of a contract depends on whether the law (which may vary by jurisdiction) considers past practice as limiting the parties’ enforceable rights and obligations. An entity’s past practice of allowing customers to terminate the contract early without enforcing collection of the termination payment only affects the contract duration in cases in which the parties’ legally enforceable rights and obligations are limited because of the lack of enforcement by the entity. If that past practice does not change the parties’ legally enforceable rights and obligations, the contract duration equals the period throughout which a substantive termination penalty would be due (which could be the stated contractual term or a shorter duration if the termination penalty did not extend to the end of the contract).⁷

2.2.1.D Accounting for a partial termination of a contract

We believe an entity should account for the partial termination of a contract (e.g. a change in the contract term from three years to two years prior to the beginning of year two) as a contract modification (see 2.4 below) because it results in a change in the scope of the contract. IFRS 15 states that ‘a contract modification exists when the parties to a contract approve a modification that either creates new or changes existing enforceable rights and obligations of the parties to the contract’. [IFRS 15.18]. A partial termination of a contract results in a change to the enforceable rights and obligations in the existing contract (see also further below 2.4.3.E for a contract modification that decreases the scope of a contract). This conclusion is consistent with TRG agenda paper no. 48, which states, ‘a substantive termination penalty is evidence of enforceable rights and obligations throughout the contract term. The termination penalty is ignored until the contract is terminated at which point it is accounted for as a modification’.⁸

Consider the following example:

2.2.1.E Accounting for consideration that was received from a customer, but not recognised as revenue, when the contract is cancelled

When a contract is cancelled (by either the customer or the entity) it is a contract modification that reduces the scope of the contract. As discussed at 2.2.1.D above and 2.4.3.E below such a modification would not be accounted for as a separate contract because it does not result in the addition of distinct goods or services. Rather, the accounting will depend on whether there are any remaining goods and services to be provided after the cancellation and, if so, whether they are distinct from the goods and services already provided.

If there are no remaining goods and services to be provided after the cancellation, the accounting depends on whether the consideration is refundable or non-refundable. To determine whether consideration is refundable or non-refundable, entities may need to consider termination penalties, legal requirements for refund, customary business practices of providing refunds or statements made to customers that create a constructive or legal obligation to provide a refund.

If the consideration received from the customer is refundable and there are no remaining goods and services to be provided after the cancellation, the entity has a refund liability. This might require the entity to reclassify any existing contract liability to refund liability. In some cases, the entity might ask the customer to waive their right to a refund of the consideration in exchange for vouchers, for example, and/or discounts on future goods or services. The accounting for such offers (including the accounting for the liability) depends on the specific facts and circumstances and may require judgement.

If the consideration received from the customer is non-refundable and there are no remaining goods and services to be provided after the cancellation, we believe that the entity can recognise revenue for the consideration received when the contract is cancelled, and the related contract liability would also be derecognised. This accounting treatment is similar to the application guidance for breakage (e.g. for gift cards, see Chapter 30 at 11 and the recognition of revenue for arrangements that fail the IFRS 15 contract criteria in accordance with paragraph 15 of IFRS 15 (see 2.5 below). In both of those situations, IFRS 15 provides guidance that permits an entity to derecognise a liability and recognise revenue, provided the relevant criteria are met, when: the entity expects the customer will not exercise its contractual rights (for breakage); [IFRS 15.B46] or the contract is effectively completed or cancelled (for contracts that do not meet the contract criteria in paragraph 9 of IFRS 15). [IFRS 15.15, BC48].

In some cases, an entity may be entitled to termination fees in the event of cancellation. The accounting for termination fees is discussed at 2.2.1.D above.

2.2.1.F Services provided during a period after contract expiration

If an entity continues to provide services to a customer during a period when a contract does not exist because a previous contract has expired and the contract has not yet been renewed, we believe that the entity would need to recognise revenue for providing those services on a cumulative catch-up basis at the time the contract is renewed (i.e. when enforceable rights and obligations exist between the entity and its customer). As discussed at 2 above, determining whether an enforceable contract exists under the model may require judgement and an evaluation of the relevant legal framework.

This approach to record revenue on a cumulative catch-up basis reflects the performance obligations that are partially satisfied at the time enforceable rights and obligations exist and is consistent with the overall principle of the standard that requires revenue to be recognised when (or as) an entity transfers control of goods or services to a customer under an enforceable contract. This conclusion is also consistent with the discussion in Chapter 30 at 3.4.6 on the accounting for goods or services provided to a customer before the contract establishment date.

Consider the following example:

An entity might receive consideration from the customer for the goods or services transferred before the existence of an enforceable contract. If so, the entity would need to follow the requirements in paragraphs 14-16 of IFRS 15 (discussed further at 2.5 below). This requires that when an arrangement does not meet the criteria to be a contract under the standard, an entity would recognise the non-refundable consideration received as revenue only if one of the two events has occurred (e.g. the entity has no remaining obligations to transfer goods or services to the customer and all, or substantially all, of the consideration promised by the customer has been received by the entity and is non-refundable).

2.4.3.A When to evaluate the contract under the contract modification requirements

An entity typically enters into a separate contract with a customer to provide additional goods or services. Stakeholders had questioned whether a new contract with an existing customer needs to be evaluated under the contract modification requirements.

A new contract with an existing customer needs to be evaluated under the contract modification requirements if the new contract results in a change in the scope or price of the original contract. Paragraph 18 of IFRS 15 states that ‘a contract modification exists when the parties to a contract approve a modification that either creates new or changes existing enforceable rights and obligations of the parties to the contract’. [IFRS 15.18]. Therefore, an entity needs to evaluate whether a new contract with an existing customer represents a legally enforceable change in scope or price to an existing contract. A legally enforceable change in scope or price to an existing contract could also be accomplished by terminating the existing contract and entering into a new contract with the same customer. In those situations, entities also need to consider the contract modification requirements in IFRS 15.

In some cases, the determination of whether a new contract with an existing customer creates new or changes existing enforceable rights and obligations is straightforward because the new contract does not contemplate goods or services in the existing contract, including the pricing of those goods or services. Purchases of additional goods or services under a separate contract that do not modify the scope or price of an existing contract do not need to be evaluated under the contract modification requirements. Rather, they are accounted for as new (separate) contract.

In other cases, the determination of whether a new contract is a modification of an existing contract requires judgement. In such circumstances, we believe an entity should consider the specific facts and circumstances surrounding the new contract in order to determine whether it represents a contract modification. This could include considering factors such as those included in the contract combination requirements (see 2.3 above):

• whether the contracts were negotiated as a package with a single commercial objective (this might be the case in situations where the existing contract contemplates future modifications);
• whether the amount of consideration to be paid in one contract depends on the price or performance of the other contract; or
• whether the goods or services promised in the contracts (or some goods or services promised in each of the contracts) are a single performance obligation.

If the pricing in the new contract is dependent on the original contract, or if the terms of the new contract are in some other way negotiated based on the original contract, it is likely that the new contract needs to be evaluated under the contract modification requirements.

2.4.3.B Reassessing the contract criteria if a contract is modified

When an arrangement that has already been determined to meet the standard’s contract criteria is modified, would an entity need to reassess whether that arrangement still meets the criteria to be considered a contract within the scope of the five-step model in the standard? There is no specific requirement in the standard to reconsider whether a contract meets the definition of a contract when it is modified. However, if a contract is modified, we believe that may indicate that ‘a significant change in facts and circumstances’ has occurred (see 2.1 above) and that the entity should reassess the criteria in paragraph 9 of IFRS 15 for the modified contract. Any reassessment is prospective in nature and would not change the conclusions associated with goods or services already transferred. That is, an entity would not reverse any receivables, revenue or contract assets already recognised under the contract because of the reassessment of the contract criteria in paragraph 9 of IFRS 15. However, due to the contract modification accounting (see 2.4.2 above), the entity may need to adjust contract assets or cumulative revenue recognised in the period of the contract modification.

See 3.6.1.J below for a discussion on how an entity would account for the exercise of a material right. See Chapter 31 at 2.1.5.A for a discussion on how entities would account for modifications to licences of intellectual property.

2.4.3.C Distinguishing between a contract modification and a change in the estimated transaction price due to variable consideration after contract inception

An entity may need to apply judgement to determine whether a change in the transaction price is the result of a contract modification (due to a change in the parties’ enforceable rights and obligations after contract inception) or the result of new information obtained about variable consideration that existed (and was estimated) at contract inception. While a contract modification may result in a change in the transaction price, not all changes in the transaction price are due to contract modifications.

When a contract with a customer includes variable consideration (see Chapter 29 at 2.2), the entity is generally required to estimate, at contract inception and throughout the contract term, the amount of consideration to which it will be entitled in exchange for transferring promised goods or services. Changes to the transaction price that are related to a change in estimates of variable consideration (because they result in the resolution of variability that existed at contract inception), are allocated to the performance obligations in the contract on the same basis as at contract inception (see Chapter 29 at 3.5). [IFRS 15.88-89]. In contrast, changes in the transaction price that are related to a contract modification are accounted for in accordance with the contract modification requirements (as described above, in paragraphs 18-21 of IFRS 15).

2.4.3.D Distinguishing between a contract modification and a marketing offer

An entity may provide incentives to customers to encourage demand. Customer incentives may include, free goods or services, options for additional goods and services at a discount (e.g. additional loyalty points, prospective coupons or discounts) or cash payments to customers. The accounting for these incentives will depend on the facts and circumstances of the offer. An offer to a current customer that creates new enforceable rights and obligations or changes the enforceable rights and obligations of the parties to an existing contract is accounted for as a contract modification. In some cases, an offer may not result in a contract modification and would be accounted for as a marketing offer (i.e. expense).

An offer that is the result of negotiations with a specific customer or group of customers may indicate the addition of new enforceable rights and obligations to an existing contract or changes to existing ones. However, the following circumstances may indicate that the entity has made a marketing offer:

• the same offer is available to both existing customers and counterparties that do not meet the definition of a customer;
• the offer is available to a broad group of (or all) current customers and is not the result of negotiations with individual customers; or
• the entity has the right to rescind the offer.

Entities need to carefully consider the terms and conditions of any customer incentive to determine whether the offer needs to be accounted for as a contract modification or a marketing offer.

In addition, as discussed at 2.4.3.A above we believe that the accounting principles for determining when contracts have to be combined under paragraph 17 of IFRS 15 be helpful when determining whether an offer of free goods or services to an existing customer is a contract modification.

For any payments to customers, entities will need to consider the requirements for consideration paid or payable to a customer (see Chapter 29 at 2.7). Such payments would be accounted for as a reduction of the transaction price (and, therefore, revenue) unless the payment to the customer is in exchange for a distinct good or service that the customer transfers to the entity.

2.4.3.E Contract modification that decreases the scope of the contract

A modification that decreases the scope of a contract is not accounted for as a separate contract because it does not result in the addition of distinct goods or services (see 2.4.2 above). The accounting will depend on whether the remaining goods and services to be provided after the contract modification are distinct from the goods and services already provided. If the remaining goods and services are distinct, the contract modification is accounted for as a termination of the old contract and the creation of a new contract (i.e. prospectively). If the remaining goods and services are not distinct, the contract modification is accounted for as if it were part of the original contract (i.e. cumulative catch-up). See above 2.2.1.D regarding a partial termination of a contract.

Furthermore, to modify a contract, a customer may agree to pay a fee. We believe that such a fee is additional consideration that needs to be included in the modified transaction price and allocated to the remaining goods and services to be provided to the customer.

Consider the following example:

2.4.3.F Accounting for a ‘blend-and-extend’ contract modification

A ‘blend-and-extend’ contract modification typically is one in which an entity, in exchange for a customer extending the term of the contract (and, therefore, purchasing additional units of a good or service), agrees to decrease the price per unit for all units to be provided (i.e. the new units, as well as the remaining units on the existing contract), resulting in a new blended price per unit. These types of contracts often occur in the power and utilities industry when market prices for the good or service decline after contract inception.

These arrangements are subject to the contract modification requirements in IFRS 15. Since these arrangements typically include the addition of distinct goods or services, the next step is for entities to evaluate whether the additional distinct goods or services are added at their stand-alone selling price in order to determine the accounting for the contract modification (i.e. as a separate contract or as a termination of the existing contract and the creation of a new contract).

When making this evaluation, stakeholders have questioned whether an entity should compare the blended contractual cash selling price or the overall contract price increase to the stand-alone selling price of the additional promised goods or services. We believe that entities should establish an approach based on the facts and circumstances of their modifications and apply that approach consistently to similar fact patterns.

Consider the following example:

The accounting will be different in contract modifications where an entity determines that the remaining goods or services to be provided after the modification date are not distinct from those goods or services provided before the modification date.

There is no presumption that such contract modifications contain a financing component that would be required to be accounted for separately. That is, the mere act of blending the rate in connection with a contract extension in which the customer pays more cash consideration for the same amount of goods or services at the beginning of the contract than the end of the contract does not automatically create a financing. However, each contract’s facts and circumstances would need to be evaluated to determine whether a significant financing component exists (see Chapter 29 at 2.5 for further discussion on significant financing components).

2.5.1.A Determining when a contract is terminated for the purpose of applying paragraph 15(b) of IFRS 15

Determining whether a contract is terminated may require significant judgement. In the Basis for Conclusions on IFRS 15, ‘the IASB noted that contracts often specify that an entity has the right to terminate the contract in the event of non-payment by the customer and that this would not generally affect the entity’s rights to recover any amounts owed by the customer. The IASB also noted that an entity’s decision to stop pursuing collection would not typically affect the entity’s rights and the customer’s obligations under the contract with respect to the consideration owed by the customer. On this basis, … the existing requirements in IFRS 15 are sufficient for an entity to conclude … that a contract is terminated when it stops providing goods or services to the customer.’ [IFRS 15.BC46H].

3.1.1.A Assessing whether pre-production activities are a promised good or service

Manufacturing and production entities in various industries had asked the TRG how they should account for activities and costs incurred prior to the production of goods under a long-term supply arrangement when they adopt IFRS 15. The questions arose because some long-term supply arrangements require an entity to incur upfront engineering and design costs to create new technology or adapt existing technology to the needs of the customer.

These pre-production activities are often a prerequisite to delivering any units under a production contract. For example, a manufacturer may incur costs to perform certain services related to the design and development of products it will sell under long-term supply arrangements. It may also incur costs to design and develop moulds, dies and other tools that will be used to produce those products. A contract may require the customer to reimburse the manufacturer for these costs. Alternatively, reimbursement may be implicitly guaranteed as part of the price of the product or by other means.

At the meeting in November 2015, the TRG members generally agreed that the determination of whether pre-production activities are a promised good or service or fulfilment activities requires judgement and consideration of the facts and circumstances. When making this evaluation, entities need to determine whether the activity transfers a good or service to a customer. If an entity determines that these activities are promised goods or services, it applies the requirements in IFRS 15 to those goods or services.

The TRG members generally agreed that if an entity is having difficulty determining whether a pre-production activity is a promised good or service in a contract, the entity needs to consider whether control of that good or service transfers to the customer. For example, if an entity is performing engineering and development services as part of developing a new product for a customer and the customer will own the resulting intellectual property (e.g. patents), it is likely that the entity would conclude that it is transferring control of the intellectual property and that the engineering and development activities are a promised good or service in the contract.

The TRG members noted that assessing whether control transfers in such arrangements may be challenging. In some arrangements, legal title of the good or service created from the pre-production activity is transferred to the customer. However, the TRG members generally agreed that an entity has to consider all indicators of control transfer under IFRS 15 and that the transfer of legal title is not a presumptive indicator.

The IASB staff noted in the TRG agenda paper that, when an entity is determining whether control transfers to a customer in such arrangements, one of the three over-time revenue recognition criteria may be applicable to pre-production activities. That criterion is whether the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs. [IFRS 15.35(a)]. As further discussed in Chapter 30 at 2.1, paragraph B3 of IFRS 15 notes that if an entity cannot readily identify whether this criterion is met, it should consider whether another entity would need to re-perform the work the entity had completed to date if that other entity were required to fulfil the remaining performance obligation.

For example, assume an entity is performing engineering and development as part of developing a new product for a customer. If the entity provided the customer with periodic progress reports in a level of detail that would not require the customer to contract with another entity to re-perform the work, or if the entity were required to provide the customer with the design information completed to date in the case of a termination, it is likely that the entity would conclude that control of that service transfers to the customer as the entity performs.

If a pre-production activity is determined to be a promised good or service, an entity allocates a portion of the transaction price to that good or service (as a single performance obligation or as part of a combined performance obligation that includes the pre-production activities along with other goods or services). If the pre-production activities are included in a performance obligation satisfied over time, they are considered when measuring progress toward satisfaction of that performance obligation (see Chapter 30 at 3).¹⁴

If a pre-production activity does not result in the transfer of control of a good or service to a customer, an entity should consider other requirements that may be applicable (e.g. IAS 16 – Property, Plant and Equipment, IAS 38 – Intangible Assets, paragraphs 95-98 of IFRS 15 on costs to fulfil a contract with a customer).

3.1.1.B The nature of the promise in a typical stand-ready obligation

Stakeholders raised questions about the nature of the promise in a ‘typical’ stand-ready obligation.

At the January 2015 TRG meeting, the TRG members discussed numerous examples of stand-ready obligations and generally agreed that the nature of the promise in a stand-ready obligation is the promise that the customer will have access to a good or service, not the delivery of the underlying good or service.¹⁵ The standard describes a stand-ready obligation as a promised service that consists of standing ready to provide goods or services or making goods or services available for a customer to use as and when it decides to do so. Stand-ready obligations are common in the software industry (e.g. unspecified updates to software on a when-and-if-available basis) and may be present in other industries.

The TRG agenda paper included the following types of promises to a customer that could be considered stand-ready obligations, depending on the facts and circumstances:¹⁶

• obligations for which the delivery of the good, service or intellectual property is within the control of the entity, but is still being developed (e.g. a software entity’s promise to transfer unspecified software upgrades at its discretion);
• obligations for which the delivery of the underlying good or service is outside the control of the entity and the customer (e.g. an entity’s promise to remove snow from an airport runway in exchange for a fixed fee for the year);
• obligations for which the delivery of the underlying good or service is within the control of the customer (e.g. an entity’s promise to provide periodic maintenance on a when-and-if needed basis on a customer’s equipment after a pre-established amount of usage by the customer); and
• obligations to make a good or service available to a customer continuously (e.g. a gym membership that provides unlimited access to a customer for a specified period of time).

An entity needs to carefully evaluate the facts and circumstances of its contracts to appropriately identify whether the nature of a promise to a customer is the delivery of the underlying good(s) or service(s) or the service of standing ready to provide goods or services. Entities also have to consider other promises in a contract that includes a stand-ready obligation to appropriately identify the performance obligations in the contract. The TRG members generally agreed that all contracts with a stand-ready element do not necessarily include a single performance obligation (see 3.1.1.C below).¹⁷

See 3.2.2.E below for a discussion on whether stand-ready obligations are generally considered to be a series of distinct goods or services.

At the TRG meeting, a FASB staff member also indicated that the staff does not believe that the FASB intended to change previous practice under US GAAP for determining when software or technology transactions include specified upgrade rights (i.e. a separate performance obligation) or unspecified upgrade rights (i.e. a stand-ready obligation).¹⁸ For details of TRG members’ discussion on measuring progress toward satisfaction for a stand-ready obligation that is satisfied over time see Chapter 30 at 3.4.1.

3.1.1.C Considering whether contracts with a stand-ready element include a single performance obligation that is satisfied over time

At the November 2015 TRG meeting, the TRG members considered whether all contracts with a stand-ready element include a single performance obligation that is satisfied over time.

The TRG members generally agreed that the stand-ready element in a contract does not always represent a single performance obligation satisfied over time. This conclusion is consistent with the discussion in 3.1.1.B above that, when identifying the nature of a promise to a customer, an entity may determine that a stand-ready element exists, but it is not the promised good or service for revenue recognition purposes. Instead, the underlying goods or services are the goods or services promised to the customer and accounted for by the entity.

Consider the following example in the TRG agenda paper:¹⁹

See 3.6.1.C below for further discussion on determining whether a contract involving variable quantities of goods or services should be accounted for as variable consideration (i.e. if the nature of the promise is to transfer one overall service to the customer, such as a stand-ready obligation) or a contract containing customer options (i.e. if the nature of the promise is to transfer the underlying distinct goods or services).

3.1.1.D Evaluating whether an exclusivity provision in a contract with customer represents a promised good or service

We generally believe that an exclusivity provision does not represent a promised good or service. Contracts with customers involving the sale of products or services may contain exclusivity clauses whereby the entity agrees that it will not provide the products or services to others or will do so only on a limited basis. Such provisions may restrict the distribution of the products or services in certain geographical areas and/or prohibit the sale of the products or services to a customer’s competitors. For example, an entity that provides advertising on its website may agree to run a banner advertisement for one customer for a specified period of time and exclude advertisements for similar products or services from the advertiser’s competitors.

In the Basis for Conclusions on IFRS 15, the IASB discussed exclusivity in relation to licences of intellectual property and concluded that exclusivity is a restriction that represents an attribute of a licence, rather than the nature of the underlying intellectual property or the entity’s promise in granting the licence. That is, exclusivity provisions define the scope of the customer’s rights to intellectual property and would not be accounted for separately (see Chapter 31 at 2.1.3 for further discussion). [IFRS 15.BC412(b)].

We believe that the same principles would apply when evaluating exclusivity provisions in contracts that do not contain a licence of intellectual property. That is, exclusivity is an attribute of the promise to the customer, rather than a separate promised good or service. This is because exclusivity does not change the nature of the entity’s performance to provide the underlying goods or services to the customer.

Any upfront payment received from a customer related to an exclusivity provision would need to be evaluated to determine whether it represents a material right (see further discussion in Chapter 29 at 2.8). Conversely, any payment made by the entity to the customer would need to be evaluated in accordance with the requirements for consideration paid or payable to a customer (see further discussion in Chapter 29 at 2.7).

3.2.1.A Capable of being distinct

The first criterion requires that a promised good or service must be capable of being distinct by providing a benefit to the customer either on its own or together with other resources that are readily available to the customer.

The standard states that a customer can benefit from a good or service if the good or service could be used, consumed, sold for an amount greater than scrap value or otherwise held in a way that generates economic benefits. A customer may be able to benefit from some goods or services on their own or in conjunction with other readily available resources. A readily available resource is a good or service that is sold separately (by the entity or another entity) or a resource that the customer has already obtained from the entity (including goods or services that the entity will have already transferred to the customer under the contract) or from other transactions or events. The fact that an entity regularly sells a good or service separately indicates that a customer can benefit from that good or service on its own or with readily available resources. [IFRS 15.28].

Determining whether a good or service is capable of being distinct is straightforward in many situations. For example, if an entity regularly sells a good or service separately, this fact would demonstrate that the good or service provides benefit to a customer on its own or with other readily available resources.

The evaluation may require more judgement in other situations, particularly when the good or service can only provide benefit to the customer with readily available resources provided by other entities. These are resources that meet either of the following conditions:

• they are sold separately by the entity (or another entity); or
• the customer has already obtained them from the entity (including goods or services that the entity has already transferred to the customer under the contract) or from other transactions or events.

As noted in the Basis for Conclusions, the assessment of whether the customer can benefit from the goods or services (either on its own or with other readily available resources) is based on the characteristics of the goods or services themselves instead of how the customer might use the goods or services. [IFRS 15.BC100]. Consistent with this notion, an entity disregards any contractual limitations that may prevent the customer from obtaining those readily available resources from a party other than the entity when making this assessment (as illustrated below in Example 28.35 at 3.2.3 below). The IFRS Interpretations Committee also reiterated this point during its March 2018 meeting (see 3.2.1.B below for further discussion).

In the Basis for Conclusions, the Board explained that ‘the attributes of being distinct are comparable to the previous revenue recognition requirements for identifying separate deliverables in a multiple-element arrangement, which specified that a delivered item must have “value to the customer on a stand-alone basis” for an entity to account for that item separately.’ However, the Board did not use similar terminology in IFRS 15 so as to avoid implying that an entity must assess a customer’s intended use for a promised good or service when it is identifying performance obligations. It observed that it would be difficult, if not impossible, for an entity to know a customer’s intent. [IFRS 15.BC101].

3.2.1.B Distinct within the context of the contract

Once an entity has determined whether a promised good or service is capable of being distinct based on the individual characteristics of the promise, the entity considers the second criterion of whether the good or service is separately identifiable from other promises in the contract (i.e. whether the promise to transfer the good or service is distinct within the context of the contract). The standard states that, when assessing whether an entity’s promises to transfer goods or services to the customer are separately identifiable from other promises in the contract, the objective is ‘to determine whether the nature of the promise, within the context of the contract, is to transfer each of those goods or services individually or, instead, to transfer a combined item or items to which the promised goods or services are inputs. Factors that indicate that two or more promises to transfer goods or services to a customer are not separately identifiable include, but are not limited to, the following:

1. The entity provides a significant service of integrating the goods or services with other goods or services promised in the contract into a bundle of goods or services that represent the combined output or outputs for which the customer has contracted. In other words, the entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer. A combined output or outputs might include more than one phase, element or unit.
2. One or more of the goods or services significantly modifies or customises, or are significantly modified or customised by, one or more of the other goods or services promised in the contract.
3. The goods or services are highly interdependent or highly interrelated. In other words, each of the goods or services is significantly affected by one or more of the other goods or services in the contract. For example, in some cases, two or more goods or services are significantly affected by each other because the entity would not be able to fulfil its promise by transferring each of the goods or services independently.’ [IFRS 15.29].

Figure 28.4 depicts the above requirements:

(a) Separately identifiable principle

To determine whether promised goods or services are separately identifiable (i.e. whether a promise to transfer a good or service is distinct within the context of the contract), an entity needs to evaluate whether its promise is to transfer each good or service individually or a combined item (or items) that comprises the individual goods or services promised in the contract. Therefore, an entity would evaluate whether the promised goods or services in the contract are outputs or they are inputs to a combined item (or items). In the Basis for Conclusions, the Board noted that, in many cases, a combined item (or items) is more than (or substantially different from) the sum of the underlying promised goods or services. [IFRS 15.BC116J].

The evaluation of whether an entity’s promise is separately identifiable considers the relationship between the various goods or services in the context of the process to fulfil the contract. Therefore, an entity considers the level of integration, interrelation or interdependence among the promises to transfer goods or services. In the Basis for Conclusions, the Board observed that, rather than considering whether one item, by its nature, depends on the other (i.e. whether two items have a functional relationship), an entity evaluates whether there is a transformative relationship between the two or more items in the process of fulfilling the contract. [IFRS 15.BC116K]. The point was also reiterated by the IFRS Interpretations Committee during its March 2018 meeting (see the discussion below).

The Board also emphasised that the separately identifiable principle is applied within the context of the bundle of promised goods or services in the contract. It is not within the context of each individual promised good or service. That is, the separately identifiable principle is intended to identify when an entity’s performance in transferring a bundle of goods or services in a contract is fulfilling a single promise to a customer. Therefore, to apply the ‘separately identifiable’ principle, an entity evaluates whether two or more promised goods or services significantly affect each other in the contract (and are, therefore, highly interdependent or highly interrelated). [IFRS 15.BC116L].

As an example of this evaluation, the IASB discussed in the Basis for Conclusions a typical construction contract that involves transferring to the customer many goods or services that are capable of being distinct (e.g. various building materials, labour, project management services). In this example, the IASB concluded that identifying all of the individual goods or services as separate performance obligations would be impractical and would not faithfully represent the nature of the entity’s promise to the customer. That is, the entity would recognise revenue when the materials and other inputs to the construction process are provided rather than when it performs (and uses those inputs) in the construction of the item the customer has contracted to receive (e.g. a building, a house). As such, when determining whether a promised good or service is distinct, an entity not only determines whether the good or service is capable of being distinct but also whether the promise to transfer the good or service is distinct within the context of the contract. [IFRS 15.BC102].

Paragraph 29 of IFRS 15 includes three factors (discussed individually below) that are intended to help entities identify when the promises in a bundle of promised goods or services are not separately identifiable and, therefore, need to be combined into a single performance obligation. [IFRS 15.29]. In the Basis for Conclusions, the IASB noted that these three factors are not an exhaustive list and that not all of the factors need to exist in order to conclude that the entity’s promises to transfer goods or services are not separately identifiable. As emphasised by the IFRS Interpretations Committee during its March 2018 meeting (see the discussion below), the three factors also are not intended to be criteria that are evaluated independently of the separately identifiable principle. Given the wide variety of arrangements that are within the scope of IFRS 15, the Board expects that there are some instances in which the factors are less relevant to the evaluation of the separately identifiable principle. [IFRS 15.BC116N]. Entities may need to apply significant judgement to evaluate whether a promised good or service is separately identifiable. The evaluation requires a thorough understanding of the facts and circumstances present in each contract. An entity should consider the following questions, which summarise what is discussed in the Basis for Conclusions: [IFRS 15.BC116J-BC116L]

• Is the combined item greater than, or substantively different from, the sum of the promised goods or services?
• Is an entity, in substance, fulfilling a single promise to the customer?
• Is the risk an entity assumes to fulfil its obligation to transfer a promised good or service inseparable from the risk relating to the transfer of the other promised goods or services in the bundle?
• Do two or more promised goods or services each significantly affect the other?
• Does each promised good or service significantly affect the other promised good or service’s utility to the customer?

In a speech, a member of the staff from the US Securities and Exchange Commission (SEC) focused on considerations for determining whether a promise to transfer a good or service to a customer is separately identifiable from other promises in the contract, which could require significant judgement, as noted above. The SEC staff member emphasised the importance of supporting a registrant’s conclusions by providing a well-reasoned analysis of the guidance in the revenue standard, rather than just referring to the manner in which the goods and services are sold to customers. The SEC staff member stated that the SEC staff are not persuaded that promises should be combined into a single performance obligation simply because they are provided as part of a ‘solution’. Instead, they expect registrants to provide a robust assessment of the requirements in the revenue standard to support an assertion that the promises to transfer goods are not separately identifiable.

To illustrate this, the SEC staff member described a consultation with the Office of the Chief Accountant (OCA) in which the staff did not object to a registrant’s conclusion that software and software updates represent a combined performance obligation. The registrant was able to demonstrate that the software updates were integral to maintaining the utility of the software. That is, without the software updates, the customer’s ability to benefit from the software would be significantly limited over the contract term. Based on this point and other facts and circumstances, the registrant was able to demonstrate that the combined output was greater than, or substantively different from, the individual promises of the software and software updates.²⁰

(b) March 2018 IFRS Interpretations Committee discussion

In 2017, the IFRS Interpretations Committee received a request regarding the identification of performance obligations in a contract for the sale of a real estate unit that includes the transfer of land. The request also asked about the timing of revenue recognition for each performance obligation (either over-time or at a point in time), which is discussed in Chapter 30 at 2.3.2.D. At its March 2018 meeting, the IFRS Interpretations Committee concluded that the principles and requirements in IFRS 15 provide sufficient guidance for an entity to recognise revenue in a contract for the sale of a real estate unit that includes the transfer of land. Consequently, the IFRS Interpretations Committee decided not to add this matter to its agenda.²²

In considering this request, the IFRS Interpretations Committee noted that the assessment of the distinct criteria requires judgement. Furthermore:

• The assessment of the first criterion is ‘based on the characteristics of the goods or services themselves. Accordingly, an entity disregards any contractual limitations that might preclude the customer from obtaining readily available resources from a source other than the entity’ (see 3.2.1.A above). [IFRS 15.BC100].
• The objective underlying the second criterion is to determine the nature of the promise within the context of the contract. That is, whether the entity has promised to transfer either the promised goods or services individually or a combined item to which those goods or services are inputs. IFRS 15 also includes some factors that indicate that two or more promises to transfer goods or services are not separately identifiable. [IFRS 15.29]. However, these factors are not intended to be criteria that an entity evaluates independently of the ‘separately identifiable’ principle because, in some instances, one or more of the factors may be less relevant to the evaluation of that principle (see the discussion above). [IFRS 15.BC116N].

  In the Basis for Conclusion, the Board indicated that the separately identifiable concept is influenced by the idea of separable risks. That is, whether the risk assumed to fulfil the obligation to transfer one of the promised goods or services to the customer is separable from the risk relating to the transfer of the other promised goods or services. Evaluating whether an entity’s promise is separately identifiable considers the interrelationship between the goods or services within the contract in the context of the process to fulfil the contract. Accordingly, an entity considers the level of integration, interrelation or interdependence among the promises in the contract to transfer goods or services. An entity evaluates whether, in the process of fulfilling the contract, there is a transformative relationship between the promises, rather than considering whether one item, by its nature, depends upon another (i.e. whether the promises have a functional relationship). [IFRS 15.BC105, 116 J, 116 K]. That is, the conclusion about whether the promised goods or services are separately identifiable hinges on whether there is a significant two-way dependency between the items. Determining whether a two-way dependency is significant such that the promises are separately identifiable is a judgement that requires careful consideration.

The IFRS Interpretations Committee discussed the identification of performance obligations in its March 2018 meeting using the following example from the IFRS Interpretations Committee agenda paper:²³

The assessment of whether a good or service is distinct must consider the specific contract with a customer. That is, an entity cannot assume that a particular good or service is distinct (or not distinct) in all instances. The manner in which promised goods or services are bundled within a contract can affect the conclusion of whether a good or service is distinct. As a result, entities may account the same goods or services differently, depending on how those goods or services are bundled within a contract.

(c) Examples

The IASB included a number of examples in the standard that illustrate the application of the requirements for identifying performance obligations. The examples include analysis of how an entity may determine whether the promises to transfer goods or services are distinct within the context of the contract. See 3.2.3 below for full extracts of several of these examples.

3.2.1.C How should an entity determine whether ‘connected’ hardware sold with cloud services represent one or more performance obligations?

To identify performance obligations in contracts containing connected hardware and cloud services, entities must determine whether the hardware and cloud services are each capable of being distinct and whether they are distinct within the context of the contract (as discussed at 3.2.1 above). An increasing number of connected hardware devices are now available (e.g. security cameras, home equipment). In contracts where a customer purchases hardware, the hardware may require the installation of an app or the purchase of a cloud service subscription in order to be used. Alternatively, the hardware may provide additional functionalities when paired with the cloud service.

In evaluating the distinct criteria, entities need to consider: whether the hardware can be used without the cloud service; how the hardware and cloud service affect each other (e.g. whether the cloud service enables the hardware to ‘learn’ or perform its intended function better over time); whether there are additional functionalities that result from using the hardware with the cloud service; and other details of how the hardware and cloud services function and are sold.

Consider the following example where an entity concludes that the connected hardware and cloud services are separately identifiable:

Entities will need to evaluate the specific features and functionality of the cloud services in arrangements that include connected hardware devices. Evaluating whether hardware and cloud services are separate performance obligations in arrangements for connected devices may be complex and require significant judgement when the cloud service has sophisticated features or functionality that the device cannot do independently. In these cases, there may be a high degree of interdependency between the hardware and the cloud service or a significant integration service may be present.

To conclude that hardware and a cloud service are a single performance obligation, entities will need to demonstrate that the functionality of both the hardware and the service is significantly elevated when they are used together. Many technology entities have concluded that they have separate performance obligations because the hardware and the cloud service do not significantly affect each other and because the hardware can be sold separately from the cloud service.

3.2.1.D How would entities determine whether implementation services are distinct?

Entities will need to assess their implementation services and consider all relevant facts and circumstances to determine whether they are separate performance obligations (i.e. they are capable of being distinct and are distinct within the context of a contract, as discussed at 3.2.1 above). Entities may include promises to provide implementation services to customers as part of their product or service contracts (i.e. the implementation activities have been determined to transfer a service to the customer, as discussed at 3.1 above). For example, these services may include training of customer personnel and data conversion.

When assessing whether implementation services are capable of being distinct, an entity first considers whether the customer can benefit from those services on their own. There is strong evidence to suggest that implementation services are capable of being distinct if third party vendors offer (or are capable of offering) implementation services for the entity’s products or services, or if the customer could perform these services on its own. This evidence would demonstrate that the implementation services provide benefit to the customer on their own (i.e. apart from the other promised products or services purchased from the entity).

If an entity concludes that the customer is not able to benefit from the implementation services on their own, the entity considers whether the customer can benefit from the services together with other readily available resources. Readily available resources include the other promised products or services from the contract if they are sold separately by the entity or if they are transferred to the customer before the implementation services. An entity disregards any contractual limitations that prevent the customer from obtaining readily available resources from a party other than the entity when making this assessment. That is, contractually restricting a customer from using another vendor to perform the installation services would not preclude an entity from determining that the implementation services are capable of being distinct.

In assessing whether the implementation services are distinct within the context of the contract, an entity needs to consider whether: the implementation services modify or customise the other promised products or services; the entity is providing a significant service of integrating the promised products or services with the implementation services into one combined output; or the entity would be able to fulfil its promise to transfer the other promised products or services in the contract independently from its promise to provide the implementation services (i.e. whether the implementation services are highly interdependent or interrelated with the other products or services). This evaluation may require judgement and is based on the facts and circumstances of the entity’s contracts.

The following example depict implementation services that are distinct and are not distinct, respectively:

3.2.2.A The series requirement: Consecutive transfer of goods or services

In March 2015, the TRG members discussed whether the goods or services must be consecutively transferred to be considered under the series requirement. The TRG members generally agreed that a series of distinct goods or services need not be consecutively transferred. That is, the series requirement must be applied even when there is a gap or an overlap in an entity’s transfer of goods or services, provided that the other criteria are met.²⁸ The IASB TRG members also noted that entities may need to carefully consider whether the series requirement applies, depending on the length of the gap between an entity’s transfer of goods or services.

Stakeholders had asked this question because the Basis for Conclusions uses the term ‘consecutively’ when it discusses the series requirement. [IFRS 15.BC113, BC116]. However, the TRG agenda paper concluded that the Board’s discussion was not meant to imply that the series requirement only applies to circumstances in which the entity provides the same good or service consecutively over a period of time.

Consider the following example from the TRG agenda paper:²⁹

3.2.2.B The series requirement versus treating the distinct goods or services as separate performance obligations

At the March 2015 TRG meeting, the TRG members were asked whether, in order to apply the series requirement, the accounting result needs to be the same as if the underlying distinct goods or services were accounted for as separate performance obligations.

The TRG members generally agreed that the accounting result does not need to be the same. Furthermore, an entity is not required to prove that the result would be the same as if the goods or services were accounted for as separate performance obligations.³⁰

Consider the following example from the TRG agenda paper to illustrate this point:³¹

3.2.2.C Assessing whether a performance obligation consists of distinct goods or services that are ‘substantially the same’

At the July 2015 TRG meeting, the TRG members were asked to consider how an entity would assess whether a performance obligation consists of distinct goods or services that are ‘substantially the same’ in order to apply the series requirement.³²

As discussed above, the TRG members generally agreed that the TRG paper, which primarily focused on the application of the series requirement to service contracts, will help entities understand how to determine whether a performance obligation consists of distinct goods or services that are ‘substantially the same’ under IFRS 15.

The TRG agenda paper noted that, when making the evaluation of whether goods or services are distinct and substantially the same, an entity first needs to determine the nature of the entity’s promise in providing services to the customer. That is, if the nature of the promise is to deliver a specified quantity of service (e.g. monthly payroll services over a defined contract period), the evaluation should consider whether each service is distinct and substantially the same. In contrast, if the nature of the entity’s promise is to stand ready or provide a single service for a period of time (i.e. because there is an unspecified quantity to be delivered), the evaluation would consider whether each time increment (e.g. hour, day), rather than the underlying activities, is distinct and substantially the same. The TRG agenda paper noted that the Board intended that a series could consist of either specified quantities of the underlying good or service delivered (e.g. each unit of a good) or distinct time increments (e.g. an hourly service), depending on the nature of the promise.

As discussed at 3.2.2 above, it is important to highlight that the underlying activities an entity performs to satisfy a performance obligation could vary significantly throughout a day and from day to day. However, the TRG agenda paper noted that this is not determinative in the assessment of whether a performance obligation consists of goods or services that are distinct and substantially the same. Consider an example where the nature of the promise is to provide a daily hotel management service. The hotel management service comprises various activities that may vary each day (e.g. cleaning services, reservation services, property maintenance). However, the entity determines that the daily hotel management services are substantially the same because the nature of the entity’s promise is the same each day and the entity is providing the same overall management service each day.

The TRG agenda paper included several examples of promised goods or services that may meet the series requirement and the analysis that supports that conclusion. The evaluation of the nature of the promise for each example is consistent with Example 13 of IFRS 15, [IFRS 15.IE67-IE68], on monthly payroll processing. Below we have summarised some of the examples and analysis in the TRG agenda paper.

The following is another example of promised goods and services that may meet the series requirement and the analysis that supports that conclusion:

3.2.2.D When to apply the series requirement

As discussed above, if a series of distinct goods or services meets the criteria in paragraphs 22(b) and 23 of IFRS 15, an entity is required to treat that series as a single performance obligation (i.e. it is not an optional requirement). [IFRS 15.22(b), 23].

3.2.2.E Do all stand-ready obligations meet the criteria to be accounted for as a series?

We generally believe that stand-ready obligations will meet the criteria and, therefore, need to be accounted for as a series of distinct goods or services. As discussed at 3.1.1.B and 3.1.1.C above, entities may need to apply judgement to determine whether the nature of a promise to a customer is the service of standing ready to provide goods or services (i.e. a stand-ready obligation) or the delivery of the underlying goods or services (i.e. not a stand-ready obligation).

3.4.2.A Principal indicators

After considering the application guidance discussed above, it still may not be clear whether an entity controls the specified good or service. Therefore, the standard provides three indicators of when an entity controls the specified good or service (and is, therefore, a principal):

‘Indicators that an entity controls the specified good or service before it is transferred to the customer (and is therefore a principal (see paragraph B35)) include, but are not limited to, the following:

1. the entity is primarily responsible for fulfilling the promise to provide the specified good or service. This typically includes responsibility for the acceptability of the specified good or service (for example, primary responsibility for the good or service meeting customer specifications). If the entity is primarily responsible for fulfilling the promise to provide the specified good or service, this may indicate that the other party involved in providing the specified good or service is acting on the entity’s behalf.
2. the entity has inventory risk before the specified good or service has been transferred to a customer or after transfer of control to the customer (for example, if the customer has a right of return). For example, if the entity obtains, or commits itself to obtain, the specified good or service before obtaining a contract with a customer, that may indicate that the entity has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the good or service before it is transferred to the customer.
3. the entity has discretion in establishing the price for the specified good or service. Establishing the price that the customer pays for the specified good or service may indicate that the entity has the ability to direct the use of that good or service and obtain substantially all of the remaining benefits. However, an agent can have discretion in establishing prices in some cases. For example, an agent may have some flexibility in setting prices in order to generate additional revenue from its service of arranging for goods or services to be provided by other parties to customers.’ [IFRS 15.B37].

The principal indicators above are meant to support an entity’s assessment of control, not to replace it. Each indicator explains how it supports the assessment of control. As emphasised in the Basis for Conclusions, the indicators do not override the assessment of control, should not be viewed in isolation and do not constitute a separate or additional evaluation. Furthermore, they should not be considered a checklist of criteria to be met or factors to be considered in all scenarios. Paragraph B37A of IFRS 15 notes that considering one or more of the indicators will often be helpful and, depending on the facts and circumstances, individual indicators will be more or less relevant or persuasive to the assessment of control. [IFRS 15.B37A, BC385H]. If an entity reaches different conclusions about whether it controls the specified good or service by applying the standard’s definition of control versus the principal indicators, the entity should re-evaluate its assessment, considering the facts and circumstances of its contract. This is because an entity’s conclusions about control and the principal indicators should align.

The first indicator that an entity is a principal, in paragraph B37(a) of IFRS 15, is that the entity is primarily responsible for fulfilling the promise to provide the specified good or service to the customer, which typically includes responsibility for the acceptability of the specified good or service. We believe that one of the reasons that this indicator supports the assessment of control of the specified good or service is because an entity generally controls a specified good or service that it is responsible for transferring control to a customer.

The terms of the contract and representations (written or otherwise) made by an entity during marketing generally provide evidence of which party is responsible for fulfilling the promise to provide the specified good or service and for the acceptability of that good or service.

It is possible that one entity may not be solely responsible for both providing the specified good or service and for the acceptability of that same good or service. For example, a reseller may sell goods or services that are provided to the customer by a supplier. However, if the customer is dissatisfied with the goods or services it receives, the reseller may be solely responsible for providing a remedy to the customer. The reseller may promote such a role during the marketing process or may agree to such a role as claims arise in order to maintain its relationship with its customer. In this situation, both the reseller and the supplier possess characteristics of this indicator. Therefore, it is likely that other indicators will need to be considered to determine which entity is the principal. However, if the reseller is responsible for providing a remedy to a dissatisfied customer, but can then pursue a claim against the supplier to recoup any remedies it provides, that may indicate that the reseller is not ultimately responsible for the acceptability of the specified good or service.

The second indicator that an entity is a principal, in paragraph B37(b) of IFRS 15, is that the entity has inventory risk (before the specified good or service is transferred to the customer or upon customer return). Inventory risk is the risk normally taken by an entity that acquires inventory in the hope of reselling it at a profit. Inventory risk exists if a reseller obtains (or commits to obtain) the specified good or service before it is ordered by a customer. Inventory risk also exists if a customer has a right of return and the reseller will take back the specified good or service if the customer exercises that right.

This indicator supports the assessment of control of the specified good or service because when an entity obtains (or commits to obtain) the specified good or service before it has contracted with a customer, it is likely that the entity has the ability to direct the use of and obtain substantially all of the remaining benefits from the good or service. For example, inventory risk can exist in a customer arrangement involving the provision of services if an entity is obliged to compensate the individual service provider(s) for work performed, regardless of whether the customer accepts that work. However, this indicator often does not apply to intangible goods or services.

Factors may exist that mitigate a reseller’s inventory risk. For example, a reseller’s inventory risk may be significantly reduced or eliminated if it has the right to return to the supplier goods it cannot sell or goods that are returned by customers. Another example is if a reseller receives inventory price protection from the supplier. In these cases, the inventory risk indicator may be less relevant or persuasive to the assessment of control.

The third principal indicator, in paragraph B37(c) of IFRS 15, is that the entity has discretion in establishing the price of the specified good or service. Reasonable latitude, within economic constraints, to establish the price with a customer for the product or service may indicate that the entity has the ability to direct the use of that good or service and obtain substantially all of the remaining benefits (i.e. the entity controls the specified good or service). However, because an agent may also have discretion in establishing the price of the specified good or service, the facts and circumstances of the transaction need to be carefully evaluated.

The example below, which is similar to Example 45 in the standard, shows how an entity might conclude that it is an agent:

In contrast, consider the following example of an entity that concludes it is acting as a principal:

3.4.5.A Considerations when there is only momentary transfer of legal title and absence of physical possession

An entity’s determination of whether it is a principal or an agent in a transaction for a specified good for which it only takes title momentarily or never has physical possession requires significant judgement and careful consideration of the facts and circumstances.

Entities may enter into contracts with third-party vendors (the vendors) to provide goods or services to be sold through their sales channels to their customers. In these arrangements, the entity may take legal title to the good only momentarily before the good is transferred to the customer, such as in scan-based trading or ‘flash title’ contracts (e.g. vendor is responsible for stocking, rotating and otherwise managing the product until the final point of sale). Alternatively, the entity may never take physical possession or legal title to the good (e.g. ‘drop shipment arrangements’ when goods are shipped directly from a vendor to the customer). In these situations, the entity needs to carefully evaluate whether it obtains control of the specified good and, therefore, is the principal in the transaction with the end-consumer. When evaluating the control principle and the principal indicators provided in the standard, we believe some questions an entity may consider when making this judgement could include:

• Does the entity take title to the goods at any point in the order-to-delivery process? If not, why?
• Is the vendor the party that the customer will hold responsible for the acceptability of the product (e.g. handling of complaints and returns)? If so, why?
• Does the entity have a return-to-vendor agreement with the vendor or have a history of returning goods to the vendor after a customer returns the good(s)? If so, why?
• Does the vendor have discretion in establishing the price for the goods (e.g. setting the floor or ceiling)? If so, why?
• Is the vendor responsible for the risk of loss or damage (e.g. shrinkage) while the goods are in the entity’s store? If so, why?
• Does the vendor have the contractual right to take back the goods delivered to the entity and, if so, has the vendor exercised that right in situations other than when the goods were at the end of their useful lives?
• Can the entity move goods between their stores or relocate goods within their stores without first obtaining permission from the vendor? If not, why?
• Does the entity have any further obligation to the customer after remitting the customer’s order to the vendor? If not, why?
• Once a customer order is placed, can the entity direct the product to another entity or prevent the product from being transferred to the customer? If not, why?

An SEC staff member said in a speech that the application of the principal-versus-agent application guidance can be especially challenging when an entity never obtains physical possession of a good. While noting that the staff has seen these types of fact patterns with conclusions of both principal and agent, the staff member further discussed certain facts and circumstances of a registrant consultation with OCA in which the SEC staff did not object to a principal determination in a transaction in which certain specialised goods were shipped directly to the end-customer by the vendor (not the registrant). In reaching this conclusion, the SEC staff member reiterated that the determination requires consideration of the definition of control in the standard, which often includes consideration of the indicators in paragraph B37 of IFRS 15. However, inventory risk is only one of those indicators and it is possible that physical possession will not coincide with control of a specified good.³⁸

Understanding the business purpose and rationale for the contractual terms between the vendor and the entity may help the entity assess whether it controls the specified goods prior to the transfer to the end-consumer and is, therefore, the principal in the sale to the end-consumer.

3.4.5.B Presentation of amounts billed to customers (e.g. shipping and handling, expenses or cost reimbursements and taxes or other assessments)

In July 2014, the TRG members were asked to consider how an entity would determine the presentation of amounts billed to customers (e.g. shipping and handling, reimbursement of out-of-pocket expenses and taxes) under the standard (i.e. as revenue or as a reduction of costs).³⁹

The TRG members generally agreed that the standard is clear that any amounts not collected on behalf of third parties would be included in the transaction price (i.e. revenue). As discussed in Chapter 29 at 2, paragraph 47 of IFRS 15 says that ‘the 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 (for example, some sales taxes)’. Therefore, if the amounts were earned by the entity in fulfilling its performance obligations, the amounts are included in the transaction price and recorded as revenue.

Shipping and handling

The appropriate presentation of amounts billed to customers for shipping and handling activities would depend on whether they entity is a principal or an agent in the shipping arrangement (see Chapter 32 at 2.3.1 for further discussion on presentation of shipping and handling costs incurred by the entity).

Expense or cost reimbursements

Many service providers routinely incur incidental expenses, commonly referred to as ‘out-of-pocket’ expenses, in the course of conducting their normal operations. Those expenses often include, but are not limited to, airfare, other travel-related costs (such as car rentals and hotel accommodation) and telecommunications charges. The entity (i.e. the service provider) and the customer may agree that the customer will reimburse the entity for the actual amount of such expenses incurred. Alternatively, the parties may negotiate a single fixed fee that is intended to compensate the service provider for both professional services rendered and out-of-pocket expenses incurred.

Out-of-pocket expenses are often costs incurred by an entity in fulfilling its performance obligation(s) (i.e. the out-of-pocket expenses are fulfilment costs) and do not transfer a good or service to the customer. In these situations, reimbursement for such costs generally should be included in the entity’s estimate of the transaction price and recognised as revenue when (or as) the performance obligation(s) is (are) satisfied, even if the entity is reimbursed at ‘cost’ (i.e. at zero margin. Alternatively, if an entity concludes that the costs do transfer a good or service to the customer, it should consider the principal-versus-agent application guidance when determining whether reimbursement amounts received from its customer need to be recorded on a gross or net basis.

In some cases, it may be appropriate to include the reimbursement in the transaction price and recognise that amount as revenue when the applicable expense is incurred. That is, an entity may not have to estimate out-of-pocket expenses in its determination of the transaction price at contract inception. This was discussed in a US Private Company Council meeting under US GAAP. The FASB staff observed in the related staff paper the following situations in which this would be the case:⁴⁰

• The entity is an agent as it relates to the specified good or service identified (see 3.4 above). That is, in cases in which the entity is an agent and the reimbursement is equal to the cost, the net effect on revenue would be zero and, therefore, no estimation would be required.
• The variable consideration is constrained (see Chapter 29 at 2.2.3). That is, if a portion of the transaction price related to reimbursements of out-of-pocket expenses is constrained, an entity would not include an estimate in the transaction price for that amount until it becomes highly probable that a significant revenue reversal will not occur, which may be when the underlying out-of-pocket expenses are incurred in some cases. For example, an entity may not be able to make reliable estimates of expenses and the related reimbursements that will not be subject to a significant revenue reversal due to a lack of historical evidence.
• The variable consideration relates specifically to a performance obligation or a distinct good or service in a series and the entity meets the variable consideration exception (see Chapter 29 at 3.3).
• The entity qualifies to apply the ‘right to invoice’ practical expedient (see Chapter 30 at 3.1.1).
• The entity applies a ‘costs incurred’ measure of progress when recognising revenue for over-time performance obligations (see Chapter 30 at 3). That is, if an entity selects a ‘costs incurred’ method, the timing of the costs being incurred and the revenue recognition associated with those costs would align.

Taxes or other assessments

Several TRG members noted that this would require entities to evaluate taxes collected in all jurisdictions in which they operate to determine whether a tax is levied on the entity or the customer. TRG members generally agreed that an entity would apply the principal versus agent application guidance when it is not clear whether the amounts are collected on behalf of third parties. This could result in amounts billed to a customer being recorded as an offset to costs incurred (i.e. on a net basis).

The issue of how an entity allocates the transaction price in a contract with multiple performance obligations in which the entity acts as both a principal and an agent is discussed in Chapter 29 at 3.2.1.

3.6.1.A Which transactions to consider when assessing customer options for additional goods or services

At their October 2014 meeting, the TRG members discussed whether entities should consider only the current transaction or also past and future transactions with the same customer when determining whether an option for additional goods or services provides the customer with a material right.

The TRG members generally agreed that entities should consider all relevant transactions with a customer (i.e. current, past and future transactions), including those that provide accumulating incentives, such as loyalty programmes, when determining whether an option represents a material right. That is, the evaluation is not solely performed in relation to the current transaction.⁴¹

3.6.1.B Nature of evaluation of customer options: quantitative versus qualitative

In October 2014, the TRG members considered whether the material right evaluation is solely a quantitative evaluation or whether it should also consider qualitative factors.

The TRG members generally agreed that the evaluation should consider both quantitative and qualitative factors that would be known to the entity (e.g. what a new customer would pay for the same service, the availability and pricing of competitors’ service alternatives, whether the average customer life indicates that the fee provides an incentive for customers to remain beyond the stated contract term, whether the right accumulates). This is because a customer’s perspective on what constitutes a ‘material right’ may consider qualitative factors. This is consistent with the notion that when identifying promised goods or services in Step 2, an entity considers reasonable expectations of the customer that the entity will transfer a good or service to it.⁴²

3.6.1.C Distinguishing between a customer option and variable consideration

In November 2015, the TRG members were asked to consider how an entity would distinguish between a contract that contains an option to purchase additional goods or services and a contract that includes variable consideration (see Chapter 29 at 2.2) based on a variable quantity (e.g. a usage-based fee).⁴³

Entities have found it challenging to distinguish between a contract that includes customer options to purchase additional goods or services and one that includes variable consideration based on a variable quantity (e.g. a usage-based fee). This is because, under both types of contracts, the ultimate quantity of goods or services to be transferred to the customer is often unknown at contact inception. The TRG members generally agreed that this determination requires judgement and consideration of the facts and circumstances. They also generally agreed that the TRG agenda paper on this question provides a framework that helps entities to make this determination.

This determination is important because it affects the accounting for the contract at inception and throughout the life of the contract, as well as disclosures. If an entity concludes that a customer option for additional goods or services provides a material right, the option itself is deemed to be a performance obligation in the contract, but the underlying goods or services are not accounted for until the option is exercised (as discussed at 3.6.1.D below). As a result, the entity is required to allocate a portion of the transaction price to the material right at contract inception and to recognise that revenue when or as the option is exercised or the option expires. If an entity, instead, concludes that an option for additional goods or services is not a material right, there is no accounting for the option and no accounting for the underlying optional goods or services until those subsequent purchases occur.

However, if the contract includes variable consideration (rather than a customer option), an entity has to estimate at contract inception the variable consideration expected over the life of the contract and update that estimate each reporting period (subject to the constraint on variable consideration) (see Chapter 29 at 2.2). There are also more disclosures required for variable consideration (e.g. the requirement to disclose the remaining transaction price for unsatisfied performance obligations) (see Chapter 32 at 3.2.1.C) than for options that are not determined to be material rights.

The TRG agenda paper explained that the first step (in determining whether a contract involving variable quantities of goods or services should be accounted for as a contract containing customer options or variable consideration) is for the entity to determine the nature of its promise in providing goods or services to the customer and the rights and obligations of each party.

In a contract in which the variable quantity of goods or services results in variable consideration, the nature of the entity’s promise is to transfer to the customer an overall service. In providing this overall service, an entity may perform individual tasks or activities. At contract inception, the entity is presently obliged by the terms and conditions of the contract to transfer all promised goods or services provided under the contract and the customer is obliged to pay for those promised goods or services. This is because the customer entered into a contract that obliges the entity to transfer those goods or services. The customer’s subsequent actions to utilise the service affect the measurement of revenue (in the form of variable consideration), but do not oblige the entity to provide additional distinct goods or services beyond those promised in the contract.

For example, consider a contract between a transaction processor and a customer in which the processor will process all of the customer’s transactions in exchange for a fee paid for each transaction processed. The ultimate quantity of transactions that will be processed is not known. The nature of the entity’s promise is to provide the customer with continuous access to the processing platform so that submitted transactions are processed. By entering into the contract, the customer has made a purchasing decision that obliges the entity to provide continuous access to the transaction processing platform. The consideration paid by the customer results from events (i.e. additional transactions being submitted for processing to the processor) that occur after (or as) the entity transfers the payment processing service. The customer’s actions do not oblige the processor to provide additional distinct goods or services because the processor is already obliged (starting at contract inception) to process all transactions submitted to it.

Another example described in the TRG agenda paper of contracts that may include variable consideration was related to certain IT outsourcing contracts. Under this type of contract (similar to the transaction processing contract, discussed above), the entity provides continuous delivery of a service over the contract term and the amount of service provided is variable.

In contrast, when an entity provides a customer option, the nature of its promise is to provide the quantity of goods or services specified in the contract, if any, and a right for the customer to choose the amount of additional distinct goods or services the customer will purchase. That is, the entity is not obliged to provide any additional distinct goods or services until the customer exercises the option. The customer has a contractual right that allows it to choose the amount of additional distinct goods or services to purchase, but the customer has to make a separate purchasing decision to obtain those additional distinct goods or services. Prior to the customer’s exercise of that right, the entity is not obliged to provide (nor does it have a right to consideration for transferring) those goods or services.

Since an option that is a marketing offer is considered a new contract if it is exercised, the IASB staff noted in the TRG agenda paper that an analogy to the contract modification requirements in paragraphs 20-21 of IFRS 15 (see 2.4 above) could be helpful when an entity is distinguishing between optional purchases and variable consideration. For a modification to be considered a separate contract, one of the criteria is that the modification results in the addition of promised goods or services that are distinct. Similarly, the IASB staff noted that the exercise of a customer option would typically result in the addition of promised goods or services that are distinct.

The TRG agenda paper included the following example of a contract that includes a customer option (rather than variable consideration).

Contrast the above example with another contract that includes a customer option that is determined to be a material right:

The TRG agenda paper also included the following example of a contract in which the variable quantity of goods or services includes a customer option.

The TRG agenda paper also included the following example of a contract in which the variable quantity of goods or services results in variable consideration.

3.6.1.D When, if ever, to consider the goods or services underlying a customer option as a separate performance obligation when there are no contractual penalties

At their November 2015 meeting, TRG members generally agreed that an entity does not need to identify the additional goods or services underlying the option as promised goods or services (or performance obligations) if there are no contractual penalties (e.g. termination fees, monetary penalties for not meeting contractual minimums), even if it believes that it is virtually certain that a customer will exercise its option for additional goods or services. Only the option is assessed to determine whether it represents a material right (and accounted for as a performance obligation). As a result, any consideration that would be received in return for optional goods or services is not included in the transaction price at contract inception.⁴⁶

The TRG agenda paper included the following example of a contract in which it is virtually certain that a customer will exercise its option for additional goods or services:

However, contractual minimums may represent fixed consideration in a contract, even if the contract also contains optional purchases. For example, an MSA may set minimum purchase quantities that the entity is obliged to provide, but any quantities above the minimum may require the customer to make a separate purchasing decision (i.e. exercise a customer option). If contractual penalties exist (e.g. termination fees, monetary penalties assessed for not meeting contractual minimums), it may be appropriate to include some or all of the goods or services underlying customer options as part of the contract at inception. This is because the penalty effectively creates a minimum purchase obligation for the goods or services that would be purchased if the penalty were enforced.

3.6.1.E Volume rebates and/or discounts on goods or services: customer options versus variable consideration

Should volume rebates and/or discounts on goods or services be accounted for as variable consideration or as customer options to acquire additional goods or services at a discount? It depends on whether rebate or discount programme is applied retrospectively or prospectively.

Generally, if a volume rebate or discount is applied prospectively, we believe the rebate or discount would be accounted for as a customer option (not variable consideration). This is because the consideration for the goods or services in the present contract is not contingent upon or affected by any future purchases. Rather, the discounts available from the rebate programme affect the price of future purchases. Entities need to evaluate whether the volume rebate or discount provides the customer with an option to purchase goods or services in the future at a discount that represents a material right (and is, therefore, accounted for as a performance obligation) (see 3.6.1.F below).

However, we believe a volume rebate or discount that is applied retrospectively is accounted for as variable consideration (see Chapter 29 at 2.2). This is because the final price of each good or service sold depends upon the customer’s total purchases that are subject to the rebate programme. That is, the consideration is contingent upon the occurrence or non-occurrence of future events. This view is consistent with Example 24 in the standard (which is included as Example 29.1 in Chapter 29 at 2.2.1).

Entities should keep in mind that they need to evaluate whether contract terms, other than those specific to the rebate or discount programme, create variable consideration that needs to be separately evaluated (e.g. if the goods subject to the rebate programme are also sold with a right of return).

3.6.1.F Considering the class of customer when evaluating whether a customer option is a material right

At its meeting in April 2016, the FASB TRG discussed the issue how an entity should consider the class of customer when evaluating whether a customer option is a material right. FASB TRG members generally agreed that an entity should consider ‘class of customer’ when determining whether a customer option to acquire additional goods or services represents a material right. In addition, in making this evaluation, they agreed that an entity first determines whether the customer option exists independently of the existing contract. That is, would the entity offer the same pricing to a similar customer independent of a prior contract with the entity? If the pricing is independent, the option is considered a marketing offer and there is no material right. FASB TRG members also generally agreed that it is likely that the determination will require an entity to exercise significant judgement and consider all facts and circumstances.

As discussed above, paragraph B40 of IFRS 15 states that when an entity grants a customer the option to acquire additional goods or services, that option is a separate performance obligation if it provides a material right that the customer would not receive without entering into the contract (e.g. a discount that exceeds the range of discounts typically given for those goods or services to that class of customer in that region or market). [IFRS 15.B40]. Furthermore, paragraph B41 of IFRS 15 states that an option to purchase additional goods or services at their stand-alone selling prices does not provide a material right and instead is a marketing offer. [IFRS 15.B41]. The FASB staff noted in the TRG agenda paper that these requirements are intended to make clear that a customer option to acquire additional goods or services would not give rise to a material right if a customer could execute a separate contract to obtain the goods or services at the same price. That is, customer options that would exist independently of an existing contract with a customer do not constitute performance obligations in that existing contract.

The TRG agenda paper provided several examples of the FASB staff’s views on this topic, including the following:

3.6.1.G Considering whether prospective volume discounts determined to be customer options are material rights

At the April 2016 FASB TRG meeting, the FASB TRG members were asked to consider how an entity should consider whether prospective volume discounts determined to be customer options are material rights.⁴⁹

The FASB TRG members generally agreed that in making this evaluation, similar to the discussion in 3.6.1.F above, an entity would first evaluate whether the option exists independently of the existing contract. That is, would the entity offer the same pricing to a similar high-volume customer independent of a prior contract with the entity? If yes, it indicates that the volume discount is not a material right, as it is not incremental to the discount typically offered to a similar high-volume customer. If the entity typically charges a higher price to a similar customer, it may indicate that the volume discount is a material right as the discount is incremental.

The TRG agenda paper included the following example:

Volume discounts or tiered pricing can make an entity’s assessment of whether a customer option to purchase additional goods or services is a material right more complex. It is likely that this assessment will require significant judgement, as illustrated below:

3.6.1.H Considering whether a renewal option is a material right

An entity assesses whether a renewal option represents a material right in the same manner as other customer options discussed above. That is, an entity would determine whether the customer renewal option would be offered at the same price to a similar class of customer, independent of a prior contract with the entity. Customer renewal options may be explicitly included in the original contract or, as discussed in Chapter 29 at 2.8, the existence of a non-refundable upfront fee may indicate that the contract includes a renewal option for future goods or services (e.g. if the customer renews the contract without the payment of an additional upfront fee).

As discussed above at 3.6, paragraph B41 of IFRS 15 specifies that if a customer has the option to purchase additional goods or services (e.g. by exercising a renewal option) at a price that would reflect the stand-alone selling prices of those goods or services, the renewal option would not provide a material right and, instead, is a marketing offer. [IFRS 15.B41]. Determining the stand-alone selling price of a renewal option may require significant judgement. For example, a renewal option offered at the current stand-alone selling price may or may not be determined to be a material right. That is, if the pricing for the goods and service are expected to remain stable, it would be appropriate for a renewal option offered at a current stand-alone selling price to be considered a marketing offer. In contrast, a renewal option at the current stand-alone selling price could be a material right if, for example, prices are highly likely to significantly increase or the renewal option is offered for an extended period of time.

The following example from the standard describes the accounting for a renewal option that is a material right. This example also includes guidance on how to allocate a portion of the transaction price to the material right, which is further discussed in Chapter 29 at 3.1.5. [IFRS 15.IE257-IE266].

3.6.1.I Considering whether a loyalty or reward programme is a material right

Entities frequently offer loyalty or reward programmes under which customers accumulate points that they can redeem for ‘free’ or discounted products or services. Under paragraph B40 of IFRS 15, an entity typically concludes that such a loyalty or reward programme provides a material right to customers that they would not receive without entering into a contract. This is because the customer effectively pays in advance for the right to obtain a future good or service (e.g. travel, upgrades, products) or a discount on that good or service.

This is also consistent with the discussion of the TRG members, as noted at 3.6.1.A and 3.6.1.B above, that entities should consider all relevant transactions with a customer (i.e. current, past and future transactions) and both quantitative and qualitative factors, including those that provide accumulating incentives, when determining whether an option represents a material right. Example 52 in the standard (included as Example 30.17 in Chapter 30 at 11) illustrates the accounting for a loyalty programme.

3.6.1.J Accounting for the exercise of a material right

At the March 2015 TRG meeting, the TRG members were asked to consider how an entity would account for the exercise of an option for additional goods or services that provides the customer with a material right (a material right).⁵⁰

The TRG members generally agreed that it is reasonable for an entity to account for the exercise of a material right as either a contract modification or as a continuation of the existing contract (i.e. a change in the transaction price). TRG members also generally agreed that it is not appropriate to account for the exercise of a material right as variable consideration.

Under the approach that treats the exercise of a material right as a continuation of the existing contract (i.e. because the customer decided to purchase additional goods or services contemplated in the original contract), an entity would update the transaction price of the contract to include any consideration to which the entity expects to be entitled as a result of the exercise, in accordance with the requirements for changes in the transaction price included in paragraphs 87-90 of IFRS 15 (see Chapter 29 at 3.5).

Under these requirements, changes in the total transaction price are generally allocated to the separate performance obligations on the same basis as the initial allocation. However, paragraph 89 of IFRS 15 requires an entity to allocate a change in the transaction price entirely to one or more, but not all, performance obligations if the criteria in paragraph 85 of IFRS 15 are met. [IFRS 15.89]. These criteria (discussed further in Chapter 29 at 3.3) are that the additional consideration specifically relates to the entity’s efforts to satisfy the performance obligation(s) and that allocating the additional consideration entirely to one or more, but not all, performance obligation(s) is consistent with the standard’s allocation objective (see Chapter 29 at 3). The additional consideration received for the exercise of the option is likely to meet the criteria to be allocated directly to the performance obligation(s) underlying the material right. Revenue would be recognised when (or as) the performance obligation(s) is (are) satisfied. [IFRS 15.85].

The TRG agenda paper included the following example.

Under the second approach, which treats the exercise of a material right as a contract modification (i.e. because there a change in the scope and/or price of a contract), an entity follows the contract modification requirements in paragraphs 18-21 of IFRS 15 (see 2.4 above).

Since more than one approach would be acceptable, the TRG members generally agreed that an entity needs to consider which approach is most appropriate, based on the facts and circumstances, and consistently apply that approach to similar contracts.⁵²

3.6.1.K Customer options that provide a material right: Evaluating whether there is a significant financing component

At their March 2015 TRG meeting, the TRG members discussed whether an entity is required to evaluate a customer option that provides a material right to determine if it includes a significant financing component and, if so, how entities would perform this evaluation.

The TRG members generally agreed that an entity has to evaluate whether a material right includes a significant financing component (see Chapter 29 at 2.5) in the same way that it evaluates any other performance obligation. This evaluation requires judgement and consideration of the facts and circumstances.⁵³

On this question, the TRG agenda paper discussed a factor that may be determinative in this evaluation. Paragraph 62(a) of IFRS 15 indicates that if a customer provides advance payment for a good or service, but the customer can choose when the good or service is transferred, no significant financing component exists. [IFRS 15.62(a)]. As a result, if the customer can choose when to exercise the option, it is unlikely that there will be a significant financing component.⁵⁴

3.6.1.L Customer options that provide a material right: recognising revenue when there is no expiration date

Stakeholders have asked this question because paragraph B40 of IFRS 15 states that an entity should recognise revenue allocated to options that are material rights when the future goods or services resulting from the option are transferred or when the option expires. [IFRS 15.B40]. However, in some cases, options may be perpetual and not have an expiration date. For example, loyalty points likely provide a material right to a customer and, sometimes, these points do not expire. We believe an entity may apply the requirements in IFRS 15 on customers’ unexercised rights (or breakage) discussed in Chapter 30 at 11 (i.e. paragraphs B44-B47 of IFRS 15). [IFRS 15.B44-B47]. That is, we believe it is appropriate for revenue allocated to a customer option that does not expire to be recognised at the earlier of when the future goods or services, resulting from the option, are transferred or, if the goods or services are not transferred, when the likelihood of the customer exercising the option becomes remote.